==============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission file number 1-6541
LOEWS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-2646102
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
667 Madison Avenue, New York, N.Y. 10021-8087
(Address of principal executive offices) (Zip code)
(212) 521-2000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------ ------
Class Outstanding at October 22, 2004
- ------------------------------------- -------------------------------
Common stock, $1.00 par value 185,499,300 shares
Carolina Group stock, $0.01 par value 57,966,750 shares
==============================================================================
1
INDEX
Page
Part I. Financial Information No.
-----
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
September 30, 2004 and December 31, 2003 3
Consolidated Condensed Statements of Operations
Three and nine months ended September 30, 2004 and 2003 4
Consolidated Condensed Statements of Cash Flows
Nine months ended September 30, 2004 and 2003 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 77
Item 3. Quantitative and Qualitative Disclosures about Market Risk 160
Item 4. Disclosure Controls and Procedures 163
Part II. Other Information
Item 1. Legal Proceedings 164
Item 6. Exhibits 167
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------
(In millions)
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
Assets:
Investments:
Fixed maturities, amortized cost of $30,906.2 and $27,664.9 $31,963.7 $28,781.3
Equity securities, cost of $440.1 and $593.1 551.0 888.2
Limited partnership investments 1,963.3 1,335.1
Other investments 36.0 245.6
Short-term investments 8,750.3 11,264.6
- ------------------------------------------------------------------------------------------------
Total investments 43,264.3 42,514.8
Cash 139.1 180.8
Receivables-net 18,892.6 20,467.9
Property, plant and equipment-net 3,763.1 3,879.7
Deferred income taxes 674.8 530.2
Goodwill 295.0 311.4
Other assets 2,547.9 3,785.4
Deferred acquisition costs of insurance subsidiaries 1,312.1 2,532.7
Separate account business 567.1 3,678.0
- ------------------------------------------------------------------------------------------------
Total assets $71,456.0 $77,880.9
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense $31,494.7 $31,730.2
Future policy benefits 5,743.3 8,160.9
Unearned premiums 4,381.1 4,891.5
Policyholders' funds 1,768.3 601.4
- ------------------------------------------------------------------------------------------------
Total insurance reserves 43,387.4 45,384.0
Payable for securities purchased 1,440.8 2,147.7
Securities sold under agreements to repurchase 115.8 441.8
Short-term debt 1,055.6 295.9
Long-term debt, less unamortized discount 4,776.6 5,524.3
Reinsurance balances payable 3,103.2 3,432.0
Other liabilities 3,911.4 4,251.3
Separate account business 567.1 3,678.0
- ------------------------------------------------------------------------------------------------
Total liabilities 58,357.9 65,155.0
Minority interest 1,646.6 1,671.6
Shareholders' equity 11,451.5 11,054.3
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $71,456.0 $77,880.9
================================================================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------
(In millions)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
Revenues:
Insurance premiums $ 1,946.0 $ 2,125.2 $ 6,218.3 $ 6,701.0
Investment income, net of expense 381.3 373.4 1,272.8 1,275.2
Investment gains (losses) (36.8) 179.5 (349.2) 503.2
Manufactured products (including excise
taxes of $167.9, $173.1, $493.6 and
$493.4) 918.0 880.1 2,625.5 2,578.4
Other 576.9 381.8 1,423.7 1,067.5
- -----------------------------------------------------------------------------------------------
Total 3,785.4 3,940.0 11,191.1 12,125.3
- -----------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits 1,596.4 4,341.7 4,859.3 8,319.6
Amortization of deferred acquisition costs 373.8 494.5 1,114.1 1,433.7
Cost of manufactured products sold 523.7 532.7 1,558.6 1,489.6
Other operating expenses 815.8 1,040.8 2,376.6 2,617.7
Interest 73.3 80.9 245.9 230.3
- -----------------------------------------------------------------------------------------------
Total 3,383.0 6,490.6 10,154.5 14,090.9
- -----------------------------------------------------------------------------------------------
402.4 (2,550.6) 1,036.6 (1,965.6)
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 120.8 (916.4) 289.4 (735.3)
Minority interest 4.0 (195.5) 18.7 (196.8)
- -----------------------------------------------------------------------------------------------
Total 124.8 (1,111.9) 308.1 (932.1)
- -----------------------------------------------------------------------------------------------
Income (loss) from continuing operations 277.6 (1,438.7) 728.5 (1,033.5)
Discontinued operations-net 55.8 55.4
- -----------------------------------------------------------------------------------------------
Net income (loss) $ 277.6 $(1,382.9) $ 728.5 $ (978.1)
===============================================================================================
Net income (loss) attributable to:
Loews common stock:
Income (loss) from continuing operations $ 224.2 $(1,465.5) $ 600.1 $(1,113.9)
Discontinued operations-net 55.8 55.4
- -----------------------------------------------------------------------------------------------
Loews common stock 224.2 (1,409.7) 600.1 (1,058.5)
Carolina Group stock 53.4 26.8 128.4 80.4
- ----------------------------------------------------------------------------------------------
Total $ 277.6 $(1,382.9) $ 728.5 $ (978.1)
==============================================================================================
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Continued)
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
Income (loss) per share of Loews common stock:
Income (loss) from continuing operations $ 1.21 $ (7.90) $ 3.24 $ (6.01)
Discontinued operations-net 0.30 0.30
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 1.21 $ (7.60) $ 3.24 $ (5.71)
================================================================================================
Net income per share of Carolina Group stock $ 0.92 $ 0.67 $ 2.21 $ 2.01
================================================================================================
Weighted average number of shares outstanding:
Loews common stock 185.49 185.45 185.48 185.45
Carolina Group stock 57.97 39.91 57.97 39.91
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------
(In millions)
Nine Months Ended
September 30,
-------------------------
2004 2003
-------------------------
Operating activities:
Net income (loss) $ 728.5 $ (978.1)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities-net 572.6 (84.5)
Gain on disposal of discontinued operation (56.7)
Changes in operating assets and liabilities-net:
Reinsurance receivable (845.0) (2,421.4)
Other receivables 345.7 (38.7)
Federal income taxes 620.2 (619.9)
Prepaid reinsurance premiums 330.9 (42.7)
Deferred acquisition costs 149.5 (127.5)
Insurance reserves and claims 597.5 5,880.4
Reinsurance balances payable (294.8) 522.6
Other liabilities (179.8) 4.6
Trading securities 157.6 132.2
Other-net 160.1 135.6
- -----------------------------------------------------------------------------------------------
2,343.0 2,305.9
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of fixed maturities (57,359.8) (56,469.5)
Proceeds from sales of fixed maturities 44,529.6 45,635.2
Proceeds from maturities of fixed maturities 7,552.7 10,336.3
Securities sold under agreements to repurchase (326.0) 328.2
Purchases of equity securities (401.3) (342.0)
Proceeds from sales of equity securities 548.3 430.9
Change in short-term investments 2,799.0 (1,166.9)
Purchases of property, plant and equipment (195.7) (370.3)
Proceeds from sales of property, plant and equipment 30.0 106.0
Sales of businesses 647.1
Change in other investments (21.1) 79.7
Purchase of Texas Gas (803.3)
- ------------------------------------------------------------------------------------------------
(2,197.2) (2,235.7)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to Loews shareholders (162.6) (137.5)
Dividends paid to minority interests (11.1) (22.6)
Purchases of treasury shares by subsidiary (18.1)
Issuance of Loews common stock 1.7 0.2
Principal payments on long-term debt (557.0) (547.3)
Issuance of long-term debt 546.9 706.4
Returns and deposits of policyholder account balances on
investment contracts 10.3 (18.7)
Other 2.4 (2.7)
- ------------------------------------------------------------------------------------------------
(187.5) (22.2)
- ------------------------------------------------------------------------------------------------
Net change in cash (41.7) 48.0
Cash, beginning of period 180.8 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 139.1 $ 233.4
================================================================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
6
Loews Corporation and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
1. Basis of Presentation
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property and casualty insurance (CNA Financial
Corporation ("CNA"), a 91% owned subsidiary); the production and sale of
cigarettes (Lorillard, Inc. ("Lorillard"), a wholly owned subsidiary); the
operation of hotels (Loews Hotels Holding Corporation ("Loews Hotels"), a
wholly owned subsidiary); the operation of offshore oil and gas drilling rigs
(Diamond Offshore Drilling, Inc. ("Diamond Offshore"), a 55% owned
subsidiary); the operation of an interstate natural gas transmission pipeline
system (Texas Gas Transmission, LLC ("Texas Gas"), a wholly owned subsidiary)
and the distribution and sale of watches and clocks (Bulova Corporation
("Bulova"), a 97% owned subsidiary). Unless the context otherwise requires,
the terms "Company," "Loews" and "Registrant" as used herein mean Loews
Corporation excluding its subsidiaries.
In the opinion of management, the accompanying Consolidated Condensed
Financial Statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as of
September 30, 2004 and December 31, 2003 and the statements of operations for
the three and nine months ended September 30, 2004 and 2003 and changes in
cash flows for the nine months ended September 30, 2004 and 2003.
Results of operations for the third quarter and the first nine months of
each of the years is not necessarily indicative of results of operations for
that entire year.
Reference is made to the Notes to Consolidated Financial Statements in the
2003 Annual Report to Shareholders on Form 10-K/A which should be read in
conjunction with these Consolidated Condensed Financial Statements.
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 2004.
In the second quarter of 2004, the expenses incurred related to
uncollectible reinsurance receivables were reclassified from "Other operating
expenses" to "Insurance claims and policyholders' benefits" on the
Consolidated Condensed Statements of Operations. Prior period amounts have
been reclassified to conform to the current year presentation. This
reclassification had no impact on net income (loss) in any period.
Accounting Changes - In January of 2003, the Financial Accounting Standards
Board ("FASB") issued Interpretation No. ("FIN") 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51." This
Interpretation clarifies the application of ARB No. 51, "Consolidated
Financial Statements," to certain entities in which equity investors do not
have the characteristics of a controlling financial interest. Prior to the
issuance of this Interpretation, ARB No. 51 defined a controlling financial
interest as ownership of a majority voting interest. FIN 46 requires an entity
to consolidate a variable interest entity even though the entity does not,
either directly or indirectly, own more than 50% of the outstanding voting
shares. FIN 46 defines a variable interest entity as having one or both of the
following characteristics: (1) the equity investment at risk is not sufficient
to permit the entity to finance its activities without additional subordinated
financial support from other parties or (2) the equity investors lack one or
7
more of the following: (a) the direct or indirect ability to make decisions
about the entity's activities through voting rights or similar rights, (b) the
obligation to absorb the expected losses of the entity, if they occur, which
makes it possible for the entity to finance its activities and (c) the right
to receive the expected residual returns of the entity, if they occur, which
is the compensation for the risk of absorbing the expected losses. On December
24, 2003, the FASB issued a complete replacement of FIN 46 ("FIN 46R"), which
clarified certain complexities of FIN 46. FIN 46R is applicable for financial
statements issued for reporting periods that end after March 15, 2004. The
adoption of FIN 46R did not have a significant impact on the results of
operations or equity of the Company.
In July of 2003, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("SOP") 03-01, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts." SOP 03-01 provides guidance on accounting and reporting by
insurance enterprises for certain nontraditional long-duration contracts and
for separate accounts. SOP 03-01 is effective for financial statements for
fiscal years beginning after December 15, 2003. SOP 03-01 may not be applied
retroactively to prior years' financial statements, and initial application
should be as of the beginning of an entity's fiscal year, therefore prior year
amounts have not been conformed to the current year presentation.
The Company adopted SOP 03-01 as of January 1, 2004. The assets and
liabilities of certain guaranteed investment contracts and indexed group
annuity contracts that were previously segregated and reported as separate
accounts no longer qualify for separate account presentation. Prior to the
adoption of SOP 03-01, the asset and liability presentation of these affected
contracts were categorized as separate account assets and liabilities in the
Consolidated Condensed Balance Sheets. The results of operations from separate
account business were primarily classified as other revenue in the
Consolidated Condensed Statements of Operations. In accordance with the
provisions of SOP 03-01, the classification and presentation of certain
balance sheet and income statement items have been modified within these
financial statements. Accordingly, the investment securities previously
classified as separate account assets have now been reclassified to the
general account and will be reported based on their investment classification
whether available-for-sale or trading securities. The investment portfolio for
the indexed group annuity contracts is classified as held for trading purposes
and is carried at fair value with both the net realized and unrealized gains
(losses) included within investment income, in the Consolidated Condensed
Statements of Operations.
The following table provides the balance sheet presentation of assets and
liabilities for certain guaranteed investment contracts and indexed group
annuity contracts upon adoption of SOP 03-01, including the classification of
the indexed group annuity contract investments as trading securities:
8
September 30, January 1,
2004 2004(a)
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments:
Fixed maturity securities, available-for-sale $ 894.0 $ 1,220.0
Fixed maturity securities, trading 317.0 304.0
Equity securities 4.0 4.0
Limited partnership investments 454.0 419.0
Short-term investments, available-for-sale 24.0 55.0
Short-term investments, trading 375.0 414.0
- ------------------------------------------------------------------------------------------------
Total investments 2,068.0 2,416.0
Accrued investment income 10.0 13.0
Receivables for securities sold 170.0 97.0
Other assets 1.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,248.0 $ 2,527.0
================================================================================================
Liabilities:
Insurance reserves:
Claim and claim adjustment expense $ 1.0
Future policy benefits $ 525.0 617.0
Policyholders' funds 1,210.0 1,324.0
Collateral on loaned securities and derivatives 17.0
Payables for securities purchased 160.0 43.0
Other liabilities 53.0 47.0
- ------------------------------------------------------------------------------------------------
Total liabilities $ 1,948.0 $ 2,049.0
================================================================================================
(a) Includes assets and liabilities of the individual life business sold on April 30, 2004. See
Note 10 for further information.
CNA continues to have contracts that meet the criteria for separate account
presentation. The assets and liabilities of these contracts are legally
segregated and reported as assets and liabilities of the separate account
business. Substantially all assets of the separate account business are
carried at fair value. Separate account liabilities are carried at contract
values.
In December of 2003, the FASB issued a revised version of SFAS No. 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits." The
revised version of SFAS No. 132 makes several significant changes to the
required disclosures for pension and other postretirement benefit plan assets,
obligations, and net cost in financial statements. SFAS No. 132 made no
changes to the methodologies underlying the measurement of obligations or
calculation of expense. In addition, SFAS No. 132 requires disclosure of
certain plan information on a quarterly basis in interim financial statements.
This quarterly report includes the disclosure of plan information required for
interim financial statements. See Note 12.
In May of 2004, the FASB issued FASB Staff Position ("FSP") 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." The FSP provides guidance on
the accounting for the effects of the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 for employers that provide prescription drug
9
benefits. FSP 106-2 supersedes FSP 106-1 "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003." Adoption of this position has not had a material
impact on the Company's results of operations or equity.
In March of 2004, the Emerging Issues Task Force ("EITF") reached consensus
on the guidance provided in EITF Issue No. 03-1, "The Meaning of Other-Than-
Temporary Impairment and its Application to Certain Investments" ("EITF 03-1")
as applicable to debt and equity securities that are within the scope of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
and equity securities that are accounted for using the cost method specified
in Accounting Principles Board Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock." An investment is impaired if the
fair value of the investment is less than its cost including adjustments for
amortization, accretion, foreign exchange, and hedging. EITF 03-1 outlines
that an impairment would be considered other-than-temporary unless (a) the
investor has the ability and intent to hold an investment for a reasonable
period of time sufficient for the recovery of the fair value up to (or beyond)
the cost of the investment and (b) evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs
evidence to the contrary. The investor should consider its cash or working
capital needs to assess its intent and ability to hold an investment for a
reasonable period of time for the recovery of fair value up to or beyond the
cost of the investment. Although not presumptive, a pattern of selling
investments prior to the forecasted recovery of fair value may call into
question the investor's intent. In addition, the severity and duration of the
impairment should also be considered in determining whether the impairment is
other-than-temporary.
This new guidance for determining whether impairment is other-than-temporary
was to be effective for reporting periods beginning after June 15, 2004. In
September of 2004, the FASB issued FSP EITF Issue 03-1-1, which delayed the
effective date for the measurement and recognition guidance included in EITF
Issue 03-1 related to other-than-temporary impairment until additional
implementation guidance is provided. As a result of the delay, during the
three month period ended September 30, 2004, the Company continued to apply
existing accounting literature for determining when a decline in fair value is
other-than-temporary.
The Company continues to evaluate the impact of this new accounting standard
on its process for determining other-than-temporary impairment of equity and
fixed maturity securities, including the potential impacts from any revisions
to the original guidance issued. Adoption of this standard as originally
issued may cause the Company to recognize impairment losses in the
Consolidated Condensed Statements of Operations which would not have been
recognized under the current guidance or to recognize such losses in earlier
periods, especially those due to increases in interest rates, and would likely
also impact the recognition of investment income on impaired securities. Such
an impact would likely increase earnings volatility in future periods.
However, since fluctuations in the fair value for available-for-sale
securities are already recorded in Accumulated Other Comprehensive Income,
adoption of this standard is not expected to have a significant impact on
shareholders' equity.
In April of 2004, the EITF reached consensus on the guidance provided in
EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under
SFAS No. 128 Earnings Per Share" ("EITF 03-6"). EITF 03-6 clarifies whether a
security should be considered a "participating security" for purposes of
computing earnings per share ("EPS") and how earnings should be allocated to a
10
"participating security" when using the two-class method for computing basic
EPS. The adoption of EITF 03-6 did not have a significant impact on the
Company.
Stock option plans - The Company has elected to follow APB No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock options and awards. Under APB No. 25, no
compensation expense is recognized when the exercise prices of options equal
the fair value (market price) of the underlying stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
Company to disclose pro forma information regarding option grants made to its
employees. SFAS No. 123 specifies certain valuation techniques that produce
estimated compensation charges for purposes of valuing stock option grants.
These amounts have not been included in the Company's Consolidated Condensed
Statements of Operations, in accordance with APB No. 25. Several of the
Company's subsidiaries also maintain their own stock option plans. The pro
forma effect of applying SFAS No. 123 includes the Company's share of expense
related to its subsidiaries' plans as well. The Company's pro forma net income
(loss) and the related basic and diluted income (loss) per Loews common and
Carolina Group shares would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions, except per share data)
Net income (loss):
Loews common stock:
Net income (loss) as reported $ 224.2 $(1,409.7) $ 600.1 $(1,058.5)
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (1.2) (1.4) (3.7) (3.9)
- ------------------------------------------------------------------------------------------------
Pro forma net income (loss) $ 223.0 $(1,411.1) $ 596.4 $(1,062.4)
================================================================================================
Carolina Group stock:
Net income as reported $ 53.4 $ 26.8 $ 128.4 $ 80.4
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (0.1) (0.1) (0.1)
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 53.4 $ 26.7 $ 128.3 $ 80.3
================================================================================================
Net income (loss) per share:
Loews common stock:
As reported $ 1.21 $ (7.60) $ 3.24 $ (5.71)
Pro forma 1.20 (7.61) 3.22 (5.73)
Carolina Group stock:
As reported 0.92 0.67 2.21 2.01
Pro forma 0.92 0.67 2.21 2.01
================================================================================================
Comprehensive Income - Comprehensive income includes all changes to
shareholders' equity, except those resulting from investments by shareholders
and distributions to shareholders. For the three and nine months ended
September 30, 2004 and 2003, comprehensive income (loss) totaled $824.3,
11
$(1,703.2), $558.6 and $(614.6) million, respectively. Comprehensive income
includes net income (loss), unrealized appreciation (depreciation) of
investments and foreign currency translation gains or losses.
2. Investments
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions)
Investment income consisted of:
Fixed maturity securities $ 399.8 $ 419.0 $ 1,204.0 $ 1,274.5
Short-term investments 17.8 20.3 48.4 74.8
Limited partnership investments 26.6 61.1 144.9 158.8
Equity securities 5.1 5.3 14.4 17.3
Interest expense on funds withheld and
other deposits (55.4) (147.6) (161.4) (287.8)
Other (6.0) 28.5 56.4 94.0
- ------------------------------------------------------------------------------------------------
Total investment income 387.9 386.6 1,306.7 1,331.6
Investment expenses (6.6) (13.2) (33.9) (56.4)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 381.3 $ 373.4 $ 1,272.8 $ 1,275.2
================================================================================================
Investment gains (losses) are as follows:
Trading securities:
Derivative instruments $ (1.6) $ 27.7 $ 9.6 $ 10.1
Equity securities, including short
positions 24.6 22.2 42.8 30.8
- ------------------------------------------------------------------------------------------------
23.0 49.9 52.4 40.9
Other than trading:
Fixed maturities 30.3 10.4 100.5 370.4
Equity securities 10.0 30.5 187.2 88.6
Short?term investments 0.1 (1.7) 1.1 1.9
Other (a) (100.2) 90.4 (690.4) 1.4
- ------------------------------------------------------------------------------------------------
Investment (losses) gains (36.8) 179.5 (349.2) 503.2
Income tax benefit (expense) 11.4 (64.4) 135.6 (174.4)
Minority interest 3.7 (8.6) 22.3 (28.2)
- ------------------------------------------------------------------------------------------------
Investment gains (losses)-net $ (21.7) $ 106.5 $ (191.3) $ 300.6
================================================================================================
(a) Includes a loss of $618.6 ($352.9 after tax and minority interest)
related to CNA's sale of its individual life insurance business for the nine
months ended September 30, 2004.
Realized investment losses were $21.7 million as compared to realized
investment gains of $106.5 million for the three months ended September 30,
2004 and 2003. The decline was primarily due to losses related to derivative
securities held to mitigate the effect of changes in long-term interest rates
on the value of the fixed maturity portfolio. While a decrease in long-term
interest rates during the third quarter of 2004 resulted in a realized loss
related to these derivatives, the fair value of CNA's fixed maturity portfolio
benefited from the interest rate movements resulting in an increase in the
Company's shareholders' equity.
12
Realized investment losses were $191.3 million for the nine months ended
September 30, 2004 as compared to realized investment gains of $300.6 million
for the nine months ended September 30, 2003. The decrease was primarily due
to a $618.6 million pretax loss on the sale of the individual life insurance
business, losses related to derivative securities and decreased realized gains
on the sale of fixed maturity securities. These decreases were partially
offset by a $162.0 million pretax gain on the disposition of CNA's equity
holdings of Canary Wharf Group PLC (Canary Wharf), a London-based real estate
company.
Realized investment gains for the three and nine months ended September 30,
2003 included $16.0 and $302.0 million of pretax impairment losses for other-
than-temporary declines in fair values for fixed maturity and equity
securities. These impairment losses were for securities across several market
sectors, including the airline, healthcare and energy industries. Impairment
losses were $19.0 million pretax for other-than-temporary declines in fair
value for fixed maturity and equity securities for the three and nine months
ended September 30, 2004.
3. Earnings Per Share
Companies with complex capital structures are required to present basic and
diluted earnings per share. Basic earnings per share excludes dilution and is
computed by dividing net income (loss) attributable to each class of common
stock by the weighted average number of common shares of each class of common
stock outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock. For the three and
nine months ended September 30, 2004 and 2003, income (loss) per common share
assuming dilution is the same as basic income (loss) per share because the
impact of securities that could potentially dilute basic income (loss) per
common share was insignificant or antidilutive for the periods presented.
Options to purchase 0.45, 0.88, 0.37 and 0.86 million shares of Loews common
stock were outstanding for the three and nine months ended September 30, 2004
and 2003, but were not included in the computation of diluted earnings per
share because the options' exercise prices were greater than the average
market price of the common shares and, therefore, the effect would be
antidilutive. Options to purchase 0.33, 0.18, 0.25 and 0.37 million shares of
Carolina Group stock were outstanding for the three and nine months ended
September 30, 2004 and 2003, but were not included in the computation of
diluted earnings per share because the options' exercise prices were greater
than the average market price of the common shares and, therefore, the effect
would be antidilutive.
13
The attribution of income (loss) to each class of common stock was as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions)
Loews common stock:
Consolidated net income (loss) $ 277.6 $(1,382.9) $ 728.5 $ (978.1)
Less income attributable to
Carolina Group stock 53.4 26.8 128.4 80.4
- ------------------------------------------------------------------------------------------------
Income (loss) attributable to Loews common
stock $ 224.2 $(1,409.7) $ 600.1 $ (1,058.5)
================================================================================================
Carolina Group stock:
Income available to Carolina Group stock $ 159.9 $ 116.4 $ 384.3 $ 349.2
Weighted average economic interest of
the Carolina Group stock 33.43% 23.01% 33.43% 23.01%
- ------------------------------------------------------------------------------------------------
Income attributable to Carolina Group stock $ 53.4 $ 26.8 $ 128.4 $ 80.4
================================================================================================
4. Loews and Carolina Group Consolidating Condensed Financial Information
The Company has a two class common stock structure which includes Loews
common stock and Carolina Group stock. Carolina Group stock is designed to
track the performance of the Carolina Group, which consists of: the Company's
ownership interest in Lorillard; notional, intergroup debt owed by the
Carolina Group to the Loews Group ($1.9 billion outstanding at September 30,
2004), bearing interest at the annual rate of 8.0% and, subject to optional
prepayment, due December 31, 2021; any and all liabilities, costs and expenses
of the Company and Lorillard arising out of the past, present or future
business of Lorillard, and all net income or net losses from the assets and
liabilities attributed to the Carolina Group. Each outstanding share of
Carolina Group stock has 1/10 of a vote per share.
As of September 30, 2004, the outstanding Carolina Group stock represents a
33.43% economic interest in the economic performance of the Carolina Group.
The Loews Group consists of all of the Company's assets and liabilities other
than the 33.43% economic interest represented by the outstanding Carolina
Group stock, and includes as an asset the notional, intergroup debt of the
Carolina Group. Holders of the Company's common stock and of Carolina Group
stock are shareholders of Loews Corporation and are subject to the risks
related to an equity investment in Loews Corporation.
The Company has separated, for financial reporting purposes, the Carolina
Group and Loews Group. The following schedules present the Consolidating
Condensed Financial Information for these individual groups. Neither group is
a separate company or legal entity. Rather, each group is intended to reflect
a defined set of assets and liabilities.
14
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
---------------------------------- Loews and
September 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 1,671.7 $ 100.0 $ 1,771.7 $ 41,492.6 $ 43,264.3
Cash 1.3 0.4 1.7 137.4 139.1
Receivables-net 29.1 29.1 18,889.5 $ (26.0) (a) 18,892.6
Property, plant and
equipment-net 230.8 230.8 3,532.3 3,763.1
Deferred income taxes 441.1 441.1 233.7 674.8
Goodwill 295.0 295.0
Other assets 367.0 367.0 2,180.9 2,547.9
Investment in combined
attributed net assets
of the Carolina Group 1,554.1 (1,941.3) (a)
387.2 (b)
Deferred acquisition
costs of insurance
subsidiaries 1,312.1 1,312.1
Separate account
business 567.1 567.1
- ------------------------------------------------------------------------------------------------
Total assets $ 2,741.0 $ 100.4 $ 2,841.4 $ 70,194.7 $ (1,580.1) $ 71,456.0
================================================================================================
Liabilities and
Shareholders' Equity:
Insurance reserves $ 43,387.4 $ 43,387.4
Payable for securities
purchased 1,440.8 1,440.8
Securities sold under
agreements to
repurchase 115.8 115.8
Short-term debt 1,055.6 1,055.6
Long-term debt, less
unamortized discounts $ 1,941.3 $ 1,941.3 4,776.6 $ (1,941.3) (a) 4,776.6
Reinsurance balances
payable 3,103.2 3,103.2
Other liabilities $ 1,465.1 16.7 1,481.8 2,455.6 (26.0) (a) 3,911.4
Separate account
business 567.1 567.1
- ------------------------------------------------------------------------------------------------
Total liabilities 1,465.1 1,958.0 3,423.1 56,902.1 (1,967.3) 58,357.9
Minority interest 1,646.6 1,646.6
Shareholders' equity 1,275.9 (1,857.6) (581.7) 11,646.0 387.2 (b) 11,451.5
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 2,741.0 $ 100.4 $ 2,841.4 $ 70,194.7 $ (1,580.1) $ 71,456.0
================================================================================================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 66.57% equity interest in the combined attributed net assets
of the Carolina Group.
15
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
---------------------------------- Loews and
December 31, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 1,530.2 $ 100.0 $ 1,630.2 $ 40,884.6 $ 42,514.8
Cash 1.5 0.4 1.9 178.9 180.8
Receivables-net 23.9 23.9 20,471.6 $ (27.6) (a) 20,467.9
Property, plant and
equipment-net 221.0 221.0 3,658.7 3,879.7
Deferred income taxes 441.9 441.9 88.3 530.2
Goodwill 311.4 311.4
Other assets 406.4 406.4 3,379.0 3,785.4
Investment in combined
attributed net assets
of the Carolina Group 1,546.7 (2,032.1) (a)
485.4 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,532.7 2,532.7
Separate account
business 3,678.0 3,678.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,624.9 $ 100.4 $ 2,725.3 $ 76,729.9 $ (1,574.3) $ 77,880.9
================================================================================================
Liabilities and
Shareholders' Equity:
Insurance reserves $ 45,384.0 $ 45,384.0
Payable for securities
purchased 2,147.7 2,147.7
Securities sold under
agreements to
repurchase 441.8 441.8
Short-term debt 295.9 295.9
Long-term debt, less
unamortized discounts $ 2,032.1 $ 2,032.1 5,524.3 $ (2,032.1) (a) 5,524.3
Reinsurance balances
payable 3,432.0 3,432.0
Other liabilities $ 1,405.0 17.4 1,422.4 2,856.5 (27.6) (a) 4,251.3
Separate account
business 3,678.0 3,678.0
- ------------------------------------------------------------------------------------------------
Total liabilities 1,405.0 2,049.5 3,454.5 63,760.2 (2,059.7) 65,155.0
Minority interest 1,671.6 1,671.6
Shareholders' equity 1,219.9 (1,949.1) (729.2) 11,298.1 485.4 (b) 11,054.3
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 2,624.9 $ 100.4 $ 2,725.3 $ 76,729.9 $ (1,574.3) $ 77,880.9
================================================================================================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 66.57% equity interest in the combined attributed net
assets of the Carolina Group.
16
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
September 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 1,946.0 $ 1,946.0
Investment income, net $ 7.5 $ 0.6 $ 8.1 412.5 $ (39.3)(a) 381.3
Investment gains (36.8) (36.8)
Manufactured products 879.3 879.3 38.7 918.0
Other 576.9 576.9
- -----------------------------------------------------------------------------------------------
Total 886.8 0.6 887.4 2,937.3 (39.3) 3,785.4
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 1,596.4 1,596.4
Amortization of deferred
acquisition costs 373.8 373.8
Cost of manufactured
products sold 504.8 504.8 18.9 523.7
Other operating expenses 85.0 0.1 85.1 730.7 815.8
Interest 39.3 39.3 73.3 (39.3)(a) 73.3
- ------------------------------------------------------------------------------------------------
Total 589.8 39.4 629.2 2,793.1 (39.3) 3,383.0
- ------------------------------------------------------------------------------------------------
297.0 (38.8) 258.2 144.2 402.4
- ------------------------------------------------------------------------------------------------
Income tax expense (benefit) 113.0 (14.7) 98.3 22.5 120.8
Minority interest 4.0 4.0
- ------------------------------------------------------------------------------------------------
Total 113.0 (14.7) 98.3 26.5 124.8
- ------------------------------------------------------------------------------------------------
Income from operations 184.0 (24.1) 159.9 117.7 277.6
Equity in earnings of the
Carolina Group 106.5 (106.5)(b)
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 184.0 $(24.1) $ 159.9 $ 224.2 $ (106.5) $ 277.6
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
17
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Three Months Ended ------------------------------------ Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $2,125.2 $ 2,125.2
Investment income, net $ 11.2 $ 0.5 $ 11.7 406.9 $(45.2)(a) 373.4
Investment (losses) gains (8.8) (8.8) 188.3 179.5
Manufactured products 842.8 842.8 37.3 880.1
Other 381.8 381.8
- ------------------------------------------------------------------------------------------------
Total 845.2 0.5 845.7 3,139.5 (45.2) 3,940.0
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 4,341.7 4,341.7
Amortization of deferred
acquisition costs 494.5 494.5
Cost of manufactured
products sold 514.0 514.0 18.7 532.7
Other operating expenses 97.7 0.3 98.0 942.8 1,040.8
Interest 45.2 45.2 80.9 (45.2)(a) 80.9
- ------------------------------------------------------------------------------------------------
Total 611.7 45.5 657.2 5,878.6 (45.2) 6,490.6
- ------------------------------------------------------------------------------------------------
233.5 (45.0) 188.5 (2,739.1) (2,550.6)
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 89.3 (17.2) 72.1 (988.5) (916.4)
Minority interest (195.5) (195.5)
- ------------------------------------------------------------------------------------------------
Total 89.3 (17.2) 72.1 (1,184.0) (1,111.9)
- ------------------------------------------------------------------------------------------------
(Loss) income from operations 144.2 (27.8) 116.4 (1,555.1) (1,438.7)
Equity in earnings of the
Carolina Group 89.6 (89.6)(b)
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing
operations 144.2 (27.8) 116.4 (1,465.5) (89.6) (1,438.7)
Discontinued operations-net 55.8 55.8
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 144.2 $(27.8) $ 116.4 $(1,409.7) $(89.6) $(1,382.9)
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
18
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Nine Months Ended ---------------------------------- Loews and
September 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 6,218.3 $ 6,218.3
Investment income, net $ 21.2 $ 1.3 $ 22.5 1,369.7 $ (119.4)(a) 1,272.8
Investment gains (losses) 0.6 0.6 (349.8) (349.2)
Manufactured products 2,515.3 2,515.3 110.2 2,625.5
Other 1,423.7 1,423.7
- -----------------------------------------------------------------------------------------------
Total 2,537.1 1.3 2,538.4 8,772.1 (119.4) 11,191.1
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 4,859.3 4,859.3
Amortization of deferred
acquisition costs 1,114.1 1,114.1
Cost of manufactured
products sold 1,504.4 1,504.4 54.2 1,558.6
Other operating expenses 288.0 0.4 288.4 2,088.2 2,376.6
Interest 119.4 119.4 245.9 (119.4)(a) 245.9
- ------------------------------------------------------------------------------------------------
Total 1,792.4 119.8 1,912.2 8,361.7 (119.4) 10,154.5
- ------------------------------------------------------------------------------------------------
744.7 (118.5) 626.2 410.4 1,036.6
- ------------------------------------------------------------------------------------------------
Income tax expense (benefit) 287.7 (45.8) 241.9 47.5 289.4
Minority interest 18.7 18.7
- ------------------------------------------------------------------------------------------------
Total 287.7 (45.8) 241.9 66.2 308.1
- ------------------------------------------------------------------------------------------------
Income (loss) from
operations 457.0 (72.7) 384.3 344.2 728.5
Equity in earnings of the
Carolina Group 255.9 (255.9)(b)
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 457.0 $ (72.7) $ 384.3 $ 600.1 $ (255.9) $ 728.5
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
19
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Nine Months Ended ---------------------------------- Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 6,701.0 $ 6,701.0
Investment income, net $ 29.7 $ 1.7 $ 31.4 1,384.5 $ (140.7)(a) 1,275.2
Investment (losses) gains (10.6) (10.6) 513.8 503.2
Manufactured products 2,467.9 2,467.9 110.5 2,578.4
Other (0.2) (0.2) 1,067.7 1,067.5
- ------------------------------------------------------------------------------------------------
Total 2,486.8 1.7 2,488.5 9,777.5 (140.7) 12,125.3
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims
and policyholders' benefits 8,319.6 8,319.6
Amortization of deferred
acquisition costs 1,433.7 1,433.7
Cost of manufactured
products sold 1,435.4 1,435.4 54.2 1,489.6
Other operating expenses 352.3 0.5 352.8 2,264.9 2,617.7
Interest 140.7 140.7 230.3 (140.7)(a) 230.3
- ------------------------------------------------------------------------------------------------
Total 1,787.7 141.2 1,928.9 12,302.7 (140.7) 14,090.9
- ------------------------------------------------------------------------------------------------
699.1 (139.5) 559.6 (2,525.2) (1,965.6)
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 262.8 (52.4) 210.4 (945.7) (735.3)
Minority interest (196.8) (196.8)
- ------------------------------------------------------------------------------------------------
Total 262.8 (52.4) 210.4 (1,142.5) (932.1)
- ------------------------------------------------------------------------------------------------
Income (loss) from operations 436.3 (87.1) 349.2 (1,382.7) (1,033.5)
Equity in earnings
of the Carolina Group 268.8 (268.8)(b)
- ------------------------------------------------------------------------------------------------
Income (loss) from continuing
operations 436.3 (87.1) 349.2 (1,113.9) (268.8) (1,033.5)
Discontinued operations-net 55.4 55.4
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 436.3 $(87.1) $ 349.2 $(1,058.5) $(268.8) $ (978.1)
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
20
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Nine Months Ended ---------------------------------- Loews and
September 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Net cash (used)
provided by
operating
activities $ 544.7 $ (73.5) $ 471.2 $ 2,029.4 $ (157.6) $ 2,343.0
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (40.0) (40.0) (155.7) (195.7)
Change in short-term
investments (104.3) (104.3) 2,903.3 2,799.0
Other investing
activities 0.4 0.4 (4,710.1) (90.8) (4,800.5)
- ------------------------------------------------------------------------------------------------
(143.9) (143.9) (1,962.5) (90.8) (2,197.2)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (401.0) 164.3 (236.7) (83.5) 157.6 (162.6)
Reduction of
intergroup notional
debt (90.8) (90.8) 90.8
Other financing
activities (24.9) (24.9)
- ------------------------------------------------------------------------------------------------
(401.0) 73.5 (327.5) (108.4) 248.4 (187.5)
- ------------------------------------------------------------------------------------------------
Net change in cash (0.2) (0.2) (41.5) (41.7)
Cash, beginning of
period 1.5 0.4 1.9 178.9 180.8
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.3 $ 0.4 $ 1.7 $ 137.4 $ 139.1
================================================================================================
21
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Nine Months Ended ---------------------------------- Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- -----------------------------------------------------------------------------------------------
(In millions)
Net cash provided (used)
by operating activities $ 869.7 $ (89.1) $ 780.6 $ 1,706.3 $(181.0) $ 2,305.9
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (38.4) (38.4) (331.9) (370.3)
Change in short-term
investments (283.6) 50.3 (233.3) (933.6) (1,166.9)
Other investing
activities 1.0 1.0 (424.6) (274.9) (698.5)
- ------------------------------------------------------------------------------------------------
(321.0) 50.3 (270.7) (1,690.1) (274.9) (2,235.7)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (549.0) 314.0 (235.0) (83.5) 181.0 (137.5)
Reduction of
intergroup notional
debt (274.9) (274.9) 274.9
Other financing
activities 115.3 115.3
- ------------------------------------------------------------------------------------------------
(549.0) 39.1 (509.9) 31.8 455.9 (22.2)
- ------------------------------------------------------------------------------------------------
Net change in cash (0.3) 0.3 48.0 48.0
Cash, beginning of
period 2.0 0.2 2.2 183.2 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.7 $ 0.5 $ 2.2 $ 231.2 $ 233.4
================================================================================================
22
5. Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, provide greater
diversification of risk, minimize exposures on larger risks and to exit
certain lines of business. The ceding of insurance does not discharge the
primary liability of CNA. Therefore, a credit exposure exists with respect to
property and casualty and life reinsurance ceded to the extent that any
reinsurer is unable to meet the obligations assumed under reinsurance
agreements.
Interest cost on reinsurance contracts accounted for on a funds withheld
basis is incurred during all periods in which a funds withheld liability
exists. Interest cost, which is included in net investment income, was $55.0
and $148.0 million for the three months ended September 30, 2004 and 2003, and
$161.0 and $288.0 million for the nine months ended September 30, 2004 and
2003. The amount subject to interest crediting rates on such contracts was
$2,726.0 and $2,789.0 million at September 30, 2004 and December 31, 2003.
Certain funds withheld reinsurance contracts, including the corporate
aggregate reinsurance treaties, require interest on additional premiums
arising from ceded losses as if those premiums were payable at the inception
of the contract.
The amount subject to interest crediting on these funds withheld contracts
will vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. CNA expects that it will continue
to incur significant interest costs on these contracts for several years.
The following table summarizes the amounts receivable from reinsurers at
September 30, 2004 and December 31, 2003.
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance receivables related to insurance reserves:
Ceded claim and claim adjustment expense $ 14,037.6 $ 14,215.9
Ceded future policy benefits 1,227.0 1,218.2
Ceded policyholders' funds 60.2 6.6
Billed reinsurance receivables 587.2 813.1
- ------------------------------------------------------------------------------------------------
Reinsurance receivables 15,912.0 16,253.8
Less allowance for doubtful accounts 530.1 572.6
- ------------------------------------------------------------------------------------------------
Reinsurance receivables-net $ 15,381.9 $ 15,681.2
================================================================================================
CNA has established an allowance for uncollectible reinsurance. The
allowance for uncollectible reinsurance was $530.1 and $572.6 million at
September 30, 2004 and December 31, 2003. The net decrease in the allowance
for uncollectible reinsurance was primarily due to a release of a previously
established allowance related to The Trenwick Group resulting from the
finalization of commutation agreements in the second quarter of 2004,
partially offset by a net increase in the allowance for other reinsurance
receivables. The expenses incurred related to uncollectible reinsurance
receivables are presented as a component of "Insurance claims and
23
policyholders' benefits" on the Consolidated Condensed Statements of
Operations.
CNA attempts to mitigate its credit risk related to reinsurance by entering
into reinsurance arrangements only with reinsurers that have credit ratings
above certain levels and by obtaining substantial amounts of collateral. The
primary methods of obtaining collateral are through reinsurance trusts,
letters of credit and funds withheld balances.
The effects of reinsurance on earned premiums are shown in the following
table.
Direct Assumed Ceded Net
---------------------------------------------
Nine Months Ended September 30, 2004
---------------------------------------------
(In millions)
Property and casualty $ 8,059.0 $ 163.0 $ 2,663.0 $ 5,559.0
Accident and health 916.0 45.0 421.0 540.0
Life 369.0 250.0 119.0
---------------------------------------------
Total earned premiums $ 9,344.0 $ 208.0 $ 3,334.0 $ 6,218.0
=============================================
Nine Months Ended September 30, 2003
---------------------------------------------
Property and casualty $ 7,977.0 $ 460.0 $ 3,459.0 $ 4,978.0
Accident and health 1,193.0 78.0 42.0 1,229.0
Life 801.0 4.0 311.0 494.0
--------------------------------------------
Total earned premiums $ 9,971.0 $ 542.0 $ 3,812.0 $ 6,701.0
============================================
Life premiums are primarily from long duration contracts; property and
casualty premiums and accident and health premiums are primarily from short
duration contracts.
CNA has an aggregate reinsurance treaty related to the 1999 through 2001
accident years that covers substantially all of CNA's property and casualty
lines of business (the "Aggregate Cover"). The Aggregate Cover provides for
two sections of coverage. These coverages attach at defined loss ratios for
each accident year. Coverage under the first section of the Aggregate Cover,
which was available for all accident years covered by the treaty, had a $500.0
million limit per accident year of ceded losses and an aggregate limit of $1.0
billion of ceded losses for the three accident years. The ceded premiums
associated with the first section are a percentage of ceded losses and for
each $500.0 million of limit the ceded premium is $230.0 million. The second
section of the Aggregate Cover, which only relates to accident year 2001,
provides additional coverage of up to $510.0 million of ceded losses for a
maximum ceded premium of $310.0 million. Under the Aggregate Cover, interest
charges on the funds withheld liability accrue at 8.0% per annum. This rate
will increase to 8.25% per annum commencing in 2006. The aggregate loss ratio
for the three-year period has exceeded certain thresholds, which require
additional ceded premiums. CNA recorded $5.0 million for the three months
ended September 30, 2004 and $8.0 million for the nine months ended September
24
30, 2004 of ceded premiums under this provision. The aggregate limits under
both sections of the Aggregate Cover were exhausted in 2003.
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------------
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ 3.0 $(223.0) $ (251.0)
Ceded claim and claim adjustment expense 422.0 500.0
Interest charges (19.0) (88.0) $(61.0) (123.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $(16.0) $ 111.0 $(61.0) $ 126.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 million of limit is $456.0 million. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. During 2003, the
aggregate limits under the CCC Cover were exhausted.
The pretax impact of the CCC Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (10.0) $ (100.0)
Ceded claim and claim adjustment expense 17.0 143.0
Interest charges $(12.0) (13.0) $(34.0) (48.0)
- ------------------------------------------------------------------------------------------------
Pretax expense $(12.0) $ (6.0) $(34.0) $ (5.0)
================================================================================================
25
6. Receivables
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance $15,912.0 $16,253.8
Other insurance 2,669.9 3,070.4
Security sales 656.9 890.7
Accrued investment income 347.3 343.3
Federal income taxes 517.4
Other 330.6 348.4
- -----------------------------------------------------------------------------------------------
Total 19,916.7 21,424.0
Less: Allowance for doubtful accounts on reinsurance receivables 530.1 572.6
Allowance for other doubtful accounts and cash discounts 494.0 383.5
- -----------------------------------------------------------------------------------------------
Receivables-net $18,892.6 $20,467.9
===============================================================================================
7. Claim and Claim Adjustment Expense Reserves
CNA's property and casualty insurance claim and claim adjustment expense
reserves represent the estimated amounts necessary to settle all outstanding
claims, including claims that are incurred but not reported ("IBNR") as of the
reporting date. CNA's reserve projections are based primarily on detailed
analysis of the facts in each case, CNA's experience with similar cases and
various historical development patterns. Consideration is given to such
historical patterns as field reserving trends and claims settlement practices,
loss payments, pending levels of unpaid claims and product mix, as well as
court decisions, economic conditions and public attitudes. All of these
factors can affect the estimation of claim and claim adjustment expense
reserves.
Establishing claim and claim adjustment expense reserves, including claim
and claim adjustment expense reserves for catastrophic events that have
occurred, is an estimation process. Many factors can ultimately affect the
final settlement of a claim and, therefore, the necessary reserve. Changes in
the law, results of litigation, medical costs, the cost of repair materials
and labor rates can all affect ultimate claim costs. In addition, time can be
a critical part of reserving determinations since the longer the span between
the incidence of a loss and the payment or settlement of the claim, the more
variable the ultimate settlement amount can be. Accordingly, short-tail
claims, such as property damage claims, tend to be more reasonably estimable
than long-tail claims, such as general liability and professional liability
claims. Adjustments to prior year reserve estimates, if necessary, are
reflected in the results of operations in the period that the need for such
adjustments is determined.
Catastrophes are an inherent risk of the property and casualty insurance
business and have contributed to material period-to-period fluctuations in
CNA's results of operations and/or equity. The level of catastrophe losses
experienced in any period cannot be predicted and can be material to the
results of operations and/or equity of the Company.
Catastrophe losses were $271.0 and $132.0 million pretax for the nine months
ended September 30, 2004 and 2003. The catastrophe losses in 2004 related
26
primarily to Hurricanes Charley, Frances, Ivan and Jeanne. The catastrophe
losses in 2003 related primarily to Hurricane Claudette, Hurricane Isabel,
Texas tornadoes, and Midwest rain storms.
Claim and Claim Adjustment Expense reserves are presented net of amounts due
from insureds related to losses under high deductible policies. CNA has
established a valuation allowance related to these amounts, which is presented
as a component of the allowance for doubtful accounts for insurance
receivables.
Asbestos, Environmental Pollution and Mass Tort ("APMT") Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims.
Establishing reserves for APMT claim and claim adjustment expenses is
subject to uncertainties that are greater than those presented by other
claims. Traditional actuarial methods and techniques employed to estimate the
ultimate cost of claims for more traditional property and casualty exposures
are less precise in estimating claim and claim adjustment expense reserves for
APMT, particularly in an environment of emerging or potential claims and
coverage issues that arise from industry practices and legal, judicial, and
social conditions. Therefore, these traditional actuarial methods and
techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are
required of management. Accordingly, a high degree of uncertainty remains for
CNA's ultimate liability for APMT claim and claim adjustment expenses.
In addition to the difficulties described above, estimating the ultimate
cost of both reported and unreported APMT claims is subject to a higher degree
of variability due to a number of additional factors, including among others:
the number and outcome of direct actions against CNA; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
"joint and several" liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs' lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states; enactment of
national federal legislation to address asbestos claims; a future increase in
asbestos and environmental pollution claims which cannot now be anticipated; a
future increase in number of mass tort claims relating to silica and silica-
containing products, and the outcome of ongoing disputes as to coverage in
relation to these claims; a further increase of claims and claims payments
that may exhaust underlying umbrella and excess coverages at accelerated
rates; and future developments pertaining to CNA's ability to recover
reinsurance for asbestos and environmental pollution claims.
CNA regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of CNA's APMT reserves. In performing its comprehensive ground up
analysis, CNA considers input from its professionals with direct
responsibility for the claims, inside and outside counsel with responsibility
for representation of CNA, and its actuarial staff. These professionals
review, among many factors, the policyholder's present and predicted future
exposures, including such factors as claims volume, trial conditions, prior
settlement history, settlement demands and defense costs; the impact of
asbestos defendant bankruptcies on the policyholder; the policies issued by
CNA, including such factors as aggregate or per occurrence limits, whether the
policy is primary, umbrella or excess, and the existence of policyholder
27
retentions and/or deductibles; the existence of other insurance; and
reinsurance arrangements.
With respect to other court cases and how they might affect CNA's reserves
and reasonable possible losses, the following should be noted. State and
federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers' obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers' loss control inspections of their insured's premises do not
give rise to a duty to warn third parties to the dangers of asbestos. Examples
of unfavorable developments include decisions limiting the application of the
absolute pollution exclusion; and decisions holding carriers liable for
defense and indemnity of asbestos and pollution claims on a joint and several
basis.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA after 1989. Due to the inherent uncertainties described above,
including the inconsistency of court decisions, the number of waste sites
subject to cleanup, and in the area of environmental pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
Due to the inherent uncertainties in estimating claim and claim adjustment
expense reserves for APMT and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to CNA's
business, insurer financial strength and debt ratings and the Company's
results of operations and equity. Due to, among other things, the factors
described above, it may be necessary for CNA to record material changes in its
APMT claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge.
The following table provides data related to CNA's APMT claim and claim
adjustment expense reserves:
28
September 30, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Asbestos Mass Tort Asbestos Mass Tort
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 3,221.0 $ 787.0 $ 3,347.0 $ 839.0
Ceded reserves (1,514.0) (279.0) (1,580.0) (262.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 1,707.0 $ 508.0 $ 1,767.0 $ 577.0
================================================================================================
Asbestos
CNA's property and casualty insurance subsidiaries have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves limitations such as inconsistency of
court decisions, specific policy provisions, allocation of liability among
insurers and insureds, and additional factors such as missing policies and
proof of coverage. Furthermore, estimation of asbestos-related claims is
difficult due to, among other reasons, the proliferation of bankruptcy
proceedings and attendant uncertainties, the targeting of a broader range of
businesses and entities as defendants, the uncertainty as to which other
insureds may be targeted in the future and the uncertainties inherent in
predicting the number of future claims.
As of September 30, 2004 and December 31, 2003, CNA carried approximately
$1,707.0 and $1,767.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
claims. CNA recorded $44.0 million of unfavorable asbestos-related net claim
and claim adjustment expense reserve development for the nine months ended
September 30, 2004 and $642.0 million asbestos-related net claim and claim
adjustment expense development for the same period in 2003. The 2004
unfavorable net prior year development was primarily related to a commutation
loss related to The Trenwick Group Ltd. ("Trenwick"). See Note 5 for further
details. CNA paid asbestos-related claims, net of reinsurance recoveries, of
$104.0 and $101.0 million for the nine months ended September 30, 2004 and
2003.
Some asbestos-related defendants have asserted that their policies issued by
CNA are not subject to aggregate limits on coverage. CNA has such claims from
a number of insureds. Some of these claims involve insureds facing exhaustion
of products liability aggregate limits in their policies, who have asserted
that their asbestos-related claims fall within so-called "non-products"
liability coverage contained within their policies rather than products
liability coverage, and that the claimed "non-products" coverage is not
subject to any aggregate limit. It is difficult to predict the ultimate size
of any of the claims for coverage purportedly not subject to aggregate limits
or predict to what extent, if any, the attempts to assert "non-products"
claims outside the products liability aggregate will succeed. CNA has
attempted to manage its asbestos exposure by aggressively seeking to settle
claims on acceptable terms. There can be no assurance that any of these
settlement efforts will be successful, or that any such claims can be settled
on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable
terms, CNA aggressively litigates the claim. Adverse developments with respect
29
to such matters could have a material adverse effect on the Company's results
of operations and/or equity.
Certain asbestos litigation in which CNA is currently engaged is described
below:
On February 13, 2003, CNA announced it had resolved asbestos related
coverage litigation and claims involving A.P. Green Industries, A.P. Green
Services and Bigelow - Liptak Corporation. Under the agreement, CNA is
required to pay $74.0 million, net of reinsurance recoveries, over a ten year
period. The settlement resolves CNA's liabilities for all pending and future
asbestos claims involving A.P. Green Industries, Bigelow - Liptak Corporation
and related subsidiaries, including alleged "non-products" exposures. The
settlement has received initial bankruptcy court approval and CNA expects to
procure confirmation of a bankruptcy plan containing an injunction to protect
CNA from any future claims.
CNA is engaged in insurance coverage litigation with underlying plaintiffs
who have asbestos bodily injury claims against the former Robert A. Keasbey
Company ("Keasbey") in New York state court (Continental Casualty Co. v.
Nationwide Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a
currently dissolved corporation, was a seller and installer of asbestos-
containing insulation products in New York and New Jersey. Thousands of
plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey's
involvement at a number of work sites is a highly contested issue. Therefore,
the defense disputes the percentage of valid claims against Keasbey. CNA
issued Keasbey primary policies for 1970-1987 and excess policies for 1972-
1978. CNA has paid an amount substantially equal to the policies' aggregate
limits for products and completed operations claims. Claimants against Keasbey
allege, among other things, that CNA owes coverage under sections of the
policies not subject to the aggregate limits, an allegation CNA vigorously
contests in the lawsuit.
CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. ("Burns & Roe"). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns &
Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District
of New Jersey, No. 00-41610. Burns & Roe provided engineering and related
services in connection with construction projects. At the time of its
bankruptcy filing, Burns & Roe faced approximately 11,000 claims alleging
bodily injury resulting from exposure to asbestos as a result of construction
projects in which Burns & Roe was involved. CNA allegedly provided primary
liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with
certain project-specific policies from 1964-1970.
CIC issued certain primary and excess policies to Bendix Corporation
("Bendix"), now part of Honeywell International, Inc. ("Honeywell"). Honeywell
faces approximately 75,105 pending asbestos bodily injury claims resulting
from alleged exposure to Bendix friction products. CIC's primary policies
allegedly covered the period from at least 1939 (when Bendix began to use
asbestos in its friction products) to 1983, although the parties disagree
about whether CIC's policies provided product liability coverage before 1940
and from 1945 to 1956. CIC asserts that it owes no further material
obligations to Bendix under any primary policy. Honeywell alleges that two
primary policies issued by CIC covering 1969-1975 contain occurrence limits
but not product liability aggregate limits for asbestos bodily injury claims.
CIC has asserted, among other things, which even if Honeywell's allegation is
correct, which CNA denies, its liability is limited to a single occurrence
limit per policy or per year, and in the alternative, a proper allocation of
30
losses would substantially limit its exposure under the 1969-1975 policies to
asbestos claims. These and other issues are being litigated in Continental
Insurance Co., et al. v. Honeywell International Inc., No. MRS-L-1523-00
(Morris County, New Jersey).
Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
two Ohio actions, plaintiffs allege the defendants negligently performed
duties undertaken to protect workers and the public from the effects of
asbestos (Varner v. Ford Motor Co., et al. (Cuyahoga County, Ohio) and
Peplowski v. Ace American Ins. Co., et al. (U.S.D.C. N.D. Ohio)). The state
trial court recently granted insurers, including CNA, summary judgment against
a representative group of plaintiffs, ruling that insurers had no duty to warn
plaintiffs about asbestos. Similar lawsuits have also been filed in Texas
against CNA, and other insurers and non-insurer corporate defendants asserting
liability for failing to warn of the dangers of asbestos (Boson v. Union
Carbide Corp., et al. (District Court of Nueces County, Texas)). Many of the
Texas claims have been dismissed as time-barred by the applicable statute of
limitations. In other claims, the Texas court recently ruled that the carriers
did not owe any duty to the plaintiffs or the general public to advise on the
effects of asbestos thereby dismissing these claims. The time period for
filing an appeal of this ruling has not expired and it remains uncertain
whether the plaintiffs' will continue to pursue their causes of action.
CNA has been named in Adams v. Aetna, Inc., et al. (Circuit Court of Kanawha
County, West Virginia), a purported class action against CNA and other
insurers, alleging that the defendants violated West Virginia's Unfair Trade
Practices Act in handling and resolving asbestos claims against their policy-
holders. A direct action has also been filed in Montana (Pennock, et al. v.
Maryland Casualty, et al. First Judicial District Court of Lewis & Clark
County, Montana) by eight individual plaintiffs (all employees of W.R. Grace &
Co. ("W.R. Grace")) and their spouses against CNA, Maryland Casualty and the
State of Montana. This action alleges that the carriers failed to warn of or
otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R.
Grace vermiculite mining facility in Libby, Montana. The Montana direct action
is currently stayed as to CNA because of W.R. Grace's pending bankruptcy.
CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and
it is extremely difficult to predict the outcome or ultimate financial
exposure represented by these matters. Adverse developments with respect to
any of these matters could have a material adverse effect on CNA's business,
insurer financial strength and debt ratings, and the Company's results of
operations and/or equity.
As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage;
limits and deductibles; the potential role of other insurance, particularly
underlying coverage below any CNA excess liability policies; and applicable
coverage defenses, including asbestos exclusions. Estimation of asbestos-
related claim and claim adjustment expense reserves involves a high degree of
judgment on the part of management and consideration of many complex factors,
including: inconsistency of court decisions, jury attitudes and future court
decisions; specific policy provisions; allocation of liability among insurers
and insureds; missing policies and proof of coverage; the proliferation of
31
bankruptcy proceedings and attendant uncertainties; novel theories asserted by
policyholders and their counsel; the targeting of a broader range of
businesses and entities as defendants; the uncertainty as to which other
insureds may be targeted in the future and the uncertainties inherent in
predicting the number of future claims; volatility in claim numbers and
settlement demands; increases in the number of non-impaired claimants and the
extent to which they can be precluded from making claims; the efforts by
insureds to obtain coverage not subject to aggregate limits; the long latency
period between asbestos exposure and disease manifestation and the resulting
potential for involvement of multiple policy periods for individual claims;
medical inflation trends; the mix of asbestos-related diseases presented and
the ability to recover reinsurance.
Environmental Pollution and Mass Tort
Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to cleanup. The insurance industry is involved in extensive litigation
regarding coverage issues. Judicial interpretations in many cases have
expanded the scope of coverage and liability beyond the original intent of the
policies. The Comprehensive Environmental Response Compensation and Liability
Act of 1980 ("Superfund") and comparable state statutes ("mini-Superfunds")
govern the cleanup and restoration of toxic waste sites and formalize the
concept of legal liability for cleanup and restoration by "Potentially
Responsible Parties" ("PRPs"). Superfund and the mini-Superfunds establish
mechanisms to pay for cleanup of waste sites if PRPs fail to do so and assign
liability to PRPs. The extent of liability to be allocated to a PRP is
dependent upon a variety of factors. Further, the number of waste sites
subject to cleanup is unknown. To date, approximately 1,400 cleanup sites have
been identified by the Environmental Protection Agency ("EPA") and included on
its National Priorities List ("NPL"). State authorities have designated many
cleanup sites as well.
Many policyholders have made claims against various CNA insurance
subsidiaries for defense costs and indemnification in connection with
environmental pollution matters. The vast majority of these claims relate to
accident years 1989 and prior, which coincides with CNA's adoption of the
Simplified Commercial General Liability coverage form, which includes what is
referred to in the industry as an absolute pollution exclusion. CNA and the
insurance industry are disputing coverage for many such claims. Key coverage
issues include whether cleanup costs are considered damages under the
policies, trigger of coverage, allocation of liability among triggered
policies, applicability of pollution exclusions and owned property exclusions,
the potential for joint and several liability and the definition of an
occurrence. To date, courts have been inconsistent in their rulings on these
issues.
A number of proposals to modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 2003 or in the first
three quarters of 2004, and it is unclear what positions Congress or the
Administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental cleanup may be significantly
reduced in favor of state action. Substantial changes in the federal statute
or the activity of the EPA may cause states to reconsider their environmental
cleanup statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result or the possible effect upon the
Company's results of operations or equity.
32
As of September 30, 2004 and December 31, 2003, CNA carried approximately
$508.0 and $577.0 million of claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported environmental
pollution and mass tort claims. There was no environmental pollution and mass
tort net claim and claim adjustment expense reserve development for the nine
months ended September 30, 2004 and $153.0 million of unfavorable reserve
development for the nine months ended September 30, 2003. CNA paid
environmental pollution-related claims and mass tort-related claims, net of
reinsurance recoveries, of $79.0 and $68.0 million for the nine months ended
September 30, 2004 and 2003. Additionally, CNA recorded $10.0 million of
current accident year losses related to mass tort in 2004.
CNA has made resolution of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating settlement agreements. In its settlements, CNA sought
to resolve those exposures and obtain the broadest release language to avoid
future claims from the same policyholders seeking coverage for sites or claims
that had not emerged at the time CNA settled with its policyholder. While the
terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad scope of the release provisions contained in those
settlement agreements should, in many cases, prevent future exposure from
settled policyholders. It remains uncertain, however, whether a court
interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the
agreements.
In 2003, CNA observed a marked increase in silica claims frequency in
Mississippi, where plaintiff attorneys appear to have filed claims to avoid
the effect of tort reform. In 2004, silica claims frequency in Mississippi has
moderated notably due to implementation of tort reform measures and favorable
court decisions. To date, the most significant silica exposures identified
included a relatively small number of accounts with significant numbers of new
claims reported in 2003 and continuing in 2004. Establishing claim and claim
adjustment expense reserves for silica claims is subject to uncertainties
because of disputes concerning medical causation with respect to certain
diseases, including lung cancer, geographical concentration of the lawsuits
asserting the claims, and the large rise in the total number of claims without
underlying epidemiological developments suggesting an increase in disease
rates or plaintiffs. Moreover, judicial interpretations regarding application
of various tort defenses, including application of various theories of joint
and several liabilities, impede CNA's ability to estimate its ultimate
liability for such claims.
Net Prior Year Development
Unfavorable net prior year development of $116.0 million, including $227.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $111.0 million of favorable premium development, was recorded
for the nine months ended September 30, 2004. Unfavorable net prior year
development of $2,835.0 million, including $2,312.0 million of unfavorable
claim and allocated claim adjustment expense reserve development and $523.0
million of unfavorable premium development, was recorded for the same period
in 2003. The gross carried claim and claim adjustment expense reserves for CNA
were $31,495.0 and $31,730.0 million at September 30, 2004 and December 31,
2003. The net carried claim and claim adjustment expense reserves for CNA were
$17,457.0 and $17,514.0 million at September 30, 2004 and December 31, 2003.
33
Standard Lines
Unfavorable net prior year development of $13.0 million, including $111.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $98.0 million of favorable premium development, was recorded
for the nine months ended September 30, 2004 for Standard Lines. Unfavorable
net prior year development of $1,425.0 million, including $957.0 million of
unfavorable claim and allocated claim adjustment expense reserve development
and $468.0 million of unfavorable premium development, was recorded for the
same period in 2003. The gross and net carried claim and claim adjustment
expense reserves were $14,370.0 and $9,236.0 million at September 30, 2004.
The gross and net carried claim and claim adjustment expense reserves for
Standard Lines were $14,282.0 and $8,967.0 million at December 31, 2003.
In the second quarter of 2004, CNA finalized commutation agreements with
several members of the Trenwick Group. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance.
In addition approximately $75.0 million of unfavorable net prior year claim
and allocated claim adjustment expense development recorded in the second
quarter of 2004 resulted from increased severity trends for workers
compensation on large account policies primarily in accident years 2002 and
prior. Favorable premium development on retrospectively rated large account
policies of $25.0 million was recorded in relation to this unfavorable net
prior year claim and allocated claim adjustment expense development. Also,
favorable net prior year premium development of approximately $60.0 million
resulted primarily from higher audit and endorsement premiums on workers
compensation and general liability policies. Approximately $30.0 million of
the unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded related to the higher audit and endorsement
premium.
In the third quarter of 2004, approximately $15.0 million of unfavorable net
prior year claim and allocated claim adjustment expense development was
recorded in relation to CNA's share of the National Workers Compensation
Reinsurance Pool ("NWCRP"). During the third quarter of 2004, the NWCRP
reached an agreement with a former pool member to settle their pool
liabilities at an amount less than their established share. The result of this
settlement will be a higher allocation to the remaining pool members,
including CNA.
The following discusses net prior year development for Standard Lines
recorded for the nine months ended September 30, 2003.
Approximately $495.0 million of unfavorable claim and allocated claim
adjustment expense reserve development was recorded related to construction
defect claims for the nine months ended September 30, 2003. Based on analyses
completed during the third quarter of 2003, it became apparent that the
assumptions regarding the number of claims, which were used to estimate the
expected losses, were no longer appropriate. The analyses indicated that the
actual number of claims reported during 2003 was higher than expected
primarily in states other than California. States where this activity is most
evident include Texas, Arizona, Nevada, Washington and Colorado. The number of
claims reported in states other than California during the first six months of
2003 was almost 35.0% higher than the last six months of 2002. The number of
claims reported during the last six months of 2002 increased by less than
10.0% from the first six months of 2002. In California, claims resulting from
34
additional insured endorsements increased throughout 2003. Additional insured
endorsements are regularly included on policies provided to subcontractors.
The additional insured endorsement names general contractors and developers as
additional insureds covered by the policy. Current California case law
(Presley Homes, Inc. v. American States Insurance Company, (June 11, 2001) 90
Cal App. 4th 571, 108 Cal. Rptr. 2d 686) specifies that an individual
subcontractor with an additional insured obligation has a duty to defend the
additional insured in the entire action, subject to contribution or recovery
later. In addition, the additional insured is allowed to choose one specific
carrier to defend the entire action. These additional insured claims can
remain open for a longer period of time than other construction defect claims
because the additional insured defense obligation can continue until the
entire case is resolved. The adverse reserve development recorded related to
construction defect claims was primarily related to accident years 1999 and
prior.
Unfavorable net prior year development of approximately $595.0 million,
including $518.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $77.0 million of unfavorable premium
development, was recorded for large account business including workers
compensation coverages for the nine months ended September 30, 2003. Many of
the policies issued to these large accounts include provisions tailored
specifically to the individual accounts. Such provisions effectively result in
the insured being responsible for a portion of the loss. An example of such a
provision is a deductible arrangement where the insured reimburses CNA for all
amounts less than a specified dollar amount. These arrangements often limit
the aggregate amount the insured is required to reimburse CNA.
Analyses completed during the second and third quarters of 2003, including
claims handled by third party administrators ("TPA"), indicated higher losses
from the large accounts. In addition, these analyses indicated that the
provisions that result in the insured being responsible for a portion would
have less of an impact due to the larger size of claims as well as the
increased number of claims. The development recorded was primarily related to
accident years 2000 and prior.
Approximately $98.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003, resulted from a program covering facilities
that provide services to developmentally disabled individuals. This net prior
year development was due to an increase in the size of known claims and
increases in policyholder defense costs. With regard to average claim size,
updated data showed the average claim increasing at an annual rate of
approximately 20.0%. Prior data had shown average claim size to be level.
Similar to the average claim size, updated data showed the average
policyholder defense cost increasing at an annual rate of approximately 20.0%.
Prior data had shown average policyholder defense cost to be level. The net
prior year development recorded was primarily for accident years 2001 and
prior.
Approximately $40.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was for excess workers compensation coverages
due to increasing severity. The increase in severity means that a higher
percentage of the total loss dollars will be CNA's responsibility since more
claims will exceed the point at which CNA's coverage begins. The net prior
year development recorded was primarily for accident year 2000.
35
Approximately $73.0 million of unfavorable development recorded for the nine
months ended September 30, 2003 was the result of a commutation of all ceded
reinsurance treaties with Gerling Global Group of companies ("Gerling"),
related to accident years 1999 through 2001, including $41.0 million of
unfavorable claim and allocated claim adjustment expense development and $32.0
million of unfavorable premium development.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $40.0 million recorded for the nine
months ended September 30, 2003 was related to a program covering tow truck
and ambulance operators, primarily impacting the 2001 accident year. CNA had
previously expected that loss ratios for this business would be similar to its
middle market commercial automobile liability business. During 2002, CNA
ceased writing business under this program.
Approximately $25.0 million of unfavorable net prior year premium
development was recorded for the nine months ended September 30, 2003 was
related to a second quarter of 2003 reevaluation of losses ceded to a
reinsurance contract covering middle market workers compensation exposures.
The reevaluation of losses led to a new estimate of the number and dollar
amount of claims that would be ceded under the reinsurance contract. As a
result of the reevaluation of losses, the Company recorded approximately $36.0
million of unfavorable claim and allocated claim adjustment expense reserve
development, which was ceded under the contract. The net prior year
development was recorded for accident year 2000.
Approximately $11.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was related to directors and officers
exposures in Global Lines. The unfavorable net prior year reserve development
was primarily due to securities class action cases related to certain known
corporate malfeasance cases and investment banking firms. This net prior year
development recorded was primarily for accident years 2000 through 2002.
The following premium and claim and allocated claim adjustment expense
development was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in reserve positions within the
segment. Unfavorable net prior year development of approximately $210.0
million related to small and middle market workers compensation exposures and
approximately $110.0 million related to E&S lines was recorded in the third
quarter of 2003. Offsetting these increases was $210.0 million of favorable
net prior year development in the property line of business, including $79.0
million related to the September 11, 2001 World Trade Center Disaster and
related events ("WTC event").
Also, offsetting the unfavorable premium and claim and allocated claim
adjustment expense development was a $215.0 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties recorded in the nine
months ended September 30, 2003 of which $140.0 million was recorded in the
third quarter of 2003. The benefit is comprised of $480.0 million of ceded
losses and $265.0 million of ceded premiums for accident years 2000 and 2001.
Specialty Lines
Unfavorable net prior year development of $39.0 million, including $65.0
million of unfavorable net claim and allocated claim adjustment expense
reserve development and $26.0 million of favorable premium development, was
recorded for the nine months ended September 30, 2004 for Specialty Lines.
Unfavorable net prior year development of $287.0 million, including $263.0
36
million of unfavorable net claim and allocated claim adjustment expense
reserve development and $24.0 million of unfavorable premium development, was
recorded for the same period in 2003. The gross and net carried claim and
claim adjustment expense reserves were $4,658.0 and $3,141.0 million at
September 30, 2004. The gross and net carried claim and claim adjustment
expense reserves for Specialty Lines were $4,200.0 and $2,919.0 million at
December 31, 2003.
CNA finalized commutation agreements with several members of the Trenwick
Group in the second quarter of 2004. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance. Additionally, unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from the
increased emergence of several large directors and officers claims, primarily
in recent accident years.
The following discusses net prior year development for Specialty Lines
recorded for the nine months ended September 30, 2003.
Approximately $50.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was related to increased severity in excess
coverages provided to facilities providing health care services. The increase
in reserves is based on reviews of individual accounts where claims had been
expected to be less than the point at which CNA's coverage applies. The
current claim trends indicated that the layers of coverage provided by CNA
would be impacted. The net prior year development recorded was primarily for
accident years 2001 and prior.
Approximately $68.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was for surety coverages related to primarily
workers compensation bond exposure from accident years 1990 and prior and
large losses for accident years 1999 and 2002. Approximately $21.0 million of
unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded in the surety line of business in the second
quarter of 2003 as the result of recent developments on one large claim.
Approximately $75.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was related to directors and officers
exposures in CNA Pro. The unfavorable net prior year reserve development was
primarily due to securities class action cases related to certain known
corporate malfeasance cases and investment banking firms. This net prior year
development recorded was primarily for accident years 2000 through 2002.
Approximately $47.0 million of losses was recorded for third quarter of 2003
as the result of a commutation of ceded reinsurance treaties with Gerling,
relating to accident years 1999 through 2002. An additional $37.0 million of
losses was recorded in the second quarter of 2003 as the result of a
commutation of three ceded reinsurance treaties covering CNA HealthPro,
relating to accident years 1999 through 2001.
The following development was recorded in the third quarter of 2003 as a
result of the elimination of deficiencies and redundancies in reserve
positions within the segment. An additional $50.0 million of unfavorable net
prior year claim and allocated claim adjustment expense reserve development
was recorded related to medical malpractice and long term care facilities.
37
Partially offsetting this unfavorable claim and allocated claim adjustment
expense reserve development was a $27.0 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties. The benefit was
comprised of $59.0 million of ceded losses and $32.0 million of ceded premiums
for accident years 2000 and 2001. See Note 5 for further discussion of CNA's
aggregate reinsurance treaties.
Other Insurance
Unfavorable net prior year development of $76.0 million, including $63.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $13.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2004 for other insurance.
Unfavorable net prior year development of $1,058.0 million, including $1,027.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $31.0 million of unfavorable premium development, was
recorded for the same period in 2003. The gross and net carried claim and
claim adjustment expense reserves were $8,760.0 and $3,277.0 million at
September 30, 2004. The gross and net carried claim and claim adjustment
expense reserves for other insurance were $9,672.0 and $3,737.0 million at
December 31, 2003.
The net prior year development recorded for 2004 relates primarily to
commutation agreements with several members of the Trenwick Group which
resulted in unfavorable net prior year development which was partially offset
by a release of a previously established allowance for uncollectible
reinsurance.
The following discusses net prior year development for Other Insurance
recorded for the nine months ended September 30, 2003.
Unfavorable claim and allocated claim adjustment expense reserve development
of $795.0 million related to APMT was recorded in the nine months ended
September 30, 2003. Unfavorable net prior year development of $148.0 million,
including $109.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $39.0 million of unfavorable premium
development, was recorded for the nine months ended September 30, 2003 related
to CNA Re.
The unfavorable net prior year development was primarily a result of a
general change in the reporting pattern of losses as reported by the companies
that purchased reinsurance from CNA Re. Losses have continued to show large
increases for accident years in the late 1990s and into 2000 and 2001. These
increases are greater than the increases indicated by patterns from older
accident years and have a similar effect on several lines of business.
Approximately $67.0 million unfavorable net prior year development recorded
for nine months ended September 30, 2003 was related to proportional liability
exposures, primarily from multi-line and umbrella treaties in accident years
1997 through 2001. Approximately $32.0 million of unfavorable net prior year
development recorded for the nine months ended September 30, 2003, was related
to assumed financial reinsurance for accident years 2001 and prior and
approximately $24.0 million of unfavorable net prior year development related
to professional liability exposures in accident years 2001 and prior.
CNA Re recorded an additional $15.0 million of unfavorable development for
construction defect related exposures. Because of the unique nature of this
exposure, losses have not followed expected development patterns. The
continued reporting of claims in California, the increase in the number of
claims from states other than California and a review of individual ceding
38
companies' exposure to this type of claim resulted in an increase in the
estimated reserve.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $25.0 million was recorded primarily for
directors and officers exposures. The net prior year reserve development was a
result of a claims review that was completed during the second quarter of
2003. The unfavorable net prior year reserve development was primarily due to
securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. The net prior year reserve development
recorded was for accident years 2000 and 2001.
The following premium and claim and allocated claim adjustment expense
development, was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in the reserve positions of
individual products within the segment. Unfavorable net prior year premium and
claim and allocated claim adjustment expense development of approximately
$42.0 million related to surety exposures, $32.0 million related to excess of
loss liability exposures and $12.0 million related to facultative liability
exposures were recorded in the third quarter of 2003. Offsetting this
unfavorable premium and claim and allocated claim adjustment expense reserve
development was approximately $55.0 million of favorable development related
to the WTC event. In addition, there was a $47.0 million underwriting benefit
from cessions to corporate aggregate reinsurance treaties for the nine months
ended September 30, 2003 of which $55.0 million was recorded in the third
quarter of 2003. The benefit was comprised of $104.0 million of ceded losses
and $57.0 million of ceded premiums for accident years 2000 and 2001. See Note
5 for further discussion of CNA's aggregate reinsurance treaties.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $75.0 million recorded for the nine
months ended September 30, 2003 was related to an adverse arbitration decision
in the second quarter of 2003 involving a single large property and business
interruption loss. The decision was rendered against a voluntary insurance
pool in which CNA was a participant. The loss was caused by a fire which
occurred in 1995. CNA no longer participates in this pool.
39
8. Shareholders' Equity
September 30, December 31,
2004 2003
- -----------------------------------------------------------------------------------------------
(In millions of dollars, except per share data)
Preferred stock, $0.10 par value,
Authorized - 100,000,000 shares
Common stock:
Loews common stock, $1.00 par value:
Authorized - 600,000,000 shares
Issued and outstanding - 185,499,300 and 185,447,050 shares $ 185.5 $ 185.4
Carolina Group stock, $0.01 par value:
Authorized - 600,000,000 shares
Issued - 58,306,750 and 58,305,000 shares 0.6 0.6
Additional paid-in capital 1,514.8 1,513.7
Earnings retained in the business 9,168.0 8,602.1
Accumulated other comprehensive income 590.3 760.2
- -----------------------------------------------------------------------------------------------
11,459.2 11,062.0
Less treasury stock, at cost (340,000 shares of Carolina Group stock) 7.7 7.7
- -----------------------------------------------------------------------------------------------
Total shareholders' equity $11,451.5 $11,054.3
===============================================================================================
9. Debt
Unamortized Short-term Long-term
September 30, 2004 Principal Discount Net Debt Debt
- ------------------------------------------------------------------------------------------------
(In millions)
Loews Corporation $ 2,325.0 $ 20.6 $ 2,304.4 $ 2,304.4
CNA 1,674.3 6.9 1,667.4 $ 530.8 1,136.6
Diamond Offshore 1,202.0 17.1 1,184.9 479.2 705.7
Texas Gas 535.0 3.9 531.1 531.1
Loews Hotels 144.4 144.4 45.6 98.8
- ------------------------------------------------------------------------------------------------
Total $ 5,880.7 $ 48.5 $ 5,832.2 $ 1,055.6 $ 4,776.6
================================================================================================
40
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Loews Corporation (Parent Company):
Senior:
6.8% notes due 2006 (effective interest rate of 6.8%)
(authorized, $300) $ 300.0 $ 300.0
8.9% debentures due 2011 (effective interest rate of 9.0%)
(authorized, $175) 175.0 175.0
5.3% notes due 2016 (effective interest rate of 5.4%)
(authorized, 300) (a) 300.0
7.6% notes due 2023 (effective interest rate of 7.8%)
(authorized, $300) 300.0
7.0% notes due 2023 (effective interest rate of 7.2%)
(authorized, $400) (b) 400.0 400.0
Subordinated:
3.1% exchangeable subordinated notes due 2007
(effective interest rate of 3.4%) (authorized, $1,150) (c) 1,150.0 1,150.0
CNA Financial Corporation:
Senior:
6.5% notes due 2005 (effective interest rate of 6.6%)
(authorized, $500) 492.8 492.8
6.8% notes due 2006 (effective interest rate of 6.8%)
(authorized, $250) 250.0 250.0
6.5% notes due 2008 (effective interest rate of 6.6%)
(authorized, $150) 150.0 150.0
6.6% notes due 2008 (effective interest rate of 6.7%)
(authorized, $200) 200.0 200.0
8.4% notes due 2012 (effective interest rate of 8.6%)
(authorized, $100) 69.6 69.6
7.0% notes due 2018 (effective interest rate of 7.1%)
(authorized, $150) 150.0 150.0
7.3% debentures due 2023 (effective interest rate of 7.3%)
(authorized, $250) 243.0 243.0
5.1% debentures due 2034 (effective interest rate of 5.1%)
(authorized, $31) 30.5
Revolving credit facility due 2004 (effective interest rate of 2.3%) 250.0
Term loan due 2005 (effective interest rate of 2.8% and 2.8%) 10.0 20.0
Revolving credit facility due 2005 (effective interest rate
of 3.5 and 2.6%) 25.0 30.0
Other senior debt (effective interest rates approximate 7.7% and 7.8%) 53.4 56.1
Diamond Offshore Drilling, Inc.:
Senior:
Zero coupon convertible debentures due 2020, net of discount of $337.8
and $349.8 (effective interest rate of 3.6%) (d) 467.2 455.2
1.5% convertible senior debentures due 2031 (effective interest rate
of 1.6%) (authorized $460) (e) 460.0 460.0
5.2% notes, due 2014 (effective interest rate of 5.2%)
(authorized $250) (f) 250.0
Subordinated debt due 2005 (effective interest rate of 7.1%) 24.8 24.8
Texas Gas:
4.6% notes due 2015 (effective interest rate of 5.1%) (authorized, $250) 250.0 250.0
5.2% notes due 2018 (effective interest rate of 5.4%) (authorized, $185) 185.0 185.0
7.3% debentures due 2027 (effective interest rate of 8.1%)
(authorized, $100) 100.0 100.0
Other senior debt (effective interest rate of 9.0%) 17.3
Loews Hotels:
Senior debt, principally mortgages (effective interest rates
approximate 4.2% and 4.1%) 144.4 146.5
- ------------------------------------------------------------------------------------------------
5,880.7 5,875.3
Less unamortized discount 48.5 55.1
- ------------------------------------------------------------------------------------------------
Debt, less unamortized discount $ 5,832.2 $ 5,820.2
================================================================================================
41
(a) Redeemable in whole or in part at the greater of the principal amount or the net present
value of scheduled payments discounted at the specified treasury rate plus 25 basis points.
(b) Redeemable in whole or in part at 102.4%, and decreasing percentages annually.
(c) The notes are exchangeable into 15.376 shares of Diamond Offshore's common stock per one
thousand dollars principal amount of notes, at a price of $65.04 per share. Redeemable in
whole or in part at 101.3%, and decreasing percentages annually.
(d) The debentures are convertible into Diamond Offshore's common stock at the rate of 8.6075
shares per one thousand dollars principal amount, subject to adjustment. Each debenture
will be purchased by Diamond Offshore at the option of the holder on the fifth, tenth and
fifteenth anniversaries of issuance at the accreted value through the date of repurchase.
The debentures were issued on June 6, 2000. Diamond Offshore, at its option, may elect to
pay the purchase price in cash or shares of common stock, or in certain combinations
thereof. The debentures are redeemable at the option of Diamond Offshore at any time after
June 6, 2005, at prices which reflect a yield of 3.5% to the holder.
(e) The debentures are convertible into Diamond Offshore's common stock at an initial
conversion rate of 20.3978 shares per one thousand dollars principal amount, subject to
adjustment in certain circumstances. Upon conversion, Diamond Offshore has the right to
deliver cash in lieu of shares of its common stock. Diamond Offshore may redeem all or a
portion of the Debentures at any time on or after April 15, 2008 at a price equal to 100%
of the principal amount. Holders may require Diamond Offshore to purchase all or a portion
of the debentures on April 15, 2008, at a price equal to 100% of the principal amount.
Diamond Offshore, at its option, may elect to pay the purchase price in cash or shares of
common stock, or in certain combinations thereof.
(f) Redeemable in whole or in part at the greater of the principal amount or the net present
value of scheduled payments discounted at the specified treasury rate plus 20 basis points.
On March 11, 2004 the Company issued $300.0 million aggregate principal
amount of 5.3% notes due March 15, 2016. These notes were issued at 99.8050%
of principal amount and resulted in net proceeds to the Company of $297.1
million.
On April 12, 2004 the Company redeemed $300.0 million principal amount of
its 7.6% notes due 2016.
On August 27, 2004, Diamond Offshore issued $250.0 million aggregate
principal amount of 5.2% senior notes due September 1, 2014. These notes were
issued at 99.759% of the principal amount and resulted in net proceeds to
Diamond Offshore of $247.8 million.
As of September 30, 2004, the aggregate accreted value of Diamond Offshore's
Zero Coupon Debentures was $467.2 million. Since the holders of the debentures
have the right to require Diamond Offshore to repurchase the debentures within
the current operating cycle, the debentures are classified as short-term debt
in the Company's Consolidated Condensed Balance Sheet at September 30, 2004.
10. Significant Transactions
Hellespont Shipping Corporation
Hellespont Shipping Corporation ("Hellespont"), in which the Company has a
49% common stock interest, sold all of its ultra-large crude oil tankers in
July of 2004. The Company received cash distributions from Hellespont and
recognized income of $179.3 million ($116.5 million after taxes) for the three
and nine months ended September 30, 2004.
Texas Gas Transmission, LLC
As previously discussed in the Company's 2003 Annual Report on Form 10-K/A,
the Company, through a wholly owned subsidiary, TGT Pipeline, LLC ("TGT"),
acquired Texas Gas from The Williams Companies, Inc. ("Williams") in May of
2003.
42
The following unaudited pro forma financial information is presented as if
Texas Gas had been acquired as of January 1, 2003. The pro forma amounts
include certain adjustments, including a reduction of depreciation expense
based on the preliminary allocation of purchase price to property, plant and
equipment; adjustment of interest expense to reflect the issuance of debt by
Texas Gas and TGT, and redemption of $132.7 million principal amount of Texas
Gas's existing notes; and the related tax effect of these items. The pro forma
amounts do not reflect any adjustments related to the separation of Texas Gas
from Williams for certain services provided by Williams under a transition
services agreement.
Nine Months Ended
September 30, 2003
----------------------
(In millions, except
per share data)
Total revenues $12,241.5
Loss from continuing operations (998.6)
Net loss (943.2)
Loss per share of Loews common stock:
Loss from continuing operations (5.82)
Net loss (5.52)
================================================================================================
The pro forma information does not necessarily reflect the actual results
that would have occurred had the companies been combined during the period
presented, nor is it necessarily indicative of future results of operations.
CNA Trust
On August 1, 2004, CNA completed the sale of the retirement plan trust and
recordkeeping business portfolio of CNA Trust to Union Bank of California,
N.A. ("Union Bank") for approximately $12.0 million. As a result of the sale,
CNA recorded a realized investment gain of approximately $9.0 million pretax
($4.6 million after-tax and minority interest) for the three and nine months
ended September 30, 2004.
Union Bank assumed assets and liabilities of $172.0 and $172.0 million at
August 1, 2004. The assets and liabilities of CNA Trust were $216.0 and $184.0
million at December 31, 2003. The revenues of the business sold through the
sale date were $1.0 and $6.0 million for the three months ended September 30,
2004 and 2003, and $11.0 and $20.0 million for the nine months ended September
30, 2004 and 2003. Net results of this business through the sale date were a
net loss of $0.3 and $0.4 million for the three months ended September 30,
2004 and 2003, and a net loss of $1.8 and $0.03 million for the nine months
ended September 30, 2004 and 2003.
Individual Life Sale
On April 30, 2004, CNA completed the sale of its individual life insurance
business to Swiss Re. The business sold included term, universal and permanent
life insurance policies and individual annuity products. CNA's individual long
term care and structured settlement businesses were excluded from the sale.
Swiss Re acquired Valley Forge Life Insurance Company, a wholly owned
subsidiary of CAC, and CNA's Nashville, Tennessee insurance servicing and
administration building as part of the sale. In connection with the sale, CNA
43
entered into a reinsurance agreement in which CAC ceded its individual life
insurance business to Swiss Re on a 100.0% indemnity reinsurance basis. As a
result of this reinsurance agreement, approximately $1.0 billion of future
policy benefit reserves were ceded to Swiss Re. CNA received consideration of
approximately $700.0 million and recorded a realized investment loss of $618.6
million pretax ($352.9 million after-tax and minority interest) during the six
months ended June 30, 2004.
Swiss Re assumed assets and liabilities of $6.6 and $5.2 billion at April
30, 2004. The assets and liabilities of the individual life business sold were
$6.6 and $5.4 billion at December 31, 2003. The revenues of the individual
life business through the sale date were $151.0 million for the nine months
ended September 30, 2004 and $168.0 and $475.0 million for the three and nine
months ended September 30, 2003. The net results for this business through the
sale date were a net loss of $5.5 million for the nine months ended September
30, 2004 and net income of $20.7 and $24.3 million for the three and nine
months ended September 30, 2003.
Group Benefits Sale
On December 31, 2003, CNA completed the sale of the majority of its group
benefits business through the sale of CNA Group Life Assurance Company
("CNAGLA") to Hartford Financial Services Group, Inc. ("Hartford"). The
business sold included group life and accident, short and long term disability
and certain other products. CNA's group long term care and specialty medical
businesses were excluded from the sale. In connection with the sale, CNA
received consideration of approximately $530.0 million and recorded an after-
tax and minority interest realized investment loss on the sale of $109.1
million ($163.0 million pretax), including an after tax and minority interest
realized investment gain of $7.3 million ($13.0 million pretax) recorded in
the second quarter of 2004.
As a result of this agreement, Hartford assumed assets and liabilities of
$2.4 and $1.6 billion at December 31, 2003. The revenues of the group benefits
business were $314.0 and $910.0 million for the three and nine months ended
September 30, 2003. Net income was $10.8 and $24.3 million for the three and
nine months ended September 30, 2003.
Personal Insurance Transaction
As part of the sale of CNA's personal insurance business to The Allstate
Corporation on October 1, 1999, CNA shared in claim and allocated claim
adjustment expenses if payments related to losses incurred prior to October 1,
1999 on the CNA policies transferred to Allstate exceeded the claim and
allocated claim adjustment expense reserves of approximately $1.0 billion at
the date of sale. CNA's remaining obligation with respect to claim and
allocated claim adjustment expense reserves, valued as of October 1, 2003, was
settled in March of 2004 and the sharing agreement was terminated. This
settlement did not have a material impact on the results of operations of the
Company for the nine months ended September 30, 2004.
11. Statutory Accounting Practices
CNA's insurance subsidiaries maintain their accounts in conformity with
accounting practices prescribed or permitted by state insurance regulatory
authorities which vary in certain respects from GAAP. In converting from
statutory to GAAP, typical adjustments include deferral of policy acquisition
costs and the inclusion of net realized holding gains or losses in
shareholders' equity relating to fixed maturity securities. The National
44
Association of Insurance Commissioners ("NAIC") developed a codified version
of statutory accounting principles, designed to foster more consistency among
the states for accounting guidelines and reporting.
CNA's insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or permitted by the respective jurisdictions'
insurance regulators. Prescribed statutory accounting practices are set forth
in a variety of publications of the NAIC as well as state laws, regulations
and general administrative rules.
CNA follows a permitted practice that allows CIC to classify voluntary pools
that are unauthorized in South Carolina but were classified as authorized in
New Hampshire, CIC's former state of domicile, as authorized in order to allow
credit for the related reinsurance balances. Due to CIC's redomestication to
South Carolina effective January 1, 2004, this permitted practice was
requested and has been granted through the period ended December 31, 2004, and
is intended to allow CIC time to pursue the authorization of certain
reinsurers on a South Carolina basis. CNA has now determined that pool members
representing approximately 80.0% of the participation in the underlying pools
are either currently licensed or authorized in the State of South Carolina. As
of December 31, 2003, the ceded reserve credit for the entire reinsurance
recoverable from voluntary pools classified as authorized was $348.0 million.
The impact of this permitted practice on statutory surplus has not been fully
quantified as CNA's review of the South Carolina status of the underlying pool
members is still in process.
CNA's ability to pay dividends and other credit obligations is significantly
dependent on receipt of dividends from its subsidiaries. The payment of
dividends to CNA by its insurance subsidiaries without prior approval of the
insurance department of each subsidiary's domiciliary jurisdiction is limited
by formula. Dividends in excess of these amounts are subject to prior approval
by the respective state insurance departments.
Dividends from CCC are subject to the insurance holding company laws of the
State of Illinois, the domiciliary state of CCC. Under these laws, ordinary
dividends, or dividends that do not require prior approval of the Illinois
Department of Insurance (the "Department"), may be paid only from earned
surplus, which is calculated by removing unrealized gains from unassigned
surplus. As of September 30, 2004, CCC is in a negative earned surplus
position. Until CCC is in a positive earned surplus position, all dividends
require prior approval of the Department. In January of 2004, the Department
approved extraordinary dividend capacity in the amount of approximately $312.0
million to be used to fund CNA's 2004 debt service and principal repayment
requirements. As of September 30, 2004, there is approximately $41.0 million
of this dividend capacity available.
Combined statutory capital and surplus and net income (loss), determined in
accordance with accounting practices prescribed or permitted by insurance
regulatory authorities for the property and casualty and the life and group
insurance subsidiaries, were as follows.
45
Statutory Net Income (Loss)
Statutory Capital --------------------------------------------------------
and Surplus Three Months Ended Nine Months Ended
------------------------- September 30, September 30,
September 30, December 31, -------------------------- ---------------------------
2004 2003 2004 2003 2004 2003
- ------------------------------------- --------------------------------------------------------
(In millions)
Property and
casualty
companies $6,603.0 $6,170.0 $(132.0) $(1,886.0) $ 259.0 $(1,886.0)
Life insurance
companies (a) 1,255.0 707.0 20.0 50.0 709.0 (11.0)
- ------------------------------------------------------------------------------------------------
(a) The statutory net income (loss) for the nine months ended September 30, 2004 and the three
and nine months ended September 30, 2003 includes the individual life insurance business.
The statutory net income (loss) for the three and nine months ended September 30, 2003
includes the group benefits business sold on December 31, 2003.
12. Benefit Plans
Pension Plans - The Company has several non-contributory defined benefit
plans for eligible employees. The benefits for certain plans which cover
salaried employees and certain union employees are based on formulas which
include, among others, years of service and average pay. The benefits for one
plan which covers union workers under various union contracts and certain
salaried employees are based on years of service multiplied by a stated
amount. Benefits for another plan are determined annually based on a specified
percentage of annual earnings (based on the participant's age) and a specified
interest rate (which is established annually for all participants) applied to
accrued balances.
The Company's funding policy is to make contributions in accordance with
applicable governmental regulatory requirements. The assets of the plans are
invested primarily in interest-bearing obligations.
Other Postretirement Benefit Plans - The Company has several postretirement
benefit plans covering eligible employees and retirees. Participants generally
become eligible after reaching age 55 with required years of service. Actual
requirements for coverage vary by plan. Benefits for retirees who were covered
by bargaining units vary by each unit and contract. Benefits for certain
retirees are in the form of a Company health care account.
Benefits for retirees reaching age 65 are generally integrated with
Medicare. Other retirees, based on plan provisions, must use Medicare as their
primary coverage, with the Company reimbursing a portion of the unpaid amount;
or are reimbursed for the Medicare Part B premium or have no Company coverage.
The benefits provided by the Company are basically health and, for certain
retirees, life insurance type benefits.
The Company does not fund any of these benefit plans and accrues
postretirement benefits during the active service of those employees who would
become eligible for such benefits when they retire.
46
Net periodic benefit cost components:
Pension Benefits
- ------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Service cost $ 12.6 $ 13.3 $ 47.9 $ 39.7
Interest cost 46.5 51.5 199.0 154.7
Expected return on plan assets (48.7) (54.2) (214.2) (162.6)
Amortization of unrecognized net loss 0.7 0.4 2.1 1.1
Amortization of unrecognized prior service cost 1.9 2.3 6.5 6.8
Actuarial loss 3.3 1.6 13.2 4.8
- ------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 16.3 $ 14.9 $ 54.5 $ 44.5
================================================================================================
Other Postretirement Benefits
- ------------------------------------------------------------------------------------------------
Service cost $ 2.6 $ 3.2 $ 10.4 $ 9.6
Interest cost 8.4 9.5 36.6 28.4
Expected return on plan assets (1.3) (0.8) (3.9) (2.4)
Amortization of unrecognized net gain (0.2) (0.9) (0.6) (2.7)
Amortization of unrecognized prior service cost (3.5) (4.6) (21.6) (13.6)
Actuarial loss 0.8 1.0 3.7 3.1
- ------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 6.8 $ 7.4 $ 24.6 $ 22.4
================================================================================================
13. Business Segments
The Company's reportable segments are primarily based on its individual
operating subsidiaries. Each of the principal operating subsidiaries are
headed by a chief executive officer who is responsible for the operation of
its business and has the duties and authority commensurate with that position.
Investment gains (losses) and the related income taxes, excluding those of CNA
Financial, are included in the Corporate and other segment.
As a result of CNA's decisions to focus on property and casualty operations
and to exit certain businesses, the Company revised its reportable segment
structure to reflect changes in CNA's core operations and how it makes
business decisions. CNA now manages its property and casualty operations in
two operating segments which represent CNA's core operations: Standard Lines
and Specialty Lines. The non-core operations are now managed in Life and Group
Non-Core Segment and Other Insurance Segment. Standard Lines includes standard
property and casualty coverages sold to small and middle market commercial
businesses primarily through an independent agency distribution system, and
excess and surplus lines, as well as insurance and risk management products
sold to large corporations in the U.S. and globally. Specialty Lines provides
professional, financial and specialty property and casualty products and
services. Life and Group Non-Core primarily includes the results of the life
and group lines of business sold or placed in run-off. Other Insurance
primarily includes the results of certain property and casualty lines of
business placed in run-off, including CNA Re. This segment also includes the
results related to the centralized adjusting and settlement of APMT claims as
well as the results of CNA's participation in voluntary insurance pools, which
47
are primarily in run-off and various other non-insurance operations. Prior
period segment disclosures have been conformed to the current year
presentation.
The changes made to the Company's reportable segments were as follows: 1)
Standard Lines and Specialty Lines (formerly included in the Property and
Casualty segment) are now reported as separate individual segments; 2) CNA
Global (formerly included in Specialty Lines) which consists of marine and
global standard lines is now included in Standard Lines; 3) CNA Guaranty and
Credit (formerly included in Specialty Lines) is currently in run-off and is
now included in the Other Insurance segment; 4) CNA Re (formerly included in
the Property and Casualty segment) is currently in run-off and is also now
included in the Other Insurance segment; 5) Group Operations and Life
Operations (formerly separate reportable segments) have now been combined into
one reportable segment where the run-off of the retained group and life
products will be managed; and 6) certain run-off life and group operations
(formerly included in the Other Insurance segment) are now included in the
Life and Group Non-Core segment.
In addition, the operations of Bulova were formerly reported in its own
operating segment and are now included in the Corporate and other segment.
Lorillard is engaged in the production and sale of cigarettes with its
principal products marketed under the brand names of Newport, Kent, True,
Maverick and Old Gold with substantially all of its sales in the United
States.
Loews Hotels owns and/or operates 20 hotels, 18 of which are in the United
States and two are in Canada.
Diamond Offshore's business primarily consists of operating 45 offshore
drilling rigs that are chartered on a contract basis for fixed terms by
companies engaged in exploration and production of hydrocarbons. Offshore rigs
are mobile units that can be relocated based on market demand.
Texas Gas owns and operates a 5,800-mile natural gas pipeline system that
transports natural gas originating in the Louisiana Gulf Coast and East Texas
and running north and east through Louisiana, Arkansas, Mississippi,
Tennessee, Kentucky, Indiana and into Ohio, with smaller diameter lines
extending into Illinois. Texas Gas has a delivery capacity of 2.8 billion
cubic feet ("Bcf") per day and a working storage capacity of 55 Bcf.
The Corporate and other segment consists primarily of investment income,
including investment gains (losses) from non-insurance subsidiaries, as well
as the operations of Bulova Corporation which distributes and sells watches
and clocks, equity earnings from shipping operations, corporate interest
expenses and other corporate administrative costs.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. In addition, CNA does not
maintain a distinct investment portfolio for each of its insurance segments,
and accordingly, allocation of assets to each segment is not performed.
Therefore, investment income and investment gains (losses) are allocated based
on each segment's carried insurance reserves, as adjusted.
48
The following tables set forth the Company's consolidated revenues and
income (loss) by business segment:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues (a):
CNA Financial:
Standard Lines $ 1,305.9 $ 1,149.2 $ 4,340.7 $ 3,943.4
Specialty Lines 659.8 552.5 1,983.2 1,650.5
Life and Group Non-core 305.2 908.7 626.9 2,536.6
Other Insurance 46.2 115.4 297.6 549.1
- ------------------------------------------------------------------------------------------------
Total CNA Financial 2,317.1 2,725.8 7,248.4 8,679.6
Lorillard 886.7 854.0 2,536.2 2,497.4
Loews Hotels 66.9 65.9 233.9 213.5
Diamond Offshore 209.7 185.0 583.3 504.9
Texas Gas 47.2 45.0 185.3 68.1
Corporate and other 257.8 64.3 404.0 161.8
- ------------------------------------------------------------------------------------------------
Total $ 3,785.4 $ 3,940.0 $11,191.1 $12,125.3
================================================================================================
Pretax income (loss)(a):
CNA Financial:
Standard Lines $ (163.5) $(1,407.3) $ 246.3 $(1,386.8)
Specialty Lines 109.8 (238.6) 392.2 (115.7)
Life and Group Non-core (24.2) 57.4 (659.1) 103.1
Other Insurance 1.8 (1,188.1) 113.2 (1,177.6)
- ------------------------------------------------------------------------------------------------
Total CNA Financial (76.1) (2,776.6) 92.6 (2,577.0)
Lorillard 297.0 242.4 744.1 709.8
Loews Hotels (1.2) (0.1) 23.1 17.6
Diamond Offshore 1.4 (8.4) (29.1) (56.1)
Texas Gas 1.8 4.1 53.3 6.7
Corporate and other 179.5 (12.0) 152.6 (66.6)
- ------------------------------------------------------------------------------------------------
Total $ 402.4 $(2,550.6) $ 1,036.6 $(1,965.6)
================================================================================================
Net income (loss)(a):
CNA Financial:
Standard Lines $ (87.8) $ (819.8) $ 185.6 $ (788.4)
Specialty Lines 66.0 (114.4) 236.6 (41.8)
Life and Group Non-core (10.4) 42.9 (367.8) 73.5
Other Insurance 7.4 (689.5) 84.2 (670.3)
- ------------------------------------------------------------------------------------------------
Total CNA Financial (24.8) (1,580.8) 138.6 (1,427.0)
Lorillard 184.0 149.9 456.6 443.2
Loews Hotels (0.8) 14.0 11.2
Diamond Offshore 0.1 (5.1) (13.5) (26.5)
Texas Gas 1.0 2.2 32.0 3.8
Corporate and other 118.1 (4.9) 100.8 (38.2)
- ------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 277.6 (1,438.7) 728.5 (1,033.5)
Discontinued operations-net 55.8 55.4
- ------------------------------------------------------------------------------------------------
Total $ 277.6 $(1,382.9) $ 728.5 $ (978.1)
================================================================================================
49
(a) Investment gains (losses) included in Revenues, Pretax income (loss) and
Net income (loss) are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues and pretax income (loss):
CNA Financial:
Standard Lines $ (33.4) $ 57.8 $ 101.0 $ 249.2
Specialty Lines (12.9) 18.4 36.7 80.7
Life and Group Non-core 2.5 59.7 (612.2) 9.0
Other Insurance (18.4) 28.4 63.1 138.0
- ------------------------------------------------------------------------------------------------
Total CNA Financial (62.2) 164.3 (411.4) 476.9
Corporate and other 25.4 15.2 62.2 26.3
- ------------------------------------------------------------------------------------------------
Total $ (36.8) $ 179.5 $(349.2) $ 503.2
================================================================================================
Net income (loss):
CNA Financial:
Standard Lines $ (20.5) $ 32.4 $ 59.6 $ 144.8
Specialty Lines (7.7) 10.8 21.0 46.7
Life and Group Non-core 1.0 34.9 (349.6) 5.2
Other Insurance (11.0) 16.6 37.4 84.5
- ------------------------------------------------------------------------------------------------
Total CNA Financial (38.2) 94.7 (231.6) 281.2
Corporate and other 16.5 11.8 40.3 19.4
- ------------------------------------------------------------------------------------------------
Total $ (21.7) $ 106.5 $(191.3) $ 300.6
================================================================================================
14. Legal Proceedings
INSURANCE RELATED
IGI Contingency
In 1997, CNA Reinsurance Company Limited ("CNA Re Ltd.") entered into an
arrangement with IOA Global, Ltd. ("IOA"), an independent managing general
agent based in Philadelphia, Pennsylvania, to develop and manage a book of
accident and health coverages. Pursuant to this arrangement, IGI Underwriting
Agencies, Ltd.("IGI"), a personal accident reinsurance managing general
underwriter, was appointed to underwrite and market the book under the
supervision of IOA. Between April 1, 1997 and December 1, 1999, IGI underwrote
a number of reinsurance arrangements with respect to personal accident
insurance worldwide (the "IGI Program"). Under various arrangements, CNA Re
Ltd. both assumed risks as a reinsurer and also ceded a substantial portion of
those risks to other companies, including other CNA insurance subsidiaries and
ultimately to a group of reinsurers participating in a reinsurance pool known
as the Associated Accident and Health Reinsurance Underwriters ("AAHRU")
Facility. CNA's group operations business unit, now included in the Life and
Group Non-Core segment, participated as a pool member in the AAHRU Facility in
varying percentages between 1997 and 1999.
CNA has determined that a portion of the premiums assumed under the IGI
Program related to United States workers compensation "carve-out" business.
50
Some of these premiums were received from John Hancock Financial Services,
Inc. ("John Hancock"). CNA is aware that a number of reinsurers with workers
compensation carve-out insurance exposure, including John Hancock, have
disavowed their obligations under various legal theories. If one or more such
companies are successful in avoiding or reducing their liabilities, then it is
likely that CNA's potential liability will also be reduced. Moreover, based on
information known at this time, CNA believes it has strong grounds to
successfully challenge its alleged exposure on a substantial portion of its
United States workers compensation carve-out business, including all purported
exposure derived from John Hancock, through legal action.
As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. CNA believes it has valid and enforceable
reinsurance contracts with the AAHRU Facility and other reinsurers with
respect to the IGI Program, including the United States workers compensation
carve-out business. However, certain reinsurers have disputed their
liabilities to CNA, and CNA has commenced arbitration proceedings against such
reinsurers. CNA has resolved its dispute with respect to the validity and
enforceability of ceding IGI Program losses to the AAHRU Facility, including
the United States workers compensation carve-out business; however, an
arbitration is still pending with certain members of the AAHRU Facility
related to a dispute over the allocation of such losses to pool years. As a
result, CNA increased its insurance reserves related to the IGI program by
$18.0 million in the second quarter of 2004. An arbitration with another
reinsurer is also still pending.
CNA has established reserves for its estimated exposure under the IGI
Program, other than that derived from John Hancock, and an estimate for
recoverables from retrocessionaires. CNA has not established any reserve for
any exposure derived from John Hancock because, as indicated, CNA believes the
contract will be rescinded. An arbitration to determine whether rescission
will be granted is pending.
CNA is pursuing a number of loss mitigation strategies with respect to the
entire IGI Program. Although the results of these various actions to date
support the recorded reserves, the estimate of ultimate losses is subject to
considerable uncertainty due to the complexities described above. As a result
of these uncertainties, the results of operations in future periods may be
adversely affected by potentially significant reserve additions. Management
does not believe that any such reserve additions would be material to the
equity of CNA, although results of operations may be adversely affected. CNA's
position in relation to the IGI Program was unaffected by the sale of CNA Re
Ltd. in 2002.
California Wage and Hour Litigation
Ernestine Samora, et al. v. CCC, Case No. BC 242487, Superior Court of
California, County of Los Angeles, California and Brian Wenzel v. Galway
Insurance Company, Superior Court of California, County of Orange No.
BC01CC08868 are purported class actions on behalf of present and former CNA
employees asserting they worked hours for which they should have been
compensated at a rate of one and one-half times their base hourly wage over a
four-year period. CNA has denied the material allegations of the amended
complaint and intends to vigorously contest the claims. Based on facts and
circumstances presently known, in the opinion of management, an unfavorable
outcome would not materially affect the equity of the Company, although
results of operations may be adversely affected.
51
Voluntary Market Premium Litigation
CNA, along with dozens of other insurance companies, is a defendant in
twelve cases, including eleven purported class actions, brought by large
policyholders which generally allege that the defendants, as part of an
industry-wide conspiracy, included improper charges in their retrospectively
rated and other loss-sensitive insurance programs. Among the claims asserted
are violations of state antitrust laws, breach of contract, fraud and unjust
enrichment. In one federal court case, Sandwich Chef of Texas, Inc. v.
Reliance National Indemnity Insurance Co., 202 F.R.D. 480 (S.D. Tex. 2001),
rev'd, 319 F.3d 205 (5th Cir. 2003), cert. denied, 72 USLW 3235 (U.S. Oct 6,
2003), the United States Court of Appeals for the Fifth Circuit reversed a
decision by the District Court for the Southern District of Texas certifying a
multi-state class. CNA intends to vigorously contest these claims. Based on
facts and circumstances presently known, in the opinion of management, an
unfavorable outcome will not materially affect the equity of CNA, although
results of operations may be adversely affected.
See Note 7 for information with respect to claims and litigation involving
CNA related to environmental pollution, asbestos and mass torts.
Non-Insurance
TOBACCO RELATED
Tobacco Related Product Liability Litigation
Approximately 4,100 product liability cases are pending against cigarette
manufacturers in the United States. Lorillard is a defendant in approximately
3,750 of these cases.
The pending product liability cases are comprised of the following types of
cases:
"Conventional product liability cases" are brought by individuals who allege
cancer or other health effects caused by smoking cigarettes, by using
smokeless tobacco products, by addiction to tobacco, or by exposure to
environmental tobacco smoke. Approximately 1,350 cases are pending, including
approximately 1,050 cases against Lorillard. The 1,350 cases include
approximately 1,000 cases pending in a single West Virginia court that have
been consolidated for trial. Lorillard is a defendant in nearly 925 of the
approximately 1,000 consolidated West Virginia cases.
"Flight Attendant cases" are brought by non-smoking flight attendants
alleging injury from exposure to environmental smoke in the cabins of
aircraft. Plaintiffs in these cases may not seek punitive damages for injuries
that arose prior to January 15, 1997. Lorillard is a defendant in each of the
approximately 2,700 pending Flight Attendant cases.
"Class action cases" are purported to be brought on behalf of large numbers
of individuals for damages allegedly caused by smoking. Eleven of these cases
are pending against Lorillard. One of the cases pending against Lorillard and
other cigarette manufacturers, McLaughlin v. Philip Morris USA, Inc., et al.,
is on behalf of a purported nationwide class composed of purchasers of "light"
cigarettes. Lorillard is not a defendant in approximately 30 additional
"lights" class actions that are pending against other cigarette manufacturers.
"Reimbursement cases" are brought by or on behalf of entities who seek
reimbursement of expenses incurred in providing health care to individuals who
allegedly were injured by smoking. Plaintiffs in these cases have included the
52
U.S. federal government, U.S. state and local governments, foreign
governmental entities, hospitals or hospital districts, American Indian
tribes, labor unions, private companies and private citizens. Lorillard is a
defendant in eight of the 11 pending Reimbursement cases. Lorillard and the
Company also are named as defendants in a case pending in Israel.
Included in this category is the suit filed by the federal government,
United States of America v. Philip Morris USA, Inc., et al., that seeks
disgorgement and injunctive relief. Trial of this matter began during
September of 2004 and is proceeding.
"Contribution cases" are brought by private companies, such as asbestos
manufacturers or their insurers, who are seeking contribution or indemnity for
court claims they incurred on behalf of individuals injured by their products
but who also allegedly were injured by smoking cigarettes. Lorillard is a
defendant in each of the two pending Contribution cases.
Excluding the flight attendant and the consolidated West Virginia suits,
approximately 400 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 150 of the 400 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in five of the actions.
Plaintiffs assert a broad range of legal theories in these cases, including,
among others, theories of negligence, fraud, misrepresentation, strict
liability, breach of warranty, enterprise liability (including claims asserted
under the Racketeering Influenced and Corrupt Organizations Act), civil
conspiracy, intentional infliction of harm, violation of consumer protection
statutes, violation of antitrust statutes, injunctive relief, indemnity,
restitution, unjust enrichment, public nuisance, claims based on antitrust
laws and state consumer protection acts, and claims based on failure to warn
of the harmful or addictive nature of tobacco products.
Plaintiffs in most of the cases seek unspecified amounts of compensatory
damages and punitive damages, although some seek damages ranging into the
billions of dollars. Plaintiffs in some of the cases seek treble damages,
statutory damages, disgorgement of profits, equitable and injunctive relief,
and medical monitoring, among other damages.
CONVENTIONAL PRODUCT LIABILITY CASES -
Approximately 1,350 cases are pending against cigarette manufacturers in the
United States. Lorillard is a defendant in approximately 1,050 of these cases.
The Company is a defendant in two of the pending cases.
Approximately 1,000 of the 1,350 cases are pending in a single West Virginia
court in a consolidated proceeding. The West Virginia court had scheduled a
single trial for these consolidated cases, but it has certified a question to
the Supreme Court of Appeals of West Virginia that seeks a determination of
the scope of any forthcoming consolidated trial. As of October 15, 2004, the
Supreme Court of Appeals had not determined whether it will review the
certified question. Lorillard is a defendant in nearly 925 of the 1,000
consolidated West Virginia cases. The Company is not a defendant in any of the
consolidated West Virginia cases.
One of the states in which cases are pending against Lorillard is
Mississippi. During 2003, the Mississippi Supreme Court ruled that the
Mississippi Product Liability Act "precludes all tobacco cases that are based
on products liability." Based on this ruling, Lorillard is seeking, or intends
53
to seek, dismissal of each of the approximately 40 cases pending against it in
Mississippi.
Since January 1, 2002, verdicts have been returned in 23 matters. Lorillard
was not a defendant in any of these cases. Defense verdicts were returned in
13 of the cases. In a fourteenth case, the court determined that the jury's
verdict in favor of the plaintiffs was not supported by the evidence and it
entered judgment in the defendant's favor.
Listed below are those cases in which verdicts were returned in favor of the
plaintiffs since January 1, 2002, as well as those cases in which defendants'
appeals were pending during 2004 from plaintiffs' verdicts returned prior to
2002. As of October 22, 2004, appeals were pending in eleven of the sixteen
cases listed below. The five other cases are in various stages of activity. In
one of them, a cigarette manufacturer was unsuccessful in all of its appeals
and has paid the damages awarded by the jury. In another suit, an appellate
court vacated the jury's award and ordered a new trial. In two of the cases,
all post-trial activity has not been resolved and the time for the defendants
to pursue appeals has not expired. In the fifth case, no information is
available as to whether the defendant paid the judgment, or whether it filed
any post-trial motions or has pursued an appeal. Neither the Company nor
Lorillard were defendants in any of these cases. These 16 cases, and the
verdict amounts, are below:
Arnitz v. Philip Morris USA (Circuit Court, Hillsborough County, Florida).
During October of 2004, the jury returned a verdict in favor of the plaintiff
and awarded him $600,000 in actual damages. The jury also determined that
plaintiff was 60% responsible for his injuries. The court did not permit
plaintiff to seek punitive damages. As of October 22, 2004, a final judgment
reflecting the verdict had not been entered and the opportunity for the
defendant to seek post-verdict relief or to pursue an appeal had not expired.
Davis v. Liggett Group, Inc. (Circuit Court, Palm Beach County, Florida).
During May of 2004, the jury returned a verdict in favor of the plaintiff and
awarded her a total of $550,000 in actual damages. The jury did not award
punitive damages.
Frankson v. Brown & Williamson Tobacco Corporation, et al. (Supreme Court,
New York County, New York). During December of 2003, plaintiff was awarded
$350,000 in actual damages. The jury also determined that the decedent was 50%
contributorily negligent. During January of 2004, plaintiff was awarded $20.0
million in punitive damages. During June of 2004, the court granted in part
the plaintiff's motion for a larger actual damages award and increased the
award to $500,000. The court also granted in part defendants' motion to reduce
the amount of punitive damages awarded by the jury and reduced the award to
$5.0 million. As of October 15, 2004, a final judgment had not been entered.
Thompson v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Jackson County, Missouri). During November of 2003, the jury awarded actual
damages and damages for loss of consortium to the plaintiffs and did not award
punitive damages. The final judgment entered by the court reflects the jury's
findings that the smoker was 50% contributorily negligent and, as a result,
awarded the plaintiffs $1.1 million in damages. Defendants have appealed.
Boerner v. Brown & Williamson Tobacco Corporation (U.S. District Court,
Eastern District, Arkansas). During May of 2003, plaintiffs were awarded $4.0
million in actual damages and $15.0 million in punitive damages. Brown &
Williamson has appealed.
54
Eastman v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Pinellas County, Florida). During April of 2003, plaintiff was awarded $6.5
million in actual damages. During May of 2004, the Florida Court of Appeal
affirmed the judgment. The court denied defendants' petition for rehearing
during October of 2004. As of October 15, 2004, the opportunity for defendants
to seek further appellate review of this matter had not expired.
Bullock v. Philip Morris USA (Superior Court, Los Angeles County,
California). During September and October of 2002, plaintiff was awarded $5.5
million in actual damages and $28.0 billion in punitive damages. The court
reduced the punitive damages award to $28.0 million. Philip Morris and
plaintiff have appealed.
Figueroa v. R.J. Reynolds Tobacco Company (U.S. District Court, Puerto
Rico). During September of 2002, plaintiffs were awarded $1.0 million in
actual damages. The court granted the defendant's motion for judgment as a
matter of law and entered a final judgment in favor of R.J. Reynolds. The U.S.
Court of Appeals for the First Circuit affirmed the judgment during October of
2003 and subsequently denied plaintiffs' motion for rehearing. Plaintiffs have
filed a petition for writ of certiorari with the U.S. Supreme Court that seeks
review of the judgment. As of October 15, 2004, the Court had not ruled
whether it would grant review of plaintiffs' petition.
Schwarz v. Philip Morris Incorporated (Circuit Court, Multnomah County,
Oregon). During March of 2002, plaintiff was awarded approximately $120,000 in
economic damages, $50,000 in noneconomic damages and $150.0 million in
punitive damages, although the court subsequently reduced the punitive damages
award to $100.0 million. Many of plaintiff's claims were directed to
allegations that the defendant had made false representations regarding the
low tar cigarettes smoked by the decedent. Philip Morris has appealed.
Burton v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Kansas). During February of 2002, plaintiff was awarded approximately $200,000
in actual damages and the jury determined that plaintiff was entitled to
punitive damages. During June of 2002, the court awarded plaintiff $15.0
million in punitive damages from R.J. Reynolds. R.J. Reynolds has appealed.
Kenyon v. R.J. Reynolds Tobacco Company (Circuit Court, Hillsborough County,
Florida). During December of 2001, plaintiff was awarded $165,000 in actual
damages. During 2003, the Florida Court of Appeal affirmed the judgment in
favor of the plaintiff and denied R.J. Reynolds' subsequent attempt to seek
further review of the ruling. R.J. Reynolds has paid approximately $200,000 in
damages and interest to the plaintiff. R.J. Reynolds pursued simultaneous
appeals to the Florida Supreme Court and the U.S. Supreme Court. During
January of 2004, the U.S. Supreme Court denied R.J. Reynolds' petition for
writ of certiorari. During April of 2004, the Florida Supreme Court denied
R.J. Reynolds' other petition.
Boeken v. Philip Morris Incorporated (Superior Court, Los Angeles County,
California). During June of 2001, plaintiff was awarded $5.5 million in actual
damages and $3.0 billion in punitive damages. The court reduced the punitive
damages award to $100.0 million. During September of 2004, the California
Court of Appeal further reduced the punitive damages award to $50.0 million
but otherwise affirmed the judgment entered in favor of the plaintiff. During
October of 2004, the Court of Appeal granted the parties' separate petitions
that sought rehearing of its decision and it has vacated the order it entered
during September of 2004.
55
Jones v. R.J. Reynolds Tobacco Co. (Circuit Court, Hillsborough County,
Florida). During October of 2000, plaintiff was awarded $200,000 in actual
damages. The court granted the defendant's motion for new trial. The Florida
Court of Appeal affirmed this ruling. Plaintiff has filed for permission to
appeal to the Florida Supreme Court.
Whiteley v. Raybestos-Manhattan, Inc., et al. (Superior Court, San Francisco
County, California). During March of 2000, plaintiffs were awarded $1.0
million in economic damages, $500,000 in noneconomic damages, $250,000 in loss
of consortium and $20.0 million in punitive damages from Philip Morris and
R.J. Reynolds. During April of 2004, the California Court of Appeal reversed
the judgment and remanded the case for a new trial. The court denied
plaintiffs' petition for rehearing. Plaintiffs did not seek further appellate
review and the case has been remanded to the Superior Court of California, San
Francisco County, for a new trial.
Williams v. Philip Morris USA Inc. (Circuit Court, Multnomah County,
Oregon). During March of 1999, plaintiff was awarded $21,000 in economic
damages, $800,000 in actual damages and $79.5 million in punitive damages.
Although the circuit court reduced the punitive damages award to $32.0 million
following trial, the Oregon Court of Appeals reinstated the full amount of the
punitive damages verdict in its 2002 order that otherwise affirmed the
judgment in its entirety. During October of 2003, the U.S. Supreme Court
vacated the judgment and remanded the case to the Oregon Court of Appeals for
further consideration. During June of 2004, the Oregon Court of Appeals
reaffirmed its 2002 ruling and reinstated the full amount of the jury's
punitive damages award. Philip Morris has sought review of the case by the
Oregon Supreme Court. As of October 15, 2004, the Oregon Supreme Court had not
ruled whether it would review Philip Morris' petition.
Henley v. Philip Morris Incorporated (Superior Court, San Francisco County,
California). During February of 1999, plaintiff was awarded $1.5 million in
actual damages and $50.0 million in punitive damages, although the court
reduced the latter award to $25.0 million. During September of 2003, the
California Court of Appeals reduced the punitive damages award to $9.0
million. During September of 2004, the California Supreme Court dismissed the
appeal filed by Philip Morris. Further activity in the case has been stayed in
order to permit Philip Morris to seek additional appellate review.
Defense verdicts have been returned in the following 13 matters since
January 1, 2002. Neither Lorillard nor the Company are defendants in any of
these cases. As of October 15, 2004, either appeals were pending or all post-
verdict activity had not been concluded in three of these cases.
Mash v. Brown & Williamson Tobacco Corporation (U.S. District Court, Eastern
District, Missouri). During September of 2004, the jury returned a verdict in
favor of the defendant. As of October 15, 2004, the opportunity for plaintiffs
to seek post-verdict relief or to notice an appeal had not expired.
Eiser v. Brown & Williamson Tobacco Corporation, et al. (Court of Common
Pleas, Philadelphia County, Pennsylvania). During August of 2003, the jury
returned a verdict in favor of the defendants. Plaintiff has appealed.
Reller v. Philip Morris USA (Superior Court, Los Angeles County,
California). During July of 2003, the jury found that a smoker's lung cancer
was caused by smoking but declined to award damages. The jury did not reach a
verdict as to one of the claims that was submitted to it. Trial of that claim
has been scheduled for January of 2005. A judgment reflecting the July of 2003
verdict will not be entered until the remaining claim is resolved.
56
In ten cases in which defendants prevailed at trial after January 1, 2002,
plaintiffs either chose not to appeal or have withdrawn their appeals and the
cases are concluded. These ten matters and the dates of the verdicts are Hall
v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Hillsborough County,
Florida, December of 2003); Longden v. Philip Morris USA, Inc. (Hillsborough
Superior Court, Northern District, New Hampshire, November of 2003); Welch v.
Brown & Williamson Tobacco Corporation, et al. (Circuit Court, Jackson County,
Missouri, June of 2003); Allen v. R.J. Reynolds Tobacco Company, et al. (U.S.
District Court, Southern District, Florida, February of 2003); Inzerilla v.
The American Tobacco Company, et al. (Supreme Court, Queens County, New York,
February of 2003); Lucier v. Philip Morris USA, et al. (Superior Court,
Sacramento County, California, February of 2003); Carter v. Philip Morris USA
(Court of Common Pleas, Philadelphia County, Pennsylvania, January of 2003);
Conley v. R.J. Reynolds Tobacco Co., et al. (U.S. District Court, Northern
District of California, December of 2002); Tune v. Philip Morris Incorporated
(Circuit Court of Pinellas County, Florida, May of 2002); and Hyde v. Philip
Morris Incorporated (U.S. District Court, Rhode Island, March of 2002).
Lorillard was not a defendant in any of these ten matters.
In addition to these cases, trial has been held against Lorillard in one
case in which plaintiffs asserted both Conventional Product Liability claims
and Filter claims, the case of Gadaleta v. AC&S, Inc., et al. (Supreme Court,
New York County, New York). During October of 2004, the jury returned a
verdict in favor of Lorillard, which was the only defendant in the case at
trial. The opportunity for plaintiffs to seek review of the jury's verdict has
not expired.
In addition to the cases listed above, one case was pending on appeal
against Lorillard from a verdict that was returned in favor of the defendants
before 2002:
Tompkin v. The American Tobacco Company, et al. (U.S. District Court,
Northern District, Ohio). Lorillard was a defendant in this matter. A defense
verdict was returned during October of 2001. During March of 2004, the U.S.
Court of Appeals for the Sixth Circuit rejected plaintiff's appeal and
affirmed the verdict. Plaintiff did not seek further appellate review of this
matter and it is concluded.
As of October 30, 2004, trial was not proceeding in any Conventional Product
Liability case in the United States. Some cases against U.S. cigarette
manufacturers and manufacturers of smokeless tobacco products are scheduled
for trial during the remainder of 2004 and beyond. As of October 30, 2004,
Lorillard is a defendant in one case scheduled for trial during the remainder
of 2004 and the first quarter of 2005. As of October 30, 2004, the Company is
not a defendant in any of the cases scheduled for trial during the remainder
of 2004 or in the first quarter of 2005. The trial dates are subject to
change.
FLIGHT ATTENDANT CASES - As of October 15, 2004, approximately 2,700 Flight
Attendant cases were pending. Lorillard and three other cigarette
manufacturers are the defendants in each of these matters. The Company is not
a defendant in any of these cases. These suits were filed as a result of a
settlement agreement by the parties, including Lorillard, in Broin v. Philip
Morris Companies, Inc., et al. (Circuit Court, Dade County, Florida, filed
October 31, 1991), a class action brought on behalf of flight attendants
claiming injury as a result of exposure to environmental tobacco smoke. The
settlement agreement, among other things, permitted the plaintiff class
57
members to file these individual suits. These individuals may not seek
punitive damages for injuries that arose prior to January 15, 1997.
The judges that have presided over the cases that have been tried through
October 15, 2004, have relied upon an order entered during October of 2000 by
the Circuit Court of Miami-Dade County, Florida. The October 2000 order has
been construed by these judges as holding that the flight attendants are not
required to prove the substantive liability elements of their claims for
negligence, strict liability and breach of implied warranty in order to
recover damages. The court further ruled that the trials of these suits are to
address whether the plaintiffs' alleged injuries were caused by their exposure
to environmental tobacco smoke and, if so, the amount of damages to be
awarded. Defendants are continuing to seek review of the October 2000 order by
the appellate court.
Lorillard has been a defendant in each of the six flight attendant cases in
which verdicts have been returned. In one of the six trials, the plaintiff was
awarded $5.5 million in actual damages, although the court reduced the award
to $500,000. Defendants have noticed an appeal from this verdict and plaintiff
has noticed a cross-appeal. Defendants have prevailed in the five other
trials. In one of them, the court granted plaintiff's motion for new trial and
defendants have appealed.
As of October 15, 2004, one flight attendant case was scheduled for trial
through the end of the first quarter of 2005. Trial dates are subject to
change.
CLASS ACTION CASES - Lorillard is a defendant in eleven pending cases. The
Company is a defendant in two of these cases. In most of the pending cases,
plaintiffs purport to seek class certification on behalf of groups of
cigarette smokers, or the estates of deceased cigarette smokers, who reside in
the state in which the case was filed. One of the eleven pending cases,
McLaughlin v. Philip Morris USA, Inc., et al., is a purported national class
action of purchasers of "light" cigarettes. Neither Lorillard nor the Company
are defendants in approximately 30 additional class action cases pending
against other cigarette manufacturers in various courts throughout the nation.
All of these 30 additional cases assert claims on behalf of smokers or
purchasers of "light" cigarettes.
Cigarette manufacturers, including Lorillard, have defeated motions for
class certification in a total of 34 cases, 13 of which were in state court
and 21 of which were in federal court. These 34 cases were filed in 17 states,
the District of Columbia and the Commonwealth of Puerto Rico. In addition, a
Nevada court granted motions to deny class certification in 20 separate cases
in which the class definition asserted by the plaintiffs was identical to
those in which the court had previously ruled in defendants' favor. Motions
for class certification have also been ruled upon in some of the "lights"
cases or in other class actions to which Lorillard was not a party. In some of
these cases, courts have denied class certification to the plaintiffs, while
classes have been certified in other matters.
The Engle Case - One of the class actions pending against Lorillard is Engle
v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida,
filed May 5, 1994). Engle was certified as a class action on behalf of Florida
residents, and survivors of Florida residents, who were injured or died from
medical conditions allegedly caused by addiction to cigarettes. During 2000, a
jury awarded approximately $16.3 billion in punitive damages against Lorillard
as part of a $145.0 billion verdict against all of the defendants. During May
of 2003, a Florida appellate court reversed the judgment and decertified the
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class. The court also held that the claims for punitive damages asserted by
Florida smokers were barred as these claims are based on the same misconduct
alleged in the case filed by the State of Florida against cigarette
manufacturers, including Lorillard, which was concluded by a 1997 settlement
agreement and judgment (see "Settlement of State Reimbursement Litigation"
below). The court subsequently denied plaintiffs' motion for rehearing. The
Florida Supreme Court has agreed to hear plaintiffs' appeal and argument is
scheduled for November 3, 2004. Even if the Florida Supreme Court were to rule
in favor of the defendants, plaintiffs will not have exhausted all of the
appellate options available to them as they could seek review of the case by
the U.S. Supreme Court. The Company and Lorillard believe that the appeals
court's decision should be upheld upon further appeals.
The case was tried between 1998-2000, and the same jury heard all phases of
the trial. The first phase, which involved certain issues deemed common to the
certified class, ended on July 7, 1999 with findings against the defendants,
including Lorillard. Among other things, the jury found that cigarette smoking
is addictive and causes lung cancer and a variety of other diseases, that the
defendants concealed information about the health risks of smoking, and that
defendants' conduct rose to a level that would permit a potential award or
entitlement to punitive damages.
The first portion of Phase Two of the trial ended on April 7, 2000 when the
jury awarded three plaintiffs $12.5 million in damages for their individual
claims. The jury did not consider any class-wide issues during this first
portion of Phase Two.
The second part of Phase Two considered evidence as to the punitive damages
to be awarded to the class. On July 14, 2000, the jury awarded approximately
$145.0 billion in punitive damages against all defendants, including $16.3
billion against Lorillard. The judgment provided that the jury's awards would
bear interest at the rate of 10.0% per year.
During May of 2000, while the trial was proceeding, legislation was enacted
in Florida that limited the amount of an appellate bond required to be posted
in order to stay execution of a judgment for punitive damages in a certified
class action. While Lorillard believes this legislation is valid and that any
challenges to the possible application or constitutionality of this
legislation would fail, Lorillard entered into an agreement with the
plaintiffs during May of 2001 in which it contributed $200.0 million to a fund
held for the benefit of the Engle plaintiffs (the "Engle Agreement"). The
$200.0 million contribution included the $100.0 million that Lorillard posted
as collateral for the appellate bond. Accordingly, Lorillard recorded a pretax
charge of $200.0 million in the year ended December 31, 2001. Two other
defendants executed agreements with the plaintiffs that were similar to
Lorillard's. As a result, the class agreed to a stay of execution, with
respect to Lorillard and the two other defendants on its punitive damages
judgment until appellate review is completed, including any review by the U.S.
Supreme Court.
The Engle Agreement provides that in the event that Lorillard, Inc.'s
balance sheet net worth falls below $921.2 million (as determined in
accordance with generally accepted accounting principles in effect as of July
14, 2000), the stay granted in favor of Lorillard in the Engle Agreement would
terminate and the class would be free to challenge the Florida legislation. As
of September 30, 2004, Lorillard, Inc. had a balance sheet net worth of
approximately $1.3 billion.
59
In addition, the Engle Agreement requires Lorillard to obtain the written
consent of class counsel or the court prior to selling any trademark of or
formula comprising a cigarette brand having a U.S. market share of 0.5% or
more during the preceding calendar year. The Engle Agreement also requires
Lorillard to obtain the written consent of the Engle class counsel or the
court to license to a third party the right to manufacture or sell such a
cigarette brand unless the cigarettes to be manufactured under the license
will be sold by Lorillard. It is not clear how the Engle Agreement is affected
by the decertification of the class and by the order vacating the judgment.
Lorillard is a defendant in eleven separate cases pending in the Florida
courts in which the plaintiffs claim that they are members of the Engle class,
that all liability issues associated with their claims were resolved in the
earlier phases of the Engle proceedings, and that trials on their claims
should proceed immediately. Prior to the May 2003 appellate ruling that
vacated the Engle judgment and decertified the class, Lorillard opposed trials
of these actions on the grounds that they should be considered during Phase
Three of the Engle case and should be stayed while the Engle appeal is
proceeding. Additional cases with similar contentions are pending against
other cigarette manufacturers. In one of the matters in which Lorillard was
not a party, a jury in the Circuit Court of Miami-Dade County, Florida
returned a verdict in favor of the plaintiffs during June of 2002 in the case
of Lukacs v. Brown & Williamson Tobacco Corporation, et al. and awarded them
$500,000 in economic damages, $24.5 million in noneconomic damages and $12.5
million in damages for loss of consortium. The court has reduced the loss of
consortium award to $125,000. No post-trial motions are scheduled to be filed
in Lukacs as a final judgment reflecting the verdict will not be entered until
the Engle appeal is resolved. None of the cases in which plaintiffs contend
they are members of the Engle class are now expected to proceed until all
appellate activity in Engle is concluded.
The Scott case - Another class action pending against Lorillard is Scott v.
The American Tobacco Company, et al. (District Court, Orleans Parish,
Louisiana, filed May 24, 1996). During 1997, the court certified a class
comprised of certain cigarette smokers resident in the State of Louisiana who
desire to participate in medical monitoring or smoking cessation programs and
who began smoking prior to September 1, 1988, or who began smoking prior to
May 24, 1996 and allege that defendants undermined compliance with the
warnings on cigarette packages.
Trial in Scott was heard in two phases. While the jury in its July 2003
Phase I verdict rejected medical monitoring, the primary relief requested by
plaintiffs, it returned sufficient findings in favor of the class to proceed
to a Phase II trial on plaintiffs' request for a state-wide smoking cessation
program. The second phase of the trial began in March of 2004.
During May of 2004, the jury returned its verdict in the trial's second
phase and awarded approximately $591.0 million to fund cessation programs for
Louisiana smokers. The court's final judgment, entered during June of 2004,
reflects the jury's award of damages and also awarded judicial interest. As of
September 30, 2004 judicial interest totaled an additional amount of
approximately $350.0 million. The judicial interest award will continue to
accrue until the judgment is paid. Lorillard's share of the judgment and the
judicial interest has not been determined. The court denied defendants' motion
for judgment notwithstanding the verdict or, in the alternative, for new
trial. Lorillard and the other defendants have initiated an appeal from the
judgment to the Louisiana Court of Appeals. The parties filed a stipulation in
the trial court agreeing that an article of the Louisiana Code of Civil
Procedure, and a Louisiana statute governing the amount of appellate bonds in
civil cases involving a signatory to the Master Settlement Agreement, required
60
that the amount of the bond for the appeal be set at $50.0 million for all
defendants collectively. The parties further agreed that the plaintiffs have
full reservations of rights to contest in the trial court, at a later date,
the sufficiency or amount of the bond on any grounds. The trial court entered
an order setting the amount of the bond at $50.0 million for all defendants.
Defendants collectively posted a surety bond in that amount, of which
Lorillard secured 25%, or $12.5 million. While Lorillard believes the
limitation on the appeal bond amount is valid and required by Louisiana law,
and that any challenges to the amount of the bond would fail, in the event of
a successful challenge the amount of the appeal bond could be set as high as
150% of the judgment and judicial interest combined. If such an event
occurred, it has not been determined what would be Lorillard's share of the
appeal bond.
Other Class Action Cases - In five additional class actions in which Lorillard
has been a defendant, courts have granted plaintiffs' motions for class
certification. Two of these matters have been resolved in favor of the
defendants and plaintiffs' claims in a third case were resolved through a
settlement agreement. These five matters are listed below in alphabetical
order:
Blankenship v. American Tobacco Company, et al. (Circuit Court, Ohio County,
West Virginia, filed January 31, 1997). During 2000, the court certified a
class comprised of certain West Virginia cigarette smokers who sought, among
other things, medical monitoring. During November of 2001, the jury returned a
verdict in favor of the defendants, including Lorillard. During May of 2004,
the West Virginia Supreme Court of Appeals affirmed the judgment entered in
favor of the defendants, and it denied plaintiffs' petition for rehearing
during July of 2004. Plaintiffs did not seek further appellate review of this
matter and the case has been concluded in favor of the defendants.
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, filed October 31, 1991). This is the matter concluded by a settlement
agreement and discussed under "Flight Attendant Cases" above.
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San
Diego County, California, filed June 10, 1997). During 2001, the court
certified a class comprised of residents of California who smoked at least one
of defendants' cigarettes between June 10, 1993 and April 23, 2001 and who
were exposed to defendants' marketing and advertising activities in
California. Trial has been scheduled to begin during March of 2005.
Daniels v. Philip Morris, Incorporated, et al. (Superior Court, San Diego
County, California, filed August 2, 1998). During 2000, the court certified a
class comprised of California residents who, while minors, smoked at least one
cigarette between April of 1994 and December 31, 1999 and were exposed to
defendants' marketing and advertising activities in California. During 2002,
the court granted defendants' motion for summary judgment and entered final
judgment in their favor. During October of 2004, the California Court of
Appeal affirmed the dismissal of the case. Plaintiffs have filed motions for
rehearing and for modification with the Court of Appeal. As of October 15,
2004, the court had not determined whether it would review either motion.
In re: Simon II Litigation v. R.J. Reynolds Tobacco Company, et al. (U.S.
District Court, Eastern District, New York, filed September 6, 2000). During
2002, the case was certified as a nationwide non-opt out class comprised of
the punitive damages claims asserted by individuals who allege certain
injuries or medical conditions allegedly caused by smoking. Certain
individuals, including those who allege membership in the class certified in
61
Engle v. R.J. Reynolds Tobacco Company, et al., were excluded from the class.
Defendants are appealing the ruling.
As discussed above, motions for class certification have been granted in
some cases in which Lorillard is not a defendant. One of these is the case of
Price v. Philip Morris USA (Circuit Court, Madison County, Illinois, filed
February 10, 2000, and formerly known as Miles). Plaintiffs in Price contended
they were defrauded by Philip Morris' marketing of its cigarettes labeled as
"light" or "ultra light." Price was certified as a class comprised of Illinois
residents who purchased certain of Philip Morris' "light" brands. During March
of 2003, the court returned a verdict in favor of the class and awarded it
$7.1 billion in actual damages. The court also awarded $3.0 billion in
punitive damages to the State of Illinois, which was not a party to the suit,
and awarded plaintiffs' counsel approximately $1.8 billion in fees and costs.
Pursuant to Illinois law and according to the final judgment that reflected
these awards, Philip Morris USA would have been required to post a bond of
approximately $12.0 billion in order to pursue an appeal from the judgment.
The Illinois Supreme Court permitted Philip Morris USA to post a bond in the
amount of approximately $6.0 billion and accepted direct appellate review of
the appeal. Philip Morris USA has initiated a separate action in the Circuit
Court of Cook County, Illinois, in which it seeks a declaration that the state
has released any right or interest in the punitive damages award. While
approximately 30 purported "lights" class actions are pending against U.S.
cigarette manufacturers, Lorillard is a defendant in one such case, McLaughlin
v. Philip Morris USA, Inc., et al., a purported national class action filed
during May of 2004 in which class certification has not been decided.
REIMBURSEMENT CASES - Although the cases settled by the State Settlement
Agreements, as described below, are concluded, certain matters are pending
against cigarette manufacturers. The pending cases include Reimbursement cases
on file in U.S. courts, a Reimbursement case on file in Israel, and cases
challenging the State Settlement Agreements. Lorillard is a defendant in eight
pending Reimbursement cases in the U.S. and has been named as a party to the
case in Israel. The Company is a defendant in two of the pending U.S. cases
and also has been named as a party to the case in Israel. Additional cases are
pending against other cigarette manufacturers. The plaintiffs in the pending
cases include the U.S. federal government, several U.S. county or city
governments, foreign governments that have filed suits in U.S. courts,
American Indian tribes, hospitals or hospital districts, private companies and
private citizens. Plaintiffs in some of these cases seek certification as
class actions.
More than 75 cases filed by labor union health and welfare funds as well as
more than 35 cases filed by foreign governments in U.S. courts have been
dismissed, either due to orders that granted defendants' dispositive motions
or as the result of plaintiffs' voluntary dismissal of their claims. Each of
the courts of appeal that reviewed these dismissals have affirmed the trial
courts' orders.
U.S. Federal Government Action - A bench trial of the U.S. federal
government's reimbursement and racketeering case began during September of
2004 and is proceeding (United States of America v. Philip Morris USA, Inc.,
et al., U.S. District Court, District of Columbia, filed September 22, 1999).
Lorillard is a defendant in this case. Other defendants include other
cigarette manufacturers, two parent companies and two trade associations. The
Company is not a defendant in this action. The trial involves issues as to
whether the defendants, including Lorillard, violated the Racketeer Influenced
and Corrupt Organizations Act ("RICO"), and conspired to do so. Under RICO,
the government is seeking an aggregate of approximately $280.0 billion in
62
disgorgement of profits from the defendants, including Lorillard, as well as
injunctive relief. While the trial is proceeding, defendants are pursuing an
interlocutory appeal from one of the court's pre-trial rulings that denied the
defendants' motion to limit the scope of the government's recovery of the
disgorgement claim. The U.S. Court of Appeals for the District of Columbia
Circuit is scheduled to hear argument of this appeal during November of 2004
and a ruling is expected to be issued before the court returns its verdict. As
of October 15, 2004, the trial was not expected to conclude until the first
quarter of 2005. Prior to trial, the court dismissed plaintiff's two other
claims, which alleged the defendants violated the Medical Care Recovery Act
and Medicare as Secondary Payer provisions of the Social Security Act. Neither
claim is being considered by the court during the trial.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - As of
October 15, 2004, three cases were pending in U.S. courts in which the
plaintiffs are foreign governments. Lorillard is a defendant in one of these
three matters. Approximately 35 of the cases filed by foreign governments have
been dismissed in favor of the defendants, including approximately 25 during
2003.
Since January 1, 2002, none of the Reimbursement cases have been tried.
During June of 2001, a jury in the U.S. District Court for the Eastern
District of New York returned a verdict in Blue Cross and Blue Shield of New
Jersey, Inc., et al. v. Philip Morris, Incorporated, et al., and awarded
damages against the defendants, including Lorillard, in the amount of
approximately $17.8 million in actual damages, including approximately $1.5
million attributable to Lorillard. The claims of only one of the plaintiffs,
the entity then known as Empire Blue Cross and Blue Shield ("Empire"), was
heard at trial pursuant to the court's trial plan. Additional Blue Cross
entities and self-insured parties are plaintiffs in the suit. Empire was
awarded approximately $55,000 in pre-judgment interest for a total award
against Lorillard of approximately $1.6 million. The jury's findings in favor
of the defendants precluded any award of punitive damages. The court has
awarded plaintiff's counsel approximately $38.0 million in attorneys' fees.
The defendants have noticed an appeal to the U.S. Court of Appeals for the
Second Circuit from the final judgment and from the order awarding plaintiff's
counsel attorneys' fees. During September of 2003, the Second Circuit reversed
the portion of the judgment addressing plaintiff's Subrogation claim but it
certified questions to the New York Court of Appeal in order to assist it in
ruling on issues of New York law concerning plaintiff's Direct claim. During
October of 2004, the New York Court of Appeal determined that New York law
does not permit Empire to assert the Direct claim. The matter has been
returned to the Second Circuit Court of Appeal. In its September of 2003
order, the Second Circuit deferred ruling on the appeal of the attorney's fees
award until the certified questions are resolved.
In addition to the above, the District Court of Jerusalem, Israel, has
permitted a private insurer in Israel, Clalit Health Services, to make service
outside the jurisdiction on the Company and Lorillard with a suit in which
Clalit Health Services seeks damages for providing treatment to individuals
allegedly injured by cigarette smoking. The Company and Lorillard have
separately moved to set aside the order that permitted service outside the
jurisdiction. As of October 15, 2004, the court had not ruled on the motions
to set aside the attempted service.
SETTLEMENT OF STATE REIMBURSEMENT LITIGATION - On November 23, 1998,
Lorillard, Philip Morris Incorporated, Brown & Williamson Tobacco Corporation
and R.J. Reynolds Tobacco Company, the "Original Participating Manufacturers,"
entered into a Master Settlement Agreement ("MSA") with 46 states, the
63
District of Columbia, the Commonwealth of Puerto Rico, Guam, the U.S. Virgin
Islands, American Samoa and the Commonwealth of the Northern Mariana Islands
to settle the asserted and unasserted health care cost recovery and certain
other claims of those states. These settling entities are generally referred
to as the "Settling States." The Original Participating Manufacturers had
previously settled similar claims brought by Mississippi, Florida, Texas and
Minnesota, which together with the Master Settlement Agreement are generally
referred to as the "State Settlement Agreements."
The State Settlement Agreements provide that the agreements are not
admissions, concessions or evidence of any liability or wrongdoing on the part
of any party, and were entered into by the Original Participating
Manufacturers to avoid the further expense, inconvenience, burden and
uncertainty of litigation.
Lorillard recorded pretax charges of $213.6, $214.6, $649.0 and $592.2
million ($132.8, $132.5, $398.3 and $369.6 million after taxes), for the three
and nine months ended September 30, 2004 and 2003, respectively, to accrue its
obligations under the State Settlement Agreements. Lorillard's portion of
ongoing adjusted payments and legal fees is based on its share of domestic
cigarette shipments in the year preceding that in which the payment is due.
Accordingly, Lorillard records its portions of ongoing settlement payments as
part of cost of manufactured products sold as the related sales occur.
The State Settlement Agreements require that the domestic tobacco industry
make annual payments in the following amounts, subject to adjustment for
several factors, including inflation, market share and industry volume: $8.4
billion through 2007 and $9.4 billion thereafter. In addition, the domestic
tobacco industry is required to pay settling plaintiffs' attorneys' fees,
subject to an annual cap of $500.0 million, as well as an additional amount of
up to $125.0 million in each year beginning 2004 through 2008. These payment
obligations are the several and not joint obligations of each settling
defendant.
The State Settlement Agreements also include provisions relating to
significant advertising and marketing restrictions, public disclosure of
certain industry documents, limitations on challenges to tobacco control and
underage use laws, and other provisions.
From time to time, lawsuits have been brought against Lorillard and other
participating manufacturers to the MSA, or against one or more of the states,
challenging the validity of that agreement on certain grounds, including as a
violation of the antitrust laws. As of October 15, 2004, Lorillard was a
defendant in one such case. Lorillard understands that additional such cases
are proceeding against other defendants.
In addition, in connection with the MSA, the Original Participating
Manufacturers entered into an agreement to establish a $5.2 billion trust fund
payable between 1999 and 2010 to compensate the tobacco growing communities in
14 states. Payments to the trust fund are allocated among the Original
Participating Manufacturers generally according to their relative domestic
market share. Of the total $5.2 billion, a total of $2.1 billion has been paid
since 1999 through September 30, 2004, $200.0 million of which has been paid
by Lorillard. Lorillard estimates its remaining payments under the agreement
will total approximately $300.0 - $350.0 million. All payments will be
adjusted for inflation, changes in the unit volume of domestic cigarette
shipments, and the effect of increases in state or federal excise taxes on
tobacco products that benefit the tobacco growing community. Lorillard
believes that its payment obligations to tobacco growers in 2004 and
64
subsequent years under the trust fund will be wholly offset by payments
required under a federal law enacted in 2004 repealing the federal supply
management program for tobacco growers.
The Company believes that the State Settlement Agreements will materially
adversely affect its cash flows and operating income in future years. The
degree of the adverse impact will depend, among other things, on the rates of
decline in U.S. cigarette sales in the premium price and discount price
segments, Lorillard's share of the domestic premium price and discount price
cigarette segments, and the effect of any resulting cost advantage of
manufacturers not subject to significant payment obligations under the State
Settlement Agreements.
CONTRIBUTION CLAIMS - Plaintiffs seek recovery of funds paid by them to
individuals whose asbestos disease or illness was alleged to have been caused
in whole or in part by smoking-related illnesses. Two such cases are pending
against Lorillard. The Company is not a defendant in any of these cases.
FILTER CASES -In addition to the above, claims have been brought against
Lorillard by smokers as well as former employees of Lorillard seeking damages
resulting from alleged exposure to asbestos fibers that were incorporated into
filter material used in one brand of cigarettes manufactured by Lorillard for
a limited period of time, ending almost 50 years ago. Approximately 70 such
matters are pending against Lorillard. The Company is not a defendant in any
of these matters. Since January 1, 2002 and through October 15, 2004,
Lorillard has paid, or has reached agreement to pay, a total of approximately
$14 million in payments of judgments and settlements to finally resolve
approximately 40 claims. Juries have returned verdicts in favor of Lorillard
in both of the cases that have been tried since January 1, 2002 in which
plaintiffs have asserted Filter claims, Sachs v. Lorillard Tobacco Co. (U.S.
District Court, Maryland) and Gadaleta v. AC&S, Inc., et al. (Supreme Court of
New York, New York County). Plaintiffs in Gadaleta asserted both Filter claims
and Conventional Product Liability claims. The opportunity for the Gadaleta
plaintiffs to seek review of the verdict in their case has not expired. Trial
dates are scheduled in some of the pending cases. Trial dates are subject to
change.
Other Tobacco - Related
TOBACCO - RELATED ANTITRUST CASES -
Indirect Purchaser Suits - Approximately 30 antitrust suits were filed on
behalf of putative classes of consumers in various state courts against
Lorillard and its major competitors. The suits allege that the defendants
entered into agreements to fix the wholesale prices of cigarettes in violation
of state antitrust laws which permit indirect purchasers, such as retailers
and consumers, to sue under price fixing or consumer fraud statutes.
Approximately 20 states permit such suits. Lorillard is a defendant in all but
one of these indirect purchaser cases. Three indirect purchaser suits in New
York, Florida and Michigan, were dismissed in their entirety and plaintiffs
have withdrawn their appeals. Since November 30, 2003, the state court
indirect purchaser price-fixing actions in the following states have been
voluntarily dismissed: Nevada, Minnesota, District of Columbia, South Dakota,
Michigan, Maine, West Virginia, North Dakota and Arizona. Motions to approve
stipulated orders of dismissal in all of the remaining actions, except for New
Mexico and Kansas, are pending. A decision granting class certification in New
Mexico is being appealed by the defendants. Discovery is proceeding in the
Kansas case, and the parties are in the process of litigating certain
privilege issues with no date having yet been set by the Court for dispositive
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motions and trial. The Company was also named as a defendant in most of these
indirect purchaser cases but has been voluntarily dismissed without prejudice
from all of them.
Tobacco Growers Suit - DeLoach v. Philip Morris Inc., et al. (U.S. District
Court, Middle District of North Carolina, filed February 16, 2000). On October
1, 2003, the Court approved a settlement by Lorillard with a class consisting
of all persons holding a quota (the licenses that a farmer must either own or
rent to sell the crop) to grow, and all domestic producers who sold flue-cured
or burley tobacco at anytime from February 1996 to present. In addition to
payments previously made, Lorillard has committed to buy 20 million pounds of
domestic tobacco for each year through 2012. Lorillard has also committed to
purchase at least 35% of its annual total requirements for flue-cured and
burley tobacco domestically for the same period. The other major domestic
tobacco companies and the major leaf buyers are also defendants, and all of
the defendants with the exception of R.J. Reynolds were parties to the
settlement agreement entered on October 1, 2003. R.J. Reynolds signed a
settlement agreement with the class on April 22, 2004. That agreement has been
approved by the court but no proceeds have been distributed. Lorillard
contends that the R.J. Reynolds settlement agreement triggers a clause in
Lorillard's settlement agreement that would substantially reduce Lorillard's
commitments to buy domestic tobacco. The court has ruled against Lorillard on
that issue and the matter is currently under appeal to the United States Court
of Appeals for the Fourth Circuit.
MSA Federal Antitrust Suit - Sanders v. Lockyer, et al. (U.S. District Court,
Northern District of California, filed June 9, 2004). Lorillard and the other
major cigarette manufacturers, along with the Attorney General of the State of
California, have been sued by a consumer purchaser of cigarettes in a putative
class action alleging violations of the Sherman Act and California state
antitrust and unfair competition laws. The plaintiff seeks treble damages of
an unstated amount for the putative class as well as declaratory and
injunctive relief. All claims are based on the assertion that the Master
Settlement Agreement that Lorillard and the other cigarette manufacturer
defendants entered into with the State of California and more than forty other
states, together with certain implementing legislation enacted by California,
constitute unlawful restraints of trade. The defendants filed a motion to
dismiss the complaint on August 19, 2004, which is scheduled for hearing in
December 2004. Pretrial discovery has not yet commenced in the action.
Vending Machine Operators Antitrust Suit - Genessee Vending, Inc., et al. v.
Lorillard Tobacco Co. (U.S. District Court, Eastern District of Michigan,
filed May 14, 2004). More than 220 cigarette vending machine operators have
instituted a suit against Lorillard individually and on behalf of a putative
class of all domestic cigarette vending machine operators, claiming that
Lorillard has violated the federal Robinson-Patman Act by allegedly
discriminating against them in price and with respect to advertising and
promotional payments and services provided in connection with the sale of
cigarettes to competing convenience stores, gasoline stations, mini-marts,
kiosks and discount stores. Lorillard filed a motion to dismiss the action on
July 2, 2004, for failure to state claims upon which relief can be granted.
That motion has been argued but not yet decided by the Court. Virtually
identical suits have been filed against Philip Morris and R.J. Reynolds.
REPARATION CASES - During 2002, the Company was named as a defendant in
three cases in which plaintiffs seek reparations for the alleged financial
benefits derived from the uncompensated use of slave labor. These three cases
are pending in the U.S. District Court for the Northern District of Illinois
as a result of a multi-district litigation proceeding. The Company was named
66
as a defendant in these matters as a result of conduct purportedly engaged in
by Lorillard and various other entities. Plaintiffs in these suits seek
various types of damages including disgorgement of profits, restitution and
punitive damages. Plaintiffs seek class certification on behalf of the
descendants of enslaved African Americans. During 2004, another Reparations
case was filed in the U.S. District Court for the Northern District of
Illinois. This suit, however, named Lorillard, but not the Company, as a
defendant. This suit was voluntarily dismissed by the plaintiffs during June
of 2004. Lorillard never received service of this matter.
Defenses
Lorillard believes that it has valid defenses to the cases pending against
it. Lorillard also believes it has valid bases for appeal of the adverse
verdicts against it. To the extent the Company is a defendant in any of the
lawsuits described in this section, the Company believes that it is not a
proper defendant in these matters and has moved or plans to move for dismissal
of all such claims against it. While Lorillard intends to defend vigorously
all tobacco products liability litigation, it is not possible to predict the
outcome of any of this litigation. Litigation is subject to many
uncertainties. Plaintiffs have prevailed in several cases, as noted above. It
is possible that one or more of the pending actions could be decided
unfavorably as to Lorillard or the other defendants. Lorillard may enter into
discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
In addition, some developments on health issues related to tobacco products
have received widespread media attention, which could have adverse effects on
the ability of Lorillard to prevail in smoking and health litigation. These
developments also could prompt the filing of additional litigation. These
developments include, but are not limited to, the release of industry
documents beginning in 1998 and the adverse outcomes in some of the cases
tried during the past few years, some of which have resulted in awards to the
plaintiffs for billions of dollars.
Except for the impact of the State Settlement Agreements as described above,
management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending litigation and,
therefore, no provision has been made in the Consolidated Condensed Financial
Statements for any unfavorable outcome. It is possible that the Company's
results of operations or cash flows in a particular quarterly or annual period
or its financial position could be materially adversely affected by an
unfavorable outcome or settlement of certain pending litigation.
OTHER LITIGATION
The Company and its subsidiaries are also parties to other litigation
arising in the ordinary course of business. The outcome of this other
litigation will not, in the opinion of management, materially affect the
Company's results of operations and/or equity.
15. Commitments and Contingencies
Guarantees
CNA has provided guarantees related to irrevocable standby letters of credit
for certain of its subsidiaries. Certain of these subsidiaries have been sold;
however, the irrevocable standby letter of credit guarantees remain in effect.
CNA would be required to remit prompt payment on the letters of credit in
67
question if the primary obligor drew down on these letters of credit and
failed to repay such amounts in accordance with the terms of the letters of
credit. The maximum potential amount of future payments that CNA could be
required to pay under these guarantees is approximately $30.0 million at
September 30, 2004.
CNA has provided parent company guarantees, which expire in 2015, related to
lease obligations of certain subsidiaries. Certain of those subsidiaries have
been sold; however, the lease obligation guarantees remain in effect. CNA
would be required to remit prompt payment on leases in question if the primary
obligor fails to observe and perform its covenants under the lease agreements.
The maximum potential amount of future payments that the Company could be
required to pay under these guarantees are approximately $7.0 million at
September 30, 2004.
CCC and CAC are parties to a corporate guarantee whereby CCC agrees to cause
CAC to have sufficient cash for the timely payment of claims under certain
insurance policies or contracts issued by CAC so long as CAC is owned directly
or indirectly by CNA.
CNA holds an investment in a real estate joint venture. In the normal course
of business, CNA, on a joint and several basis with other unrelated insurance
company shareholders, has committed to continue funding the operating deficits
of this joint venture. Additionally, CNA and the other unrelated shareholders,
on a joint and several basis, have guaranteed an operating lease for an office
building, which expires in 2016.
The guarantee of the operating lease is a parallel guarantee to the
commitment to fund operating deficits; consequently, the separate guarantee to
the lessor is not expected to be triggered as long as the joint venture
continues to be funded by its shareholders and continues to make its annual
lease payments.
In the event that the other parties to the joint venture are unable to meet
their commitments in funding the operations of this joint venture, CNA would
be required to assume the obligation for the entire office building operating
lease. The maximum potential future lease payments at September 30, 2004 that
CNA could be required to pay under this guarantee are approximately $303.0
million. If CNA were required to assume the entire lease obligation, CNA would
have the right to pursue reimbursement from the other shareholders and would
have the right to all sublease revenues.
CNA has provided guarantees of the indebtedness of certain of its
independent insurance producers. These guarantees expire in 2008. CNA would be
required to remit prompt and complete payment when due, should the primary
obligor default. In the event of default on the part of the primary obligor,
CNA has a right to any and all shares of common stock of the primary obligor.
The maximum potential amount of future payments that CNA could be required to
pay under these guarantees is approximately $7.0 million at September 30,
2004.
In the course of selling business entities and assets to third parties, CNA
has agreed to indemnify purchasers for losses arising out of breaches of
representation and warranties with respect to the business entities or assets
being sold, including, in certain cases, losses arising from undisclosed
liabilities or certain named litigation. Such indemnification provisions
generally survive for periods ranging from nine months following the
applicable closing date to the expiration of the relevant statutes of
limitation. As of September 30, 2004, the aggregate amount of quantifiable
68
indemnification agreements in effect for sales of business entities, assets
and third party loans was $970.0 million.
In addition, CNA has agreed to provide indemnification to third party
purchasers for certain losses associated with sold business entities or assets
that are not limited by a contractual monetary amount. As of September 30,
2004, CNA had outstanding unlimited indemnifications in connection with the
sales of certain of its business entities or assets for tax liabilities
arising prior to a purchaser's ownership of an entity or asset, defects in
title at the time of sale, employee claims arising prior to closing and in
some cases losses arising from certain litigation and undisclosed liabilities.
These indemnification agreements survive until the applicable statutes of
limitation expire, or until the agreed upon contract terms expire.
Additionally, CNA has provided a contingent guarantee to the lenders of two
third parties, related to loans extended by their lenders. CNA recorded
approximately $21.0 and $16.0 million of other liabilities related to these
indemnification agreements as of September 30, 2004 and December 31, 2003.
In connection with the issuance of preferred securities by CNA Surety
Capital Trust I, a subsidiary of CNA Surety, CNA Surety issued a guarantee of
$75.0 million to guarantee the payment by CNA Surety Capital Trust I of annual
dividends of $1.5 million over 30 years and redemption of $30.5 million of
preferred securities.
Other
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. As of September 30, 2004 and December 31, 2003, there were
approximately $44.0 and $58.0 million of outstanding letters of credit.
The Company is obligated to make future payments totaling $425.6 million for
non-cancelable operating leases expiring from 2004 through 2014 primarily for
office space and data processing, office and transportation equipment.
Estimated future minimum payments under these contracts are as follows: $17.6
million in 2004; $66.3 million in 2005; $77.6 million in 2006; $51.4 million
in 2007; $47.0 million in 2008; and $165.7 million in 2009 and beyond.
Additionally, CNA has entered into a limited number of guaranteed payment
contracts, primarily relating to telecommunication services, amounting to
approximately $15.0 million. Estimated future minimum payments under these
contracts are as follows: $2.0 million in 2004; $7.0 million in 2005; $4.0
million in 2006; and $2.0 million in 2007.
As of September 30, 2004 and December 31, 2003, CNA had committed
approximately $138.0 and $154.0 million for future capital calls from various
third-party limited partnership investments in exchange for an ownership
interest in the related partnership.
The Company invests in multiple bank loan participations as part of its
overall investment strategy and has committed to additional future purchases
and sales. The purchase and sale of these investments are recorded on the date
that the legal agreements are finalized and cash settlement is made. As of
September 30, 2004, the Company had commitments to purchase $60.2 million and
sell $47.3 million of various bank loan participations.
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of September 30, 2004 to future capital calls
from certain of its unconsolidated affiliates in exchange for an ownership
interest in such affiliates.
69
CNA Surety
CNA has entered into a credit agreement with a large national contractor
that undertakes projects for the construction of government and private
facilities to provide an $86.0 million credit facility. CNA Surety has
provided significant surety bond protection for projects by this contractor
through surety bonds underwritten by CCC or its affiliates. The loans were
provided by CNA to help the contractor meet its liquidity needs. The credit
facility and all loans under it will mature in March of 2006. Advances under
the credit facility bear interest at the prime rate plus 6.0%. Interest of
3.0% is deferred until the credit facility matures, and the remainder is to be
paid monthly in cash. Loans under the credit facility are secured by a pledge
of substantially all of the assets of the contractor and certain of its
affiliates.
Loews and CNA have entered into a participation agreement, pursuant to which
Loews has purchased a participation interest in one-third of the loans and
commitments under the credit facility, on a dollar-for-dollar basis, up to a
maximum of $25.0 million. Although Loews does not have rights against the
contractor directly under the participation agreement, it shares recoveries
and certain fees under the facility proportionally with CNA.
In March of 2003, CNA purchased the contractor's outstanding bank debt for
$16.0 million. The contractor purchased the bank debt from CNA and retired it,
with $11.0 million of the purchase price being funded under the new credit
facility and $5.0 million from money loaned to the contractor by its
shareholders. Under its purchase agreement with the banks, CNA is also
required to reimburse the banks for any draws upon outstanding letters of
credit issued by the banks for the contractor's benefit. Letters of credit in
the amount of $3.0 million are due to expire in August of 2005. CNA has also
provided collateral for letters of credit issued by another bank for the
contractor's benefit in the aggregate amount of $8.0 million. Any CNA
reimbursements or access of CNA collateral for draws upon the banks' letters
of credit will become obligations of the contractor to CNA as draws upon the
credit facility. As of September 30, 2004, the aggregate amount of outstanding
principal and accrued interest under the credit facility was $85.0 million.
As of March 31, 2004, the credit facility was amended to provide for
calculating the amount available for borrowing without regard to approximately
$1.1 million representing accrued interest on a bridge loan provided by CNA
that became a borrowing under the facility; the elimination of a reduction in
CNA's commitment upon receipt by the contractor of certain claim proceeds; and
an increase in the monthly compensation limits for the contractor's
principals. In connection with the amendment, the principals and an affiliate
contributed $5.0 million in the aggregate to the contractor's capital by
forgiving certain of the contractor's indebtedness.
The contractor is implementing a restructuring plan that is intended to
reduce costs and improve cash flow, and a chief restructuring officer has been
appointed to manage execution of the plan. CNA Surety intends to continue to
provide surety bonds on behalf of the contractor during this restructuring
period, subject to the contractor's initial and ongoing compliance with CNA
Surety's underwriting standards and ongoing management of CNA Surety's
exposure to the contractor. Based on the contractor's restructuring efforts to
date, CNA estimates that amounts due under the credit facility are
collectible.
70
Any losses to CNA Surety arising from bonds issued to the contractor or
assumed are excluded from CNA Surety's $40.0 million excess of $20.0 million
per principal reinsurance program with unaffiliated reinsurers in place in
2002. As a result, CNA Surety retains the first $60.0 million of losses on
bonds written with an effective date of September 30, 2002 and prior, and CCC
will incur 100% of losses above that retention level. Through facultative
reinsurance contracts with CCC, CNA Surety's exposure on bonds written from
October 1, 2002 through October 31, 2003 has been limited to $20.0 million per
bond. For bonds written subsequent to November 1, 2003, CNA Surety's exposure
is limited to $14.5 million per bond subject to an aggregate limit of $150.0
million under all facultative insurance coverage and two excess of loss
treaties between CNA Surety and CCC. Both excess of loss contracts are
effective January 1, 2004. The first excess of loss contract, $40.0 million
excess of $60.0 million, provides CNA Surety coverage exclusively for the
national contractor, while the second excess of loss contract, $50.0 million
excess of $100.0 million, provides CNA Surety with coverage for the national
contractor as well as other CNA Surety risks.
CCC and CNA Surety have had discussions with their insurance regulatory
authorities regarding the level of bonds provided for this principal and will
continue to apprise the insurance regulators regarding their ongoing exposure
to this account.
Indemnification and subrogation rights, including rights to contract
proceeds on construction projects in the event of default, exist that reduce
CNA Surety's and ultimately the Company's exposure to loss. While CNA believes
that the contractor's restructuring efforts may be successful and provide
sufficient cash flow for its operations, the contractor's failure to achieve
its restructuring plan or perform its contractual obligations under the credit
facility or under CNA's surety bonds could have a material adverse effect on
the Company's results of operations and/ or equity. If such failures occur,
CNA estimates the surety loss, net of indemnification and subrogation
recoveries, but before the effects of minority interest, to be approximately
$200.0 million pretax. In addition, such failures could cause the full amount
due under the credit facility to be uncollectible.
CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety over a period that expired on December 31, 2000
(the "stop loss contract"). The stop loss contract limits the net loss ratios
for CNA Surety with respect to certain accounts and lines of insurance
business. In the event that CNA Surety's accident year net loss ratio exceeds
24.0% for 1997 through 2000 (the "contractual loss ratio"), the stop loss
contract requires CCC to pay amounts equal to the amount, if any, by which CNA
Surety's actual accident year net loss ratio exceeds the contractual loss
ratio multiplied by the applicable net earned premiums. The minority
shareholders of CNA Surety do not share in any losses that apply to this
contract. There were no reinsurance balances payable under this stop loss
contract as of September 30, 2004 and December 31, 2003.
Effective October 1, 2002, CCC provided an excess of loss protection for new
and renewal bonds for CNA Surety for each principal exposures that exceed
$60.0 million since October 1, 2002 in two parts - a) $40.0 million excess of
$60.0 million and b) $50.0 million excess of $100.0 million for CNA Surety.
Effective January 1, 2004, this contract was commuted and CCC paid CNA Surety
$11.0 million in return premium in the first quarter of 2004 based on
experience under the contract. Effective October 1, 2003, the CCC entered into
a $3.0 million excess of $12.0 million excess of loss contract with CNA
Surety. The reinsurance premium for the coverage provided by the $3.0 million
excess of $12.0 million contract was $0.3 million plus, if applicable,
71
additional premiums based on paid losses. The contract provided for aggregate
coverage of $12.0 million. This contract was to expire on December 31, 2004.
Effective January 1, 2004, CNA obtained replacement coverage from third party
reinsurers as part of the 2004 Excess of Loss Treaty.
16. Consolidating Financial Information
The following schedules present the Company's Consolidating Balance Sheet
Information at September 30, 2004 and December 31, 2003, and Consolidating
Statements of Operations Information for the nine months ended September 30,
2004 and 2003. These schedules present the individual subsidiaries of the
Company and their contribution to the Consolidated Condensed Financial
Statements. Amounts presented will not necessarily be the same as those in the
individual financial statements of the Company's subsidiaries due to
adjustments for purchase accounting, income taxes and minority interests. In
addition, many of the Company's subsidiaries use a classified balance sheet
which also leads to differences in amounts reported for certain line items.
This information also does not reflect the impact of the Company's issuance of
Carolina Group stock. Lorillard is reported as a 100% owned subsidiary and
does not include any adjustments relating to the tracking stock structure. See
Note 4 for Loews and Carolina Group Consolidating Condensed Financial
Information.
The Corporate and Other column primarily reflects the parent company's
investment in its subsidiaries, invested cash portfolio, corporate long-term
debt and Bulova Corporation, a 97% owned subsidiary. The elimination
adjustments are for intercompany assets and liabilities, interest and
dividends, the parent company's investment in capital stocks of subsidiaries,
and various reclasses of debit or credit balances to the amounts in
consolidation. Purchase accounting adjustments have been pushed down to the
appropriate subsidiary.
72
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate
September 30, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 37,946.1 $ 1,671.7 $ 80.4 $ 867.3 $ 18.0 $ 2,680.8 $43,264.3
Cash 70.8 1.3 4.5 15.8 1.9 44.8 139.1
Receivables-net 18,666.3 29.1 26.0 154.0 38.9 116.3 $ (138.0) 18,892.6
Property, plant and equipment 198.4 230.8 377.2 2,230.4 700.1 26.2 3,763.1
Deferred income taxes 767.8 441.1 63.5 31.3 (628.9) 674.8
Goodwill 118.3 2.6 10.6 163.5 295.0
Investments in capital stocks
of subsidiaries 11,258.6 (11,258.6)
Other assets 1,706.5 367.0 92.7 104.1 209.4 341.7 (273.5) 2,547.9
Deferred acquisition costs
of insurance subsidiaries 1,312.1 1,312.1
Separate account business 567.1 567.1
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 61,353.4 $ 2,741.0 $ 583.4 $3,382.2 $1,195.3 $14,499.7 $(12,299.0) $71,456.0
=================================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 43,387.4 $43,387.4
Payable for securities purchased 1,351.0 $ 0.2 $ 89.6 1,440.8
Securities sold under agreements
to repurchase 115.8 115.8
Short-term debt 530.8 45.6 $ 479.2 1,055.6
Long-term debt, less unamortized
discounts 1,182.2 98.8 705.7 $ 531.1 2,304.4 $ (45.6) 4,776.6
Reinsurance balances payable 3,103.2 3,103.2
Deferred income taxes 30.0 361.2 237.7 (628.9)
Other liabilities 1,970.3 $ 1,465.1 202.4 165.6 158.8 183.7 (234.5) 3,911.4
Separate account business 567.1 567.1
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 52,207.8 1,465.1 377.0 1,711.7 689.9 2,815.4 (909.0) 58,357.9
Minority interest 905.0 736.4 5.2 1,646.6
Shareholders' equity 8,240.6 1,275.9 206.4 934.1 505.4 11,679.1 (11,390.0) 11,451.5
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 61,353.4 $ 2,741.0 $ 583.4 $3,382.2 $1,195.3 $14,499.7 $(12,299.0) $71,456.0
=================================================================================================================================
73
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate
December 31, 2003 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 38,121.5 $ 1,530.2 $ 81.4 $ 591.2 $ 15.2 $ 2,175.3 $ 42,514.8
Cash 139.0 1.5 2.0 19.1 3.9 15.3 180.8
Receivables-net 20,143.2 23.9 20.1 154.1 57.4 168.2 $ (99.0) 20,467.9
Property, plant and equipment 239.6 221.0 369.6 2,297.7 703.5 48.3 3,879.7
Deferred income taxes 646.5 441.9 88.1 21.5 (667.8) 530.2
Goodwill 118.7 2.6 20.8 169.3 311.4
Investments in capital stocks
of subsidiaries 11,402.5 (11,402.5)
Other assets 2,832.7 406.4 96.2 75.7 200.6 360.9 (187.1) 3,785.4
Deferred acquisition costs
of insurance subsidiaries 2,532.7 2,532.7
Separate account business 3,678.0 3,678.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 68,451.9 $ 2,624.9 $ 571.9 $3,158.6 $1,238.0 $14,192.0 $(12,356.4) $ 77,880.9
=================================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 45,384.0 $ 45,384.0
Payable for securities purchased 2,022.1 $ 1.1 $ 124.5 2,147.7
Securities sold under
agreements to repurchase 441.8 441.8
Short-term debt 263.4 3.2 $ 12.0 $ 17.3 295.9
Long-term debt, less
unamortized discounts 1,640.2 143.3 910.9 530.8 2,299.1 5,524.3
Reinsurance balances payable 3,432.0 3,432.0
Deferred income taxes 75.9 370.1 221.8 $ (667.8)
Other liabilities 2,438.7 $ 1,405.0 172.0 134.5 166.5 142.5 (207.9) 4,251.3
Separate account business 3,678.0 3,678.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 59,300.2 1,405.0 395.5 1,427.5 714.6 2,787.9 (875.7) 65,155.0
Minority interest 896.9 769.5 5.2 1,671.6
Shareholders' equity 8,254.8 1,219.9 176.4 961.6 523.4 11,398.9 (11,480.7) 11,054.3
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 68,451.9 $ 2,624.9 $ 571.9 $3,158.6 $1,238.0 $14,192.0 $(12,356.4) $ 77,880.9
=================================================================================================================================
74
Loews Corporation
Consolidating Statement of Operations Information
Nine Months Ended CNA Loews Diamond Texas Corporate
September 30, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
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(In millions)
Revenues:
Insurance premiums $ 6,221.1 $ (2.8) $ 6,218.3
Investment income, net 1,212.0 $ 21.2 $ 1.6 $ 7.6 $ 0.3 $ 35.9 (5.8) 1,272.8
Intercompany interest
and dividends 464.1 (464.1)
Investment gains (losses) (411.4) 0.6 0.2 61.4 (349.2)
Manufactured products 2,515.3 110.2 2,625.5
Other 226.7 232.3 575.7 185.0 204.0 1,423.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total 7,248.4 2,537.1 233.9 583.5 185.3 875.6 (472.7) 11,191.1
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 4,859.3 4,859.3
Amortization of deferred 1,114.1 1,114.1
acquisition costs
Cost of manufactured
products sold 1,504.4 54.2 1,558.6
Other operating expenses 1,088.6 288.0 206.3 592.0 109.5 95.0 (2.8) 2,376.6
Interest 93.8 4.5 20.4 22.5 110.5 (5.8) 245.9
- ---------------------------------------------------------------------------------------------------------------------------------
Total 7,155.8 1,792.4 210.8 612.4 132.0 259.7 (8.6) 10,154.5
- ---------------------------------------------------------------------------------------------------------------------------------
92.6 744.7 23.1 (28.9) 53.3 615.9 (464.1) 1,036.6
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) (73.1) 287.7 9.1 (6.9) 21.3 51.3 289.4
Minority interest 27.1 (8.5) 0.1 18.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total (46.0) 287.7 9.1 (15.4) 21.3 51.4 308.1
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 138.6 $ 457.0 $ 14.0 $ (13.5) $ 32.0 $ 564.5 $ (464.1) $ 728.5
=================================================================================================================================
75
Loews Corporation
Consolidating Statement of Operations Information
Nine Months Ended CNA Loews Diamond Texas Corporate
September 30, 2003 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 6,703.8 $ (2.8) $ 6,701.0
Investment income, net 1,211.3 $ 29.7 $ 1.5 $ 10.2 $ 22.5 1,275.2
Intercompany interest
and dividends 575.5 (575.5)
Investment gains (losses) 476.9 (10.6) (7.3) 44.2 503.2
Manufactured products 2,467.9 110.5 2,578.4
Other 287.6 (0.2) 212.0 494.7 $ 68.1 5.3 1,067.5
- ---------------------------------------------------------------------------------------------------------------------------------
Total 8,679.6 2,486.8 213.5 497.6 68.1 758.0 (578.3) 12,125.3
- --------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 8,319.6 8,319.6
Amortization of deferred
acquisition costs 1,433.7 1,433.7
Cost of manufactured
products sold 1,435.4 54.2 1,489.6
Other operating expenses 1,403.8 352.3 188.7 543.6 49.8 82.3 (2.8) 2,617.7
Interest 99.5 7.2 17.4 11.6 94.6 230.3
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Total 11,256.6 1,787.7 195.9 561.0 61.4 231.1 (2.8) 14,090.9
- ---------------------------------------------------------------------------------------------------------------------------------
(2,577.0) 699.1 17.6 (63.4) 6.7 526.9 (575.5) (1,965.6)
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax (benefit) expense (976.0) 262.8 6.4 (11.6) 2.9 (19.8) (735.3)
Minority interest (174.0) (23.0) 0.2 (196.8)
- ---------------------------------------------------------------------------------------------------------------------------------
Total (1,150.0) 262.8 6.4 (34.6) 2.9 (19.6) (932.1)
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from
continuing operations (1,427.0) 436.3 11.2 (28.8) 3.8 546.5 (575.5) (1,033.5)
Discontinued operations-net 55.4 55.4
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(1,427.0) $ 436.3 $ 66.6 $ (28.8) $ 3.8 $ 546.5 $(575.5) $ (978.1)
=================================================================================================================================
76
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Management's discussion and analysis of financial condition and results of
operations ("MD&A") is comprised of the following sections:
Page No.
--------
Overview 77
Consolidated Financial Results 78
CNA Recent Developments 80
Classes of Common Stock 81
Parent Company Structure 82
Critical Accounting Estimates 83
Results of Operations by Business Segment 86
CNA Financial 88
Net Prior Year Development 88
Reserves - Estimates and Uncertainties 92
Reinsurance 94
Terrorism Insurance 98
Restructuring 99
Non-GAAP Financial Measures 99
Standard Lines 102
Specialty Lines 110
Life and Group Non-core 114
Other Insurance 115
APMT Reserves 117
Lorillard 129
Results of Operations 129
Selected Market Share Data 131
Business Environment 132
Loews Hotels 135
Diamond Offshore 136
Texas Gas 137
Corporate and Other 138
Liquidity and Capital Resources 139
CNA Financial 139
Lorillard 142
Loews Hotels 143
Diamond Offshore 143
Texas Gas 144
Corporate and Other 145
Investments 145
Forward-Looking Statements Disclaimer 157
OVERVIEW
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: commercial insurance (CNA Financial Corporation
("CNA"), a 91% owned subsidiary); the production and sale of cigarettes
(Lorillard, Inc. ("Lorillard"), a wholly owned subsidiary); the operation of
hotels (Loews Hotels Holding Corporation ("Loews Hotels"), a wholly owned
subsidiary); the operation of offshore oil and gas drilling rigs (Diamond
77
Offshore Drilling, Inc. ("Diamond Offshore"), a 55% owned subsidiary); the
operation of an interstate natural gas transmission pipeline system (Texas Gas
Transmission, LLC ("Texas Gas"), a wholly owned subsidiary) and the
distribution and sale of watches and clocks (Bulova Corporation ("Bulova"), a
97% owned subsidiary). Unless the context otherwise requires, the terms
"Company," "Loews" and "Registrant" as used herein mean Loews Corporation
excluding its subsidiaries. The following discussion should be read in
conjunction with the Consolidated Condensed Financial Statements in Item 1 and
the Company's Annual Report on Form 10-K/A for the year ended December 31,
2003.
Consolidated Financial Results
Loews Corporation reported consolidated net income (including both the Loews
Group and Carolina Group) for the 2004 third quarter of $277.6 million,
compared to a loss of $1,382.9 million in the 2003 third quarter. Consolidated
net income for the first nine months of 2004 was $728.5 million, compared to a
loss of $978.1 million in the comparable period of the prior year.
Net income (loss) and earnings per share information attributable to Loews
common stock and Carolina Group stock is summarized in the table below:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Net income (loss) attributable to Loews
common stock:
Income (loss) before net investment
(losses) gains (a) $ 245.9 $(1,573.3) $ 791.5 $(1,416.1)
Net investment (losses) gains (b) (21.7) 107.8 (191.4) 302.2
- ------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 224.2 (1,465.5) 600.1 (1,113.9)
Discontinued operations-net 55.8 55.4
- ------------------------------------------------------------------------------------------------
Net income (loss) attributable to Loews
common stock 224.2 (1,409.7) 600.1 (1,058.5)
Net income attributable to Carolina
Group stock 53.4 26.8 128.4 80.4
- ------------------------------------------------------------------------------------------------
Consolidated net income (loss) $ 277.6 $(1,382.9) $ 728.5 $ (978.1)
================================================================================================
Net income (loss) per share:
Loews common stock $ 1.21 $ (7.60) $ 3.24 $ (5.71)
Carolina Group stock 0.92 0.67 2.21 2.01
================================================================================================
(a) Includes income of $116.5 (after tax) for the three and nine months ended September 30, 2004
from an investee's sale of four ultra-large crude oil tankers.
(b) Includes a loss of $352.9 (after tax and minority interest) for the nine months ended
September 30, 2004 related to CNA's sale of its individual life insurance business.
Quarter Ended September 30, 2004 Compared With 2003
Net income attributable to Loews common stock for the third quarter of 2004
amounted to $224.2 million or $1.21 per share, compared to a loss of $1,409.7
million or $7.60 per share in the comparable period of the prior year.
78
Income before net investment gains (losses) attributable to Loews common
stock amounted to $245.9 million in the third quarter of 2004 compared to a
loss of $1,573.3 million in the comparable 2003 quarter. Results for 2004
include charges at CNA of $158.8 million (after tax and minority interest) due
to the impact of Hurricanes Charley, Frances, Ivan and Jeanne, partially
offset by income of $116.5 million (after taxes) from Hellespont Shipping
Corporation, a 49%-owned company, following the sale of its four ultra-large
crude oil tankers. The 2003 third quarter results include significant charges
by CNA for net prior year development of $1,345.8 million (after tax and
minority interest) and an increase in bad debt reserves for insurance and
reinsurance receivables of $298.9 million (after tax and minority interest).
Net income attributable to Loews common stock includes net investment losses
of $21.7 million (after tax and minority interest) compared to net investment
gains of $107.8 million (after tax and minority interest) in the comparable
period of the prior year. The decline was primarily due to losses at CNA
related to derivative securities held to mitigate the effect of changes in
long term interest rates on the value of the fixed maturity portfolio. While a
decrease in long term interest rates during the third quarter resulted in a
realized loss related to these derivatives, the fair value of CNA's fixed
maturity portfolio benefited from the interest rate movements resulting in an
increase in the Company's shareholders' equity. Consolidated net loss in the
third quarter of 2003 also includes a gain from discontinued operations of
$55.8 million, or $0.30 per share of Loews common stock, related to the sale
of a hotel property.
Net income attributable to Carolina Group stock for the third quarter of
2004 was $53.4 million or $0.92 per Carolina Group share, compared to $26.8
million or $0.67 per Carolina Group share in the third quarter of 2003. The
Company is issuing a separate press release reporting the results of the
Carolina Group for the third quarter of 2004.
Consolidated revenues in the third quarter of 2004 amounted to $3.8 billion
compared to $3.9 billion in the comparable 2003 quarter. The decline in
revenues reflects CNA's sale of its group benefits business in December of
2003 and individual life insurance business in April of 2004.
Nine Months Ended September 30, 2004 Compared With 2003
Net income attributable to Loews common stock for the first nine months of
2004 amounted to $600.1 million or $3.24 per share, compared to a loss of
$1,058.5 million or $5.71 per share in the comparable period of the prior
year.
Income before net investment losses attributable to Loews common stock
amounted to $791.5 million in the first nine months of 2004 compared to a loss
of $1,416.1 million in the comparable period of the prior year. Results for
2004 include income from the Hellespont Shipping Corporation transaction and
the charges from the impact of the four hurricanes. The net loss in 2003
reflects CNA's unfavorable net prior year development and increase in bad debt
reserves as discussed above.
Net income attributable to Loews common stock includes net investment losses
of $191.4 million (after tax and minority interest), compared to net
investment gains of $302.2 million (after tax and minority interest) in the
comparable period of the prior year. The increase in net investment losses is
due primarily to a loss of $352.9 million (after tax and minority interest)
from CNA's sale of its individual life insurance business and losses related
to derivative securities discussed above.
79
Net income attributable to Carolina Group stock for the first nine months of
2004 was $128.4 million or $2.21 per Carolina Group share, compared to $80.4
million or $2.01 per Carolina Group share in the comparable period of the
prior year.
Consolidated revenues in the first nine months of 2004 amounted to $11.2
billion compared to $12.1 billion in the comparable period of the prior year.
The decline in revenues reflects the sale of CNA's group benefits and
individual life insurance businesses as well as the impact of the $618.6
million pretax investment loss related to the life sale.
CNA Recent Developments
During 2003, CNA completed a strategic review of its operations and decided
to concentrate its efforts on the property and casualty business. As a result
of this review, and several significant charges in 2003, a capital plan was
developed to replenish the statutory capital of the property and casualty
subsidiaries. A summary of the capital plan, related actions, and other
significant business decisions is discussed below.
On April 30, 2004, CNA completed the sale of its individual life insurance
business. The business sold included term, universal and permanent life
insurance policies and individual annuity products. CNA's individual long term
care and structured settlement businesses were excluded from the sale.
Consideration from the sale was approximately $700.0 million. The Company
recorded a realized investment loss of $352.9 million after-tax and minority
interest ($618.6 million pretax) during the first six months of 2004. See Note
10 of the Notes to Consolidated Condensed Financial Statements in Item 1 for
further discussion.
On December 31, 2003, CNA completed the sale of the majority of its group
benefits business. The business sold included group life and accident, short
and long term disability and certain other products. CNA's group long term
care and specialty medical businesses were excluded from the sale.
Consideration from the sale was approximately $530.0 million, resulting in an
after-tax and minority interest realized investment loss on the sale of $109.1
million ($163.0 million pretax), including an after-tax and minority interest
realized investment gain of $7.3 million ($13.0 million pretax) recorded in
the second quarter of 2004.
During 2003, CNA sold the renewal rights for most of the treaty business of
CNA Re and withdrew from the assumed reinsurance business. CNA is managing the
run-off of its retained liabilities.
The group benefits business, individual life and annuity insurance business
and CNA Re absorbed approximately $150.0 million of the total shared corporate
overhead expenses that are allocated to all of CNA's businesses. CNA expects
that the 2004 consolidated net operating results will include approximately
$35.0 million after-tax of losses for these three businesses, largely due to
these corporate overhead expenses. This amount has been revised from the $50.0
million loss estimate that was previously disclosed in the Company's 2003 Form
10-K/A primarily because of the impact of the loss on the sale of the
individual life business and favorable mortality and investment results in the
first quarter of 2004. The 2003 expense initiative did not contemplate the
sale or exit of these businesses, and therefore the savings from that
initiative will be partially offset by these expenses.
80
The primary components of the 2003 expense initiative were a reduction of
the workforce by approximately five percent, lower commissions and other
acquisition costs, principally related to workers compensation, and reduced
spending in other areas. As of December 31, 2003, CNA achieved the targeted
workforce reduction. Actions related to reducing commissions and other
acquisition expenses began in 2003 and were completed in 2004.
CNA has undertaken additional expense initiatives in 2004 that are expected
to produce expense savings in excess of $100.0 million beginning in 2004 and
continuing through 2005. The primary components of the expense initiatives are
a reduction in certain business expenses through more stringent expense
policies and guidelines, reduced facilities cost through consolidation of
locations, and to a lesser extent, workforce reductions.
The capital plan established in November of 2003 consisted of the November
sale of $750.0 million of a new series of CNA convertible preferred stock to
Loews. The preferred stock converted into 32,327,015 shares of CNA common
stock on April 20, 2004. Additionally, the capital plan included a commitment
from Loews for additional capital support of up to $500.0 million by February
27, 2004 through the purchase of surplus notes of Continental Casualty Company
("CCC"), CNA's principal insurance subsidiary, in the event certain additions
to CCC's statutory capital were not achieved through asset sales and up to an
additional $150.0 million to support the statutory capital of CCC in the event
of additional shortfalls in relation to business and asset sales. In
accordance with such commitments, in February of 2004, Loews purchased $45.6
million of surplus notes from CCC, in relation to the sale of CNA's group
benefits business, and also purchased $300.0 million of additional surplus
notes of CCC in relation to the sale of CNA's individual life business,
discussed above. The sale of the individual life business resulted in an
addition to statutory capital in excess of $550.0 million. CCC received
insurance regulatory approval for the repayment of the $300.0 million CCC Life
surplus note issued in February of 2004, including accrued interest, and
repaid these amounts in full on June 16, 2004. CCC plans to seek approval from
the insurance regulatory authority for the repayment of the CCC Group surplus
note in 2004. The purchase of the preferred stock and the surplus notes
fulfilled the commitment from Loews in relation to the capital plan.
On August 1, 2004, CNA completed the sale of the retirement plan trust and
recordkeeping business portfolio of CNA Trust to Union Bank of California.
Consideration from the sale was approximately $12.0 million, resulting in an
after-tax and minority interest realized investment gain on the sale of $4.6
million ($9.0 million pretax).
Classes of Common Stock
The issuance of Carolina Group stock has resulted in a two class common
stock structure for Loews Corporation. Carolina Group stock, commonly called a
tracking stock, is intended to reflect the economic performance of a defined
group of assets and liabilities of the Company referred to as the Carolina
Group. The principal assets and liabilities attributed to the Carolina Group
are: (a) the Company's 100% stock ownership interest in Lorillard, Inc.; (b)
notional, intergroup debt owed by the Carolina Group to the Loews Group ($1.9
billion outstanding at September 30, 2004), bearing interest at the annual
rate of 8.0% and, subject to optional prepayment, due December 31, 2021; and
(c) any and all liabilities, costs and expenses arising out of or related to
tobacco or tobacco-related businesses.
As of September 30, 2004, the outstanding Carolina Group stock represents a
33.43% economic interest in the economic performance of the Carolina Group.
81
The Loews Group consists of all the Company's assets and liabilities other
than the 33.43% economic interest represented by the outstanding Carolina
Group stock, and includes as an asset the notional, intergroup debt of the
Carolina Group.
The existence of separate classes of common stock could give rise to
occasions where the interests of the holders of Loews common stock and
Carolina Group stock diverge or conflict or appear to diverge or conflict.
Subject to its fiduciary duties, the Company's board of directors could, in
its sole discretion, from time to time, make determinations or implement
policies that affect disproportionately the groups or the different classes of
stock. For example, Loews's board of directors may decide to reallocate
assets, liabilities, revenues, expenses and cash flows between groups, without
the consent of shareholders. The board of directors would not be required to
select the option that would result in the highest value for holders of
Carolina Group stock.
As a result of the flexibility provided to Loews's board of directors, it
might be difficult for investors to assess the future prospects of the
Carolina Group based on the Carolina Group's past performance.
The creation of the Carolina Group and the issuance of Carolina Group stock
does not change the Company's ownership of Lorillard, Inc. or Lorillard,
Inc.'s status as a separate legal entity. The Carolina Group and the Loews
Group are notional groups that are intended to reflect the performance of the
defined sets of assets and liabilities of each such group as described above.
The Carolina Group and the Loews Group are not separate legal entities and the
attribution of assets and liabilities to the Loews Group or the Carolina Group
does not affect title to the assets or responsibility for the liabilities.
Holders of the Company's common stock and of Carolina Group stock are
shareholders of Loews Corporation and are subject to the risks related to an
equity investment in Loews Corporation.
Parent Company Structure
The Company is a holding company and derives substantially all of its cash
flow from its subsidiaries, principally Lorillard. The Company relies upon its
invested cash balances and distributions from its subsidiaries to generate the
funds necessary to meet its obligations and to declare and pay any dividends
to its stockholders. The ability of the Company's subsidiaries to pay
dividends is subject to, among other things, the availability of sufficient
funds in such subsidiaries, applicable state laws, including in the case of
the insurance subsidiaries of CNA, laws and rules governing the payment of
dividends by regulated insurance companies. Claims of creditors of the
Company's subsidiaries will generally have priority as to the assets of such
subsidiaries over the claims of the Company and its creditors and stockholders
(see Liquidity and Capital Resources - CNA Financial below).
At September 30, 2004, the book value per share of Loews common stock was
$62.78, compared to $60.92 at December 31, 2003.
82
Critical Accounting Estimates
The preparation of the Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP") requires management to make estimates and assumptions that affect the
amounts reported in the Consolidated Financial Statements and the related
notes. Actual results could differ from those estimates.
The Consolidated Financial Statements and accompanying notes have been
prepared in accordance with GAAP, applied on a consistent basis. The Company
continually evaluates the accounting policies and estimates used to prepare
the Consolidated Financial Statements. In general, management's estimates are
based on historical experience, evaluation of current trends, information from
third party professionals and various other assumptions that are believed to
be reasonable under the known facts and circumstances.
The accounting policies discussed below are considered by management to be
critical to an understanding of the Company's Consolidated Condensed Financial
Statements as their application places the most significant demands on
management's judgment. Due to the inherent uncertainties involved with this
type of judgment, actual results could differ significantly from estimates and
have a material adverse impact on the Company's results of operations and/or
equity.
Insurance Reserves
Insurance reserves are established for both short and long-duration
insurance contracts. Short-duration contracts are primarily related to
property and casualty insurance policies where the reserving process is based
on actuarial estimates of the amount of loss, including amounts for known and
unknown claims. Long-duration contracts typically include traditional life
insurance and long-term care products and are estimated using actuarial
estimates about mortality and morbidity as well as assumptions about expected
investment returns. Changes in estimates of claim and allocated claim
adjustment expense reserves and premium accruals for prior accident years are
defined as development within this MD&A. These changes can be favorable or
unfavorable. The inherent risks associated with the reserving process are
discussed in Reserves - Estimates and Uncertainties, below.
Reinsurance
Amounts recoverable from reinsurers are estimated in a manner consistent
with claim and claim adjustment expense reserves or future policy benefits
reserves and are reported as receivables in the Consolidated Condensed Balance
Sheets. The ceding of insurance does not discharge the primary liability of
CNA. An estimated allowance for doubtful accounts is recorded on the basis
of periodic evaluations of balances due from reinsurers, reinsurer solvency,
management's experience and current economic conditions. Further information
on reinsurance is provided in Results of Operations - Reinsurance, below.
Tobacco and Other Litigation
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. Plaintiffs in most of the cases seek unspecified
amounts of compensatory damages and punitive damages, although some seek
damages ranging into the billions of dollars. Plaintiffs in some of the cases
seek treble damages, statutory damages, disgorgement of profits, equitable and
injunctive relief, and medical monitoring, among other damages.
83
Lorillard believes that it has valid defenses to the cases pending against
it. Lorillard also believes it has valid bases for appeal of the adverse
verdicts against it. To the extent the Company is a defendant in any of the
lawsuits, the Company believes that it is not a proper defendant in these
matters and has moved or plans to move for dismissal of all such claims
against it. While Lorillard intends to defend vigorously all tobacco products
liability litigation, it is not possible to predict the outcome of any of this
litigation. Litigation is subject to many uncertainties, and it is possible
that some of these actions could be decided unfavorably. Lorillard may enter
into discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
On May 21, 2003 the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeal also decertified the class
ordered during pre-trial proceedings. The Florida Supreme Court has agreed to
review the case and has scheduled argument for November of 2004. The Company
and Lorillard believe that the appeals court's decision should be upheld upon
further appeals.
During May of 2004, a jury in the Circuit Court of Louisiana, Orleans
Parish, awarded $591.0 million to fund cessation programs for Louisiana
smokers in the case of Scott v. The American Tobacco Company, et al. The jury
was not asked to apportion damages in its verdict so Lorillard's share of the
judgment has not been determined. The court denied defendants' motion for
judgment notwithstanding the verdict or, in the alternative, for new trial.
Lorillard and the other defendants in this matter have initiated an appeal
from the judgment to the Louisiana Court of Appeals. Pursuant to Louisiana
law, the trial court entered an order setting the amount of the appeal bond at
$50.0 million for all defendants, of which Lorillard secured $12.5 million.
While Lorillard believes the limitation on the appeal bond amount is valid and
required by Louisiana law, and that any challenges to the amount of the bond
would fail, in the event of a successful challenge the amount of the appeal
bond could be set as high as 150% of the judgment and judicial interest
combined. If such an event occurred, Lorillard's share of the appeal bond is
uncertain.
Except for the impact of the State Settlement Agreements as described in
Note 14 of the Notes to Consolidated Condensed Financial Statements included
in Item 1 of this Report, management is unable to make a meaningful estimate
of the amount or range of loss that could result from an unfavorable outcome
of pending litigation and, therefore, no provision has been made in the
Consolidated Condensed Financial Statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially adversely affected by an unfavorable
outcome of certain pending or future litigation.
84
Valuation of Investments and Impairment of Securities
Invested assets are exposed to various risks, such as interest rate, market
and credit risks. Due to the level of risk associated with certain invested
assets and the level of uncertainty related to changes in the value of these
assets, it is possible that changes in risks in the near term could have an
adverse material impact on the Company's results of operations or equity.
The Company's investment portfolio is subject to market declines below book
value that may be other-than-temporary. CNA has an Impairment Committee, which
reviews its investment portfolio on a quarterly basis with ongoing analysis as
new information becomes available. Any decline that is determined to be other-
than-temporary is recorded as an impairment loss in the results of operations
in the period in which the determination occurred.
In March of 2004, the Emerging Issues Task Force ("EITF") reached consensus
on the guidance provided in EITF Issue No. 03-1, "The Meaning of Other-Than-
Temporary Impairment and its Application to Certain Investments" ("EITF 03-1")
as applicable to debt and equity securities that are within the scope of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
and equity securities that are accounted for using the cost method specified
in Accounting Principles Board Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock." An investment is impaired if the
fair value of the investment is less than its cost including adjustments for
amortization, accretion, foreign exchange and hedging. EITF 03-1 outlines that
an impairment would be considered other-than-temporary unless (a) the investor
has the ability and intent to hold an investment for a reasonable period of
time sufficient for the recovery of the fair value up to (or beyond) the cost
of the investment and (b) evidence indicating that the cost of the investment
is recoverable within a reasonable period of time outweighs evidence to the
contrary. The investor should consider its cash or working capital needs to
assess its intent and ability to hold an investment for a reasonable period of
time for the recovery of fair value up to or beyond the cost of the
investment. Although not presumptive, a pattern of selling investments prior
to the forecasted recovery of fair value may call into question the investor's
intent. In addition, the severity and duration of the impairment should also
be considered in determining whether the impairment is other-than-temporary.
This new guidance for determining whether an impairment is other-than-
temporary was to be effective for reporting periods beginning after June 15,
2004. In September 2004, the FASB issued FASB Staff Position ("FSP") EITF
Issue 03-1-1, which delayed the effective date for the measurement and
recognition guidance included in EITF Issue 03-1 related to other-than-
temporary impairment until additional implementation guidance is provided. As
a result of the delay, during the three month period ended September 30, 2004,
the Company continued to apply existing accounting literature for determining
when a decline in fair value is other-than-temporary.
The Company continues to evaluate the impact of this new accounting standard
on its process for determining other-than-temporary impairment of equity and
fixed maturity securities, including the potential impacts from any revisions
to the original guidance issued. Adoption of this standard as originally
issued may cause the Company to recognize impairment losses in the
Consolidated Condensed Statements of Operations which would not have been
recognized under the current guidance or to recognize such losses in earlier
periods, especially those due to increases in interest rates, and would likely
also impact the recognition of investment income on impaired securities. Such
an impact would likely increase earnings volatility in future periods.
However, since fluctuations in the fair value for available-for-sale
85
securities are already recorded in Accumulated Other Comprehensive Income,
adoption of this standard as originally issued is not expected to have a
significant impact on shareholders' equity. Further information on CNA's
investments is provided in the Investments section below.
Securities in the parent company's investment portfolio that are not part of
its cash management activities are classified as trading securities in order
to reflect the Company's investment philosophy. These investments are carried
at fair value with the net unrealized gain or loss included in the
Consolidated Condensed Statements of Operations.
Individual Long-term Care Products
CNA's reserves and deferred acquisition costs for its individual long-term
care product offerings are based on certain assumptions including morbidity,
policy persistency and interest rates. Actual experience may differ from these
assumptions. The recoverability of deferred acquisition costs and the adequacy
of the reserves are contingent on actual experience related to these key
assumptions and other factors including potential future premium increases and
future health care cost trends. The Company's results of operations and/or
equity may be materially affected if actual experience varies significantly
from these assumptions.
Loans to National Contractor
CNA has made loans through a credit facility provided to a national
contractor to whom CNA Surety provides significant amounts of surety bond
insurance coverage. As of September 30, 2004, the Company has credit exposure
of $85.0 million under the credit facility. The credit facility was
established to help the contractor meet its liquidity needs. The contractor is
implementing restructuring efforts to reduce costs and improve cash flow.
Based on the contractor's restructuring efforts to date, CNA estimates that
amounts due under the credit facility are collectible.
Indemnification and subrogation rights, including rights to contract
proceeds on construction projects in the event of default, exist that reduce
CNA Surety's and ultimately CNA's exposure to loss. While CNA believes that
the contractor's restructuring efforts may be successful and provide
sufficient cash flow for its operations, the contractor's failure to achieve
its restructuring plan or perform its contractual obligations under the credit
facility or under CNA's surety bonds could have a material adverse effect on
CNA's results of operations and/ or equity. If such failures occur, CNA
estimates the surety loss, net of indemnification and subrogation recoveries,
but before the effects of minority interest, to be approximately $200.0
million pretax. In addition, such failures could cause the full amount due
under the credit facility to be uncollectible. Further information on this
credit agreement is provided in Note 15 of the Notes to Consolidated Condensed
Financial Statements included under Item 1 of this report, and the Liquidity
and Capital Resources sections, below.
Results of Operations by Business Segment
As a result of the strategic review and other actions described above in
"CNA Recent Developments," in 2004 CNA changed how it manages its core
operations and makes business decisions. Accordingly, the Company and CNA have
revised the reportable business segment structure to reflect these changes.
CNA now manages its property and casualty operations in two operating
segments which represent CNA's core operations: Standard Lines and Specialty
86
Lines. The non-core operations are now managed in the Life and Group Non-Core
and Other Insurance segments. Standard Lines includes standard property and
casualty coverages sold to small and middle market commercial businesses
primarily through an independent agency distribution system, and excess and
surplus lines, as well as insurance and risk management products sold to large
corporations in the U.S., as well as globally. Specialty Lines includes
professional, financial and specialty property and casualty products and
services. Life and Group Non-Core primarily includes the results of the life
and group lines of business sold or placed in run-off. Other Insurance
includes the results of certain property and casualty lines of business placed
in run-off, including CNA Re (formerly included in the Property and Casualty
segment). This segment also includes the results related to the centralized
adjusting and settlement of Asbestos, Environment Pollution and Mass Tort
("APMT") claims as well as the results of CNA's participation in voluntary
insurance pools, which are primarily in run-off, and various other non-
insurance operations. Prior period segment disclosures have been conformed to
the current year presentation.
The changes made to the Company's reportable segments were as follows: 1)
Standard Lines and Specialty Lines (formerly included in the Property and
Casualty segment) are now reported as separate individual segments; 2) CNA
Global (formerly included in Specialty Lines) which consists of marine and
global standard lines is now included in Standard Lines; 3) CNA Guaranty and
Credit (formerly included in Specialty Lines) is currently in run-off and is
now included in the Other Insurance segment; 4) CNA Re (formerly included in
the Property and Casualty segment) is currently in run-off and is also now
included in the Other Insurance segment; 5) Group Operations and Life
Operations (formerly separate reportable segments) have now been combined into
one reportable segment where the run-off of the retained group and life
products will be managed; and 6) certain run-off life and group operations
(formerly included in the Other Insurance segment) are now included in the
Life and Group Non-Core segment.
Throughout this MD&A, the results of operations include discussion and
results for all of CNA's businesses, including those sold or exited as
described above.
In the second quarter of 2004, the expenses incurred related to
uncollectible reinsurance receivables were reclassified from "Other operating
expenses" to "Insurance claims and policyholders' benefits" on the
Consolidated Condensed Statements of Operations. Prior period amounts and
ratios have been reclassified to conform to the current year presentation.
This reclassification had no impact on net income (loss) or the combined
ratios in any period, however this change impacted the loss and loss
adjustment expense and the expense ratios.
In addition, until 2003, the operations of Bulova were formerly reported in
its own operating segment and are now included in the Corporate and other
segment.
87
CNA Financial
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is a 91% owned subsidiary of the Company.
Net Prior Year Development
A significant component of the results of operations for the three and nine
months ended September 30, 2003 was unfavorable net prior year development
recorded for the property and casualty and the non-core segments. Changes in
estimates of claim and allocated claim adjustment expense reserves and premium
accruals, net, for prior years, are defined as net prior year development
within this MD&A. These changes can be favorable or unfavorable.
The following tables summarize the pretax net prior year development for
core operations and asbestos and environmental pollution and mass tort
("APMT") by segment for the three and nine months ended September 30, 2004 and
2003.
Standard Specialty Other
Three Months Ended September 30, 2004 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ (6.0) $ 1.0 $ (5.0)
APMT 4.0 4.0
Ceded losses related to corporate
aggregate reinsurance treaties 4.0 $ (9.0) 5.0
- ------------------------------------------------------------------------------------------------
Pretax unfavorable (favorable) net
prior year development before impact
of premium development (2.0) (9.0) 10.0 (1.0)
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding the impact of
corporate aggregate reinsurance
treaties 11.0 (15.0) 5.0 1.0
Ceded premiums related to corporate
aggregate reinsurance treaties (3.0) 3.0 (3.0) (3.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable (favorable)
premium development 8.0 (12.0) 2.0 (2.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable (favorable) net prior
year development (pretax) $ 6.0 $ (21.0) $ 12.0 $ (3.0)
================================================================================================
Total unfavorable (favorable) net prior year
development (after-tax and minority interest) $ 3.6 $ (12.8) $ 7.4 $ (1.8)
================================================================================================
88
Standard Specialty Other
Three Months Ended September 30, 2003 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $1,123.0 $ 223.0 $ 188.0 $1,534.0
APMT 795.0 795.0
Ceded losses related to corporate
aggregate reinsurance treaties (300.0) (59.0) (80.0) (439.0)
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 823.0 164.0 903.0 1,890.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding the impact of
corporate aggregate reinsurance
treaties 128.0 (1.0) (3.0) 124.0
Ceded premiums related to corporate
aggregate reinsurance treaties 160.0 32.0 43.0 235.0
- ------------------------------------------------------------------------------------------------
Total premium development 288.0 31.0 40.0 359.0
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $1,111.0 $ 195.0 $ 943.0 $2,249.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 650.0 $ 115.2 $ 551.8 $1,317.0
================================================================================================
89
Standard Specialty Other
Nine Months Ended September 30, 2004 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 107.0 $ 74.0 $ 14.0 $ 195.0
APMT 44.0 44.0
Ceded losses related to corporate
aggregate reinsurance treaties 4.0 (9.0) 5.0
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 111.0 65.0 63.0 239.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding the impact of
corporate aggregate reinsurance
treaties (97.0) (29.0) 15.0 (111.0)
Ceded premiums related to corporate
aggregate reinsurance treaties (1.0) 3.0 (2.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable (favorable)
premium development (98.0) (26.0) 13.0 (111.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $ 13.0 $ 39.0 $ 76.0 $ 128.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 7.3 $ 22.8 $ 44.7 $ 74.8
================================================================================================
90
Standard Specialty Other
Nine Months Ended September 30, 2003 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $1,437.0 $ 322.0 $ 336.0 $2,095.0
APMT 795.0 795.0
Ceded losses related to corporate aggregate
reinsurance treaties (480.0) (59.0) (104.0) (643.0)
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 957.0 263.0 1,027.0 2,247.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding the impact of
corporate aggregate reinsurance
treaties 203.0 (8.0) (26.0) 169.0
Ceded premiums related to corporate
aggregate reinsurance treaties 265.0 32.0 57.0 354.0
- ------------------------------------------------------------------------------------------------
Total premium development 468.0 24.0 31.0 523.0
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $1,425.0 $ 287.0 $1,058.0 $2,770.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 833.6 $ 168.3 $ 619.3 $1,621.2
================================================================================================
91
Reserves - Estimates and Uncertainties
CNA maintains reserves to cover its estimated ultimate unpaid liability for
claim and claim adjustment expenses and future policy benefits, including the
estimated cost of the claims adjudication process, for claims that have been
reported but not yet settled and claims that have been incurred but not
reported ("IBNR"). Claim and claim adjustment expense and future policy
benefit reserves are reflected as liabilities on the Consolidated Condensed
Balance Sheets under the heading "Insurance Reserves." Adjustments to prior
year reserve estimates, if necessary, are reflected in the results of
operations in the period that the need for such adjustments is determined.
The level of Insurance Reserves maintained by CNA represents management's
best estimate, as of a particular point in time, of what the ultimate
settlement and administration of claims will cost based on its assessment of
facts and circumstances known at that time. Insurance Reserves are not an
exact calculation of liability but instead are complex estimates that are
derived by CNA, generally utilizing a variety of actuarial reserve estimation
techniques, from numerous assumptions and expectations about future events,
both internal and external, many of which are highly uncertain.
Among the many uncertain future events about which CNA makes assumptions and
estimates, many of which have become increasingly unpredictable, are claims
severity, frequency of claims, mortality, morbidity, expected interest rates,
inflation, claims handling and case reserving policies and procedures,
underwriting and pricing policies, changes in the legal and regulatory
environment and the lag time between the occurrence of an insured event and
the time it is ultimately settled, referred to in the insurance industry as
the "tail." These factors must be individually considered in relation to CNA's
evaluation of each type of business. Many of these uncertainties are not
precisely quantifiable, particularly on a prospective basis, and require
significant management judgment.
Given the factors described above, it is not possible to quantify precisely
the ultimate exposure represented by claims and related litigation. As a
result, CNA regularly reviews the adequacy of its reserves and reassesses its
reserve estimates as historical loss experience develops, additional claims
are reported and settled and additional information becomes available in
subsequent periods.
In addition, CNA is subject to the uncertain effects of emerging or
potential claims and coverage issues that arise as industry practices and
legal, judicial, social and other environmental conditions change. These
issues have had, and may continue to have, a negative effect on CNA's business
by either extending coverage beyond the original underwriting intent or by
increasing the number or size of claims. Recent examples of emerging or
potential claims and coverage issues include:
. increases in the number and size of water damage claims, including those
related to expenses for testing and remediation of mold conditions;
. increases in the number and size of claims relating to injuries from
medical products, and exposure to lead;
. the effects of accounting and financial reporting scandals and other
major corporate governance failures, which have resulted in an increase
in the number and size of claims, including director and officer and
errors and omissions insurance claims;
92
. class action litigation relating to claims handling and other practices;
. increases in the number of construction defect claims, including claims
for a broad range of additional insured endorsements on policies; and
. increases in the number of claims alleging abuse by members of the
clergy.
The impact of these and other unforeseen emerging or potential claims and
coverage issues is difficult to predict and could materially adversely affect
the adequacy of CNA's claim and claim adjustment expense reserves and could
lead to future reserve additions. See the Operating Results sections of this
MD&A for a discussion of changes in reserve estimates and the impact on CNA's
results of operations.
CNA's experience has been that establishing reserves for casualty coverages
relating to APMT claim and claim adjustment expenses is subject to
uncertainties that are greater than those presented by other claims.
Estimating the ultimate cost of both reported and unreported APMT claims is
subject to a higher degree of variability due to a number of additional
factors, including among others:
. coverage issues, including whether certain costs are covered under the
policies and whether policy limits apply;
. inconsistent court decisions and developing legal theories;
. increasingly aggressive tactics of plaintiffs' lawyers;
. the risks and lack of predictability inherent in major litigation;
. changes in the volume of asbestos and environmental pollution and mass
tort claims which cannot now be anticipated;
. continued increase in mass tort claims relating to silica and silica-
containing products;
. the impact of the exhaustion of primary limits and the resulting increase
in claims on any umbrella or excess policies CNA has issued;
. the number and outcome of direct actions against CNA; and
. CNA's ability to recover reinsurance for asbestos and environmental
pollution and mass tort claims.
It is also not possible to predict changes in the legal and legislative
environment and the impact on the future development of APMT claims. This
development will be affected by future court decisions and interpretations, as
well as changes in applicable legislation. It is difficult to predict the
ultimate outcome of large coverage disputes until settlement negotiations near
completion and significant legal questions are resolved or, failing
settlement, until the dispute is adjudicated. This is particularly the case
with policyholders in bankruptcy where negotiations often involve a large
number of claimants and other parties and require court approval to be
effective. A further uncertainty exists as to whether a national privately
financed trust to replace litigation of asbestos claims with payments to
claimants from the trust will be established and approved through federal
legislation, and, if established and approved, whether it will contain funding
requirements in excess of CNA's carried loss reserves.
93
Due to the factors described above, among others, establishing reserves for
APMT claim and claim adjustment expenses is subject to uncertainties that are
greater than those presented by other claims. Traditional actuarial methods
and techniques employed to estimate the ultimate cost of claims for more
traditional property and casualty exposures are less precise in estimating
claim and claim adjustment reserves for APMT, particularly in an environment
of emerging or potential claims and coverage issues that arise from industry
practices and legal, judicial and social conditions. Therefore, these
traditional actuarial methods and techniques are necessarily supplemented with
additional estimating techniques and methodologies, many of which involve
significant judgments that are required of management. Due to the inherent
uncertainties in estimating reserves for APMT claim and claim adjustment
expenses and the degree of variability due to, among other things, the factors
described above, CNA may be required to record material changes in its claim
and claim adjustment expense reserves in the future, should new information
become available or other developments emerge. See the APMT Reserves section
of this MD&A for additional information relating to APMT claims and reserves.
CNA's recorded Insurance Reserves, including APMT reserves, reflect
management's best estimate as of a particular point in time based upon known
facts, current law and management's judgment. In light of the many
uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, CNA reviews its reserve
estimates on a regular basis and makes adjustments in the period that the need
for such adjustments is determined. These reviews have resulted in CNA
identifying information and trends that have caused CNA to increase its
reserves in prior periods and could lead to the identification of a need for
additional material increases in claim and claim adjustment expense reserves,
which could materially adversely affect the Company's results of operations,
equity, business, insurer financial strength and debt ratings. See the Ratings
section of this MD&A for further information on CNA's ratings. In addition,
CNA periodically undergoes state regulatory financial examinations. Such
examinations are currently underway. CNA is presently engaged in discussions
related to the examination with state regulatory agencies. See the Regulatory
Matters section of the MD&A for further information.
Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, provide greater
diversification of risk, minimize exposures on larger risks and to exit
certain lines of business. The ceding of insurance does not discharge the
primary liability of CNA. Therefore, a credit exposure exists with respect to
property and casualty and life reinsurance ceded to the extent that any
reinsurer is unable to meet the obligations assumed under reinsurance
agreements.
Interest cost on reinsurance contracts accounted for on a funds withheld
basis is incurred during all periods in which a funds withheld liability
exists. Interest cost, which is included in net investment income, was $55.0
and $148.0 million for the three months ended September 30, 2004 and 2003, and
$161.0 and $288.0 million for the nine months ended September 30, 2004 and
2003. The amount subject to interest crediting rates on such contracts was
$2,726.0 and $2,789.0 million at September 30, 2004 and December 31, 2003.
Certain funds withheld reinsurance contracts, including the corporate
aggregate reinsurance treaties, require interest on additional premiums
94
arising from ceded losses as if those premiums were payable at the inception
of the contract.
The amount subject to interest crediting on these funds withheld contracts
will vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. CNA expects that it will continue
to incur significant interest costs on these contracts for several years.
The following table summarizes the amounts receivable from reinsurers at
September 30, 2004 and December 31, 2003.
September 30, December 31,
Components of reinsurance receivables 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance receivables related to insurance reserves:
Ceded claim and claim adjustment expense $14,037.6 $14,215.9
Ceded future policy benefits 1,227.0 1,218.2
Ceded policyholders' funds 60.2 6.6
Billed reinsurance receivables 587.2 813.1
- ------------------------------------------------------------------------------------------------
Reinsurance receivables 15,912.0 16,253.8
Less allowance for doubtful accounts 530.1 572.6
- ------------------------------------------------------------------------------------------------
Reinsurance receivables-net $15,381.9 $15,681.2
================================================================================================
CNA has established an allowance for uncollectible reinsurance receivables.
The allowance for uncollectible reinsurance receivables was $530.1 and $572.6
million at September 30, 2004 and December 31, 2003. The net decrease in the
allowance was primarily due to a release of a previously established allowance
related to The Trenwick Group resulting from the finalization of commutation
agreements in the second quarter of 2004, partially offset by a net increase
in the allowance for other reinsurance receivables. The expenses incurred
related to uncollectible reinsurance receivables are presented as a component
of "Insurance claims and policyholders' benefits" on the Consolidated
Condensed Statements of Operations.
CNA attempts to mitigate its credit risk related to reinsurance by entering
into reinsurance arrangements only with reinsurers that have credit ratings
above certain levels and by obtaining substantial amounts of collateral. The
primary methods of obtaining collateral are through reinsurance trusts,
letters of credit and funds withheld balances.
In certain circumstances, including significant deterioration of a
reinsurer's financial strength ratings, CNA may engage in commutation
discussions with individual reinsurers. The outcome of such discussions may
result in a lump sum settlement that is less than the recorded receivable, net
of any applicable allowance for doubtful accounts. Losses arising from
commutations could have an adverse material impact on CNA's results of
operations.
95
The effects of reinsurance on earned premiums are shown in the following
table.
Components of Earned Premiums
Direct Assumed Ceded Net
- ------------------------------------------------------------------------------------------------
(In millions) Nine Months Ended September 30, 2004
---------------------------------------------
Property and casualty $ 8,059.0 $ 163.0 $ 2,663.0 $ 5,559.0
Accident and health 916.0 45.0 421.0 540.0
Life 369.0 250.0 119.0
- ------------------------------------------------------------------------------------------------
Total earned premiums $ 9,344.0 $ 208.0 $ 3,334.0 $ 6,218.0
================================================================================================
Nine Months Ended September 30, 2003
---------------------------------------------
Property and casualty $ 7,977.0 $ 460.0 $ 3,459.0 $ 4,978.0
Accident and health 1,193.0 78.0 42.0 1,229.0
Life 801.0 4.0 311.0 494.0
- ------------------------------------------------------------------------------------------------
Total earned premiums $ 9,971.0 $ 542.0 $ 3,812.0 $ 6,701.0
================================================================================================
CNA has an aggregate reinsurance treaty related to the 1999 through 2001
accident years that covers substantially all of the Company's property and
casualty lines of business (the "Aggregate Cover"). The Aggregate Cover
provides for two sections of coverage. These coverages attach at defined loss
ratios for each accident year. Coverage under the first section of the
Aggregate Cover, which is available for all accident years covered by the
treaty, has a $500.0 million limit per accident year of ceded losses and an
aggregate limit of $1.0 billion of ceded losses for the three accident years.
The ceded premiums associated with the first section are a percentage of ceded
losses and for each $500.0 million of limit the ceded premium is $230.0
million. The second section of the Aggregate Cover, which only relates to
accident year 2001, provides additional coverage of up to $510.0 million of
ceded losses for a maximum ceded premium of $310.0 million. Under the
Aggregate Cover, interest charges on the funds withheld liability accrue at
8.0% per annum. The aggregate loss ratio has exceeded certain thresholds which
requires additional premiums to be paid and an increase in the rate at which
interest charges are accrued. This rate will increase to 8.25% per annum
commencing in 2006. The aggregate limits under both sections of the Aggregate
Cover were fully utilized in 2003.
96
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ 3.0 $(223.0) $(251.0)
Ceded claim and claim adjustment expense 422.0 500.0
Interest charges (19.0) (88.0) $(61.0) (123.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $(16.0) $ 111.0 $(61.0) $ 126.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 million of limit is $456.0 million. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. If the aggregate
loss ratio would exceed these certain thresholds, then additional interest
charges on funds withheld would be approximately $34.0 million in 2004. During
2003, the aggregate limits under the CCC Cover were fully utilized.
The pretax impact of the CCC Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (10.0) $(100.0)
Ceded claim and claim adjustment expense 17.0 143.0
Interest charges $ (12.0) (13.0) $ (34.0) (48.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ (12.0) $ (6.0) $ (34.0) $ (5.0)
================================================================================================
97
The pretax impact by operating segment of the Aggregate Cover and the CCC
Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ (23.0) $ 72.0 $ (66.0) $ 93.0
Specialty Lines 6.0 17.0 16.0
Other Insurance (11.0) 16.0 (29.0) 12.0
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ (28.0) $ 105.0 $ (95.0) $ 121.0
================================================================================================
Terrorism Insurance
CNA and the insurance industry incurred substantial losses related to the
2001 World Trade Center event. For the most part, the industry was able to
absorb the loss of capital from these losses, but the capacity to withstand
the effect of any additional terrorism events was significantly diminished.
The Terrorism Risk Insurance Act of 2002 (the "Act") established a program
within the Department of the Treasury under which the federal government will
share the risk of loss by commercial property and casualty insurers arising
from future terrorist attacks. The Act expires on December 31, 2005. Each
participating insurance company must pay a deductible, ranging from 7.0% of
direct earned premiums from commercial insurance lines in 2003 to 15.0% in
2005, before federal government assistance becomes available. For losses in
excess of a company's deductible, the federal government will cover 90.0% of
the excess losses, while companies retain the remaining 10.0%. Losses covered
by the program will be capped annually at $100.0 billion; above this amount,
insurers are not liable for covered losses and Congress is to determine the
procedures for and the source of any payments. Amounts paid by the federal
government under the program over certain phased limits are to be recouped by
the Department of the Treasury through policy surcharges, which cannot exceed
3.0% of annual premium.
CNA is required to participate in the program, but it does not cover life or
health insurance products. State law limitations applying to premiums and
policies for terrorism coverage are not generally affected under the program.
The Act requires insurers to offer terrorism coverage through 2004. On June
18, 2004, the Department of the Treasury announced its decision to extend this
offer requirement until December 31, 2005.
While the Act provides the property and casualty industry with an increased
ability to withstand the effect of a terrorist event through 2005, given the
unpredictability of the nature, targets, severity or frequency of potential
terrorist events, the Company's results of operations or equity could
nevertheless be materially adversely impacted by them. CNA is attempting to
mitigate this exposure through its underwriting practices, policy terms and
conditions (where applicable) and the use of reinsurance. In addition, under
state laws, CNA is generally prohibited from excluding terrorism exposure from
its primary workers compensation policies. In those states that mandate
98
property insurance coverage of damage from fire following a loss, CNA is also
prohibited from excluding terrorism exposure under such coverage.
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's assumed reinsurance arrangements,
beginning with the January 1, 2002 renewal period, either exclude terrorism
coverage or significantly limit the level of coverage.
As noted, the Act expires on December 31, 2005. In anticipation of the
expiration of the Act, CNA is participating in a coalition to encourage
reauthorization of the Act. The Financial Services Committee of the House of
Representatives has passed a reauthorization bill, H.R. 4634, but it has not
been voted on by the entire House. A similar Senate measure, S. 2764, is
pending in the Senate Banking Committee, but no vote has yet been taken.
Although the Congress is expected to reconvene in mid-November of 2004, it is
not expected that they will resume debate on this matter until early in 2005.
The pending bills described above would extend the Act for two additional
years and require that terrorism coverage be made available for all years.
Deductibles under the bills would be held at 15.0% in year four and raised to
20.0% in year five. Notwithstanding these developments, enactment of a law
extending the Act is not assured.
If the Act is not extended, CNA will, among other steps, seek to exclude
risks with perceived terrorism exposure, to the extent permitted by law.
Strict underwriting standards and risk avoidance measures will be taken where
exclusions are not permitted. Annual policy renewals with effective dates of
January 1, 2005 or later will be underwritten with the assumption that the Act
will not be extended and that no Federal backstop for terrorism exposure will
be available. In advance of that date, CNA expects to apply for regulatory
approval of terrorism exclusions. There is no assurance that CNA will be able
to eliminate or limit terrorism exposure risks in coverages, or that
regulatory authorities will approve policy exclusions for terrorism.
Restructuring
As discussed in the Company's 2003 Form 10-K/A, CNA continues to manage the
liabilities from two separate restructuring plans. The first plan related to
CNA's Information Technology operations (the "IT Plan"). The second plan
related to restructuring the property and casualty segments and the former
Life Operations, discontinuation of the variable life and annuity business and
consolidation of real estate locations (the "2001 Plan").
No restructuring and other related charges related to the IT Plan were
incurred for the three or nine months ended September 30, 2004 and 2003.
During the third quarter of 2004, the remaining IT Plan accrual was released.
No restructuring and other related charges related to the 2001 Plan were
incurred for the three or nine months ended September 30, 2004 and 2003.
During 2004, $5.0 million in payments for lease termination costs were charged
against the liability. As of September 30, 2004, the accrued liability,
relating primarily to lease termination costs, was $15.0 million. Of the
remaining accrual, approximately $1.0 million is expected to be paid in 2004.
Non-GAAP Financial Measures
This MD&A discusses certain GAAP and non-GAAP financial measures to provide
information used by management to monitor CNA's operating performance.
Management utilizes various financial measures to monitor CNA's insurance
99
operations and investment portfolio. Underwriting results, which are derived
from certain income statement amounts, are considered non-GAAP financial
measures and are used by management to monitor performance of CNA's insurance
operations. CNA's investment portfolio is monitored through analysis of
various quantitative and qualitative factors and certain decisions are made
related to the sale or impairment of investments that will produce realized
gains and losses. Net realized investment gains and losses, which are
comprised of after-tax realized investment gains and losses net of
participating policyholders' and minority interests are a non-GAAP financial
measure.
Underwriting results are computed as net earned premiums less net incurred
claims and the cost incurred to settle these claims, acquisition expenses,
underwriting expenses and dividend expenses. Management uses underwriting
results and operating ratios to monitor its insurance operations' results
without the impact of certain factors, including investment income, other
revenues, other expenses, minority interest, income tax benefit (expense) and
net realized investment gains or losses. Management excludes these factors in
order to analyze the direct relationship between the net earned premiums and
the related claims and the cost incurred to settle these claims, acquisition
expenses, underwriting expenses and dividend expenses.
Management excludes after-tax net realized investment gains or losses when
analyzing the insurance operations because net realized investment gains or
losses related to CNA's available-for-sale investment portfolio are largely
discretionary, except for losses related to other-than-temporary impairments,
and are generally driven by economic factors that are not necessarily
consistent with key drivers of underwriting performance.
CNA's investment portfolio is monitored by management through analyses of
various factors including unrealized gains and losses on securities, portfolio
duration and exposure to interest rate, market and credit risk. Based on such
analyses, CNA may impair an investment security in accordance with its policy,
or sell a security. Such activities will produce realized gains and losses.
Operating ratios are calculated using insurance results and are used by the
insurance industry and regulators such as state departments of insurance and
the National Association of Insurance Commissioners for financial regulation
and as a basis of comparison among companies. The ratios discussed in this
MD&A are calculated using GAAP financial results and include the loss and loss
adjustment expense ratio (loss ratio) as well as the expense, dividend and
combined ratios. The loss ratio is the percentage of net incurred claim and
claim adjustment expenses to net earned premiums. The expense ratio is the
percentage of underwriting and acquisition expenses, including the
amortization of deferred acquisition costs, to net earned premiums. The
dividend ratio is the ratio of dividends incurred to net earned premiums. The
combined ratio is the sum of the loss, expense and dividend ratios.
While management uses various non-GAAP financial measures to monitor various
aspects of CNA's performance, relying on any measure other than net income
(loss), which is the most directly comparable GAAP measure to underwriting
results and realized gains and losses, is not a complete representation of
financial performance. Management believes that its process of evaluating
performance through the use of these non-GAAP financial measures provides a
basis for understanding the operations and the impact to net income (loss) as
a whole. Management also believes that investors find these non-GAAP financial
measures described above useful to help interpret the underlying trends and
performance, as well as to provide visibility into the significant components
of net income (loss).
100
Throughout this MD&A, certain business segment results are discussed using
underwriting results, which as described above is a non-GAAP measure. The
following reconciliation provides the differences between Underwriting Income
(Loss) and Net Income (Loss).
Three Months Ended Three Months Ended
September 30, 2004 September 30, 2003
- ------------------------------------------------------------------------------------------------
Standard Specialty Standard Specialty
Lines Lines Lines Lines
- ------------------------------------------------------------------------------------------------
(In millions)
Underwriting income (loss) $(262.0) $ 55.0 $(1,519.0) $(310.0)
Net investment income 125.0 61.0 55.0 47.0
Other revenues 32.0 36.0 34.0 35.0
Other expenses (25.0) (29.0) (35.0) (30.0)
- ------------------------------------------------------------------------------------------------
Income (loss) before income tax
(expense) benefit, minority interest
and net realized
investment (losses) gains (130.0) 123.0 (1,465.0) (258.0)
Income tax (expense) benefit 58.5 (38.1) 520.3 103.6
Minority interest 4.2 (11.2) 92.5 29.2
- ------------------------------------------------------------------------------------------------
Income (loss) before net realized
investment (losses) gains (67.3) 73.7 (852.2) (125.2)
Realized investment (losses) gains,
net of participating
policyholders' and
minority interest (31.4) (12.1) 54.3 17.2
Income tax expense on realized
investment (losses) gains 10.9 4.4 (21.9) (6.4)
- ------------------------------------------------------------------------------------------------
Net income (loss) $ (87.8) $ 66.0 $ (819.8) $(114.4)
================================================================================================
101
Nine Months Ended Nine Months Ended
September 30, 2004 September 30, 2003
- ------------------------------------------------------------------------------------------------
Standard Specialty Standard Specialty
Lines Lines Lines Lines
- ------------------------------------------------------------------------------------------------
(In millions)