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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission file number 1-6541
LOEWS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-2646102
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
667 Madison Avenue, New York, N.Y. 10021-8087
(Address of principal executive offices) (Zip code)
(212) 521-2000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------ ------
Class Outstanding at May 1, 2003
- ------------------------------ --------------------------
Common stock, $1.00 par value 185,447,050 shares
Carolina Group stock, $0.01 par value 39,910,000 shares
==============================================================================
1
INDEX
Page
Part I. Financial Information No.
-----
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
March 31, 2003 and December 31, 2002 3
Consolidated Condensed Statements of Income
Three months ended March 31, 2003 and 2002 4
Consolidated Condensed Statements of Cash Flows
Three months ended March 31, 2003 and 2002 6
Notes to Consolidated Condensed Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 60
Item 3. Quantitative and Qualitative Disclosures about Market Risk 109
Item 4. Controls and Procedures 112
Part II. Other Information
Item 1. Legal Proceedings 113
Item 6. Exhibits and Reports on Form 8-K 114
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
- --------------------------------------------------------------------------------
- ----------------
(In millions)
March
31, December 31,
2003 2002
- --------------------------------------------------------------------------------
- ----------------
Assets
Investments:
Fixed maturities, amortized cost of $27,557.5 and $26,688.8
$28,656.3 $27,433.7
Equity securities, cost of $1,020.2 and $1,002.8
1,066.1 1,120.5
Other investments
1,463.7 1,420.8
Short-term investments
8,870.1 10,161.7
- --------------------------------------------------------------------------------
- ----------------
Total investments
40,056.2 40,136.7
Cash
213.5 185.4
Receivables-net
18,192.9 16,601.0
Property, plant and equipment-net
3,213.2 3,138.2
Deferred income taxes
514.4 627.2
Goodwill
171.0 177.8
Other assets
4,097.8 3,999.2
Deferred acquisition costs of insurance subsidiaries
2,597.1 2,551.4
Separate account business
3,240.1 3,102.7
- --------------------------------------------------------------------------------
- ----------------
Total assets
$72,296.2 $70,519.6
================================================================================
================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense
$27,445.6 $27,369.9
Future policy benefits
7,575.9 7,408.9
Unearned premiums
5,115.1 4,820.0
Policyholders' funds
568.1 580.1
- --------------------------------------------------------------------------------
- ----------------
Total insurance reserves
40,704.7 40,178.9
Payable for securities purchased
1,915.6 799.1
Securities sold under agreements to repurchase
670.2 552.4
Long-term debt, less unamortized discount
5,528.7 5,651.9
Reinsurance balances payable
2,791.3 2,763.3
Other liabilities
3,968.1 4,340.8
Separate account business
3,240.1 3,102.7
================================================================================
================
Total liabilities
58,818.7 57,389.1
Minority interest
1,902.2 1,895.3
Shareholders' equity
11,575.3 11,235.2
- --------------------------------------------------------------------------------
- ----------------
Total liabilities and shareholders' equity
$72,296.2 $70,519.6
================================================================================
================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Three Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(Restated)
Revenues:
Insurance premiums
$2,380.2 $ 2,836.2
Investment income, net of expense
456.6 463.0
Investment (losses) gains
(95.6) 23.5
Manufactured products (including excise taxes of $156.9 and $180.4)
884.0 1,004.8
Other
324.0 464.8
- --------------------------------------------------------------------------------
- ---------------
Total 3,949.2
4,792.3
- --------------------------------------------------------------------------------
- ---------------
Expenses:
Insurance claims and policyholders' benefits 1,869.8
2,310.1
Amortization of deferred acquisition costs 458.2
440.1
Cost of manufactured products sold 481.2
607.7
Other operating expenses 784.4
875.3
Interest 73.7
76.5
- --------------------------------------------------------------------------------
- ---------------
Total 3,667.3
4,309.7
- --------------------------------------------------------------------------------
- ---------------
281.9
482.6
- --------------------------------------------------------------------------------
- ---------------
Income tax expense 92.9
171.2
Minority interest
(1.0) 28.0
- --------------------------------------------------------------------------------
- ---------------
Total 91.9
199.2
- --------------------------------------------------------------------------------
- ---------------
Income from continuing operations 190.0
283.4
Discontinued operations-net
(31.0)
Cumulative effect of change in accounting principle-net
(39.6)
- --------------------------------------------------------------------------------
- ---------------
Net income $ 190.0
$ 212.8
================================================================================
===============
Net income attributable to:
Loews common stock:
Income from continuing operations $ 161.4
$ 265.4
Discontinued operations-net
(31.0)
Cumulative effect of change in accounting principle-net
(39.6)
- --------------------------------------------------------------------------------
- ---------------
Loews common stock 161.4
194.8
Carolina Group stock 28.6
18.0
- --------------------------------------------------------------------------------
- --------------
Total $ 190.0
$ 212.8
================================================================================
==============
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Continued)
- --------------------------------------------------------------------------------
- ----------------
(In millions, except per share data)
Three
Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(Restated)
Income per Loews common share:
Income from continuing operations $
0.87 $ 1.39
Discontinued operations-net
(0.16)
Cumulative effect of change in accounting principle-net
(0.21)
- --------------------------------------------------------------------------------
- ----------------
Net income $
0.87 $ 1.02
================================================================================
================
Net income per Carolina Group common share $
0.72 $ 0.45
================================================================================
================
Weighted average number of shares outstanding:
Loews common stock
185.45 191.09
Carolina Group stock
39.91 40.25
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Three
Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003
2002
- --------------------------------------------------------------------------------
- ----------------
(Restated)
Operating Activities:
Net income $
190.0 $ 212.8
Adjustments to reconcile net income to net cash used in
operating activities-net
136.5 85.8
Loss on disposal of discontinued operations
31.0
Cumulative effect of change in accounting principle-net
39.6
Changes in assets and liabilities-net:
Reinsurance receivable
(235.7) (155.9)
Other receivables
(175.0) 56.8
Federal income taxes
(33.7) 215.7
Prepaid reinsurance premiums
(116.7) (326.0)
Deferred acquisition costs
(56.8) (38.7)
Insurance reserves and claims
527.9 181.5
Reinsurance balances payable
28.0 159.0
Other liabilities
(339.6) (321.9)
Trading securities
(170.3) (290.2)
Other-net
59.3 15.7
- --------------------------------------------------------------------------------
- ---------------
(186.1) (134.8)
- --------------------------------------------------------------------------------
- ----------------
Investing Activities:
Purchases of fixed maturities
(20,029.3) (16,794.8)
Proceeds from sales of fixed maturities
15,727.3 15,870.4
Proceeds from maturities of fixed maturities
3,536.2 661.0
Securities sold under agreements to repurchase
117.8 (431.3)
Purchases of equity securities
(121.1) (333.4)
Proceeds from sales of equity securities
73.5 285.3
Change in short-term investments
1,270.6 (20.2)
Purchases of property, plant and equipment
(177.1) (100.2)
Proceeds from sales of property, plant and equipment
0.1 90.3
Change in other investments
6.1 (52.1)
- --------------------------------------------------------------------------------
- ----------------
404.1 (825.0)
- --------------------------------------------------------------------------------
- ----------------
6
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Continued)
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Three
Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003
2002
- --------------------------------------------------------------------------------
- ----------------
(Restated)
Financing Activities:
Dividends paid to Loews shareholders (45.7)
(28.7)
Dividends paid to minority interests (7.5)
(7.7)
Issuance of Loews common stock 0.2
0.4
Issuance of Carolina Group stock
1,070.5
Purchases of Loews treasury shares
(104.5)
Purchases of treasury shares by subsidiaries
(16.9)
Principal payments on long-term debt (129.3)
(0.2)
Receipts credited to policyholders 0.3
0.1
Withdrawals of policyholders account balances (7.0)
(13.5)
Other (0.9)
8.2
- --------------------------------------------------------------------------------
- ----------------
(189.9)
907.7
- --------------------------------------------------------------------------------
- ----------------
Net change in cash 28.1
(52.1)
Cash, beginning of period 185.4
181.3
- --------------------------------------------------------------------------------
- ----------------
Cash, end of period $ 213.5
$ 129.2
================================================================================
================
See accompanying Notes to Consolidated Condensed Financial Statements.
7
Loews Corporation and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
1. Basis of Presentation
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property, 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).
On April 11, 2003, the Company entered into an agreement to purchase Texas
Gas Transmission Corporation ("Texas Gas") from The Williams Companies, Inc.
The transaction value is $1.045 billion, which includes $795.0 million in cash
to be paid to the seller and $250.0 million of outstanding debt at Texas Gas.
The closing of the transaction, which is expected to occur in the second
quarter of 2003, is subject to normal and customary conditions. Immediately
following the acquisition of Texas Gas, the Company intends to issue
additional debt through its subsidiaries
Unless the context otherwise requires, the terms "Company" and "Registrant"
as used herein mean Loews Corporation excluding its subsidiaries.
In the opinion of management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as of
March 31, 2003 and December 31, 2002 and the statements of income and changes
in cash flows for the three months ended March 31, 2003 and 2002.
Results of operations for the first three months of each of the years is not
necessarily indicative of results of operations for that entire year.
Reference is made to the Notes to Consolidated Financial Statements in the
2002 Annual Report to Shareholders on Form 10-K which should be read in
conjunction with these consolidated condensed financial statements.
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 2003.
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, the Company has restated
its results of operations for the three months ended March 31, 2002. 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. The impact of this adjustment on operating
results in 2002 was insignificant.
Accounting Changes - Effective January 1, 2002, the Company recorded a $39.6
million goodwill impairment charge as a cumulative effect of a change in
accounting principle, adjusted to reflect purchase accounting adjustments, net
of income taxes and minority interest of $5.8 and $6.4 million, respectively,
primarily related to CNA's Specialty Lines and Life Operations.
8
In June of 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 in January 2003 has not had a material impact on
the Company's results of operations or equity.
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 for variable interest entities created before February
1, 2003, no later than the beginning of the first interim or annual reporting
period beginning after June 15, 2003. The Company is currently evaluating the
impact FIN 46 may have on its consolidated financial statements.
On April 30, 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. The Company is currently in the process of evaluating the impact SFAS
No. 149 may have on its consolidated financial statements.
Stock option plans - The Company has elected to follow Accounting Principles
Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for its employee stock options and
awards. Under APB No. 25, no compensation expense is recognized when the
exercise prices of options equals the fair value (market price) of the
underlying stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
Company to disclose pro forma information regarding option grants made to its
employees. SFAS No. 123 specifies certain valuation techniques that produce
estimated compensation charges for purposes of valuing stock option grants.
These amounts have not been included in the Company's Consolidated Statements
of Operations, in accordance with APB No. 25. Several of the Company's
subsidiaries also maintain their own stock option plans. The pro forma effect
9
of applying SFAS No. 123 includes the Company's share of expense related to
its subsidiaries' plans as well. The Company's pro forma net income and the
related basic and diluted income per Loews common and Carolina Group shares
would have been as follows:
Three Months Ended March 31
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions, except per share data)
(Restated)
Net income:
Loews common stock:
Net income as reported $
161.4 $ 194.8
Deduct: Total stock-based employee compensation expense
determined under the fair value based method, net
(1.3) (0.9)
- --------------------------------------------------------------------------------
- ----------------
Pro forma net income $
160.1 $ 193.9
================================================================================
================
Carolina Group stock:
Net income as reported $
28.6 $ 18.0
Deduct: Total stock-based employee compensation expense
determined under the fair value based method, net
- --------------------------------------------------------------------------------
- ----------------
Pro forma net income $
28.6 $ 18.0
================================================================================
================
Net income per share:
Loews common stock:
As reported $
0.87 $ 1.02
Pro forma
0.86 1.01
Carolina Group stock:
As reported
0.72 0.45
Pro forma
0.72 0.45
================================================================================
================
Comprehensive Income (Loss) - Comprehensive income (loss) includes all
changes to shareholders' equity, except those resulting from investments by
shareholders and distributions to shareholders. For the three months ended
March 31, 2003 and 2002, comprehensive income (loss) totaled $385.6 and
$(28.7), respectively. Comprehensive income (loss) includes net income,
unrealized appreciation (depreciation) of investments and foreign currency
translation gains or losses.
10
2. Investments
Three Months Ended March 31 2003
2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Investment income consisted of:
Fixed maturity securities $
429.4 $ 457.1
Short-term investments
28.5 30.4
Limited partnerships
23.3 6.8
Equity securities
5.3 8.2
Interest expense on funds withheld and other deposits
(46.7) (58.1)
Other
36.4 34.3
- --------------------------------------------------------------------------------
- ----------------
Total investment income
476.2 478.7
Investment expenses
(19.6) (15.7)
- --------------------------------------------------------------------------------
- ----------------
Investment income-net $
456.6 $ 463.0
================================================================================
================
Three Months Ended March 31
2003 2002
- --------------------------------------------------------------------------------
- ----------------
Investment (losses) gains are as follows:
Trading securities:
Derivative instruments $ 6.7
$ 10.0
Equity securities, including short positions
(37.3) 9.1
- --------------------------------------------------------------------------------
- ----------------
(30.6) 19.1
Other than trading:
Fixed maturities
(35.9) 6.9
Equity securities
7.2
Short?term investments 5.3
7.3
Other, including guaranteed separate account business
(34.4) (17.0)
- --------------------------------------------------------------------------------
- ----------------
Investment (losses) gains
(95.6) 23.5
Income tax benefit (expense) 34.1
(6.5)
Minority interest 4.9
(1.2)
- --------------------------------------------------------------------------------
- ----------------
Investment (losses) gains-net
$(56.6) $ 15.8
================================================================================
================
Realized investment losses included $255.0 and $18.0 million of pretax other
than temporary impairment losses for the three months ended March 31, 2003 and
2002. The impairment losses recorded for the three months ended March 31, 2003
were primarily for securities in certain market sectors, including the
airline, healthcare and energy industries. For the three months ended March
31, 2002, the impairment losses recorded related primarily to the credit
deterioration of a specific equity holding.
3. Earnings Per Share
Companies with complex capital structures are required to present basic and
diluted earnings per share. Basic earnings per share excludes dilution and is
computed by dividing net income attributable to each class of common stock by
the weighted average number of common shares of each class of common stock
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. For the three months
ended March 31, 2003 and 2002, income per common share assuming dilution is
11
the same as basic income per share because the impact of securities that could
potentially dilute basic income per common share is insignificant or
antidilutive for the periods presented.
Options to purchase 0.81 and 0.20 million shares of Loews common stock were
outstanding at March 31, 2003 and 2002, respectively, but were not included in
the computation of diluted earnings per share because the options' exercise
prices were greater than the average market price of the common shares and,
therefore, the effect would be antidilutive. Options to purchase 0.34 and 0.20
million shares of Carolina Group stock were outstanding at March 31, 2003 and
2002, but were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market
price of the common shares and, therefore, the effect would be antidilutive.
The attribution of income to each class of common stock, for the three
months ended March 31, 2003 and 2002, was as follows:
Three Months Ended March 31
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
(Restated)
Loews common stock:
Consolidated net income $
190.0 $ 212.8
Less income attributable to Carolina Group stock
(28.6) (18.0)
- --------------------------------------------------------------------------------
- ----------------
Income attributable to Loews common stock $
161.4 $ 194.8
================================================================================
================
Carolina Group stock:
Carolina Group net income $
124.4 $ 150.7
Less net income for January 2002
(73.1)
- --------------------------------------------------------------------------------
- ----------------
Income available to Carolina Group stock
124.4 77.6
Weighted average economic interest of the Carolina Group stock
23.01% 23.17%
- --------------------------------------------------------------------------------
- ----------------
Income attributable to Carolina Group stock $
28.6 $ 18.0
================================================================================
================
4. Loews and Carolina Group Consolidating Condensed Financial Information
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. This stock is designed to track the performance of the
12
Carolina Group, which consists of the Company's ownership interest in
Lorillard; notional, intergroup debt owed by the Carolina Group to the Loews
Group ($2.4 billion outstanding at March 31, 2003), bearing interest at the
annual rate of 8.0% and, subject to optional prepayment, due December 31,
2021; any and all liabilities, costs and expenses of the Company and Lorillard
arising out of the past, present or future business of Lorillard, and all net
income or net losses from the assets and liabilities attributed to the
Carolina Group. Each outstanding share of Carolina Group stock has 1/10 of a
vote per share.
The issuance of Carolina Group stock has resulted in a two class common
stock structure for the Company. During the year ended December 31, 2002, the
Company purchased, for the account of the Carolina Group, 340,000 shares of
Carolina Group stock. As of March 31, 2003, 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 of 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. Holders of the Company's common stock
and of Carolina Group stock are shareholders of Loews Corporation and are
subject to the risks related to an equity investment in Loews Corporation.
The Company has separated, for financial reporting purposes, the Carolina
Group and Loews Group. The following schedules present the consolidating
condensed financial information for these individual groups. Neither group is
a separate company or legal entity. Rather, each group is intended to reflect
a defined set of assets and liabilities.
13
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group
Adjustments
------------------------------------ Loews
and
March 31, 2003 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Assets:
Investments $ 1,403.5 $ 149.9 $ 1,553.4 $38,502.8
$40,056.2
Cash 1.3 0.3 1.6 211.9
213.5
Receivables-net 30.1 0.2 30.3 18,194.6 $
(32.0) (a) 18,192.9
Property, plant and
equipment-net 195.5 195.5 3,017.7
3,213.2
Deferred income taxes 442.7 442.7 71.7
514.4
Goodwill 171.0
171.0
Other assets 468.1 0.1 468.2 3,629.6
4,097.8
Investment in combined
attributed net assets
of the Carolina Group 1,729.2
(2,374.2) (a)
645.0 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,597.1
2,597.1
Separate account business 3,240.1
3,240.1
- --------------------------------------------------------------------------------
- ----------------
Total assets $ 2,541.2 $ 150.5 $ 2,691.7 $71,365.7
$(1,761.2) $72,296.2
================================================================================
================
Liabilities and Shareholders' Equity:
Insurance reserves $40,704.7
$40,704.7
Payable for securities
purchased 1,915.6
1,915.6
Securities sold under
agreements to
repurchase 670.2
670.2
Long-term debt, less
unamortized discount $2,374.2 $ 2,374.2 5,528.7
$(2,374.2) (a) 5,528.7
Reinsurance balances
payable 2,791.3
2,791.3
Other liabilities $ 1,135.4 19.9 1,155.3 2,844.8
(32.0) (a) 3,968.1
Separate account business 3,240.1
3,240.1
- --------------------------------------------------------------------------------
- ----------------
Total liabilities 1,135.4 2,394.1 3,529.5 57,695.4
(2,406.2) 58,818.7
Minority interest 1,902.2
1,902.2
Shareholders' equity 1,405.8 (2,243.6) (837.8) 11,768.1
645.0 (b) 11,575.3
- --------------------------------------------------------------------------------
- ----------------
Total liabilities and
shareholders' equity $ 2,541.2 $ 150.5 $ 2,691.7 $71,365.7
$(1,761.2) $72,296.2
================================================================================
================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 76.99% equity interest in the combined
attributed net
assets of the Carolina Group.
14
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group
Adjustments
------------------------------------ Loews
and
December 31, 2002 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Assets:
Investments $ 1,640.7 $ 150.3 $1,791.0 $38,345.7
$40,136.7
Cash 2.0 0.2 2.2 183.2
185.4
Receivables-net 30.2 30.2 16,603.9 $
(33.1) (a) 16,601.0
Property, plant and
equipment-net 197.8 197.8 2,940.4
3,138.2
Deferred income taxes 437.0 437.0 190.2
627.2
Goodwill 177.8
177.8
Other assets 469.2 469.2 3,530.0
3,999.2
Investment in combined
attributed net assets
of the Carolina Group 1,757.9
(2,438.1) (a)
680.2 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,551.4
2,551.4
Separate account business 3,102.7
3,102.7
- --------------------------------------------------------------------------------
- ----------------
Total assets $ 2,776.9 $ 150.5 $2,927.4 $69,383.2
$(1,791.0) $70,519.6
================================================================================
================
Liabilities and Shareholders' Equity:
Insurance reserves $40,178.9
$40,178.9
Payable for securities
purchased 799.1
799.1
Securities sold under
agreements to repurchase 552.4
552.4
Long-term debt, less
unamortized discount $ 2,438.1 $ 2,438.1 5,651.9
$(2,438.1) (a) 5,651.9
Reinsurance balances
payable 2,763.3
2,763.3
Other liabilities $ 1,352.1 20.7 1,372.8 3,001.1
(33.1) (a) 4,340.8
Separate account business 3,102.7
3,102.7
- --------------------------------------------------------------------------------
- ----------------
Total liabilities 1,352.1 2,458.8 3,810.9 56,049.4
(2,471.2) 57,389.1
Minority interest 1,895.3
1,895.3
Shareholders' equity 1,424.8 (2,308.3) (883.5) 11,438.5
680.2 (b) 11,235.2
- --------------------------------------------------------------------------------
- ----------------
Total liabilities and
shareholders' equity $ 2,776.9 $ 150.5 $ 2,927.4 $69,383.2
$(1,791.0) $70,519.6
================================================================================
================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 76.99% equity interest in the combined
attributed net
assets of the Carolina Group.
15
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group
Adjustments
Three Months Ended ------------------------------------ Loews and
March 31, 2003 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Revenues:
Insurance premiums $2,380.2
$2,380.2
Investment income, net $ 7.9 $ 0.6 $ 8.5 496.3 (48.2)
(a) 456.6
Investment gains (losses) 0.3 0.3 (95.9)
(95.6)
Manufactured products 844.2 844.2 39.8
884.0
Other (0.2) (0.2) 324.2
324.0
- --------------------------------------------------------------------------------
- ----------------
Total 852.2 0.6 852.8 3,144.6 (48.2)
3,949.2
- --------------------------------------------------------------------------------
- ----------------
Expenses:
Insurance claims and
policyholders' Benefits 1,869.8
1,869.8
Amortization of deferred
acquisition costs 458.2
458.2
Cost of manufactured
products sold 459.7 459.7 21.5
481.2
Other operating expenses (b) 141.2 0.1 141.3 643.1
784.4
Interest 48.2 48.2 73.7 (48.2)
(a) 73.7
- --------------------------------------------------------------------------------
- ----------------
Total 600.9 48.3 649.2 3,066.3 (48.2)
3,667.3
- --------------------------------------------------------------------------------
- ----------------
251.3 (47.7) 203.6 78.3
281.9
- --------------------------------------------------------------------------------
- ---------------
Income tax (benefit)
expense 97.8 (18.6) 79.2 13.7
92.9
Minority interest (1.0)
(1.0)
- --------------------------------------------------------------------------------
- ----------------
Total 97.8 (18.6) 79.2 12.7
91.9
- --------------------------------------------------------------------------------
- ----------------
Income from operations 153.5 (29.1) 124.4 65.6
190.0
Equity in earnings of the
Carolina Group 95.8 (95.8)
(c)
- --------------------------------------------------------------------------------
- ----------------
Net income $153.5 $(29.1) $124.4 $161.4 $(95.8)
$190.0
================================================================================
================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.1 of expenses allocated by the Carolina Group to the Loews
Group for computer
related charges and $0.1 of expenses allocated by Loews Group to the
Carolina Group for
services provided pursuant to a service agreement, which eliminate in these
consolidating
statements.
(c) To eliminate the Loews Group's intergroup interest in the earnings of the
Carolina Group.
16
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group
Adjustments
Three Months Ended --------------------------------- Loews and
March 31, 2002 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ----------------
(In millions) (Restated)
(Restated)
Revenues:
Insurance premiums $2,836.2
$2,836.2
Investment income, net $ 11.2 $ 11.2 480.8 $
(29.0) (a) 463.0
Investment gains 2.8 2.8 20.7
23.5
Manufactured products 973.1 973.1 31.7
1,004.8
Other 464.8
464.8
- --------------------------------------------------------------------------------
- ----------------
Total 987.1 987.1 3,834.2
(29.0) 4,792.3
- --------------------------------------------------------------------------------
- ----------------
Expenses:
Insurance claims and
policyholders' benefits 2,310.1
2,310.1
Amortization of deferred
acquisition costs 440.1
440.1
Cost of manufactured
products sold 592.3 592.3 15.4
607.7
Other operating expenses (b) 119.4 $ 0.1 119.5 755.8
875.3
Interest 29.0 29.0 76.5
(29.0) (a) 76.5
- --------------------------------------------------------------------------------
- ---------------
Total 711.7 29.1 740.8 3,597.9
(29.0) 4,309.7
- --------------------------------------------------------------------------------
- ---------------
275.4 (29.1) 246.3 236.3
482.6
- --------------------------------------------------------------------------------
- ---------------
Income taxes 106.9 (11.3) 95.6 75.6
171.2
Minority interest 28.0
28.0
- --------------------------------------------------------------------------------
- ---------------
Total 106.9 (11.3) 95.6 103.6
199.2
- --------------------------------------------------------------------------------
- ---------------
Income from operations 168.5 (17.8) 150.7 132.7
283.4
Equity in earnings of the
Carolina Group 132.7
(132.7) (c)
- --------------------------------------------------------------------------------
- ---------------
Income from continuing
operations 168.5 (17.8) 150.7 265.4
(132.7) 283.4
Discontinued operations- net (31.0)
(31.0)
Cumulative effect of
change in accounting
principle-net (39.6)
(39.6)
- --------------------------------------------------------------------------------
- ----------------
Net income $168.5 $ (17.8) $150.7 $194.8
$(132.7) $ 212.8
================================================================================
================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.1 of expenses allocated by the Carolina Group to the Loews
Group for computer related charges and $0.1 of expenses allocated by
Loews Group to the Carolina Group for services provided pursuant to a
services agreement, which eliminate in these consolidating statements.
(c) To eliminate the Loews Group's intergroup interest in the earnings of the
Carolina Group.
17
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group
Adjustments
Three Months Ended -------------------------------- Loews and
March 31, 2003 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ---------------
(In millions)
Net cash used in
operating activities $ (56.5) $ (30.1) $ (86.6) $ (40.1) $
(59.4) $(186.1)
- --------------------------------------------------------------------------------
- ----------------
Investing activities:
Purchases of property and
equipment (7.2) (7.2) (169.9)
(177.1)
Proceeds from sales of
property and equipment 0.1
0.1
Change in short-term
investments 234.0 0.3 234.3 1,036.3
1,270.6
Other investing activities (625.6)
(63.9) (689.5)
- --------------------------------------------------------------------------------
- ----------------
226.8 0.3 227.1 240.9
(63.9) 404.1
- --------------------------------------------------------------------------------
- ----------------
Financing activities:
Dividends paid to
shareholders (171.0) 93.8 (77.2) (27.9)
59.4 (45.7)
Reduction of intergroup
notional debt (63.9) (63.9)
63.9
Other financing activities (144.2)
(144.2)
- --------------------------------------------------------------------------------
- ----------------
(171.0) 29.9 (141.1) (172.1)
123.3 (189.9)
- --------------------------------------------------------------------------------
- ----------------
Net change in cash (0.7) 0.1 (0.6) 28.7
28.1
Cash, beginning of period 2.0 0.2 2.2 183.2
185.4
- --------------------------------------------------------------------------------
- ----------------
Cash, end of period $ 1.3 $ 0.3 $ 1.6 $211.9
$213.5
================================================================================
================
18
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group
Adjustments
Three Months Ended ----------------------------------- Loews
and
March 31, 2002 Lorillard Other Consolidated Group
Eliminations Total
- --------------------------------------------------------------------------------
- ----------------
(In millions) (Restated)
(Restated)
Net cash (used) provided
by operating activities $(84.2) $ (0.1) $(84.3) $ 49.5
$(100.0) $(134.8)
- --------------------------------------------------------------------------------
- ----------------
Investing activities:
Purchases of property and
equipment (12.6) (12.6) (87.6)
(100.2)
Proceeds from sales of
property and equipment 1.2 1.2 89.1
90.3
Change in short-term
investments 195.6 195.6 (215.8)
(20.2)
Other investing activities (794.9)
(794.9)
- --------------------------------------------------------------------------------
- ----------------
184.2 184.2 (1,009.2)
(825.0)
- --------------------------------------------------------------------------------
- ----------------
Financing activities:
Dividends paid to
shareholders (100.0) (100.0) (28.7)
100.0 (28.7)
Other financing activities 936.4
936.4
- --------------------------------------------------------------------------------
- ----------------
(100.0) (100.0) 907.7
100.0 907.7
- --------------------------------------------------------------------------------
- ----------------
Net change in cash (0.1) (0.1) (52.0)
(52.1)
Cash, beginning of period 1.7 1.7 179.6
181.3
- --------------------------------------------------------------------------------
- ----------------
Cash, end of period $ 1.7 $ (0.1) $ 1.6 $ 127.6
$129.2
================================================================================
================
5. Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, provide greater
diversification of risk, minimize exposures on larger risks and to exit
certain lines of business. 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
19
more detail later in this note, 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 Condensed 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 $46.7 and $58.1 million for the three months ended
March 31, 2003 and 2002. The amount subject to interest crediting rates on
such contracts was $2,550.0 and $2,766.0 million at March 31, 2003 and
December 31, 2002.
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.
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. One of CNA's principal credit exposures from
these recent events arise from reinsurance receivables from Gerling Global
("Gerling").
In March of 2003, Gerling informed CNA that, under Gerling's interpretation
of three treaties relating to CNA HealthPro, CNA was required to transfer
approximately $205.0 million of funds withheld balances to a trust established
by Gerling for CNA's benefit or the treaties would be commuted. In April of
2003, Gerling advised CNA that it deems these treaties to be commuted as of
April 7, 2003. CNA, in turn, advised Gerling that it disputes the commutation
and regards the reinsurance treaties as remaining in effect. CNA has begun
discussions with Gerling with respect to resolving the dispute concerning
these treaties, as well as a possible commutation of all other reinsurance
arrangements between CNA and Gerling.
Life premiums are primarily from long duration contracts and property and
casualty premiums and accident and health premiums are primarily from short
duration contracts.
20
The effects of reinsurance on earned premiums are shown in the following
table:
Direct Assumed
Ceded Net
- --------------------------------------------------------------------------------
- ---------------
(In millions)
Three Months Ended March 31, 2003
Property-casualty $ 2,638.0 $ 161.0 $
981.0 $ 1,818.0
Accident and health 388.0 37.0
24.0 401.0
Life 258.0 5.0
102.0 161.0
- --------------------------------------------------------------------------------
- ----------------
Total earned premiums $ 3,284.0 $ 203.0
$1,107.0 $ 2,380.0
================================================================================
================
Three Months Ended March 31, 2002
Property-casualty $ 2,440.0 $ 237.0
$1,015.0 $ 1,662.0
Accident and health 972.0 19.0
(12.0) 1,003.0
Life 263.0 21.0
113.0 171.0
- --------------------------------------------------------------------------------
- ---------------
Total earned premiums $ 3,675.0 $ 277.0
$1,116.0 $ 2,836.0
================================================================================
================
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
21
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 September 11,
2001 World Trade Center disaster and related events ("WTC event"), the limit
under this section was exhausted. Additionally, as a result of significant
reserve additions recorded in 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. Included
in the pretax results of operations for the three months ended March 31, 2003
and 2002 is $13.0 million of interest charges from the Aggregate Cover.
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 March 31, 2003.
The impact of the CCC Cover on pretax results of operations was as follows:
Three Months Ended March 31
2003 2002
- --------------------------------------------------------------------------------
- ---------------
(In millions)
Ceded earned premiums
$ (61.0)
Ceded claim and claim adjustment expense
93.0
Interest charges $
(8.0) (10.0)
- --------------------------------------------------------------------------------
- ---------------
Pretax (expense) benefit $
(8.0) $ 22.0
================================================================================
===============
6. Receivables
March
31, December 31,
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Reinsurance
$12,931.0 $12,695.3
Other insurance
3,305.4 3,163.2
Security sales
1,675.0 493.3
Accrued investment income
362.0 316.8
Other
287.4 294.8
- --------------------------------------------------------------------------------
- ---------------
Total
18,560.8 16,963.4
Less: Allowance for doubtful accounts on reinsurance receivables
198.5 195.7
Allowance for doubtful accounts and cash discounts
169.4 166.7
- --------------------------------------------------------------------------------
- ---------------
Receivables-net
$18,192.9 $16,601.0
================================================================================
===============
7. Claim and Claim Adjustment Expense Reserves
CNA's property and casualty insurance claim and claim adjustment expense
reserves represent the estimated amounts necessary to settle all outstanding
claims, including claims that are incurred but not reported ("IBNR") as of the
reporting date. CNA's reserve projections are based primarily on detailed
analysis of the facts in each case, CNA's experience with similar cases and
various historical development patterns. Consideration is given to such
historical patterns as field reserving trends and claims settlement practices,
loss payments, pending levels of unpaid claims and product mix, as well as
22
court decisions, economic conditions and public attitudes. All of these
factors can affect the estimation of claim and claim adjustment expense
reserves.
Establishing claim and claim adjustment expense reserves, including claim
and claim adjustment expense reserves for catastrophic events that have
occurred, is an estimation process. Many factors can ultimately affect the
final settlement of a claim and, therefore, the necessary reserve. Changes in
the law, results of litigation, medical costs, the cost of repair materials
and labor rates can all affect ultimate claim costs. In addition, time can be
a critical part of reserving determinations since the longer the span between
the incidence of a loss and the payment or settlement of the claim, the more
variable the ultimate settlement amount can be. Accordingly, short-tail
claims, such as workers compensation, property damage claims, tend to be more
reasonably estimable than long-tail claims, such as general liability and
professional liability claims. Adjustments to prior year reserve estimates, if
necessary, are reflected in the results of operations in the period that the
need for such adjustments is determined.
Catastrophes are an inherent risk of the property and casualty insurance
business and have contributed to material period-to-period fluctuations in
CNA's results of operations and equity. The level of catastrophe losses
experienced in any period cannot be predicted and can be material to the
results of operations or equity of the Company.
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:
March 31, 2003
December 31, 2002
- --------------------------------------------------------------------------------
- ----------------
Environmental
Environmental
Pollution and Pollution
and
Mass Tort Asbestos Mass
Tort Asbestos
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Gross reserves $ 811.0 $1,719.0 $
830.0 $1,758.0
Ceded reserves (319.0) (527.0)
(313.0) (527.0)
- --------------------------------------------------------------------------------
- ---------------
Net reserves $ 492.0 $1,192.0 $
517.0 $1,231.0
================================================================================
================
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
23
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.
However no reforms were enacted by Congress during 2002 or during the first
three months of 2003, and it is unclear what positions Congress or the
administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental cleanup may be significantly
reduced in favor of state action. Substantial changes in the federal statute
or the activity of the EPA may cause states to reconsider their environmental
cleanup statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result or the possible effect upon the
Company's results of operations or equity.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA 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 pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
As of March 31, 2003 and December 31, 2002, CNA carried approximately $492.0
and $517.0 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and mass tort claims. There was no environmental pollution and mass tort net
claim and claim adjustment expense reserve development for the three months
ended March 31, 2003 and 2002. CNA paid environmental pollution-related claims
and mass tort-related claims, net of reinsurance recoveries, of $25.0 and
$33.0 million for the three months ended March 31, 2003 and 2002.
24
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 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% 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 March 31, 2003 and December 31, 2002, CNA carried approximately
$1,192.0 and $1,231.0 million of 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 three months ended March 31, 2003 and 2002. CNA
paid asbestos-related claims, net of reinsurance, of $39.0 million for the
three months ended March 31, 2003 and had net reinsurance recoveries of $20.0
million for the three months ended March 31, 2002.
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 effect on the Company's results of
operations or equity.
25
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 subsidiaries, including alleged "non-products" exposures. 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 is engaged in insurance coverage litigation with Robert A. Keasbey
Company ("Keasbey") and associated claimants in New York state court
(Continental Casualty Company vs. 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
26
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. Another of these variables is the possible creation of a national
privately financed trust, which if established and approved through federal
legislation, could replace litigation of asbestos claims with payments to
claimants from the trust. It is uncertain at the present time whether such a
trust will be created or, if it is, what will be the terms and conditions of
its establishment. Adverse developments with respect to such matters discussed
in this paragraph could have a material adverse effect on the Company's
results of operations or equity.
The results of operations or equity of the Company in future years may be
adversely affected 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.
Other Reserves
Net unfavorable prior year development of $31.0 million, including $97.0
million of unfavorable claim and claim adjustment expense reserve development
and $66.0 million of favorable premium development, was recorded for the three
months ended March 31, 2003. The net unfavorable prior year reserve
development not associated with the favorable premium development was recorded
principally in Standard Lines.
Unfavorable net prior year reserve development of approximately $47.0
million was recorded related to certain programs written in Excess & Surplus
("E&S"). One E&S program, covering facilities that provide services to
developmentally disabled individuals, accounted for approximately $10.0
million of the unfavorable prior year reserve development. The reserve
development was due to an increase in the size of known claims and increases
in policyholder defense costs. These increases became apparent as the result
of an actuarial review completed during the first quarter of 2003, with most
of the reserve development from accident years 1999 and 2000. Another E&S
program, which accounts for approximately $25.0 million of E&S reserve
development, covers tow truck and ambulance operators in the 2000 and 2001
accident years. CNA expected that loss ratios for this business would be
similar to its middle market commercial automobile liability business. During
2002, CNA ceased writing business under this program. Approximately $12.0
million of unfavorable prior year reserve development was recorded during 2003
related to a specific large loss.
Partially offsetting the unfavorable reserve development in E&S was
favorable prior year reserve development recorded in property lines during
2003. The favorable reserve development was principally from accident years
2001 and 2002 and was the result of the low number of large losses in recent
years.
27
8. Long-Term Debt
Unamortized
Current
March 31, 2003 Principal Discount Net
Maturities
- --------------------------------------------------------------------------------
- ----------------
(In millions
Loews Corporation $2,325.0 $ 28.1 $
2,296.9
Cna 2,172.5 9.0
2,163.5 $ 291.0
Diamond Offshore 939.4 17.6
921.8 11.1
Loews Hotels 146.5
146.5 2.0
- --------------------------------------------------------------------------------
- ----------------
Total $5,583.4 $ 54.7 $
5,528.7 $ 304.1
================================================================================
================
28
March
31, December 31,
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Loews Corporation (Parent Company):
Senior:
6.8% notes due 2006 (effective interest rate of 6.8%) (authorized,
$300) $
300.0 $ 300.0
8.9% debentures due 2011 (effective interest rate of 9.0%)
(authorized, $175)
175.0 175.0
7.6% notes due 2023 (effective interest rate of 7.8%) (authorized,
$300) (a)
300.0 300.0
7.0% notes due 2023 (effective interest rate of 7.2%) (authorized,
$400) (b)
400.0 400.0
Subordinated:
3.1% exchangeable subordinated notes due 2007 (effective interest
rate of 3.4%) (authorized, $1,150) (c)
1,150.0 1,150.0
CNA Financial Corporation:
Senior:
6.3% notes due 2003 (effective interest rate of 6.4%) (authorized,
$250)
248.4 248.4
7.3% notes due 2003 (effective interest rate of 7.8%) (authorized,
$150)
128.5
6.5% notes due 2005 (effective interest rate of 6.6%) (authorized,
$500)
492.8 492.8
6.8% notes due 2006 (effective interest rate of 6.8%) (authorized,
$250)
250.0 250.0
6.5% notes due 2008 (effective interest rate of 6.6%) (authorized,
$150)
150.0 150.0
6.6% notes due 2008 (effective interest rate of 6.7%) (authorized,
$200)
200.0 200.0
8.4% notes due 2012 (effective interest rate of 8.6%) (authorized,
$100)
69.6 69.6
7.0% notes due 2018 (effective interest rate of 7.1%) (authorized,
$150)
150.0 150.0
7.3% debentures due 2023 (effective interest rate of 7.3%) (authorized,
$250)
243.0 243.0
Term loan due 2005 (effective interest rate of and 2.8% and 2.0%)
30.0 30.0
Revolving credit facility due 2004 (effective interest rate of 2.0%
and 2.3%)
250.0 250.0
Revolving credit facility due 2003 (effective interest rate of 1.8%
and 2.0%)
30.0 30.0
Other senior debt (effective interest rates approximate 7.8% and 7.8%)
58.7 59.3
Diamond Offshore Drilling, Inc.:
Senior:
Zero coupon convertible debentures due 2020, net of discount of
$361.5 and $365.3 (effective interest rate of 3.6%) (d)
443.5 439.7
1.5% convertible senior debentures due 2031 (effective interest
rate of 1.6%) (authorized $460) (e)
460.0 460.0
Subordinated debt due 2005 (effective interest rate of 7.1%)
35.9 35.9
Loews Hotels senior debt, principally mortgages (effective interest rates
approximate 6.0% and 6.0%)
146.5 145.8
- --------------------------------------------------------------------------------
- ----------------
5,583.4 5,708.0
Less unamortized discount
54.7 56.1
- --------------------------------------------------------------------------------
- ----------------
Long-term debt, less unamortized discount
$5,528.7 $5,651.9
================================================================================
================
29
(a) Redeemable in whole or in part at June 1, 2003 at 103.8%, and decreasing
percentages thereafter.
(b) Redeemable in whole or in part at October 15, 2003 at 102.4%, and
decreasing percentages thereafter.
(c) The notes are exchangeable into 15.376 shares of Diamond Offshore's
common stock per one thousand dollars principal amount of notes, at a
price of $65.04 per share. Redeemable in whole or in part at 101.6%, and
decreasing percentages annually.
(d) The debentures are convertible into Diamond Offshore's common stock at
the rate of 8.6075 shares per one thousand dollars principal amount,
subject to adjustment. Each debenture will be purchased by Diamond
Offshore at the option of the holder on the fifth, tenth and fifteenth
anniversaries of issuance at the accreted value through the date of
repurchase. Diamond Offshore, at its option, may elect to pay the
purchase price in cash or shares of common stock, or in certain
combinations thereof. The debentures are redeemable at the option of
Diamond Offshore at any time after June 6, 2005, at prices which reflect
a yield of 3.5% to the holder.
(e) The Debentures are convertible into Diamond Offshore's common stock at an
initial conversion rate of 20.3978 shares per one thousand dollars
principal amount, subject to adjustment in certain circumstances. Upon
conversion, Diamond Offshore has the right to deliver cash in lieu of
shares of its common stock. Diamond Offshore may redeem all or a portion
of the Debentures at any time on or after April 15, 2008 at a price equal
to 100% of the principal amount.
During the first quarter of 2003, CNA repaid its $128.5 million, 7.3% Senior
Note, due March 1, 2003.
CNA pays a facility fee to the lenders for having funds available for loans
under the credit facility maturing April 30, 2004. The fee varies based on the
long-term debt ratings of CNA. At March 31, 2003 and December 31, 2002, the
facility fee was 17.5 basis points.
CNA pays interest on any outstanding debt/borrowings under the 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 facility, CNA also will pay a utilization fee
of 12.5 basis points on such loans. At March 31, 2003 and December 31, 2002,
the weighted-average interest rate on the borrowings under the facility,
including facility fees and utilization fees, was 2.3%.
A Moody's Investors Service downgrade of the CNA senior debt rating from
Baa2 to Baa3 would increase the facility fee 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.
The terms of CNA's credit agreement requires CNA to maintain certain
financial ratios and combined property-casualty company statutory surplus
levels. At March 31, 2003 and December 31, 2002, CNA was in compliance with
all restrictive debt covenants.
30
CNA Surety Corporation ("CNA Surety"), a 64.0% owned and consolidated
subsidiary of CNA, pays interest on any outstanding borrowings under its
credit agreement based on an applicable margin determined by the amount of
leverage of the company. The current interest rate on any borrowings under the
facility is LIBOR plus 45.0 basis points. In addition, CNA Surety pays a
facility fee that is currently 12.5 basis points. If utilization of the credit
facility is greater than 50.0% of the amount available under the facility, an
additional fee of 5.0 basis points will be incurred. Effective January 30,
2003, CNA Surety entered into an interest rate swap on the term loan portion
of its credit agreement that fixed the interest rate at 2.8%. At March 31,
2003 and 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 2.4% and 2.0%. At March 31, 2003 and
December 31, 2002, CNA Surety was in compliance with all restrictive debt
covenants.
9. Shareholders' Equity
March
31, December 31,
2003
2002
- --------------------------------------------------------------------------------
- ---------------
(In millions of dollars, except per share data)
Preferred stock, $0.10 par value,
Authorized - 100,000,000 shares
Common stock:
Loews common stock, $1.00 par value:
Authorized - 600,000,000 shares
Issued and outstanding - 185,447,050 and 185,441,200 share
$
185.4 $ 185.4
Carolina Group stock, $0.01 par value:
Authorized - 600,000,000 shares
Issued - 40,250,000 shares
0.4 0.4
Additional paid-in capital
1,114.4 1,114.2
Earnings retained in the business
9,548.9 9,404.6
Accumulated other comprehensive income
733.9 538.3
- --------------------------------------------------------------------------------
- ----------------
11,583.0 11,242.9
Less treasury stock, at cost (340,000 shares of Carolina Group stock)
7.7 7.7
- --------------------------------------------------------------------------------
- ---------------
Total shareholders' equity
$11,575.3 $11,235.2
================================================================================
================
Investments in securities, which are held principally by insurance
subsidiaries of CNA are considered 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.
Investments are written down to estimated fair values and impairment losses
are recognized in income when a decline in value is determined to be other
than temporary (See Note 2).
31
10. Significant Transactions
National Postal Mail Handlers Union Contract Termination
During the second quarter of 2002, CNA sold Claims Administration
Corporation and transferred the National Postal Handlers Union group benefits
plan ("the Mail Handlers Plan") to First Health Group Corporation. Revenues
for the Mail Handlers Plan were $616.0 million for the three months ended
March 31, 2002.
CNA Vida
In the first quarter of 2002, CNA completed the sale of the common stock of
CNA Holdings Limited and its subsidiaries ("CNA Vida"), CNA's life operations
in Chile, to Consorcio Financiero S.A. ("Consorcio"). In connection with the
sale, CNA received proceeds of $73.0 million and recorded a loss from
discontinued operations of $31.0 million, after tax and minority interest of
$9.3 and $4.0 million. This loss is composed of a $32.8 million realized loss
on the sale of CNA Vida and income of $1.8 million from CNA Vida's operations
for 2002.
Personal Insurance Transaction
CNA entered into a retroactive reinsurance agreement as part of the sale of
its personal insurance business to The Allstate Corporation ("Allstate") in
1999. 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.
11. Restructuring and Other Related Charges
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 integrated technology roadmap that included common
architecture and platform standards that directly support CNA's strategies.
32
No restructuring and other related charges related to the IT Plan were
incurred for the three months ended March 31, 2003 and 2002. Employee
termination and related benefit payments will continue through 2004 due to
employment contract obligations. The following table summarizes the remaining
IT Plan accrual at March 31, 2003 and the activity in that accrual since
inception.
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
Costs 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
Payments charged against liability in 2003
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at March 31, 2003 $ 5.0
$ 5.0
================================================================================
================
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.
No restructuring and other related charges related to the 2001 Plan were
incurred for the three months ended March 31, 2003 and 2002. The following
table summarizes the remaining 2001 Plan accrual as of March 31, 2003 and the
activity in that accrual since inception.
33
Employee
Termination Lease Impaired
and Related Termination Asset
Other
Benefit Costs Costs Charges
Costs Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
2001 Plan Initial Accrual $ 68.0 $ 56.0 $ 30.0 $
35.0 $ 189.0
Costs that did not require cash
(35.0) (35.0)
Payments charged against
liability (2.0)
(2.0)
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at 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 at December 31,
2002 2.0 34.0 2.0
38.0
Costs that did not require cash (1.0)
(1.0)
Payments charged against
liability (1.0) (6.0)
(7.0)
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at March 31, 2003 $ 1.0 $ 28.0 $ 1.0
$ 30.0
================================================================================
================
12. Statutory Accounting Practices
CNA's insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or permitted by the respective jurisdictions'
insurance regulators. Prescribed statutory accounting practices are set forth
in a variety of publications of the National Association of Insurance
Commissioners ("NAIC") as well as state laws, regulations and general
administrative rules. CNA's insurance subsidiaries follow one significant
permitted accounting practice at March 31, 2003, related to discounting of
certain non-tabular workers compensation claims. The impact of this permitted
practice was to increase statutory surplus by approximately $46.0 and $56.0
million at March 31, 2003 and December 31, 2002. This practice was followed by
an acquired company, and CNA received permission to eliminate the effect of
the permitted practice over a ten-year period, which ends in 2003.
13. Business Segments
The Company's reportable segments are based on its individual operating
subsidiaries. Each of the subsidiaries are headed by a chief executive officer
who is responsible for the operation of its business and has the duties and
authority commensurate with that position. Investment gains (losses) and the
related income taxes, excluding those of CNA Financial, are included in the
Corporate and other segment.
CNA's insurance products include property and casualty coverages; life,
accident and health insurance; and retirement products and annuities. CNA's
services include risk management, information services, health care management
and claims administration. CNA's products and services are marketed through
agents, brokers, managing general agents and direct sales.
34
The Other Insurance segment is comprised primarily of losses and expenses
related to the centralized adjusting and settlement of APMT claims, certain
run-off insurance operations and other operations. This segment's results also
include interest expense on CNA's corporate borrowings, eBusiness initiatives
and CNA UniSource. Beginning in 2003, expenses related to eBusiness were
allocated to the operating segments of CNA.
Lorillard's principal products are marketed under the brand names of
Newport, Kent, True, Maverick and Old Gold with substantially all of its sales
in the United States.
Loews Hotels owns and/or operates 18 hotels, 16 of which are in the United
States and two are in Canada.
Diamond Offshore's business primarily consists of operating 47 offshore
drilling rigs that are chartered on a contract basis for fixed terms by
companies engaged in exploration and production of hydrocarbons. Offshore rigs
are mobile units that can be relocated based on market demand. As of March 31,
2003, 28 of these rigs were located in the Gulf of Mexico, 5 were located in
Brazil and the remaining 14 were located in various other foreign markets.
Bulova distributes and sells watches and clocks under the brand names of
Bulova, Wittnauer, Caravelle and Accutron with substantially all of its sales
in the United States and Canada. Substantially all watches and clocks are
purchased from foreign suppliers.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies in Note 1 of the Notes to
Consolidated Financial Statements in the Annual Report on Form 10-K for the
year ended December 31, 2002. In addition, CNA does not maintain a distinct
investment portfolio for each of its insurance segments, and accordingly,
allocation of assets to each segment is not performed. Therefore, investment
income and investment gains (losses) are allocated based on each segment's
carried insurance reserves, as adjusted.
35
The following tables set forth the Company's consolidated revenues and
income by business segment:
Three Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
(Restated)
Revenues (a):
CNA Financial:
Property and casualty $
2,120.5 $ 2,004.7
Life
359.7 413.6
Group
344.0 996.3
Other Insurance
21.3 31.1
- --------------------------------------------------------------------------------
- ----------------
Total CNA Financial
2,845.5 3,445.7
Lorillard
851.9 984.3
Loews Hotels
76.4 77.2
Diamond Offshore
152.0 211.9
Bulova
41.1 32.7
Corporate
(17.7) 40.5
- --------------------------------------------------------------------------------
- ----------------
Total $
3,949.2 $ 4,792.3
================================================================================
================
Pretax income (a):
CNA Financial:
Property and casualty $
153.4 $ 138.9
Life
(36.3) 59.0
Group
(23.4) 36.9
Other Insurance
14.3 (62.2)
- --------------------------------------------------------------------------------
- ----------------
Total CNA Financial
108.0 172.6
Lorillard
251.0 272.5
Loews Hotels
8.0 9.5
Diamond Offshore
(28.8) 27.7
Bulova
4.3 3.0
Corporate
(60.6) (2.7)
- --------------------------------------------------------------------------------
- ----------------
Total $
281.9 $ 482.6
================================================================================
================
Net income (a):
CNA Financial:
Property and casualty $
101.3 $ 82.8
Life
(20.8) 34.3
Group
(13.3) 21.6
Other Insurance
12.3 (35.6)
- --------------------------------------------------------------------------------
- ----------------
Total CNA Financial
79.5 103.1
Lorillard
153.3 166.7
Loews Hotels
5.1 6.0
Diamond Offshore
(12.1) 8.7
Bulova
3.0 1.6
Corporate
(38.8) (2.7)
- --------------------------------------------------------------------------------
- ----------------
Income from continuing operations
190.0 283.4
Discontinued operations-net
(31.0)
Cumulative effect of change in accounting principles-net
(39.6)
- --------------------------------------------------------------------------------
- ---------------
Total $
190.0 $ 212.8
================================================================================
===============
36
(a) Investment gains (losses) included in Revenues, Pretax income and Net
income are as follows:
Three
Months Ended
March 31,
- --------------------------------------------------------------------------------
- ----------------
2003 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Revenues and pretax income:
CNA Financial:
Property and casualty $
8.7 $ 11.0
Life
(51.3) 11.3
Group
(52.2) 9.6
Other Insurance
18.7 (30.9)
- --------------------------------------------------------------------------------
- ----------------
Total CNA Financial
(76.1) 1.0
Corporate and other
(19.5) 22.5
- --------------------------------------------------------------------------------
- ----------------
Total $
(95.6) $ 23.5
================================================================================
================
Net income:
CNA Financial:
Property and casualty $
5.7 $ 8.0
Life
(30.0) 6.2
Group
(30.5) 5.5
Other Insurance
10.9 (17.5)
- --------------------------------------------------------------------------------
- ----------------
Total CNA Financial
(43.9) 2.2
Corporate and other
(12.7) 13.6
- --------------------------------------------------------------------------------
- ----------------
Total $
(56.6) $ 15.8
================================================================================
================
14. Legal Proceedings
Insurance Related
IGI Contingency - In 1997, CNA Reinsurance Company Limited ("CNA Re Ltd."),
entered into an arrangement with IOA Global, Ltd. ("IOA"), an independent
managing general agent based in Philadelphia, Pennsylvania, to develop and
manage a book of accident and health coverages. Pursuant to this arrangement,
IGI Underwriting Agencies, Ltd. ("IGI"), a personal accident reinsurance
managing general underwriter, was appointed to underwrite and market the book
under the supervision of IOA. Between April 1, 1997 and December 1, 1999, IGI
underwrote a number of reinsurance arrangements with respect to personal
accident insurance worldwide (the "IGI Program"). Under various arrangements,
CNA Re Ltd. both assumed risks as a reinsurer and also ceded a substantial
portion of those risks to other companies, including other CNA insurance
subsidiaries and ultimately to a group of reinsurers participating in a
reinsurance pool known as the Associated Accident and Health Reinsurance
Underwriters ("AAHRU") Facility. CNA's Group Operations business unit
participated as a pool member in the AAHRU Facility in varying percentages
between 1997 and 1999.
CNA has determined that a portion of the premiums assumed under the IGI
Program related to United States workers compensation "carve-out" business.
37
Some of these premiums were received from John Hancock Financial Services,
Inc. ("John Hancock"). CNA is aware that a number of reinsurers with workers
compensation carve-out insurance exposure, including John Hancock, have
disavowed their obligations under various legal theories. If one or more such
companies are successful in avoiding or reducing their liabilities, then it is
likely that CNA's potential liability will also be reduced. Moreover, based on
information known at this time, CNA believes it has strong grounds to
successfully challenge its alleged exposure on a substantial portion of its
United States workers compensation carve-out business, including all purported
exposure derived from John Hancock, through legal action.
As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. CNA believes it has valid and enforceable
reinsurance contracts with the AAHRU Facility and other reinsurers with
respect to the IGI Program, including the United States workers compensation
carve-out business. However, certain reinsurers dispute their liabilities to
CNA, and CNA has commenced arbitration proceedings against such reinsurers.
CNA has established reserves for its estimated exposure under the IGI
Program, other than that derived from John Hancock, and an estimate for
recoverables from retrocessionaires. CNA has not established any reserve for
any exposure derived from John Hancock because, as indicated, CNA believes the
contract will be rescinded.
CNA is pursuing a number of loss mitigation strategies with respect to the
entire IGI Program. Although the results of these various actions to date
support the recorded reserves, the estimate of ultimate losses is subject to
considerable uncertainty due to the complexities described above. As a result
of these uncertainties, the results of operations in future periods may be
adversely affected by potentially significant reserve additions. Management
does not believe that any such reserve additions would be material to the
equity of CNA, although results of operations may be adversely affected. CNA's
position in relation to the IGI Program was unaffected by the sale of CNA Re
Ltd. in 2002.
California Wage and Hour Litigation - In Ernestine Samora, et al. v. CCC,
Case No. BC 242487, Superior Court of California, County of Los Angeles,
California and Brian Wenzel v. Galway Insurance Company, Superior Court of
California, County of Orange No. BC01CC08868 (coordinated), two former CNA
employees filed lawsuits in Los Angeles Superior Court on behalf of purported
classes of CNA employees asserting they worked hours for which they should
have been compensated at a rate of one and one-half times their base hourly
wage over a four-year period. The cases were coordinated and an amended
complaint was filed which alleges overtime claims under California law over a
four-year period. In June of 2002, CNA filed a responsive pleading denying the
material allegations of the amended complaint. CNA intends to defend this case
vigorously. Due to the recent commencement of discovery and the uncertainty of
how the courts may interpret California law as applied to the facts of these
cases, the extent of losses beyond any amounts that may be accrued are not
readily determinable at this time. Based on facts and circumstances presently
known, however, in the opinion of management, the outcome will not materially
affect the equity of CNA, although results of operations may be adversely
affected.
Voluntary Market Premium Litigation - CNA, along with dozens of other
insurance companies, is a defendant in sixteen purported class action cases
brought by large policyholders, which generally allege that the defendants, as
part of an industry-wide conspiracy, included improper charges in their
retrospectively rated and other loss-sensitive insurance premiums. Fourteen
38
lawsuits were brought as class actions in state courts and two in federal
court. Among the claims asserted were violations of state antitrust laws,
breach of contract, fraud and unjust enrichment. In two of the cases, the
defendants won dismissals on motions and, in four others, class certification
was denied after hearing. Plaintiffs voluntarily dismissed their claims in
four states. In the federal court case, Sandwich Chef of Texas, Inc., et al.
v. Reliance National Indemnity Insurance Company, et al., Civil Action No. H-
98-1484, United States District Court for the Southern District of Texas, the
district court certified a multi-state class but was reversed on interlocutory
appeal by the U.S. Court of Appeals for the Fifth Circuit. Due to the
uncertainty of how the courts may interpret state and federal law as applied
to the facts of the cases, the extent of potential losses beyond any amounts
that may be accrued are not readily determinable at this time. Based on facts
and circumstances presently known, however, in the opinion of management the
outcome will not materially affect the equity of CNA, although results of
operations may be adversely affected.
See Note 7 for information with respect to claims and litigation involving
CNA related to environmental pollution, asbestos and mass torts.
Tobacco Related
Product Liability
Approximately 4,500 product liability cases are pending against cigarette
manufacturers in the United States. Lorillard is a defendant in approximately
4,100 of these cases.
The pending product liability cases are comprised of the following types of
cases:
"Conventional product liability cases" are brought by individuals who allege
cancer or other health effects caused by smoking cigarettes, by using
smokeless tobacco products, by addiction to tobacco, or by exposure to
environmental tobacco smoke. Approximately 1,600 cases are pending, including
approximately 1,175 cases against Lorillard. Included in this group are
approximately 1,100 cases pending in a single West Virginia court that has
been consolidated for trial. Lorillard is a defendant in approximately 1,000
of the 1,100 consolidated West Virginia cases.
"Flight Attendant cases" are brought by non-smoking flight attendants
alleging injury from exposure to environmental smoke in the cabins of
aircraft. Plaintiffs in these cases may not seek punitive damages for injuries
that arose prior to January 15, 1997. Lorillard is a defendant in each of the
approximately 2,800 pending Flight Attendant cases.
"Class action cases" are purported to be brought on behalf of large numbers
of individuals for damages allegedly caused by smoking. Approximately 40 of
these cases are pending against Lorillard. Lorillard is not a defendant in
approximately 25 additional class actions that are pending against other
cigarette manufacturers and assert claims on behalf of smokers of "light"
cigarettes.
"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
39
of taxpayers. Lorillard is a defendant in most of the approximately 40 pending
Reimbursement cases.
"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.
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.
Plaintiffs assert a broad range of legal theories in these cases, including,
among others, theories of negligence, fraud, misrepresentation, strict
liability, breach of warranty, enterprise liability (including claims asserted
under the Racketeering Influenced and Corrupt Organizations Act), civil
conspiracy, intentional infliction of harm, violation of consumer protection
statutes, violation of antitrust statutes, injunctive relief, indemnity,
restitution, unjust enrichment, public nuisance, claims based on antitrust
laws and state consumer protection acts, and claims based on failure to warn
of the harmful or addictive nature of tobacco products.
Plaintiffs in most of the cases seek unspecified amounts of compensatory
damages and punitive damages, although some seek damages ranging into the
billions of dollars. Plaintiffs in some of the cases seek treble damages,
statutory damages, disgorgement of profits, equitable and injunctive relief,
and medical monitoring, among other damages.
The Mississippi Supreme Court has issued a ruling in a product liability
case brought against cigarette manufacturers in which it held that the
Mississippi Product Liability Act "precludes all tobacco cases that are based
on products liability." It is uncertain what affect, if any, this ruling will
have on litigation against cigarette manufacturers in Mississippi. Neither
Lorillard, nor the Company, were parties to this case.
During March of 2003, a verdict in favor of a class of Illinois residents
who smoked Philip Morris' "light" brand cigarettes was returned in Price v.
Philip Morris U.S.A. (Circuit Court, Madison County, Illinois). The court
awarded the class approximately $7.1 billion in actual damages. It also
awarded $3.0 billion in punitive damages to the State of Illinois, which was
not a party to the suit. The court awarded plaintiffs' counsel approximately
$1.8 billion in fees and costs. The court denied Philip Morris USA's motion
seeking reversal of the judgment or, in the alternative, a new trial, a
modification of the court's judgment, or a reduction in damages. Philip Morris
USA has announced that it will pursue an appeal from the judgment. Pursuant to
Philip Morris USA's application, the court has reduced the dollar amount of
the bond Philip Morris USA must post to pursue the appeal. In addition, Philip
Morris USA has initiated an action in the Circuit Court of Cook County,
Illinois, in which it seeks a declaration that the state has released any
right or interest in the punitive damages award. Neither Lorillard nor the
Company are parties in this matter. See "Class Action Cases."
CONVENTIONAL PRODUCT LIABILITY CASES - Approximately 1,600 cases are
pending, including approximately 1,175 cases against Lorillard. This total
includes approximately 1,100 cases pending in a single West Virginia court
40
that have been consolidated for trial. The trial is presently scheduled to
begin during June of 2003. Lorillard is a defendant in approximately 1,000 of
the 1,100 consolidated West Virginia cases. The Company, which is not a
defendant in any of the consolidated West Virginia cases, is a defendant in
five of the pending cases.
Since January 1, 2001 and through May 1, 2003, verdicts have been returned
in 20 matters. Lorillard was a defendant in two of the cases. Defense verdicts
were returned in 13 of the cases, including both tried against Lorillard.
Eleven cases are pending in which verdicts have been returned in favor of
the plaintiffs. Neither the Company nor Lorillard were defendants in any of
these cases. These eleven cases, and the verdict amounts, are below:
Eastman v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Pinellas County, Florida). During April of 2003, plaintiff was awarded $6.5
million in actual damages. As of May 1, 2003, the deadline for defendants to
file any post-trial motions or to file an appeal had not expired.
Bullock v. Philip Morris USA (Superior Court, Los Angeles County,
California). During September and October of 2002, plaintiff was awarded $5.5
million in actual damages and $28.0 billion in punitive damages. The court
reduced the punitive damages award to $28.0 million. Philip Morris has
appealed.
Figueroa v. R.J. Reynolds Tobacco Company (U.S. District Court, Puerto
Rico). During September of 2002, plaintiffs were awarded $1.0 million in
actual damages. The court granted the defendant's motion for judgment as a
matter of law and entered a final judgment in favor of R.J. Reynolds.
Plaintiffs have appealed.
Schwarz v. Philip Morris Incorporated (Circuit Court, Multnomah County,
Oregon). During March of 2002, plaintiff was awarded approximately $120,000 in
economic damages, $50,000 in noneconomic damages and $150.0 million in
punitive damages, although the court subsequently reduced the punitive damages
award to $100.0 million. Many of plaintiff's claims were directed to
allegations that the defendant had made false representations regarding the
low tar cigarettes smoked by the decedent. Philip Morris has appealed.
Burton v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Kansas). During February of 2002, plaintiff was awarded approximately $200,000
in actual damages and the jury determined that plaintiff was entitled to
punitive damages. During June of 2002, the court awarded plaintiff $15.0
million in punitive damages from R.J. Reynolds. R.J. Reynolds has appealed.
Kenyon v. R.J. Reynolds Tobacco Company (Circuit Court, Hillsborough County,
Florida). During December of 2001, plaintiff was awarded $165,000 in actual
damages. R.J. Reynolds has appealed.
Boeken v. Philip Morris Incorporated (Superior Court, Los Angeles County,
California). During June of 2001, plaintiff was awarded $5.5 million in actual
damages and $3.0 billion in punitive damages. The court reduced the punitive
damages award to $100.0 million. Philip Morris has appealed.
Jones v. R.J. Reynolds Tobacco Co. (Circuit Court, Hillsborough County,
Florida). During October of 2000, plaintiff was awarded $200,000 in actual
damages. The court granted the defendant's motion for new trial. The Florida
Court of Appeal affirmed this ruling. Plaintiff has filed for permission to
appeal to the Florida Supreme Court.
41
Whiteley v. Raybestos - Manhattan, Inc., et al. (Superior Court, San
Francisco County, California). During March of 2000, plaintiffs were awarded
$1.0 million in economic damages, $500,000 in noneconomic damages, $250,000 in
loss of consortium and $20.0 million in punitive damages from Philip Morris
and R.J. Reynolds. Both defendants have appealed.
Williams v. Philip Morris, Inc. (Circuit Court, Multnomah County, Oregon).
During March of 1999, plaintiff was awarded $21,000 in economic damages,
$800,000 in actual damages and $79.5 million in punitive damages. The court
reduced the punitive damages award to $32.0 million. During 2002, the Oregon
Court of Appeals affirmed the verdict and reinstated the full amount of the
punitive damages award. The Oregon Supreme Court declined to review the case.
Philip Morris has filed a petition for writ of certiorari with the U.S.
Supreme Court. As of May 1, 2003, the Court had not ruled whether it would
grant review of the petition.
Henley v. Philip Morris Incorporated (Superior Court, San Francisco County,
California). During February of 1999, plaintiff was awarded $1.5 million in
actual damages and $50.0 million in punitive damages, although the court
reduced the latter award to $25.0 million. During 2001, the California Court
of Appeals affirmed the verdicts. During 2002, the California Supreme Court
remanded the case to the Court of Appeals with directions that it reconsider
its 2001 ruling. During 2003, the Court of Appeals reaffirmed its 2001 order.
Philip Morris is attempting to notice an appeal to the California Supreme
Court.
Defense verdicts have been returned in the following 13 matters since
January 1, 2001. Unless otherwise noted, neither Lorillard nor the Company was
a defendant in these matters:
Inzerilla v. The American Tobacco Company, et al. (Supreme Court Queens
County, New York). A defense verdict was returned during February of 2003. A
final judgment has not been entered.
Lucier v. Philip Morris USA, et al. (Superior Court, Sacramento County,
California). A defense verdict was returned during February of 2003. The court
has denied plaintiffs' motion for new trial. As of May 1, 2003, the deadline
for plaintiff to notice an appeal had not expired.
Carter v. Philip Morris USA (Court of Common Pleas, Philadelphia County,
Pennsylvania). A defense verdict was returned during January of 2003. The
court has denied plaintiff's motion for new trial. As of May 1, 2003, the
deadline for plaintiff to notice an appeal had not expired.
Conley v. R.J. Reynolds Tobacco Co., et al. (U.S. District Court, Northern
District of California). A defense verdict was returned during December of
2002. Plaintiffs have appealed.
Tompkin v. The American Tobacco Company, et al. (U.S. District Court,
Northern District, Ohio). Lorillard is a defendant in this matter. A defense
verdict was returned during October of 2001. Plaintiff has appealed.
In eight cases in which defendants prevailed at trial after January 1, 2001,
plaintiffs either chose not to appeal or have withdrawn their appeals and the
cases are concluded. These eight matters and the dates of the verdicts are
Allen v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court, Southern
District, Florida, February of 2003); Tune v. Philip Morris Incorporated
(Circuit Court of Pinellas County, Florida, May of 2002); Hyde v. Philip
42
Morris Incorporated (U.S. District Court, Rhode Island, March of 2002); DuJack
v. Brown & Williamson Tobacco Corporation (Superior Court of Connecticut at
Rockville, November of 2001); Mehlman v. Philip Morris, Inc., et al. (Superior
Court, Middlesex County, New Jersey, May of 2001); Grinnell v. The American
Tobacco Company (District Court, Jefferson County, Texas, March of 2001);
Little v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court, South
Carolina, February of 2001) and Apostolou v. The American Tobacco Company, et
al. (Supreme Court, Kings County, New York, January of 2001). Lorillard was a
defendant in one of these eight matters, Apostolou v. The American Tobacco
Company, et al.
No trials were underway as of May 1, 2003. Some cases against U.S. cigarette
manufacturers and manufacturers of smokeless tobacco products are scheduled
for trial during the remainder of 2003 and beyond. As of May 1, 2003,
Lorillard is a defendant in two trials scheduled for 2003. A consolidated
trial involving the approximately 1,000 cases pending against Lorillard in the
Circuit Court of Ohio County, West Virginia, had been scheduled for trial
during 2003 but that trial date has been vacated. A new date for the
consolidated trial was not scheduled as of May 1, 2003 and it is not known
whether this trial will begin during 2003. The Company is a not a defendant in
any of the cases scheduled for trial during 2003 as of May 1, 2003. The trial
dates are subject to change.
FLIGHT ATTENDANT CASES - As of May 1, 2003, approximately 2,800 Flight
Attendant cases were pending. Lorillard and three other cigarette
manufacturers are the defendants in each of these matters. The Company is not
a defendant in any of these cases. These suits were filed as a result of a
settlement agreement by the parties, including Lorillard, in Broin v. Philip
Morris Companies, Inc., et al. (Circuit Court, Dade County, Florida, filed
October 31, 1991), a class action brought on behalf of flight attendants
claiming injury as a result of exposure to environmental tobacco smoke. The
settlement agreement, among other things, permitted the plaintiff class
members to file these individual suits. These individuals may not seek
punitive damages for injuries that arose prior to January 15, 1997.
During October of 2000, the Circuit Court of Miami-Dade County, Florida
entered an order that may be construed to hold that the flight attendants are
not required to prove the substantive liability elements of their claims for
negligence, strict liability and breach of implied warranty in order to
recover damages. The court further ruled that the trials of these suits are to
address whether the plaintiffs' alleged injuries were caused by their exposure
to environmental tobacco smoke and, if so, the amount of damages to be
awarded. It is not clear how the trial judges will apply this order. The
defendants' appeals were rejected as premature. Defendants retain the right to
appeal this order in the future.
Verdicts have been returned in five of the flight attendant cases. Lorillard
has been a defendant in each of these five cases. In one of the cases, the
plaintiff was awarded $5.5 million in actual damages, although the court
reduced the award to $500,000. Defendants have noticed an appeal from this
verdict and plaintiff has noticed a cross-appeal. Defendants have prevailed in
the four other cases. In one of them, the court granted plaintiff's motion for
new trial and defendants have appealed.
As of May 1, 2003, approximately 10 flight attendant cases were scheduled
for trial during 2003. Trial dates are subject to change.
CLASS ACTION CASES - Lorillard is a defendant in approximately 40 pending
cases. The Company is a defendant in two of these cases. In most of the
43
pending cases, plaintiffs purport to seek class certification on behalf of
groups of cigarette smokers, or the estates of deceased cigarette smokers, who
reside in the state in which the case was filed. The pending class action
cases against Lorillard include approximately 25 separate suits filed in a
single Nevada court in which the plaintiffs assert virtually identical class
definitions. Neither Lorillard nor the Company are defendants in approximately
25 additional class action cases pending against other cigarette manufacturers
in various courts throughout the nation. Many of these 25 cases assert claims
on behalf of smokers of "light" cigarettes.
Cigarette manufacturers, including Lorillard, have defeated motions for
class certification in a total of 28 cases, 12 of which were in state court
and 16 of which were in federal court. These 28 cases were filed in 16 states,
the District of Columbia and the Commonwealth of Puerto Rico.
The Engle Case - One of the class actions pending against Lorillard is Engle
v. R.J. Reynolds Tobacco co., et al. (Circuit Court, Dade County, Florida,
filed May 5, 1994), a case in which a jury awarded approximately $16.3 billion
in punitive damages against Lorillard during 2000 as part of a $145.0 billion
verdict against all of the defendants. Lorillard and the other defendants have
appealed this award and other rulings in this case, which is described below.
A three-phase trial plan governed Engle when trial began in July of 1998.
The first phase involved certain issues deemed common to the certified class,
which was defined as Florida residents, and survivors of Florida residents,
who were injured or died from medical conditions allegedly caused by addiction
to cigarettes. The trial's first phase ended on July 7, 1999 with findings
against the defendants, including Lorillard. Among other things, the jury
found that cigarette smoking is addictive and causes lung cancer and a variety
of other diseases, that the defendants concealed information about the health
risks of smoking, and that defendants' conduct rose to a level that would
permit a potential award or entitlement to punitive damages. The jury was not
asked to award damages in the Phase One verdict, and the verdict permitted the
trial to proceed to a second phase.
Following the Phase One verdict, the trial judge amended the trial plan with
respect to the manner of determining punitive damages. This ruling, known as
the Punitive Damages Order, provided that the jury would determine punitive
damages, if any, on a lump-sum dollar amount basis for the entire qualified
class. The Florida Third District Court of Appeal rejected as premature
defendants' appeals from the Punitive Damages Order, and the Florida Supreme
Court declined to review the Punitive Damages Order at that time.
The first portion of Phase Two of the trial began on November 1, 1999 before
the same jury that returned the verdict in Phase One. On April 7, 2000, the
jury returned a verdict against the defendants and awarded three plaintiffs
$12.5 million in damages for their individual claims.
The second part of Phase Two, which began on May 22, 2000, was heard by the
same jury that heard the trial's prior phases and considered evidence as to
the punitive damages to be awarded to the class. On July 14, 2000, the jury
awarded approximately $145.0 billion in punitive damages against all
defendants, including $16.3 billion against Lorillard. The judgment provides
that the jury's awards bear interest at the rate of 10% per year.
Lorillard has noticed an appeal from the final judgment to the Florida Third
District Court of Appeal and has posted its appellate bond in the amount of
$100.0 million pursuant to Florida legislation enacted in May of 2000 limiting
the amount of an appellate bond required to be posted in order to stay
44
execution of a judgment for punitive damages in a certified class action.
While Lorillard believes this legislation is valid and that any challenges to
the possible application or constitutionality of this legislation would fail,
during May of 2001, Lorillard entered into an agreement with the plaintiffs
(the "Engle Agreement") in which it contributed $200.0 million to a fund held
for the benefit of the Engle plaintiffs that will not be recoverable by
Lorillard even if the challenges to the judgment are resolved in favor of the
defendants. The $200.0 million contribution included the $100.0 million that
Lorillard posted as collateral for the appellate bond. Accordingly, Lorillard
recorded a pretax charge of $200.0 million in the second quarter of the year
ended December 31, 2001. Two other defendants executed agreements with the
plaintiffs that are similar to Lorillard's. As a result, the class has agreed
to a stay of execution, with respect to Lorillard and the two other defendants
on its punitive damages judgment until appellate review is completed,
including any review by the U.S. Supreme Court.
The Engle Agreement provides that in the event that Lorillard, Inc.'s
balance sheet net worth falls below $921.2 million (as determined in
accordance with generally accepted accounting principles in effect as of July
14, 2000), the stay granted in favor of Lorillard in the Engle agreement would
terminate and the class would be free to challenge the Florida legislation. As
of March 31, 2003, Lorillard, Inc. had a balance sheet net worth of
approximately $1.4 billion.
In addition, the Engle Agreement requires Lorillard to obtain the written
consent of class counsel or the court prior to selling any trademark of or
formula comprising a cigarette brand having a U.S. market share of 0.5% or
more during the preceding calendar year. The Engle Agreement also requires
Lorillard to obtain the written consent of the Engle class counsel or the
court to license to a third party the right to manufacture or sell such a
cigarette brand unless the cigarettes to be manufactured under the license
will be sold by Lorillard.
Although the jury has awarded punitive damages and final judgment has been
entered, Lorillard believes that it is unclear how the Punitive Damages Order
will be implemented. The Punitive Damages Order provides that the lump-sum
punitive damages amount, if any, will be allocated equally to each class
member and acknowledges that the actual size of the class will not be known
until the last case has withstood appeal, i.e., the punitive damages amount,
if any, determined for the entire qualified class, would be divided equally
among those plaintiffs who are ultimately successful. The Punitive Damages
Order does not address whether defendants would be required to pay the
punitive damages award, if any, prior to a determination of claims of all
class members, which is Phase Three of the trial plan, a process that could
take years to conclude. The final judgment entered by the court on November 6,
2000 directs that the amounts awarded by the jury are to be paid immediately.
Phase Three would address potentially hundreds of thousands of other class
members' claims, including issues of specific causation, reliance, affirmative
defenses and other individual-specific issues regarding entitlement to
damages, in individual trials before separate juries.
Lorillard is a defendant in eleven separate cases pending in the Florida
courts in which the plaintiffs claim that they are members of the Engle class,
that all liability issues associated with their claims were resolved in the
earlier phases of the Engle proceedings, and that trials on their claims
should proceed immediately. Lorillard is opposing trials of these actions on
the grounds that they should be considered during Phase Three of the Engle
case and should be stayed while the Engle appeal is proceeding. Additional
cases with similar contentions are pending against other cigarette
45
manufacturers. In one of the matters in which Lorillard was not a party, a
jury in the Circuit Court of Miami-Dade County, Florida returned a verdict in
favor of the plaintiffs during June of 2002 in the case of Lukacs v. Brown &
Williamson Tobacco Corporation, et al. and awarded them $500,000 in economic
damages, $24.5 million in noneconomic damages and $12.5 million in damages for
loss of consortium. The court has reduced the loss of consortium award to
$125,000. No post-trial motions are scheduled to be filed in Lukacs as a final
judgment reflecting the verdict will not be entered until the Engle appeal is
resolved.
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 and it is not known when a ruling will be issued.
Lorillard believes that an appeal of these issues on the merits should
prevail.
Other Class Action Cases - In six additional class actions in which
Lorillard is a defendant, courts have granted plaintiffs' motions for class
certification. Two of these matters have been resolved in favor of the
defendants and plaintiffs' claims in a third case were resolved through a
settlement agreement. These six matters are listed below in alphabetical
order:
Blankenship v. American Tobacco Company, et al. (Circuit Court, Ohio County,
West Virginia, filed January 31, 1997). During 2000, the court certified a
class comprised of certain West Virginia cigarette smokers who sought, among
other things, medical monitoring. During November of 2001, the jury returned a
verdict in favor of the defendants, including Lorillard. Plaintiffs have
noticed an appeal.
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, filed October 31, 1991). This is the matter concluded by a settlement
agreement and discussed under "Flight Attendant Cases" above.
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San
Diego County, California, filed June 10, 1997). During 2001, the court
certified a class comprised of adult residents of California who smoked at
least one of defendants' cigarettes between June 10, 1993 and April 23, 2001
and who were exposed to defendants' marketing and advertising activities in
California. Trial is scheduled to begin during September of 2003.
Daniels v. Philip Morris, Incorporated, et al. (Superior Court, San Diego
County, California, filed August 2, 1998). During 2000, the court certified a
class comprised of California residents who, while minors, smoked at least one
cigarette between April of 1994 and December 31, 1999. During 2002, the court
granted defendants' motion for summary judgment and entered final judgment in
their favor. Plaintiffs have appealed.
In re: Simon II Litigation v. R.J. Reynolds Tobacco Company, et al. (U.S.
District Court, Eastern District, New York, filed September 6, 2000). During
2002, the case was certified as a nationwide non-opt out class comprised of
the punitive damages claims asserted by individuals who allege certain
injuries or medical conditions allegedly caused by smoking. Certain
46
individuals, including those who allege membership in the class certified in
Engle v. R.J. Reynolds Tobacco Company, et al., were excluded from the class.
Defendants are appealing the ruling.
Scott v. The American Tobacco Company, et al. (District Court, Orleans
Parish, Louisiana, filed May 24, 1996). The court certified a class comprised
of certain cigarette smokers resident in the State of Louisiana who desire to
participate in medical monitoring or smoking cessation programs and who began
smoking prior to September 1, 1988, or who began smoking prior to May 24, 1996
and allege that defendants undermined compliance with the warnings on
cigarette packages. Jury selection began during 2001, but the jury did not
begin hearing evidence until January of 2003. Trial was proceeding as of May
1, 2003.
In addition to the above, motions for class certification have been granted
in some cases in which Lorillard is not a defendant. One of these is the case
of Price v. Philip Morris USA (Circuit Court, Madison County, Illinois, filed
February 10, 2000, and formerly known as Miles). The court in Price certified
a class comprised of Illinois residents who smoked Philip Morris' cigarettes
labeled as "light" or "ultra light." During 2003, the court returned a verdict
in favor of the class; see above for a discussion of the judgment entered in
plaintiffs' favor at trial.
REIMBURSEMENT CASES - The cases settled by the State Settlement Agreements
described below are concluded. Approximately 40 other suits are pending in
which Lorillard is a defendant. The Company is a defendant in 26 of the
pending cases. Plaintiffs in 28 of the cases are foreign governments that have
filed suit in U.S. courts. The plaintiffs in the remaining pending cases
include the U.S. federal government, several U.S. county or city governments,
American Indian tribes, hospitals or hospital districts, private companies and
private citizens suing on behalf of taxpayers. Plaintiffs in some of these
cases seek certification as class actions.
U.S. Federal Government Action - The U.S. federal government filed a
reimbursement suit on September 22, 1999 in the U.S. District Court for the
District of Columbia against Lorillard, other U.S. cigarette manufacturers,
some parent companies and two trade associations. The Company is not a
defendant in this action. Plaintiff asserted claims under the Medical Care
Recovery Act, the Medicare as Secondary Payer provisions of the Social
Security Act, and the Racketeer Influenced and Corrupt Organizations Act. The
court has dismissed plaintiff's Medical Care Recovery Act and the Medicare as
Secondary Payer provisions of the Social Security Act claims. In a recent
filing, the government stated that it is seeking an aggregate of $289.0
billion in disgorgement of profits from the defendants, including Lorillard,
as well as injunctive relief.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - Cases have
been brought in U.S. courts by 13 nations, more than 20 Brazilian states or
cities, and one Canadian province. Some of the cases have been voluntarily
dismissed, while courts have granted defendants' dismissal motions in some of
the other matters. Twenty-eight of the cases are pending. Both the Company and
Lorillard are named as defendants in most of these cases, although both have
been dismissed from three suits that remain pending against other defendants.
Other pending Reimbursement cases - In addition to the cases described
above, approximately 15 Reimbursement cases are pending against Lorillard.
Plaintiffs in these suits include U.S. city or county governments, hospitals
or hospital districts, American Indian tribes, private companies and private
citizens suing on behalf of taxpayers.
47
Excluding the cases filed by U.S. state governments that are described
below, defendants have successfully defended many of the Reimbursement cases.
For instance, each of the approximately 75 cases filed by labor union health
and welfare funds were dismissed, either due to orders that granted
defendants' dispositive motions or as the result of plaintiffs voluntarily
withdrawing their claims. In addition, various courts of appeal have affirmed
orders dismissing cases in favor of the defendants. For instance, during
February of 2003, the Appellate Division of the New York Supreme Court
affirmed the order dismissing the case filed by approximately 170 New York
hospitals or hospital districts, while the U.S. Supreme Court denied the
petition for writ of certiorari filed by the plaintiff in one of the tribal
cases during January of 2003.
Since January 1, 2001, one of the Reimbursement cases has been tried. During
June of 2001, a jury in the U.S. District Court for the Eastern District of
New York returned a verdict in Blue Cross and Blue Shield of New Jersey, Inc.,
et al. v. Philip Morris, Incorporated, et al., and awarded damages against the
defendants, including Lorillard. In this trial, the jury heard evidence as to
the claims of only one of the plan plaintiffs, Empire Blue Cross and Blue
Shield, referred to as "Empire." In its verdict, the jury found in favor of
the defendants on some of Empire's claims, one of which precluded the jury
from considering Empire's claims for punitive damages. The jury found in favor
of Empire on certain other of plaintiff's claims. As a result of these
findings, a final judgment was entered in which Empire was awarded a total of
approximately $17.8 million in actual damages, including approximately $1.5
million attributable to Lorillard. Empire was awarded approximately $55,000 in
pre-judgment interest for a total award against Lorillard of approximately
$1.6 million. The court has awarded plaintiff's counsel approximately $38.0
million in attorneys' fees. The defendants have noticed an appeal to the U.S.
Court of Appeals for the Second Circuit from the final judgment and from the
order awarding plaintiff's counsel attorneys' fees. The Court of Appeals heard
argument of defendants' appeal during February of 2003.
In addition to the above, the District Court of Jerusalem, Israel, has
permitted a private insurer in Israel, Clalit Health Services, to make service
outside the jurisdiction on the Company and Lorillard with a suit in which
Clalit Health Services seeks damages for providing treatment to individuals
allegedly injured by cigarette smoking. The Company and Lorillard have
separately moved to set aside the order that permitted service outside the
jurisdiction. As of May 1, 2003, the court had not ruled on the motions to set
aside the attempted service.
CONTRIBUTION CLAIMS - Approximately 10 cases are pending against Lorillard.
The Company is a defendant in one of these cases. Plaintiffs seek recovery of
funds expended by them to individuals whose asbestos disease or illness was
alleged to have been caused in whole or in part by smoking-related illnesses.
SETTLEMENT OF STATE REIMBURSEMENT LITIGATION - On November 23, 1998,
Lorillard, Philip Morris Incorporated, Brown & Williamson Tobacco Corporation
and R.J. Reynolds Tobacco Company, the "Original Participating Manufacturers,"
entered into a Master Settlement Agreement with 46 states, the District of
Columbia, the Commonwealth of Puerto Rico, Guam, the U.S. Virgin Islands,
American Samoa and the Commonwealth of the Northern Mariana Islands to settle
the asserted and unasserted health care cost recovery and certain other claims
of those states. These settling entities are generally referred to as the
"Settling States." The Original Participating Manufacturers had previously
settled similar claims brought by Mississippi, Florida, Texas and Minnesota,
48
which together with the Master Settlement Agreement are generally referred to
as the "State Settlement Agreements."
The State Settlement Agreements provide that the agreements are not
admissions, concessions or evidence of any liability or wrongdoing on the part
of any party, and were entered into by the Original Participating
Manufacturers to avoid the further expense, inconvenience, burden and
uncertainty of litigation.
Lorillard recorded pretax charges of $197.5 and $295.8 million ($120.6 and
$180.7 million after taxes), for the three months ended March 31, 2003 and
2002, respectively, to accrue its obligations under the State Settlement
Agreements. Lorillard's portion of ongoing adjusted payments and legal fees is
based on its share of domestic cigarette shipments in the year preceding that
in which the payment is due. Accordingly, Lorillard records its portions of
ongoing settlement payments as part of cost of manufactured products sold as
the related sales occur.
The State Settlement Agreements require that the domestic tobacco industry
make annual payments in the following amounts, subject to adjustment for
several factors, including inflation, market share and industry volume: 2003,
$10.9 billion; 2004 through 2007, $8.4 billion; and thereafter, $9.4 billion.
In addition, the domestic tobacco industry is required to pay settling
plaintiffs' attorneys' fees, subject to an annual cap of $500.0 million, as
well as an additional amount of $250.0 million in 2003. These payment
obligations are the several and not joint obligations of each settling
defendant.
The State Settlement Agreements also include provisions relating to
significant advertising and marketing restrictions, public disclosure of
certain industry documents, limitations on challenges to tobacco control and
underage use laws, and other provisions.
In addition, as part of the Master Settlement Agreement, the Original
Participating Manufacturers committed to work cooperatively with the tobacco
growing community to address concerns about the potential adverse economic
impact on that community. On January 21, 1999, the Original Participating
Manufacturers reached an agreement to establish a $5.2 billion trust fund
payable between 1999 and 2010 to compensate the tobacco growing communities in
14 states. Payments to the trust fund are to be allocated among the Original
Participating Manufacturers according to their relative market share of
domestic cigarette shipments, except that Philip Morris paid more than its
market share in 1999 but will have its payment obligations reduced in 2009 and
2010 to make up for the overpayment. Of the total $5.2 billion, a total of
$1.5 billion was paid since 1999 through March 31, 2003, $135.2 million of
which was paid by Lorillard. Lorillard believes its remaining payments under
the agreement will total approximately $358.8 million. All payments will be
adjusted for inflation, changes in the unit volume of domestic cigarette
shipments, and the effect of new increases in state or federal excise taxes on
tobacco products that benefit the tobacco growing community.
The Company believes that the State Settlement Agreements will materially
adversely affect its cash flows and operating income in future years. The
degree of the adverse impact will depend, among other things, on the rates of
decline in U.S. cigarette sales in the premium price and discount price
segments, Lorillard's share of the domestic premium price and discount price
cigarette segments, and the effect of any resulting cost advantage of
manufacturers not subject to significant payment obligations under the State
Settlement Agreements. Almost all domestic manufacturers have agreed to become
49
subject to the terms of the Master Settlement Agreement, however, under the
terms of the Master Settlement Agreement, manufacturers other than the
Original Participating Manufacturers retain much of their cost advantage.
FILTER CASES - Claims have been brought against Lorillard by smokers as well
as former employees of Lorillard seeking damages resulting from alleged
exposure to asbestos fibers that were incorporated into filter material used
in one brand of cigarettes manufactured by Lorillard for a limited period of
time, ending almost 50 years ago. Approximately 55 such matters are currently
pending against Lorillard. The Company is a defendant in one of these matters.
Since January 1, 2000 and through May 1, 2003, Lorillard has paid, or has
reached agreement to pay, a total of approximately $17.8 million in payments
of judgments and settlements to finally resolve approximately 45 previously
pending claims. In Sachs v . Lorillard Tobacco Co., the only filter case tried
to a verdict since January 1, 2001, the jury found in favor of Lorillard.
Other Tobacco - Related
TOBACCO - RELATED ANTITRUST CASES - Wholesalers and Direct Purchaser Suits -
Lorillard and other domestic and international cigarette manufacturers and
their parent companies, including the Company, were named as defendants in
nine separate federal court actions brought by tobacco product wholesalers for
violations of U.S. antitrust laws and international law. The complaints allege
that defendants conspired to fix the price of cigarettes to wholesalers since
1993 in violation of the Sherman Act. These actions seek certification of a
class including all domestic and international wholesalers similarly affected
by such alleged conduct, and damages, injunctive relief and attorneys' fees.
These actions were consolidated for pre-trial purposes in the U.S. District
Court for the Northern District of Georgia. The Court granted class
certification for a four-year class (beginning in 1996 and ending in 2000) of
domestic direct purchasers. The Company has been voluntarily dismissed without
prejudice from all direct purchaser cases. On July 11, 2002, the Court granted
motions for summary judgment filed by Lorillard and all other defendants
dismissing the actions in their entirety. Plaintiffs appeal in the U.S. Court
of Appeals for the Eleventh Circuit was argued May 1, 2003.
Indirect Purchaser Suits - Approximately 30 suits are pending in various
state courts alleging violations of state antitrust laws which permit indirect
purchasers, such as retailers and consumers, to sue under price fixing or
consumer fraud statutes. Approximately 18 states permit such suits. Lorillard
is a defendant in all but one of these indirect purchaser cases. Two indirect
purchaser suits in New York and Florida, have been dismissed in their entirety
and plaintiffs have withdrawn their appeals. The Arizona indirect purchaser
suit was dismissed by the trial court, but the dismissal was reversed on
appeal, and an appeal from the reversal to the Arizona Supreme Court was
argued in January of 2003. While two state courts have granted plaintiffs'
motions to certify a class of consumers, two other state courts have refused
to do so, and other motions seeking class certification have been deferred by
other courts pending resolution of the federal case discussed above. The
decision granting certification in New Mexico is being appealed by the
defendants. In Kansas, a Motion to Compel against Lorillard (and other
defendants) seeking certain documents for which Lorillard has claimed
privilege and a motion to extend discovery deadlines are pending before the
court. The Company was also named as a defendant in most of these indirect
purchaser cases but has been voluntarily dismissed without prejudice from all
of them.
Tobacco Growers Suit - DeLoach v. Philip Morris Inc., et al. (U.S. District
Court, Middle District of North Carolina, filed February 16, 2000). Lorillard
50
is named as a defendant in a lawsuit that, after several amendments, alleges
only antitrust violations. The other major domestic tobacco companies are also
presently named as defendants, and the plaintiffs have now added the major
leaf buyers as defendants. This case was originally filed in U.S. District
Court, District of Columbia, and transferred to a North Carolina federal court
upon motion by the defendants. The plaintiffs' claims relate to the conduct of
the companies in the purchase of tobacco through the auction system under the
federal program. The suit seeks an unspecified amount of actual damages,
trebled under the antitrust laws, and injunctive relief. On April 3, 2002 the
court certified a class consisting of all persons holding a quota (the
licenses that a farmer must either own or rent to sell the crop) to grow, and
all domestic producers who sold flue-cured or burley tobacco at anytime from
February 1996 to present. Defendants' petition to the United States Court of
Appeals for the Fourth Circuit seeking permission to appeal the District
Court's decision on class certification was denied on June 12, 2002. Pre-trial
discovery has commenced and is currently scheduled to be completed on or
before September 1, 2003. A trial date has not yet been scheduled.
REPARATION CASES - During 2002, the Company was named as a defendant in
three cases in which plaintiffs seek reparations for the alleged financial
benefits derived from the uncompensated use of slave labor. The Company was
named as a defendant in these matters as a result of conduct purportedly
engaged in by Lorillard and various other entities. Plaintiffs in these suits
seek various types of damages including disgorgement of profits, restitution
and punitive damages. Plaintiffs seek class certification on behalf of the
descendants of enslaved African Americans.
Defenses
Lorillard believes that it has valid defenses to the cases pending against
it. Lorillard also believes it has valid bases for appeal of the adverse
verdicts against it. To the extent the Company is a defendant in any of the
lawsuits described in this section, the Company believes that it is not a
proper defendant in these matters and has moved or plans to move for dismissal
of all such claims against it. While Lorillard intends to defend vigorously
all tobacco products liability litigation, it is not possible to predict the
outcome of any of this litigation. Litigation is subject to many
uncertainties, 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.
In addition, some developments on health issues related to tobacco products
have received widespread media attention, which could have adverse effects on
the ability of Lorillard to prevail in smoking and health litigation. These
developments also could prompt the filing of additional litigation. These
developments include, but are not limited to, the release of industry
documents beginning in 1998 and the adverse outcomes in some of the cases
tried during the past few years, some of which have resulted in awards to the
plaintiffs for billions of dollars. Defendants have appealed, or intend to
appeal, each of the verdicts returned to date in which plaintiffs were awarded
damages.
Except for the impact of the State Settlement Agreements as described above,
management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending litigation and,
therefore, no provision has been made in the consolidated financial statements
for any unfavorable outcome. It is possible that the Company's results of
operations or cash flows in a particular quarterly or annual period or its
51
financial position could be materially affected by an unfavorable outcome of
certain pending litigation.
OTHER LITIGATION - The Company and its subsidiaries are also parties to other
litigation arising in the ordinary course of business. The outcome of this
other litigation will not, in the opinion of management, materially affect the
Company's results of operations or equity.
15. Contingencies
Guarantees
CNA has provided guarantees related to irrevocable standby letters of credit
for certain of its subsidiaries. Certain of these subsidiaries have been sold;
however, the irrevocable standby letter of credit guarantees remain in effect.
CNA would be required to remit prompt payment on the letters of credit in
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 March
31, 2003.
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 is approximately $7.0 million at March 31, 2003.
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
has committed to continue funding the operating deficits of this joint
venture. Additionally, CNA and the other unrelated shareholders, on a joint
and several basis, have guaranteed an operating lease for an office building,
which expires in 2016.
The guarantee of the operating lease is a parallel guarantee to the
commitment to fund operating deficits; consequently, the separate guarantee to
the lessor is not expected to be triggered as long as the joint venture
continues to be funded by its shareholders and continues to make its annual
lease payments.
In the event that the other parties to the joint venture are unable to meet
their commitments in funding the operations of this joint venture, CNA would
be required to assume the obligation for the entire office building operating
lease. The maximum potential future lease payments at March 31, 2003 that CNA
could be required to pay under this guarantee is approximately $333.0 million.
If CNA were required to assume the entire lease obligation, CNA would have the
right to pursue reimbursement from the other shareholders and would have the
right to all sublease revenues.
CNA has recorded a liability of approximately $10.0 million as of March 31,
2003 and December 31, 2002 for its share of estimated future operating
deficits of this joint venture through 2016.
CNA has provided guarantees of the indebtedness of certain of its
independent insurance producers. These guarantees expire in 2003. CNA would be
52
required to remit prompt and complete payment when due, should the primary
obligor default. In the event of default on the part of the primary obligor,
CNA has a right to any and all shares of common stock of the primary obligor.
The maximum potential amount of future payments that CNA could be required to
pay under these guarantees are approximately $7.0 million at March 31, 2003.
CNA Surety
In March of 2003, CNA entered into a credit agreement with a large national
contractor, which undertakes projects for the construction of government and
private facilities, to provide loans to the contractor in a maximum aggregate
amount of $86.4 million (the "Credit Facility"). Of the $86.4 million, $57.0
million was outstanding at March 31, 2003. The Credit Facility and all related
loans will mature in March of 2006. Advances under the Credit Facility bear
interest at the prime rate plus 6.0%. Payment of 3.0% of the interest is
deferred until the Credit Facility matures, and the remainder is to be paid
monthly in cash. Loans under the Credit Facility are secured by a pledge of
substantially all of the assets of the contractor and certain affiliates. 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.
In March of 2003, CNA also purchased the contractor's outstanding bank debt
for $16.4 million. The contractor retired the bank debt by paying CNA $16.4
million, with $11.4 million of the payoff amount 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 amounts paid by CNA to
the banks as reimbursements for draws upon the banks' letters of credit will
become obligations of the contractor to CNA as draws upon the Credit Facility.
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 certain fees under the Credit Facility proportionally with CNA.
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
53
the contractor's restructuring efforts are expected to be successful and
provide sufficient cash flow for its operations and repayment of its
borrowings under the Credit Facility, the contractor's failure to achieve its
restructuring plan or perform its contractual obligations under the Credit
Facility and underlying all of CNA's surety bonds 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.
CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety over a period that expired on December 31, 2000
(the "stop loss contract"). The stop loss contract limits the net loss ratios
for CNA Surety with respect to certain accounts and lines of insurance
business. In the event that CNA Surety's accident year net loss ratio exceeds
24% for 1997 through 2000 (the "contractual loss ratio"), the stop loss
contract requires CCC to pay amounts equal to the amount, if any, by which CNA
Surety's actual accident year net loss ratio exceeds the contractual loss
ratio multiplied by the applicable net earned premiums. The minority
shareholders of CNA Surety do not share in any losses that apply to this
contract. There were no reinsurance balances payable under this stop loss
contract as of March 31, 2003 and December 31, 2002.
CCC, effective October 1, 2002, has secured replacement excess of loss
protection for new and renewal bonds for CNA Surety for per principal
exposures that exceed $60.0 million since October 1, 2002 in two parts - (a)
$40.0 million excess of $60.0 million and (b) $50.0 million excess of $100.0
million for CNA Surety. This excess of loss protection is necessary primarily
to support new and renewal bonds for contract surety accounts with bonded
backlogs or work-in-process in excess of $60.0 million. In consideration for
the reinsurance coverage provided by the $40.0 million excess of $60.0 million
contract, CNA Surety will pay to CCC, on a quarterly basis, a premium equal to
$3.0 million. In consideration for the reinsurance coverage provided by the
$50.0 million excess of $100.0 million, the insurance subsidiaries of CNA
Surety will pay $6.0 million in premium to CCC.
Other
As of March 31, 2003 and December 31, 2002, the Company had committed
approximately $111.0 and $141.0 million for future capital calls from various
third-party limited partnership investments in exchange for an ownership
interest in the related partnership.
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of March 31, 2003 to future capital calls from
certain of its unconsolidated affiliates in exchange for an ownership interest
in such affiliates.
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. As of March 31, 2003 and December 31, 2002 there were
approximately $187.0 and $222.0 million of outstanding letters of credit.
CNA 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.
54
The Company is obligated to make future payments totaling $516.5 million for
non-cancelable operating leases expiring from 2003 through 2058 primarily for
office space and data processing, office and transportation equipment.
Estimated future minimum payments under these contracts are as follows: $71.4
million in 2003; $71.9 million in 2004; $63.6 million in 2005; $53.2 million
in 2006; and $256.4 million in 2007 and beyond. Additionally, the Company 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.
16. Consolidating Financial Information
The following schedules present the Company's consolidating balance sheet
information at March 31, 2003 and December 31, 2002, and consolidating
statements of income information for the three months ended March 31, 2003 and
2002. These schedules present the individual subsidiaries of the Company and
their contribution to the consolidated financial statements. Amounts presented
will not necessarily be the same as those in the individual financial
statements of the Company's subsidiaries due to adjustments for purchase
accounting, income taxes and minority interests. In addition, many of the
Company's subsidiaries use a classified balance sheet which also leads to
differences in amounts reported for certain line items. This information also
does not reflect the impact of the Company's issuance of Carolina Group stock.
Lorillard is reported as a 100% owned subsidiary and does not include any
adjustments relating to the tracking stock structure. See Note 4 for
consolidating information of the Carolina Group and Loews Group.
The Corporate and Other column primarily reflects the parent company's
investment in its subsidiaries, invested cash portfolio and corporate long-
term debt. The elimination adjustments are for intercompany assets and
liabilities, interest and dividends, the parent company's investment in
capital stocks of subsidiaries, and various reclasses of debit or credit
balances to the amounts in consolidation. Purchase accounting adjustments have
been pushed down to the appropriate subsidiary.
55
Loews Corporation
Consolidating Balance Sheet Information
CNA Diamond
Corporate
March 31, 2003 Financial Lorillard Loews Hotels Offshore
Bulova and Other Eliminations Total
- --------------------------------------------------------------------------------
- ----------------------------------------
(In millions)
Assets:
Investments $35,217.7 $1,403.5 $ 105.0 $ 668.2 $
0.9 $ 2,660.9 $40,056.2
Cash 166.1 1.3 2.3 22.9
10.8 10.1 213.5
Receivables 17,895.6 30.1 28.7 138.9
78.3 24.5 $ (3.2) 18,192.9
Property, plant and equipment 287.1 195.5 389.5 2,292.4
15.9 32.8 3,213.2
Deferred income taxes 621.6 442.7
22.7 10.8 (583.4) 514.4
Goodwill 137.4 2.6 31.0
171.0
Investments in capital stocks
of subsidiaries
11,684.1 (11,684.1)
Other assets 3,215.4 468.1 99.5 91.8
72.2 306.8 (156.0) 4,097.8
Deferred acquisition costs of
insurance subsidiaries 2,597.1
2,597.1
Separate account business 3,240.1
3,240.1
- --------------------------------------------------------------------------------
- ----------------------------------------
Total assets $63,378.1 $2,541.2 $ 627.6 $3,245.2
$200.8 $14,730.0 $(12,426.7) $72,296.2
================================================================================
========================================
Liabilities and Shareholders'
Equity:
Insurance reserves $40,704.7
$40,704.7
Payable for securities
purchased 1,666.1 $ 3.4
$ 246.1 1,915.6
Securities sold under
agreements to repurchase 419.1
251.1 670.2
Long-term debt, less
unamortized discounts 2,163.5 146.5 $ 921.9
2,296.8 5,528.7
Reinsurance balances payable 2,791.3
2,791.3
Deferred income taxes 44.0 359.2
180.2 $ (583.4)
Other liabilities 2,499.6 $1,135.4 190.5 144.6 $
53.6 87.2 (142.8) 3,968.1
Separate account business 3,240.1
3,240.1
- --------------------------------------------------------------------------------
- ----------------------------------------
Total liabilities 53,484.4 1,135.4 384.4 1,425.7
53.6 3,061.4 (726.2) 58,818.7
Minority interest 1,080.5 0.2 816.7
4.8 1,902.2
Shareholders' equity 8,813.2 1,405.8 243.0 1,002.8
142.4 11,668.6 (11,700.5) 11,575.3
- --------------------------------------------------------------------------------
- ----------------------------------------
$63,378.1 $2,541.2 $627.6 $3,245.2
$200.8 $ 14,730.0 $(12,426.7) $72,296.2
================================================================================
========================================
56
Loews Corporation
Consolidating Balance Sheet Information
CNA Diamond
Corporate
December 31, 2002 Financial Lorillard Loews Hotels Offshore
Bulova and Other Eliminations Total
- --------------------------------------------------------------------------------
- ----------------------------------------
(In millions)
Assets:
Investments $35,271.2 $ 1,640.7 $ 104.6 $ 794.1 $
1.4 $ 2,324.7 $40,136.7
Cash 126.2 2.0 4.8 18.4
8.7 25.3 185.4
Receivables 16,262.1 30.2 24.2 147.0
87.6 52.7 $ (2.8) 16,601.0
Property, plant and equipment 292.4 197.8 391.2 2,207.5
16.3 33.0 3,138.2
Deferred income taxes 772.2 437.0
22.6 0.3 (604.9) 627.2
Goodwill 140.8 2.6 34.4
177.8
Investments in capital stocks
of subsidiaries
11,451.2 (11,451.2)
Other assets 3,130.1 469.2 95.5 92.2
74.3 160.0 (22.1) 3,999.2
Deferred acquisition costs of
insurance subsidiaries 2,551.4
2,551.4
Separate account business 3,102.7
3,102.7
- --------------------------------------------------------------------------------
- ----------------------------------------
Total assets $61,649.1 $ 2,776.9 $ 622.9 $3,293.6
$210.9 $14,047.2 $(12,081.0) $70,519.6
================================================================================
========================================
Liabilities and Shareholders' Equity:
Insurance reserves $40,178.9
$40,178.9
Payable for securities
purchased 531.2 $ 4.0
$ 263.9 799.1
Securities sold under
agreements to repurchase 552.4
552.4
Long-term debt, less
unamortized discounts 2,292.1 145.8 $ 917.8
2,296.2 5,651.9
Reinsurance balances payable 2,763.3
2,763.3
Deferred income taxes 47.1 374.0
183.8 $ (604.9)
Other liabilities 2,659.7 $ 1,352.1 195.7 141.3 $
67.5 87.3 (162.8) 4,340.8
Separate account business 3,102.7
3,102.7
- --------------------------------------------------------------------------------
- ----------------------------------------
Total liabilities 52,080.3 1,352.1 392.6 1,433.1
67.5 2,831.2 (767.7) 57,389.1
Minority interest 1,055.0 0.2 835.4
4.7 1,895.3
Shareholders' equity 8,513.8 1,424.8 230.1 1,025.1
138.7 11,216.0 (11,313.3) 11,235.2
- --------------------------------------------------------------------------------
- ----------------------------------------
Total liabilities and
shareholders' equity $61,649.1 $ 2,776.9 $ 622.9 $3,293.6
$210.9 $14,047.2 $(12,081.0) $70,519.6
================================================================================
========================================
57
Loews Corporation
Consolidating Statement of Income Information
Three Months Ended CNA Diamond
Corporate
March 31, 2003 Financial Lorillard Loews Hotels Offshore
Bulova and Other Eliminations Total
- --------------------------------------------------------------------------------
- ---------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,381.1
$ (0.9) $ 2,380.2
Investment income, net 432.2 $ 7.9 $ 0.5 $ 4.2
$ 11.8 456.6
Intercompany interest
and dividends
8.8 (8.8)
Investment (losses) gains (76.1) 0.3 (0.1)
(19.7) (95.6)
Manufactured products 844.2 $
41.0 (1.2) 884.0
Other 108.3 (0.2) 75.9 147.8
0.1 (7.9) 324.0
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 2,845.5 852.2 76.4 151.9
41.1 (8.2) (9.7) 3,949.2
- --------------------------------------------------------------------------------
- ----------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 1,869.8
1,869.8
Amortization of deferred
acquisition costs 458.2
458.2
Cost of manufactured
products sold 459.7
21.2 0.3 481.2
Other operating expenses 375.2 141.2 66.1 175.2
15.6 12.0 (0.9) 784.4
Interest 34.3 2.3 5.6
31.5 73.7
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 2,737.5 600.9 68.4 180.8
36.8 43.8 (0.9) 3,667.3
- --------------------------------------------------------------------------------
- ----------------------------------------
108.0 251.3 8.0 (28.9)
4.3 (52.0) (8.8) 281.9
- --------------------------------------------------------------------------------
- ----------------------------------------
Income tax expense (benefit) 19.6 97.8 2.9 (6.8)
1.2 (21.8) 92.9
Minority interest 8.9 (10.0)
0.1 (1.0)
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 28.5 97.8 2.9 (16.8)
1.3 (21.8) 91.9
- --------------------------------------------------------------------------------
- ----------------------------------------
Net income $ 79.5 $153.5 $ 5.1 $ (12.1) $
3.0 $(30.2) $ (8.8) $190.0
================================================================================
========================================
58
Loews Corporation
Consolidating Statement of Income Information
Three Months Ended CNA Diamond
Corporate
March 31, 2002 Financial Lorillard Loews Hotels Offshore
Bulova and Other Eliminations Total
- --------------------------------------------------------------------------------
- ----------------------------------------
(In millions) (Restated)
(Restated)
Revenues:
Insurance premiums $2,837.1
$ (0.9) $2,836.2
Investment income, net 425.9 $ 11.2 $ 0.2 $ 9.6 $
0.1 $ 16.0 463.0
Intercompany interest
and dividends
108.8 (108.8)
Investment gains 1.0 2.8 3.5
16.2 23.5
Manufactured products 973.1
31.7 1,004.8
Other 181.7 77.0 202.3
0.9 2.9 464.8
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 3,445.7 987.1 77.2 215.4
32.7 143.9 (109.7) 4,792.3
- --------------------------------------------------------------------------------
- ----------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 2,310.1
2,310.1
Amortization of deferred
acquisition costs 440.1
440.1
Cost of manufactured
products sold 592.3
15.4 607.7
Other operating expenses 485.6 119.4 65.4 178.7
14.3 11.9 875.3
Interest 37.3 2.3 5.5
31.4 76.5
Intercompany charges
0.9 (0.9)
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 3,273.1 711.7 67.7 184.2
29.7 44.2 (0.9) 4,309.7
- --------------------------------------------------------------------------------
- ----------------------------------------
172.6 275.4 9.5 31.2
3.0 99.7 (108.8) 482.6
- --------------------------------------------------------------------------------
- ----------------------------------------
Income tax expense (benefit) 52.1 106.9 3.5 10.7
1.3 (3.3) 171.2
Minority interest 17.4 10.6
0.1 (0.1) 28.0
- --------------------------------------------------------------------------------
- ----------------------------------------
Total 69.5 106.9 3.5 21.3
1.4 (3.4) 199.2
- --------------------------------------------------------------------------------
- ----------------------------------------
Income from continuing
operations 103.1 168.5 6.0 9.9
1.6 103.1 (108.8) 283.4
Discontinued operations-net (31.0)
(31.0)
Cumulative effect of change
in accountingprinciples-net (39.6)
(39.6)
- --------------------------------------------------------------------------------
- ----------------------------------------
Net income $ 32.5 $168.5 $ 6.0 $ 9.9 $
1.6 $103.1 $(108.8) $ 212.8
================================================================================
========================================
59
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
- ------------------------------------------------------------------------------
OVERVIEW
The Company reported consolidated net income (including both the Loews Group
and Carolina Group) for the 2003 first quarter of $190.0 million, compared to
$212.8 million in the 2002 first quarter.
Net income for the 2002 first quarter included a loss from discontinued
operations at CNA of $31.0 million or $0.16 per share of Loews common stock
and 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 at CNA.
Consolidated net operating income for the first quarter of 2003 amounted to
$246.6 million (determined by excluding net investment losses of $56.6 million
from net income). Consolidated net operating income for the first quarter of
2002 amounted to $267.6 million (determined by excluding net investment gains
of $15.8 million, loss from discontinued operations of $31.0 million and the
cumulative effect of accounting changes of $39.6 million from net income).
Net operating income attributable to Loews common stock for the first
quarter of 2003 amounted to $218.0 million (determined by excluding net
investment losses of $56.6 million and income attributable to Carolina Group
stock of $28.6 million from net income). Net operating income attributable to
Loews common stock for the first quarter of 2002 amounted to $249.9 million
(determined by excluding net investment gains of $15.5 million, income
attributable to Carolina Group stock of $18.0 million, loss from discontinued
operations of $31.0 million and the cumulative effect of accounting changes of
$39.6 million from net income).
Net income attributable to Carolina Group stock for the first quarter of
2003 was $28.6 million or $0.72 per Carolina Group share, compared to $18.0
million, or $0.45 per Carolina Group share in the first quarter of 2002.
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 March 31, 2003), 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 March 31, 2003, 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.
60
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.
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, (i) the availability of
sufficient funds in such subsidiaries, (ii) applicable state laws, (iii) in
the case of the insurance subsidiaries of CNA, laws and rules governing the
payment of dividends by regulated insurance companies (see Liquidity and
Capital Resources - CNA, below), and (iv) any agreements by the subsidiaries
restricting the payment of dividends. 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 March 31, 2003, the book value per share of Loews common stock was
$63.46, compared to $61.68 at December 31, 2002.
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 condensed financial statements and accompanying notes have
been prepared in accordance with GAAP, applied on a consistent basis. The
61
Company continually evaluates the accounting policies and estimates used to
prepare the consolidated condensed 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, and Environmental
Pollution and Mass Tort and Asbestos Reserves 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 Condensed
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
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
62
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 14 of the Notes to Consolidated Condensed Financial Statements included
in Item 1 of this Report, management is unable to make a meaningful estimate
of the amount or range of loss that could result from an unfavorable outcome
of pending litigation and, therefore, no provision has been made in the
consolidated condensed financial statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially 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 of the 2002 Annual Report
on Form 10-K 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 Condensed Statements of Income.
63
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
CNA Financial
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-
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 CNA's reportable
segments. The financial results for the segment changes are reflected
throughout the Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A").
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 including CNA's interest
expense on its corporate borrowings.
Certain amounts applicable to prior periods have been reclassified to
conform to the current period presentation.
Operating Results
The MD&A presents certain non-GAAP measures in order to provide information
used by management to monitor its operating performance. Net operating income
(loss) excludes the after-tax effects of net realized investment gains or
losses, gains or losses from discontinued operations and any cumulative
changes in accounting principle, net of tax, which are included in net income.
Management excludes after-tax net realized investment gains or losses from net
operating income (loss) because net realized investment gains or losses
related to CNA's available-for-sale investment portfolio are largely
discretionary, except for losses related to other-than-temporary investments,
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. CNA believes that net operating income
(loss) is a meaningful measure of operating performance for insurance
companies.
In addition to net operating income (loss), management monitors other
industry non-GAAP measures such as underwriting results in the property and
casualty segment and deposits in the life operations and group operations
segments. Management believes that the discussion of results in terms of these
non-GAAP measures provides a meaningful analysis of the underlying business
results of CNA's insurance subsidiaries.
Underwriting results are net earned premiums less net incurred claims and
the cost incurred to settle these claims, acquisition expenses and
underwriting expenses. The loss and loss adjustment expense ratio ("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
64
incurred to net earned premiums. The combined ratio is the sum of the loss and
dividend ratios.
Throughout the MD&A, CNA's business segment results are discussed using net
operating income (loss), which as described above is a non-GAAP measure. The
following reconciliation is provided in order to understand the differences
between net operating income (loss) and net income (loss).
Property
and Group Life
Other
Three Months Ended March 31, 2003 Casualty Operations Operations
Insurance Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Net operating income $ 95.6 $ 17.2 $ 9.2 $
1.4 $123.4
Realized investment gains
(losses), net of participating
policyholders' and minority
interest 8.0 (48.8) (48.0)
17.4 (71.4)
Income tax (expense) benefit
on realized investment gains
(losses) (2.3) 18.3 18.0
(6.5) 27.5
- --------------------------------------------------------------------------------
- ----------------
Net income (loss) $101.3 $(13.3) $(20.8) $
12.3 $ 79.5
================================================================================
================
Property
Three Months Ended March 31, 2002 and Group Life
Other
Casualty Operations Operations
Insurance Total
- --------------------------------------------------------------------------------
- ----------------
(In millions) (Restated)
(Restated)
Net operating income (loss) $ 74.8 $16.1 $ 28.1
$(18.1) $100.9
Realized investment gains
(losses), net of
participating policyholders'
and minority interest 10.0 8.9 10.5
(28.7) 0.7
Income tax (expense) benefit
on realized investment gains
(losses) (2.0) (3.4) (4.3)
11.2 1.5
- --------------------------------------------------------------------------------
- ----------------
Income (loss) from continuing
operations 82.8 21.6 34.3
(35.6) 103.1
Discontinued operations-net (31.0)
(31.0)
Cumulative effect of change in
accounting principle-net (33.3) (5.6)
(0.7) (39.6)
- --------------------------------------------------------------------------------
- ----------------
Net income (loss) $ 49.5 $21.6 $ (2.3)
$(36.3) $ 32.5
================================================================================
================
In addition, CNA's Property and Casualty segment results are also discussed
using underwriting gain (loss), which is a non-GAAP measure. The following
reconciliation is provided in order to understand the differences between
underwriting gain (loss) and net income (loss).
65
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Underwriting loss $(75.0) $(104.0)
Net investment income 204.0 196.0
Other revenues 92.0 138.0
Other expenses (77.0) (102.0)
- ------------------------------------------------------------------------------
Pretax operating income 144.0 128.0
Income tax expense (35.0) (39.0)
Minority interest (13.4) (14.2)
- ------------------------------------------------------------------------------
Net operating income from continuing operations 95.6 74.8
Realized investment gains, net of participating
policyholders' and minority interest 8.0 10.0
Income tax expense on realized investment gains (2.3) (2.0)
- ------------------------------------------------------------------------------
Income from continuing operations 101.3 82.8
Cumulative effect of change in accounting
principle-net (33.3)
- ------------------------------------------------------------------------------
Net income $101.3 $ 49.5
==============================================================================
Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, provide greater
diversification of risk, minimize exposures on larger risks and to exit
certain lines of business. 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
66
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 Condensed 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 $46.7 and $58.1 million for the three months ended
March 31, 2003 and 2002. The amount subject to interest crediting rates on
such contracts was $2,550.0 and $2,766.0 million at March 31, 2003 and
December 31, 2002.
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.
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. One of CNA's principal credit exposures from
these recent events arise from reinsurance receivables from Gerling Global
("Gerling").
In March of 2003, Gerling informed CNA that, under Gerling's interpretation
of three treaties relating to CNA HealthPro, CNA was required to transfer
approximately $205.0 million of funds withheld balances to a trust established
by Gerling for CNA's benefit or the treaties would be commuted. In April of
2003, Gerling advised CNA that it deems these treaties to be commuted as of
April 7, 2003. CNA, in turn, advised Gerling that it disputes the commutation
and regards the reinsurance treaties as remaining in effect. CNA has begun
discussions with Gerling with respect to resolving the dispute concerning
these treaties, as well as a possible commutation of all other reinsurance
arrangements between CNA and Gerling.
If these three CNA HealthPro treaties were commuted as of April 7, 2003, CNA
would reduce reinsurance recoverables and the related funds withheld
liability, which would result in a non-cash pretax loss of approximately $43.0
million. Furthermore, CNA estimates that pretax interest expense would be
reduced by $10.0 million over the balance of 2003 and $11.0 million in 2004.
In certain circumstances, including significant deterioration of a
reinsurer's financial strength ratings, CNA may engage in other commutation
discussions with individual reinsurers. The outcome of such discussions may
result in a lump-sum settlement that is less than the recorded receivable, net
of any applicable allowance for doubtful accounts. Losses arising from
commutations, 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 $198.5 and $195.7 million at March 31, 2003 and December 31,
2002. While CNA believes the allowance for doubtful accounts is adequate based
on current collateral and information currently available, failure of
67
reinsurers to meet their obligations could have a material adverse impact on
the Company's results of operations or equity.
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 September 11,
2001 World Trade Center Disaster and related events ("WTC event"), the limit
under this section was exhausted. Additionally, as a result of significant
reserve additions recorded in 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. Included
in the pretax results of operations for the three months ended March 31, 2003
and 2002, is $13.0 million of interest charges from the Aggregate Cover.
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 March 31, 2003.
68
The impact of the CCC Cover on pretax results of operations was as follows:
Three Months Ended March 31, 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $(61.0)
Ceded claim and claim adjustment expenses 93.0
Interest charges $(8.0) (10.0)
- ------------------------------------------------------------------------------
Pretax (expense) benefit $(8.0) $ 22.0
=============================================================================
The impact by operating segment of the Aggregate Cover and the CCC Cover on
results of operations was as follows:
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Standard Lines $(13.0) $(12.0)
Specialty Lines (2.0) (2.0)
CNA Re (5.0) 23.0
- ------------------------------------------------------------------------------
Total Property and Casualty (20.0) 9.0
Corporate and Other (1.0)
- ------------------------------------------------------------------------------
Pretax (expense) benefit $(21.0) $ 9.0
==============================================================================
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 integrated technology roadmap that included common
architecture and platform standards that directly support CNA's strategies.
69
No restructuring and other related charges related to the IT Plan were
incurred for the three months ended March 31, 2003 and 2002. Employee
termination and related benefit payments will continue through 2004 due to
employment contract obligations. The following table summarizes the remaining
"IT Plan" accrual at March 31, 2003 and the activity in that accrual since
inception.
Employee
Termination Impaired
Three Months Ended March 31, 2003 and Related Assets
Other
(Restated) Benefit Costs Charges
Costs Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
IT Plan Initial Accrual $ 29.0 $ 32.0 $
1.0 $ 62.0
Costs 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
Payments charged against liability in 2003
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at March 31, 2003 $ 5.0
$ 5.0
================================================================================
================
The remaining $5.0 million of the accrual relating to employee termination
and related benefit costs is expected to be paid through 2004.
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.
No restructuring and other related charges related to the 2001 Plan were
incurred for the three months ended March 31, 2003 and 2002. The following
table summarizes the remaining 2001 Plan accrual as of March 31, 2003 and the
activity in that accrual since inception.
70
Employee
Termination Lease Impaired
and Related Termination Assets
Other
Benefit Costs Costs Charges
Costs Total
- --------------------------------------------------------------------------------
- ----------------
(In millions)
2001 Plan Initial Accrual $ 68.0 $ 56.0 $ 30.0 $
35.0 $189.0
Costs that did not require
cash
(35.0) (35.0)
Payments charged against
liability (2.0)
(2.0)
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at
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 at
December 31, 2002 2.0 34.0 2.0
38.0
Costs that did not require
cash (1.0)
(1.0)
Payments charged against
liability in 2003 (1.0) (6.0)
(7.0)
- --------------------------------------------------------------------------------
- ----------------
Accrued costs at
March 31, 2003 $ 1.0 $ 28.0 $ 1.0
$ 30.0
================================================================================
================
Of the remaining $30.0 million accrual relating to lease termination costs
and impaired asset charges, approximately $10.0 million is expected to be paid
in the remainder of 2003.
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 Condensed Balance
Sheets under the heading "Insurance Reserves." Changes in estimates of
Insurance Reserves are reflected in the Company's Consolidated Condensed
Statements of Income, 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
71
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 Environmental Pollution and Mass Tort and
Asbestos ("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 Environmental Pollution and Mass Tort and Asbestos Reserves that
follows for further information.
In addition to the uncertainties inherent in estimating APMT and catastrophe
losses, CNA is subject to the uncertain effects of the regulatory environment,
including regulatory reserve reviews and 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 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 recorded Insurance Reserves reflect management's best estimate at
March 31, 2003 and December 31, 2002, 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 reserves. Management considers factors such
as changes in inflation, changes in claims-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. 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 equity. Any such
increase in reserves would be reflected in the Company's Consolidated
Condensed Statements of Income in the period in which the change in estimate
arises.
72
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.
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
established 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. In those
states that mandate property insurance coverage of damage from fire following
a loss, CNA is also prohibited from excluding terrorism exposure under such
coverage.
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's current reinsurance arrangements
either exclude terrorism coverage or significantly limit the level of
coverage.
73
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.
The following table summarizes key components of the Property and Casualty
Segment results of operations for the Three Months Ended March 31, 2003 and
2002:
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Net written premiums $1,973.0 $1,790.0
Net earned premiums 1,816.0 1,661.0
Underwriting loss (75.0) (104.0)
Net investment income 204.0 196.0
Net operating income 95.6 74.8
Ratios
Loss and loss adjustment expense 71.6% 72.4%
Expense 31.6 32.8
Dividend 0.9 1.0
- ------------------------------------------------------------------------------
Combined 104.1% 106.2%
==============================================================================
Net written premiums for the Property and Casualty Segment increased $183.0
million and net earned premiums increased $155.0 million for the three months
ended March 31, 2003 as compared with the
74
same period in 2002. The increase in net written and net earned premiums was
due primarily to strong rate increases and increased new business in Standard
Lines and Specialty Lines and the absence of cessions to the CCC Cover
discussed below and CNA Reinsurance Company Limited ("CNA Re U.K.") ceded
premiums, which was sold in 2002.
Standard Lines achieved average rate increases of 21.0% and 31.0% in the
first three months of 2003 and 2002 for the contracts that renewed during the
period and had retention rates of 70.0% and 66.0% for those contracts that
were up for renewal.
Specialty Lines achieved average rate increases of 31.0% and 20.0% in the
first three months of 2003 and 2002 for the contracts that renewed during the
period and had retention rates of 77.0% and 75.0% for those contracts that
were up for renewal.
The combined ratio decreased 2.1 points and underwriting results improved
$29.0 million for the three months ended March 31, 2003 as compared with the
same period in 2002. This change was due to decreases in the loss and dividend
ratios. The loss ratio decreased 0.8 points due principally to improvement in
the current net accident year loss ratio, partially offset by the absence of
the underwriting benefit related to corporate aggregate reinsurance treaties
discussed below, and offset by increased adverse net prior year development,
including premium and loss development, in the first three months of 2003. The
expense ratio decreased 1.2 points as a result of an increased net earned
premium base, and the absence of CNA Re U.K. expenses, partially offset by the
inclusion of expenses related to eBusiness. The eBusiness expenses were
included in the Other Insurance segment during 2002.
Unfavorable net prior year reserve development, including premium and claim
and claim adjustment expense reserve development, of $29.0 million was
recorded in the first three months of 2003 as compared with $39.0 million of
favorable net prior year development recorded for the same period in 2002, of
which $32.0 million related primarily to the corporate aggregate reinsurance
treaties discussed below. The gross carried claim and claim adjustment expense
reserve was $19,494.0 and $19,714.0 million at March 31, 2003 and December 31,
2002. The net carried claim and claim adjustment expense reserve was $11,640.0
and $11,997.0 million at March 31, 2003 and December 31, 2002.
Unfavorable net prior year reserve development of approximately $47.0
million was recorded related to certain programs written in Excess & Surplus
("E&S"). One E&S program, covering facilities that provide services to
developmentally disabled individuals, accounted for approximately $10.0
million of the unfavorable prior year reserve development. The reserve
development was due to an increase in the size of known claims and increases
in policyholder defense costs. These increases became apparent as the result
of an actuarial review completed during the first quarter of 2003, with most
of the reserve development from accident years 1999 and 2000. Another E&S
program, which accounts for approximately $25.0 million of E&S reserve
development, covers tow truck and ambulance operators in the 2000 and 2001
accident years. CNA expected that loss ratios for this business would be
similar to its middle market commercial automobile liability business. During
2002, CNA ceased writing business under this program. Approximately $12.0
million of unfavorable prior year reserve development was recorded during the
first quarter of 2003 related to a specific large loss.
Partially offsetting the unfavorable reserve development in E&S was
favorable prior year reserve development recorded in property lines during
2003. The favorable reserve development was principally from accident years
2001 and 2002 and was the result of the low number of large losses in recent
years.
During the first quarter of 2002, CNA Re revised its estimate of premiums
and losses related to the WTC event. In estimating CNA Re's WTC event losses,
CNA performed a treaty-by-treaty analysis of exposure. CNA's original loss
estimate was based on a number of assumptions including the loss to the
industry, the loss to individual lines of business and the market share of CNA
Re's cedants. Information that became available in the first quarter of 2002
resulted in CNA Re increasing its estimate of WTC event related premiums and
losses on its property facultative and property catastrophe business. The
impact of increasing the estimate of gross WTC event losses by $144.0 million
was fully offset on a net of reinsurance basis (before the impact of the CCC
Cover) by higher reinstatement premiums and a reduction of return premiums. As
a result, additional cessions were recorded to the CCC Cover.
Net operating income increased $20.8 million for the three months ended
March 31, 2003 as compared with the same period in 2002. The improvement in
75
net operating income was primarily related to improved underwriting results
and increased net investment income, principally as a result of improved
limited partnership income. In addition, results of operations for the first
quarter of 2002 included a non-recurring currency translation gain on U.S.
dollar denominated investments held by an Argentinean subsidiary. The
Argentine government changed its local currency and required conversion of all
U.S. denominated investments to Argentine Pesos. This conversion resulted in a
translation gain of $16.2 million, which was partially offset by a write-off
of the goodwill of that entity in the amount of $9.0 million.
Group
Net earned premiums for Group Operations decreased $590.0 million for the
three months ended March 31, 2003 as compared with the same period in 2002.
The decrease in net earned premiums was due primarily to the transfer of the
Mail Handlers Plan. Net earned premiums for the Mail Handlers Plan were $616.0
million for the three months ended March 31, 2002. This decrease was partially
offset by premium growth in the disability, life and long term care products
within Group Benefits.
Group Operations achieved rate increases that averaged approximately 6.0%
and 5.0% in the first three months of 2003 and 2002 for the disability,
accident and life lines of business within Group Benefits. Premium persistency
rates were approximately 89.0% and 76.0% in the first three months of 2003 and
2002.
Deposits for Group Operations increased $486.0 million for the three months
ended March 31, 2003 as compared with the same period in 2002. The increase in
deposits was due primarily to new sales in the Index 500 product, partially
offset by decreased guaranteed investment contracts ("GICs") deposits.
Net operating income increased by $1.1 million for the three months ended
March 31, 2003 as compared with the same period in 2002. The increase in net
operating income related primarily to the absence of unfavorable net operating
results related to the variable products business, which was sold to The
Phoenix Companies, Inc. in the third quarter of 2002, and favorable single
premium guaranteed annuities ("SPGA") mortality. These increases were
partially offset by the absence of net operating income related to the Mail
Handlers Plan.
Life
Net earned premiums for Life Operations increased $16.0 million for the
three months ended March 31, 2003 as compared with the same period in 2002.
The increase in net earned premiums was due primarily to growth in the long
term care product.
Deposits for Life Operations increased $9.0 million for the three months
ended March 31, 2003 as compared with the same period in 2002. The increase in
deposits was due primarily to higher sales of structured settlement annuities.
During the second quarter of 2003, CNA completed a review of its individual
long term care product offerings. The focus of the review was to determine
whether the current products provide adequate pricing flexibility under the
range of reasonably possible claims experience levels. Based on the review and
current market conditions, CNA has decided to significantly reduce new sales
of this product and certain infrastructure costs, with any associated expense
to be recorded in the second quarter of 2003. Premium will continue to be
received on inforce business, but the actions to reduce new business will
76
lower the rate of overall premium growth for this line. CNA does not expect
these actions to have a material adverse impact on the results of operations.
Net operating income decreased by $18.9 million for the three months ended
March 31, 2003 as compared with the same period in 2002. The decrease in net
operating income related primarily to unfavorable individual long term care
morbidity due to increases in severity and incidence and the write-off of $4.5
million after-tax of capitalized software costs. These decreases were
partially offset by improved mortality in life insurance and improved net
operating results for life settlement contracts.
Other Insurance
Operating revenues, which includes net earned premiums, net investment
income and other revenue, decreased $59.0 million for the three months ended
March 31, 2003 as compared with the same period in 2002. The decrease in total
operating revenues was due primarily to reduced revenues from CNA UniSource
and reduced earned premiums in group reinsurance due to the exit from these
businesses in 2002.
Favorable net prior year development, including premium and claim and claim
adjustment expenses development, of $3.0 million was recorded in the three
months ended March 31, 2003 as compared with $1.0 million of favorable net
prior year development recorded for the same period in 2002. The gross carried
claim and claim adjustment expense reserve was $5,085.0 million and $4,847.0
million at March 31, 2003 and December 31, 2002. The net carried claim and
claim adjustment expense reserve was $1,890.0 million and $2,002.0 million for
March 31, 2003 and December 31, 2002.
CNA entered into a retroactive reinsurance agreement as part of the sale of
CNA's personal insurance business to The Allstate Corporation ("Allstate") in
1999. 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.
Net operating results improved $19.5 million for the three months ended
March 31, 2003 as compared with the same period in 2002. The improvement in
the net results of operations was due primarily to decreased eBusiness
expenses and decreased interest expense on corporate borrowings. Beginning in
2003, expenses related to eBusiness were included in the property and casualty
operating segments of CNA.
Environmental Pollution and Mass Tort and Asbestos Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to environmental pollution and mass tort and asbestos
claims.
77
The following table provides data related to CNA's environmental pollution
and mass tort and asbestos claim and claim adjustment expense reserves:
March 31, 2003
December 31, 2002
- --------------------------------------------------------------------------------
- ----------------
Environmental
Environmental
Pollution and Pollution
and
Mass Tort Asbestos Mass Tort
Asbestos
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Gross reserves $ 811.0 $1,719.0 $ 830.0
$1,758.0
Ceded reserves (319.0) (527.0) (313.0)
(527.0)
- --------------------------------------------------------------------------------
- ----------------
Net reserves $ 492.0 $1,192.0 $ 517.0
$1,231.0
================================================================================
================
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.
However no reforms were enacted by Congress during 2002 or during the first
three months of 2003, and it is unclear what positions Congress or the
administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental cleanup may be significantly
reduced in favor of state action. Substantial changes in the federal statute
78
or the activity of the EPA may cause states to reconsider their environmental
cleanup statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result or the possible effect upon the
Company's results of operations or equity.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA 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 pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
As of March 31, 2003 and December 31, 2002, CNA carried approximately $492.0
and $517.0 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 three months ended March
31, 2003 and 2002. CNA paid environmental pollution-related claims and mass
tort related claims, net of reinsurance recoveries, of $25.0 and $33.0 million
for the three months ended March 31, 2003 and 2002.
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 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% 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 March 31, 2003 and December 31, 2002, CNA carried approximately
$1,192.0 and $1,231.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
79
claims. There was no asbestos-related net claim and claim adjustment expense
reserve development for the three months ended March 31, 2003 and 2002. CNA
paid asbestos-related claims, net of reinsurance, of $39.0 million during the
three months ended March 31, 2003 and had net reinsurance recoveries of $20.0
million for the three months ended March 31, 2002.
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 67 companies, including the 15 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 effect 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 subsidiaries, including alleged "non-products" exposures. 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 is engaged in insurance coverage litigation with Robert A. Keasbey
Company ("Keasbey") and associated claimants in New York state court
(Continental Casualty Company vs. 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
80
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. Another of these variables is the possible creation of a national
privately financed trust, which if established and approved through federal
legislation, could replace litigation of asbestos claims with payments to
claimants from the trust. It is uncertain at the present time whether such a
trust will be created or, if it is, what will be the terms and conditions of
its establishment. Adverse developments with respect to such matters discussed
in this paragraph could have a material adverse effect on the Company's
results of operations or equity.
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
81
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.
. 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 volume declines in the first quarter of 2003, as
compared to the first quarter of 2002, of 12.9% for the domestic U.S.
cigarette industry and 13.4% 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 1.86 share points from 6.21% in the first
quarter of 2002 to 8.07% in the first quarter of 2003, as estimated by
Management Science Associates.
. Continuing increases in state excise taxes on cigarette sales in the
first quarter of 2003, ranging from $0.09 per pack to $0.40 per pack, in
three states and the District of Columbia, as well as scheduled
increases in other states throughout 2003 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 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
82
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 Part II, Item 1 - Legal Proceedings and Note 14 of the Notes to
Consolidated Condensed Financial Statements included in Part I, Item 1 of this
Report, for information with respect to the Engle action and other litigation
against cigarette manufacturers and the State Settlement Agreements.
2003 Compared with 2002
- -----------------------
Revenues decreased by $132.4 million, or 13.5%, and net income decreased by
$13.4 million, or 8.0%, for the three months ended March 31, 2003, as compared
to the corresponding period of the prior year. Net income for the three
months ended March 31, 2003 was reduced by a charge of $17.1 million (net of
taxes) to record the effect of an agreement with the Brown & Williamson
Corporation (the "B&W Agreement") discussed in Liquidity and Capital
Resources. Excluding this charge, net income would have increased by $3.7
million, or 2.2%.
Revenues decreased due to lower net sales and reduced investment income.
Net sales decreased by $128.9 million for the three months ended March 31,
2003, as compared to 2002, due to decreased unit sales volume of approximately
$108.9 million, or 11.1%, and by decreased average unit prices which decreased
revenues by approximately $20.0 million, or 2.0%.
Net income decreased for the three months ended March 31, 2003, due to
decreased sales volume, increased sales promotion costs, the charge for the
B&W Agreement and decreased investment income, partially offset by reduced
tobacco settlement costs. The $98.3 million decrease in tobacco settlement
costs for the three months ended March 31, 2003, as compared to the comparable
period of the prior year, is due to the expiration of up-front payments ($41.5
million), reduced charges for lower unit volume ($26.6 million) and other
adjustments ($30.2 million).
For the three months ended March 31, 2003, Lorillard's net wholesale price
of cigarettes increased by an average of $4.98 per thousand cigarettes ($0.10
per pack of 20 cigarettes), or 4.0%, before the impact of any promotional
activities. Federal excise taxes are included in the price of cigarettes and
remained at $19.50 per thousand cigarettes ($0.39 per pack of 20 cigarettes).
The decreased unit prices reflect the increase in promotional expenses,
mostly in the form of retail/price promotions and other discounts provided to
retailers and passed through to the consumer, partially offset by the higher
average net wholesale prices in 2003.
Lorillard's total (U.S. domestic, Puerto Rico and certain U.S. Territories)
unit sales volume decreased 11.9% while domestic wholesale volume declined
13.4% for the three months ended March 31, 2003, as compared to the
corresponding period in 2002. Newport's unit sales volume decreased by 9.4%
overall and 11.0% for domestic wholesale volume for the three months ended
March 31, 2003 as compared to the corresponding period in 2002. Continued
decreases in unit volume for Old Gold and Maverick in the discount segment
83
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 for the three months ended March 31, 2003 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 1.86 share points for the three
months ended March 31, 2003 to 8.07% of the domestic market. As a result of
lower payments, these companies can price their brands at a significant
advantage, by as much as 66%, as compared with offerings from the major
cigarette manufacturers.
Lorillard's share of domestic wholesale cigarette shipments was 9.39% for
the three months ended March 31, 2003 as compared to 9.44% in the comparable
period of 2002. Newport, a premium brand, accounted for approximately 90% of
Lorillard's unit sales and approximately 91% of net sales revenue for the
three months ended March 31, 2003, compared to 88% of Lorillard's overall unit
sales and approximately 89% overall of net sales revenue in the comparable
period of 2002. Newport's share of the domestic premium segment was 11.6% for
the three months ended March 31, 2003 as compared to 11.1% in the comparable
period of 2002 according to Management Science Associates estimates of
wholesale unit shipments. Newport had the highest share of the menthol segment
of the market with an approximately 30% share of retail shipments within the
category as measured by Lorillard based on its retail shipment data, for the
three months ended March 31, 2003 and 2002. Menthol comprised approximately
26.7% and 26.4% of total U.S. retail industry shipments for the three months
ended March 31, 2003 and 2002. Premium priced cigarette sales accounted for
96.0% and 94.4% of Lorillard's total domestic sales for the three months ended
March 31, 2003 and 2002.
Overall, domestic industry unit sales volume decreased by 12.9% for three
months ended March 31, 2003. Industry sales for premium brands decreased to
72.9% for the three months ended March 31, 2003 as compared to 74.5% in the
comparable period of 2002. Industry and Lorillard sales volume comparisons for
the three months ended March 31, 2003 were negatively impacted due to
wholesale inventory adjustments during the first three months of 2002.
Wholesale inventories increased in January of 2002 following the inventory
reduction in fourth quarter of 2001 as a result of the federal excise tax
increase that took effect on January 1, 2002. In addition, wholesale
inventories were increased during February and March of 2002 in anticipation
of an industry price increase that occurred in early April of 2002.
Lorillard recorded pretax charges of $197.5 and $295.8 million ($120.6 and
$180.7 million after taxes), for the three months ended March 31, 2003 and
2002, 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
84
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.
Loews Hotels
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Revenues and net income decreased by $0.8 and $0.9 million, or 1.0% and
15.0%, respectively, for the three months ended March 31, 2003 as compared to
the corresponding period of the prior year.
Revenues decreased for the three months ended March 31, 2003, as compared to
2002, due primarily to a decline in revenue per available room and lower other
hotel operating revenues. Revenue per available room decreased by $3.02, or
2.5%, to $117.07 due primarily to lower occupancy 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 for the three months ended March 31, 2003, due to the
lower revenues, partially offset by improved operating results at the
Universal Orlando properties.
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 as a result.
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. As a
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.
The offshore drilling industry has historically been very cyclical with the
demand for its services fluctuating with the price of oil and natural gas.
However, the strong product prices that were prevalent throughout 2002 and in
the first quarter of 2003 did not generate the expected increase in dayrates
and utilization.
Revenues from dayrate drilling contracts are recognized currently. Diamond
Offshore may receive lump-sum payments in connection with specific contracts.
Such payments are recognized as revenues over the term of the related drilling
contract. Mobilization revenues, less costs incurred to mobilize an offshore
85
rig from one market to another, are recognized over the primary term of the
related drilling contract.
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. Diamond
Offshore recognizes as operating expenses activities such as inspections,
painting projects and routine overhauls, meeting certain criteria, which
maintain rather than upgrade its rigs. These expenses vary from period to
period. Costs of rig enhancements are capitalized and depreciated over the
expected useful lives of the enhancements. Higher depreciation expense
decreases operating income in periods subsequent to capital upgrades.
Revenues decreased by $59.9 million, or 28.3% and net income decreased by
$20.8 million for the three months ended March 31, 2003, as compared to the
corresponding period of the prior year. Revenues decreased due primarily to
lower contract drilling revenue of $53.8 million, reduced investment income of
$5.4 million, and lower revenues from reimbursable expenses.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $47.4 million, or 22.4%, for the three months ended March 31,
2003, as compared the corresponding period of the prior year. The decrease
reflects lower dayrates ($24.7 million) and lower utilization ($22.7 million),
partially offset by revenues generated by the Ocean Baroness 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 $5.9 million, or 2.8%, due primarily
to decreased dayrates ($1.3 million) and decreased utilization ($4.6 million)
for the three months ended March 31, 2003. Interest income decreased by $5.4
million, or 56.6%, for the three months ended March 31, 2003, primarily due to
a reduction in marketable securities held and lower interest rates earned on
cash and marketable securities for the three months ended March 31, 2003
compared to 2002.
Net income decreased due primarily to the lower revenues for the three
months ended March 31, 2003 as discussed above, partially offset by lower
contract drilling expenses.
Bulova
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
86
Revenues and net income increased by $8.4 and $1.4 million, or 25.7% and
88.0%, respectively, for the three months ended March 31, 2003, as compared to
the corresponding period of the prior year. Net sales increased $9.4 million
for the three months ended March 31, 2003, as compared to the corresponding
period of the prior year, due primarily to a 26.5% increase in unit volume and
a 5.0% increase in unit prices for Bulova's watch brands, as well as higher
clock unit volume of 16.8%, partially offset by lower average clock selling
prices of 10.9%. The increase in sales is due to higher purchases, principally
by larger retailers, to replenish low inventory levels following a cautious
selling season in 2002.
Net income increased due to the increase in net sales, partially offset by
lower royalty income and lower interest income due to a decline in the level
of invested assets and lower interest rates.
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.
The components of investment (losses) gains included in Corporate operations
are as follows:
Three months ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Derivative instruments $ 6.7 $ 10.0
Equity securities, including short positions (37.3) 9.1
Short-term investments 1.2 7.3
Other 9.9 (3.9)
- ------------------------------------------------------------------------------
(19.5) 22.5
Income tax benefit (expense) 6.8 (7.9)
Minority interest (1.0)
- ------------------------------------------------------------------------------
Net (loss) gain $ (12.7) $ 13.6
==============================================================================
Exclusive of investment (losses) gains, revenues decreased $16.2 million and
net loss increased $9.8 million for the three months ended March 31, 2003, as
compared to the prior year. Revenues decreased due primarily to decreased
results from Majestic of $13.6 million reflecting reduced demand and charter
rates in the crude oil tanker markets, and lower investment income due to
reduced yields from invested assets. The impact of the lower results from
shipping operations and investment income increased the net loss by $12.2
million.
87
LIQUIDITY AND CAPITAL RESOURCES
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.
For the three months ended March 31, 2003, net cash provided by operating
activities was $45.0 million as compared with net cash used by operating
activities of $78.0 million for the same period in 2002. 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 three months ended March 31, 2003, net cash provided by investing
activities was $132.0 million as compared with $35.0 million for the same
period in 2002. Cash flows provided by investing activities were related
principally to trading gains of fixed maturity securities.
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 three months ended March 31, 2003, net cash used by financing
activities was $137.0 million as compared with $5.0 million for the same
period in 2002. Cash flows used by financing activities were related
principally to repayment of debt.
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 April 4, 2003, the Company has paid $490.0 million in
claims and recovered $250.0 million from reinsurers.
CNA's estimated gross pretax losses for the WTC event were $1,648.0 million
pretax ($1,071.0 million after-tax). Net pretax losses before the effect of
corporate aggregate reinsurance treaties were $727.0 million. Approximately
1.0%, 72.0% and 21.0% of the reinsurance recoverables on the estimated losses
related to the WTC event are from companies with S&P ratings of AAA, AA or A.
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.
During the first quarter of 2003, CNA repaid its $128.5 million, 7.3% Senior
Note, due March 1, 2003.
CNA pays a facility fee to the lenders for having funds available for loans
under the credit facility maturing April 30, 2004. The fee varies based on the
long term debt ratings of CNA. At March 31, 2003 and December 31, 2002, the
facility fee was 17.5 basis points.
88
CNA pays interest on any outstanding debt/borrowings under the 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 facility, CNA will also pay a utilization fee
of 12.5 basis points on such loans. At March 31, 2003 and December 31, 2002,
the weighted-average interest rate on the borrowings under the facility,
including facility fees and utilization fees, was 2.3%.
A Moody's downgrade of the CNA senior debt rating from Baa2 to Baa3 would
increase the facility fee 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.
CNA Surety Corporation ("CNA Surety"), a 64.0% owned and consolidated
subsidiary of CNA, pays interest on any outstanding borrowings under its
credit agreement based on an applicable margin determined by the amount of
leverage of CNA. The current interest rate on any borrowings under the
facility is LIBOR plus 45.0 basis points. In addition, CNA Surety pays a
facility fee of 12.5 basis points. If the utilization of the credit facility
is greater than 50.0% of the amount available under the facility, an
additional fee of 5.0 basis points will be incurred. Effective January 30,
2003, CNA Surety entered into an interest rate swap on the term loan portion
of its credit agreement that fixed the interest rate at 2.8%. At March 31,
2003 and 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 2.4% and 2.0%. At March 31, 2003 and
December 31, 2002, CNA Surety was in compliance with all restrictive debt
covenants.
In March of 2003, CNA entered into a credit agreement with a large national
contractor which undertakes projects for the construction of government and
private facilities to provide loans to the contractor in a maximum aggregate
amount of $86.4 million (the "Credit Facility"). Of the $86.4 million, $57.0
million was outstanding at March 31, 2003. The Credit Facility related loans
will mature in March of 2006. Advances under the Credit Facility bear interest
at the prime rate plus 6.0%. Payment of 3.0% of the interest is deferred until
the Credit Facility matures, and the remainder is to be paid monthly in cash.
Loans under the Credit Facility are secured by a pledge of substantially all
of the assets of the contractor and certain affiliates. 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.
In March of 2003, CNA also purchased the contractor's outstanding bank debt
for $16.4 million. The contractor retired the bank debt by paying CNA $16.4
million, with $11.4 million of the payoff amount 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 amounts paid by CNA to
the banks as reimbursements for draws upon the banks' letters of credit will
become obligations of the contractor to CNA as draws upon the Credit Facility.
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
89
against the contractor directly under the participation agreement, it shares
recoveries and certain fees under the facility proportionally with CNA.
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 are expected to be successful and
provide sufficient cash flow for its operations and repayment of its
borrowings under the credit facility, the contractor's failure to achieve its
restructuring plan or perform its contractual obligations under the credit
facility and underlying all of CNA's surety bonds 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.
CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety over a period that expired on December 31, 2000
(the "stop loss contract"). The stop loss contract limits the net loss ratios
for CNA Surety with respect to certain accounts and lines of insurance
business. In the event that CNA Surety's accident year net loss ratio exceeds
24.0% for 1997 through 2000 (the contractual loss ratio), the stop loss
contract requires CCC to pay amounts equal to the amount, if any, by which CNA
Surety's actual accident year net loss ratio exceeds the contractual loss
ratio multiplied by the applicable net earned premiums. The minority
shareholders of CNA Surety do not share in any losses that apply to this
contract. There were no reinsurance balances payable under this stop loss
contract as of March 31, 2003 and December 31, 2002.
CCC, effective October 1, 2002, has secured replacement excess of loss
protection for new and renewal bonds for CNA Surety for per principal
exposures that exceed $60.0 million since October 1, 2002 in two parts - a)
$40.0 million excess of $60.0 million and b) $50.0 million excess of $100.0
million for CNA Surety. This excess of loss protection is necessary primarily
to support new and renewal bonds for contract surety accounts with bonded
backlogs or work-in-process in excess of $60.0 million. In consideration for
the reinsurance coverage provided by the $40.0 million excess of $60.0 million
contract, CNA Surety will pay to CCC, on a quarterly basis, a premium equal to
$3.0 million. In consideration for the reinsurance coverage provided by the
$50.0 million excess of $100.0 million, the insurance subsidiaries of CNA
Surety will pay $6.0 million in premium to CCC.
90
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. As of March 31, 2003 and December 31, 2002 there were
approximately $187.0 million and $222.0 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 March
31, 2003.
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 $7.0 million at March 31, 2003.
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
has committed to continue funding the operating deficits of this joint
venture. Additionally, CNA and the other unrelated shareholders, on a joint
and several basis, have guaranteed an operating lease for an office building,
which expires in 2016.
The guarantee of the operating lease is a parallel guarantee to the
commitment to fund operating deficits; consequently, the separate guarantee to
the lessor is not expected to be triggered as long as the joint venture
continues to be funded by its shareholders and continues to make its annual
lease payments.
In the event that the other parties to the joint venture are unable to meet
their commitments in funding the operations of this joint venture, CNA would
be required to assume the obligation for the entire office building operating
lease. The maximum potential future lease payments at March 31, 2003 that CNA
could be required to pay under this guarantee is approximately $333.0 million.
If CNA were required to assume the entire lease obligation, CNA would have the
right to pursue reimbursement from the other shareholders and would have the
right to all sublease revenues.
CNA has recorded a liability of approximately $10.0 million as of March 31,
2003 and December 31, 2002 for its share of the estimated operating deficits
of this joint venture through 2016.
CNA 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.
CNA has provided guarantees of the indebtedness of certain of its
independent insurance producers. These guarantees expire in 2003. CNA would be
required to remit prompt and complete payment when due, should the primary
91
obligor default. In the event of default on the part of the primary obligor,
CNA has a right to any and all shares of common stock of the primary obligor.
The maximum potential amount of future payments that CNA could be required to
pay under these guarantees is approximately $7.0 million at March 31, 2003.
As of March 31, 2003 and December 31, 2002, CNA had committed approximately
$111.0 and $141.0 million for future capital calls from various third-party
limited partnership investments in exchange for an ownership interest in the
related partnerships.
In the normal course of investing activities, CCC has committed
approximately $51.0 million as of March 31, 2003 to future capital calls from
certain of its unconsolidated affiliates in exchange for an ownership interest
in such affiliates.
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 affected.
The table below reflects the various group ratings issued by A.M. Best, S&P,
Moody's and Fitch as of April 25, 2003 for the Property and Casualty and Life
and Group Companies. The table also includes the ratings for CNA's senior debt
and Continental senior debt.
Insurance Financial Strength Ratings
Debt Ratings
- --------------------------------------------------------------------------------
- ----------------
Property and Casualty Life & Group CNA
Continental
- --------------------------------------------------------------------------------
- ----------------
CCC CIC
Senior Senior
Group Group CAC/VFL CNAGLA
Debt Debt
- --------------------------------------------------------------------------------
- ----------------
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.
* Continental Assurance Corporation ("CAC") and Valley Forge Life Insurance
Company ("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.
92
In February of 2003, S&P affirmed the ratings of the property and casualty
pools, CCC and CIC, and downgraded the life pool, CAC, 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.
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.
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.
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 March 31, 2003, CCC's earned
surplus is in a positive position, thereby enabling CCC to pay approximately
$1,210.0 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.
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.
Except for the impact of the State Settlement Agreements as described in Note
14 of the Notes to Consolidated Condensed Financial Statements included in
Item 1 of this Report, management is unable to make a meaningful estimate of
the amount or range of loss that could result from an unfavorable outcome of
pending litigation and, therefore, no provision has been made in the
consolidated condensed financial statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially affected by an unfavorable outcome of
certain pending litigation.
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 the first
quarter of 2003 was approximately $525.3 million. In 2003, Lorillard
anticipates its total payments under the State Settlement Agreements to range
from $750.0 to $800.0 million in accordance with the terms of those
agreements.
93
See Part II, Item 1 - Legal Proceedings and Note 14 of the Notes to
Consolidated Condensed Financial Statements included in Part I of this Report
for additional information regarding this settlement and other litigation
matters.
In 1977, Lorillard sold substantially all of its cigarette trademarks
outside of the United States and the international business associated with
those brands. Lorillard received notice from Brown & Williamson Tobacco
Corporation ("B&W"), a successor to the purchaser, that sought indemnity under
certain provisions of the 1977 Agreement with respect to suits brought by
various foreign jurisdictions, and certain cases brought in foreign countries
by individuals concerning periods prior to June 1977 and during portions of
1978. In April of 2003, Lorillard entered into a settlement agreement with B&W
and paid $28.0 million to B&W for a release of all indemnity obligations and
the agreement by B&W and its affiliates to terminate all rights to use the
Lorillard name within 18 months.
Lorillard's marketable securities totaled $1,403.5 and $1,640.7 million at
March 31, 2003 and December 31, 2002. At March 31, 2003, fixed maturity
securities represented 93.2% of the total investment in marketable securities
including 32.1% invested in Treasury Bills with an average duration of
approximately 30 days and 58.8% 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's operating
activities resulted in a net cash outflow of approximately $56.5 million for
the three months ended March 31, 2003, compared to $84.2 million for the prior
year. 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
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
At March 31, 2003, Diamond Offshore's cash and marketable securities totaled
$691.1 million, down from $812.5 million at December 31, 2002. Cash provided
by operating activities for the three months ended March 31, 2003 decreased by
$86.4 million to $30.6 million, compared to $117.0 million in 2002. The
decrease is primarily due to a decline in results of operations in 2003.
During the first quarter of 2003, Diamond Offshore spent $39.9 million,
including capitalized interest expense, for rig upgrades. These expenditures
were primarily for the deepwater upgrade of the Ocean Rover ($24.1 million),
which is expected to be completed in the third quarter of 2003, upgrades to
six of Diamond Offshore's jack-ups ($15.8 million) of which three were
completed in 2002 and three are expected to be completed during 2003. Diamond
Offshore expects to spend approximately $125.0 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 ($45.0 million).
94
During the three months ended March 31, 2003, Diamond Offshore spent $30.3
million in association with its ongoing rig equipment replacement and
enhancement programs and to meet other corporate requirements. In addition
Diamond Offshore spent $65.0 million ($63.5 million capitalized to rig
equipment) for the purchase of the third-generation semisubmersible drilling
rig, Omega, renamed the Ocean Patriot. Diamond Offshore has budgeted $110.0
million in 2003 for 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.
Bulova
For the three months ended March 31, 2003, net cash provided by operations
was $1.8 million as compared to $18.5 million in 2002. The decrease in net
cash flow in 2003, as compared to the corresponding period of the prior year,
is attributable to an increase in accounts receivable reflecting higher sales
for the first quarter, a related increase in inventory to meet the increased
sales levels, and cash expended on accounts payable and accrued expenses,
partially offset by the increase in net income. Bulova's inventory purchases
increased for the three months ended March 31, 2003 to meet increased demand,
principally from larger retailers, to replenish low inventory levels following
a cautious selling season in 2002. Bulova's cash and cash equivalents, and
short-term investments amounted to $11.8 million at March 31, 2003, compared
to $10.1 million at December 31, 2002.
Bulova has no material commitments for capital expenditures as of March 31,
2003.
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
As previously reported in the Company's 2002 Annual Report on Form 10-K,
subsidiaries of Hellespont acquired four new supertankers for approximately
$370.8 million. Hellespont issued to Majestic a $57.5 million promissory note.
The ships were financed by bank debt of up to $200.0 million, guaranteed by
95
Hellespont. As of March 31, 2003, $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 April 25, 2003, the Company filed a shelf Registration Statement on Form
S-3 to sell up to $1.5 billion of debt and/or equity securities, which was
declared effective by the Securities and Exchange Commission on May 6, 2003.
On April 11, 2003, the Company entered into an agreement to purchase Texas
Gas Transmission Corporation ("Texas Gas") from The Williams Companies, Inc.
The transaction value is $1.045 billion, which includes $795.0 million in cash
to be paid to the seller and $250.0 million of outstanding debt at Texas Gas.
The closing of the transaction, which is expected to occur in the second
quarter of 2003, is subject to normal and customary conditions. Immediately
following the acquisition of Texas Gas, the Company intends to issue
additional debt through its subsidiaries.
As of March 31, 2003, there were 185,447,050 shares of Loews common stock
outstanding. 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.
The Company continues to pursue conservative financial strategies while
seeking opportunities for responsible growth.
Investments:
- -----------
Insurance
The significant components of CNA's investment income are presented in the
following table:
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Fixed maturity securities $420.1 $447.2
Short term investments 20.2 15.6
Limited partnerships 23.3 6.8
Equity securities 4.5 7.3
Interest on funds withheld and other deposits (46.7) (58.1)
Other 25.3 21.2
- ------------------------------------------------------------------------------
Gross investment income 446.7 440.0
Investment expense (14.5) (14.1)
- ------------------------------------------------------------------------------
Net investment income $432.2 $425.9
==============================================================================
96
CNA experienced higher net investment income for the three months ended
March 31, 2003 as compared with the same period in 2002. The increase was due
primarily to increased limited partnership income and lower interest costs on
funds withheld and other deposits, partially offset by lower investment yields
on fixed income securities. See the Reinsurance section previously discussed
for additional information regarding interest costs on funds withheld and
other deposits, which is included in net investment income.
The bond segment of the investment portfolio yielded 5.5% and 6.0% for the
first quarter of 2003 and 2002.
The components of net realized investment (losses) gains are presented in
the following table:
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Realized investment gains (losses):
Fixed maturity securities:
U.S. Government bonds $ 38.1 $ 5.1
Corporate and other taxable bonds (118.2) 8.6
Tax-exempt bonds 19.4 1.8
Asset-backed bonds 17.9 9.5
Redeemable preferred stock (5.1) (14.1)
- ------------------------------------------------------------------------------
Total fixed maturity securities (47.9) 10.9
Equity securities 7.2
Derivative securities (22.2) (21.2)
Other invested assets (9.0) 4.1
Allocated to participating policyholders'
and minority interest 3.0
- ------------------------------------------------------------------------------
Total investment (losses) gains (76.1) 1.0
Income tax benefit 27.3 1.4
Minority Interest 4.9 (0.2)
- ------------------------------------------------------------------------------
Net realized investment (losses) gains $ (43.9) $ 2.2
==============================================================================
Net realized investment gains (losses) decreased $46.1 million after-tax for
the three months ended March 31, 2003 as compared with the same period in
2002. This change was due primarily to impairment losses related to the
investment portfolio of $149.4 million after tax for the three months ended
March 31, 2003 across certain market sectors, including the airline,
healthcare and energy industries. Impairment losses related to the investment
portfolio of $10.8 million after tax were recorded for the three months ended
March 31, 2002 primarily due to the credit deterioration of a specific equity
holding. The increase in impairment losses was partially offset by increased
net gains on sales of fixed maturity securities.
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
97
advantage of market conditions or other investment opportunities for credit or
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 net investment income. Changes in fair value are reported
as a component of other comprehensive income.
The following table provides further detail of gross realized gains and
gross realized losses on fixed maturity securities and equity securities:
Three Months Ended March 31 2003 2002
- ------------------------------------------------------------------------------
(In millions)
Net realized gains (losses) on fixed
maturity securities and equity securities:
Fixed maturity securities:
Gross realized gains $ 285.0 $140.0
Gross realized losses 333.0 129.0
- ------------------------------------------------------------------------------
Net realized (losses) gains on fixed
maturity securities (48.0) 11.0
- ------------------------------------------------------------------------------
Equity securities:
Gross realized gains 12.0 59.0
Gross realized losses 12.0 52.0
- ------------------------------------------------------------------------------
Net realized gains on equity securities 7.0
- ------------------------------------------------------------------------------
Net realized (losses) gains on fixed
maturity and equity securities $ (48.0) $ 18.0
==============================================================================
The following table provides details of the largest realized losses from
sales of securities aggregated by issuer for the three months ended March 31,
2003, 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. Also footnoted is a narrative
providing the industry sector along with the facts and circumstances giving
rise to the loss.
98
Fair
Months in
Value at
Unrealized
Date of
Loss Loss Prior
Issuer Description and Discussion Sale On
Sale To Sale
- --------------------------------------------------------------------------------
- ----------------
(In millions)
A food retailer of supermarkets and discount
stores in the U.S. and Europe. Also supplies
food to institutional foodservice companies (a) $ 34.0
$12.0 0-6
A company which manufactures rubber and rubber-related
Various,
chemicals. They also manufacture and distribute tires (b) 21.0
9.0 0-24
A company which provides and operates a network of in-
patient and outpatient surgery and rehabilitation
Various,
facilities (c) 12.0
6.0 0-12
A company which provides wholesale financing and capital
loans to auto retail dealerships and vehicle leasing
Various,
companies (d) 70.0
6.0 0-12
- --------------------------------------------------------------------------------
- ----------------
$137.0
$33.0
================================================================================
================
(a) The issuer is under investigation for accounting fraud. Losses relate to
trades that took place to reduce issuer exposure.
(b) These losses relate to trades that took place to reduce issuer exposure.
Remaining holdings have been impaired in the first quarter of 2003.
(c) The issuer is under investigation for accounting fraud and various
security issues relating to management. These losses relate to trades
that took place to reduce issuer exposure. Remaining holdings have been
impaired in the first quarter of 2003.
(d) The issuer's financial condition is in good standing and is investment
grade quality. A decision was made to reduce the portfolio's overall
exposure to this issuer.
Invested assets are exposed to various risks, such as interest rate, market
and credit risk. Due to the level of risk associated with certain invested
assets and the level of uncertainty related to changes in the value of these
assets, it is possible that changes in risks in the near term could have an
adverse material impact on the Company's results of operations or equity.
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
99
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
the Company 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 above. For securities that are impaired, the security is written
down to fair value and the resulting losses are recognized in realized
gains/losses in the Consolidated Condensed Statements of Income.
Substantially all invested assets are marketable securities classified as
available-for-sale in the accompanying consolidated condensed financial
statements. Accordingly, changes in fair value for these securities are
reported as a component of accumulated other comprehensive income.
The following table details the carrying value of CNA's general account
investment portfolios:
March 31, 2003
December 31, 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)
General account investments:
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 1,200.0 3.4% $
1,376.0 3.9%
Asset-backed securities 9,278.0 26.3
8,208.0 23.2
States, municipalities and political subdivisions
- tax-exempt 5,842.0 16.6
5,074.0 14.4
Corporate securities 7,300.0 20.7
7,591.0 21.5
Other debt securities 4,050.0 11.5
3,827.0 10.8
Redeemable preferred stock 157.0 0.5
69.0 0.2
Options embedded in convertible debt securities 144.0 0.4
130.0 0.4
- --------------------------------------------------------------------------------
- ----------------
Total fixed maturity securities 27,971.0 79.4
26,275.0 74.4
- --------------------------------------------------------------------------------
- ----------------
Equity securities:
Common stock 427.0 1.2
461.0 1.3
Non-redeemable preferred stock 126.0 0.4
205.0 0.6
- --------------------------------------------------------------------------------
- ----------------
Total equity securities 553.0 1.6
666.0 1.9
- --------------------------------------------------------------------------------
- ----------------
Short-term investments 5,354.0 15.7
7,008.0 19.9
Limited partnerships 1,069.0 3.0
1,060.0 3.0
Other investments 266.0 0.3
284.0 0.8
- --------------------------------------------------------------------------------
- ----------------
Total general account investments $35,213.0 100.0%
$35,293.0 100.0%
================================================================================
================
100
CNA's general 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
$1,212.0 million at March 31, 2003 compared with $887.0 million at December
31, 2002. The net unrealized position at March 31, 2003 was composed of a net
unrealized gain of $1,104.0 million for fixed maturities, a net unrealized
gain of $111.0 million for equity securities and a net unrealized loss of $3.0
million for short-term securities. The net 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.
Unrealized gains (losses) on fixed maturity and equity securities are
presented in the following tables:
Cost or Gross
Gross Net
Amortized Unrealized
Unrealized Unrealized
March 31, 2003 Cost Gains
Losses Gain
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 1,092.0 $ 112.0 $
4.0 $ 108.0
Asset-backed securities 8,987.0 294.0
3.0 291.0
States, municipalities and political subdivisions
-tax-exempt 5,736.0 154.0
48.0 106.0
Corporate securities 6,969.0 487.0
156.0 331.0
Other debt securities 3,782.0 349.0
81.0 268.0
Redeemable preferred stock 157.0 8.0
8.0
Options embedded in convertible debt securities 144.0
- --------------------------------------------------------------------------------
- ----------------
Total fixed maturity securities 26,867.0 1,404.0
300.0 1,104.0
- --------------------------------------------------------------------------------
- ----------------
Equity securities:
Common stock 325.0 121.0
19.0 102.0
Non-redeemable preferred stock 117.0 10.0
1.0 9.0
- --------------------------------------------------------------------------------
- ----------------
Total equity securities 442.0 131.0
20.0 111.0
- --------------------------------------------------------------------------------
- ----------------
Total fixed maturity and equity securities $27,309.0 $1,535.0
$320.0 $1,215.0
================================================================================
================
101
Cost or Gross
Gross Net
Amortized Unrealized
Unrealized Unrealized
March 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
================================================================================
================
CNA's investment policies for the general account emphasizes 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 March 31, 2003, the carrying value of the general account fixed
maturities was $27,971.0 million, representing 79.0% of the total investment
portfolio. The net unrealized gain related to this fixed maturity portfolio
was $1,104.0 million, comprising gross unrealized gains of $1,404.0 million
and gross unrealized losses of $300.0 million. Corporate bonds represented
52.0%, municipal securities represented 16.0%, other debt securities, which
includes public utility and foreign government bonds, represented 27.0% and
other fixed maturity securities represented 5.0% of the gross unrealized
losses. Within corporate bonds, the largest industry sectors were consumer -
cyclical, utilities, and financial, which represented 16.0%, 14.0%, and 14.0%
of gross unrealized losses. Gross unrealized losses in any single issuer did
not exceed 0.1% of the carrying value of the total general account fixed
maturity portfolio.
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.
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:
102
Percent of Percent of
Market Unrealized
March 31, 2003 Value Loss
- ------------------------------------------------------------------------------
Due in one year or less 2.4% 2.3%
Due after one year through five years 17.7 20.3
Due after five years through ten years 23.6 26.7
Due after ten years 44.1 49.3
Asset-backed securities 12.2 1.4
- ------------------------------------------------------------------------------
Total 100.0% 100.0%
==============================================================================
The following tables summarize for fixed maturity and equity securities in
an unrealized loss position at March 31, 2003 and December 31, 2002, the
aggregate fair value and gross unrealized loss by length of time those
securities have been continuously in an unrealized loss position.
March 31, 2003
December 31, 2002
- --------------------------------------------------------------------------------
- ----------------
Gross
Gross
Estimated Unrealized
Estimated Unrealized
Fair Value Gains Fair
Value Loss
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Fixed maturity securities:
Investment grade:
0-6 months $2,288.0 $ 46.0
$2,632.0 $ 100.0
7-12 months 287.0 32.0
361.0 30.0
13-24 months 103.0 9.0
163.0 21.0
Greater than 24 months 95.0 13.0
172.0 20.0
- --------------------------------------------------------------------------------
- ----------------
Total investment grade 2,773.0 100.0
3,328.0 171.0
- --------------------------------------------------------------------------------
- ----------------
Non-investment grade:
0-6 months 338.0 33.0
892.0 119.0
7-12 months 621.0 60.0
473.0 115.0
13-24 months 416.0 81.0
458.0 157.0
Greater than 24 months 150.0 26.0
169.0 73.0
- --------------------------------------------------------------------------------
- ----------------
Total non-investment grade 1,525.0 200.0
1,992.0 464.0
- --------------------------------------------------------------------------------
- ----------------
Total fixed maturity securities 4,298.0 300.0
5,320.0 635.0
- --------------------------------------------------------------------------------
- ----------------
Equity securities:
0-6 months 43.0 9.0
119.0 13.0
7-12 months 25.0 6.0
79.0 9.0
13-24 months 28.0 4.0
4.0
Greater than 24 months 9.0 1.0
4.0
- --------------------------------------------------------------------------------
- ----------------
Total equity securities 105.0 20.0
206.0 22.0
- --------------------------------------------------------------------------------
- ----------------
Total fixed maturity and equity securities $4,403.0 $320.0
$5,526.0 $ 657.0
================================================================================
================
103
CNA's non-investment grade fixed maturity securities held as of March 31,
2003 that were in a gross unrealized loss position had a fair value of
$1,525.0 million. 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 March 31, 2003 and December 31, 2002.
Fair Value as a Percentage of Book Value
Gross
Estimated ----------------------------------------
- - Unrealized
March 31, 2003 Fair Value 90-99% 80-89% 70-79% <70%
Loss
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Fixed maturity securities:
Non-investment grade:
0-6 months $ 338.0 $ 8.0 $ 6.0 $ 8.0
$11.0 $ 33.0
7-12 months 621.0 14.0 23.0 23.0
60.0
13-24 months 416.0 8.0 17.0 12.0
44.0 81.0
Greater than 24 months 150.0 4.0 5.0 5.0
12.0 26.0
- --------------------------------------------------------------------------------
- ----------------
Total non-investment grade $1,525.0 $34.0 $51.0 $48.0
$67.0 $200.0
================================================================================
================
Fair Value as a Percentage of Book Value
Gross
Estimated ----------------------------------------
- - Unrealized
March 31, 2002 Fair Value 90-99% 80-89% 70-79% <70%
Loss
- --------------------------------------------------------------------------------
- ----------------
(In millions)
Fixed maturity securities:
Non-investment grade:
0-6 months $ 892.0 $30.0 $28.0 $ 28.0 $
33.0 $119.0
7-12 months 473.0 9.0 12.0 24.0
70.0 115.0
13-24 months 458.0 5.0 12.0 50.0
90.0 157.0
Greater than 24 months 169.0 2.0 6.0 15.0
50.0 73.0
- --------------------------------------------------------------------------------
- ----------------
Total non-investment grade $1,992.0 $46.0 $58.0 $117.0
$243.0 $464.0
================================================================================
================
The non-investment grade securities that were in an unrealized loss severity
of less than 70.0% for longer than six months as of March 31, 2003 primarily
consisted of a municipal security representing 55.0% of the gross unrealized
loss and corporate bonds in the communications, utilities, and transportation
sectors representing 16.0%, 12.0%, and 12.0% 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 March 31, 2003 primarily
consisted of a security in the communications sector representing 75.0% of the
unrealized loss. Unrealized losses in the communication sector are
predominately attributable to a European leader in telecommunication services.
104
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 March 31, 2003. This
determination was based on a number of factors that the Impairment 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 March 31, 2003 that were in a gross
unrealized loss position had a fair value of $105.0 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, the Company 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, 88.4% and 89.4% of which were rated as investment grade at
March 31, 2003 and December 31, 2002. The following table summarizes the
ratings of CNA's general account bond portfolio at carrying value.
March 31, 2003
December 31, 2002
- --------------------------------------------------------------------------------
- ----------------
(In millions)