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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
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)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Loews Common Stock, par value $1.00 per share New York Stock Exchange
Carolina Group Stock, par value $0.01 per share New York Stock Exchange
3 1/8% Exchangeable Subordinated Notes Due 2007 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
----- -----
The aggregate market value of voting and non-voting common equity held by
non-affiliates as of the last business day of the registrant's most recently
completed second fiscal quarter was approximately $8,375,100,000.
As of March 14, 2003, 185,441,200 shares of Loews common stock and
39,910,000 shares of Carolina Group stock were outstanding.
Documents Incorporated by Reference:
Portions of the definitive Loews Corporation Notice of Annual Meeting of
Stockholders and Proxy Statement intended to be filed by Registrant with the
Commission prior to April 30, 2003 are incorporated by reference into Part
III.
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1
LOEWS CORPORATION
INDEX TO ANNUAL REPORT ON
FORM 10-K FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
For the Year Ended December 31, 2002
Item Page
No. PART I No.
- ---- ----
1 BUSINESS
Carolina Group Tracking Stock 3
CNA Financial Corporation 4
Lorillard, Inc. 13
Loews Hotels Holding Corporation 19
Diamond Offshore Drilling, Inc. 20
Bulova Corporation 23
Other interests 23
Available information (www.loews.com) 24
2 PROPERTIES 24
3 LEGAL PROCEEDINGS 24
4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26
EXECUTIVE OFFICERS OF THE REGISTRANT 26
PART II
5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED 26
STOCKHOLDER MATTERS
6 SELECTED FINANCIAL DATA 28
7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 29
RESULTS OF OPERATIONS
7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 89
8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 92
9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING 186
AND FINANCIAL DISCLOSURE
PART III
Certain information called for by Part III (Items 10, 11, 12 and 13)
has been omitted as Registrant intends to file with the Securities and
Exchange Commission not later than 120 days after the close of its
fiscal year a definitive Proxy Statement pursuant to Regulation 14A.
14 CONTROLS AND PROCEDURES 186
PART IV
15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 186
2
PART I
Item 1. Business.
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property, casualty and life insurance (CNA
Financial Corporation, a 90% owned subsidiary); the production and sale of
cigarettes (Lorillard, Inc., a wholly owned subsidiary); the operation of
hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary); the
operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling,
Inc., a 54% owned subsidiary); and the distribution and sale of watches and
clocks (Bulova Corporation, a 97% owned subsidiary).
Unless the context otherwise requires, the terms "Company" and "Registrant"
as used herein mean Loews Corporation excluding its subsidiaries.
Information relating to the major business segments from which the Company's
consolidated revenues and income are derived is contained in Note 22 of the
Notes to Consolidated Financial Statements, included in Item 8.
CAROLINA GROUP TRACKING STOCK
On February 6, 2002 the Company sold 40,250,000 shares of a new class of its
common stock, referred to as Carolina Group Stock, for net proceeds of $1.1
billion. See Note 6 of the Notes to Consolidated Financial Statements,
included in Item 8.
The Carolina Group stock, commonly called a tracking stock, is designed to
reflect the economic performance of a defined group of assets and liabilities
of the Company referred to as the Carolina Group. The Company has attributed
the following assets and liabilities to the Carolina Group:
(a) the Company's 100% stock ownership interest in Lorillard, Inc.;
(b) notional, intergroup debt owed by the Carolina Group to the Loews
Group, bearing interest at the annual rate of 8.0% and, subject to optional
prepayment, due December 31, 2021 (as of March 14, 2003, $2.4 billion was
outstanding);
(c) any and all liabilities, costs and expenses of the Company and
Lorillard, Inc. and the subsidiaries and predecessors of Lorillard, Inc.,
arising out of or related to tobacco or otherwise arising out of the past,
present or future business of Lorillard, Inc. or its subsidiaries or
predecessors, or claims arising out of or related to the sale of any
businesses previously sold by Lorillard, Inc. or its subsidiaries or
predecessors, in each case, whether grounded in tort, contract, statute or
otherwise, whether pending or asserted in the future;
(d) all net income or net losses arising from the assets and liabilities
that are reflected in the Carolina Group and all net proceeds from any
disposition of those assets, in each case, after deductions to reflect
dividends paid to holders of Carolina Group stock or credited to the Loews
Group in respect of its intergroup interest; and
(e) any acquisitions or investments made from assets reflected in the
Carolina Group.
As of March 14, 2003, 39,910,000 shares of Carolina Group stock are
outstanding reflecting an approximately 23.01% economic interest in the
Carolina Group.
The Loews Group consists of all of the Company's assets and liabilities
other than the 23.01% economic interest in the Carolina Group represented by
the outstanding Carolina Group stock, and includes as an asset the notional
intergroup debt of the Carolina Group referred to above.
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
3
attribution of assets and liabilities of the Company to the Loews Group or the
Carolina Group does not affect title to the assets or responsibility for the
liabilities so attributed.
Each outstanding share of Carolina Group Stock has 1/10 of a vote per share.
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.
CNA FINANCIAL CORPORATION
CNA Financial Corporation (together with its subsidiaries, "CNA") was
incorporated in 1967 and is an insurance holding company whose primary
subsidiaries consist of property and casualty and life and group insurance
companies. CNA's property and casualty insurance operations are conducted by
Continental Casualty Company ("CCC"), incorporated in 1897, and its
affiliates, and The Continental Insurance Company ("CIC"), organized in 1853,
and its affiliates. Life and group insurance operations are conducted by
Continental Assurance Company ("CAC"), incorporated in 1911, and its
affiliates, Valley Forge Life Insurance Company ("VFL"), incorporated in 1956,
and CNA Group Life Assurance Company ("CNAGLA"), incorporated in 2000. CIC
became an affiliate of CNA in 1995 as a result of the acquisition of The
Continental Corporation ("Continental"). CNA's principal market is the United
States with a continued focus on expanding globally to serve those with
growing worldwide interests. CNA accounted for 70.23%, 69.73% and 74.49% of
the Company's consolidated total revenue for the years ended December 31,
2002, 2001 and 2000, respectively.
CNA conducts its operations through five operating groups: Standard Lines,
Specialty Lines and CNA Re (these groups comprise the Company's property and
casualty segment), Group Operations and Life Operations. In addition to these
five operating segments, certain other activities are reported in the Other
Insurance segment.
During 2002, CNA underwent management changes and strategic realignment.
These events have changed the way CNA manages its operations and makes
business decisions and, therefore, necessitated a change in the Company's
reportable segments. CNA Trust, a limited-operations bank specializing in 401
(k) plan administration, and Institutional Markets, which provides guaranteed
return investment products for qualified and non-qualified institutional
buyers, was transferred from Life Operations to Group Operations. Group
reinsurance, the business which assumes reinsurance from unaffiliated entities
on group life, accident and health products as well as excess medical risk
coverages for self-funded employers, was transferred from Group Operations to
Other Operations to be included as part of run-off insurance operations. The
Environmental Pollution and Mass Tort and Asbestos ("APMT") Reserves related
to assumed reinsurance, along with the assumed business underwritten through a
managing general agent, IOA Global, which consists primarily of certain
accident and health coverages, was transferred from CNA Re to Other
Operations. The U.S. zone of Global business, which primarily offers
international insurance to U.S. based corporations and U.S. insurance to
foreign corporations, was transferred from Specialty Lines to Standard Lines.
A more detailed description of each segment follows.
Property and Casualty Operations
Standard Lines
Standard Lines works with an independent agency distribution system and
network of brokers to market a broad range of property and casualty insurance
products and services to small, middle-market and large businesses. The
Standard Lines operating model focuses on underwriting performance, exposure
based pricing and relationships with selected distribution sources and
customers.
Standard Lines includes Property and Casualty and Excess & Surplus.
Property and Casualty ("P&C"): P&C provides standard property and casualty
insurance products such as workers compensation, general and product
liability, property and commercial auto coverages through traditional and
innovative advanced financial risk products to a wide range of businesses. The
majority of P&C customers are small and middle-market businesses, with less
than $1 million in annual insurance premiums. Most insurance programs are
provided on a guaranteed cost basis; however, P&C has the capability to offer
specialized, loss-sensitive insurance programs to those risks viewed as higher
risk and less predictable in exposure.
4
P&C's field structure consists of 68 branch locations in 63 cities. Each
branch provides the marketing, underwriting and risk control expertise on the
entire portfolio of products. In addition, these branches provide streamlined
claim services utilizing the same regional structure. A centralized processing
center for small and middle-market customers, located in Maitland, Florida,
handles policy processing and accounting, and also acts as a call center to
optimize customer service. The branches and processing center are all located
in the United States.
Also, Standard Lines, primarily through RSKCo, provides total risk
management services relating to claim services, risk control, cost management
and information services to the commercial insurance marketplace.
Excess & Surplus ("E&S"): E&S provides specialized insurance and other
financial products for selected commercial risks on both an individual
customer and program basis. Risks insured by E&S are generally viewed as
higher risk and less predictable in exposure than those covered by standard
insurance markets. E&S's products are distributed throughout the United States
through specialist producers, program agents, and P&C's agents and brokers.
The target market for these specialized programs is large accounts within
Fortune 1000 businesses. E&S has specialized underwriting and claim resources
in Chicago, New York, Denver and Columbus.
Specialty Lines
Specialty Lines provides professional, financial and specialty domestic and
international property and casualty products and services through a network of
brokers, managing general agencies and independent agencies. Specialty Lines
provides solutions for managing the risks of its clients including architects,
engineers, lawyers, healthcare professionals, financial intermediaries and
corporate directors and officers. Product offerings also include surety and
fidelity bonds and vehicle and equipment warranty services.
Specialty Lines includes the following business groups: Professional
Liability Insurance, CNA Guaranty and Credit, Surety, CNA Global and Warranty.
Professional Liability Insurance ("CNA Pro"): CNA Pro provides management
and professional liability insurance and risk management services, primarily
in the United States. This unit provides professional liability coverage for
architects and engineers, realtors, non-Big Four accounting firms and law
firms. CNA Pro also has market positions in directors and officers, employment
practices, fiduciary and fidelity coverages. Specific areas of focus include
privately held firms and not-for-profit organizations where CNA offers
products. Products within CNA Pro are distributed through brokers, agents and
managing general underwriters.
CNA Pro, through CNA HealthPro, also offers insurance products to serve the
healthcare delivery system. Products are distributed on a national basis
through a variety of channels including brokers, agents and managing general
underwriters. Key customer segments include long term care facilities, allied
healthcare providers, dental professionals and mid-size and large healthcare
facilities and delivery systems. Additionally, CNA HealthPro offers risk
management consulting services to assist customers in managing quality of care
risks associated with the delivery of healthcare. Claim services are provided
to manage and resolve claims. In addition, Caronia Corporation, an affiliate
of CNA HealthPro, provides third-party claims administration for healthcare
providers and facilities.
CNA Guaranty and Credit: CNA Guaranty and Credit provides credit insurance
on short-term trade receivables for domestic and international clients as well
as reinsurance to insurers who provide financial guarantees to issuers of
asset-backed securities, money market funds and investment-grade corporate
debt securities. The Guaranty business underwritten by CNA's insurance
affiliates excluding CNA's ownership interest in R.V.I. Guaranty Co. Ltd.
("RVI"), an unconsolidated affiliate, is currently in run-off. The Credit
business underwritten by CNA's insurance affiliates was sold on December 31,
2002; however, all in-force business and reserves at the date of sale were
retained by CNA. The run-off of these businesses will occur over several
years.
RVI is a monoline residual value insurer offering coverages to protect the
insured against a decrease in the market value of a properly maintained asset
at the termination of a lease.
Surety: Surety consists primarily of CNA Surety Corporation ("CNA Surety"),
and its insurance subsidiaries. CNA Surety is traded on the New York Stock
Exchange (SUR). CNA Surety provides surety and fidelity bonds in all 50 states
5
through a combined network of approximately 35,000 independent agencies. CNA
owns approximately 64% of CNA Surety.
CNA Global consists of Marine and Global Standard Lines.
Marine: Marine serves domestic and global ocean marine needs, with markets
extending across North America, Europe and throughout the world. Marine offers
hull, cargo, primary and excess marine liability, marine claims and recovery
products and services. Business is sold through national brokers, regional
marine specialty brokers and independent agencies.
Global Standard Lines: Global Standard Lines is responsible for coordinating
and managing the direct business of CNA's overseas property and casualty
operations. This business currently has operations in Hawaii, Europe, Latin
America and Canada.
Warranty: Warranty provides warranty services that protect individuals and
businesses from the financial burden associated with breakdown, under-
performance or maintenance of a product. Products are distributed via a sales
force employed or contracted through a program administrator. Warranty
consists primarily of CNA National Warranty Corporation, which sells vehicle
warranty services in the United States and Canada.
CNA Re
CNA Re offers treaty, facultative, and financial reinsurance, and operates
primarily in the U.S. and select global markets as a reinsurer in the broker
market for Treaty products and in the direct market for Facultative products.
Both Treaty and Facultative operations are headquartered in Chicago. CNA Re
also operates Facultative branch offices in Atlanta, Chicago, Cleveland,
Dallas, Hartford, New York, Philadelphia and Phoenix.
CNA Re's operations also included the business of CNA Re U.K., a United
Kingdom reinsurance company. On October 31, 2002, CNA completed the sale of
CNA Re U.K. to Tawa U.K. Limited, a subsidiary of the Artemis Group, a
diversified French-based holding company. The sale includes business
underwritten since inception by CNA Re U.K., except for certain risks retained
by CCC. See the Investment section of Management's Discussion and Analysis in
Item 7, for further details of the sale of CNA Re U.K. CNA Re's U.K.
subsidiaries ceased new underwriting activities in the third quarter of 2001.
This sale does not impact CNA Re's on-going U.S.-based operations.
CNA Re markets products in the following treaty business segments: standard
lines, global catastrophe, specialty lines, surplus lines and financial
reinsurance. In addition, CNA Re markets property and casualty facultative
products directly to clients through its facultative offices, as well as
through smartfac.com, CNA Re's online facultative submission site.
Group Operations
Group Operations provides group life, group health insurance and investment
products and services to employers, affinity groups and other entities that
purchase insurance as a group.
Group Operations includes three principal business units: Group Benefits,
Federal Markets and Institutional Markets and Other, which also includes
results from businesses that CNA has exited; retail variable life and
annuities and life reinsurance.
Group Benefits: Group Benefits is in the employee benefit market place and
offers group term life and accident insurance, short term and long term
disability, statutory disability, long-term care and specialty medical
products and related services. Target employers range from small private
companies to large public corporations. Products are marketed through a
nationwide operation of 31 sales offices, third-party administrators, managing
general agents and insurance consultants.
Federal Markets: Federal Markets provided health insurance benefits to
federal employees, retirees and their families, insuring nearly one million
members under the National Postal Mail Handlers Union group benefits plan (the
"Mail Handlers Plan"). On July 1, 2002, CNA sold its federal health plan
administrator, Claims Administration Corporation,
6
and transferred the Mail Handlers Plan to First Health Group. As a result of
this transaction, CNA recognized a $7.0 million pretax realized loss on the
sale of Claims Administration Corporation and $15.0 million of pretax non-
recurring fee income related to the transfer of the Mail Handlers Plan.
Institutional Markets and Other: Institutional Markets and Other is a
provider of annuities and investment products to pension plan sponsors and
other institutional customers. The products include traditional and synthetic
guaranteed investment contract ("GICs"), indexed contracts, group annuities
and funding agreements. CNA offers an index 500 product, which is a guaranteed
investment contract that is indexed to the performance of the Standard &
Poor's 500 ("S&P 500") index.
Also within Group Operations is CNA Trust, a limited operations bank located
in Costa Mesa, California, which provides full trustee and pension third-party
administrative services to the under 500-life employer markets. Products
include qualified and non-qualified plans and IRAs. Products are marketed
through life insurers and mutual fund companies.
The variable products business was exited in the fourth quarter of 2001.
During July 2002, CNA entered into an agreement, whereby the Phoenix
Companies, Inc. acquired the variable life and annuity business of VFL through
a coinsurance arrangement, with modified coinsurance on the separate accounts.
The life reinsurance business was sold on December 31, 2000.
Life Operations
Life Operations provides financial protection to individuals through term
life insurance, universal life insurance, individual long-term care insurance,
annuities and other products. Life Operations has several distribution
relationships and partnerships including managing general agencies, other
independent agencies working with CNA life sales offices, a network of brokers
and dealers, and other independent insurance consultants.
Individual life primarily offers level premium term life insurance,
universal life insurance and related products. Single premium immediate
annuities as well as structured settlement annuities are also offered.
Individual long term care products provide reimbursement for covered nursing
home and home health care expenses incurred due to physical or mental
disability.
Other operations include operations in certain international markets and the
life settlements contract business. CNA decided to cease purchasing new life
settlement policies indefinitely beginning in 2001 and ceased sale of new
policies in its international operations in 2002.
Other
The Other Insurance segment is principally comprised of losses and expenses
related to the centralized adjusting and settlement of APMT claims, certain
run-off insurance operations and other operations.
APMT consists of the losses and expenses related to the centralized
adjusting and settlement of APMT claims that were formerly included in the
property and casualty segments. See Note 9 of the Notes to Consolidated
Financial Statements included in Item 8 for a discussion of APMT reserves.
Run-off insurance operations consists of personal insurance, entertainment
insurance, agriculture insurance, group reinsurance and other financial lines
as well as the direct financial guarantee business underwritten by CNA's
insurance affiliates and other insurance run-off operations. Run-off insurance
operations also includes assumed business underwritten through a managing
general agent, IOA Global, which consists primarily of certain accident and
health coverage ("IGI Program").
On October 1, 1999, certain CNA subsidiaries completed a transaction with
The Allstate Corporation ("Allstate") to transfer substantially all of CNA's
personal insurance lines of business.
Other operations include interest expense on CNA's borrowings, asbestos
claims related to Fibreboard Corporation, eBusiness initiatives, CNA UniSource
and inter-company eliminations. CNA UniSource provided human resources,
7
information technology, payroll processing and professional employer
organization services. During 2002, CNA decided to exit the lines of business
provided by CNA UniSource. Effective March 31, 2002, CNA UniSource ceased
providing professional employer organization services. Effective December 31,
2002, CNA UniSource ceased payroll processing services.
Supplementary Insurance Data
The following table sets forth supplementary insurance data:
Year Ended December 31 2002 2001* 2000*
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(In millions, except ratio information)
Trade Ratios - GAAP basis (a):
Loss and loss adjustment expense ratio 79.4% 125.2% 81.1%
Expense ratio 29.3 36.7 30.4
Dividend ratio 0.9 1.5 0.9
- ------------------------------------------------------------------------------------------------
Combined ratio 109.6% 163.4% 112.4%
================================================================================================
Trade Ratios - Statutory basis (a):
Loss and loss adjustment expense ratio 79.2% 126.2% 80.4%
Expense ratio 30.1 32.3 33.3
Dividend ratio 1.0 1.7 1.2
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Combined ratio 110.3% 160.2% 114.9%
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Individual Life and Group Life Insurance In-Force:
Individual Life (b) $345,272.0 $426,822.0 $462,799.0
Group Life 92,479.0 70,910.0 71,982.0
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$437,751.0 $497,732.0 $534,781.0
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Other Data - Statutory basis (c):
Property and casualty companies'
capital and surplus (d) $ 6,836.0 $ 6,241.0 $ 8,373.0
Life and group companies' capital and surplus 1,645.0 1,752.0 1,274.0
Property and casualty companies' written
premium to surplus ratio 1.3 1.3 1.1
Life and group companies' capital and
surplus-percent to total liabilities 21.0% 25.3% 24.5%
Participating policyholders-percent of gross
life insurance in force 0.5% 0.4% 0.4%
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* Restated to reflect an adjustment to the Company's historical accounting for
CNA's investment in life settlement contracts and the related revenue
recognition. See Notes 1 and 23 of the Notes to Consolidated Financial
Statements included in Item 8.
(a) Trade ratios reflect the results of CNA's property and casualty
insurance subsidiaries. Trade ratios are industry measures of property and
casualty underwriting results. The loss and loss adjustment expense ratio is
the percentage of net incurred loss and loss adjustment expenses to net earned
premiums. The primary difference in this ratio between accounting principles
generally accepted in the United States of America ("GAAP") and statutory
accounting principles ("SAP") is related to the treatment of active life
reserves ("ALR") related to long term care insurance products written in
property and casualty insurance subsidiaries. For GAAP, ALR is classified as
claim and claim adjustment expense reserves whereas for SAP, ALR is classified
as unearned premium reserves. The expense ratio, using amounts determined in
accordance with GAAP, is the percentage of underwriting and acquisition
expenses, including the amortization of deferred acquisition expenses to net
earned premiums. The expense ratio, using amounts determined in accordance
with SAP, is the percentage of acquisition and underwriting expenses (with no
deferral of acquisition expenses) to net written premiums. The dividend ratio,
using amounts determined in accordance with GAAP, is the ratio of dividends
incurred to net earned premiums. The dividend ratio, using amounts determined
in accordance with SAP, is the ratio of dividends paid to net earned premiums.
The combined ratio is the sum of the loss and loss adjustment expense, expense
and dividend ratios.
8
(b) Lapse ratios for individual life insurance, as measured by surrenders
and withdrawals as a percentage of average ordinary life insurance in-force,
were 34.7%, 8.7% and 12.7% in 2002, 2001 and 2000, respectively. (The 2002
lapse ratio includes the novation of CNA's individual life insurance business.
Excluding the novation, the 2002 lapse ratio was 7.6%. See Note 14 of the
Notes to Consolidated Financial Statements included in Item 8 for further
discussion).
(c) Other data is determined in accordance with SAP. Life and group
statutory capital and surplus as a percent of total liabilities is determined
after excluding separate account liabilities and reclassifying the statutorily
required Asset Valuation Reserve to surplus.
(d) Surplus includes the property and casualty companies' equity ownership
of the life and group insurance subsidiaries.
The following table displays the distribution of gross written premiums for
CNA's operations by geographic concentration:
Year Ended December 31 2002 2001 2000
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Illinois 9.1% 8.3% 9.2%
California 7.7 6.8 6.0
New York 7.2 7.9 7.3
Florida 6.7 6.2 4.8
Texas 6.2 5.8 4.7
New Jersey 4.6 4.4 3.4
Pennsylvania 4.5 4.3 3.8
Maryland 2.3 2.4 5.6
United Kingdom 1.7 3.3 5.3
All other states, countries or political
subdivisions (a) 50.0 50.6 49.9
- ------------------------------------------------------------------------------
100.0% 100.0% 100.0%
==============================================================================
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(a) No other individual state, country or political subdivision accounts for
more than 3.0% of gross written premium.
Approximately 3.5%, 4.8% and 8.2% of CNA's gross written premiums were
derived from outside of the United States for the years ended December 31,
2002, 2001 and 2000. Premiums from any individual foreign country excluding
the United Kingdom, which is stated in the table above, were not significant.
Property and Casualty Claim and Claim Adjustment Expenses
The following loss reserve development table illustrates the change over
time of reserves established for property and casualty claim and claim
adjustment expenses at the end of the preceding ten calendar years for CNA's
property and casualty insurance operations. The first section shows the
reserves as originally reported at the end of the stated year. The second
section, reading down, shows the cumulative amounts paid as of the end of
successive years with respect to the originally reported reserve liability.
The third section, reading down, shows re-estimates of the originally recorded
reserves as of the end of each successive year, which is the result of CNA's
property and casualty insurance subsidiaries' expanded awareness of additional
facts and circumstances that pertain to the unsettled claims. The last section
compares the latest re-estimated reserves to the reserves originally
established, and indicates whether the original reserves were adequate or
inadequate to cover the estimated costs of unsettled claims. This table is
cumulative and, therefore, ending balances should not be added since the
amount at the end of each calendar year includes activity for both the current
and prior years.
9
Schedule of Property-Casualty Loss Reserve Development
- -----------------------------------------------------------------------------------------------------------
Year Ended December 31 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
(a) (a) (a) (b) (c) (d) (d) (e)
- -----------------------------------------------------------------------------------------------------------
(In millions of dollars)
Originally reported
gross reserves for
unpaid claim and
claim adjustment
expenses 20,812 21,639 31,044 29,357 28,533 28,317 26,631 26,408 29,551 25,648
Originally reported
ceded recoverable 2,491 2,705 6,089 5,660 5,326 5,424 6,273 7,568 11,798 10,583
- ------------------------------------------------------------------------------------------------------------
Originally reported
net reserves for
unpaid claim and
claim adjustment
expenses 17,167 18,321 18,934 24,955 23,697 23,207 22,893 20,358 18,840 17,753 15,065
Cumulative net
paid as of:
One year later 3,706 3,629 3,656 6,510 5,851 5,954 7,321 6,546 7,686 5,981 -
Two years later 6,354 6,143 7,087 10,485 9,796 11,394 12,241 11,935 11,988 - -
Three years later 8,121 8,764 9,195 13,363 13,602 14,423 16,020 15,247 - - -
Four years later 10,241 10,318 10,624 16,271 15,793 17,042 18,271 - - - -
Five years later 11,461 11,378 12,577 17,947 17,736 18,568 - - - - -
Six years later 12,308 13,100 13,472 19,465 18,878 - - - - - -
Seven years later 13,974 13,848 14,394 20,410 - - - - - - -
Eight years later 14,640 14,615 15,024 - - - - - - - -
Nine years later 15,319 15,161 - - - - - - - - -
Ten years later 15,805 - - - - - - - - - -
Net reserves
re-estimated as of:
End of initial year 17,167 18,321 18,934 24,955 23,697 23,207 22,893 20,358 18,840 17,753 15,065
One year later 17,757 18,250 18,922 24,864 23,441 23,470 23,920 20,785 21,306 17,805 -
Two years later 17,728 18,125 18,500 24,294 23,102 23,717 23,774 22,903 21,377 - -
Three years later 17,823 17,868 18,088 23,814 23,270 23,414 25,724 22,780 - - -
Four years later 17,765 17,511 17,354 24,092 22,977 24,751 25,407 - - - -
Five years later 17,560 17,082 17,506 23,854 24,105 24,330 - - - - -
Six years later 17,285 17,176 17,248 24,883 23,736 - - - - - -
Seven years later 17,398 17,017 17,751 24,631 - - - - - - -
Eight years later 17,354 17,500 17,650 - - - - - - - -
Nine years later 17,834 17,443 - - - - - - - - -
Ten years later 17,805 - - - - - - - - - -
- ------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy (638) 878 1,284 324 (39)(1,123)(2,514) (2,422)(2,537) (52) -
============================================================================================================
Reconciliation to gross
re-estimated reserves:
Net reserves
re-estimated 17,805 17,443 17,650 24,631 23,736 24,330 25,407 22,780 21,377 17,805 -
Re-estimated ceded ======
recoverable 1,784 2,074 6,688 5,927 5,195 5,507 7,618 7,852 11,985 -
- ------------------------------------------------------------------------------------------------------------
Total gross re-estimated
reserves 19,227 19,724 31,319 29,663 29,525 30,914 30,398 29,229 29,790 -
============================================================================================================
Net (deficiency) redundancy
related to:
Asbestos claims (2,063)(1,466)(1,433) (1,660) (1,761) (1,659)(1,415) (838) (773) - -
Environmental claims (1,215) (772) (604) (645) (589) (608) (388) (483) (468) - -
- ------------------------------------------------------------------------------------------------------------
Total asbestos and
environmental (3,278)(2,238)(2,037) (2,305) (2,350) (2,267)(1,803)(1,321)(1,241) - -
Other claims 2,640 3,116 3,321 2,629 2,311 1,144 (711)(1,101)(1,296) (52) -
- ------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy (638) 878 1,284 324 (39) (1,123)(2,514)(2,422)(2,537) (52) -
============================================================================================================
- ------------
(a) Reflects reserves of CNA's property and casualty insurance subsidiaries,
excluding CIC reserves which were acquired on May 10, 1995. Accordingly, the
reserve development (net reserves recorded at the end of the year, as
initially estimated, less net reserves re-estimated as of subsequent years)
does not include CIC.
(b) Includes CIC gross reserves of $9,713.0 million and net reserves of
$6,063.0 million acquired on May 10, 1995 and subsequent development thereon.
(c) Ceded recoverable includes reserves transferred under retroactive
reinsurance agreements of $784.0 million, as of December 31, 1999.
(d) Effective January 1, 2001, CNA established a new life insurance company,
CNAGLA. Further, on January 1, 2001 approximately $1,055.0 million of reserves
were transferred from CCC to CNAGLA.
(e) Effective October 31, 2002, CNA sold CNA Reinsurance Company Limited "CNA
Re U.K." As a result of the sale, net reserves were reduced by approximately
$1,316.0 million. See Note 14 of the Notes to Consolidated Financial
Statements included in Item 8 for further discussion of the sale.
10
Additional information as to CNA's property and casualty claim and claim
adjustment expense reserves and reserve development is set forth in Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and in Notes 1 and 9 of the Notes to Consolidated Financial
Statements, included in Item 8.
Investments
See Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations -Investments and Notes 1, 2, 3 and 4 of the Notes to
Consolidated Financial Statements, incorporated by reference to Item 8, for
information regarding CNA's investment portfolio.
Other
Competition: The property and casualty and life and health insurance
industry is highly competitive both as to rate and service. CNA's consolidated
property and casualty subsidiaries compete not only with other stock insurance
companies, but also with mutual insurance companies, reinsurance companies and
other entities for both producers and customers. CNA must continuously
allocate resources to refine and improve its insurance and reinsurance
products and services.
Rates among insurers vary according to the types of insurers and methods of
operation. CNA competes for business not only on the basis of rate, but also
on the basis of availability of coverage desired by customers and quality of
service, including claim adjustment services.
There are approximately 2,400 individual companies that sell property and
casualty insurance in the United States. CNA's consolidated property and
casualty subsidiaries ranked as the ninth largest property and casualty
insurance organization in the United States based upon 2001 statutory net
written premiums. CNA Re, CNA's principal property and casualty assumed
reinsurance operation, ranked as the 14th largest property and casualty
reinsurance organization in the United States based upon 2001 statutory net
written premiums.
There are approximately 990 companies selling life and health insurance in
the United States. CNA's consolidated life insurance companies are ranked as
the 51st largest life-health insurance organization in the United States based
on 2001 statutory net written premiums.
Regulation: The insurance industry is subject to comprehensive and detailed
regulation and supervision throughout the United States. Each state has
established supervisory agencies with broad administrative powers relative to
licensing insurers and agents, approving policy forms, establishing reserve
requirements, fixing minimum interest rates for accumulation of surrender
values and maximum interest rates of policy loans, prescribing the form and
content of statutory financial reports and regulating solvency and the type
and amount of investments permitted. Such regulatory powers also extend to
premium rate regulations, which require that rates not be excessive,
inadequate or unfairly discriminatory. In addition to regulation of dividends
by insurance subsidiaries, intercompany transfers of assets may be subject to
prior notice or approval by the state insurance regulator, depending on the
size of such transfers and payments in relation to the financial position of
the insurance affiliates making the transfer or payments.
Insurers are also required by the states to provide coverage to insureds who
would not otherwise be considered eligible by the insurers. Each state
dictates the types of insurance and the level of coverage that must be
provided to such involuntary risks. CNA's share of these involuntary risks is
mandatory and generally a function of its respective share of the voluntary
market by line of insurance in each state.
Insurance companies are subject to state guaranty fund and other insurance-
related assessments. Guaranty fund and other insurance-related assessments are
levied by the state departments of insurance to cover claims of insolvent
insurers.
Reform of the U.S. tort liability system is another issue facing the
insurance industry. Over the last decade, many states have passed some type of
reform, but more recently, a number of state courts have modified or
overturned these reforms. Additionally, new causes of action and theories of
damages continue to be proposed in state court actions or by legislatures.
Continued unpredictability in the law means that insurance underwriting and
rating is expected to continue to be difficult in commercial lines,
professional liability and some specialty coverages.
11
Although the federal government and its regulatory agencies do not directly
regulate the business of insurance, federal legislative and regulatory
initiatives can impact the insurance business in a variety of ways. These
initiatives and legislation include tort reform proposals; proposals to
overhaul the Superfund hazardous waste removal and liability statutes; and
various tax proposals affecting insurance companies. In 1999, Congress passed
the Financial Services Modernization or "Gramm-Leach-Bliley" Act ("GLB Act"),
which repealed portions of the Glass-Steagall Act and enabled closer
relationships between banks and insurers. Although "functional regulation" was
preserved by the GLB Act for state oversight of insurance, additional
financial services modernization legislation could include provisions for an
alternate federal system of regulation for insurance companies.
CNA and the insurance industry incurred substantial losses related to the
September 11, 2001 World Trade Center disaster and related events. For the
most part, CNA believes 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.
CNA's domestic insurance subsidiaries are subject to risk-based capital
requirements. Risk-based capital is a method developed by the National
Association of Insurance Commissioners ("NAIC") to determine the minimum
amount of statutory capital appropriate for an insurance company to support
its overall business operations in consideration of its size and risk profile.
The formula for determining the amount of risk-based capital specifies various
factors, weighted based on the perceived degree of risk, that are applied to
certain financial balances and financial activity. The adequacy of a company's
actual capital is evaluated by a comparison to the risk-based capital results,
as determined by the formula. Companies below minimum risk-based capital
requirements are classified within certain levels, each of which determines a
specified level of regulatory attention applicable to a company. As of
December 31, 2002 and 2001, all of CNA's domestic insurance subsidiaries
exceeded the minimum risk-based capital requirements.
Subsidiaries with insurance operations outside the United States are also
subject to regulation in the countries in which they operate. CNA has
operations in the United Kingdom, Canada, and other countries.
Terrorism
On November 26, 2002, the President of the United States of America signed
into law the Terrorism Risk Insurance Act of 2002 (the "Act"), which
establishes a program within the Department of the Treasury under which the
federal government will share the risk of loss from future terrorist attacks
with the insurance industry. The Act terminates on December 31, 2005. Each
participating insurance company must pay a deductible before federal
government assistance becomes available. This deductible is based on a
percentage of direct earned premiums for commercial insurance lines from the
previous calendar year, and rises from 1.0% from date of enactment to December
31, 2002 (the "Transition Period") to 7.0% during the first subsequent
calendar year, 10.0% in year two and 15.0% in year three. 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.
Insurance companies providing commercial property and casualty insurance are
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, but they
are pre-empted in relation to prior approval requirements for rates and forms.
The Act has policyholder notice requirements in order for insurers to be
reimbursed for terrorism-related losses and, from the date of enactment until
December 31, 2004, a mandatory offer requirement for terrorism coverage,
although it may be rejected by insureds. The Secretary of the Department of
the Treasury has discretion 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 during the next three
years, 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, individual life and
group life and health policies and is also prohibited from excluding coverage
for fire losses following a terrorist event in a number of states.
12
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's current reinsurance arrangements
either exclude terrorism coverage or significantly limit the level of
coverage.
Reinsurance: See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and Notes 1 and 18 of the Notes to
Consolidated Financial Statements, included in Item 8, for information related
to CNA's reinsurance activities.
Properties: CNA Plaza serves as the executive office for CNA and its
insurance subsidiaries. CNA owns or leases office space in various cities
throughout the United States and in other countries. The following table sets
forth certain information with respect to the principal office buildings owned
or leased by CNA:
Size
Location (square feet) Principal Usage
- ------------------------------------------------------------------------------------------------
Owned:
CNA Plaza 1,144,378 Principal executive offices of CNA
333 S. Wabash
Chicago, Illinois
100 CNA Drive 251,363 Life insurance offices
Nashville, Tennessee
1110 Ward Avenue 100,075 Property and casualty insurance offices
Honolulu, Hawaii
Leased:
40 Wall Street 196,438 Property and casualty insurance offices
New York, New York
2405 Lucien Way 178,744 Property and casualty insurance offices
Maitland, Florida
3500 Lacey Road 168,793 Property and casualty insurance offices
Downers Grove, Illinois
1100 Cornwall Road 112,926 Property and casualty insurance offices
Monmouth Junction, New Jersey
LORILLARD, INC.
The Company's wholly owned subsidiary, Lorillard, Inc. ("Lorillard"), is
engaged, through its subsidiaries, in the production and sale of cigarettes.
The principal cigarette brand names of Lorillard are Newport, Kent, True,
Maverick and Old Gold. Lorillard's largest selling brand is Newport, the
second largest selling cigarette brand in the United States and the largest
selling brand in the menthol segment of the U.S. cigarette market in 2002.
Newport accounted for approximately 88% of Lorillard's sales in 2002.
Substantially all of Lorillard's sales are in the United States, Puerto Rico
and certain U.S. territories. Lorillard's major trademarks outside of the
United States were sold in 1977. Lorillard accounted for 22.18%, 21.08% and
18.71% of the Company's consolidated total revenue for the years ended
December 31, 2002, 2001 and 2000, respectively.
The tobacco industry in the United States, including Lorillard, continues to
be faced with a number of issues that have or may adversely impact the
business, results of operations and financial condition of Lorillard and the
Company, including a substantial volume of litigation seeking compensatory and
punitive damages ranging into the billions of dollars, as well as equitable
and injunctive relief; a $16.3 billion punitive damage judgment, currently
under appeal, against Lorillard in Engle vs. R.J. Reynolds Tobacco Company, et
al; substantial annual payment obligations, continuing in perpetuity, under
the terms of the settlement agreements entered into between the major
cigarette manufacturers, including Lorillard, and each of the 50 states, the
District of Columbia, the Commonwealth of Puerto Rico and certain other U.S.
territories (together, the "State Settlement Agreements"); increasing actual
and proposed regulation of the tobacco industry and restrictions on smoking in
public places; a continuing decline in the volume of cigarette sales in the
United States; continuing and substantial increases in excise taxes; the
diminishing social acceptability of smoking; increases in industry-wide
promotional expenses and sales incentives implemented in reaction to
continuing intense
13
competition among the four largest cigarette manufacturers
and competition from discount and deep-discount cigarette brands; and
increasing sales of counterfeit cigarettes in the United States.
See Item 3 of this Report and Note 20 of the Notes to Consolidated Financial
Statements included in Item 8 of this Report for information with respect to
litigation against or affecting Lorillard, including among others the Engle
class action and the State Settlement Agreements. See also, Management's
Discussion and Analysis-Results of Operations-Lorillard, and-Liquidity and
Capital Resources-Lorillard included in Item 7 of this Report.
Legislation and Regulation: Lorillard's business operations are subject to a
variety of federal, state and local laws and regulations governing, among
other things, publication of health warnings on cigarette packaging,
advertising and sales of tobacco products, restrictions on smoking in public
places and fire safety standards. Further, from time to time new legislation
or regulations are proposed and reports are published by government sponsored
committees and others recommending additional regulations of tobacco products.
Federal Regulation: The Federal Comprehensive Smoking Education Act, which
became effective in 1985, requires that cigarette packaging and advertising
display one of the following four warning statements, on a rotating basis: (1)
"SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease,
Emphysema, And May Complicate Pregnancy." (2) "SURGEON GENERAL'S WARNING:
Quitting Smoking Now Greatly Reduces Serious Risks to Your Health." (3)
"SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in Fetal
Injury, Premature Birth, and Low Birth Weight." (4) "SURGEON GENERAL'S
WARNING: Cigarette Smoke Contains Carbon Monoxide." This law also requires
that each person who manufactures, packages or imports cigarettes shall
annually provide to the Secretary of Health and Human Services a list of the
ingredients added to tobacco in the manufacture of cigarettes. This list of
ingredients may be submitted in a manner that does not identify the company
that uses the ingredients or the brand of cigarettes that contain the
ingredients.
In addition, from time to time, bills have been introduced in Congress,
among other things, to end or limit the price supports for leaf tobacco; to
prohibit all tobacco advertising and promotion; to require new health warnings
on cigarette packages and advertising; to authorize the establishment of
various anti-smoking education programs; to provide that current federal law
should not be construed to relieve any person of liability under common or
state law; to permit state and local governments to restrict the sale and
distribution of cigarettes; concerning the placement of advertising of tobacco
products; to provide that cigarette advertising not be deductible as a
business expense; to prohibit the mailing of unsolicited samples of cigarettes
and otherwise to restrict the sale or distribution of cigarettes in retail
stores and over the internet; to impose an additional, or to increase
existing, excise taxes on cigarettes; to require that cigarettes be
manufactured in a manner that will cause them, under certain circumstances, to
be self-extinguishing; and to subject cigarettes to regulation in various ways
by the U.S. Department of Health and Human Services or other regulatory
agencies.
In addition, in 1996 the U.S. Food and Drug Administration published
regulations that would have extensively regulated the distribution, marketing
and advertising of cigarettes, including the imposition of a wide range of
labeling, reporting, record keeping, manufacturing and other requirements.
Challenges to the FDA's assertion of jurisdiction over cigarettes made by
Lorillard and other manufacturers were upheld by the Supreme Court in March
2000 when that Court ruled that Congress did not give the FDA authority to
regulate tobacco products under the federal Food, Drug and Cosmetic Act.
Since the Supreme Court decision, various proposals and recommendations have
been made for additional federal and state legislation to regulate cigarette
manufacturers. Congressional advocates of FDA regulation have introduced
legislation that would give the FDA authority to regulate the manufacture,
sale, distribution and labeling of tobacco products to protect public health,
thereby allowing the FDA to reinstate its prior regulations or adopt new or
additional regulations.
In December 1999, the FDA requested the Institute of Medicine, a private,
non-profit organization which advises the federal government on medical
issues, to convene a committee of experts to formulate scientific methods and
standards for the assessment of potentially reduced-exposure products
("PREPs"), including conventional and alternative cigarettes. In February
2001, the committee issued a report recommending that Congress enact
legislation enabling a suitable agency to regulate tobacco-related products
that purport to reduce exposure to one or more tobacco toxicants or
14
to reduce risk of disease, and to implement other policies designed to reduce
the harm from tobacco use. The report recommended regulation of all tobacco
products, including PREPs.
In 2002 certain public health groups petitioned the FDA to assert
jurisdiction over several PREP type products that have been introduced into
the marketplace. These groups assert that claims made by manufacturers of
these products allow the FDA to regulate the manufacture, advertising and sale
of these products as drugs or medical devices under the Food Drug and Cosmetic
Act. The agency has received comments on these petitions but has taken no
action.
In late 2002 Philip Morris U.S.A., the largest U.S. manufacturer of
cigarettes, filed a request for rulemaking petition with the Federal Trade
Commission ("FTC") seeking changes in the existing FTC regulatory scheme for
measuring and reporting tar and nicotine to the federal government and for
inclusion in cigarette advertising. The agency procedures allow for interested
parties to submit comments on this proposal. The agency has received comments
on these petitions but has taken no action.
In 1986, the Surgeon General of the United States and the National Academy
of Sciences reported that environmental tobacco smoke ("ETS") exposes
nonsmokers to an increased risk of lung cancer and respiratory illness. In
addition, in 1993, the United States Environmental Protection Agency released
a report (the "EPA Risk Assessment") concluding that ETS is a human lung
carcinogen in adults, and causes respiratory effects in children, including
increased risk of lower respiratory tract infections, increased prevalence of
fluid in the middle ear and additional episodes and increased severity and
frequency of asthma. In July 1998, a federal district court judge struck down
the lung cancer related portions of the EPA's scientific risk assessment. In
an opinion issued in December 2002, the federal Fourth Circuit Court of Appeal
overturned the District Court's decision on procedural grounds, and vacated
the decision. The time in which an appeal may be lodged has not yet expired.
In May 2000, the Department of Health and Human Service's National Toxicology
Program listed ETS as "known to be a human carcinogen." Various public health
organizations have also issued statements on environmental tobacco smoke and
its health effects and many scientific papers on ETS have been published since
the EPA Risk Assessment, with varying conclusions.
Lorillard cannot predict the ultimate outcome of these proposals, reports
and recommendations, though if enacted, certain of these proposals could have
a material adverse effect on Lorillard's business and the Company's financial
position or results of operations in the future.
State and Local Regulation: In recent years, many state, local and municipal
governments and agencies, as well as private businesses, have adopted
legislation, regulations or policies which prohibit or restrict, or are
intended to discourage, smoking, including legislation, regulations or
policies prohibiting or restricting smoking in various places such as public
buildings and facilities, stores, restaurants and bars and on airline flights
and in the workplace. This trend has increased significantly since the release
of the EPA Risk Assessment. The following are examples of some of the more
significant state and local regulations affecting Lorillard's business:
In September 1997, the California Environmental Protection Agency released a
report (the "Cal/EPA Report") concluding that ETS causes specified
development, respiratory, carcinogenic, and cardiovascular effects including
lung and nasal sinus cancer, heart disease, sudden infant death syndrome,
respiratory infections and asthma induction and exacerbation in children. The
Cal/EPA Report was subsequently released as a monograph by the National Cancer
Institute in November of 1999.
The California Air Resources Board is in the early stages of the process of
determining whether to identify ETS as a toxic air contaminant, or "TAC,"
under the Toxic Air Contaminant Identification and Control Act, a California
statute referred to as the "Tanner Act." The Children's Environmental Health
Protection Act amended the Tanner Act to require a review of TACs for the
purpose of ensuring adequate protection of children's health, and to tighten
existing controls as needed. If California, on the basis of its assessments of
risk and exposure, identifies ETS as a TAC, California could initiate the
control phase of the Tanner Act, which involves adoption of measures to reduce
or eliminate emissions. These measures could include further restrictions
regarding venues where smoking is permitted or controls on product emissions.
The Commonwealth of Massachusetts has enacted legislation requiring each
manufacturer of cigarettes and smokeless tobacco sold in Massachusetts to
submit to the state's Department of Public Health ("DPH") an annual report
identifying for each brand sold certain "added constituents," and providing
nicotine yield ratings and other information for certain
15
brands based on regulations promulgated by the DPH. The provisions of the
legislation that provide for the public release of this information, which
includes trade secret ingredients used in cigarettes, were challenged by
several cigarette manufacturers, and were found unconstitutional by a federal
district court in Boston and that ruling was upheld by the U.S. Circuit Court
of Appeals for the First Circuit. The Commonwealth has decided that it will
not seek to appeal this decision to the U.S. Supreme Court.
The State of Texas has implemented legislation similar to the Massachusetts
law described above. However, the Texas legislation does not allow for the
public release of trade secret information.
New York State has enacted legislation that requires the State's Office of
Fire Prevention and Control ("OFPC") to promulgate fire-safety standards for
cigarettes sold in New York and that cigarettes sold in New York meet ignition
propensity performance standards established by that agency. The law states
that the effective date of regulations implementing the legislation is to be
within 180 days after final adoption of the standards. On December 31, 2002,
OFPC issued Proposed Fire Safety Standards For Cigarettes proposing
performance and testing standards pursuant to the legislation. Under
applicable state administrative law, interested parties may submit comments to
the agency. The time within which to submit comments has not yet expired.
Similar legislation is being considered in other states and at the federal
level.
Other similar laws and regulations have been enacted or considered by other
state and local governments. Lorillard cannot predict the impact which these
regulations may have on Lorillard's business, though if enacted, they could
have a material adverse effect on Lorillard's business and the Company's
financial position or results of operations in the future.
Excise Taxes: Cigarettes are subject to substantial federal, state and local
excise taxes in the United States and, in general, such taxes have been
increasing. On January 1, 2002, the federal excise tax on cigarettes increased
by $2.50 per thousand cigarettes and is now $19.50 per thousand cigarettes (or
$0.39 per pack of 20 cigarettes). State excise taxes, which are levied upon
and paid by the distributors, are also in effect in the fifty states, the
District of Columbia and many municipalities. Increases in state excise taxes
on cigarette sales in 2002 ranged from $0.18 per pack to $0.69 per pack in 21
states, and excise tax increases were implemented by several municipalities
such as New York City where the local tax increased from $0.08 to $1.50 per
pack in 2002. Proposals for additional increases in federal, state and local
excise taxes continue to be considered. The state and municipal taxes
generally range from $0.025 to $3.00 per pack of cigarettes.
Advertising and Marketing: Lorillard advertises its products to adult
smokers in magazines, newspapers, direct mail and point-of-sale display
materials. In addition, Lorillard promotes its cigarette brands to adult
smokers through distribution of store coupons, retail price promotions, and
personal contact with distributors and retailers. Although Lorillard's sales
are made primarily to wholesale distributors rather than retailers,
Lorillard's sales personnel monitor retail and wholesale inventories, work
with retailers on displays and signs, and enter into promotional arrangements
with retailers from time to time.
As a general matter, Lorillard allocates its marketing expenditures among
brands on the basis of marketplace opportunity and profitable return. In
particular, Lorillard focuses its marketing efforts on the premium segment of
the U.S. cigarette industry, with a specific focus on Newport.
Advertising of tobacco products through television and radio has been
prohibited since 1971. In addition, on November 23, 1998, Lorillard and the
three other largest major cigarette manufacturers entered into a Master
Settlement Agreement ("MSA") with 46 states, the District of Columbia, the
Commonwealth of Puerto Rico and certain other U.S. territories to settle
certain health care cost recovery and other claims. These manufacturers had
previously settled similar claims brought by the four remaining states which
together with the MSA are generally referred to as the "State Settlement
Agreements." Under the State Settlement Agreements the participating cigarette
manufacturers agreed to severe restrictions on their advertising and promotion
activities. Among other things, the MSA prohibits the targeting of youth in
the advertising, promotion or marketing of tobacco products; bans the use of
cartoon characters in all tobacco advertising and promotion; limits each
tobacco manufacturer to one event sponsorship during any twelve-month period,
which may not include major team sports or events in which the intended
audience includes a significant percentage of youth; bans all outdoor
advertising of tobacco products with the exception of small signs at retail
establishments that sell tobacco products; bans tobacco manufacturers from
offering or selling apparel and other merchandise that bears a tobacco brand
name, subject to specified exceptions; prohibits the distribution of free
samples of tobacco products except
16
within adult-only facilities; prohibits payments for tobacco product placement
in various media; and bans gift offers
based on the purchase of tobacco products without sufficient proof that the
intended gift recipient is an adult.
Many states, cities and counties have enacted legislation or regulations
further restricting tobacco advertising. There may be additional local, state
and federal legislative and regulatory initiatives relating to the advertising
and promotion of cigarettes in the future. Lorillard cannot predict the impact
of such initiatives on its marketing and sales efforts.
Lorillard has funded and plans to continue to fund a Youth Smoking
Prevention Program, which is designed to discourage youth from smoking. The
program addresses not only youth, but also parents and, through the "We Card"
program, retailers, to prevent purchase of cigarettes by underage purchasers.
Lorillard has determined not to advertise its cigarettes in magazines with
large readership among people under the age of 18.
Distribution Methods: Lorillard sells its products primarily to
distributors, who in turn service retail outlets; chain store organizations;
and government agencies, including the U.S. Armed Forces. Upon completion of
the manufacturing process, Lorillard ships cigarettes to public distributing
warehouse facilities for rapid order fulfillment to wholesalers and other
direct buying customers. Lorillard retains a portion of its manufactured
cigarettes at its Greensboro central distribution center and Greensboro cold-
storage facility for future finished goods replenishment.
As of December 31, 2002, Lorillard had approximately 774 direct buying
customers servicing more than 400,000 retail accounts. Lorillard does not sell
cigarettes directly to consumers. During 2002, 2001 and 2000, sales made by
Lorillard to McLane Company, Inc., a wholesale distributor wholly owned by
Wal-Mart Stores, Inc., comprised 17%, 15% and 15%, respectively, of
Lorillard's revenues. No other customer accounted for more than 10% of 2002,
2001 or 2000 sales. Lorillard does not have any backlog orders.
Most of Lorillard's customers buy cigarettes on a next-day-delivery basis.
Approximately 90% of Lorillard's customers purchase cigarettes using
electronic funds transfer, which provides immediate payment to Lorillard.
Raw Materials and Manufacturing: In its production of cigarettes, Lorillard
uses burley leaf tobacco, and flue-cured leaf tobacco grown in the United
States and abroad, and aromatic tobacco grown primarily in Turkey and other
Near Eastern countries. A domestic supplier manufactures all of Lorillard's
reconstituted tobacco.
Lorillard purchases more than 90% of its domestic leaf tobacco from Dimon
International, Inc. Lorillard directs Dimon in the purchase of tobacco
according to Lorillard's specifications for quality, grade, yield, particle
size, moisture content and other characteristics. Dimon purchases and
processes the whole leaf and then dries and packages it for shipment to and
storage at Lorillard's Danville, Virginia facility. Dimon historically has
procured most of Lorillard's leaf tobacco requirements through commission
buyers at tobacco auctions. However, the tobacco industry is currently
shifting to direct contract purchasing from tobacco farmers. Dimon has stated
in its public filings that it believes it is well prepared to participate in
direct contracting with tobacco farmers in the United States and that it does
not expect any material economic effect from the progressive shift from the
auction system to direct contract buying. Lorillard entered into a new
contract with Dimon to reflect the transition from auction to direct contract
purchasing. In the event that Dimon becomes unwilling or unable to supply leaf
tobacco to Lorillard, Lorillard believes that it can readily obtain high-
quality leaf tobacco from well-established, alternative industry sources.
Due to the varying size and quality of annual crops and other economic
factors, including U.S. tobacco production controls administered by the United
States Department of Agriculture, tobacco prices have historically fluctuated.
The U.S. price supports that accompany production controls have inflated the
market price of tobacco. In addition, the transition in tobacco purchasing
from auction markets to direct farmer contracting may increase the market
price of domestically grown tobacco. However, Lorillard does not believe that
this increase, if any, will have a material effect on its business
Lorillard stores its tobacco in 29 storage warehouses on its 130-acre
Danville facility. To protect against loss, amounts of all types and grades of
tobacco are stored in separate warehouses. Because the process of aging
tobacco normally requires approximately two years, Lorillard maintains large
quantities of leaf tobacco at all times. Lorillard believes its current
tobacco supplies are adequately balanced for its present production
requirements. If necessary, Lorillard can purchase aged tobacco in the open
markets to supplement existing inventories.
17
Lorillard produces cigarettes at its Greensboro, North Carolina
manufacturing plant, which has a production capacity of approximately 193
million cigarettes per day and approximately 55 billion cigarettes per year.
Through various automated systems and sensors, Lorillard actively monitors all
phases of production to promote quality and compliance with applicable
regulations.
Prices: Lorillard believes that the volume of U.S. cigarette sales is
sensitive to price changes. Changes in pricing by Lorillard or other cigarette
manufacturers could have an adverse impact on Lorillard's volume of units
sold, which in turn could have an adverse impact on Lorillard's profits and
earnings. Lorillard makes independent pricing decisions based on a number of
factors. Lorillard cannot predict the potential adverse impact of price
changes on industry volume or Lorillard volume, on the mix between premium and
discount sales, on Lorillard's market share or on Lorillard's profits and
earnings. During 2002, Lorillard increased its net wholesale price of its
cigarettes by an aggregate of $6.71 per thousand cigarettes ($0.13 per pack of
20 cigarettes).
Properties: Lorillard's manufacturing facility is located on approximately
80 acres in Greensboro, North Carolina. This 942,600 square-foot plant
contains modern high-speed cigarette manufacturing machinery. The Greensboro
facility also includes a warehouse with shipping and receiving areas totaling
54,800 square feet. In addition, Lorillard owns tobacco receiving and storage
facilities totaling approximately 1,500,000 square feet in Danville, Virginia.
Lorillard's executive offices are located in a 130,000 square-foot, four-story
office building in Greensboro, North Carolina. Its 79,000 square-foot research
facility is also located in Greensboro.
Lorillard's principal properties are owned in fee. With minor exceptions,
Lorillard owns all of the machinery it uses. Lorillard believes that its
properties and machinery are in generally good condition. Lorillard leases
sales offices in major cities throughout the United States, a cold-storage
facility in Greensboro and warehousing space in 34 public distributing
warehouses located throughout the United States.
Competition: The domestic U.S. market for cigarettes is highly competitive.
Competition is primarily based on a brand's price, positioning, consumer
loyalty, retail display, promotion, quality and taste. Lorillard's principal
competitors are the three other major U.S. cigarette manufacturers, Philip
Morris, R.J. Reynolds and Brown & Williamson.
Lorillard believes its ability to compete even more effectively has been
restrained by the Philip Morris Retail Leaders program. The terms of Philip
Morris' merchandising contracts preclude Lorillard from obtaining visible
space in the retail store to effectively promote its brands. As a result in a
large number of retail locations, Lorillard either has a severely limited or
no opportunity to competitively support its promotion programs thereby
limiting its sales potential.
Lorillard's 9.05% market share of the 2002 U.S. domestic cigarette industry
was fourth highest overall. Philip Morris, R.J. Reynolds and Brown &
Williamson accounted for approximately 48.9%, 23.1% and 11.2%, respectively,
of wholesale shipments in 2002. Among the four major manufacturers, Lorillard
ranked third behind Philip Morris and R.J. Reynolds with an 11.8% share of the
premium segment in 2002.
The following table sets forth cigarette sales data provided by the industry
and by Lorillard to Management Science Associates. For reporting purposes,
unit sales by small manufacturers, selling deep-discounted brands, many of
whom are not currently affected to a significant degree by payment obligations
under the State Settlement Agreements, are estimated by Management Science
Associates. The table below indicates the relative position of Lorillard in
the U.S. Each of these years has been restated to reflect Management Science
Associates' estimates for the small manufacturers' shipments.
Lorillard
Industry Lorillard to
Calendar Year (000) (000) Industry
- -----------------------------------------------------------------------------
2002 391,404,000 35,444,000 9.05%
2001 406,304,000 37,626,000 9.26%
2000 419,536,000 40,432,000 9.64%
- ------------
Management Science Associates divides the cigarette market into two price
segments, the premium price segment and the discount or reduced price segment.
According to Management Science Associates, the discount segment share of
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market increased from approximately 26.0% in 2001 to 27.2% in 2002. Virtually
all of Lorillard's sales are in the full price segment where Lorillard's share
amounted to approximately 11.8% in 2002 and 11.5% in 2001, as reported by
Management Science Associates.
LOEWS HOTELS HOLDING CORPORATION
The subsidiaries of Loews Hotels Holding Corporation ("Loews Hotels"), a
wholly owned subsidiary of the Company, presently operate the following 18
hotels. Loews Hotels accounted for 1.75%, 1.71% and 1.64% of the Company's
consolidated total revenue for the years ended December 31, 2002, 2001 and
2000, respectively.
Number of
Name and Location Rooms Owned, Leased or Managed
- ------------------------------------------------------------------------------------------------
Loews Annapolis 220 Owned
Annapolis, Maryland
Loews Coronado Bay Resort 440 Land lease expiring 2034
San Diego, California
Loews Denver 185 Owned
Denver, Colorado
Hard Rock Hotel, 650 Management contract (b)
at Universal Orlando
Orlando, Florida
House of Blues Hotel, a Loews Hotel 370 Management contract expiring 2005 (a)
Chicago, Illinois
The Jefferson, a Loews Hotel 100 Management contract expiring 2010 (a)
Washington, D.C.
Loews Le Concorde 405 Land lease expiring 2069
Quebec City, Canada
Loews L'Enfant Plaza 370 Management contract expiring 2003
Washington, D.C.
Loews Miami Beach Hotel 790 Land lease expiring 2096
Miami Beach, Florida
The Metropolitan Hotel 720 Owned
New York, New York
Loews Philadelphia Hotel 585 Owned
Philadelphia, Pennsylvania
Portofino Bay Hotel, 750 Management contract (b)
at Universal Orlando, a Loews Hotel
Orlando, Florida
The Regency, a Loews Hotel 350 Land lease expiring 2013, with
New York, New York renewal option for 47 years
Royal Pacific Resort at Universal 1,000 Management contract (b)
Orlando, a Loews Hotel
Orlando, Florida
Loews Santa Monica Beach 340 Management contract expiring 2018,
Santa Monica, California with renewal option for 5 years (a)
Loews Vanderbilt Plaza 340 Owned
Nashville, Tennessee
Loews Ventana Canyon Resort 400 Management contract expiring 2004,
Tucson, Arizona with renewal options for 10 years
(a)
Loews Hotel Vogue 140 Owned
Montreal, Canada
- ------------
(a) These management contracts are subject to termination rights.
(b) A Loews Hotels subsidiary is a 50% owner of these hotels located at the
Universal Orlando theme park, through a joint venture with Universal Studios
and the Rank Group. The hotels are constructed on land leased by the joint
venture from the resort's owners and are being operated by Loews Hotels
pursuant to a management contract.
19
The hotels which are operated by Loews Hotels contain shops, a variety of
restaurants and lounges, and some contain parking facilities, swimming pools,
tennis courts and access to golf courses.
The hotels owned by Loews Hotels are subject to mortgage indebtedness
aggregating approximately $145.8 million at December 31, 2002 with interest
rates ranging from 3.8% to 8.9% and maturing between 2003 and 2028. In
addition, certain hotels are held under leases which are subject to formula
derived rental increases, with rentals aggregating approximately $8.0 million
for the year ended December 31, 2002.
Competition from other hotels, motor hotels and inns, including facilities
owned by local interests and by national and international chains, is vigorous
in all areas in which Loews Hotels operates. The demand for hotel rooms in
many areas is seasonal and dependent on general and local economic conditions.
Loews Hotels properties also compete with facilities offering similar services
in locations other than those in which its hotels are located. Competition
among luxury hotels is based primarily on location and service. Competition
among resort and commercial hotels is based on price as well as location and
service. Because of the competitive nature of the industry, hotels must
continually make expenditures for updating, refurnishing and repairs and
maintenance, in order to prevent competitive obsolescence.
DIAMOND OFFSHORE DRILLING, INC.
Diamond Offshore Drilling Inc. ("Diamond Offshore"), is engaged, through its
subsidiaries, in the business of owning and operating drilling rigs that are
used primarily in the drilling of offshore oil and gas wells on a contract
basis for companies engaged in exploration and production of hydrocarbons.
Diamond Offshore operates 47 offshore rigs. Diamond Offshore accounted for
4.69%, 5.37% and 3.62% of the Company's consolidated total revenue for the
years ended December 31, 2002, 2001 and 2000, respectively.
Drilling Units and Equipment: Diamond Offshore currently owns and operates
47 mobile offshore drilling rigs (32 semisubmersible rigs, 14 jack-up rigs and
one drillship) and related equipment, including the March of 2003 acquisition
of a third generation semisubmersible drilling rig for $65.0 million. Offshore
rigs are mobile units that can be relocated via either self-propulsion or the
use of tugs enabling them to be repositioned based on market demand.
Semisubmersible rigs are supported by large pontoons and are partially
submerged during drilling for greater stability. They are generally designed
for water depths of up to 7,500 feet. Semisubmersibles are typically anchored
in position and remain stable for drilling in the semi-submerged floating
position due in part to their wave transparency characteristics at the water
line. Semisubmersibles can also be held in position through the use of a
computer controlled thruster (dynamic-positioning) system to maintain the
rig's position over a drillsite. Diamond Offshore has three such
semisubmersible rigs.
Diamond Offshore owns and operates eight high specification semisubmersible
rigs. These semisubmersibles are larger than many other semisubmersibles, are
capable of working in deep water or harsh environments, and have other
advanced features. Diamond Offshore's 32 semisubmersible rigs are currently
located as follows: 16 in the Gulf of Mexico, four in the North Sea and four
in Brazil, with the remaining rigs located in various foreign markets.
Diamond Offshore owns and operates 14 jack-up rigs. These rigs stand on the
ocean floor with their drilling platforms "jacked up" on support legs above
the water. They are used extensively for drilling in water depths from 20 feet
to 350 feet. Eleven of Diamond Offshore's jack-up rigs are cantilevered rigs
capable of over platform development drilling and workover as well as
exploratory drilling. Twelve of Diamond Offshore's jack-up rigs are currently
located in the Gulf of Mexico.
Diamond Offshore's drillship is self-propelled and designed to drill in deep
water. Shaped like a conventional vessel, it is the most mobile of the major
rig types. Diamond Offshore's drillship has dynamic-positioning capabilities
and is currently operating in Brazil.
Markets: Diamond Offshore's principal markets for its offshore contract
drilling services are the Gulf of Mexico, Europe, including principally the
U.K. and Norwegian sectors of the North Sea, South America, Africa, and
Australia/Southeast Asia. Diamond Offshore actively markets its rigs
worldwide.
20
Diamond Offshore contracts to provide offshore drilling services vary in
their terms and provisions. Diamond Offshore often obtains its contracts
through competitive bidding, although it is not unusual for Diamond Offshore
to be awarded drilling contracts without competitive bidding. Drilling
contracts generally provide for a basic drilling rate on a fixed dayrate basis
regardless of whether such drilling results in a productive well. Drilling
contracts may also provide for lower rates during periods when the rig is
being moved or when drilling operations are interrupted or restricted by
equipment breakdowns, adverse weather or water conditions or other conditions
beyond the control of Diamond Offshore. Under dayrate contracts, Diamond
Offshore generally pays the operating expenses of the rig, including wages and
the cost of incidental supplies. Dayrate contracts have historically accounted
for a substantial portion of Diamond Offshore's revenues. In addition, Diamond
Offshore has worked some of its rigs under dayrate contracts pursuant to which
the customer also agrees to pay Diamond Offshore an incentive bonus based upon
performance.
A dayrate drilling contract generally extends over a period of time covering
either the drilling of a single well, a group of wells (a "well-to-well
contract") or a stated term (a "term contract") and may be terminated by the
customer in the event the drilling unit is destroyed or lost or if drilling
operations are suspended for a specified period of time as a result of a
breakdown of equipment or, in some cases, due to other events beyond the
control of either party. In addition, certain of Diamond Offshore's contracts
permit the customer to terminate the contract early by giving notice and in
some circumstances may require the payment of an early termination fee by the
customer. The contract term in many instances may be extended by the customer
exercising options for the drilling of additional wells at fixed or mutually
agreed terms, including dayrates.
The duration of offshore drilling contracts is generally determined by
market demand and the respective management strategies of the offshore
drilling contractor and its customers. In periods of rising demand for
offshore rigs, contractors typically prefer well-to-well contracts that allow
contractors to profit from increasing dayrates. In contrast, during these
periods customers with reasonably definite drilling programs typically prefer
longer term contracts to maintain dayrate prices at a consistent level.
Conversely, in periods of decreasing demand for offshore rigs, contractors
generally prefer longer term contracts to preserve dayrates at existing levels
and ensure utilization, while customers prefer well-to-well contracts that
allow them to obtain the benefit of lower dayrates. If possible, Diamond
Offshore seeks to have a foundation of long-term contracts with a reasonable
balance of single-well, well-to-well and short-term contracts to minimize the
downside impact of a decline in the market while still participating in the
benefit of increasing dayrates in a rising market.
Customers: Diamond Offshore provides offshore drilling services to a
customer base that includes major and independent oil and gas companies and
government-owned oil companies. Several customers have accounted for 10.0% or
more of Diamond Offshore's annual consolidated revenues, although the specific
customers may vary from year to year. During 2002, Diamond Offshore performed
services for 46 different customers with BP, Petrobraspetroleo Brasileiro SA
("Petrobras") and Murphy Exploration and Production Company accounting for
20.5%, 17.4% and 10.4% of Diamond Offshore's annual total consolidated
revenues, respectively. During 2001, Diamond Offshore performed services for
44 different customers with BP and Petrobras accounting for 21.8% and 17.3% of
Diamond Offshore's annual total consolidated revenues, respectively. During
2000, Diamond Offshore performed services for approximately 48 different
customers with Petrobras and BP accounting for 24.6% and 20.3% of Diamond
Offshore's annual total consolidated revenues, respectively. During periods of
low demand for offshore drilling rigs, the loss of a single significant
customer could have a material adverse effect on Diamond Offshore's results of
operations.
Competition: The contract drilling industry is highly competitive and is
influenced by a number of factors, including the current and anticipated
prices of oil and natural gas, the expenditures by oil and gas companies for
exploration and development of oil and natural gas and the availability of
drilling rigs. In addition, demand for drilling services remains dependent on
a variety of political and economic factors beyond Diamond Offshore's control,
including worldwide demand for oil and natural gas, the ability of the
Organization of Petroleum Exporting Countries ("OPEC") to set and maintain
production levels and pricing, the level of production of non-OPEC countries
and the policies of the various governments regarding exploration and
development of their oil and natural gas reserves.
Customers often award contracts on a competitive bid basis, and although a
customer selecting a rig may consider, among other things, a contractor's
safety record, crew quality, rig location, and quality of service and
equipment, the historical oversupply of rigs has created an intensely
competitive market in which price is the primary factor in determining the
selection of a drilling contractor. In periods of increased drilling activity,
rig availability has, in some cases, also become a consideration, particularly
with respect to technologically advanced units. Diamond Offshore
21
believes that competition for drilling contracts will continue to be intense
in the foreseeable future. Contractors are also able to adjust localized
supply and demand imbalances by moving rigs from areas of low utilization and
dayrates to areas of greater activity and relatively higher dayrates. Such
movements, reactivations or a decrease in drilling activity in any major
market could depress dayrates and could adversely affect utilization of
Diamond Offshore's rigs.
Governmental Regulation: Diamond Offshore's operations are subject to
numerous federal, state and local laws and regulations that relate directly or
indirectly to its operations, including certain regulations controlling the
discharge of materials into the environment, requiring removal and clean-up
under certain circumstances, or otherwise relating to the protection of the
environment. For example, Diamond Offshore may be liable for damages and costs
incurred in connection with oil spills for which it is held responsible. Laws
and regulations protecting the environment have become increasingly stringent
in recent years and may, in certain circumstances, impose "strict liability"
rendering a company liable for environmental damage without regard to
negligence or fault on the part of such company. Liability under such laws and
regulations may result from either governmental or citizen prosecution. Such
laws and regulations may expose Diamond Offshore to liability for the conduct
of or conditions caused by others, or for acts of Diamond Offshore that were
in compliance with all applicable laws at the time such acts were performed.
The application of these requirements or the adoption of new requirements
could have a material adverse effect on Diamond Offshore.
The United States Oil Pollution Act of 1990 ("OPAk'90"), and similar
legislation enacted in Texas, Louisiana and other coastal states, addresses
oil spill prevention and control and significantly expands liability exposure
across all segments of the oil and gas industry. OPAk'90, such similar
legislation and related regulations impose a variety of obligations on Diamond
Offshore related to the prevention of oil spills and liability for damages
resulting from such spills. OPAk'90 imposes strict and, with limited
exceptions, joint and several liability upon each responsible party for oil
removal costs and a variety of public and private damages.
Indemnification and Insurance: Diamond Offshore's operations are subject to
hazards inherent in the drilling of oil and gas wells such as blowouts,
reservoir damage, loss of production, loss of well control, cratering or
fires, the occurrence of which could result in the suspension of drilling
operations, injury to or death of rig and other personnel and damage to or
destruction of Diamond Offshore's, Diamond Offshore's customers' or a third
party's property or equipment. Damage to the environment could also result
from Diamond Offshore's operations, particularly through oil spillage or
uncontrolled fires. In addition, offshore drilling operations are subject to
perils peculiar to marine operations, including capsizing, grounding,
collision and loss or damage from severe weather. Diamond Offshore has
insurance coverage and contractual indemnification for certain risks, but
there can be no assurance that such coverage or indemnification will
adequately cover Diamond Offshore's loss or liability in many circumstances or
that Diamond Offshore will continue to carry such insurance or receive such
indemnification.
In December of 2002, Diamond Offshore renewed its Hull and Machinery
insurance policy. Diamond Offshore's retention of liability for property
damage increased at the time of renewal from approximately $0.2 million per
incident to between $1.0 and $2.5 million per incident, depending on the value
of the equipment, with an aggregate annual deductible of $5.0 million. In
addition, Diamond Offshore retained 10% of its insured liability.
Operations Outside the United States: Operations outside the United States
accounted for approximately 55.5%, 37.3% and 45.4% of Diamond Offshore's total
consolidated revenues for the years ended December 31, 2002, 2001 and 2000,
respectively. Diamond Offshore's non-U.S. operations are subject to certain
political, economic and other uncertainties not encountered in U.S.
operations, including risks of war and civil disturbances (or other risks that
may limit or disrupt markets), expropriation and the general hazards
associated with the assertion of national sovereignty over certain areas in
which operations are conducted. No prediction can be made as to what
governmental regulations may be enacted in the future that could adversely
affect the international drilling industry. Diamond Offshore's operations
outside the United States may also face the additional risk of fluctuating
currency values, hard currency shortages, controls of currency exchange and
repatriation of income or capital.
Properties: Diamond Offshore owns an eight-story office building located in
Houston, Texas containing approximately 182,000 net rentable square feet,
which is used for its corporate headquarters. Diamond Offshore also owns an
18,000 square foot building and 20 acres of land in New Iberia, Louisiana for
its offshore drilling warehouse and storage facility, and a 13,000 square foot
building and five acres of land in Aberdeen, Scotland for its North Sea
operations. In addition, Diamond Offshore leases various office, warehouse and
storage facilities in Louisiana, Australia,
22
Brazil, Indonesia, Scotland, Vietnam, Singapore, the Netherlands, Norway and
New Zealand to support its offshore drilling operations.
BULOVA CORPORATION
Bulova Corporation ("Bulova") is engaged in the distribution and sale of
watches, clocks and timepiece parts for consumer use. Bulova accounted for
0.95%, 0.78% and 0.78% of the Company's consolidated total revenue for the
years ended December 31, 2002, 2001 and 2000, respectively.
Bulova's principal watch brands are Bulova, Caravelle, Wittnauer and
Accutron. Clocks are principally sold under the Bulova brand name. All watches
and clocks are purchased from foreign suppliers. Bulova's principal markets
are the United States, Canada and Mexico. In most other areas of the world
Bulova has appointed licensees who market watches under Bulova's trademarks in
return for a royalty. Bulova's product breakdown includes luxury watch lines
represented by Wittnauer and Accutron, a mid-priced watch line represented by
Bulova, and a lower-priced watch line represented by Caravelle. Bulova's
principal Far East license agreement expired at the end of 2001 and its
principal European license agreement expired at the end of 2002. In
anticipation of the expiration of the European license agreement, Bulova
established a Swiss subsidiary, Bulova Swiss SA, in the third quarter of 2002
to distribute product throughout Europe. Bulova Swiss SA began selling Bulova
products in Italy, Greece and the Netherlands during the first quarter of
2003. Bulova entered the grandfather clock market in the United States and
Canada with the purchase in July of 2002 of select assets of a grandfather
clock manufacturer and distributor of high quality grandfather clocks.
Properties: Bulova owns an 80,000 square foot facility in Woodside, New York
which it uses for executive and sales offices, watch distribution, service and
warehouse purposes and also owns a 91,000 square foot facility in Brooklyn,
New York, which it uses for clock service and warehouse purposes. Bulova also
owns 6,100 square feet of office space in Hong Kong which it uses for quality
control and sourcing purposes. Bulova leases an approximately 31,000 square
foot facility in Toronto, Canada, which it uses for watch and clock sales and
service; an approximately 27,000 square foot office and manufacturing facility
in Ontario, Canada which it uses for its grandfather clock operations;
approximately 5,400 square feet of office space in Mexico, Federal District,
and approximately 6,000 square feet of office space in Fribourg, Switzerland.
OTHER INTERESTS
A subsidiary of the Company, Majestic Shipping Corporation ("Majestic"),
owns a 49% common stock interest in Hellespont Shipping Corporation
("Hellespont"). Hellespont is engaged in the business of owning and operating
six ultra large crude oil tankers that are used primarily to transport crude
oil from the Persian Gulf to a limited number of ports in the Far East,
Northern Europe and the United States. A subsidiary of Hellespont has entered
into an agreement for the new building of an additional ultra large crude oil
tanker which is expected to be delivered in the second quarter of 2003. The
cost of this additional tanker is estimated to amount to approximately $93.0
million.
EMPLOYEE RELATIONS
The Company, inclusive of its operating subsidiaries as described below,
employed approximately 25,800 persons at December 31, 2002 and considers its
employee relations to be satisfactory.
Lorillard employed approximately 3,200 persons at December 31, 2002.
Approximately 1,200 of these employees are represented by labor unions covered
by three collective bargaining agreements.
Lorillard has collective bargaining agreements covering hourly rated
production and service employees at various Lorillard plants with the Bakery,
Confectionery, Tobacco Workers and Grain Millers International Union, and the
National Conference of Fireman and Oilers/SEIU. Lorillard has experienced
satisfactory labor relations and provides a retirement plan, a deferred profit
sharing plan, and other benefits for its hourly paid employees who are
represented by the foregoing unions. In addition, Lorillard provides to its
salaried employees a retirement plan, group life, disability and health
insurance program and a savings plan.
23
Loews Hotels employed approximately 2,500 persons at December 31, 2002,
approximately 1,100 of whom are union members covered under collective
bargaining agreements. Loews Hotels has experienced satisfactory labor
relations and provides comprehensive benefit plans for its hourly paid
employees.
The Company maintains a retirement plan, group life, disability and health
insurance program and a savings plan for salaried employees. Loews Hotels
salaried employees also participate in these benefit plans.
CNA employed approximately 15,500 full-time equivalent employees at December
31, 2002 and has experienced satisfactory labor relations. CNA and its
subsidiaries have comprehensive benefit plans for substantially all of their
employees, including retirement plans, savings plans, disability programs,
group life programs and group health care programs.
Diamond Offshore employed approximately 3,800 persons at December 31, 2002
including international crew personnel furnished through independent labor
contractors. Diamond Offshore has experienced satisfactory labor relations and
provides comprehensive benefit plans for its employees. Diamond Offshore does
not currently consider the possibility of a shortage of qualified personnel to
be material factor in its business.
Bulova and its subsidiaries employed approximately 560 persons at December
31, 2002, approximately 190 of whom are union members. Bulova and its
subsidiaries have experienced satisfactory labor relations. Bulova has
comprehensive benefit plans for substantially all employees.
AVAILABLE INFORMATION
The Company's website address is www.loews.com. The Company makes available,
-------------
free of charge, through its website its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended, as soon as reasonably practicable
after such reports are electronically filed with or furnished to the
Securities and Exchange Commission ("SEC"). The Company has made these reports
available in this manner since March of 2003. Prior to that time the Company
made such reports available at no charge upon request.
Item 2. Properties.
Information relating to the properties of Registrant and its subsidiaries is
contained under Item 1.
Item 3. Legal Proceedings.
1. Insurance Related. Information with respect to insurance related legal
-----------------
proceedings is incorporated by reference to Note 20, "Legal Proceedings -
Insurance Related" of the Notes to Consolidated Financial Statements included
in Item 8.
2. Tobacco Related. Approximately 4,500 product liability cases are pending
---------------
against cigarette manufacturers in the United States. Lorillard is a defendant
in approximately 4,075 of these cases. The Company is a defendant in fewer
than 35 of the pending cases. Information with respect to tobacco related
legal proceedings is incorporated by reference to Note 20, "Legal Proceedings
- - Tobacco Related" of the Notes to Consolidated Financial Statements included
in Item 8. Additional information regarding tobacco related legal proceedings
is contained below and in Exhibit 99.01.
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 1,600 cases are pending, including
approximately 1,185 cases against Lorillard. Included in this group are
approximately 1,100 cases pending in a single West Virginia court in which a
consolidated trial is scheduled. Lorillard is a defendant in approximately
1,000 of the 1,100 consolidated West Virginia cases. The Company is a
defendant in five of the conventional product liability cases and is not a
party to any of the consolidated West Virginia Cases.
24
"Class action cases" are purported to be brought on behalf of large numbers
of individuals for damages allegedly caused by smoking. Approximately 40 of
these cases are pending against Lorillard. The Company is a defendant in two
of the class action cases. An additional group of approximately 20 class
action cases are pending against other cigarette manufacturers and assert
claims on behalf of smokers of "light" cigarettes. In Price v. Philip Morris
USA, a "light" cigarette class action pending only against Philip Morris, an
Illinois judge issued a verdict during March of 2003 in favor of a class of
Illinois smokers and awarded $7.1 billion in actual damages to the class
members, $3.0 billion in punitive damages to the State of Illinois (which was
not a plaintiff in this matter), and approximately $1.8 billion in attorney's
fees and costs. Entry of judgment has been stayed. Press reports have quoted
Philip Morris officials as stating the company plans to appeal the verdict.
Reference is made to Exhibit 99.01 to this Report for a list of pending Class
Action Cases in which Lorillard is a party.
"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
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 suing on behalf
of taxpayers. Lorillard is a defendant in most of the approximately 40 pending
Reimbursement cases. The Company is a defendant in 26 of the pending
Reimbursement cases. Reference is made to Exhibit 99.01 to this Report for a
list of pending Reimbursement Cases in which Lorillard is a party.
"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 approximately 10 pending Contribution cases. The
Company is a defendant in one of the pending Contribution cases. Reference is
made to Exhibit 99.01 to this Report for a list of pending Contribution cases
in which Lorillard is a party.
"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 2,800 pending Flight Attendant cases. The Company is not a
defendant in any of the Flight Attendant cases.
Excluding the flight attendant and the consolidated West Virginia suits,
approximately 600 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 275 of the 600 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in fewer than 35 of the
actions.
Other tobacco-related litigation includes "Tobacco Related Anti-Trust
Cases." Reference is made to Exhibit 99.01 to this Report for a list of
pending Tobacco Related Anti-Trust Cases in which Lorillard is a party.
25
Item 4. Submission of Matters to a Vote of Security Holders.
None
EXECUTIVE OFFICERS OF THE REGISTRANT
First
Became
Name Position and Offices Held Age Officer
- ------------------------------------------------------------------------------
Gary W. Garson Senior Vice President, 56 1988
General Counsel and Secretary
Herbert C. Hofmann Senior Vice President 60 1979
Peter W. Keegan Senior Vice President 58 1997
and Chief Financial Officer
Arthur L. Rebell Senior Vice President 61 1998
and Chief Investment Officer
Andrew H. Tisch Office of the President 53 1985
and Chairman of the
Executive Committee
James S. Tisch Office of the President, 50 1981
President and Chief
Executive Officer
Jonathan M. Tisch Office of the President 49 1987
Laurence A. Tisch Co-Chairman of the Board 80 1959
Preston R. Tisch Co-Chairman of the Board 76 1960
Laurence A. Tisch and Preston R. Tisch are brothers. Andrew H. Tisch and
James S. Tisch are sons of Laurence A. Tisch and Jonathan M. Tisch is a son of
Preston R. Tisch. None of the other officers or directors of Registrant is
related to any other.
All executive officers of Registrant, except Arthur L. Rebell, have been
engaged actively and continuously in the business of Registrant for more than
the past five years. Arthur L. Rebell has been a senior vice president of the
Company since June of 1998. Prior to joining Loews, during 1997 and 1998 he
was an associate professor of Mergers and Acquisitions at New York University,
a Managing Director of Highview Capital and a Partner in Strategic Investors.
Officers are elected and hold office until their successors are elected and
qualified, and are subject to removal by the Board of Directors.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
Price Range of Common Stock
Loews common stock
Loews Corporation's common stock is listed on the New York Stock Exchange.
The following table sets forth the reported high and low sales prices in each
calendar quarter of 2002 and 2001:
2002 2001
--------------------------------------
High Low High Low
- ------------------------------------------------------------------------------
First Quarter $ 62.10 $ 53.95 $ 59.95 $ 44.00
Second Quarter 62.30 52.00 72.50 56.51
Third Quarter 53.89 40.67 63.82 41.05
Fourth Quarter 45.62 37.50 58.00 44.55
26
Carolina Group stock
Carolina Group stock is listed on the New York Stock Exchange and trading of
the stock started on February 1, 2002. The following table sets forth the
reported high and low sales prices in each calendar quarter of 2002:
High Low
- ------------------------------------------------------------------------------
First Quarter $ 30.05 $ 27.70
Second Quarter 33.59 25.85
Third Quarter 27.25 17.35
Fourth Quarter 21.20 16.41
Dividend Information
The Company has paid quarterly cash dividends on Loews common stock in each
year since 1967. Regular dividends of $0.13 per share of Loews common stock
were paid in the first calendar quarter of 2001. The Company increased its
dividend to $0.15 per share beginning in the second quarter of 2001.
The Company has paid a quarterly cash dividend on Carolina Group stock of
$0.445 per share beginning in the second quarter of 2002.
Approximate Number of Equity Security Holders
The Company has approximately 2,035 holders of record of Loews common stock
and 40 holders of record of Carolina Group stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides certain information as of December 31, 2002
with respect to the Company's equity compensation plans under which equity
securities of the Company are authorized for issuance.
Number of
Number of securities remaining
Securities to Weighted for future issuance
be issued upon average under equity
exercise of exercise price compensation plans
outstanding of outstanding (excluding securities
options, warrants options, warrants reflected in the first
and rights and rights column)
- ------------------------------------------------------------------------------------------------
Loews Common Stock:
Equity compensation
plans approved by
security holders (a) 827,000 $46.535 1,147,600
Carolina Group Stock:
Equity compensation
plans approved by
security holders (c) 195,000 $28.000 1,305,000
Equity compensation
plans not approved
by security holders (b) N/A N/A N/A
- ------------
(a) Consists of the Loews Corporation 2000 Stock Option Plan.
(b) The Company has no equity compensation plan that has not been authorized
by its stockholders.
(c) Consists of the Carolina Group 2002 Stock Option Plan.
27
Item 6. Selected Financial Data.
Year Ended December 31 2002 2001* 2000* 1999* 1998*
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Results of Operations:
Revenues $17,495.4 $18,769.6 $20,684.1 $20,890.4 $20,988.2
Income (loss) before taxes
and minority interest $ 1,647.1 $ (822.2) $ 3,151.1 $ 876.5 $ 993.7
Income (loss) from continuing
operations $ 982.6 $ (543.2) $ 1,844.1 $ 482.0 $ 418.5
Discontinued operations - net (31.0) 9.4 4.5 3.2 0.2
Cumulative effect of changes in
accounting principles-net (39.6) (53.3) (157.9)
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6 $ 327.3 $ 418.7
================================================================================================
Income (loss) attributable to:
Loews common stock:
Income (loss) from continuing
operations $ 841.9 $ (543.2) $ 1,844.1 $ 482.0 $ 418.5
Discontinued operations-net (31.0) 9.4 4.5 3.2 0.2
Cumulative effect of changes
in accounting principles-net (39.6) (53.3) (157.9)
- ------------------------------------------------------------------------------------------------
Loews common stock 771.3 (587.1) 1,848.6 327.3 418.7
Carolina Group stock 140.7
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6 $ 327.3 $ 418.7
================================================================================================
Income (Loss) Per Share:
Loews common stock:
Income (loss) from continuing
operations $ 4.49 $ (2.79) $ 9.28 $ 2.22 $ 1.83
Discontinued operations - net (0.17) 0.05 0.02 0.01
Cumulative effect of changes
in accounting principles-net (0.21) (0.27) (0.73)
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 4.11 $ (3.01) $ 9.30 $ 1.50 $ 1.83
================================================================================================
Carolina Group stock $ 3.50
================================================================================================
Financial Position:
Investments $40,136.7 $41,159.1 $41,332.7 $42,008.0 $44,356.6
Total assets 70,519.6 75,006.6 71,594.8 70,635.1 72,477.0
Long-term debt 5,651.9 5,920.3 6,040.0 5,706.3 5,966.7
Shareholders' equity 11,235.2 9,429.3 10,969.1 9,783.8 10,043.2
Cash dividends per share:
Loews common stock 0.60 0.58 0.50 0.50 0.50
Carolina Group stock 1.34
Book value per share of
Loews common stock 61.68 49.24 55.62 46.82 44.60
Shares outstanding:
Loews common stock 185.44 191.49 197.23 208.96 225.16
Carolina Group stock 39.91
- ------------------------------------------------------------------------------------------------
* Restated to reflect an adjustment to the Company's historical accounting for
CNA's investment in life settlement contracts and the related revenue
recognition. See Notes 1 and 23 of the Notes to Consolidated Financial
Statements included in Item 8.
28
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
OVERVIEW
Consolidated net income (including both the Loews Group and Carolina Group)
for the year ended December 31, 2002, was $912.0 million, compared to a net
loss of $587.1 million in 2001. The 2001 results include a restatement of
previously reported financial results related to the life settlement business
of CNA, as described below.
Net income for 2002 included a loss from discontinued operations at CNA of
$31.0 million or $0.17 per share of Loews common stock, compared to income
from discontinued operations of $9.4 million or $0.05 per share of Loews
common stock in the comparable period of the prior year. Results for 2002 also
included a charge for accounting changes of $39.6 million or $0.21 per share
of Loews common stock, related to accounting for goodwill and other intangible
assets, compared to a charge of $53.3 million or $0.27 per share of Loews
common stock in the comparable period of the prior year, related to accounting
for derivative instruments at CNA.
Consolidated net operating income for the year ended December 31, 2002,
which excludes net investment gains (losses), discontinued operations and the
effects of accounting changes, was $1,099.3 million, compared to a loss of
$1,333.1 million in the comparable period of the prior year.
Net operating income (loss) is calculated by deducting net investment gains
or losses, discontinued operations and the cumulative effect of a change in
accounting principle (after deduction of related income taxes and minority
interests), from net income (loss). Analysts following the Company's stock
have advised the Company that such information is meaningful in assisting them
in measuring the performance of its insurance subsidiaries. In addition, it is
used in management's discussion of the results of operations for the insurance
related segments due to the significance of the amount of net investment gains
or losses. Net operating income (losses) is also a common measure throughout
the insurance industry. Net realized investment gains (losses) are excluded
from this operating measure because investment gains or losses related to
CNA's available-for-sale investment portfolio are largely discretionary, are
generally driven by economic factors that are not necessarily consistent with
key drivers of underwriting performance, and are therefore not an indication
of trends in operations.
Net operating income attributable to Loews common stock for the year ended
December 31, 2002, which excludes net investment (losses) gains, discontinued
operations and the effects of accounting changes, was $963.9 million, compared
to a loss of $1,333.1 million in the comparable period of the prior year.
Net income attributable to Carolina Group stock for the year ended December
31, 2002 was $140.7 million or $3.50 per share.
Consolidated net income for the quarter ended December 31, 2002 was $261.3
million, compared to $191.0 million in 2001. Consolidated net operating income
for the 2002 fourth quarter, which excludes net investment losses and
discontinued operations, was $285.0 million, compared to a net operating loss
of $47.2 million in the fourth quarter of 2001.
Net income attributable to Loews common stock for the 2002 fourth quarter
was $224.4 million or $1.21 per share, compared to $191.0 million or $0.99 per
share in the comparable period of the prior year. Net income in the 2002
fourth quarter includes net investment losses attributable to Loews common
stock of $24.2 million, compared to gains of $235.5 million in the comparable
period of the prior year.
Net operating income attributable to Loews common stock for the 2002 fourth
quarter, which excludes net investment losses and discontinued operations, was
$248.6 million, compared to a net operating loss of $47.2 million in the
comparable period of the prior year.
Net income attributable to Carolina Group Stock for the 2002 fourth quarter
was $36.9 million or $0.92 per share.
29
CNA's Life Settlement Contract Accounting
As a result of a routine review of CNA's periodic filings by the Division of
Corporation Finance of the Securities and Exchange Commission ("SEC"), the
Company has restated its financial statements as of and for the years ended
December 31, 2001 and 2000 as well as its interim financial statements for the
first three quarters of 2002 and all interim periods of 2001. The restated
financial statements reflect an adjustment to the Company's historical
accounting for CNA's investment in life settlement contracts and the related
revenue recognition.
CNA's historical accounting was to record an asset for the amount paid to
acquire the life settlement contract along with other direct acquisition
costs, and to recognize revenue over the period the contract was held. The SEC
concluded that the Financial Accounting Standards Board ("FASB") Technical
Bulletin ("FTB") 85-4 "Accounting for Purchases of Life Insurance" should have
been applied to CNA's investment in life settlement contracts. Under FTB 85-4,
the carrying value of each contract at purchase and at the end of each
reporting period is equal to the cash surrender value of the policy. Amounts
paid to purchase these contracts that are in excess of the cash surrender
value, at the date of purchase, are expensed immediately. Periodic maintenance
costs, such as premiums, necessary to keep the underlying policy in-force are
expensed as incurred and included in other operating expense. Revenue is
recognized and included in other revenue in the Consolidated Statements of
Operations when the life insurance policy underlying the life settlement
contract matures.
The adjustment related to life settlement contracts increased (decreased)
previously reported results of operations by $2.0 and $(28.1) million for the
years ended December 31, 2001 and 2000, respectively. Additionally, the
Consolidated Statements of Shareholders' Equity reflects a decrease in
earnings retained in the business of $193.9 million as of January 1, 2000.
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 ($2.4
billion outstanding at December 31, 2002), 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 December 31, 2002, the outstanding Carolina Group Stock represents a
23.01% economic interest in the economic performance of the Carolina Group.
The Loews Group consists of all the Company's assets and liabilities other
than the 23.01% 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, revenue, 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.
30
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
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 (see Liquidity and Capital Resources -CNA,
below), 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.
At December 31, 2002, the book value per share of Loews Common Stock was
$61.68, compared to $49.24 at December 31, 2001. The increase in book value
per share of Loews Common Stock is primarily due to proceeds from the issuance
of the Carolina Group Stock in February 2002 and the net economic interest
attributable to the Loews Common Stock in the notional intergroup debt
receivable from the Carolina Group, net income for 2002 and an increase in the
Company's unrealized gains on available-for-sale investments.
CRITICAL ACCOUNTING ESTIMATES
The preparation of 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 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 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 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. The inherent risks associated with the reserving process
are discussed below, in Reserves - Estimates and Uncertainties. Additionally,
a review of Results of Operations for CNA's segment results, Environmental
Pollution and Mass Tort and Asbestos Reserves and Second Quarter 2001 Reserve
Strengthening sections that follow is necessary to understand the sensitivity
of management's estimate.
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 a receivable in the Consolidated Balance Sheets.
The cost of reinsurance related to long-duration contracts is accounted for
over the life of the underlying reinsured policies using assumptions
consistent with those used to account for the underlying policies. The ceding
of insurance does not discharge the primary liability of CNA. An estimated
allowance for doubtful accounts is recorded on the basis of
31
periodic evaluations of balances due from reinsurers, reinsurer solvency,
management's experience and current economic conditions. Further information
on reinsurance is provided in the Reinsurance section that follows.
Tobacco 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.
On July 14, 2000, the jury in Engle v. R.J. Reynolds Tobacco Co., et al.
awarded a total of $145.0 billion in punitive damages against all defendants,
including $16.3 billion against Lorillard. The judgment also provides that the
jury's awards bear interest at the rate of 10% per year. Lorillard remains of
the view that the Engle case should not have been certified as a class action.
Lorillard believes that class certification in the Engle case is inconsistent
with the majority of federal and state court decisions which have held that
mass smoking and health claims are inappropriate for class treatment.
Lorillard has challenged the class certification, as well as numerous other
legal errors that it believes occurred during the trial. The Florida Third
District Court of Appeal heard argument in defendants' appeal on November 6,
2002. The Court of Appeal took the appeal under advisement. The Company and
Lorillard believe that an appeal of these issues on the merits should prevail.
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.
Except for the impact of the State Settlement Agreements as described in
Note 20 of the Notes to Consolidated Financial Statements included in Item 8
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 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 affected by an unfavorable outcome of certain
pending litigation.
Valuation of Investments and Impairment of Securities
The Company classifies its holdings of fixed maturity securities (bonds and
redeemable preferred stocks) and equity securities, which are held principally
by insurance subsidiaries, as available-for-sale, and are carried at fair
value. Changes in fair value are recorded as a component of accumulated other
comprehensive income in shareholders' equity, net of applicable deferred
income taxes and participating policyholders' and minority interest. The
amortized cost of fixed maturity securities is adjusted for amortization of
premiums and accretion of discounts to maturity, which are included in
investment income.
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 period in which the
determination occurred. See "Investments - CNA" and Note 2 of the Notes to
Consolidated Financial Statements included in Item 8 for information related
to the Company's impairment charges.
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 Statements of Operations.
32
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
CNA
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is a 90% owned subsidiary of the Company.
CNA conducts its operations through five operating groups: Standard Lines,
Specialty Lines and CNA Re (these groups comprise the Company's property and
casualty segment); Group Operations and Life Operations. In addition to these
five operating segments, certain other activities are reported in the Other
Insurance segment. The Other Insurance segment consists of losses and expenses
related to centralized adjusting and settlement of asbestos, pollution and
mass tort claims ("APMT"), certain run-off insurance operations, interest
expense on corporate debt, e-Business initiatives, and intercompany
eliminations. These segments reflect the way CNA manages its operations and
makes business decisions.
Run-off insurance operations consist of personal insurance, entertainment
insurance, agriculture insurance, group reinsurance and other financial lines
as well as the direct financial guarantee business underwritten by CNA's
insurance affiliates and other insurance run-off operations. Run-off insurance
operations also include assumed business underwritten through a managing
general agent, IOA Global, which consists primarily of certain accident and
health coverages ("IGI Program").
During 2002, CNA underwent management changes and strategic realignment.
These events have changed the way CNA manages its operations and makes
business decisions and, therefore, necessitated a change in CNA's reportable
segments.
CNA Trust, a limited-operations bank specializing in 401(k) plan
administration, and Institutional Markets, which provides guaranteed return
investment products for qualified and non-qualified institutional buyers, was
transferred from Life Operations to Group Operations. Group Reinsurance, the
business which assumes reinsurance from unaffiliated entities on group life,
accident and health products and excess medical risk coverages for self-funded
employers, was transferred from Group Operations to Other Insurance to be
included as part of run-off insurance operations. The Environmental Pollution
and Mass Tort and Asbestos ("APMT") Reserves related to assumed reinsurance,
along with the assumed business underwritten through a managing general agent,
IOA Global, which consists primarily of certain accident and health coverages,
was transferred from CNA Re to Other Insurance. The U.S. zone of Global
business, which primarily offers international insurance to U.S. based
corporations and U.S. insurance to foreign corporations, was transferred from
Specialty Lines to Standard Lines.
The consolidated operations for the year ended December 31, 2001 were
significantly impacted by the second quarter 2001 prior year reserve
strengthening, WTC event, and restructuring and other related charges. A
discussion of these items, along with CNA's current terrorism exposure and
description of reserves is presented below.
World Trade Center Event
During the third quarter of 2001, CNA recorded estimated incurred losses of
$468.0 million pretax, net of reinsurance, related to the World Trade Center
disaster and related events ("WTC event"). The loss estimate was based on a
total industry loss of $50.0 billion and included all lines of insurance. This
estimate took into account CNA's substantial reinsurance agreements, including
its catastrophe reinsurance program and corporate reinsurance programs. CNA
has closely monitored reported losses as well as the collection of reinsurance
on WTC event claims. As of December 31, 2002, CNA believes its recorded
reserves, net of reinsurance, for the WTC event are adequate.
33
The following table provides management's estimate of losses related to the
WTC event on a gross basis (before reinsurance) and a net basis (after
reinsurance) on CNA's operating segments:
Pretax Net of
Pretax Aggregate Total Tax and
Gross Net Reinsurance Pretax Minority
Year Ended December 31, 2001 Losses Impact (a) Benefit Impact Interest
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 375.0 $ 185.0 $ 108.0 $ 77.0 $ 44.0
Specialty Lines 214.0 30.0 12.0 18.0 11.0
CNA Re 662.0 410.0 139.0 271.0 154.0
- ------------------------------------------------------------------------------------------------
Total Property and Casualty 1,251.0 625.0 259.0 366.0 209.0
Group Operations 235.0 53.0 53.0 31.0
Life Operations 75.0 22.0 22.0 12.0
Other Insurance 87.0 27.0 27.0 15.0
- ------------------------------------------------------------------------------------------------
Total $1,648.0 $ 727.0 $ 259.0 $ 468.0 $ 267.0
================================================================================================
(a) Pretax impact of the WTC event before the corporate aggregate reinsurance
treaties. The pretax net impact includes $85.0 of reinstatement and additional
premiums.
Second Quarter 2001 Prior Year Reserve Strengthening
During the second quarter of 2001, CNA noted the continued emergence of
adverse loss experience across several lines of business related to prior
years, which are discussed in further detail below. CNA completed a number of
reserve studies during the second quarter of 2001 for many of its lines of
business, including those in which these adverse trends were noted.
The second quarter 2001 prior year reserve strengthening and related items
comprising the amounts noted above are detailed by segment in the following
table:
Standard Specialty Other
Year Ended December 31, 2001 Lines Lines CNA Re Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Net reserve strengthening excluding
the impact of the corporate
aggregate reinsurance treaty:
APMT $1,197.0 $1,197.0
Non-APMT $ 523.0 $ 407.0 $ 571.0 93.0 1,594.0
- ------------------------------------------------------------------------------------------------
Total 523.0 407.0 571.0 1,290.0 2,791.0
Pretax benefit from corporate
aggregate reinsurance treaty
on accident year 1999 (197.0) (26.0) (223.0)*
Accrual for insurance-related
assessments 48.0 48.0
- ------------------------------------------------------------------------------------------------
Net reserve strengthening
and related accruals 374.0 407.0 545.0 1,290.0 2,616.0
- ------------------------------------------------------------------------------------------------
Change in estimate of premium
accruals 632.0 (13.0) (3.0) 616.0
Reduction of related commission
accruals (50.0) (50.0)
- ------------------------------------------------------------------------------------------------
Net premium and related accrual
reductions 582.0 (13.0) (3.0) 566.0
- ------------------------------------------------------------------------------------------------
Total pretax second quarter
2001 reserve strengthening
and other related accruals $ 956.0 $ 407.0 $ 532.0 $1,287.0 $3,182.0
================================================================================================
Total after tax and minority
interest second quarter 2001
reserve strengthening and other
related accruals $ 540.0 $ 239.0 $ 301.0 $ 729.0 $1,809.0
================================================================================================
* $500.0 of ceded losses reduced by $230.0 of ceded premiums and $47.0 of
interest charges.
34
With respect to environmental and mass tort reserves, commencing in 2000 and
continuing into the first and second quarters of 2001, CNA received a number
of new reported claims, some of which involved declaratory judgment actions
premised on court decisions purporting to expand insurance coverage for
pollution claims. In these decisions, several courts adopted rules of
insurance policy interpretation which established joint and several liability
for insurers consecutively on a risk during a period of alleged property
damage; and in other instances adopted interpretations of the "absolute
pollution exclusion," which weakened its effectiveness in most circumstances.
In addition to receiving new claims and declaratory judgment actions premised
upon these unfavorable legal precedents, these court decisions also impacted
CNA's pending pollution and mass tort claims and coverage litigation. During
the spring of 2001, CNA reviewed specific claims and litigation, as well as
general trends, and concluded reserve strengthening in this area was
necessary.
In the area of mass torts, several well-publicized verdicts arising out of
bodily injury cases related to allegedly toxic mold led to a significant
increase in mold-related claims in 2000 and the first half of 2001. CNA's
reserve increase in the second quarter of 2001 was caused in part by this
increased area of exposure.
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.
Throughout 2000 and into 2001, CNA experienced significant increases in new
asbestos bodily injury claims. In light of this development, CNA formed the
view that payments for asbestos claims could be higher in future years than
previously estimated. Moreover, in late 2000 through mid-2001, industry
sources such as rating agencies and actuarial firms released analyses and
studies commenting on the increase in claim volumes and other asbestos
liability developments. For example, A.M. Best Company ("A.M. Best") released
a study in May 2001 increasing its ultimate asbestos reserve estimate 62.5%
from $40.0 to $65.0 billion, citing an unfunded insurance industry reserve
shortfall of $33.0 billion. In June 2001, Tillinghast raised its asbestos
ultimate exposure from $55.0 to $65.0 billion for the insurance industry and
its estimate of the ultimate/remaining asbestos liability for all industries
was raised to $200.0 billion.
Also in the 2000 to 2001 time period, a number of significant asbestos
defendants filed for bankruptcy, increasing the likelihood that excess layers
of insurance coverage could be called upon to indemnify policyholders and
creating the potential that novel legal doctrines could be employed, which
could accelerate the time when such indemnification payments could be due.
These developments led CNA to the conclusion that its asbestos reserves
required strengthening.
The non-APMT adverse reserve development in 2001 was the result of analyses
of several lines of business. This development related principally to
commercial insurance coverages including automobile liability and multiple-
peril, as well as assumed reinsurance and healthcare-related coverages. A
brief summary of these lines of business and the associated reserve
development is discussed below.
Approximately $600.0 million of the adverse loss development was a result of
several coverages provided to commercial entities. The gross and net carried
claim and claim adjustment expense reserves for Standard Lines at the
beginning of 2001 was $12,070.0 and $9,129.0 million. Reserve analyses
performed during 2001 showed unexpected increases in the size of claims for
several lines, including commercial automobile liability, general liability
and the liability portion of commercial multiple-peril coverages. In addition,
the number of commercial automobile liability claims was higher than expected
and several state-specific factors resulted in higher than anticipated losses,
including developments associated with commercial automobile liability
coverage in Ohio and general liability coverage provided to contractors in New
York. The unfavorable development was driven principally by accident years
1997 through 2000.
35
The remaining development affecting years prior to 1997 was driven principally
by construction defect claims as described below.
The commercial automobile liability analysis indicated increased ultimate
claim and claim adjustment expense across several accident years due to higher
paid and reported claim and claim adjustment expense resulting from several
factors. These factors include uninsured/underinsured motorists coverage in
Ohio, a change in the rate at which the average claim size was increasing and
a lack of improvement in the ratio of the number of claims per exposure unit,
the frequency. First, Ohio courts had significantly broadened the population
covered through the uninsured/underinsured motorists' coverage. The broadening
of the population covered by this portion of the policy, and the retrospective
nature of this broadening of coverage, resulted in additional claims for older
years. Second, in recent years, the average claim size had been increasing at
less than a 2.0% annual rate. The available data indicated that the rate of
increase was closer to 8.0% with only a portion of this increase explainable
by a change in mix of business. Finally, the review completed during the
second quarter of 2001 indicated that the frequency for the 2000 accident year
was 6.0% higher than 1999. Expectations were that the 2000 frequency would
show an improvement from the 1999 level.
The analyses of general liability and the liability portion of commercial
multiple-peril coverages showed several factors affecting these lines.
Construction defect claims in California and a limited number of other states
have had a significant impact. It was expected that the number of claims being
reported and the average size of those claims would fall quickly due to the
decrease in business exposed to those losses. However, the number of claims
reported during the first six months of 2001 increased from the number of
claims reported during the last six months of 2000. In addition to the effects
of construction defect claims, the average claim associated with New York
labor law has risen to more than $125,000 from less than $100,000, which was
significantly greater than previously expected.
An analysis of assumed reinsurance business written by CNA Re showed that
the paid and reported losses for recent accident years were higher than
expectations, which resulted in management recording net unfavorable
development on prior year loss reserves of approximately $560.0 million. The
gross and net claim and claim adjustment expense reserves at the beginning of
2001 for CNA Re was $4,238.0 and $2,735.0 million. Because of the long and
variable reporting pattern associated with assumed reinsurance as well as
uncertainty regarding possible changes in the reporting methods of the ceding
companies, the carried reserves for assumed reinsurance was based mainly on
the pricing assumptions until experience emerges to show that the pricing
assumptions are no longer valid. The reviews completed during the second
quarter of 2001, including analysis at the individual treaty level, showed
that the pricing assumptions were no longer appropriate. The classes of
business with the most significant changes included excess of loss liability,
professional liability and proportional and retrocessional property. The
unfavorable reserve development was driven principally by accident years 1996
through 2000.
Approximately $320.0 million of adverse loss development was due to adverse
experience in all other lines, primarily in coverages provided to healthcare-
related entities written by CNA HealthPro. The gross and net claim and claim
adjustment expense reserves at the beginning of 2001 for Specialty Lines was
approximately $4,813.0 and $3,429.0 million. The level of paid and reported
losses associated with coverages provided to national long-term care
facilities were higher than expected. The long-term care facility business had
traditionally been limited to local facilities. In recent years, CNA began to
provide coverage to large chains of long-term care facilities. Original
assumptions were that these chains would exhibit loss ratios similar to the
local facilities. The most recent review of these large chains indicated an
overall loss ratio in excess of 500.0% versus approximately 100.0% for the
remaining business. In addition, the average size of claims resulting from
coverages provided to physicians and institutions providing healthcare related
services increased more than expected. The review indicated that the average
loss had increased to over $330,000. Prior to this review, the expectation for
the average loss was approximately $250,000. Unfavorable reserve development
of $240.0 million was recorded for accident years 1997 through 2000. The
remaining unfavorable reserve development was attributable to accident years
prior to 1997.
Concurrent with CNA's review of loss reserves, CNA completed comprehensive
studies of estimated premium receivable accruals on retrospectively rated
insurance policies and involuntary market facilities. These studies included
ground-up reviews of retrospective premium accruals utilizing a more
comprehensive database of retrospectively rated contracts. This review
included application of the policy retrospective rating parameters to the
revised estimate of ultimate loss ratio and consideration of actual interim
cash settlement. This study resulted in a change in the estimated
retrospective premiums receivable balances.
36
As a result of this review and changes in premiums associated with the
change in estimates for loss reserves, CNA recorded a pretax reduction in
premium accruals of $566.0 million. The effect on net earned premiums was
$616.0 million offset by a reduction of accrued commissions of $50.0 million.
The studies included the review of all such retrospectively rated insurance
policies and the estimate of ultimate losses.
Approximately $188.0 million of this amount resulted from a change in
estimate in premiums related to involuntary market facilities, which had an
offsetting impact on net losses and therefore had no impact on the net
operating results. More than one-half of the change in estimate in premiums
was attributable to accident years 1997 through 1999 with the remainder
attributable to years prior to 1992. Accruals for ceded premiums related to
other reinsurance treaties increased $83.0 million due to the reserve
strengthening. This increase in accruals for ceded premiums were principally
recorded in accident year 2000. The remainder of the decrease in premium
accruals relates to the change in estimate of the amount of retrospective
premium receivables as discussed above, which were principally recorded in
accident years prior to 1999.
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. Reinsurance coverages are tailored to the specific
risk characteristics of each product line and CNA's retained amount varies by
type of coverage. Generally, property risks are reinsured on an excess of
loss, per risk basis. Liability coverages are generally reinsured on a quota
share basis in excess of CNA's retained risk. CNA's ceded life reinsurance
includes utilization of coinsurance, yearly renewable term and facultative
programs. A majority of the reinsurance utilized by CNA's life insurance
operations relates to term life insurance policies. Term life insurance
policies issued from 1994 onward are generally ceded at 60%-90% of the face
value. Universal Life policies issued from 1998 onward are generally ceded at
75% of the face value.
CNA's overall reinsurance program includes certain property and casualty
contracts, such as the corporate aggregate reinsurance treaties discussed in
more detail later in this section, that are entered into and accounted for on
a "funds withheld" basis. Under the funds withheld basis, CNA records the cash
remitted to the reinsurer for the reinsurer's margin, or cost of the
reinsurance contract, as ceded premiums. The remainder of the premiums ceded
under the reinsurance contract is recorded as funds withheld liabilities. CNA
is required to increase the funds withheld balance at stated interest
crediting rates applied to the funds withheld balance or as otherwise
specified under the terms of the contract. The funds withheld liability is
reduced by any cumulative claim payments made by CNA in excess of CNA's
retention under the reinsurance contract. If the funds withheld liability is
exhausted, interest crediting will cease and additional claim payments are
recoverable from the reinsurer. The funds withheld liability is recorded in
reinsurance balances payable in the Consolidated Balance Sheets.
Interest cost on these contracts is credited during all periods in which a
funds withheld liability exists. Interest cost, which is included in
investment income, net was $239.6, $241.4 and $86.9 million in 2002, 2001 and
2000. The amount subject to interest crediting rates on such contracts was
$2,766.0 and $2,724.0 million at December 31, 2002 and 2001.
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 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.
Amounts receivable from reinsurers were $12,695.3 and $13,823.4 million at
December 31, 2002 and 2001. Of these amounts, $957.0 and $838.0 million were
billed to reinsurers as of December 31, 2002 and 2001, as reinsurance
contracts generally require payment of claims by the ceding company before the
amount can be billed to the reinsurer. The remaining receivable relates to the
estimated case and incurred but not reported losses ("IBNR") reserves and
future policyholder benefits ceded under reinsurance contracts.
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
37
methods of obtaining collateral are through reinsurance trusts, letters of
credit and funds withheld balances. Such collateral was approximately $4,825.0
and $3,696.0 million at December 31, 2002 and 2001.
CNA's largest recoverables from a single reinsurer at December 31, 2002,
including prepaid reinsurance premiums, were approximately $2,090.0, $1,456.0,
$890.0, $616.0, $598.0, and $541.0 million from subsidiaries of Allstate,
subsidiaries of Hannover Reinsurance (Ireland) Ltd., American Reinsurance
Company, European Reinsurance Company of Zurich, subsidiaries of Gerling
Global Reinsurance Corporation, and Lloyd's Underwriters.
CNA has reinsurance receivables from several reinsurers who have recently
experienced multiple downgrades of their financial strength ratings, have
announced that they will no longer accept new business and are placing their
books of business into run-off. CNA's principal credit exposures from these
recent events arise from reinsurance receivables from Gerling Global
("Gerling"), Trenwick and Commercial Risk insurance groups. At December 31,
2002, CNA had approximately $926.0 million of reinsurance receivables from
these reinsurers, of which $384.0 million was not supported by collateral. The
majority of the uncollateralized receivables were due from U.S.-domiciled
insurers. Of the $384.0 million of reinsurance recoverables unsupported by
collateral, $170.0 million relates to Gerling. Gerling has stated that CNA
transfer approximately $204.0 million of funds withheld balances on three
treaties relating to CNA HealthPro to a trust established by Gerling for the
benefit of CNA, or in the absence of such transfer, that these treaties be
commuted. CNA has taken Gerling's statement under advisement.
In certain circumstances, including significant deterioration of a
reinsurer's financial strength ratings, CNA may engage in commutation
discussions with an individual reinsurer. 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, including any related to Gerling, could have an adverse material
impact on the Company's results of operations or equity.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The allowance for doubtful
accounts was $195.7 and $170.0 million at December 31, 2002 and 2001. While
CNA believes the allowance for doubtful accounts is adequate based on current
collateral and information currently available, failure of reinsurers to meet
their obligations could have a material adverse impact on the Company's
results of operations or equity.
For 2002, CNA entered into a corporate aggregate reinsurance treaty covering
substantially all of CNA's property and casualty lines of business (the "2002
Cover"). Ceded premium related to the reinsurer's margin of $10.0 million was
recorded in 2002. No losses were ceded during 2002 under this contract, and
the 2002 Cover was commuted as of December 31, 2002.
In 1999, CNA entered into an aggregate reinsurance treaty related to the
1999 through 2001 accident years covering substantially all of CNA's property
and casualty lines of business (the "Aggregate Cover"). CNA has two sections
of coverage under the terms of the Aggregate Cover. 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 contract, has annual limits of $500.0 million of ceded losses with an
aggregate limit of $1.0 billion of ceded losses for the three year period. The
ceded premiums 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 was only utilized for 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. If the aggregate loss ratio for
the three-year period exceeds certain thresholds, additional premiums may be
payable and the rate at which interest charges are accrued would increase to
8.25% per annum commencing in 2006.
The coverage under the second section of the Aggregate Cover was triggered
for the 2001 accident year. As a result of losses related to the WTC event,
the limit under this section was exhausted. Additionally, as a result of the
significant reserve additions recorded in the second quarter of 2001, the
$500.0 million limit on the 1999 accident year under the first section was
also fully utilized. No losses have been ceded to the remaining $500.0 million
of aggregate limit on accident years 2000 and 2001 under the first section of
the Aggregate Cover.
38
The impact of the Aggregate Cover on pretax operating results was as
follows:
Year Ended December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions)
Ceded earned premium $ (543.0)
Ceded claim and claim adjustment expenses 1,010.0
Interest charges $(51.0) (81.0)
- ------------------------------------------------------------------------------
Pretax (expense) benefit on operating results $(51.0) $ 386.0
==============================================================================
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 $760.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $760.0 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. Losses of $618.0
million have been ceded under the CCC Cover through December 31, 2002.
The impact of the CCC Cover on pretax operating results was as follows:
Year Ended December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $(101.0) $ (260.0)
Ceded claim and claim adjustment expenses 148.0 470.0
Interest charges (37.0) (20.0)
- ------------------------------------------------------------------------------
Pretax benefit on operating results $ 10.0 $ 190.0
==============================================================================
The impact by operating segment of the Aggregate Cover and the CCC Cover on
pretax operating results was as follows:
Year Ended December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions)
Standard Lines $ (52.0) $ 381.0
Specialty Lines 2.0 33.0
CNA Re 12.0 162.0
- ------------------------------------------------------------------------------
Total Property and Casualty (38.0) 576.0
Other Insurance (3.0)
- ------------------------------------------------------------------------------
Pretax impact on operating results $ (41.0) $ 576.0
==============================================================================
2001 Restructuring
In 2001, CNA finalized and approved 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 Life Operations, discontinuation of the variable life and annuity business
and consolidation of real estate locations (the "2001 Plan").
IT Plan
The overall goal of the IT Plan was to improve technology for the
underwriting function and throughout CNA and to eliminate inefficiencies in
the deployment of IT resources. The changes facilitated a strong focus on
enterprise-wide system initiatives. The IT Plan had two main components, which
included the reorganization of IT resources into the Technology and Operations
Group with a structure based on centralized, functional roles and the
implementation of an
39
integrated technology roadmap that included common architecture and platform
standards that directly support CNA's strategies.
As summarized in the following table, during 2001, CNA incurred $62.0
million pretax, or $35.0 million after tax and minority interest, of
restructuring and other related charges for the IT Plan. During 2002, $4.0
million pretax, or $2.6 million after tax and minority interest, of this
accrual was reduced.
Employee
Termination Impaired
and Related Asset Other
Year Ended December 31, 2001 Benefit Costs Charges Costs Total
- ------------------------------------------------------------------------------
(In millions)
Standard Lines $ 5.0 $ 1.0 $ 6.0
Specialty Lines 2.0 2.0
- ------------------------------------------------------------------------------
Total Property and Casualty 7.0 1.0 8.0
Life Operations 17.0 17.0
Other Insurance 22.0 14.0 $ 1.0 37.0
- ------------------------------------------------------------------------------
Pretax impact on operating results $ 29.0 $ 32.0 $ 1.0 $ 62.0
==============================================================================
In connection with the IT Plan after the write-off of impaired assets, CNA
accrued $30.0 million of restructuring and other related charges in 2001 (the
"IT Plan Initial Accrual"). These charges primarily related to $29.0 million
of workforce reductions of approximately 260 positions gross and net and $1.0
million of other costs.
The following table summarizes the IT Plan Initial Accrual and the activity
in that accrual during 2002 and 2001.
Employee
Termination Impaired
and Related Asset Other
Benefit Costs Charges Costs Total
- ------------------------------------------------------------------------------
(In millions)
IT Plan Initial Accrual $ 29.0 $ 32.0 $ 1.0 $ 62.0
Cost that did not require
cash in 2001 (32.0) (32.0)
Payments charged against
liability in 2001 (19.0) (19.0)
- ------------------------------------------------------------------------------
Accrued costs at
December 31, 2001 10.0 1.0 11.0
Payments charged against
liability in 2002 (2.0) (2.0)
Reduction of accrual (3.0) (1.0) (4.0)
- ------------------------------------------------------------------------------
Accrued costs at
December 31, 2002 $ 5.0 $ 5.0
==============================================================================
Through December 31, 2002, 249 employees were released due to the IT Plan,
nearly all of whom were technology support staff. In December of 2002, the
accrual was reduced by $4.0 million in the Other Insurance segment primarily
related to employee termination costs. The remaining $5.0 million of the
accrual relating to employee termination and related benefit costs is expected
to be paid through 2005.
2001 Plan
The overall goal of the 2001 Plan was to create a simplified and leaner
organization for customers and business partners. The major components of the
plan included a reduction in the number of strategic business units ("SBUs")
in the property and casualty operations, changes in the strategic focus of the
Life Operations and Group Operations and consolidation of real estate
locations. The reduction in the number of property and casualty SBUs resulted
in consolidation of SBU functions, including underwriting, claims, marketing
and finance. The strategic changes in Group Operations included a decision to
discontinue the variable life and annuity business.
40
As summarized in the following table, during 2001, CNA incurred $189.0
million pretax, or $109.4 million after tax and minority interest, of
restructuring and other related charges for the 2001 Plan. During 2002, $32.0
million pretax, or $18.4 million after tax and minority interest, of this
accrual was reduced.
Employee
Termination Lease Impaired
and Related Termination Asset Other
Year Ended December 31, 2001 Benefit Costs Costs Charges Costs Total
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 40.0 $ 40.0
Specialty Lines 7.0 7.0
CNA Re 2.0 $ 4.0 6.0
- ------------------------------------------------------------------------------------------------
Total Property and Casualty 49.0 4.0 53.0
Group Operations 7.0 $ 35.0 42.0
Life Operations 3.0 $ 9.0 12.0
Other Insurance 9.0 52.0 21.0 82.0
- ------------------------------------------------------------------------------------------------
Pretax impact on operating results $ 68.0 $ 56.0 $ 30.0 $ 35.0 $189.0
==============================================================================
All lease termination costs and impaired asset charges, except lease
termination costs incurred by operations in the United Kingdom and software
write-offs incurred by Life Operations, were charged to the Other Insurance
segment because office closure and consolidation decisions were not within the
control of the other segments affected. Lease termination costs incurred in
the United Kingdom relate solely to the operations of CNA Re. All other
charges were recorded in the segment benefiting from the services or existence
of an employee or an asset.
In connection with the 2001 Plan, CNA accrued $189.0 million of these
restructuring and other related charges (the "2001 Plan Initial Accrual").
These charges include employee termination and related benefit costs, lease
termination costs, impaired asset charges and other costs.
The following table summarizes the 2001 Plan Initial Accrual and the
activity in that accrual during 2001 and 2002.
Employee
Termination Lease Impaired
and Related Termination Asset Other
Year Ended December 31, 2001 Benefit Costs Costs Charges Costs Total
- ------------------------------------------------------------------------------------------------
(In millions)
2001 Plan Initial Accrual $ 68.0 $ 56.0 $ 30.0 $ 35.0 $189.0
Cost that did not require cash (35.0) (35.0)
Payments charged against liability (2.0) (2.0)
- ------------------------------------------------------------------------------------------------
Accrued costs December 31, 2001 66.0 56.0 30.0 152.0
Costs that did not require cash (1.0) (3.0) (9.0) (13.0)
Payments charged against liability (53.0) (12.0) (4.0) (69.0)
Reduction of accrual (10.0) (7.0) (15.0) (32.0)
- ------------------------------------------------------------------------------------------------
Accrued costs December 31, 2002 $ 2.0 $ 34.0 $ 2.0 $ 38.0
================================================================================================
41
The following table summarizes the reduction of the 2001 Plan Initial
Accrual by segment in 2002.
Employee
Termination Lease Impaired
and Related Termination Asset
Year Ended December 31, 2002 Benefit Costs Costs Charges Total
- ------------------------------------------------------------------------------
(In millions)
Standard Lines $ (8.0) $ (8.0)
Specialty Lines (1.0) (1.0)
- ------------------------------------------------------------------------------
Total Property and Casualty (9.0) (9.0)
Life Operations $ (1.0) (1.0)
Other Insurance (1.0) $ (7.0) (14.0) (22.0)
- ------------------------------------------------------------------------------
Total $(10.0) $ (7.0) $(15.0) $(32.0)
==============================================================================
The 2001 Plan charges incurred and accrued by Standard Lines were $40.0
million in 2001, related entirely to employee termination and related benefit
costs for planned reductions in the workforce of 1,063 positions gross and
net, of which $27.0 million related to severance and outplacement costs and
$13.0 million related to other salary costs. Through December 31, 2002,
approximately 882 employees net were released due to the 2001 Plan.
Approximately 39.0% of these employees were administrative, technology or
financial support staff; approximately 52.0% of these employees were
underwriters, claim adjusters and related insurance services staff; and
approximately 9.0% of these employees were in various other positions. During
December of 2002, $8.0 million of the accrual was reduced primarily due to
successful redeployment of employees to other positions within the
organization. An accrual of $1.0 million remained at December 31 2002 relating
to employee termination costs which will be paid in 2003.
The 2001 Plan charges incurred and accrued by Specialty Lines were $7.0
million in 2001, related entirely to employee termination and related benefit
costs for planned reductions in the workforce of 177 positions gross and net,
of which $5.0 million related to severance and outplacement costs and $2.0
million related to other salary costs. Through December 31, 2002,
approximately 126 employees net were released due to the 2001 Plan.
Approximately 26.0% of these employees were administrative, technology or
financial support staff; approximately 63.0% of these employees were
underwriters, claim adjusters and related insurance services staff; and
approximately 11.0% of these employees were in various other positions. During
December of 2002, the accrual was reduced by $1.0 million. An accrual of $1.0
million remained at December 31, 2002 relating to employee termination costs
which will be paid in 2003.
The 2001 Plan charges incurred and accrued by CNA Re were $6.0 million.
Costs related to employee termination and related benefit costs for planned
reductions in the workforce of 33 positions gross and net, amounted to $2.0
million, all of which related to severance and outplacement costs. Payments of
$1.0 million were made in 2002 for approximately 15 employees net released
through December 31, 2002 due to the 2001 Plan. The remaining $4.0 million of
charges incurred by CNA Re related to lease termination costs. Approximately
$1.0 million was paid in 2002 related to lease termination costs. As a result
of the sale of CNA Re U.K., the remaining accrual related to CNA Re of $4.0
million was reduced. See "Investments - Insurance" that follows for further
information.
The 2001 Plan charges incurred and accrued by Group Operations were $42.0
million. Costs related to employee termination and related benefit costs for
planned reductions in the workforce of 187 positions, gross and net, amounted
to $7.0 million. Through December 31, 2002, 82 employees net in Group
Operations were released due to the 2001 Plan. Approximately 28.0% of these
employees were administrative, technology or financial support staff; and
approximately 72.0% of these employees were underwriters, claim adjusters and
related insurance services staff. Other costs of $35.0 million in Group
Operations relate to a write-off of deferred acquisition costs on in-force
variable life and annuity contracts, as CNA believes that the decision to
discontinue these products will negatively impact the persistency of the
business.
The 2001 Plan charges incurred and accrued by Life Operations were $12.0
million. Costs related to employee termination and related benefit costs for
planned reductions in workforce of 207 positions gross and net, amounted to
$3.0 million, which related primarily to severance and outplacement costs.
Through December 31, 2002, approximately 144 employees net were released due
to the 2001 Plan. Approximately 23.0% of these employees were administrative,
technology or financial support staff; approximately 65.0% of these employees
were underwriters, claim adjusters and
42
related insurance services staff; and approximately 12.0% of these employees
were in various other positions. Life Operations incurred and accrued $9.0
million of impaired asset charges related to software in 2001. In December of
2002, the remaining $1.0 million of this accrual was reduced.
The 2001 Plan charges incurred and accrued by the Other Insurance segment
were $82.0 million. Costs related to employee termination and related benefit
costs for planned reductions in the workforce of 194 positions gross and net,
amounted to $9.0 million, of which $6.0 million related to severance and
outplacement costs and $3.0 million related to other salary costs. Through
December 31, 2002, 157 employees net were released due to the 2001 Plan.
Approximately 63.0% of these employees were administrative, technology or
financial support staff; approximately 28.0% of these employees were
underwriters, claim adjusters and related insurance services staff; and
approximately 9.0% of these employees were in various other positions. In
December of 2002, $1.0 million of the accrual was reduced for employee
termination and related benefit cost. The Other Insurance segment also
incurred $73.0 million of lease termination and asset impairment charges
related to office closure and consolidation decisions not within the control
of the other segments affected. Additionally, $7.0 million was reversed and
included in 2002 income relating to lease obligations and $14.0 million
relating to impaired asset charges. CNA's original plan contained a timeline
to consolidate and reduce the number of office locations. Due to unfavorable
conditions in the commercial real estate market, certain office relocations
and consolidations occurred later than planned. As a result of such delays, a
portion of the planned leasehold write-offs and vacant office space were
expensed as period costs, resulting in an excess initial accrual. Of the
remaining $36.0 million accrual relating to lease termination costs and
impaired asset charges, approximately $18.0 million is expected to be paid in
2003.
At December 31, 2001, an accrual of $1.0 million for lease termination costs
remained related to the August 1998 restructuring ("1998 Plan"). In December
of 2002, this accrual was reduced.
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. Claim and claim adjustment expense and future policy benefit
reserves are reflected as liabilities on the Consolidated Balance Sheets under
the heading "Insurance Reserves." Changes in estimates of Insurance Reserves
are reflected in the Company's Consolidated Statements of Operations, in the
period in which the change arises.
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 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. Some of the many uncertain
future events about which CNA makes assumptions and estimates are claims
severity, frequency of claims, mortality, morbidity, expected interest rates,
economic inflation, the impact of underwriting policy and claims handling
practices 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").
CNA's experience has been that the inherent uncertainties of estimating
Insurance Reserves are generally greater for casualty coverages (particularly
long-tail casualty risks such as APMT losses) than for property coverages.
Estimates of the cost of future APMT claims are highly complex and include an
assessment of, among other things, whether certain costs are covered under the
policies and whether recovery limits apply, allocation of liability among
numerous parties, some of whom are in bankruptcy proceedings, inconsistent
court decisions and developing legal theories and tactics of plaintiffs'
lawyers. Reserves for property-related catastrophes, both natural disasters
and man-made catastrophes such as terrorist acts, are also difficult to
estimate. See the discussion of the Second Quarter 2001 Prior Year Reserve
Strengthening, the WTC Event, and Environmental Pollution and Mass Tort and
Asbestos Reserves for further information.
In addition to the uncertainties inherent in estimating APMT and catastrophe
losses, CNA is subject to the uncertain effects of emerging or potential
claims and coverage issues, which arise as industry practices and legal,
judicial, social, and other environmental conditions change. These issues can
have a negative effect on CNA's business by either
43
extending coverage beyond the original underwriting intent or by increasing
the number or size of claims. Either development could require material
increases in claim and claim adjustment expense reserves. Examples of emerging
or potential claims and coverage issues include: (i) increases in the number
and size of water damage claims related to expenses for testing and
remediation of mold conditions; (ii) increases in the number and size of
claims relating to injuries from medical products, and exposure to lead and
radiation related to cellular phone usage; (iii) expected increases in the
number and size of claims relating to accounting and financial reporting,
including director and officer and errors and omissions insurance claims, in
an environment of major corporate bankruptcies; and (iv) a growing trend of
plaintiffs targeting insurers in class action litigation relating to claims-
handling and other practices. The future impact of these and other unforeseen
emerging or potential claims and coverage issues is extremely hard 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.
CNA's current Insurance Reserve levels reflect management's best estimate of
CNA's ultimate claims and claim adjustment expenses and future policy benefits
at December 31, 2002, based upon known facts and current law. However, in
light of the many uncertainties associated with making the estimates and
assumptions necessary to establish reserve levels, CNA reviews its reserve
estimates on a regular and ongoing basis and makes changes as experience
develops. CNA may in the future determine that its recorded Insurance Reserves
are not sufficient and may increase its reserves by amounts that may be
material, which could materially adversely affect the Company's business and
financial condition. Any such increase in reserves would be recorded as a
charge against the Company's earnings for the period in which the change in
estimate arises.
The following table presents estimated volatility in carried claim and claim
adjustment loss reserves for the property and casualty segments.
Gross Estimated
Carried Loss Volatility in
December 31, 2002 Reserves Reserves
- ------------------------------------------------------------------------------
(In millions, except %)
Standard Lines $11,576.0 +/- 5.0%
Specialty Lines 5,874.0 +/- 7.0%
CNA Re 2,264.0 +/- 15.0%
Other Insurance 4,847.0 +/- 20.0%
The estimated volatility noted above does not represent a range around the
actuarial point estimate of CNA's gross loss reserves, and it does not
represent the range of all possible outcomes. The volatility represents an
estimate of the inherent volatility associated with estimating loss reserves
for the specific type of business written by each segment. The primary
characteristics influencing the estimated level of volatility are the length
of the claim settlement period, changes in medical and other claim costs,
changes in the level of litigation or other dispute resolution processes,
changes in the legal environment and the potential for different types of
injuries emerging. Ceded reinsurance arrangements may reduce the volatility.
Since ceded reinsurance arrangements vary by year, volatility in gross
reserves may not result in comparable impacts to underwriting income or
equity.
CNA's insurance loss reserves are recorded at management's best estimate
which is based on the reviews and analyses performed by CNA's actuaries and
management's judgment as to the responsiveness of these reviews and analyses
to the factors affecting CNA's loss and loss adjustment expense loss reserves.
Management considers factors such as changes in inflation, changes in claim
handling and case reserving, changes in underwriting and pricing, and changes
in the legal environment. Management considers different specific factors for
each situation since the factors affect each type of business differently.
Terrorism Exposure
CNA and the insurance industry incurred substantial losses related to the
WTC event. For the most part, CNA believes 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.
44
On November 26, 2002, the President of the United States of America signed
into law the Terrorism Risk Insurance Act of 2002 (the "Act"), which
establishes a program within the Department of the Treasury under which the
federal government will share the risk of loss from future terrorist attacks
with the insurance industry. The Act terminates on December 31, 2005. Each
participating insurance company must pay a deductible before federal
government assistance becomes available. This deductible is based on a
percentage of direct earned premiums for commercial insurance lines from the
previous calendar year, and rises from 1.0% from date of enactment to December
31, 2002 (the "Transition Period") to 7.0% during the first subsequent
calendar year, 10.0% in year two and 15.0% in year three. 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.
Insurance companies providing commercial property and casualty insurance are
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, but they
are pre-empted in relation to prior approval requirements for rates and forms.
The Act has policyholder notice requirements in order for insurers to be
reimbursed for terrorism-related losses and, from the date of enactment until
December 31, 2004, a mandatory offer requirement for terrorism coverage,
although it may be rejected by insureds. The Secretary of the Department of
the Treasury has discretion 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 during the next three
years, given the unpredictability of the nature, targets, severity or
frequency of potential terrorist events, CNA'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, individual life and group life and health
policies, and is also prohibited from excluding coverage for fire losses
following a terrorist event in a number of states.
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's current reinsurance arrangements
either exclude terrorism coverage or significantly limit the level of
coverage.
Property and Casualty
CNA conducts its property and casualty operations through the following
operating segments: Standard Lines, Specialty Lines, and CNA Re. The
discussion of underwriting results and ratios reflect the underlying business
results of CNA's property and casualty insurance subsidiaries. Underwriting
ratios are industry measures of property and casualty underwriting results.
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.
45
The following table summarizes key components of the property and casualty
segment operating results for the years ended December 31, 2002, 2001 and
2000.
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions, except %)
Net written premiums $ 7,008.0 $ 5,459.0 $ 6,773.0
Net earned premiums 6,838.0 5,010.0 6,927.0
Underwriting loss (439.0) (3,053.0) (644.0)
Investment income, net 795.0 974.0 1,330.0
Net operating income (loss) 258.4 (1,224.8) 428.2
Ratios:
Loss and loss adjustment expense 74.2% 113.3% 76.6%
Expense 31.1 45.3 31.5
Dividend 1.1 2.3 1.2
- ------------------------------------------------------------------------------
Combined 106.4% 160.9% 109.3%
==============================================================================
2001 adjusted underwriting loss* $ (805.0)
=================================================================
2001 adjusted ratios
Loss and loss adjustment expense 74.3%
Expense 37.2
Dividend 1.9
- -----------------------------------------------------------------
Combined 113.4%
=================================================================
* The 2001 adjusted underwriting loss and adjusted ratios exclude the
impact of the second quarter 2001 reserve strengthening, the WTC event, both
net of the related benefit of corporate aggregate reinsurance treaties, and
restructuring and other related charges.
2002 Compared with 2001
Net operating income for the property and casualty segment was $258.4
million in 2002 as compared with a net operating loss of $1,224.8 million in
2001. The 2001 operating results include prior year reserve strengthening of
$1,086.8 million recorded in the second quarter of 2001 related to a change in
estimate of prior year net loss reserves and retrospective premium accruals,
net of the related corporate aggregate reinsurance treaty benefit, estimated
losses related to the WTC event of $209.0 million, net of the related
corporate aggregate reinsurance treaties benefit, and restructuring and other
related charges of $36.8 million recorded in 2001.
Excluding these 2001 significant items, 2002 net operating results increased
$150.6 million. This increase was due primarily to improved underwriting
results and a reduction in the accrual for restructuring and other related
charges of $5.4 million after tax and minority interest. The 2001 operating
results include a $141.8 million charge, after tax and minority interest, to
strengthen prior underwriting year loss reserves for CNA Re U.K., unfavorable
2001 underwriting results for the London-based primary commercial and marine
operations, $46.1 million related to the bankruptcy filing by certain Enron
entities and $52.5 million benefit related to core corporate aggregate
reinsurance treaties. Partially offsetting these improvements was a decline in
investment income, including a $48.3 million decrease in limited partnership
income.
The combined ratio decreased 7.0 points in 2002 as compared with 2001 and
the underwriting results for the property and casualty segment improved $366.0
million. This change was due to decreases in the loss expense and dividend
ratios. The loss ratio decreased 0.1 points as a result of improved current
accident year results related to rate increases and new business across
property and casualty operations and favorable prior year reserve development
in Standard Lines in 2002. Partially offsetting these improvements was
unfavorable prior year reserve development in Specialty Lines and CNA Re
recorded in 2002. The property and casualty segment recorded $26.0 million of
unfavorable reserve
46
development in 2002 as compared with $284.0 million of unfavorable reserve
development in 2001. The gross carried claim and claim adjustment expense
reserve was $19,714.0 and $23,166.0 million for the years ended December 31,
2002 and 2001. The net carried claim and claim adjustment expense reserve was
$11,997.0 and $14,262.0 million for the years ended December 31, 2002 and
2001.
Specialty Lines recorded unfavorable prior year reserve development of
approximately $180.0 million for CNA HealthPro in 2002, which was driven
principally by medical malpractice excess products provided to hospitals and
physicians and coverages provided to long term care facilities, principally
national for-profit nursing homes. Approximately $100.0 million of the prior
year unfavorable reserve development was related to assumed excess products
and loss portfolio transfers, and was primarily driven by unexpected increases
in the number of excess claims in accident years 1999 and 2000. The percentage
of total claims greater than $1.0 million has increased by 33.0%, from less
than 3.0% of all claims to more than 4.0% of all claims. CNA HealthPro no
longer writes assumed excess products and loss portfolio transfers.
Approximately $50.0 million of the prior year unfavorable reserve
development was related to long term care facilities. The development was
principally recorded for accident years 1997 through 2000. The average value
of claims closed during the first several months of 2002 increased by more
than 50.0% when compared to claims closed during 2001. In response to those
trends, CNA HealthPro has reduced its writings of national for-profit nursing
home chains. Excess products provided to healthcare institutions and physician
coverages in a limited number of states were responsible for the remaining
development in CNA HealthPro. The unfavorable reserve development on excess
products provided to institutions for accident years 1996 through 1999
resulted from increases in the size of claims experienced by these
institutions. Due to the increase in the size of claims, more claims were
exceeding the point at which these excess products apply. The unfavorable
reserve development on physician coverages was recorded for accident years
1999 through 2001 in Oregon, California, Arizona and Nevada. The average claim
size in these states has increased by 20.0%, driving the change in losses.
The Marine business recorded unfavorable reserve development of
approximately $65.0 million during 2002. Approximately $50.0 million of this
unfavorable reserve development was due to participation in voluntary pools.
About half of the reserve development was recorded in accident years 1999 and
2000 with the remainder attributable to accident years prior to 1999. The
reserves were based on recommendations provided by the pools. Participation in
many of these pools has been discontinued. The remaining reserve development
for the Marine business was due principally to unfavorable reserve development
on hull and liability coverages from accident years 1999 and 2000 offset by
favorable reserve development on cargo coverages recorded for accident year
2001. Reviews completed during 2002 showed additional reported losses on
individual large accounts and other bluewater business that drove the
unfavorable hull and liability reserve development. These additional losses
during 2002 for accident years 1999 and 2000 were almost 75.0% higher than the
provision that had been established at the end of 2001.
Offsetting the unfavorable reserve development was favorable development in
CNA Pro and for Enron related exposures. Programs providing professional
liability coverage to accountants, lawyers and realtors primarily drove
favorable prior year reserve development of approximately $110.0 million in
CNA Pro. Reviews of this business completed during 2002 have shown little
activity for older accident years (principally prior to 1999), which reduced
the need for reserves on these years. The reported losses on these programs
for accident years prior to 1999 increased by approximately $5.0 million
during 2002. This increase compared to the total reserve at the beginning of
2002 of approximately $180.0 million, net of reinsurance. Additionally,
favorable reserve development of $20.0 million was associated with the Enron
settlement. CNA had established a $20.0 million reserve for accident year 2001
for an excess layer associated with Enron related surety losses; however, the
case has settled for less than the attachment point of this excess layer. Also
recorded in 2001 was reserve strengthening for the London-based commercial and
marine operations and losses related to Enron entities as discussed above.
CNA Re recorded prior year reserve strengthening as a result of an actuarial
review completed during 2002 and was primarily recorded in the directors and
officers, professional liability errors and omissions, and surety lines of
business. Several large losses, as well as continued increases in the overall
average size of claims for these lines, have resulted in higher than expected
loss ratios.
Standard Lines recorded approximately $140.0 million of favorable prior year
reserve development attributable to participation in the Workers Compensation
Reinsurance Bureau ("WCRB"), a reinsurance pool, and residual market. The
favorable prior year reserve development for WCRB was the result of
information received from the WCRB that
47
reported the results of a recent actuarial review. This information indicated
that CNA's net required reserves for accident years 1970 through 1996 were
$60.0 million less than the carried reserves. In addition, during 2002, CNA
commuted accident years 1965 through 1969 for a payment of approximately $5.0
million to cover carried reserves of approximately $13.0 million, resulting in
further favorable reserve development of $8.0 million. The favorable residual
market prior year reserve development was the result of lower than expected
paid loss activity during recent periods for accident years dating back to
1984. The paid losses during 2002 on prior accident years were approximately
60.0% of the previously expected amount.
In addition, Standard Lines had favorable prior year reserve development,
primarily in the package liability and auto liability lines of business due to
new claims initiatives. These new claims initiatives, which included
specialized training on specific areas of the claims adjudication process,
enhanced claims litigation management, enhanced adjuster-level metrics to
monitor performance and more focused metric-based claim file review and
oversight, are expected to produce significant reductions in ultimate claim
costs. Based on management's best estimate of the reduction in ultimate claim
costs, approximately $100.0 million of favorable prior year reserve
development was recorded in 2002. Approximately one-half of this favorable
reserve development was recorded in accident years prior to 1999, with the
remainder of the favorable reserve development recorded in accident years 1999
to 2001. Additional favorable reserve development may be recorded in the
future as management continues to monitor these estimates and as additional
evidence becomes available to measure the effectiveness of the claim cost
containment initiatives and management's corresponding estimate of such
expected ultimate claim cost reductions. While management believes that the
estimate of ultimate claim cost reductions as a result of the claim cost
containment initiatives is reasonable, there can be no assurance that the
ultimate expected claim cost reductions will be achieved, or that any
additional favorable development will be recorded as a result of the claim
cost containment initiatives described above.
Approximately $50.0 million of favorable prior year reserve development
during 2002 was recorded in commercial automobile liability. Most of the
favorable development was from accident year 2000. The most recent actuarial
review showed that underwriting actions have resulted in reducing the number
of commercial automobile liability claims for recent accident years,
especially the number of large losses.
Approximately $45.0 million of favorable reserve development was recorded in
property lines during 2002. The favorable reserve development was principally
from accident years 1999 through 2001, and was the result of the low number of
large losses in recent years. Although property claims are generally reported
relatively quickly, determining the ultimate cost of the claim can involve a
significant amount of time between the occurrence of the claim and settlement.
Offsetting these favorable reserve developments were approximately $100.0
million of unfavorable reserve development in middle market workers
compensation, approximately $70.0 million of unfavorable reserve development
in programs written in CNA E&S, approximately $30.0 million of unfavorable
reserve development on a contractors account package policy program, and
approximately $20.0 million of unfavorable development on middle market
general liability coverages.
The unfavorable reserve development on workers compensation was principally
due to additional reinsurance premiums for accident years 1999 through 2001.
A CNA E&S program covering facilities that provide services to
developmentally disabled individuals, accounts for approximately $50.0 million
of the unfavorable reserve development. The development is due to an increase
in the size of known claims and increases in policyholder defense costs. These
increases became apparent as the result of a review completed during 2002,
with most of the development from accident years 1999 and 2000. The other
program, which contributed to the CNA E&S development, covers tow truck and
ambulance operators in the 2000 and 2001 accident years. This program was
started in 1999. CNA expected that loss ratios for this business would be
similar to its middle market commercial automobile liability business. Reviews
completed during the year resulted in estimated loss ratios on the tow truck
and ambulance business that are 25 points higher than the middle market
commercial automobile liability loss ratios.
The unfavorable reserve development on contractors account package policies
was the result of an actuarial review completed during 2002. Since this
program is no longer being written, CNA expected that the change in reported
losses
48
would decrease each quarterly period. However, in recent quarterly periods,
the change in reported losses has been higher than prior quarters, resulting
in the unfavorable reserve development.
The expense ratio decreased 6.1 points primarily as a result of reduced
underwriting expenses resulting from decreased head count as a result of the
2001 Plan and other expense reduction initiatives and an increase in the net
earned premium base. The dividend ratio decreased 0.8 points due primarily to
favorable current accident year dividends in Standard Lines.
Net written premiums for the property and casualty segment increased
$1,549.0 million for 2002 compared with 2001. Included in 2001 net written
premium was $957.0 million of ceded premiums related to the corporate
aggregate reinsurance treaties, additional ceded premiums arising from both
the reserve strengthening and WTC event, and a change in estimate for
involuntary market premium accruals. Excluding these 2001 significant items,
net written premium increased $592.0 million primarily as a result of strong
rate increases, increased new business and lower ceded premiums across the
property and casualty segment.
Net earned premiums for the property and casualty segment increased $1,828.0
million for 2002 compared with 2001. Included in 2001 net earned premium was
$1,336.0 million of ceded premiums related to the corporate aggregate
reinsurance treaties, additional ceded premiums arising from both the reserve
strengthening and WTC event, and a change in estimate for involuntary market
premium accruals. Excluding these 2001 significant items, net earned premium
increased $492.0 million due primarily to the increases in net written
premiums noted above.
Specialty Lines achieved average rate increases of 26.0%, 13.0% and 5.0% in
2002, 2001 and 2000 for the contracts that renewed during these years and had
retention rates of 76.0%, 78.0% and 78.0% for those contracts that were up for
renewal. The retention rates above apply to Specialty Lines excluding the CNA
Guaranty and Credit, Surety and Warranty businesses.
Standard Lines achieved average rate increases of 27.0%, 17.0% and 13.0% in
2002, 2001 and 2000 for the contracts that renewed during these years and had
retention rates of 68.0%, 76.0% and 68.0% for those contracts that were up for
renewal.
2001 Compared with 2000
The net operating loss for the property and casualty segment was $1,224.8
million in 2001 as compared with net operating income of $428.2 million in
2000. The 2001 operating results include prior year reserve strengthening of
$1,086.8 million recorded in the second quarter of 2001 related to a change in
estimate of prior year net loss reserves and retrospective premium accruals,
net of the related corporate aggregate reinsurance treaty benefit, estimated
losses related to the WTC event of $209.0 million, net of the related
corporate aggregate reinsurance treaties benefit, and restructuring and other
related charges of $36.8 million recorded in 2001.
Excluding these 2001 significant items, 2001 net operating results declined
$320.4 million. Net operating results for 2001 declined due to a $97.1 million
decline in limited partnership income, unfavorable 2001 underwriting results
for the London-based primary commercial and marine operations and $46.1
million related to the bankruptcy filing by certain Enron entities. These
declines were partially offset by lower prior year adverse loss reserve
development (excluding the second quarter 2001 reserve development) and a
$52.5 million benefit related to corporate aggregate reinsurance treaties for
core operations. Net operating results in 2000 benefited from a change in
estimate for certain insurance-related assessments of $52.0 million in 2000.
The combined ratio increased 4.1 points in 2001 as compared with 2000 and
the underwriting results for the property and casualty segment declined $161.0
million. This change was due to a decrease in the loss ratio, more than offset
by increases in the expense and dividend ratios. The loss ratio decreased 2.3
points as a result of the improved underwriting results across most standard
lines, particularly the automobile and package lines, due to earned rate
achievement and re-underwriting efforts undertaken last year, and lower prior
year adverse loss development (excluding the second quarter 2001 reserve
strengthening). These improvements were partially offset by reduced net earned
premium base, losses related to Enron, favorable loss development recorded in
2000 for the architects and engineers business not present in 2001, declined
underwriting results in global and marine lines related to current accident
year reserve strengthening as discussed above, and the prior underwriting year
reserve strengthening of CNA Re U.K. The expense ratio increased 5.7
49
points primarily due to the decrease in the net earned premium base, the
write-off of unrecoverable deferred acquisition costs in the vehicle warranty
line of business, an increase in the accrual for guaranty fund assessments
related to the Reliance insolvency, and the decreased impact of the change in
estimate for certain insurance-related assessments. The dividend ratio
increased 0.7 points primarily due to adverse development in dividend reserves
in Standard Lines in 2001 compared with favorable development taken in 2000.
Net written premiums for the property and casualty segment decreased
$1,314.0 million for 2001 compared with 2000. Included in 2001 net written
premium was $957.0 million of ceded premiums related to the corporate
aggregate reinsurance treaties, additional ceded premiums arising from both
the reserve strengthening and WTC event, and a change in estimate for
involuntary market premium accruals. Excluding these 2001 significant items,
net written premium decreased $357.0 million primarily as a result of a change
in the timing of recording written premiums for policies with future effective
dates in Standard Lines of $119.0 million and in Specialty Lines of $23.0
million and additional ceded premiums related to the corporate aggregate
reinsurance treaties of $77.0 million in Specialty Lines and $161.0 million in
CNA Re. Partially offsetting these decreases was $89.0 million of
reinstatement and additional premiums related to the WTC event recorded in CNA
Re.
Net earned premiums for the property and casualty segment decreased $1,917.0
million for 2001 compared with 2000. Included in 2001 net earned premium was
$1,336.0 million of ceded premiums related to the corporate aggregate
reinsurance treaties, additional ceded premiums arising from both the reserve
strengthening and WTC event, and a change in estimate for involuntary market
premium accruals. Excluding these 2001 significant items, net earned premium
decreased $581.0 million due primarily to the decreases in net written premium
noted above.
Group
Group Operations provides group life and group health insurance and
investment products and services to employers, affinity groups and other
entities that purchase insurance as a group.
Group Operations includes three principal business units: Group Benefits,
Federal Markets and Institutional Markets and Other, which also includes
results from businesses that CNA has exited; retail variable life and
annuities, and life reinsurance.
2002 Compared with 2001
Net operating income increased by $74.2 million in 2002 as compared with
2001. Included in the 2001 results were $30.6 million related to the WTC event
and $23.6 million related to restructuring and other related charges.
Excluding these 2001 significant items, net operating results improved $20.0
million due primarily to growth in the disability and long term care products,
increased investment income and diminished losses due to the exit of
unprofitable variable life and annuity lines of business. Net operating
results also improved due to favorable reserve development relating to the WTC
event of $3.6 million after tax and minority interest recorded in 2002.
Partially offsetting these improvements was net unfavorable reserve
strengthening in Group Benefits due to unfavorable mortality trends.
Net earned premiums for Group Operations decreased $1,051.0 million for 2002
as compared with 2001. This decline was due primarily to the transfer of the
Mail Handlers Plan partially offset by an increase in premiums in the
disability and long term care products within Group Benefits. Net earned
premiums for the Mail Handlers Plan was $1,151.0 million as compared with
$2,218.0 million in 2001. Deposits for Group Operations decreased $41.0
million for 2002 as compared with 2001 primarily due to reduced sales of S&P
500 contracts in Institutional Markets.
Group Operations achieved rate increases that averaged approximately 5.0%,
6.0% and 3.0% in 2002, 2001 and 2000 for the disability, accident and life
lines of business within Group Benefits. Premium persistency rates were
approximately 81.0%, 81.0% and 84.0% in 2002, 2001 and 2000.
50
2001 Compared with 2000
Net operating income decreased by $55.0 million in 2001 as compared with
2000. Included in the 2001 results were $30.6 million related to the WTC event
and $23.6 million related to restructuring and other related charges. Included
in the restructuring and other related charges was a $20.1 million write-off
of deferred acquisition costs on in-force variable life and annuity contracts
as CNA believes that its decision to discontinue these products would
negatively impact the persistency of the business. Excluding these 2001
significant items, net operating results decreased $0.8 million primarily as a
result of the sale of life reinsurance and a decrease in limited partnership
income of $13.1 million. Life reinsurance contributed net operating income of
$19.1 million in 2000. Partially offsetting these declines were improvements
realized by exiting unprofitable lines of approximately $15.8 million and
increased income in other product lines, primarily the single premium
guaranteed annuity, GIC and disability and group long-term care lines, of
$15.8 million.
Net earned premiums for Group Operations decreased $66.0 million for 2001 as
compared with 2000. Net earned premiums declined $228.0 million as a result of
the sale of life reinsurance. This decline was partially offset by increases
in Federal Markets of $138.0 million due to increased medical cost trends and
growth in Group Benefits of $36.0 million, particularly in the disability and
group long-term care lines of business. Deposits for Group Operations
decreased $296.0 million in 2001 as compared to 2000 due to reduced sales of
GIC and S&P 500 contracts in Institutional Markets.
Life
Life Operations provides financial protection to individuals through term
life insurance, universal life insurance, individual long term care insurance,
annuities and other products. Life Operations has several distribution
relationships and partnerships including managing general agencies, other
independent agencies working with CNA life sales offices, a network of brokers
and dealers, and other independent insurance consultants.
2002 Compared with 2001
Net operating income increased by $29.0 million in 2002 as compared with
2001. Included in the 2001 results were $16.6 million related to restructuring
and other related charges and $12.3 million related to the WTC event.
Excluding these 2001 significant items, net operating results decreased $1.8
million due primarily to net reserve strengthening for individual long term
care, unfavorable individual long term care morbidity and increased costs
related to the life settlement business in 2002. These decreases were
partially offset by higher investment income, a decrease in reinsurance
charges, favorable reserve development relating to the WTC event of $8.9
million after tax and minority interest recorded in 2002 as compared with
2001, and a $0.9 million after tax and minority interest reduction of the
accrual for restructuring and other related charges recorded in 2002.
Sales volume for Life Operations decreased by $13.0 million in 2002 as
compared with 2001. This decrease was attributable primarily to lower sales of
structured settlement annuities, partially offset by increased sales in the
individual long term care product. Net earned premiums increased $57.0 million
in 2002 as compared with 2001 attributable primarily to growth in the
individual long term care product partially offset by sales declines in
structured settlement annuities.
As a result of recent experience and the fourth quarter reserve
strengthening of $35.0 million pretax for individual long term care, CNA is
undertaking a full review of its product offerings in this line. The focus is
to determine whether the current products provide adequate pricing flexibility
under the range of reasonably possible claims experience levels. Until this
review is completed, CNA intends to significantly reduce new sales of this
product. Premium will continue to be received on in-force business, but the
actions to reduce new business will lower the rate of overall premium growth
for this line. The outcome of CNA's review and potential actions could have a
material adverse effect on the Company's results of operations.
2001 Compared with 2000
Net operating income decreased by $48.2 million in 2001 as compared with
2000. Included in the 2001 results were $16.6 million related to restructuring
and other related charges and $12.3 million related to the WTC event.
Excluding
51
these 2001 significant items, net operating results decreased $19.3 million
due primarily to decreased investment income from limited partnerships of
$18.4 million.
Sales volume for Life Operations increased by $133.0 million in 2001 as
compared with 2000. This increase was driven primarily by improved sales in
structured settlements and increased renewals and new sales in individual long
term care products. Net earned premiums increased $100.0 million in 2001 as
compared with 2000. This improvement is attributable primarily to improved
sales of structured settlement annuities due to favorable pricing conditions
and individual long term care products, partially offset by a decrease in new
individual life business.
Other Insurance
The Other Insurance segment contains CNA's corporate interest expense,
certain run-off insurance operations, including personal insurance, losses and
expenses related to the centralized adjusting and settlement of APMT claims,
direct financial guarantee business underwritten by CNA's insurance
affiliates, certain non-insurance operations, including eBusiness initiatives
and CNA UniSource, and inter-company eliminations.
2002 Compared with 2001
Net operating results increased by $865.7 million in 2002 as compared with
2001. The impact of the second quarter 2001 reserve strengthening on the Other
Insurance segment was $732.4 million after tax and minority interest,
including $680.8 million for APMT. See the Environmental Pollution and Mass
Tort and Asbestos Reserves section following for a discussion of this charge.
Net operating income in 2001 also decreased by $67.4 million of restructuring
and other related charges and $14.9 million related to the WTC event for group
reinsurance.
Excluding these 2001 significant items, net operating results improved $51.0
million in 2002 as compared with 2001. Reduced expenses for e-Business
initiatives and improved results for group reinsurance were offset by lower
investment income, principally resulting from a $5.4 million decline in
limited partnership income, higher losses related to the run-off of CNA
UniSource and severance and other costs related to changes in senior
management in 2002. Also contributing to the improvement was a $15.2 million
reduction, after tax and minority interest, in the accrual for restructuring
and other related charges recorded in 2002.
During 2002, favorable net reserve development, including premium
development, of $23.0 million was recorded in the Other Insurance segment as
compared with unfavorable net reserve development of $63.0 million recorded in
2001, excluding the second quarter 2001 reserve strengthening. The gross
carried claim and claim adjustment expense reserve was $4,847.0 and $5,043.0
million at December 31, 2002 and 2001. The net carried claim and claim
adjustment expense reserve was $2,002.0 and $2,110.0 million at December 31,
2002 and 2001.
Personal insurance recorded unfavorable reserve development of $35.0 million
on accident years 1997 through 1999. These losses were subject to retroactive
reinsurance agreements with Allstate that cover losses occurring prior to
October 1, 1999. These reinsurance agreements were entered into as part of the
sale of CNA's personal insurance business to Allstate. CNA shares in indemnity
and claim and allocated claim adjustment expenses if payments related to
losses incurred prior to October 1, 1999 on the CNA policies transferred to
Allstate exceed the claim and allocated claim adjustment expense reserves of
approximately $1.0 billion at the date of sale. CNA must begin to reimburse
Allstate for claim and allocated claim adjustment expense payments when
cumulative claim payments after October 1, 1999 on losses occurring prior to
that date exceed the $1.0 billion. CNA's remaining obligation valued under
this loss sharing provision as of October 1, 2003, will be settled by
agreement of the parties or by an independent actuarial review of the unpaid
claim liabilities as of that date. Cumulative payments of indemnity and
allocated loss adjustment expenses on such policies are expected to exceed
$1.0 billion during 2003. CNA has established reserves for its estimated
liability under this loss sharing arrangement. The unfavorable reserve
development was principally due to continuing policyholder defense costs
associated with remaining open claims. At the end of 2002, approximately 4,800
claims remain open. It was anticipated these claims would be closed more
quickly, eliminating further defense coverage costs.
The unfavorable reserve development on personal insurance was offset by
favorable reserve development on other run-off business, driven principally by
financial and mortgage guarantee coverages from accident years 1997 and prior.
The favorable reserve development on financial and mortgage guarantee
coverages resulted from a review of the
52
underlying exposures and the outstanding losses. This review showed that
salvage and subrogation continues to be collected on these types of claims,
thereby reducing estimated future losses net of anticipated reinsurance
recoveries.
Total operating revenues decreased $31.0 million in 2002 as compared with
2001. This decrease was due primarily to reduced revenues for CNA UniSource,
due to the exit of this business, and reduced investment income partially
offset by increased net earned premiums in group reinsurance.
2001 Compared with 2000
Net operating results declined $786.3 million in 2001 as compared with 2000.
The impact of the second quarter 2001 reserve strengthening on the Other
Insurance segment was $732.4 million after tax and minority interest,
including $680.8 million for APMT. See the Environmental Pollution and Mass
Tort and Asbestos Reserves section following for a discussion of this charge.
Net operating income for 2001 also decreased by $67.4 million for
restructuring and other related charges and $14.9 million related to the WTC
event for group reinsurance.
Excluding these 2001 significant items, net operating results increased
$28.4 million primarily as a result of lower interest expense on corporate
borrowings in 2001 as compared with 2000 and a non-recurring favorable
adjustment of expense recoveries under a service contract related to personal
insurance. These increases were partially offset by $39.1 million for non-
recurring ceding commissions included in 2000 results related to the transfer
of the personal insurance line of business to Allstate in 1999, $30.6 million
related to increased eBusiness initiatives in 2001 and $10.5 million due to
decreased limited partnership income.
Total operating revenues decreased $254.0 million in 2001 as compared with
2000. This decline was due to a decrease in investment income and net earned
premiums from run-off insurance operations, particularly the entertainment and
agriculture insurance lines.
Environmental Pollution and Mass Tort and Asbestos ("APMT") Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to environmental pollution and mass tort and asbestos
claims.
The following table provides data related to CNA's environmental pollution
and mass tort and asbestos claim and claim adjustment expense reserves.
December 31, 2002 December 31, 2001
- ------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Mass Tort Asbestos Mass Tort Asbestos
- ------------------------------------------------------------------------------
(In millions)
Gross reserves $ 830.0 $ 1,758.0 $ 837.0 $1,644.0
Ceded reserves (313.0) (527.0) (204.0) (392.0)
- ------------------------------------------------------------------------------
Net reserves $ 517.0 $ 1,231.0 $ 633.0 $1,252.0
==============================================================================
There was no asbestos or environmental pollution and mass tort-related net
claim and claim adjustment expense reserve development for the year ended
December 31, 2002. As a result of a change in estimate resulting from CNA's
semi-annual ground-up review of APMT accounts gross and ceded APMT reserves
were increased. The settlement scenarios that supported higher estimated gross
and higher estimated ceded reserves were judged to be the most appropriate.
However, net reserves remained unchanged. The estimation of reinsurance
recoverables on accounts is highly dependent on the allocation of each
account's estimated ultimate losses to their available historical insurance
coverage. This allocation becomes more refined as accounts and their insurers
enter more serious settlement negotiations.
During 2002, net reserves were identified relating to APMT related claim and
claim adjustment expense reserves for assumed reinsurance pools, which
reflects improvements in the identification of APMT activity from assumed
reinsurance and pools. The inclusion of these additional APMT reserves
increased the APMT reserves and decreased other reserves, resulting in no net
change in CNA's overall carried claim and claim adjustment expense reserves.
53
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 to
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 1,200 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 reform Superfund have been made by various parties.
In 2002, no reforms were enacted by Congress. 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 impact upon the Company's results
of operations or equity.
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, court decisions that continue to restrict the scope and
applicability of the absolute pollution exclusion contained in policies issued
by CNA post 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, 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.
As of December 31, 2002 and 2001, CNA carried approximately $517.0 and
$633.0 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 and mass tort net claim and
claim adjustment expense reserve development for the year ended December 31,
2002. Unfavorable environmental pollution and mass tort net claim and claim
adjustment expense reserve development for the years ended December 31, 2001
and 2000 amounted to $468.0 and $15.0 million, respectively. CNA paid
environmental pollution-related claims and mass tort related claims, net of
reinsurance recoveries, of $116.0, $203.0 and $135.0 million during the years
ended December 31, 2002, 2001 and 2000, respectively.
Asbestos
CNA's property and casualty insurance subsidiaries also have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves many of the same limitations discussed
above for environmental pollution claims, 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
54
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.
In the past several years, CNA has experienced significant increases in
claim counts for asbestos-related claims. The factors that led to these
increases included, among other things, intensive advertising campaigns by
lawyers for asbestos claimants, mass medical screening programs sponsored by
plaintiff lawyers, and the addition of new defendants such as the distributors
and installers of products containing asbestos. Currently, the majority of
asbestos bodily injury claims are filed by persons exhibiting few, if any,
disease symptoms. It is estimated that approximately 90.0% of the current non-
malignant asbestos claimants do not meet the American Medical Association's
definition of impairment. Some courts, including the federal district court
responsible for pre-trial proceedings in all federal asbestos bodily injury
actions, have ordered that so-called "unimpaired" claimants may not recover
unless at some point the claimant's condition worsens to the point of
impairment.
As of December 31, 2002 and 2001, CNA carried approximately $1,231.0 and
$1,252.0 million of net claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported asbestos-related claims.
There was no asbestos-related net claim and claim adjustment expense reserve
development for the year ended December 31, 2002. Unfavorable asbestos-related
net claim and claim adjustment expense reserve development for the years ended
December 31, 2001 and 2000 amounted to $773.0 and $65.0 million. CNA paid
asbestos-related claims, net of reinsurance, of $20.0, $171.0 and $126.0
million during the years ended December 31, 2002, 2001 and 2000, excluding
payments made in connection with the 1993 settlement of litigation related to
Fibreboard Corporation.
CNA has structured settlement agreements with four of its policyholders for
which it has future payment obligations. Structured settlement agreements
provide for payments of sums certain over multiple years as set forth in each
individual agreement. As to the four structured settlement agreements existing
at December 31, 2002, payment obligations under those settlement agreements
are projected to terminate in 2016. For these four structured settlement
agreements, CNA has reserved $118.0 million, net of reinsurance.
CNA, through its acquisition of CIC in 1995, acquired obligations under the
Wellington Agreement. In 1985, 47 asbestos producers and their insurers,
including CIC, executed the Wellington Agreement. The agreement intended to
resolve all issues and litigation related to coverage for asbestos exposures.
Under this agreement, signatory insurers committed scheduled policy limits and
made the limits available to pay asbestos claims based upon coverage blocks
designated by the policyholders in 1985, subject to extension by
policyholders. CIC was a signatory insurer to the Wellington Agreement. At
December 31, 2002, CNA had fulfilled its Wellington Agreement obligations as
to all but five accounts. With respect to the five remaining unpaid Wellington
obligations, CNA has evaluated its exposure under these agreements and has
established a $28.0 million reserve, net of reinsurance, for Wellington
obligations.
CNA has also used coverage in place agreements to resolve large asbestos
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
asbestos related liabilities. Claims payments are contingent on presentation
of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. At December 31, 2002, CNA had
negotiated 23 such agreements in which CNA committed coverage for payment of
claims and claim related adjustment expenses subject to documentation
requirements as set forth in the terms of each specific agreement. CNA has
evaluated these commitments and has established a $66.0 million reserve, net
of reinsurance, to fund coverage in place agreements based on current
projections of claims volumes and severities.
At December 31, 2002, CNA's total IBNR reserve for asbestos was $729.0
million, net of reinsurance. For asbestos exposures, CNA classifies its IBNR
reserve as assigned or unassigned. In circumstances where CNA has executed a
settlement agreement with its policyholder, CNA assigns IBNR reserve to that
account to cover the projected value of the settlement. At December 31, 2002,
the assigned IBNR reserve was $166.0 million, net of reinsurance. The
unassigned IBNR reserve relates to potential development on accounts that have
not settled and potential future claims for unidentified policyholders. At
December 31, 2002, CNA's unassigned IBNR reserve was $563.0 million, net of
reinsurance.
55
At December 31, 2002, CNA categorized active accounts as large or small
accounts. CNA defined a large account as an active account with more than
$100,000 cumulative paid losses through December 31, 2002. CNA had 150 large
accounts with a collective reserve of $220.0 million, net of reinsurance. CNA
made closing large accounts a significant management priority. Small accounts
were defined as active accounts with $100,000 or less cumulative paid losses
through December 31, 2002. CNA had 939 small accounts with a collective
reserve of $90.0 million, net of reinsurance.
The chart below depicts CNA's overall pending asbestos accounts and
associated reserves:
Asbestos Reserves (net)
---------------------------------
Percent
Net Paid Net of
Number of Losses Asbestos Asbestos
December 31, 2002 Policyholders (Recoveries) Reserves Reserves
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Policyholders with settlement agreements
Structured settlements 4 $ 12.0 $ 118.0 9.6%
Wellington 5 28.0 2.3
Coverage in place 23 (15.0) 66.0 5.3
Fibreboard 1 1.0 55.0 4.5
- ------------------------------------------------------------------------------------------------
Total with settlement agreements 33 (2.0) 267.0 21.7
- ------------------------------------------------------------------------------------------------
Other policyholders with active accounts
Large asbestos accounts 150 (8.0) 220.0 17.9
Small asbestos accounts 939 16.0 90.0 7.3
- ------------------------------------------------------------------------------------------------
Total other policyholders 1,089 8.0 310.0 25.2
- ------------------------------------------------------------------------------------------------
Assumed reinsurance and pools 15.0 91.0 7.4
Unassigned IBNR 563.0 45.7
- ------------------------------------------------------------------------------------------------
Total 1,122 $ 21.0 $1,231.0 100.0%
==============================================================================
In 2002, at least fifteen companies filed for bankruptcy protection citing
costs associated with asbestos claims litigation as a basis for filing. Since
1982, at least sixty-seven companies, including the fifteen companies that
filed in 2002, that mined asbestos, or manufactured or used asbestos-
containing products, have filed for bankruptcy. This phenomenon has prompted
plaintiff attorneys to file claims against companies that had only peripheral
involvement with asbestos. Many of these defendants were users or distributors
of asbestos-containing products, or manufacturers of products in which
asbestos was encapsulated. These defendants include equipment manufacturers,
brake, gasket, and sealant manufacturers, and general construction
contractors. According to a comprehensive report on asbestos litigation
recently released by the Rand Corporation, over 6,000 companies have been
named as defendants in asbestos lawsuits, with 75 out of 83 different types of
industries in the United States impacted by asbestos litigation. The study
found that a typical claimant names 70 to 80 defendants, up from an average of
20 in the early years of asbestos litigation.
Some asbestos-related defendants have asserted that their claims for
insurance 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 such exposures by aggressive settlement strategies.
Nevertheless, there can be no assurance any of these settlement efforts will
be successful, or that any such claims can be settled on terms acceptable to
CNA. Adverse developments with respect to such matters discussed in this
paragraph could have a material adverse impact on the Company's results of
operations or equity.
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 will be
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
56
subsidiaries, including alleged "non-products" exposure. The settlement is
subject to bankruptcy court approval and confirmation of a bankruptcy plan
containing a channeling injunction to protect CNA from any future claims.
CNA's recorded reserves as of December 31, 2002, included reserves for this
exposure.
CNA is engaged in insurance coverage litigation with Robert A. Keasbey
Company ("Keasbey") and associated claimants in New York state court.
(Continental Casualty Company v. Robert A. Keasbey Company et al., Supreme
Court State of New York - County of New York, No. 401621/02). Keasbey was a
seller and installer of asbestos products in the New York and New Jersey area.
CNA paid its full product liability limits to Keasbey in prior years.
Claimants against Keasbey now claim CNA owes additional coverage under the
operations section of policies issued to it by CNA. CNA is also a party to
insurance coverage litigation between Burns & Roe Enterprises, Inc. ("Burns &
Roe") and its insurance carriers related to asbestos bodily injury and
wrongful death claims. (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 various engineering and related services in connection with
construction projects. Burns & Roe is currently in bankruptcy. There are
numerous factual and legal issues to be resolved in connection with these
cases and it is difficult to predict the outcome or financial exposure
represented by these matters in light of the novel theories asserted by
policyholders and their counsel.
Policyholders have also initiated litigation directly against CNA and other
insurers. CNA has been named in Adams v. Aetna, Inc., et al. (Circuit Court of
Kanhwha 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
policyholders. In addition, lawsuits have 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)). It is difficult to predict the
outcome or financial exposure represented by this type of litigation in light
of the broad nature of the relief requested and the novel theories asserted.
CNA reviews each active asbestos account every six months to determine
whether changes in reserve estimates may be necessary. CNA considers input
from its analyst 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 future exposures (including such factors as claims
volume, disease mix, trial conditions, settlement demands and defense costs);
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 retentions and/or deductibles); the existence of
other insurance; and reinsurance arrangements.
Due to the uncertainties created by volatility in claim numbers and
settlement demands, the effect of bankruptcies, the extent to which non-
impaired claimants can be precluded from making claims and the efforts by
insureds to obtain coverage not subject to aggregate limits, the ultimate
liability of CNA for asbestos-related claims may vary substantially from the
amount currently recorded. Other variables that will influence CNA's ultimate
exposure to asbestos-related claims will be medical inflation trends, jury
attitudes, the strategies of plaintiff attorneys to broaden the scope of
defendants, the mix of asbestos-related diseases presented, CNA's abilities to
recover reinsurance, future court decisions and the possibility of legislative
reform. Adverse developments with respect to such matters discussed in this
paragraph could have a material adverse impact on the Company's results of
operations or equity.
With respect to environmental and mass tort reserves, commencing in 2000 and
continuing into the first and second quarters of 2001, CNA received a number
of new reported claims, some of which involved declaratory judgment actions
premised on court decisions purporting to expand insurance coverage for
pollution claims. In these decisions, several courts adopted rules of
insurance policy interpretation which established joint and several liability
for insurers consecutively on a risk during a period of alleged property
damage; and in other instances adopted interpretations of the "absolute
pollution exclusion," which weakened its effectiveness in most circumstances.
In addition to receiving new claims and declaratory judgment actions premised
upon these unfavorable legal precedents, these court decisions also impacted
CNA's pending pollution and mass tort claims and coverage litigation. During
the spring of 2001, CNA reviewed specific claims and litigation, as well as
general trends, and concluded reserve strengthening in this area was
necessary.
57
In the area of mass torts, several well-publicized verdicts arising out of
bodily injury cases related to allegedly toxic mold led to a significant
increase in mold-related claims in 2000 and the first half of 2001. CNA's
reserve increase in the second quarter of 2001 was caused in part by this
increased area of exposure.
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.
Throughout 2000, and into 2001, CNA experienced significant increases in new
asbestos bodily injury claims. In light of this development, CNA formed the
view that payments for asbestos claims could be higher in future years than
previously estimated. Moreover, in late 2000 through mid-2001, industry
sources such as rating agencies and actuarial firms released analyses and
studies commenting on the increase in claim volumes and other asbestos
liability developments. For example, A.M. Best released a study in May of 2001
increasing its ultimate asbestos reserve estimate 63.0% from $40.0 to $65.0
billion, citing an unfunded insurance industry reserve shortfall of $33.0
billion. In June of 2001, Tillinghast raised its asbestos ultimate exposure
from $55.0 to $65.0 billion for the insurance industry and its estimate of the
ultimate remaining asbestos liability for all industries was raised to $200.0
billion.
Also in the 2000 to 2001 time period, a number of significant asbestos
defendants filed for bankruptcy, increasing the likelihood that excess layers
of insurance coverage could be called upon to indemnify policyholders and
creating the potential that novel legal doctrines could be employed which
could accelerate the time when such indemnification payments could be due.
These developments led CNA to the conclusion that its asbestos reserves
required strengthening.
The results of operations or equity of the Company in future years may be
adversely impacted by environmental pollution and mass tort and asbestos claim
and claim adjustment expenses. Management will continue to review and monitor
these liabilities and make further adjustments, including the potential for
further reserve strengthening, as necessary.
Lorillard
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
The tobacco industry in the United States, including Lorillard, continues to
be faced with a number of issues that have or may adversely impact the
business, results of operations and financial condition of Lorillard and the
Company, including the following:
.. A substantial volume of litigation seeking compensatory and punitive
damages ranging into the billions of dollars, as well as equitable and
injunctive relief, arising out of allegations of cancer and other health
effects resulting from the use of cigarettes, addiction to smoking or
exposure to environmental tobacco smoke, including claims for reimbursement
of health care costs allegedly incurred as a result of smoking, as well as
other alleged damages.
.. A $16.3 billion punitive damage judgment against Lorillard in Engle v. R.J.
Reynolds Tobacco Company, et al., a class action case in state court in
Florida in which the jury awarded a total of $145.0 billion in punitive
damages against all the defendants and which is currently on appeal.
58
.. Substantial annual payments by Lorillard, continuing in perpetuity, and
restrictions on marketing and advertising agreed to under the terms of the
settlement agreements entered into between the major cigarette
manufacturers, including Lorillard, and each of the 50 states, the District
of Columbia, the Commonwealth of Puerto Rico and certain other U.S.
territories (together, the "State Settlement Agreements").
.. A continuing decline in the volume of wholesale cigarette sales in the
United States, including 2002 volume declines of 3.7% for the domestic U.S.
cigarette industry and 6.3% for Lorillard, according to information
provided by Management Science Associates.
.. Increases in industry-wide promotional expenses and sales incentives
implemented in reaction to the volume declines and impact of the price
increases, and continuing intense competition among the four largest
cigarette manufacturers, including Lorillard, and many smaller participants
who have gained market share in recent years, principally in the discount
and deep-discount cigarette segment. Market share for the deep discount
brands increased by an estimated 1.19 share points from 5.98% to 7.17% in
2002.
.. Continuing and substantial increases in state excise taxes on cigarette
sales in 2002 ranging from $0.18 per pack to $0.69 per pack in 21 states,
as well as excise tax increases by several municipalities such as New York
City where the local tax increased from $0.08 to $1.50 in 2002, and
proposals for additional increases in federal, state and local excise
taxes. Lorillard believes that increases in excise and similar taxes have
had an adverse impact on sales of cigarettes and that any future increases,
the extent of which cannot be predicted, could result in further volume
declines for the cigarette industry, including Lorillard, and an increased
sales shift toward lower priced discount cigarettes rather than premium
brands.
.. Increasing sales of counterfeit cigarettes in the United States which
adversely impact sales by the manufacturer of the counterfeited brands and
potentially damage the value and reputation of those brands.
.. Increases in actual and proposed federal, state and local regulation of the
tobacco industry and governmental restrictions on smoking.
See Item 3 -Legal Proceedings and Note 20 of the Notes to Consolidated
Financial Statements included in Item 8 of this Report for information with
respect to the Engle action and other litigation against cigarette
manufacturers and the State Settlement Agreements.
2002 Compared with 2001
Revenues decreased by $111.5 million, or 2.8%, and net income increased by
$93.6 million, or 13.9%, in 2002 as compared to 2001. Net income for the year
ended December 31, 2001, included a charge of $121.0 million related to an
agreement with the class in the Engle case. See Note 20 of the Notes to
Consolidated Financial Statements included in Item 8 of this Report for
information with respect to the Engle action. Excluding this charge, net
income decreased by $27.3 million, or 3.4%, due to lower sales volume,
increased sales promotion costs and reduced investment income reflecting lower
invested cash balances and reduced yields on investments, partially offset by
increased unit prices and decreased tobacco settlement and legal expenses.
Revenues decreased due to lower net sales and reduced investment income. Net
sales decreased by $70.3 million in 2002 as compared to 2001, due to lower
unit sales volume of approximately $257.0 million, or 6.6%, assuming prices
were unchanged from the prior year. The decline in unit sales volume was
partially offset by higher average unit prices which increased revenues by
approximately $186.7 million, or 4.8%, including $93.0 million from an
increase in federal excise taxes effective January 1, 2002.
During 2002, Lorillard increased its net wholesale price of cigarettes by an
average of $6.71 per thousand cigarettes ($0.13 per pack of 20 cigarettes), or
5.6%, before the impact of any promotional activities. Federal excise taxes
are included in the price of cigarettes and on January 1, 2002, the federal
excise tax on cigarettes increased by $2.50 per thousand cigarettes ($0.05 per
pack of 20 cigarettes) to $19.50 per thousand cigarettes.
59
The increased unit prices reflect the increase in net wholesale prices,
partially offset by promotional expenses, mostly in the form of coupons and
other discounts provided to retailers and passed through to the consumer.
Increased promotional expenses in 2002, as compared to 2001, partially offset
the higher average unit prices in 2002.
Lorillard's overall unit sales volume decreased 6.3% in 2002 as compared to
2001. Newport's unit sales volume decreased by 2.8% in 2002. Continued
decreases in unit volume for Old Gold and Maverick in the discount segment
were also contributing factors. Old Gold and Maverick declines were due to
severe competitive price pressure from deep discount brands produced by
manufacturers who do not have the same financial payment obligations related
to the State Settlement Agreements as does Lorillard and other major tobacco
companies. Additionally, volume in 2002 was affected by generally weak
economic conditions and ongoing limitations imposed by Philip Morris' retail
merchandising arrangements.
Deep discount price brands produced by manufacturers who are not obligated
by the same payment terms of the State Settlement Agreements have continued to
increase their market share by approximately one share point during 2002 to
7.17% of the U.S. domestic market. As a result of lower payments, these
companies can price their brands at a significant advantage, by as much as
60%, as compared with offerings from the major cigarette manufacturers.
Lorillard's share of domestic U.S. wholesale cigarette shipments was 9.05%
in 2002 as compared to 9.26% in 2001. Newport, a premium brand, accounted for
approximately 88% of Lorillard's unit sales and 89% of net sales revenue in
2002, compared to 85% and 86%, respectively, in 2001. Newport's share of the
premium segment was 10.9% in 2002 as compared to 10.6% in 2001. Newport had
the highest share of the menthol segment of the market with an approximately
31% share of the category. Menthol comprised approximately 26% of total
domestic U.S. industry sales in 2002. Premium priced cigarette sales accounted
for 94.7% and 92.4% of Lorillard's total sales in 2002 and 2001.
Overall, industry unit sales volume decreased by 3.7% in 2002. Industry
sales for premium brands declined to 72.8% in 2002 as compared to 74.0% in
2001.
Lorillard recorded pretax charges of $1,062.2 and $1,140.4 million ($646.1
and $694.2 million after taxes), for the years ended December 31, 2002 and
2001, respectively, to record its obligations under various settlement
agreements. Lorillard's portion of ongoing adjusted settlement payments and
related legal fees are 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 impose a stream of future payment
obligations on Lorillard and the other major U.S. cigarette manufacturers and
place significant restrictions on their ability to market and sell cigarettes.
The Company believes that the implementation of the State Settlement
Agreements will materially adversely affect its consolidated results of
operations and cash flows in future periods. The degree of the adverse impact
will depend, among other things, on the rates of decline in U.S. cigarette
sales in the premium and discount segments, Lorillard's share of the domestic
premium and discount segments, and the effect of any resulting cost advantage
of manufacturers not subject to all of the payments of the State Settlement
Agreements.
During the first quarter of 2002, Lorillard adopted Emerging Issues Task
Force ("EITF") No. 00-25 and No. 00-14 relating to the classification of
vendor consideration and certain sales incentives. As a result, promotional
expenses historically included in other operating expenses have been
reclassified primarily as reductions of revenues from manufactured products,
or to cost of manufactured products sold. Prior period amounts have been
reclassified for comparative purposes. Adoption of the EITF issues had no
impact on the results of operations and cash flows of Lorillard.
2001 Compared with 2000
Revenues increased by $85.1 million, or 2.2% and net income decreased $81.7
million, or 10.8%, in 2001 as compared to 2000. Net income for the year ended
December 31, 2001, included a charge of $121.0 million to record the effect of
the Engle agreement. Excluding this charge, net income would have increased by
$39.3 million, or 5.2%, for the year ended December 31, 2001, as compared to
2000, due to the impact of wholesale price increases, partially offset by
lower unit sales volume and increased sales promotional expenses, mostly in
the form of coupons and other discounts provided to retailers and passed
through to the consumer.
60
Revenues increased due to higher net sales, partially offset by reduced
investment income. Net sales increased by $106.5 million in 2001 as compared
to 2000, due to higher average unit prices which would have resulted in an
aggregate increase of approximately $399.2 million, or 10.6%, partially offset
by a decrease of approximately $292.7 million, or 7.8%, reflecting lower unit
sales volume. During 2001, Lorillard increased its net wholesale price of
cigarettes by an average of $13.58 per thousand cigarettes ($0.27 per pack of
20 cigarettes), or 12.8%, before the impact of any promotional activities.
Federal excise taxes are included in the price of cigarettes and remained
constant during 2001 at $17.00 per thousand units, or $0.34 per pack of 20
cigarettes.
Lorillard's overall unit sales volume decreased by 6.5% in 2001, as compared
to 2000. Newport's unit sales volume increased by 0.4% for 2001, primarily as
a result of the introduction of the Newport Medium line extension and
strengthened promotional support, as compared to 2000. The decrease in
Lorillard's overall unit sales volume reflects lower unit sales of its
Maverick and Old Gold brands in the discount market segment due primarily to
increased competition in the discount segment and continued limitations
imposed by Philip Morris's merchandising arrangements and general competitive
conditions. Overall, industry unit sales volume decreased by 3.2% for the year
ended December 31, 2001.
Lorillard's share of domestic U.S. wholesale cigarette shipments was 9.26%
in 2001, as compared to 9.63% for 2000. Newport, a premium brand, accounted
for approximately 85% of Lorillard's unit sales and 86% of net sales revenue
for the year ended December 31, 2001 compared to 79% and 82%, respectively, in
2000. Newport's market share of the premium segment was 10.6% for the year
ended December 31, 2001 compared to 10.3% in 2000.
Lorillard recorded pretax charges of $1,140.4 and $1,076.5 million ($694.2
and $642.3 million after taxes), for the years ended December 31, 2001 and
2000, respectively, to record its obligations under various settlement
agreements.
Loews Hotels
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
2002 Compared with 2001
Revenues and net income decreased by $16.5 and $6.8 million, or 5.1% and
34.9%, respectively, in 2002 as compared to 2001.
Revenues decreased in 2002 as compared to 2001, due primarily to a decline
in revenue per available room, reduced investment income, and lower other
hotel operating revenues. Revenue per available room decreased by $5.41, or
4.4%, to $117.62 due primarily to lower average room rates and reflects the
continued economic weakness and its impact on the travel industry.
Revenue per available room is an industry measure of the combined effect of
occupancy rates and average room rates on room revenues. Other hotel operating
revenues include, among other items, guest charges for food and beverages,
telecommunication services, garage and parking fees.
Net income decreased in 2002 due to the lower revenues and pre-opening costs
incurred related to the Royal Pacific Hotel at Universal Orlando, partially
offset by improved operating results at the Universal Orlando properties and
lower interest expense.
2001 Compared with 2000
Revenues and net income decreased by $16.7 and $7.3 million, or 4.9% and
27.2%, respectively, in 2001 as compared to 2000.
Revenues decreased primarily due to lower occupancy rates and lower average
room rates, partially offset by the addition of the Philadelphia Hotel, which
commenced operations in spring of 2000. The decline in revenues reflects the
continued economic weakness and the impact that the September 11, 2001 World
Trade Center attack had on the travel
61
industry. Net income decreased due primarily to lower revenues and increased
depreciation expenses related to the Philadelphia Hotel, partially offset by
lower advertising and administrative expenses and lower pre-opening costs.
Diamond Offshore
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 54% owned subsidiary of the Company.
Diamond Offshore's revenues vary based upon demand, which affects the number
of days the fleet is utilized and the dayrates earned. When a rig is idle,
generally no dayrate is earned and revenues will decrease. Revenues can also
increase or decrease as a result of the acquisition or disposal of rigs. In
order to improve utilization or realize higher dayrates, Diamond Offshore may
mobilize its rigs from one market to another. During periods of mobilization,
however, revenues may be adversely affected. In response to changes in demand,
Diamond Offshore may withdraw a rig from the market by stacking it or may
reactivate a rig stacked previously, which may decrease or increase revenues,
respectively.
Revenues from offshore turnkey drilling contracts are accrued to the extent
of costs until the specified turnkey depth and other contract requirements are
met. Income is recognized on the completed contract method. Provisions for
future losses on turnkey contracts are recognized when it becomes apparent
that expenses to be incurred on a specific contract will exceed the revenue
from that contract.
Operating income is primarily affected by revenue factors, but is also a
function of varying levels of operating expenses. Operating expenses generally
are not affected by changes in dayrates and may not be significantly affected
by fluctuations in utilization. For instance, if a rig is to be idle for a
short period of time, Diamond Offshore may realize few decreases in operating
expenses since the rig is typically maintained in a prepared state with a full
crew. In addition, when a rig is idle, Diamond Offshore is responsible for
certain operating expenses such as rig fuel and supply boat costs, which are
typically a cost of the operator under drilling contracts. However, if the rig
is to be idle for an extended period of time, Diamond Offshore may reduce the
size of a rig's crew and take steps to "cold stack" the rig, which lowers
expenses and partially offsets the impact on operating income.
2002 Compared with 2001
Revenues decreased by $197.2 million, or 20.1% and net income decreased by
$56.9 million, or 80.1%, respectively, in 2002 as compared to 2001. Revenues
decreased due primarily to lower contract drilling revenue of $161.1 million,
reduced investment income of $18.9 million, and lower revenues from
reimbursable expenses.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $95.4 million, or 9.7% in 2002 as compared to 2001. The decrease
reflects lower dayrates ($60.7 million) and lower utilization ($70.4 million)
partially offset by revenues generated by the Ocean Baroness ($35.7 million),
which completed a conversion to a high specification semisubmersible drilling
unit and commenced operations in March of 2002.
Revenues from jack-up rigs decreased by $75.1 million, or 7.7%, due
primarily to decreased dayrates ($48.6 million) and lower utilization ($26.5
million) in 2002. Interest income decreased by $18.9 million, or 1.9%, in 2002
primarily due to a reduction in marketable securities held and lower interest
rates earned on cash and marketable securities in 2002 compared to 2001.
Net income decreased due primarily to the reduced revenues in 2002 as
discussed above, partially offset by lower interest expenses related to a
premium paid on early extinguishment of debt in 2001.
In 2002 Diamond Offshore implemented EITF 01-14, "Income Statement
Characterization of Reimbursements Received for 'Out-of-Pocket' Expense
Incurred." EITF 01-14 requires a company to record the gross amount billed to
its customers as revenue as opposed to a reduction of expenses. Diamond
Offshore has reclassified its prior periods for comparative purposes.
62
2001 Compared with 2000
Revenues increased by $232.7 million, or 31.1%, and net income increased by
$39.0 million, in 2001 as compared to 2000. Revenues and net income included a
gain from the sale of a drilling rig of $13.9 and $4.7 million, respectively,
for the year ended December 31, 2000.
Revenues from high specification floaters and other semisubmersible rigs
increased by $179.3 million, or 24.0%, in 2001 as compared to 2000. These
increases reflect higher utilization ($23.6 million) and dayrates ($94.2
million) for 2001 as compared 2000. Revenue generated by the Ocean Confidence
($61.5 million), which began a five-year drilling program in the Gulf of
Mexico on January 5, 2001 after completion of a conversion to a high
specification semisubmersible drilling unit, also contributed to the increase
in revenues.
Revenues from jack-up rigs increased by $55.6 million, or 7.4%, due
primarily to increased dayrates ($63.6 million) for 2001, partially offset by
lower utilization in 2001.
Net income increased due primarily to the increased revenues discussed
above, partially offset by increased interest and depreciation expenses.
Depreciation expenses increased in 2001 primarily due to the Ocean Confidence,
which completed its conversion from an accommodation vessel to a high
specification semisubmersible drilling unit and commenced operations in
January 2001. In addition, interest expense increased due to a premium paid on
early extinguishment of debt and increased interest expense due to the Ocean
Confidence, as a result of less interest capitalized.
Bulova
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
2002 Compared with 2001
Revenues and net income increased by $19.5 and $1.7 million, or 13.3% and
16.8%, respectively, in 2002 compared to 2001. Revenues and net income
increased primarily as a result of the addition of the Wittnauer watch brand,
acquired in 2001, and the commencement in 2002 of the Harley Davidson watch
line resulting from a licensing agreement signed in 2001. An increase in clock
unit volume sales, partially offset by a decrease in Bulova's watch brand unit
volume, also contributed to the increase in revenues and net income. These
increases were partially offset by lower royalty income of $0.7 million and
decreased interest income of $0.7 million in 2002.
2001 Compared with 2000
Revenues and net income decreased by $14.0 and $4.9 million, or 8.7% and
32.7%, respectively, in 2001 compared to 2000. Revenues and net income
decreased due primarily to royalty income of $5.5 and $3.0 million,
respectively, reported in 2000 related to the settlement of a contract
dispute. The remaining decline in revenues for 2001 reflects lower watch and
clock unit sales volume due primarily to the continued economic downturn,
partially offset by higher watch unit prices.
Net income decreased due to the lower revenues and costs incurred during
business process reengineering of Bulova's information systems, partially
offset by improved gross margins attributable to Bulova's product sales mix.
Corporate
Corporate operations consist primarily of investment income, including
investment gains (losses) from non-insurance subsidiaries, as well as equity
earnings from Majestic Shipping Corporation ("Majestic"), corporate interest
expenses and other corporate administrative costs. Majestic, a wholly owned
subsidiary, owns a 49% common stock interest in Hellespont Shipping
Corporation ("Hellespont"). Hellespont is engaged in the business of owning
and operating six ultra large crude oil tankers that are used primarily to
transport crude oil from the Persian Gulf to a limited number of ports in the
Far East, Northern Europe and the United States.
63
The components of investment gains (losses) included in Corporate operations
are as follows:
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions)
Derivative instruments $ (14.1) $ 18.2 $(146.5)
Equity securities, including short positions (41.2) 69.1 125.1
Short-term investments 73.3 28.5 (3.3)
Other 25.5 12.6 17.3
- ------------------------------------------------------------------------------
43.5 128.4 (7.4)
Income tax (expense) benefit (16.1) (45.0) 2.6
Minority interest (11.1) (8.3)
- ------------------------------------------------------------------------------
Net gain (loss) $ 16.3 $ 75.1 $ (4.8)
==============================================================================
2002 Compared with 2001
Exclusive of investment gains (losses), revenues decreased $81.6 million and
net loss increased $51.3 million in 2002 compared to 2001. Revenues declined
due primarily to lower results from Majestic of $41.7 million reflecting
reduced demand and charter rates in the crude oil tanker markets, and lower
investment income of $41.6 million relating to reduced yields from invested
assets. The impact of the lower results from shipping operations and
investment income increased the net loss by $35.4 and $21.9 million,
respectively.
2001 Compared with 2000
Exclusive of investment gains (losses), revenues decreased $19.1 million and
net loss increased $3.0 million, or 11.5% and 21.1%, respectively, in 2001
compared to 2000, due primarily to lower investment income. This change was
partially offset by increased operating results from Majestic reflecting
increased demand and charter rates in the crude oil tanker markets.
LIQUIDITY AND CAPITAL RESOURCES
The Company's contractual cash payment obligations are as follows:
Payments Due by Period
---------------------------------------------------------
Less than More than
December 31, 2002 Total 1 year 1-3 years 4-5 years 5 years
- ------------------------------------------------------------------------------------------------
Long-term debt $ 5,672.4 $ 430.6 $ 825.0 $ 1,772.6 $ 2,644.2
Capital lease obligations 35.6 2.4 5.7 7.2 20.3
Operating leases 556.7 91.9 140.0 102.2 222.6
- ------------------------------------------------------------------------------------------------
Total $ 6,264.7 $ 524.9 $ 970.7 $ 1,882.0 $ 2,887.1
================================================================================================
In addition, as previously discussed, Lorillard has entered into the State
Settlement Agreements which impose a stream of future payment obligations on
Lorillard and the other major U.S. cigarette manufacturers. Lorillard's
portion of ongoing adjusted settlement payments and related legal fees are
based on its share of domestic cigarette shipments in the year preceding that
in which the payment is due. Payment obligations are not incurred until the
related sales occur.
CNA
The principal operating cash flow sources of CNA's property and casualty and
life insurance subsidiaries are premiums and investment income. The primary
operating cash flow uses are payments for claims, policy benefits and
operating expenses.
64
For the year ended December 31, 2002, net cash provided by operating
activities was $1,039.9 million as compared with net cash used in operating
activities of $599.0 million in 2001. The improvement related primarily to
federal tax refunds received in 2002 as compared to taxes paid in 2001 and
decreased net payments for insurance claims.
For the year ended December 31, 2001, net cash used for operating activities
was $599.0 million as compared with net cash used of $1,345.5 million in 2000.
The improvement related primarily to decreased paid claims.
Cash flows from investing activities include purchases and sales of
financial instruments, as well as the purchase and sale of land, buildings,
equipment and other assets not generally held for resale.
For the year ended December 31, 2002, net cash used for investing activities
was $1,488.0 million as compared with $205.0 million in 2001. Cash flows used
by investing activities were related principally to increased purchases of
invested assets due to positive operating cash flow and cash provided by
financing activities.
For the year ended December 31, 2001, net cash used for investing activities
was $205.0 million as compared with net cash inflows of $1,842.0 million in
2000. Cash flows for investing activities were related principally to
increased net purchases of invested assets related to investing $1.0 billion
of proceeds from the common stock rights offering completed in the third
quarter of 2001.
Cash flows from financing activities include proceeds from the issuance of
debt or equity securities, outflows for dividends or repayment of debt and
outlays to reacquire equity instruments. For the year ended December 31, 2002,
net cash provided from financing activities was $432.0 million as compared
with $783.0 million in 2001.
For the year ended December 31, 2001, net cash provided from financing
activities was $783.0 million as compared with $487.0 million of net cash used
in 2000.
On December 19, 2002 CNA received $750.0 million from the Company in
exchange for 7,500 shares of Series H Cumulative Preferred Stock ("Preferred
Issue"). Of the proceeds from the Preferred Issue, $250.0 million was used to
prepay the $250.0 million one-year bank term loan due April 29, 2003 and an
additional $250.0 million was contributed to CCC to improve its statutory
surplus. It is expected that the rest of the proceeds will be used to repay
other debt of CNA and CIC, a CNA controlled subsidiary, maturing in 2003 and
for other general corporate purposes.
CNA completed a common stock rights offering on September 26, 2001,
successfully raising $1,006.0 million (40.3 million shares sold at $25.00 per
share). The Company purchased 38.3 million shares issued in connection with
the rights offering for $957.0 million, and an additional 0.8 million shares
in the open market. Additionally, CNA borrowed $500.0 million against its bank
credit facility. Partially offsetting these cash inflows were reductions to
CNA's commercial paper borrowings of $627.0 million.
CNA is closely managing the cash flows related to claims and reinsurance
recoverables from the WTC event. It is anticipated that significant claim
payments will be made prior to receipt of the corresponding reinsurance
recoverables. CNA does not anticipate any liquidity problems resulting from
these payments. As of March 14, 2003, the Company has paid $488.0 million in
claims and recovered $237.0 million from reinsurers.
CNA's estimated gross pretax losses for the WTC event were $1,648.0 million
pretax ($958.3 million after tax and minority interest). Net pretax losses
before the effect of corporate aggregate reinsurance treaties were $727.0
million. Approximately 1.0%, 73.0% and 20.0% of the reinsurance recoverables
on the estimated losses related to the WTC event are from companies with
Standard & Poor's ("S&P") ratings of AAA, AA or A.
Effective January 30, 2001, CNA sold the 180 Maiden Lane, New York,
facility. The sale of this property provided additional liquidity to CNA with
net sale proceeds of $264.0 million.
CNA has an existing shelf registration statement under which it may issue an
aggregate of $549.0 million of debt or equity securities, declared effective
by the SEC.
65
CNA has a $250.0 million three-year bank credit facility with an April 30,
2004 expiration date. CNA previously had a $250.0 million 364-day facility
with an expiration date of April 29, 2002. An option to convert the 364-day
facility to a one-year term loan was exercised in April of 2002. The term loan
was subsequently prepaid on December 23, 2002.
CNA pays a facility fee to the lenders for having funds available for loans
under the three-year credit facility maturing April 30, 2004. The fee varies
based on the long term debt ratings of CNA. At December 31, 2002, the facility
fee on the three-year component was 17.5 basis points.
CNA pays interest on any outstanding debt/borrowings under the three-year
facility based on a rate determined using the long term debt ratings of CNA.
The interest rate is equal to the London Interbank Offering Rate ("LIBOR")
plus 57.5 basis points. Further, if CNA has outstanding loans greater than
50.0% of the amounts available under the three-year facility, CNA will also
pay a utilization fee of 12.5 basis points on such loans. At December 31, 2002
and 2001, the weighted-average interest rate on the borrowings under the
facility, including facility fees and utilization fees, was 2.3% and 3.1%.
A Moody's downgrade of the CNA senior debt rating from Baa2 to Baa3 would
increase the facility fee on the three-year component of the facility from
17.5 basis points to 25.0 basis points. The applicable interest rate would
increase from LIBOR plus 57.5 basis points to LIBOR plus 75.0 basis points.
The utilization fee would remain unchanged on the three-year facility at 12.5
basis points.
On September 30, 2002, CNA Surety Corporation, a 64.0% owned and
consolidated subsidiary of CNA, entered into a $65.0 million credit agreement
with one bank, which consisted of a $35.0 million 364-day revolving credit
facility and a $30.0 million three-year term loan payable semi-annually at the
rate of $5.0 million. The credit agreement replaced a $130.0 million five-year
revolving credit facility that terminated September 30, 2002. The new credit
facility was fully utilized at inception.
The terms of the new credit facility agreement required the assumption by a
second bank of $15.0 million of the credit risk by November 30, 2002 or CNA
Surety would be required to repay $15.0 million to reduce the amount of the
credit facility commitment from $35.0 million to $20.0 million. On November
29, 2002, CNA Surety repaid $11.0 million of the outstanding borrowings and
arranged for the due date on the remaining $4.0 million to be delayed to March
31, 2003. A second bank subsequently assumed $10.0 million of the credit risk
resulting in an additional $6.0 million of outstanding borrowings, leaving the
credit facility commitment at $30.0 million. As of December 31, 2002, the
revolving credit facility was fully utilized.
Under the new credit facility agreement, CNA Surety pays a facility fee of
12.5 basis points, interest at LIBOR plus 45.0 basis points, and for
utilization greater than 50.0% of the amount available to borrow an additional
fee of 5.0 basis points. On the term loan, CNA Surety pays interest at LIBOR
plus 62.5 basis points. At December 31, 2002, the weighted-average interest
rate on the $60.0 million of outstanding borrowings under the credit
agreement, including facility fees and utilization fees was 2.0%.
Under the former credit facility agreement, CNA Surety paid interest on
outstanding borrowings based on, among other rates, LIBOR plus the applicable
margin. The applicable margin was determined by CNA's leverage ratio (debt to
total capitalization). At the termination date of the old facility, the
applicable margin was 30.0 basis points, including the 10.0 basis point
facility fee. At December 31, 2001, the weighted-average interest rate on the
borrowings under the facility, including facility fees, was 2.6%.
The terms of CNA's and CNA Surety's credit facilities require CNA and CNA
Surety to maintain certain financial ratios and combined property and casualty
company statutory surplus levels. At December 31, 2002 and 2001, CNA and CNA
Surety were in compliance with all restrictive debt covenants.
In December of 2002 and January of 2003, CNA provided loans in an aggregate
amount of approximately $45.0 million to a large national contractor that
undertakes projects for the construction of government and private facilities.
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 loans are evidenced by demand notes and currently accrue interest
at 10.0% until replaced by the credit facility
66
described below. The contractor and certain of its affiliates have pledged to
CNA substantially all of their assets as collateral for these loans.
In March of 2003, CNA entered into an agreement with the contractor to
provide an $86.4 million credit facility, which includes the already advanced
$45.0 million described above. The credit facility and all loans thereunder
would mature in March of 2006. Advances under the credit facility, including
the already-funded $45.0 million, bear interest at the prime rate plus 6.0%.
Payment of 3.0% interest would be deferred until the credit facility matures,
and the remainder would 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 affiliates.
The Company and CNA have entered into a participation agreement, pursuant to
which the Company has purchased a participation interest in one-third of the
loans and commitments under the new credit facility, on a dollar-for-dollar
basis, up to a maximum of $25.0 million. Although the Company does not have
rights against the contractor directly under the participation agreement, it
shares recoveries and fees under the facility proportionally with CNA.
In March of 2003, CNA also purchased the contractor's outstanding bank debt
for $16.4 million. Under the new credit facility, the contractor agreed to
purchase from CNA and retire the bank debt for $16.4 million, with $11.4
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 approximately $6.5 million in outstanding letters of
credit issued by the banks for the contractor's benefit that expire between
May and August of 2003. Any CNA reimbursements for draws upon the banks'
letters of credit will become obligations of the contractor to CNA as draws
upon the credit facility.
The contractor has initiated 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, through its affiliate 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. Any
losses arising from bonds issued or assumed by the insurance subsidiaries of
CNA Surety to the contractor 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
on bonds with effective dates prior to September 30, 2002. Through facultative
reinsurance contracts with CCC, CNA Surety's exposure on bonds written from
October 1, 2002 through December 31, 2002 has been limited to $20.0 million
per bond.
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 and repayment of its borrowings, the
contractor's failure to achieve its restructuring plan could have a material
adverse effect on CNA's future results of operations. If such failures occur
CNA estimates the Surety loss, net of indemnification and subrogation
recoveries, but before the effects of corporate aggregate reinsurance
treaties, if any, and minority interest could be up to $200.0 million.
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. At December 31, 2002 and 2001 there were approximately $222.0
and $270.0 million of outstanding letters of credit.
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
question if the primary obligor drew down on these letters of credit and
failed to repay such loans 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
December 31, 2002.
As of December 31, 2002 and 2001, CNA had committed approximately $141.0 and
$152.0 million for future capital calls from various third-party limited
partnership investments in exchange for an ownership interest in the related
partnerships.
67
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of December 31, 2002 to future capital calls
from certain of its unconsolidated affiliates in exchange for an ownership
interest in such affiliates.
The Company has a commitment to purchase up to a $100.0 million floating
rate note issued by the California Earthquake Authority in the event of an
earthquake during calendar year 2003 that results in California earthquake
related losses greater than $4.2 billion.
As of December 31, 2002, CNA is obligated to make future payments totaling
$394.0 million for non-cancelable operating leases expiring from 2003 through
2014 primarily for office space and data processing, office and transportation
equipment. Estimated future minimum payments under these contracts are as
follows: $79.0 million in 2003; $61.0 million in 2004; $56.0 million in 2005;
and $45.0 million in 2006; $153.0 million in 2007 and beyond. Additionally,
CNA has entered into a limited number of guaranteed payment contracts,
primarily relating to telecommunication services, amounting to approximately
$24.0 million. Estimated future minimum purchases under these contracts are as
follows: $13.0 million in 2003; $9.0 million in 2004; and $2.0 million in
2005.
In certain circumstances CNA provides guarantees of the indebtedness of
certain of its independent insurance producers, which expire in 2002. 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 holds an interest in and 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 are approximately $7.0 million
at December 31, 2002.
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 CNA could be required to
pay under these guarantees are approximately $8.0 million at December 31,
2002.
CNA holds an investment in a real estate joint venture that is accounted for
on the equity basis of accounting. In the normal course of business, CNA on a
joint and several basis with other unrelated insurance company shareholders
have 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 December 31, 2002 that
CNA could be required to pay under this guarantee is approximately $333.0
million. If CNA was 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 recorded a liability of approximately $10.0 million for its share of
estimated future operating deficits of this joint venture through 2016.
Ratings have become an increasingly important factor in establishing the
competitive position of insurance companies. CNA's insurance company
subsidiaries are rated by major rating agencies, and these ratings reflect the
rating agency's opinion of the insurance company's financial strength,
operating performance, strategic position and ability to meet its obligations
to policyholders. Agency ratings are not a recommendation to buy, sell or hold
any security, and may be revised or withdrawn at any time by the issuing
organization. Each agency's rating should be evaluated independently of any
other agency's rating. One or more of these agencies could take action in the
future to change the ratings of CNA's insurance subsidiaries. If those ratings
were downgraded as a result, the Company's results of operations and/or equity
could be materially adversely impacted.
68
The table below reflects ratings issued by A.M. Best, S&P, Moody's and Fitch
as of February 24, 2003 for the CCC Pool, CIC Pool, CAC Pool and CNAGLA. Also
rated were CNA's senior debt and commercial paper and Continental senior debt.
Insurance Financial Strength Ratings Debt Ratings
- ------------------------------------------------------------------------------------------------
Property and Casualty Life & Group Senior Debt
- ------------------------------------------------------------------------------------------------
CCC Pool CIC Pool CAC Pool CNAGLA CNA Continental
- ------------------------------------------------------------------------------------------------
A.M. Best A A A A bbb bbb-
Fitch A A AA- A+ BBB BBB
Moody's A3 A3 A2 NR Baa2 Baa3
(Negative)*
S&P A- A- A NR BBB- BBB-
NR = Not Rated
All rating outlooks on the above ratings are stable unless otherwise noted.
* CAC and VFL are rated separately by Moody's and both have an A2 rating.
During the fourth quarter of 2002, A.M. Best and Fitch affirmed the existing
financial strength ratings of each of the insurance pools and the debt ratings
of CNA as noted in the above table.
In February of 2003, S&P affirmed the ratings of the property and casualty
pools, CCC and CIC, and downgraded the life pool, CAC, by one notch from A+ to
A. S&P cited that the downgrade of the life operations was primarily because
S&P wanted to bring the ratings on all the companies in the group closer
together and because the companies' business profile has changed over the past
two years.
Corporate bonds comprise a significant portion of CNA's investment
portfolio. CNA regularly reviews the market value of these securities, and
challenges whether an other-than-temporary decline in value has occurred for
securities that are trading below cost (see Investments section, below). In
light of the current volatility in the financial markets and the dramatic
impact that several recent accounting scandals have had on specific issuers,
CNA may be subject to future impairment losses that could materially adversely
impact the Company's results of operations. Any future impairment losses would
not have a material impact on the Company's equity. See the discussion of
CNA's impairment committee in the investment section that follows.
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 Department,
may be paid only from earned surplus, which is calculated by removing
unrealized gains from unassigned surplus. As of December 31, 2002, CCC's
earned surplus is in a positive position, thereby enabling CCC to pay
approximately $1,069.0 million of dividend payments during 2003 that would not
be subject to the Department's prior approval. The actual level of dividends
paid in any year is determined after an assessment of available dividend
capacity, holding company liquidity and cash needs as well as the impact the
dividends will have on the statutory surplus of the applicable insurance
company.
CCC's positive earned surplus at December 31, 2002 is contrasted to its
negative earned surplus position at December 31, 2001. Prompted, in part, by
the negative earned surplus position at December 31, 2001, CNA embarked on a
capital realignment initiative within the CCC intercompany reinsurance pool
("Pool") during 2002, the benefits of which included the restoration of CCC's
earned surplus to a positive position. This initiative involved the payment of
dividends to CCC from its insurance subsidiaries during the fourth quarter of
2002. As a result of this distribution of the cumulative earnings of CCC's
insurance subsidiaries, CCC's earned surplus was restored to a positive level
at December 31, 2002, approximating $1,069.0 million.
69
This initiative involved a change to the underwriting structure of CCC and
eight of its subsidiaries from the Pool structure to a structure in which CCC
assumes 100% of the net underwriting risks of the group of companies formerly
comprising the pool. This is CNA's first step in a multi-year project to
reduce duplicative legal entities, thereby facilitating more efficient
operations and cost savings.
In addition, by agreement with the New Hampshire Insurance Department, as
well as certain other state insurance departments, dividend payments for the
CIC pool are restricted to internal and external debt service requirements
through September 2003 up to a maximum of $85.0 million annually, without the
prior approval of the New Hampshire Insurance Department. CNA's domestic
insurance subsidiaries are subject to risk-based capital requirements. Risk-
based capital is a method developed by the NAIC to determine the minimum
amount of statutory capital appropriate for an insurance company to support
its overall business operations in consideration of its size and risk profile.
The formula for determining the amount of risk-based capital specifies various
factors, weighted based on the perceived degree of risk, which are applied to
certain financial balances and financial activity. The adequacy of a company's
actual capital is evaluated by a comparison to the risk-based capital results,
as determined by the formula. Companies below minimum risk-based capital
requirements are classified within certain levels, each of which requires
specified corrective action. As of December 31, 2002 and 2001, all of CNA's
domestic insurance subsidiaries exceeded the minimum risk-based capital
requirements.
Lorillard
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation and regulatory issues. Approximately 4,500 product
liability cases are pending against cigarette manufacturers in the United
States. Of these, approximately 1,100 cases are pending in a West Virginia
court, and approximately 2,800 cases have been brought by flight attendants
alleging injury from exposure to environmental tobacco smoke in the cabins of
aircraft. Lorillard is a defendant in all of the flight attendant suits served
to date and is a defendant in most of the cases pending in West Virginia.
The terms of the State Settlement Agreements require significant payments to
be made to the Settling States which began in 1998 and continue in perpetuity.
Lorillard's cash payment under the State Settlement Agreements in 2002 was
approximately $1.0 billion. In 2003, Lorillard anticipates its payments under
the State Settlement Agreements to range from $750.0 to $800.0 million in
accordance with the terms of those agreements.
See Item 3 -Legal Proceedings and Note 20 of the Notes to Consolidated
Financial Statements included in Item 8 of this Report for additional
information regarding this settlement and other litigation matters.
Lorillard's marketable securities totaled $1,640.7 and $1,628.9 million at
December 31, 2002 and 2001. At December 31, 2002, fixed maturity securities
represented 92.8% of the total investment in marketable securities including
71.3% invested in Treasury Bills with an average duration of 60 days and 11.4%
invested in money market accounts.
The principal source of liquidity for Lorillard's business and operating
needs is internally generated funds from its operations. Lorillard generated
net cash flow from operations of approximately $852.6 million for the year
ended December 31, 2002, compared to $709.7 million for the prior year. The
increased cash flow in 2002 reflects the absence of cash payments made in 2001
related to the Engle agreement and reduced inventory purchases. Lorillard
believes based on current conditions, that cash flows from operating
activities will be sufficient to enable it to meet its obligations under the
State Settlement Agreements and to fund its capital expenditures. Lorillard
cannot predict the impact on its cash flows of cash requirements related to
any future settlements or judgments, including cash required to bond any
appeals, if necessary, or the impact of subsequent legislative actions, and
thus can give no assurance that it will be able to meet all of those
requirements.
Loews Hotels
In 2002, Loews Hotels, with its partners, opened a third hotel at Universal
Orlando in Florida. Capital expenditures in relation to these hotel projects
have been funded by a combination of equity from Loews Hotels and its
partners, and mortgages.
70
Funds from operations continue to exceed operating requirements. Funds for
other capital expenditures and working capital requirements are expected to be
provided from existing cash balances and operations.
Diamond Offshore
Diamond Offshore operates in an industry that is historically extremely
competitive and deeply cyclical. The demand for its services has traditionally
been highly correlated with the price of oil and natural gas. However the rise
in product prices that began in late 2001 and continued throughout 2002 did
not yield the expected improvements in utilization and dayrates for Diamond
Offshore's equipment.
At December 31, 2002, Diamond Offshore's cash and marketable securities
totaled $812.5 million, down from $1.1 billion at December 31, 2001. Cash of
$199.1 million generated by repurchase agreements is included at December 31,
2001. Cash provided by operating activities was $281.2 million in 2002,
compared to $374.0 million in 2001. The decline is primarily due to reduced
net income in 2002.
During the year ended December 31, 2002, Diamond Offshore spent $187.7
million, including capitalized interest expense, for rig upgrades. These
expenditures were primarily for the deepwater upgrade of the Ocean Rover
($98.4 million) which is expected to be completed in July 2003, upgrades to
six of Diamond Offshore's jack-ups ($50.7 million) of which three were
completed during 2002 and three are expected to be completed during 2003, and
the deepwater upgrade of the Ocean Baroness ($31.4 million) which was
completed in March 2002. Diamond Offshore expects to spend approximately $123
million for rig upgrade capital expenditures during 2003 for the completion of
the Ocean Rover upgrade ($80.0 million) and the three remaining jack-up
upgrades ($43.0 million).
The significant upgrade of Diamond Offshore's semisubmersible rig, the Ocean
Baroness, to high specification capabilities resulted in an enhanced version
of Diamond Offshore's previous Victory-class upgrades. The upgrade was similar
to the upgrade being performed on the Ocean Rover. Diamond Offshore took
delivery of the Ocean Baroness in January 2002. The approximate cost of the
upgrade was $169.0 million.
In 2002 Diamond Offshore began a two year program to expand the capabilities
of its jack-up fleet by significantly upgrading six of its 14 jack-up rigs.
Diamond Offshore expects to spend approximately $100.0 million on the program,
and as of December 31, 2002, has spent $57.0 million.
All of Diamond Offshore's upgrade projects are subject to risks of delay or
cost overruns that are inherent in any large construction project.
Diamond Offshore purchased the semisubmersible drilling rig Omega for $65.0
million in the first quarter of 2003.
During the year ended December 31, 2002, Diamond Offshore spent $86.1
million in association with its ongoing rig equipment replacement and
enhancement programs and to meet other corporate requirements. These
expenditures included purchases of drill pipe, anchor chain, riser and other
drilling equipment. In addition, Diamond Offshore spent $68.5 million for the
purchase of the third-generation semisubmersible drilling rig, West Vanguard,
renamed Ocean Vanguard. Diamond Offshore has budgeted $111.3 million for 2003
capital expenditures associated with its ongoing rig equipment replacement and
enhancement programs and other corporate requirements.
Cash required to meet Diamond Offshore's capital commitments is determined
by evaluating rig upgrades to meet specific customer requirements and by
evaluating Diamond Offshore's ongoing rig equipment replacement and
enhancement programs, including water depth and drilling capability upgrades.
It is the opinion of Diamond Offshore's management that operating cash flows
and existing cash reserves will be sufficient to meet these capital
commitments; however, periodic assessments will be made based on industry
conditions. In addition, Diamond Offshore may, from time to time, issue debt
or equity securities, or a combination thereof, to finance capital
expenditures, the acquisition of assets and businesses or for general
corporate purposes. Diamond Offshore's ability to issue any such securities
will be dependent on Diamond Offshore's results of operations, its current
financial condition, current market conditions and other factors beyond its
control.
71
Bulova
For the year ended December 31, 2002, net cash utilized by operations was
$7.3 million as compared to net cash provided of $15.9 million in 2001. The
decrease in net cash flow is primarily the result of an increase in inventory
purchases related to the introduction of the Wittnauer product line, the
Harley Davidson licensed product, and the corresponding increase in accounts
receivable due to increased sales volume. These increases were partially
offset by a change in timing of accounts payable and accrued expenses.
Bulova's cash and cash equivalents, and short-term investments amounted to
$10.1 million at December 31, 2002, compared to $18.9 million at December 31,
2001.
Bulova and the Company have a credit agreement which provides, under terms
and conditions set forth therein, for unsecured loans to Bulova by the Company
from time to time, in principal amounts aggregating up to $50.0 million.
Bulova has not utilized this credit agreement since 1995 and there are no
amounts outstanding. Bulova may require working capital advances under this
credit agreement to fund its capital expenditures and working capital
requirements associated with product line extensions and international
expansion efforts.
Majestic Shipping
During 2002 subsidiaries of Hellespont acquired from a Korean shipyard three
new 442,500 deadweight ton, ultra-large crude carrying ships. A fourth such
ship has been contracted for with delivery expected by the end of the first
quarter of 2003. These subsidiaries were purchased by Hellespont from Majestic
at the Company's carrying value, excluding pretax capitalized interest expense
of $3.1 million, in March 2002. In partial consideration for this purchase,
Hellespont issued to Majestic a promissory note in the principal amount of
$57.5 million, which remains outstanding. The total cost of the three ships
delivered in 2002 amounted to approximately $277.8 million, and the fourth
ship is expected to cost approximately $93.0 million. Each ship has been, or
is expected to be, financed in part by $50.0 million of bank debt, for an
aggregate amount of up to $200.0 million of bank debt, guaranteed by
Hellespont. As of December 31, 2002, $150.0 million principal amount of this
debt was outstanding. The Company has agreed to provide credit support for
this bank debt by making available to the borrowers an operating cash flow
credit facility of up to an aggregate amount of $25.0 million, none of which
is outstanding.
Parent Company
On February 6, 2002, the Company sold 40.3 million shares of a new class of
its common stock, referred to as Carolina Group stock, for net proceeds of
$1.1 billion. Proceeds from this sale have been allocated to the Loews Group
and were used for general corporate purposes.
As of December 31, 2002, there were 185,441,200 shares of Loews Common Stock
outstanding. During 2002, the Company purchased 6,065,600 shares of Loews
Common Stock at an aggregate cost of $343.5 million. During 2002, the Company
purchased 2,717,876 shares of CNA common stock at an aggregate cost of $73.1
million. The Company also purchased 340,000 shares of Carolina Group Stock
during 2002, for the account of the Carolina Group, at an aggregate cost of
$7.7 million. Depending on market conditions, the Company from time to time
may purchase shares of its, and its subsidiaries', outstanding common stock in
the open market or otherwise. In addition, in December 2002 the Company
purchased from CNA $750.0 million of CNA series H cumulative preferred stock.
The Company continues to pursue conservative financial strategies while
seeking opportunities for responsible growth. These include the expansion of
existing businesses, full or partial acquisitions and dispositions, and
opportunities for efficiencies and economies of scale.
INVESTMENTS
Investment activities of non-insurance companies include investments in
fixed income securities, equity securities including short sales, derivative
instruments and short-term investments, and are carried at fair value. Equity
securities, which are considered part of the Company's trading portfolio,
short sales and derivative instruments are marked to market and reported as
investment gains or losses in the Consolidated Statements of Operations.
The Company enters into short sales and invests in certain derivative
instruments for a number of purposes, including: (i) asset and liability
management activities, (ii) income enhancements for its portfolio management
strategy, and (iii) to benefit from anticipated future movements in the
underlying markets. If such movements do not occur as anticipated, then
significant losses may occur.
72
Monitoring procedures include senior management review of daily detailed
reports of existing positions and valuation fluctuations to ensure that open
positions are consistent with the Company's portfolio strategy.
The credit exposure associated with these instruments is generally limited
to the positive market value of the instruments and will vary based on changes
in market prices. The Company enters into these transactions with large
financial institutions and considers the risk of nonperformance to be remote.
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex, nor do these instruments contain embedded
leverage features which would expose the Company to a higher degree of risk.
See "Results of Operations," "Quantitative and Qualitative Disclosures about
Market Risk" and Note 4 of the Notes to Consolidated Financial Statements
included in Item 8 of this Report for additional information with respect to
derivative instruments, including recognized gains and losses on these
instruments.
Insurance
The significant components of CNA's investment income are presented in the
following table:
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions)
Fixed maturity securities $ 1,854.1 $ 1,823.3 $ 1,738.7
Short-term investments 62.2 134.7 200.6
Limited partnerships (33.9) 47.3 293.0
Equity securities 65.4 37.0 51.0
Interest on funds withheld and
other deposits (239.6) (241.4) (86.9)
Other 81.6 113.5 97.9
- ------------------------------------------------------------------------------
Total investment income 1,789.8 1,914.4 2,294.3
Investment expenses (59.9) (58.3) (47.8)
- ------------------------------------------------------------------------------
Investment income-net $ 1,729.9 $ 1,856.1 $ 2,246.5
==============================================================================
CNA experienced lower investment income in 2002 as compared with 2001. The
decrease was due primarily to decreased limited partnership results and lower
investment yields, partially offset by $34.0 million of dividend income from
Canary Wharf Group plc ("Canary Wharf"). See the Reinsurance section above for
additional information for interest costs on funds withheld and other
deposits, which is included in investment income, net. The interest costs on
these contracts increased significantly in 2001 because of ceded losses
resulting from the second quarter 2001 reserve strengthening and the WTC
event. The decline in limited partnership income was primarily attributable to
many of the same factors that impacted the broader financial markets. Limited
partnership investment performance, particularly high yield bond and equity
strategies, was adversely affected by overall market volatility including
concerns over corporate accounting practices and credit deterioration.
CNA experienced lower investment income in 2001 as compared with 2000 due
primarily to the decrease in limited partnership income as well as the
increase in interest on funds withheld and other deposits. The decline in
limited partnership income was primarily attributable to many of the same
factors that impacted the broader financial markets. The bond segment of the
investment portfolio yielded 6.0% in 2002, 6.4% in 2001 and 6.7% in 2000.
73
The components of CNA's net investment (losses) gains are presented in the
following table:
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions)
Investment (losses) gains:
Fixed maturity securities:
U.S. government bonds $ 391.6 $ 233.3 $ 95.7
Corporate and other taxable bonds (557.0) (5.3) (171.1)
Tax-exempt bonds 48.0 53.9 13.1
Asset-backed bonds 36.5 75.6 (65.0)
Redeemable preferred stock (27.9) (21.5) (3.2)
- ------------------------------------------------------------------------------
Total fixed maturity securities (108.8) 336.0 (130.5)
Equity securities (152.8) 1,094.9 1,116.0
Derivative securities (52.1) (5.0) 10.5
Other invested assets 65.1 (148.9) 35.6
Allocated to participating policyholders'
and minority interests (3.6) (15.0) (3.5)
- ------------------------------------------------------------------------------
Total investment (losses) gains (252.2) 1,262.0 1,028.1
Income tax benefit (expense) 103.3 (445.4) (358.6)
Minority interest 15.9 (101.8) (87.9)
- ------------------------------------------------------------------------------
Net investment (losses) gains $ (133.0) $ 714.8 $ 581.6
==============================================================================
Net investment results decreased $847.8 million in 2002 as compared with
2001. This decline was due primarily to the change in net investment gains
(losses) on Other Insurance segment taxable bonds and equity securities. The
$321.0 million increase in realized losses (after tax and minority interest)
of Other Insurance segment taxable bonds relates primarily to impairment
charges of $377.0 million recorded in various market sectors, the most
significant being the telecommunications sector. The $728.0 million change in
net investment gains (losses) (after tax and minority interest) of equity
securities relates primarily to CNA's 2001 gain of $566.0 million for the sale
of Global Crossing Ltd. common stock ("Global Crossing") and closing of the
related hedge agreements. Also included was $140.4 million (after tax and
minority interest) of 2002 impairments recorded in various market sectors.
Also, during 2002, CNA completed the sale of several businesses, including
CNA Re U.K., the London-based reinsurer. Included in 2002 net realized
investment results was a $62.1 million gain (after tax and minority interest)
resulting from the sale of CNA Re U.K., which included a $34.1 million
reduction of the previously recognized impairment loss on CNA Re U.K. The
impairment loss recorded in 2001 for the sale of CNA Re U.K. and other
subsidiaries was $162.0 million after tax and minority interest. Further
details of these transactions are discussed below.
Net realized investment gains increased $133.0 million in 2001 as compared
with 2000. This increase was due primarily to gains from closing the hedge
agreements, which were entered into during March 2000, related to CNA's
investment in Global Crossing of $566.0 million in 2001 as compared with
$274.0 million in 2000 as well as gains of $50.0 million, resulting from the
sale of a New York real estate property and gains from the sale of fixed
maturity security investments. This improvement was partially offset by
estimated losses recorded for the planned dispositions of certain operations,
principally CNA Re U.K. described in more detail below as well as decreases in
after tax and minority interest gains from the sale of Canary Wharf of $30.0
million in 2001 as compared with $251.0 million in 2000.
A primary objective in the management of the fixed maturity and equity
portfolios is to maximize total return relative to underlying liabilities and
respective liquidity needs. In achieving this goal, assets may be sold to take
advantage of market conditions or other investment opportunities or credit and
tax considerations. This activity will produce realized gains and losses.
CNA classifies its fixed maturity securities (bonds and redeemable preferred
stocks) and its equity securities as available-for-sale, and as such, they are
carried at fair value. The amortized cost of fixed maturity securities is
adjusted for amortization of premiums and accretion of discounts to maturity,
which is included in investment income, net. Changes in fair value are
reported as a component of other comprehensive income.
74
The following table provides further detail of gross realized gains and
losses on fixed maturity and equity securities:
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions)
Net realized gains (losses) on fixed
maturity and equity securities:
Fixed maturity securities:
Gross realized gains $ 1,009.0 $ 936.0 $ 434.0
Gross realized losses (1,118.0) (600.0) (564.0)
- ------------------------------------------------------------------------------
Net realized (losses) gains on
fixed maturity securities (109.0) 336.0 (130.0)
- ------------------------------------------------------------------------------
Equity securities:
Gross realized gains 251.0 1,335.0 1,336.0
Gross realized losses (409.0) (240.0) (220.0)
- ------------------------------------------------------------------------------
Net realized (losses) gains on
equity securities (158.0) 1,095.0 1,116.0
- ------------------------------------------------------------------------------
Net realized (losses) gains on fixed
maturity and equity securities $ (267.0) $ 1,431.0 $ 986.0
==============================================================================
The largest realized losses from sales of securities aggregated by issuer
for the year ended December 31, 2002 totaled $254.0 million. The following
table provides details of those largest realized losses aggregated by issuer
including: the fair value of the securities at sales date, the amount of the
loss recorded and the period of time that the security had been in an
unrealized loss position prior to sale. The period of time that the security
had been in an unrealized loss position prior to sale can vary due to the
timing of individual security purchases. A narrative providing the industry
sector along with the facts and circumstances giving rise to the loss is
provided for each issuer.
Fair Months in
Value on Unrealized
Date of Loss Loss Prior
Description of Issuer Sale on Sale to Sale
- ------------------------------------------------------------------------------------------------
(In millions)
U.S. Treasury (a) $ 7,738.0 $ 61.0 Various, 1-24+
An industrial power producer ("IPP") and trader
of deregulated energy commodities and energy-
related risk management products (b) 113.0 46.0 Various, 0-12
A company, which operated moderately-priced
restaurants in the United States and has
filed bankruptcy (c) 28.0 24+
A wireless communication company that offers
an integrated tool with digital cellular,
text paging and two-way radio feature (d) 39.0 18.0 Various, 7-24+
A major U.S. airline carrier that filed for
bankruptcy in December of 2002 (e) 11.0 17.0 Various, 0-24+
A large telecommunication company that primarily
provides wired and wireless telephone services (f) 182.0 15.0 Various, 0-12
A telecommunication equipment company that
builds, designs and delivers network
communication (g) 17.0 15.0 0-6
A telephone company located in Canada and is
a subsidiary of a U.S. company (h) 5.0 15.0 Various, 0-12
A large cable and telecommunications company
located in the U.S. (i) 37.0 14.0 0-6
A provider of employee health and welfare products,
administration services, insurance brokerage
and related consulting services (j) 37.0 13.0 0-6
A major domestic automobile manufacturer (k) 371.0 12.0 Various, 0-12
- ------------------------------------------------------------------------------------------------
$ 8,550.0 $ 254.0
================================================================================================
- ------------
(a) During 2002, the losses recorded in this asset class were due to changes
in interest rates and certain trading for duration management purposes.
Treasury bonds are used in many portfolios as duration management tools and
for liquidity in the course of asset/liability portfolio management.
75
(b) The pressure to the IPP sector began in April of 2002. At July 31, 2002,
this issuer's financial condition was in good standing. A decision was made to
reduce the portfolio's overall exposure to this sector including this issuer.
(c) The security had been previously impaired and continued to be held in
anticipation of proceeds from asset sales and liquidation of restaurant
holdings that did not materialize.
(d) The issuer anticipated participating in proposed spectrum reallocation
that was being reviewed by the Federal Communications Commission. This process
was held up in the courts and took longer than expected. The trades that
generated the losses took place in the fourth quarter of 2002. The sales were
the result of a program to reduce exposures in this sector.
(e) Securities currently held have been impaired. These losses relate to
trades that took place prior to impairment to reduce issuer exposure and
securities with less desirable collateral.
(f) These losses were primarily attributable to the sale of fixed income and
convertible preferred securities. The bonds were sold in a rapidly
deteriorating market due to sector and issuer pressures.
(g) These losses were generated by positions primarily held in convertible
preferred stock holdings. The price decline reflects the pressures of the
issuer, sector and general equity market conditions.
(h) A portion of these securities were sold to reduce the overall position in
the telecom sector. The issuer reported a deterioration of their financial
condition and lost the financial support of its parent. The remaining
securities held were impaired when new financial information was revealed in
2002.
(i) The losses are related to the sale of securities on early news of alleged
fraud and improper accounting practices. The value of securities held fell
rapidly and were impaired prior to the issuer filing bankruptcy.
(j) The original holding was a private convertible preferred stock. The
issuer went public and all equity holders were required to convert to the new
common stock. At the time of the initial public offering, market conditions
negatively affected the transaction as originally planned. These losses
reflect the difference in the market value of the new common shares at the
time of issue and the basis of the original invested securities.
(k) Losses realized were attributable to reducing exposure to the credit and
exchanging owned bonds for newly issued bonds with more desirable maturity
structures. Losses represent 3% of the consideration for bonds sold.
Invested assets are exposed to various risks, such as interest rate, market
and credit. 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
impact on the Company's results of operations or equity.
A significant judgment in the valuation of investments is the determination
of when an other-than-temporary decline in value has occurred. CNA follows a
consistent and systematic process for impairing securities that sustain other-
than-temporary declines in value. CNA has established a committee responsible
for the impairment process. This committee, referred to as the Impairment
Committee, is made up of three officers appointed by CNA's Chief Financial
Officer. The Impairment Committee is responsible for analyzing watch list
securities on at least a quarterly basis. The watch list includes individual
securities that fall below certain thresholds or that exhibit evidence of
impairment indicators including, but not limited to, a significant adverse
change in the financial condition and near term prospects of the investment or
a significant adverse change in legal factors, the business climate or credit
ratings.
When a security is placed on the watch list, it is monitored for further
market value changes and additional news related to the issuer's financial
condition. The focus is on objective evidence that may influence the
evaluation of impairment factors.
The decision to impair a security incorporates both quantitative criteria
and qualitative information. The Impairment Committee considers a number of
factors including, but not limited to: (a) the length of time and the extent
to which the market value has been less than book value, (b) the financial
condition and near term prospects of the issuer, (c) the intent and ability of
CNA to retain its investment for a period of time sufficient to allow for any
anticipated recovery in value, (d) whether the debtor is current on interest
and principal payments and (e) general market conditions and industry or
sector specific factors.
The Impairment Committee's decision to impair a security is primarily based
on whether the security's fair value is likely to remain significantly below
its book value in light of all of the factors considered. For securities that
are impaired, the security is written down to fair value and the resulting
losses are recognized as investment losses in the Consolidated Statements of
Operations.
76
Realized investment losses included $890.0, $129.0 and $72.0 million of
pretax impairment losses for the years ended December 31, 2002, 2001 and 2000.
The impairments recorded in 2002 were primarily the result of the continued
credit deterioration on specific issuers in the bond and equity markets and
the effects on such markets due to the overall slowing of the economy.
For the year ended December 31, 2002, the impairment losses recorded related
primarily to corporate bonds in the communications industry sectors including
$129.0 million related to WorldCom Inc., $74.0 million related to Adelphia
Communication Corporation, $60.0 million for Charter Communications, $57.0
million for AT&T Canada, and $53.0 million for Telewest PLC.
For the year ended December 31, 2001 the impairment losses recorded related
primarily to corporate bonds and equities in the communications industry
sector including $31.0 million for MedicaLogic/Medscape, Inc. and $27.0
million for At Home Corporation.
For the year ended December 31, 2000 the impairment losses recorded related
primarily to corporate bonds and equities and were largely spread amongst the
consumer, financial, and communications industry sectors including $14.0
million for Specialty Foods Corporation.
If the deterioration in these industry sectors continues in future periods
and CNA continues to hold these securities, CNA is likely to have additional
impairments in the future.
During the second quarter of 2001, CNA announced its intention to sell
certain businesses. The assets being held for disposition included CNA Re U.K.
and certain other businesses. Based upon the impairment analyses performed at
that time, CNA anticipated that it would realize losses in connection with
those planned sales. In determining the anticipated loss from these sales, CNA
estimated the net realizable value of each business being held for sale. An
estimated loss of $278.4 million (after tax and minority interest) was
initially recorded in the second quarter of 2001. This loss was reported in
other realized investment losses in the Consolidated Statements of Operations.
In the fourth quarter of 2001, CNA sold certain businesses as planned. The
realized after tax loss applicable to these businesses recognized in the
second quarter of 2001 was $33.1 million (after tax and minority interest).
Revenues of these businesses included in the years ended December 31, 2001 and
2000 totaled approximately $30.0 and $37.0 million. These businesses
contributed approximately $9.6 and $6.9 million (after tax and minority
interest) of net losses in the years ended December 31, 2001 and 2000.
CNA regularly updates its impairment analyses and adjusts its loss as
necessary. Based on these updated analyses the impairment loss was reduced by
approximately $150.7 million (after tax and minority interest) in the fourth
quarter of 2001, primarily because the net assets of the businesses had been
significantly diminished by their operating losses, including adverse loss
reserve development recognized by CNA Re U.K. in the fourth quarter of 2001.
The reduction of the impairment was included in investment gains in the
Consolidated Statements of Operations.
The statutory surplus of CNA Re U.K. was below the required regulatory
minimum surplus level at December 31, 2001. CCC contributed $120.0 million of
capital on March 25, 2002 bringing the capital above the regulatory minimum.
On October 31, 2002, CNA completed the sale of CNA Re U.K. to Tawa. The sale
includes business underwritten since inception by CNA Re U.K., except for
certain risks retained by CCC as discussed below. In October, the sale was
approved in the United Kingdom by the Financial Services Authority ("FSA") and
by the Illinois Insurance Department. This sale does not impact CNA Re's on-
going U.S.-based operations.
The purchase price was $1, subject to adjustments based primarily upon the
results of operations and realized foreign currency losses of CNA Re U.K. The
final purchase price adjustments were prepared by Tawa and have been agreed to
by CNA. Under the terms of the purchase price adjustment, CCC is entitled to
receive $5.0 million from Tawa after Tawa is able to legally withdraw funds
from the former CNA Re U.K. entities. CCC has also committed to contribute up
to $5.0 million to the former CNA Re U.K. entities over a four-year period
beginning in 2010 should the FSA deem those entities to be undercapitalized.
The purchase price adjustment related to foreign currency losses resulted in
CNA contributing additional capital to CNA Re U.K. of $11.0 million. As the
sale and related agreements have now been completed, CNA has finalized its
impairment analysis based upon the terms of the completed transactions. As
such, in
77
the fourth quarter of 2002, the impairment loss was reduced by approximately
$33.9 million (after tax and minority interest). The reduction of the
impairment was included in net realized investment gains.
Concurrent with the sale, several reinsurance agreements under which CCC had
provided retrocessional protection to CNA Re U.K. were terminated. As part of
the sale, CNA Re U.K.'s net exposure to all IGI Program liabilities was
assumed by CCC. Further, CCC is providing a $100.0 million stop loss cover
attaching at carried reserves on CNA Re U.K.'s 2001 underwriting year
exposures for which CCC received premiums of $25.0 million.
CNA Re U.K. had revenues of approximately $48.0, $280.0 and $605.0 million
for the years ended December 31, 2002, 2001 and 2000. CNA Re U.K. net losses
were $19.7, $327.3 and $137.3 million for the years ended December 31, 2002,
2001 and 2000. The assets and liabilities of CNA Re U.K., including the
effects of the concurrent transactions, were approximately $2,442.0 and
$2,357.0 million at the date of sale and $2,557.0 and $2,541.0 million as of
December 31, 2001.
Substantially all of CNA's invested assets are marketable securities
classified as available-for-sale in the accompanying consolidated financial
statements. Accordingly, changes in fair value for these securities are
reported in other comprehensive income.
The following table details the carrying value of CNA's general and separate
account investment portfolios:
December 31 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
General account investments:
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 1,376.0 3.9% $ 5,081.0 14.2%
Asset-backed securities 8,208.0 23.2 7,723.0 21.6
States, municipalities and political
subdivisions-tax-exempt 5,074.0 14.4 2,720.0 7.6
Corporate securities 7,591.0 21.5 9,587.0 26.8
Other debt securities 3,827.0 10.8 3,816.0 10.6
Redeemable preferred stock 69.0 0.2 48.0 0.1
Options embedded in convertible debt
securities 130.0 0.4 189.0 0.5
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 26,275.0 74.4 29,164.0 81.4
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 461.0 1.3 996.0 2.8
Non-redeemable preferred stock 205.0 0.6 342.0 0.9
- ------------------------------------------------------------------------------------------------
Total equity securities 666.0 1.9 1,338.0 3.7
- ------------------------------------------------------------------------------------------------
Short-term investments 7,008.0 19.9 3,740.0 10.4
Limited partnerships 1,060.0 3.0 1,307.0 3.7
Other investments 284.0 0.8 277.0 0.8
- ------------------------------------------------------------------------------------------------
Total general account investments $ 35,293.0 100.0% $ 35,826.0 100.0%
================================================================================================
78
December 31 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Separate account investments:
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 166.0 5.3% $ 244.0 6.5%
Asset-backed securities 869.0 27.8 1,022.0 27.0
Corporate securities 812.0 26.0 925.0 24.5
Other debt securities 165.0 5.3 156.0 4.1
Redeemable preferred stock 2.0 0.1
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 2,014.0 64.5 2,347.0 62.1
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 112.0 3.6 149.0 4.0
Non-redeemable preferred stock 6.0 0.2 12.0 0.3
- ------------------------------------------------------------------------------------------------
Total equity securities 118.0 3.8 161.0 4.3
- ------------------------------------------------------------------------------------------------
Short-term investments 276.0 8.8 394.0 10.4
Limited partnerships 327.0 10.5 342.0 9.1
Other investments 387.0 12.4 534.0 14.1
- ------------------------------------------------------------------------------------------------
Total separate account investments $ 3,122.0 100.0% $ 3,778.0 100.0%
================================================================================================
CNA's general and separate account investment portfolio consists primarily
of publicly traded government bonds, asset-backed securities, mortgage-backed
securities, municipal bonds and corporate bonds.
Investments in the general account had a total net unrealized gain of $887.0
million at December 31, 2002 compared with $345.0 million at December 31,
2001. The unrealized position at December 31, 2002 was composed of a net
unrealized gain of $742.0 million for fixed maturities, a net unrealized gain
of $147.0 million for equity securities and a net unrealized loss of $2.0
million for short term securities. The unrealized position at December 31,
2001 was composed of a net unrealized gain of $194.0 million for fixed
maturities, a net unrealized gain of $170.0 million for equity securities and
a net unrealized loss of $19.0 million for short term securities.
Unrealized gains (losses) on fixed maturity and equity securities are
presented in the following tables:
Cost or Gross Unrealized Net
Amortized ------------------ Unrealized
December 31, 2002 Cost Gains Losses Gain (Loss)
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies $ 1,266.0 $ 114.0 $ 4.0 $ 110.0
Asset-backed securities 7,888.0 336.0 16.0 320.0
States, municipalities and political
subdivisions-tax-exempt 4,966.0 151.0 43.0 108.0
Corporate securities 7,439.0 487.0 335.0 152.0
Other debt securities 3,780.0 284.0 237.0 47.0
Redeemable preferred stock 64.0 5.0 5.0
Options embedded in convertible debt
Securities 130.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 25,533.0 1,377.0 635.0 742.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 310.0 166.0 15.0 151.0
Non-redeemable preferred stock 209.0 3.0 7.0 (4.0)
- ------------------------------------------------------------------------------------------------
Total equity securities 519.0 169.0 22.0 147.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities $ 26,052.0 $ 1,546.0 $ 657.0 $ 889.0
================================================================================================
79
Cost or Gross Unrealized Net
Amortized ------------------ Unrealized
December 31, 2001 Cost Gains Losses Gain (Loss)
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies $ 5,002.0 $ 109.0 $ 30.0 $ 79.0
Asset-backed securities 7,603.0 139.0 19.0 120.0
States, municipalities and political
subdivisions-tax-exempt 2,748.0 19.0 47.0 (28.0)
Corporate securities 9,569.0 247.0 229.0 18.0
Other debt securities 3,811.0 152.0 147.0 5.0
Redeemable preferred stock 48.0 1.0 1.0
Options embedded in convertible debt
securities 189.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 28,970.0 667.0 473.0 194.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 820.0 326.0 150.0 176.0
Non-redeemable preferred stock 348.0 17.0 23.0 (6.0)
- ------------------------------------------------------------------------------------------------
Total equity securities 1,168.0 343.0 173.0 170.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities $ 30,138.0 $ 1,010.0 $ 646.0 $ 364.0
==============================================================================
CNA's investment policies for both the general and separate accounts
emphasize high credit quality and diversification by industry, issuer and
issue. Assets supporting interest rate sensitive liabilities are segmented
within the general account to facilitate asset/liability duration management.
At December 31, 2002, the carrying value of the general account fixed
maturities was $26,275.0 million, representing 74.0% of CNA's total investment
portfolio. The net unrealized gain of this fixed maturity portfolio was $742.0
million, comprising gross unrealized gains of $1,377.0 million and gross
unrealized losses of $635.0 million. The gross unrealized losses were
primarily in corporate bonds with the largest industry sectors being
Utilities, Communications and Consumer-Cyclical, which as a percentage of
total gross unrealized losses were 23.0%, 17.0% and 16.0%. Gross unrealized
losses in any single issuer did not exceed 0.2% of the carrying value of the
total general account fixed maturity portfolio.
The following table provides the composition of fixed maturity securities
with an unrealized loss in relation to the total of all fixed maturity
securities with an unrealized loss by contractual maturities.
Percent of
Percent of Unrealized
December 31, 2002 Market Value Loss
- ------------------------------------------------------------------------------
Due in one year or less 2.4% 2.1%
Due after one year through five years 18.3 14.0
Due after five years through ten years 28.4 38.6
Due after ten years 45.0 42.8
Asset-backed securities 5.9 2.5
- ------------------------------------------------------------------------------
Total 100.0% 100.0%
==============================================================================
80
The following table summarizes for fixed maturity and equity securities in
an unrealized loss position, the aggregate fair value and gross unrealized
loss by length of time those securities have been continuously in an
unrealized loss position.
Gross
Estimated Unrealized
December 31, 2002 Fair Value Loss
- ------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Investment grade:
0-6 months $ 2,632.0 $ 100.0
7-12 months 361.0 30.0
13-24 months 163.0 21.0
Greater than 24 months 172.0 20.0
- ------------------------------------------------------------------------------
Total investment grade 3,328.0 171.0
- ------------------------------------------------------------------------------
Non-investment grade:
0-6 months 892.0 119.0
7-12 months 473.0 115.0
13-24 months 458.0 157.0
Greater than 24 months 169.0 73.0
- ------------------------------------------------------------------------------
Total non-investment grade 1,992.0 464.0
- ------------------------------------------------------------------------------
Total fixed maturity securities 5,320.0 635.0
- ------------------------------------------------------------------------------
Equity securities:
0-6 months 119.0 13.0
7-12 months 79.0 9.0
13-24 months 4.0
Greater than 24 months 4.0
- ------------------------------------------------------------------------------
Total equity securities 206.0 22.0
- ------------------------------------------------------------------------------
Total fixed maturity and equity securities $ 5,526.0 $ 657.0
==============================================================================
CNA's non-investment grade fixed maturity securities held as of December 31,
2002 that were in an unrealized loss position had a fair value of
approximately $2.0 billion. As discussed previously, a significant judgment in
the valuation of investments is the determination of when an other-than-
temporary impairment has occurred. CNA's Impairment Committee analyzes
securities placed on the watch list on at least a quarterly basis. Part of
this analysis is to monitor the length of time and severity of the decline
below book value of the watch list securities. The following table summarizes
the fair value and gross unrealized loss of non-investment grade securities
categorized by the length of time those securities have been in a continuous
unrealized loss position and further categorized by the severity of the
unrealized loss position in 10.0% increments as of December 31, 2002.
Fair Value as a Percentage of Book Value
Estimated Unrealized -----------------------------------------
December 31, 2002 Fair Value Loss 90-99% 80-89% 70-79% <70%
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Non- investment grade:
0-6 months $ 892.0 $ 119.0 $ 30.0 $ 28.0 $ 28.0 $ 33.0
7-12 months 473.0 115.0 9.0 12.0 24.0 70.0
13-24 months 458.0 157.0 5.0 12.0 50.0 90.0
Greater than 24 months 169.0 73.0 2.0 6.0 15.0 50.0
- ------------------------------------------------------------------------------------------------
Total non-investment grade $1,992.0 $ 464.0 $ 46.0 $ 58.0 $ 117.0 $ 243.0
==============================================================================
The non-investment grade securities that were in an unrealized loss severity
of less than 70.0% for longer than six months as of December 31, 2002
primarily consisted of securities in the utilities, communication and
transportation
81
sectors representing 35.0%, 21.0% and 17.0% respectively of the gross
unrealized loss. The non-investment grade securities that were in an
unrealized loss severity of less than 70.0% for greater than 24 months as of
December 31, 2002 primarily consisted of securities in the communications and
transportation sector representing 40.0% and 34.0%, of the gross unrealized
loss. Unrealized losses in the communication sector are predominately
attributable to a European leader in telecommunication services. The
unrealized losses on securities held in the transportation sector are
primarily comprised of debt issued from a major domestic airline.
As part of the ongoing impairment monitoring process, the Impairment
Committee has evaluated the facts and circumstances based on available
information for each of these non-investment grade securities and determined
that no further impairments were necessary at December 31, 2002. This
determination was based on a number of factors that the Committee regularly
considers including, but not limited to: the issuers' ability to meet current
and future interest and principal payments, an evaluation of the issuers'
financial condition and near term prospects, CNA's sector outlook and
estimates of the fair value of any underlying collateral. In all cases where a
decline in value is judged to be temporary, CNA had the intent and ability to
hold these securities for a period of time sufficient to recover the book
value of its investment through a recovery in the market value of such
securities or by holding the securities to maturity. In many cases, the
securities held are matched to liabilities as part of ongoing asset/liability
duration management. As such the Impairment Committee continually assesses its
ability to hold securities for a time sufficient to recover any temporary loss
in value or until maturity. CNA maintains sufficient levels of liquidity so as
to not impact the asset/liability management process.
CNA's equity securities held as of December 31, 2002 that were in an
unrealized loss position had a fair value of $206.0 million. CNA's Impairment
Committee, under the same process as fixed maturity securities, monitors the
equity securities for other-than-temporary declines in value. In all cases
where a decline in value is judged to be temporary, CNA expects to recover the
book value of its investment through a recovery in the market value of the
security.
The general account portfolio consists primarily of high quality (rated BBB
or higher) bonds, 89.0% and 92.0% of which are rated as investment grade at
December 31, 2002 and 2001, respectively.
The following table summarizes the ratings of CNA's general account bond
portfolio at carrying value:
December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions of dollars)
U.S. Government and affiliated
agency securities $ 1,908.0 7.3% $ 5,715.0 19.6%
Other AAA rated 10,856.0 41.4 9,204.0 31.6
AA and A rated 5,730.0 21.9 6,127.0 21.0
BBB rated 4,930.0 18.8 5,583.0 19.2
Non investment-grade 2,782.0 10.6 2,487.0 8.6
- ------------------------------------------------------------------------------
Total $ 26,206.0 100.0% $ 29,116.0 100.0%
==============================================================================
At December 31, 2002 and 2001, approximately 97% of the general account
portfolio was U.S. Government agencies or was rated by S&P or Moody's
Investors Service ("Moody's"). The remaining bonds were rated by other rating
agencies or CNA management.
82
The following table summarizes the bond ratings of the investments
supporting CNA's separate account products, which guarantee principal and a
specified rate of interest:
December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions of dollars)
U.S. government and affiliated
agency securities $ 161.0 8.6% $ 214.0 10.5%
Other AAA rated 898.0 48.1 1,017.0 49.9
AA and A rated 327.0 17.5 310.0 15.2
BBB rated 414.0 22.2 421.0 20.6
Non investment-grade 68.0 3.6 77.0 3.8
- ------------------------------------------------------------------------------
Total $1,868.0 100.0% $2,039.0 100.0%
==============================================================================
At December 31, 2002 and 2001, more than 99.0% of the separate account
portfolio was U.S. government agencies or was rated by S&P or Moody's. The
remaining bonds were rated by other rating agencies or CNA management.
Non investment-grade bonds, as presented in the tables above, are high-yield
securities rated below BBB by bond rating agencies, as well as other unrated
securities that, in the opinion of management, are below investment-grade.
High-yield securities generally involve a greater degree of risk than
investment-grade securities. However, expected returns should compensate for
the added risk. This risk is also considered in the interest rate assumptions
for the underlying insurance products.
The carrying value of non-traded private placement securities at December
31, 2002 was $237.0 million which represents 0.7% of CNA's total investment
portfolio. These securities were in a net unrealized loss position of $0.4
million at December 31, 2002. Of the non-traded securities, 78.0% are priced
by unrelated third party sources.
Included in CNA's general account fixed maturity securities at December 31,
2002 are $8,208.0 million of asset-backed securities, at fair value,
consisting of approximately 67.0% in collateralized mortgage obligations
("CMOs"), 11.0% in corporate asset-backed obligations, 7.0% in U.S. Government
agency issued pass-through certificates and 15.0% in corporate mortgage-backed
pass-through certificates. The majority of CMOs held are actively traded in
liquid markets and are priced by broker-dealers.
The carrying value of the components of the general account short term
investment portfolio is presented in the following table:
December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions)
Commercial paper $ 1,141.0 $ 1,194.0
U.S. Treasury securities 2,756.0 175.0
Money market funds 2,161.0 1,641.0
Other 950.0 730.0
- ------------------------------------------------------------------------------
Total short term investments $ 7,008.0 $ 3,740.0
==============================================================================
CNA invests in certain derivative financial instruments primarily to reduce
its exposure to market risk (principally interest rate, equity price and
foreign currency risk) and credit risk (risk of nonperformance of underlying
obligor). CNA considers the derivatives in its general account to be held for
purposes other than trading. Derivative securities are recorded at fair value
at the reporting date.
Most derivatives in separate accounts are held for hedging purposes. CNA
uses these derivatives to mitigate market risk by purchasing S&P 500 index
futures in a notional amount equal to the contract liability relating to Life
Operations' Index 500 guaranteed investment contract product.
83
ACCOUNTING STANDARDS
In June of 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 applies to the accounting and reporting
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This Statement applies to legal
obligations associated with the retirement of long-lived assets that result
from the acquisition, construction, development and/or the normal operation of
a long-lived asset, except for certain obligations of lessees. Adoption of
this Statement is required for fiscal years beginning after June 15, 2002.
Adoption of these provisions will not have a material impact on the equity or
results of operations of the Company.
In December of 2002, the FASB issued SFAS No. 148, "Accounting for Stock-
Based Compensation-Transition and Disclosure." The Statement amends SFAS No.
123, "Accounting for Stock-Based Compensation," to provide alternative methods
of transition for an entity that voluntarily changes the accounting for stock-
based employee compensation. The statement also amends the disclosure
provisions to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
compensation. Finally, this Statement amends Accounting Principles Board
("APB") Opinion No. 28, "Interim Financial Reporting," to require disclosure
of those effects in interim financial information. The disclosure and
transition requirements are effective for financial statements of interim or
annual periods ending after December 15, 2002. The amendment to APB No. 28 is
required to be adopted for interim periods ending after December 15, 2002. The
Company has not changed its accounting policies related to stock-based
compensation.
In January of 2003, the 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
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.
FIN 46 applies immediately to variable interest entities created after
January 31, 2003, and to interests obtained after that date to an interim
reporting period beginning after June 15, 2003. The Company is currently
evaluating the impact FIN 46 may have on its financial statements.
FORWARD-LOOKING STATEMENTS
Certain statements made or incorporated by reference by the Company in this
Report are "forward-looking" statements within the meaning of the federal
securities laws. Forward-looking statements include, without limitation, any
statement that may project, indicate or imply future results, events,
performance or achievements, and may contain the words "expect," "intend,"
"plan," "anticipate," "estimate," "believe," "will be," "will continue," "will
likely result," and similar expressions. Statements in this report that
contain forward-looking statements include, but are not limited to, statements
regarding CNA's insurance business relating to asbestos, pollution and mass
tort claims, expected cost savings and other results from restructuring
activities; statements regarding insurance reserves and statements regarding
planned disposition of certain businesses; statements regarding litigation and
developments affecting Lorillard's tobacco business including, among other
things statements regarding claims, litigation and settlement, and statements
regarding regulation of the industry; statements regarding Diamond Offshore's
business including, without limitation, statements with respect to
expenditures for rig conversion and upgrade, oil and gas price levels, and
exploration and production activity.
84
Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
anticipated or projected. Such risks and uncertainties include, among others,
the impact of competitive products, policies and pricing; product and policy
availability and demand and market responses, including the effect of the
absence of applicable terrorism legislation on coverages; development of
claims and the effect on loss reserves; exposure to liabilities due to claims
made by insured and others relating to asbestos remediation and health-based
asbestos impairments, and exposure to liabilities for environmental pollution
and mass tort claims; the sufficiency of CNA's loss reserves and the
possibility of future increases in reserves; the performance of reinsurance
companies under reinsurance contracts; the effects of corporate bankruptcies
and/or accounting restatements (such as Enron and WorldCom) on the financial
markets, and the resulting decline in value of securities held by the Company
which may result in additional charges for impairment; the effects of
corporate bankruptcies and/or accounting restatements on the markets for
directors and officers and errors and omissions coverages; limitations upon
CNA's ability to receive dividends from its insurance subsidiaries imposed by
state regulatory agencies; regulatory limitations and restrictions upon CNA
and its insurance subsidiaries generally; judicial decisions and rulings; the
possibility of downgrades in CNA's ratings by ratings agencies and changes in
rating agency policies and practices, and the results of financing efforts.
The tobacco industry continues to be subject to health concerns relating to
the use of tobacco products and exposure to environmental tobacco smoke,
legislation, including actual and potential excise tax increases, increasing
marketing and regulatory restrictions, governmental regulation, privately
imposed smoking restrictions, litigation, including risks associated with
adverse jury and judicial determinations, courts reaching conclusions at
variance with the general understandings of applicable law, bonding
requirements and the absence of adequate appellate remedies to get timely
relief from any of the foregoing, and the effects of price increases related
to concluded tobacco litigation settlements and excise tax increases on
consumption rates.
In addition to the factors noted above, all aspects of the operations of the
Company and its subsidiaries are affected by the impact of general economic
and business conditions, changes in financial markets (interest rate, credit,
currency, commodities and equities) or in the value of specific investments;
changes in domestic and foreign political, social and economic conditions, the
economic effects of the September 11, 2001 terrorist attacks, the impact of
judicial rulings and jury verdicts, regulatory initiatives and compliance with
governmental regulations and various other matters, many of which are beyond
the control of the Company and its subsidiaries.
Developments in any of these areas, which are more fully described elsewhere
in this Report could cause the Company's results to differ materially from
results that have been or may be anticipated or projected by or on behalf of
the Company and its subsidiaries. These forward-looking statements speak only
as of the date of this Report. The Company expressly disclaims any obligation
or undertaking to release publicly any updates or revisions to any forward-
looking statement contained herein to reflect any change in the Company's
expectations with regard thereto or any change in events, conditions or
circumstances on which any statement is based.
85
SUPPLEMENTAL FINANCIAL INFORMATION
The following supplemental condensed financial information reflects the
financial position, results of operations and cash flows of Loews Corporation
with its investments in CNA and Diamond Offshore accounted for on an equity
basis rather than as consolidated subsidiaries. It does not purport to present
the financial position, results of operations and cash flows of the Company
in accordance with generally accepted accounting principles because it does
not comply with SFAS No. 94, "Consolidation of All Majority-Owned
Subsidiaries." Management believes, however, that this disaggregated financial
data enhances an understanding of the consolidated financial statements by
providing users with a format that management uses in assessing the Company.
The supplemental financial information for 2001 and 2000 has been restated to
reflect an adjustment to the Company's historical accounting for CNA's
investment in life settlement contracts and the related revenue recognition.
See Notes 1 and 23 of the Notes to Consolidated Financial Statements included
in Item 8.
Condensed Balance Sheet Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
December 31 2002 2001
- ------------------------------------------------------------------------------
(In millions) (Restated)
Assets:
Current assets $ 579.9 $ 1,537.2
Investments, primarily short-term instruments 4,071.2 4,202.8
- ------------------------------------------------------------------------------
Total current assets and investments in securities 4,651.1 5,740.0
Investment in CNA 8,513.8 7,188.0
Investment in Diamond Offshore 1,025.1 1,033.5
Other assets 1,436.0 1,078.9
- ------------------------------------------------------------------------------
Total assets $ 15,626.0 $ 15,040.4
==============================================================================
Liabilities and Shareholders' Equity:
Current liabilities $ 1,490.1 $ 2,365.7
Securities sold under agreements to repurchase 480.4
Long-term debt, less current maturities and
unamortized discount 2,440.2 2,427.6
Other liabilities 460.5 337.4
- ------------------------------------------------------------------------------
Total liabilities 4,390.8 5,611.1
Shareholders' equity 11,235.2 9,429.3
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 15,626.0 $ 15,040.4
==============================================================================
86
Condensed Statements of Operations Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Revenues:
Manufactured products and other $ 4,277.6 $ 4,375.4 $ 4,280.3
Investment income 107.2 199.1 258.5
Investment gains (losses) 7.0 101.2 (7.4)
- ------------------------------------------------------------------------------
Total 4,391.8 4,675.7 4,531.4
- ------------------------------------------------------------------------------
Expenses:
Cost of manufactured products sold
and other 3,054.7 3,318.8 3,122.3
Interest 136.5 136.5 140.3
Income tax expense 474.2 470.1 492.1
- ------------------------------------------------------------------------------
Total 3,665.4 3,925.4 3,754.7
- ------------------------------------------------------------------------------
Income from operations 726.4 750.3 776.7
Equity in income (loss) of:
CNA 230.4 (1,373.9) 1,035.4
Diamond Offshore 25.8 80.4 32.0
- ------------------------------------------------------------------------------
Income (loss) from continuing operations 982.6 (543.2) 1,844.1
Discontinued operations-net (31.0) 9.4 4.5
Cumulative effect of changes in
accounting principles-net (39.6) (53.3)
- ------------------------------------------------------------------------------
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6
==============================================================================
87
Condensed Statements of Cash Flow Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Operating Activities:
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Undistributed (earnings) loss
of CNA and Diamond Offshore (190.1) 1,319.2 (1,036.8)
Cumulative effect of changes in
accounting principles 39.6 53.3
Investment (gains) losses (7.0) (101.2) 7.4
Other (19.1) (48.5) 12.5
Changes in assets and liabilities-net (249.5) 186.7 (88.0)
- ------------------------------------------------------------------------------
Total 485.9 822.4 743.7
- ------------------------------------------------------------------------------
Investing Activities:
Net decrease in short-term investments 338.3 243.6 193.2
Securities sold under agreements to
repurchase (480.4) 480.4 (347.8)
Purchase of CNA preferred stock (750.0)
Purchases of CNA common stock (73.1) (978.7)
Other (52.0)
(155.7) (198.1)
- ------------------------------------------------------------------------------
Total (1,017.2) (410.4) (352.7)
- ------------------------------------------------------------------------------
Financing Activities:
Dividends paid to shareholders (166.4) (112.5) (99.7)
(Decrease) increase in long-term debt-net (1.5) (18.2) 26.1
Purchases of treasury shares (351.2) (282.2) (305.7)
Issuance of common stock 1,070.1 0.4
- ------------------------------------------------------------------------------
Total 551.0 (412.5) (379.3)
- ------------------------------------------------------------------------------
Net change in cash 19.7 (0.5) 11.7
Cash, beginning of year 21.1 21.6 9.9
- ------------------------------------------------------------------------------
Cash, end of year $ 40.8 $ 21.1 $ 21.6
==============================================================================
88
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is a large diversified financial services company. As such, it
and its subsidiaries have significant amounts of financial instruments that
involve market risk. The Company's measure of market risk exposure represents
an estimate of the change in fair value of its financial instruments. Changes
in the trading portfolio would be recognized as investment gains (losses) in
the Consolidated Statements of Operations. Market risk exposure is presented
for each class of financial instrument held by the Company at December 31,
assuming immediate adverse market movements of the magnitude described below.
The Company believes that the various rates of adverse market movements
represent a measure of exposure to loss under hypothetically assumed adverse
conditions. The estimated market risk exposure represents the hypothetical
loss to future earnings and does not represent the maximum possible loss nor
any expected actual loss, even under adverse conditions, because actual
adverse fluctuations would likely differ. In addition, since the Company's
investment portfolio is subject to change based on its portfolio management
strategy as well as in response to changes in the market, these estimates are
not necessarily indicative of the actual results which may occur.
Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy employed by the
Company and has responsibility to ensure that the investment positions are
consistent with that strategy and the level of risk acceptable to it. The
Company may manage risk by buying or selling instruments or entering into
offsetting positions.
Equity Price Risk - The Company has exposure to equity price risk as a
result of its investment in equity securities and equity derivatives. Equity
price risk results from changes in the level or volatility of equity prices
which affect the value of equity securities or instruments that derive their
value from such securities or indexes. Equity price risk was measured assuming
an instantaneous 25% change in the underlying reference price or index from
its level at December 31, 2002 and 2001, with all other variables held
constant.
Interest Rate Risk - The Company has exposure to interest rate risk arising
from changes in the level or volatility of interest rates. The Company
attempts to mitigate its exposure to interest rate risk by utilizing
instruments such as interest rate swaps, interest rate caps, commitments to
purchase securities, options, futures and forwards. The Company monitors its
sensitivity to interest rate risk by evaluating the change in the value of its
financial assets and liabilities due to fluctuations in interest rates. The
evaluation is performed by applying an instantaneous change in interest rates
by varying magnitudes on a static balance sheet to determine the effect such a
change in rates would have on the recorded market value of the Company's
investments and the resulting effect on shareholders' equity. The analysis
presents the sensitivity of the market value of the Company's financial
instruments to selected changes in market rates and prices which the Company
believes are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of the
Company's interest sensitive assets and liabilities that were held on December
31, 2002 and 2001 due to instantaneous parallel shifts in the yield curve of
100 basis points, with all other variables held constant.
The interest rates on certain types of assets and liabilities may fluctuate
in advance of changes in market interest rates, while interest rates on other
types may lag behind changes in market rates. Accordingly the analysis may not
be indicative of, is not intended to provide, and does not provide a precise
forecast of the effect of changes of market interest rates on the Company's
earnings or shareholders' equity. Further, the computations do not contemplate
any actions the Company could undertake in response to changes in interest
rates.
The Company's long-term debt, as of December 31, 2002 and 2001 is
denominated in U.S. Dollars. The Company's debt has been primarily issued at
fixed rates, and as such, interest expense would not be impacted by interest
rate shifts. The impact of a 100 basis point increase in interest rates on
fixed rate debt would result in a decrease in market value of $374.6 and
$395.0 million, respectively. A 100 basis point decrease would result in an
increase in market value of $440.1 and $464.6 million, respectively.
Foreign Exchange Rate Risk - Foreign exchange rate risk arises from the
possibility that changes in foreign currency exchange rates will impact the
value of financial instruments. The Company has foreign exchange rate exposure
when it buys or sells foreign currencies or financial instruments denominated
in a foreign currency. This exposure is mitigated by the Company's
asset/liability matching strategy and through the use of futures for those
instruments which are not matched. The Company's foreign transactions are
primarily denominated in Canadian Dollars, British Pounds and the
89
European Monetary Unit. The sensitivity analysis also assumes an instantaneous
20% change in the foreign currency exchange rates versus the U.S. Dollar from
their levels at December 31, 2002 and 2001, with all other variables held
constant.
Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in gold options. Commodity price risk results from
changes in the level or volatility of commodity prices that impact instruments
which derive their value from such commodities. Commodity price risk was
measured assuming an instantaneous change of 20% from their levels at December
31, 2002 and 2001.
The following tables present the Company's market risk by category (equity
markets, interest rates, foreign currency exchange rates and commodity prices)
on the basis of those entered into for trading purposes and other than trading
purposes.
Trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
- ------------------------------------------------------------------------------------------------
December 31 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities $ 430.7 $ 290.0 $ (108.0) $ (73.0)
Options - purchased 23.7 17.5 3.0 6.0
- written (19.2) (7.8) 2.0 (3.0)
Index futures - long (2.0)
Short sales (200.7) (193.4) 50.0 48.0
Separate accounts - Equity securities (a) 6.3 11.7 (2.0) (2.0)
- Other invested assets 326.5 342.1 (5.0) (6.0)
Interest rate (2):
Options on government securities - short (2.5) (2.0)
Interest rate swaps (7.1) (31.0)
Separate accounts - Fixed maturities 145.4 308.4 3.0 (5.0)
- Short term investments 166.6 296.0
Gold (3):
Options - purchased 0.6 2.6 14.0 (3.0)
- written (0.7) (0.4) (20.0)
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) a
decrease in equity prices of 25%, (2) a decrease in interest rates of
100 basis points at December 31, 2002 and an increase in interest rates
of 100 basis points at December 31, 2001 and (3) a decrease in gold
prices of 20% at December 31, 2002 and an increase in gold prices of
20% at December 31, 2001. Adverse changes on options which differ from
those presented above would not necessarily result in a proportionate
change to the estimated market risk exposure.
(a) In addition, the Separate Accounts carry positions in equity index
futures. A decrease in equity prices of 25% would result in market risk
amounting to $(151.0) and $(217.0) million at December 31, 2002 and 2001,
respectively. This market risk would be offset by decreases in
liabilities to customers under variable insurance contracts.
90
Other than trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
- ------------------------------------------------------------------------------------------------
December 31 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities:
General accounts (a) $ 666.1 $ 1,338.5 $ (166.0) $ (322.0)
Separate accounts 112.0 148.6 (28.0) (37.0)
Other invested assets 1,157.6 1,306.9 (133.0) (134.0)
Separate accounts - Other invested assets 387.3 533.0 (97.0) (133.0)
Interest rate (2):
Fixed maturities (a) (b) 27,433.7 31,191.0 (1,650.0) (1,560.0)
Short-term investments (a) 10,161.7 6,734.8 (6.0) (1.0)
Other invested assets 263.0 258.5
Other derivative securities 18.0 16.3 (47.0) (19.0)
Separate accounts (a):
Fixed maturities 1,868.1 2,038.8 (96.0) (120.0)
Short term investments 109.5 98.0
Long-term debt (5,558.0) (5,399.0)
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) a
decrease in equity prices of 25% and (2) an increase in interest rates
of 100 basis points.
(a) Certain securities are denominated in foreign currencies. An assumed 20%
decline in the underlying exchange rates would result in an aggregate
foreign currency exchange rate risk of $(148.0), and $(114.0) million at
December 31, 2002 and 2001, respectively.
(b) Certain fixed maturities positions include options embedded in
convertible debt securities. A decrease in underlying equity prices of
25% would result in market risk amounting to $(24.0) and $(50.0) million
at December 31, 2002 and 2001, respectively.
91
Item 8. Financial Statements and Supplementary Data.
Loews Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------
Assets:
- ------------------------------------------------------------------------------
December 31 2002 2001
- ------------------------------------------------------------------------------
(Dollar amounts in millions, except per share data) (Restated)
Investments (Notes 1, 2, 3 and 4):
Fixed maturities, amortized cost of
$26,688.8 and $31,004.1 $ 27,433.7 $ 31,191.0
Equity securities, cost of $1,002.8
and $1,457.3 1,120.5 1,646.0
Other investments 1,420.8 1,587.3
Short-term investments 10,161.7 6,734.8
- ------------------------------------------------------------------------------
Total investments 40,136.7 41,159.1
Cash 185.4 181.3
Receivables-net (Notes 1 and 7) 16,601.0 19,452.8
Property, plant and equipment-net (Notes 1 and 8) 3,138.2 3,075.3
Deferred income taxes (Note 11) 627.2 738.6
Goodwill (Note 1) 177.8 318.6
Other assets (Notes 1, 14, 15, 17 and 18) 3,999.2 3,858.9
Deferred acquisition costs of insurance
subsidiaries (Note 1) 2,551.4 2,423.9
Separate account business (Notes 1, 3 and 4) 3,102.7 3,798.1
- ------------------------------------------------------------------------------
Total assets $ 70,519.6 $ 75,006.6
==============================================================================
See Notes to Consolidated Financial Statements.
92
Loews Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
Liabilities and Shareholders' Equity:
- ------------------------------------------------------------------------------
December 31 2002 2001
- ------------------------------------------------------------------------------
(Dollar amounts in millions, except per share data) (Restated)
Insurance reserves (Notes 1 and 9):
Claim and claim adjustment expense $ 27,369.9 $ 31,266.2
Future policy benefits 7,408.9 7,306.4
Unearned premiums 4,820.0 4,505.3
Policyholders' funds 580.1 546.0
- ------------------------------------------------------------------------------
Total insurance reserves 40,178.9 43,623.9
Payable for securities purchased (Note 4) 799.1 1,365.6
Securities sold under agreements to
repurchase (Notes 1 and 2) 552.4 1,602.4
Long-term debt, less unamortized discounts
(Notes 3 and 12) 5,651.9 5,920.3
Reinsurance balances payable (Notes 1 and 14) 2,763.3 2,722.9
Other liabilities (Notes 1, 3, 16 and 17) 4,340.8 4,595.2
Separate account business (Notes 1, 3 and 4) 3,102.7 3,798.1
- ------------------------------------------------------------------------------
Total liabilities 57,389.1 63,628.4
- ------------------------------------------------------------------------------
Minority interest 1,895.3 1,948.9
- ------------------------------------------------------------------------------
Commitments and contingent liabilities
(Notes 1, 2, 4, 9, 10, 11, 12, 14, 16,
17, 18, 20 and 21)
Shareholders' equity (Notes 1, 2, 5,
12 and 13):
Preferred stock, $0.10 par value:
Authorized - 100,000,000 shares
Loews common stock, $1.00 par value:
Authorized - 600,000,000 shares
Issued and outstanding - 185,441,200
and 191,493,300 shares 185.4 191.5
Carolina Group stock, $0.01 par value:
Authorized - 600,000,000 shares
Issued - 40,250,000 shares 0.4
Additional paid-in capital 1,114.2 48.2
Earnings retained in the business 9,404.6 8,994.9
Accumulated other comprehensive income 538.3 194.7
- ------------------------------------------------------------------------------
11,242.9 9,429.3
Less treasury stock, at cost (340,000
shares of Carolina Group stock) 7.7
- ------------------------------------------------------------------------------
Total shareholders' equity 11,235.2 9,429.3
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 70,519.6 $ 75,006.6
==============================================================================
93
Loews Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions, except per share data) (Restated) (Restated)
Revenues (Note 1):
Insurance premiums (Note 18) $ 10,209.9 $ 9,285.1 $ 11,385.5
Investment income, net (Note 2) 1,866.9 2,103.8 2,554.6
Investment (losses) gains (Note 2) (208.7) 1,390.4 1,020.7
Manufactured products (including
excise taxes of $667.6, $618.1
and $667.9) 3,963.5 4,011.9 3,912.4
Other 1,663.8 1,978.4 1,810.9
- ------------------------------------------------------------------------------
Total 17,495.4 18,769.6 20,684.1
- ------------------------------------------------------------------------------
Expenses (Note 1):
Insurance claims and policyholders'
benefits (Notes 9 and 18) 8,392.0 11,279.8 9,720.3
Amortization of deferred
acquisition costs 1,790.2 1,803.9 1,880.3
Cost of manufactured products sold
(Note 20) 2,226.5 2,282.9 2,289.4
Other operating expenses 3,166.8 3,642.2 3,286.1
Restructuring and other related
charges (Note 16) (36.8) 251.0
Interest 309.6 332.0 356.9
- ------------------------------------------------------------------------------
Total 15,848.3 19,591.8 17,533.0
- ------------------------------------------------------------------------------
1,647.1 (822.2) 3,151.1
- ------------------------------------------------------------------------------
Income tax expense (benefit) (Note 11) 582.2 (176.0) 1,089.7
Minority interest 82.3 (103.0) 217.3
- ------------------------------------------------------------------------------
Total 664.5 (279.0) 1,307.0
- ------------------------------------------------------------------------------
Income (loss) from continuing operations 982.6 (543.2) 1,844.1
Discontinued operations-net (Note 14) (31.0) 9.4 4.5
Cumulative effect of changes in
accounting principles-net (Note 1) (39.6) (53.3)
- ------------------------------------------------------------------------------
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6
==============================================================================
Net income (loss) attributable
to (Note 5):
Loews common stock:
Income (loss) from continuing
operations $ 841.9 $ (543.2) $ 1,844.1
Discontinued operations-net (31.0) 9.4 4.5
Cumulative effect of changes in
accounting principles-net (39.6) (53.3)
- ------------------------------------------------------------------------------
Loews common stock 771.3 $ (587.1) 1,848.6
Carolina Group stock 140.7
- ------------------------------------------------------------------------------
Total $ 912.0 $ (587.1) $ 1,848.6
==============================================================================
Income (loss) per Loews common share:
Income (loss) from continuing
operations $ 4.49 $ (2.79) $ 9.28
Discontinued operations-net (0.17) .05 .02
Cumulative effect of changes in
accounting principles-net (0.21) (0.27)
- ------------------------------------------------------------------------------
Net income (loss) $ 4.11 $ (3.01) $ 9.30
==============================================================================
Income per Carolina Group share $ 3.50
==============================================================================
Weighted average number of
shares outstanding:
Loews common stock 187.59 195.33 198.73
Carolina Group stock 40.15
See Notes to Consolidated Financial Statements.
94
Loews Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Compre- Loews Earnings Accumulated Common
hensive Loews Carolina Additional Retained Other Stock
Income Common Common Paid-in in the Comprehensive Held in
(Loss) Stock Stock Capital Business Income Treasury
- ------------------------------------------------------------------------------------------------
(In millions, except
per share data)
Balance, December
31, 1999
-as previously
reported $104.5 $ 150.7 $8,705.9 $1,016.6
Prior period
adjustment
(Notes 1 and 23) (193.9)
- ------------------------------------------------------------------------------------------------
Balance December
31, 1999-restated 104.5 150.7 8,512.0 1,016.6
Comprehensive income:
Net income-restated $ 1,848.6 1,848.6
Other comprehensive
losses (Note 13) (259.9) (259.9)
---------
Comprehensive income $ 1,588.7
=========
Dividends paid, $0.50
per share (99.7)
Purchases of common
stock $(305.7)
Retirement of treasury
stock (5.9) (8.5) (291.3) 305.7
Equity in certain
transactions of
subsidiary companies 2.0
- ------------------------------------------------------------------------------------------------
Balance, December
31, 2000-restated 98.6 144.2 9,969.6 756.7
Comprehensive loss:
Net loss-restated $ (587.1) (587.1)
Other comprehensive
losses (Note 13) (562.0) (562.0)
---------
Comprehensive losses $(1,149.1)
=========
Two-for-one stock split 98.6 (98.6)
Dividends paid, $0.58
per share (112.5)
Issuance of common
stock 0.4
Purchases of common
stock (282.2)
Retirement of treasury
stock (5.7) (1.4) (275.1) 282.2
Equity in certain
transactions of
subsidiary companies 3.6
- ------------------------------------------------------------------------------------------------
Balance, December
31, 2001-restated 191.5 48.2 8,994.9 194.7
Comprehensive income:
Net income $ 912.0 912.0
Other comprehensive
gains (Note 13) 343.6 343.6
---------
Comprehensive income $ 1,255.6
=========
Dividends paid:
Loews common stock,
$0.60 per share (112.8)
Carolina Group stock,
$1.34 per share (53.6)
Issuance of Loews
common stock 0.5
Issuance of Carolina
Group stock (Note 1) $ 0.4 1,069.2
Purchases of Loews
common stock (343.5)
Purchases of
Carolina Group stock (7.7)
Retirement of Loews
treasury stock (6.1) (1.5) (335.9) 343.5
Equity in certain
transactions of
subsidiary companies (2.2)
- ------------------------------------------------------------------------------------------------
Balance, December
31, 2002 $ 185.4 $ 0.4 $1,114.2 $ 9,404.6 $ 538.3 $ (7.7)
==============================================================================
See Notes to Consolidated Financial Statements.
95
Loews Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Operating Activities:
Net income (loss) $ 912.0 $ (587.1) $ 1,848.6
Adjustments to reconcile net income
(loss) to net cash provided
(used) by operating activities:
Loss on disposal of discontinued
operations 33.5
Cumulative effect of changes in
accounting principles 39.6 53.3
Investment losses (gains) 208.7 (1,390.4) (1,020.7)
Undistributed earnings 28.5 (92.8) (315.4)
Provision for minority interest 82.3 (103.0) 217.3
Amortization of investments (186.6) (316.0) (370.5)
Depreciation and amortization 325.6 374.7 356.6
Provision for deferred income taxes (7.3) 77.9 515.3
Other non-cash items 42.6 104.5 40.3
Changes in assets and liabilities-net:
Reinsurance receivables (123.2) (4,426.1) (1,729.2)
Other receivables 1,248.4 403.1 74.1
Prepaid reinsurance premiums (124.2) 224.6 10.7
Deferred acquisition costs (162.3) (17.3) (132.2)
Insurance reserves and claims (931.3) 4,615.8 (127.6)
Reinsurance balances payable 144.5 1,341.8 717.1
Other liabilities 584.9 56.6 (219.4)
Trading securities (305.2) 312.5 (157.5)
Transfer of business-reinsurance (41.3)
Other-net (21.3) (93.2) (105.0)
- ------------------------------------------------------------------------------
1,789.2 538.9 (438.8)
- ------------------------------------------------------------------------------
Investing Activities:
Purchases of fixed maturities (81,739.0) (75,150.6) (60,838.3)
Proceeds from sales of fixed
maturities 78,324.8 67,877.4 58,345.0
Proceeds from maturities of fixed
maturities 6,220.0 3,929.7 4,222.3
Purchases of equity securities (914.4) (1,287.2) (1,858.0)
Proceeds from sales of equity
securities 1,197.7 2,325.2 2,941.6
Purchases of property and equipment (514.4) (502.5) (667.2)
Proceeds from sales of property and
equipment 28.2 278.4 36.1
Securities sold under agreements
to repurchase (1,050.0) (643.1) (776.8)
Change in short-term investments (3,381.9) 3,412.6 (687.3)
Dispositions, net of cash acquired (177.6)
Change in other investments 74.1 (175.9) 272.2
- ------------------------------------------------------------------------------
(1,932.5) 64.0 989.6
- ------------------------------------------------------------------------------
96
Loews Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 2002 2001 2000
- ------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Financing Activities:
Dividends paid $ (166.4) $ (112.5) $ (99.7)
Dividends paid to minority interests (30.6) (31.5) (33.5)
Purchases of treasury shares (351.2) (282.2) (305.7)
Purchases of treasury shares by
subsidiaries (43.0) (37.8) (127.9)
Redemption of preferred stock by
subsidiary (150.0)
Issuance of common stock 1,070.1 0.4
Issuance of common stock by subsidiary 49.2
Principal payments on long-term debt (352.9) (1,138.2) (166.6)
Issuance of long-term debt 65.0 1,000.1 476.9
Receipts credited to policyholders 0.5 1.7 4.8
Withdrawals of policyholder account
balances (44.1) (66.0) (137.8)
- ------------------------------------------------------------------------------
147.4 (616.8) (539.5)
- ------------------------------------------------------------------------------
Net change in cash 4.1 (13.9) 11.3
Cash, beginning of year 181.3 195.2 183.9
- ------------------------------------------------------------------------------
Cash, end of year $ 185.4 $ 181.3 $ 195.2
==============================================================================
See Notes to Consolidated Financial Statements.
97
Loews Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Basis of presentation - Loews Corporation is a holding company. Its
subsidiaries are engaged in the following lines of business: property,
casualty and life insurance (CNA Financial Corporation ("CNA"), a 90% 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 54% 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" and
"Registrant" as used herein mean Loews Corporation excluding its subsidiaries.
Principles of consolidation - The consolidated financial statements include
all significant subsidiaries and all material intercompany accounts and
transactions have been eliminated. The equity method of accounting is used for
investments in associated companies in which the Company generally has an
interest of 20% to 50%.
Accounting estimates - The preparation of 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.
Restatement for CNA's Life Settlement Contract Accounting - As a result of a
routine review of CNA's periodic filings by the Division of Corporation
Finance of the Securities and Exchange Commission ("SEC"), the Company has
restated its financial statements. The restated financial statements reflect
an adjustment to the Company's historical accounting for CNA's investment in
life settlement contracts and the related revenue recognition. See Note 23 for
additional information.
Accounting changes - In 2002, the Company implemented the provisions of the
Financial Accounting Standards Board ("FASB") Emerging Issues Task Force
("EITF") Issue No. 00-14, "Accounting for Certain Sales Incentives," EITF
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration
from a Vendor to a Retailer" and EITF Issue No. 01-14 "Income Statement
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred." EITF Issue No. 00-14 addresses the recognition, measurement, and
income statement characterization of sales incentives, including rebates,
coupons and free products or services, offered voluntarily by a vendor without
charge to the customer that can be used in, or that are exercisable by a
customer as a result of, a single exchange transaction. EITF Issue No. 00-25
addresses whether consideration from a vendor to a reseller of the vendor's
products is (i) an adjustment of the selling prices of the vendor's products
and, therefore, should be deducted from revenue when recognized in the
vendor's income statement or (ii) a cost incurred by the vendor for assets or
services received from the reseller and, therefore, should be included as a
cost or an expense when recognized in the vendor's income statement. EITF 01-
14 requires a company to record the gross amount billed to its customers as
revenue as opposed to a reduction of expenses. As a result, reimbursements
received from customers have been reclassified from other operating expenses
to other revenues. In addition, promotional expenses historically included in
other operating expenses were reclassified to cost of manufactured products
sold, or as reductions of revenues from manufactured products. Prior period
amounts were reclassified for comparative purposes. Adoption of these
provisions did not have any impact on the equity or results of operations of
the Company.
In June of 2001, the FASB issued a Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No.
142 changes the accounting for goodwill and intangible assets with indefinite
lives from an amortization method to an impairment-only approach. Amortization
of goodwill and intangible assets with indefinite lives recorded in past
business combinations ceased effective January 1, 2002, upon adoption of SFAS
No. 142. Net income for the year ended December 31, 2002 does not include
amortization expense on goodwill. Had the Company not amortized goodwill in
2001 and 2000, pro forma net (loss) income and the related basic and diluted
earnings per share amounts for Loews common stock would have been as follows:
98
Year Ended December 31 2001 2000
- ------------------------------------------------------------------------------
Net loss Per share Net income Per share
- ------------------------------------------------------------------------------
(In millions)
Results as reported in prior
year - restated $(587.1) $(3.01) $1,848.6 $9.30
Adjusted for goodwill
amortization, after tax and
minority interest 18.9 0.10 22.6 0.11
- ------------------------------------------------------------------------------
Adjusted reported results to
include the impact of the
non-amortization provisions of
SFAS No. 142 $(568.2) $(2.91) $1,871.2 $9.41
==============================================================================
During the third quarter of 2002, the Company completed its initial goodwill
impairment testing and recorded a $39.6 million impairment charge, as adjusted
to reflect purchase accounting adjustments, net of income taxes and minority
interest of $5.8 and $6.4 million, respectively. In accordance with SFAS No.
142, the impairment charge, which primarily relates to CNA's Specialty Lines
and Life Operations, was recorded as a cumulative effect of a change in
accounting principle as of January 1, 2002. Any impairment losses incurred
after the initial application of this standard will be reported in operating
results.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 essentially
applies one accounting model for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
Adoption of these provisions did not have a material impact on the equity or
results of operations of the Company; however, it did impact the income
statement presentation of certain operations sold in 2002.
In June of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes EITF No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The Company adopted the provisions of
SFAS No. 146 for all disposal activities initiated after June 30, 2002. The
adoption of SFAS No. 146 did not have a significant impact on the results of
operations or equity of the Company.
In November of 2002, the FASB issued Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others (an interpretation of SFAS No.
5, 57, and 107 and rescission of FIN 34)." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions are
required on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
Company has implemented the disclosure requirements of FIN 45 and will record
the initial recognition and measurement provisions for any guarantees issued
or modified subsequent to December 31, 2002.
In the first quarter of 2001, the Company adopted SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
(collectively referred to as SFAS No. 133). The initial adoption of SFAS No.
133 did not have a significant impact on the equity of the Company; however,
adoption of SFAS No. 133 resulted in a charge to 2001 earnings of $53.3
million, net of income taxes and minority interest of $33.0 and $8.0 million,
respectively, to reflect the change in accounting principle. Of this
transition amount, approximately $50.5 million, net of income taxes and
minority interest, related to CNA's investments and investment-related
derivatives. Because CNA already carried its investment and investment-related
derivatives at fair value through other comprehensive income, there was an
equal and offsetting favorable adjustment of $50.5 million to shareholders'
equity (accumulated other comprehensive income). The remainder of the
transition adjustment is primarily attributable to collateralized debt
obligation products that are classified as derivatives under SFAS No. 133. See
Note 4 for a complete discussion of the Company's adoption of these accounting
pronouncements.
99
Investments - Investments in securities, which are held principally by
insurance subsidiaries of CNA are carried as follows:
The Company's fixed maturity securities (bonds and redeemable preferred
stocks) and its equity securities held principally by insurance subsidiaries
are classified as available-for-sale and carried at fair value. Changes in
fair value are recorded as a component of other comprehensive income in
shareholders' equity, net of applicable deferred income taxes and
participating policyholders' and minority interest. The amortized cost of
fixed maturity securities is adjusted for amortization of premiums and
accretion of discounts to maturity, which are included in investment income.
Investments are written down to fair value and losses are recognized in income
when a decline in value is determined to be other-than-temporary. See Note 2
for information related to the Company's impairment charges.
For asset-backed securities included in fixed maturity securities, the
Company recognizes income using a constant effective yield based on
anticipated prepayments and the estimated economic life of the securities.
When estimates of prepayments change, the effective yield is recalculated to
reflect actual payments to date and anticipated future payments. The net
investment in the securities is adjusted to the amount that would have existed
had the new effective yield been applied since the acquisition of the
securities. Such adjustments are reflected in investment income.
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 Statements of Operations.
Short-term investments consist primarily of U.S. government securities,
money market funds and commercial paper. These investments are generally
carried at fair value, which approximates amortized cost.
All securities transactions are recorded on the trade date. The cost of
securities sold is generally determined by the identified certificate method.
Investments are written down to estimated fair values, and losses are charged
to income when a decline in value is considered to be other-than-temporary.
Other invested assets include investments in limited partnerships and
certain derivative securities. The Company's limited partnership investments
are recorded at fair value typically reflecting a reporting lag of up to three
months, with changes in fair value reported in investment income. Fair value
of the Company's limited partnership investments represents the Company's
equity in the partnership's net assets as determined by the general partner.
The carrying value of the Company's limited partnership investments was
$1,157.6 and $1,307.0 million as of December 31, 2002 and 2001, respectively.
Limited partnerships are a relatively small portion of the Company's overall
investment portfolio. The majority of the limited partnerships invest in a
substantial number of securities that are readily marketable. The Company is a
passive investor in such partnerships and does not have influence over the
partnership management, who are committed to operate them according to
established guidelines and strategies. These strategies may include the use of
leverage and hedging techniques that potentially introduce more volatility and
risk to the partnerships.
Investments in derivative securities are carried at fair value with changes
in fair value reported as a component of realized gains or losses or other
comprehensive income, depending on their hedge designation. Changes in the
fair value of derivatives securities which are not designated as hedges, are
reported as a component of investment gains or losses in the Consolidated
Statements of Operations.
Derivative financial investments - A derivative is typically defined as an
instrument whose value is "derived" from an underlying instrument, index or
rate, has a notional amount, requires little or no initial investment, and can
be net settled. Derivatives include, but are not limited to, the following
types of investments: interest rate swaps, interest rate caps and floors, put
and call options, warrants, futures, forwards and commitments to purchase
securities and combinations of the foregoing. Derivatives embedded within non-
derivative instruments (such as call options embedded in convertible bonds)
must be split from the host instrument and accounted for in accordance with
SFAS No. 133 when the embedded derivative is not clearly and closely related
to the host instrument. In addition, non-investment instruments, including
certain types of insurance contracts, mainly Collateralized Debt Obligation
100
liabilities ("CDOs") and synthetic guaranteed investment contracts ("synthetic
GICs") that have historically not been considered derivatives, may be
derivatives or contain embedded derivatives under SFAS No. 133.
CDOs represent a credit enhancement product that is typically structured in
the form of a swap. CNA has determined that this product is a derivative under
SFAS No. 133. Changes in the estimated fair value of CDOs, like other
derivative financial instruments with no hedge designation, are recorded in
realized gains or losses as appropriate. CNA did not incur any default losses
in 2002. CNA incurred approximately $25.0 and $13.0 million of default losses
on these products for the years ended December 31, 2001 and 2000,
respectively. CNA is no longer writing this product.
In the normal course of business, CNA, through Group Operations, markets
synthetic GICs to institutional customers. These contracts are accounted for
as derivative financial instruments. Synthetic GICs are guaranteed investment
contracts that simulate the performance of a traditional GIC through the use
of financial instruments. A key difference between a synthetic GIC and a
traditional GIC is that the contract owner owns the financial instruments
underlying the synthetic GIC; whereas, the contract owner owns only the
contract itself with a traditional GIC. CNA mitigates its exposure under these
contracts by maintaining the ability to reset the crediting rate on a
monthly/quarterly basis. This rate reset effectively passes any cash flow
volatility and asset underperformance back to the contract owner.
SFAS No. 133 requires that all derivative instruments be recorded in the
balance sheet at fair value. The Company's derivatives are reported as other
invested assets, with the exception of CDOs and synthetic GICs which are
reported as other assets and/or other liabilities. Embedded derivative
instruments subject to bifurcation are also accounted for on a fair value
basis and reported together with the host contract. If certain criteria are
met, a derivative may be specifically designated as a hedge of exposures to
changes in fair value, cash flows or foreign currency exchange rates. The
accounting for changes in the fair value of a derivative instrument depends on
the intended use of the derivative and the nature of any hedge designation
thereon. The Company's accounting for changes in the fair value of derivative
instruments is as follows:
Nature of Hedge Designation Derivative's Change in Fair Value Reflected in:
- ------------------------------------------------------------------------------