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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 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)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Loews Common Stock, par value $1.00 per share New York Stock Exchange
Carolina Group Stock, par value $0.01 per share New York Stock Exchange
3 1/8% Exchangeable Subordinated Notes Due 2007 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- -----
The aggregate market value of voting and non-voting common equity held by
non-affiliates as of the last business day of the registrant's most recently
completed second fiscal quarter was approximately $7,024,000,000.
As of February 20, 2004, 185,447,050 shares of Loews common stock and
57,965,000 shares of Carolina Group stock were outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's definitive proxy statement intended to be filed
by Registrant with the Commission prior to April 29, 2004 are incorporated by
reference into Part III of this Report.
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1
LOEWS CORPORATION
INDEX TO ANNUAL REPORT ON
FORM 10-K FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
For the Year Ended December 31, 2003
Item Page
No. PART I No.
- ---- ----
1 Business
Carolina Group Tracking Stock 3
CNA Financial Corporation 4
Lorillard, Inc. 13
Loews Hotels Holding Corporation 19
Diamond Offshore Drilling, Inc. 20
Texas Gas Transmission, LLC 23
Bulova Corporation 24
Other interests 25
Available information (www.loews.com) 25
2 Properties 26
3 Legal Proceedings 26
4 Submission of Matters to A Vote of Security Holders 27
Executive Officers of The Registrant 27
PART II
5 Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities 27
6 Selected Financial Data 29
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 30
7A Quantitative and Qualitative Disclosures about Market Risk 104
8 Financial Statements and Supplementary Data 107
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 204
9A Controls and Procedures 204
PART III
Certain information called for by Part III (Items 10, 11, 12,
13 and 14) has been omitted as Registrant intends to file with
the Securities and Exchange Commission not later than 120 days
after the close of its fiscal year a definitive Proxy Statement
pursuant to Regulation 14A.
PART IV
15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 206
2
PART I
Item 1. Business.
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property and casualty insurance (CNA Financial
Corporation, a 90% owned subsidiary); the production and sale of cigarettes
(Lorillard, Inc., a wholly owned subsidiary); the operation of hotels (Loews
Hotels Holding Corporation, a wholly owned subsidiary); the operation of
offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 54%
owned subsidiary); the operation of an interstate natural gas transmission
pipeline system (Texas Gas Transmission, LLC, a wholly owned subsidiary), and
the distribution and sale of watches and clocks (Bulova Corporation, a 97%
owned subsidiary).
Unless the context otherwise requires, the terms "Company" and "Registrant"
as used herein mean Loews Corporation excluding its subsidiaries.
Information relating to the major business segments from which the Company's
consolidated revenues and income are derived is contained in Note 23 of the
Notes to Consolidated Financial Statements, included in Item 8.
CAROLINA GROUP TRACKING 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. See Note 6 of the Notes to Consolidated Financial Statements, included
in Item 8.
The Company has attributed the following assets and liabilities to the
Carolina Group:
(a) the Company's 100% stock ownership interest in Lorillard, Inc.;
(b) notional, intergroup debt owed by the Carolina Group to the Loews Group,
bearing interest at the annual rate of 8.0% and, subject to optional
prepayment, due December 31, 2021 (as of February 20, 2004, $2.0
billion was outstanding);
(c) any and all liabilities, costs and expenses of the Company and
Lorillard, Inc. and the subsidiaries and predecessors of Lorillard,
Inc., arising out of or related to tobacco or otherwise arising out of
the past, present or future business of Lorillard, Inc. or its
subsidiaries or predecessors, or claims arising out of or related to the
sale of any businesses previously sold by Lorillard, Inc. or its
subsidiaries or predecessors, in each case, whether grounded in tort,
contract, statute or otherwise, whether pending or asserted in the
future;
(d) all net income or net losses arising from the assets and liabilities
that are reflected in the Carolina Group and all net proceeds from any
disposition of those assets, in each case, after deductions to reflect
dividends paid to holders of Carolina Group stock or credited to the
Loews Group in respect of its intergroup interest; and
(e) any acquisitions or investments made from assets reflected in the
Carolina Group.
As of February 20, 2004, 57,965,000 shares of Carolina Group stock are
outstanding representing a 33.43% economic interest in the Carolina Group.
The Loews Group consists of all of the Company's assets and liabilities
other than the 33.43% economic interest in the Carolina Group represented by
the outstanding Carolina Group stock, and includes as an asset the notional
intergroup debt of the Carolina Group referred to above.
The creation of the Carolina Group and the issuance of Carolina Group stock
does not change the Company's ownership of Lorillard, Inc. or Lorillard,
Inc.'s status as a separate legal entity. The Carolina Group and the Loews
Group are notional groups that are intended to reflect the performance of the
defined sets of assets and liabilities of each such group as described above.
The Carolina Group and the Loews Group are not separate legal entities and
the
3
attribution of assets and liabilities of the Company to the Loews Group or
the Carolina Group does not affect title to the assets or responsibility for
the liabilities so attributed.
Each outstanding share of Carolina Group Stock has 1/10 of a vote per share.
Holders of the Company's common stock and of Carolina Group stock are
shareholders of Loews Corporation and are subject to the risks related to an
equity investment in Loews Corporation.
CNA FINANCIAL CORPORATION
CNA Financial Corporation (together with its subsidiaries, "CNA") was
incorporated in 1967 and is an insurance holding company whose primary
subsidiaries consist of property and casualty insurance companies. CNA's
property and casualty insurance operations are conducted by Continental
Casualty Company ("CCC"), incorporated in 1897, and its affiliates, and The
Continental Insurance Company ("CIC"), organized in 1853, and its affiliates.
CNA's principal market is the United States with a continued focus on
expanding globally to serve those with growing worldwide interests. CNA
accounted for 71.26%, 70.38% and 69.89% of the Company's consolidated total
revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
During 2003, CNA completed a strategic review of its operations and decided
to concentrate efforts on its property and casualty business and to replenish
statutory capital of its principal insurance subsidiaries. In furtherance of
those plans, CNA has taken a number of actions, including:
. CNA sold the majority of its Group Benefits business to Hartford
Financial Services Group, Inc. in December of 2003. CNA's Group Benefits
operations provided group life, health insurance and investment products
and services to employers, affinity groups and other entities that
purchase insurance as a group. The business sold to Hartford included
group life and accident, short and long term disability and certain other
products, but did not include group long term care and specialty medical
businesses.
. CNA signed a definitive agreement in February of 2004 to sell its
individual life insurance business to Swiss Re Life & Health America Inc.
CNA's Life operations provides individuals with term, universal and
permanent life insurance, individual long term care insurance, annuities
and other products. The business to be sold to Swiss Re includes term,
universal and permanent life insurance policies and individual annuity
products, but not the individual long term care and structured
settlements businesses. CNA ceased sales to new customers in its
structured settlement, institutional markets and individual long term
care businesses. CNA will continue to accept new deposits and premiums
only from existing customers and will service its existing commitments.
These businesses will be managed as a run-off operation.
. CNA withdrew from the assumed reinsurance business, which included the
sale in October of 2003 of the renewal rights for most of its treaty
reinsurance business to Folksamerica Reinsurance Company.
For additional information with respect to the transactions described above,
including a capital plan to replenish statutory capital, see Item 7. MD&A-
Overview-CNA Recent Developments.
Property and Casualty Operations
Standard Lines
Standard Lines works with an independent agency distribution system and
network of brokers to market a broad range of property and casualty insurance
products and services to small, middle-market and large businesses. The
Standard Lines operating model focuses on underwriting performance,
relationships with selected distribution sources and understanding customer
needs.
Standard Lines includes Property and Casualty and Excess & Surplus.
Property and Casualty ("P&C"): P&C provides standard property and casualty
insurance products such as workers compensation, general and product
liability, property and commercial auto coverage through traditional and
innovative advanced financial risk products to a wide range of businesses. The
majority of P&C customers are small and middle-market businesses, with less
than $1.0 million in annual insurance premiums. Most insurance programs are
provided on a
4
guaranteed cost basis; however, P&C has the capability to offer specialized,
loss-sensitive insurance programs to those risks viewed as higher risk and
less predictable in exposure.
P&C's field structure consists of 34 branch locations across the country.
Each branch provides the marketing, underwriting, claim services and risk
control expertise on the entire portfolio of products. A worldwide processing
operation for small and middle-market customers handles policy processing and
accounting, and provides a customer service call center. Also, Standard Lines,
began providing total risk management services relating to claim services,
risk control, cost management and information services to the large commercial
insurance marketplace in 2003.
Excess & Surplus ("E&S"): E&S provides specialized insurance and other
financial products for selected commercial risks on both an individual
customer and program basis. Risks insured by E&S are generally viewed as
higher risk and less predictable in exposure than those covered by standard
insurance markets. E&S's products are distributed throughout the United States
through specialist producers, program agents, and P&C's agents and brokers.
Specialty Lines
Specialty Lines provides professional, financial and specialty domestic and
international property and casualty products and services through a network of
brokers, managing general agencies and independent agencies. Specialty Lines
provides solutions for managing the risks of its clients, including
architects, engineers, lawyers, healthcare professionals, financial
intermediaries and corporate directors and officers. Product offerings also
include surety and fidelity bonds and vehicle and equipment warranty services.
Specialty Lines includes the following business groups: Professional
Liability Insurance, CNA Global, Surety, Warranty, and CNA Guaranty and Credit
Professional Liability Insurance ("CNA Pro"): CNA Pro provides management
and professional liability insurance and risk management services, primarily
in the United States. This unit provides professional liability coverages to
various professional firms, including architects and engineers, realtors, non-
Big Four accounting firms, law firms and technology firms. CNA Pro also
provides directors and officers, errors and omissions, employment practices,
fiduciary and fidelity coverages. Specific areas of focus include larger firms
as well as privately held firms and not-for-profit organizations where CNA
offers tailored products for this client segment. Products within CNA Pro are
distributed through brokers, agents and managing general underwriters.
CNA Pro, through CNA HealthPro, also offers insurance products to serve the
healthcare delivery system. Products are distributed on a national basis
through a variety of channels including brokers, agents and managing general
underwriters. Key customer segments include long term care facilities, allied
healthcare providers, life sciences, dental professionals and mid-size and
large healthcare facilities and delivery systems. Additionally, CNA HealthPro
offers risk management consulting services to assist customers in managing
quality of care risks associated with the delivery of healthcare. Claim
services are provided to manage and resolve claims.
CNA Global consists of Marine and Global Standard Lines.
Marine serves domestic and global ocean marine needs, with markets extending
across North America, Europe and throughout the world. Marine offers hull,
cargo, primary and excess marine liability, marine claims and recovery
products and services. Business is sold through national brokers, regional
marine specialty brokers and independent agencies.
Global Standard Lines is responsible for coordinating and managing the
direct business of CNA's overseas property and casualty operations. This
business identifies and capitalizes on strategic indigenous opportunities and
currently has operations in Hawaii, Europe, Latin America and Canada.
Surety: Surety consists primarily of CNA Surety Corporation ("CNA Surety"),
a 64% owned subsidiary of CNA, offering small, medium and large contract and
commercial surety bonds. CNA Surety provides surety and fidelity bonds in all
50 states through a combined network of approximately 34,000 independent
agencies.
Warranty: Warranty provides warranty service contracts that protect
individuals and businesses from the financial burden associated with
breakdown, under-performance or maintenance of a product. Products are
distributed via a sales
5
force employed or contracted through a program administrator. Warranty's
business activities are primarily performed through the wholly owned
subsidiary, CNA National Warranty Corporation, which sells vehicle service
contracts in the United States and Canada.
CNA Guaranty and Credit: CNA Guaranty and Credit provided credit insurance
on short term trade receivables for domestic and international clients as well
as reinsurance to insurers who provide financial guarantees to issuers of
asset-backed securities, money market funds and investment-grade corporate
debt securities. The Guaranty business underwritten by CNA's insurance
affiliates excluding CNA's ownership interest in R.V.I. Guaranty Co. Ltd.
("RVI"), an unconsolidated affiliate, is currently in run-off. The Credit
business underwritten by CNA's insurance affiliates was sold on December 31,
2002; however, all inforce business and reserves at the date of sale were
retained by CNA. The run-off of these businesses will occur over several
years.
CNA Re
During October of 2003, CNA sold most of the renewal rights for all treaty
business to Folksamerica Reinsurance Company ("Folksamerica"). Concurrent with
the sale, CNA announced its withdrawal from the assumed reinsurance business.
CNA will manage the run-off of its retained liabilities, including unearned
premium reserves. Prior to the sale, CNA Re had offered treaty, facultative,
and financial reinsurance while operating primarily in the United States and
select global markets. In 2002 and prior, CNA Re's operations had also
included the business of CNA Re U.K., a United Kingdom reinsurance company. On
October 31, 2002, CNA completed the sale of CNA Re U.K. to Tawa UK Limited
("Tawa"). The sale included business underwritten since inception by CNA Re
U.K., except for certain risks retained by Continental Casualty Company
("CCC"). See the Investments section of the Management's Discussion and
Analysis of Financial Conditions and Results of Operations ("MD&A") for
further details of the sale of CNA Re U.K. CNA Re's U.K. subsidiaries ceased
new underwriting activities in the third quarter of 2001.
Group Operations
Group Operations provides group life, group health insurance and investment
products and services to employers, affinity groups and other entities that
purchase insurance as a group.
Group Operations includes three principal business units: Group Benefits,
Federal Markets and Institutional Markets and Other, which also includes
results from businesses that CNA has exited; retail variable life and
annuities and life reinsurance.
Group Benefits: Group Benefits offered group long term care and specialty
medical products and related services. On December 31, 2003, CNA sold its
group term life and accident insurance and short term and long term disability
business to Hartford. Prior to this sale, products had been marketed through a
nationwide operation of 31 sales offices, third-party administrators, managing
general agents and insurance consultants. See Note 14 of the Consolidated
Financial Statements included under Item 8 for further details of this
transaction.
Federal Markets: Federal Markets provided health insurance benefits to
federal employees, retirees and their families, insuring nearly one million
members under the Mail Handlers Plan. On July 1, 2002, CNA sold its federal
health plan administrator, Claims Administration Corporation, and transferred
the Mail Handlers Plan to First Health Group. As a result of this transaction,
CNA recognized a $7.0 million pretax realized loss on the sale of Claims
Administration Corporation and $15.0 million of pretax non-recurring fee
income related to the transfer of the Mail Handlers Plan.
Institutional Markets and Other: Institutional Markets and Other is a
provider of annuities and investment products to pension plan sponsors and
other institutional customers. The products include traditional and synthetic
guaranteed investment contract ("GICs"), indexed contracts, group annuities
and funding agreements. CNA offers an index 500 product, which is a guaranteed
investment contract that is indexed to the performance of the Standard &
Poor's 500 ("S&P 500") index. During 2003, CNA ceased new sales in its
institutional markets business. CNA will continue to accept new deposits and
premiums only from existing customers and will service its existing
commitments. These businesses will be managed as a run-off operation.
Also within Group Operations is CNA Trust, a limited operations bank located
in Costa Mesa, California, which provides full trustee and pension third-party
administrative services to the under 500-life employer markets. Products
6
include qualified and non-qualified plans and IRAs. Products are marketed
through life insurers and mutual fund companies.
The variable products business was exited in the fourth quarter of 2001.
During July 2002, CNA entered into an agreement, whereby the Phoenix
Companies, Inc. acquired the variable life and annuity business of VFL through
a coinsurance arrangement, with modified coinsurance on the separate accounts.
The life reinsurance business was sold on December 31, 2000.
Life Operations
Life Operations provides financial protection to individuals through term
life insurance, universal life insurance, individual long term care insurance,
annuities and other products. Life Operations has several distribution
relationships and partnerships including managing general agencies, other
independent agencies working with CNA life sales offices, a network of brokers
and dealers, and other independent insurance consultants.
In February of 2004, CNA entered into a definitive agreement to sell its
individual life insurance business to Swiss Re Life & Health America Inc.
("Swiss Re") for approximately $690.0 million. The business sold includes
term, universal and permanent life insurance policies and individual annuity
products. The transaction is expected to be completed on or before March 31,
2004, subject to certain customary closing conditions and regulatory
approvals. See Note 25 of the Notes to Consolidated Financial Statements
included under Item 8 for further information.
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 decided to significantly reduce new sales of
this product and certain infrastructure costs.
During February of 2004, CNA also ceased new sales in its structured
settlement business. CNA will continue to accept new deposits and premiums
only from existing customers and will service its existing commitments. These
businesses will be managed as a run-off operation.
Other
The Other Insurance segment is principally comprised of losses and expenses
related to the centralized adjusting and settlement of Asbestos and
Environmental Pollution and Mass Tort ("APMT") claims, certain run-off
insurance and non-insurance operations and other operations.
APMT consists of the losses and expenses related to the centralized
adjusting and settlement of APMT claims that were formerly included in the
property and casualty segments. Run-off insurance operations consists of
personal insurance, entertainment insurance, agriculture insurance, group
reinsurance and other financial lines as well as the direct financial
guarantee business underwritten by CNA's insurance affiliates and other
insurance run-off operations. Run-off insurance operations also includes
assumed business underwritten through a managing general agent, IOA Global,
which consists primarily of certain accident and health coverages ("IGI
Program").
Other operations include interest expense on corporate borrowings, asbestos
claims related to Fibreboard Corporation and CNA UniSource and inter-company
eliminations.
CNA UniSource provided human resources, information technology, payroll
processing and professional employer organization services. During 2002, CNA
decided to exit the lines of business provided by CNA UniSource. Effective
March 31, 2002, CNA UniSource ceased providing professional employer
organization services. Effective December 31, 2002, CNA UniSource ceased
payroll processing services.
7
Supplementary Insurance Data
The following table sets forth supplementary insurance data:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions, except ratio information)
Trade Ratios - GAAP basis (a):
Loss and loss adjustment expense ratio 107.1% 79.4% 125.2%
Expense ratio 42.2 29.3 36.7
Dividend ratio 1.4 0.9 1.5
- ------------------------------------------------------------------------------------------------
Combined ratio 150.7% 109.6% 163.4%
================================================================================================
Trade Ratios - Statutory basis (a):
Loss and loss adjustment expense ratio 112.7% 79.2% 126.2%
Expense ratio 32.8 30.1 32.3
Dividend ratio 1.1 1.0 1.7
- ------------------------------------------------------------------------------------------------
Combined ratio 146.6% 110.3% 160.2%
================================================================================================
Individual Life and Group Life
Insurance In-Force:
Individual Life (b) $330,805.0 $345,272.0 $426,822.0
Group Life 58,163.0 92,479.0 70,910.0
- ------------------------------------------------------------------------------------------------
$388,968.0 $437,751.0 $497,732.0
================================================================================================
Other Data - Statutory basis (c):
Property and casualty companies'
capital and surplus (d) $ 6,170.0 $ 6,836.0 $ 6,241.0
Life and group companies' capital
and surplus (d) 707.0 1,645.0 1,752.0
Property and casualty companies'
written premium to surplus ratio 1.1 1.3 1.3
Life companies' capital and surplus-
percent to total liabilities 13.0% 21.0% 25.3%
Participating policyholders-percent of
gross life insurance in force 0.5% 0.4% 0.4%
- ----------
(a) Trade ratios reflect the results of CNA's property and casualty insurance
subsidiaries. Trade ratios are industry measures of property and casualty
underwriting results. The loss and loss adjustment expense ratio is the
percentage of net incurred loss and loss adjustment expenses to net earned
premiums. The primary difference in this ratio between accounting
principles generally accepted in the United States of America ("GAAP") and
statutory accounting practices ("SAP") is related to the treatment of
active life reserves ("ALR") related to long term care insurance products
written in property and casualty insurance subsidiaries. For GAAP, ALR is
classified as claim and claim adjustment expense reserves whereas for SAP,
ALR is classified as unearned premium reserves. The expense ratio, using
amounts determined in accordance with GAAP, is the percentage of
underwriting and acquisition expenses, including the amortization of
deferred acquisition expenses to net earned premiums. The expense ratio,
using amounts determined in accordance with SAP, is the percentage of
acquisition and underwriting expenses (with no deferral of acquisition
expenses) to net written premiums. The dividend ratio, using amounts
determined in accordance with GAAP, is the ratio of dividends incurred to
net earned premiums. The dividend ratio, using amounts determined in
accordance with SAP, is the ratio of dividends paid to net earned
premiums. The combined ratio is the sum of the loss and loss adjustment
expense, expense and dividend ratios.
(b) Lapse ratios for individual life insurance, as measured by surrenders and
withdrawals as a percentage of average ordinary life insurance in-force,
were 11.9%, 34.7% and 8.7% in 2003, 2002 and 2001, respectively. (The 2002
lapse ratio includes the novation of CNA's individual life insurance
business. Excluding the novation, the 2002 lapse ratio was 7.6%.
(c) Other data is determined in accordance with SAP. Life and group statutory
capital and surplus as a percent of total liabilities is determined after
excluding separate account liabilities and reclassifying the statutorily
required Asset Valuation Reserve to surplus.
(d) Surplus includes the property and casualty companies' equity ownership of
the life and group insurance subsidiaries in 2003, and the ownership of
life and group insurance subsidiaries in 2002 and 2001. On December
31, 2003, CNA completed the sale of the majority of its Group Benefits
business to Hartford. In February of 2004, CNA entered into a definitive
agreement to sell its individual life insurance business to Swiss Re. See
Notes 14 and 25 of the Notes to Consolidated Financial Statements included
under Item 8 for further details of these transactions.
8
The following table displays the distribution of gross written premiums for
CNA's operations by geographic concentration:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
Illinois 9.3% 9.1% 8.3%
California 8.5 7.7 6.8
New York 7.3 7.2 7.9
Florida 7.6 6.7 6.2
Texas 5.7 6.2 5.8
New Jersey 4.5 4.6 4.4
Pennsylvania 4.2 4.5 4.3
Massachusetts 3.1 2.8 2.6
All other states, countries or political
subdivisions (a) 49.8 51.2 53.7
- ------------------------------------------------------------------------------------------------
100.0% 100.0% 100.0%
================================================================================================
- ----------
(a) No other individual state, country or political subdivision accounts for
more than 2.1% of gross written premium.
`
Approximately 3.2%, 3.5% and 4.8% of CNA's gross written premiums were
derived from outside of the United States for the years ended December 31,
2003, 2002 and 2001. Gross written premiums from the United Kingdom were
approximately 1.8%, 1.7% and 3.3% of CNA's premiums for the years ended
December 31, 2003, 2002 and 2001. Premiums from any individual foreign country
excluding the United Kingdom, were not significant.
Property and Casualty Claim and Claim Adjustment Expenses
The following loss reserve development table illustrates the change over
time of reserves established for property and casualty claim and claim
adjustment expenses at the end of the preceding ten calendar years for CNA's
property and casualty insurance operations. The first section shows the
reserves as originally reported at the end of the stated year. The second
section, reading down, shows the cumulative amounts paid as of the end of
successive years with respect to the originally reported reserve liability.
The third section, reading down, shows re-estimates of the originally recorded
reserves as of the end of each successive year, which is the result of CNA's
property and casualty insurance subsidiaries' expanded awareness of additional
facts and circumstances that pertain to the unsettled claims. The last section
compares the latest re-estimated reserves to the reserves originally
established, and indicates whether the original reserves were adequate or
inadequate to cover the estimated costs of unsettled claims. This table is
cumulative and, therefore, ending balances should not be added since the
amount at the end of each calendar year includes activity for both the current
and prior years.
9
Schedule of Property and Casualty Loss Reserve Development
- ------------------------------------------------------------------------------------------------------------
Year Ended December 31 1993(a) 1994(a) 1995(b) 1996 1997 1998 1999(c) 2000 2001(d) 2002(e) 2003
- ------------------------------------------------------------------------------------------------------------
(In millions of dollars)
Originally reported
gross reserves for
unpaid claim and claim
adjustment expenses 20,812 21,639 31,044 29,357 28,533 28,317 26,631 26,408 29,551 25,648 31,282
Originally reported
ceded recoverable 2,491 2,705 6,089 5,660 5,326 5,424 6,273 7,568 11,798 10,583 13,997
- ------------------------------------------------------------------------------------------------------------
Originally reported net
reserves for unpaid
claim and claim
adjustment expenses 18,321 18,934 24,955 23,697 23,207 22,893 20,358 18,840 17,753 15,065 17,285
Cumulative net paid as
of:
One year later 3,629 3,656 6,510 5,851 5,954 7,321 6,546 7,686 5,981 5,373 -
Two years later 6,143 7,087 10,485 9,796 11,394 12,241 11,935 11,988 10,535 - -
Three years later 8,764 9,195 13,363 13,602 14,423 16,020 15,247 15,291 - - -
Four years later 10,318 10,624 16,271 15,793 17,042 18,271 18,136 - - - -
Five years later 11,378 12,577 17,947 17,736 18,568 20,779 - - - - -
Six years later 13,100 13,472 19,465 18,878 20,573 - - - - - -
Seven years later 13,848 14,394 20,410 20,828 - - - - - - -
Eight years later 14,615 15,024 22,237 - - - - - - - -
Nine years later 15,161 15,602 - - - - - - - - -
Ten years later 15,675 - - - - - - - - - -
Net reserves
re-estimated as of:
End of initial year 18,321 18,934 24,955 23,697 23,207 22,893 20,358 18,840 17,753 15,065 17,285
One year later 18,250 18,922 24,864 23,441 23,470 23,920 20,785 21,306 17,805 17,496 -
Two years later 18,125 18,500 24,294 23,102 23,717 23,774 22,903 21,377 20,368 - -
Three years later 17,868 18,088 23,814 23,270 23,414 25,724 22,780 23,890 - - -
Four years later 17,511 17,354 24,092 22,977 24,751 25,407 25,293 - - - -
Five years later 17,082 17,506 23,854 24,105 24,330 27,456 - - - - -
Six years later 17,176 17,248 24,883 23,736 26,037 - - - - - -
Seven years later 17,017 17,751 24,631 25,250 - - - - - - -
Eight years later 17,500 17,650 26,023 - - - - - - - -
Nine years later 17,443 18,193 - - - - - - - - -
Ten years later 17,926 - - - - - - - - - -
- ------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy 395 741 (1,068) (1,553) (2,830)(4,563)(4,935)(5,050) (2,616) (2,431) -
============================================================================================================
Reconciliation to gross
re-estimated reserves:
Net reserves
re-estimated 17,926 18,193 26,023 25,250 26,037 27,456 25,293 23,890 20,368 17,496 -
Re-estimated ceded
recoverable 2,725 3,030 8,367 7,526 6,828 7,163 9,411 10,406 16,037 15,093 -
- ------------------------------------------------------------------------------------------------------------
Total gross re-estimated
reserves 20,651 21,223 34,390 32,776 32,865 34,619 34,704 34,296 36,405 32,589 -
============================================================================================================
Net (deficiency)
redundancy related to:
Asbestos claims (2,106) (2,073) (2,301) (2,402) (2,300)(2,056)(1,480)(1,414) (642) (642) -
Environmental claims (909) (743) (785) (729) (751) (530) (629) (617) (153) (153) -
- ------------------------------------------------------------------------------------------------------------
Total asbestos and
environmental (3,015) (2,816) (3,086) (3,131) (3,051)(2,586)(2,109)(2,031) (795) (795) -
Other claims 3,410 3,557 2,018 1,578 221 (1,977)(2,826)(3,019) (1,820) (1,636) -
- ------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy 395 741 (1,068) (1,553) (2,830)(4,563)(4,935)(5,050) (2,615) (2,431) -
============================================================================================================
- ----------
(a) Reflects reserves of CNA's property and casualty insurance subsidiaries, excluding CIC
reserves, which were acquired on May 10, 1995 (the "Acquisition Date"). Accordingly, the
reserve development (net reserves recorded at the end of the year, as initially estimated,
less net reserves re-estimated as of subsequent years) does not include CIC.
(b) Includes CIC gross reserves of $9,713.0 million and net reserves of $6,063.0 million
acquired on the Acquisition Date and subsequent development thereon.
(c) Ceded recoverable includes reserves transferred under retroactive reinsurance agreements of
$784.0 million as of December 31, 1999.
(d) Effective January 1, 2001, CNA established a new life insurance company, CNA Group Life
Assurance Company ("CNAGLA"). Further, on January 1, 2001 approximately $1,055.0 million of
reserves were transferred from CCC to CNAGLA.
(e) Effective October 31, 2002, CNA sold CNA Reinsurance Company Limited ("CNA Re U.K."). As a
result of the sale, net reserves were reduced by approximately $1,316.0 million. See Note
14 of the Notes to Consolidated Financial Statements included under Item 8 for further
discussion of the sale.
10
(f) Effective December 31, 2003, CNA sold CNAGLA. As a result of the sale, net reserves were
reduced by approximately $1,309.0 million. See Note 14 of the Notes to Consolidated
Financial Statements included under Item 8 for further discussion of the sale.
Additional information as to CNA's property and casualty claim and claim
adjustment expense reserves and reserve development is set forth in Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and in Notes 1 and 9 of the Notes to Consolidated Financial
Statements, included in Item 8.
Investments
See Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations - Investments and Notes 1, 2, 3 and 4 of the Notes to
Consolidated Financial Statements, incorporated by reference to Item 8, for
information regarding CNA's investment portfolio.
Other
Competition: The property and casualty and life and health insurance
industries are highly competitive both as to rate and service. CNA's
consolidated property and casualty subsidiaries compete not only with other
stock insurance companies, but also with mutual insurance companies,
reinsurance companies and other entities for both producers and customers. CNA
must continuously allocate resources to refine and improve its insurance and
reinsurance products and services.
Rates among insurers vary according to the types of insurers and methods of
operation. CNA competes for business not only on the basis of rate, but also
on the basis of availability of coverage desired by customers and quality of
service, including claim adjustment services.
There are approximately 2,400 individual companies that sell property and
casualty insurance in the United States. CNA's consolidated property and
casualty subsidiaries ranked as the ninth largest property and casualty
insurance organization in the United States based upon 2002 statutory net
written premiums.
The commercial property and casualty markets continue to realize significant
rate increases, indicative of a hard market, while simultaneously using more
strict underwriting criteria and requiring higher retention amounts for
policyholders to further mitigate risk. The markets focus on underwriting
profitability and the heightened perception of risk indicate the hard market
will likely continue at a reduced level into 2004.
Regulation: The insurance industry is subject to comprehensive and detailed
regulation and supervision throughout the United States. Each state has
established supervisory agencies with broad administrative powers relative to
licensing insurers and agents, approving policy forms, establishing reserve
requirements, fixing minimum interest rates for accumulation of surrender
values and maximum interest rates of policy loans, prescribing the form and
content of statutory financial reports and regulating solvency and the type
and amount of investments permitted. Such regulatory powers also extend to
premium rate regulations, which require that rates not be excessive,
inadequate or unfairly discriminatory. In addition to regulation of dividends
by insurance subsidiaries, intercompany transfers of assets may be subject to
prior notice or approval by the state insurance regulator, depending on the
size of such transfers and payments in relation to the financial position of
the insurance affiliates making the transfer or payments. See "Liquidity and
Capital Resources - Dividend Paying Ability" included in Item 7.
Insurers are also required by the states to provide coverage to insureds who
would not otherwise be considered eligible by the insurers. Each state
dictates the types of insurance and the level of coverage that must be
provided to such involuntary risks. CNA's share of these involuntary risks is
mandatory and generally a function of its respective share of the voluntary
market by line of insurance in each state.
Insurance companies are subject to state guaranty fund and other insurance-
related assessments. Guaranty fund and other insurance-related assessments are
levied by the state departments of insurance to cover claims of insolvent
insurers.
Reform of the U.S. tort liability system is another issue facing the
insurance industry. Over the last decade, many states have passed some type of
reform, but more recently, a number of state courts have modified or
overturned these
11
reforms. Additionally, new causes of action and theories of damages continue
to be proposed in state court actions or by legislatures. Continued
unpredictability in the law means that insurance underwriting and rating is
expected to continue to be difficult in commercial lines, professional
liability and some specialty coverages.
Although the federal government and its regulatory agencies do not directly
regulate the business of insurance, federal legislative and regulatory
initiatives can impact the insurance business in a variety of ways. These
initiatives and legislation include tort reform proposals; class action reform
proposals; proposals to establish a privately financed trust to process
asbestos bodily injury claims; proposals to overhaul the Superfund hazardous
waste removal and liability statutes; and various tax proposals affecting
insurance companies. In 1999, Congress passed the Financial Services
Modernization or "Gramm-Leach-Bliley" Act ("GLB Act"), which repealed portions
of the Glass-Steagall Act and enabled closer relationships between banks and
insurers. Although "functional regulation" was preserved by the GLB Act for
state oversight of insurance, additional financial services modernization
legislation could include provisions for an alternate federal system of
regulation for insurance companies.
CNA's domestic insurance subsidiaries are subject to risk-based capital
requirements. Risk-based capital is a method developed by the National
Association of Insurance Commissioners ("NAIC") to determine the minimum
amount of statutory capital appropriate for an insurance company to support
its overall business operations in consideration of its size and risk profile.
The formula for determining the amount of risk-based capital specifies various
factors, weighted based on the perceived degree of risk, that are applied to
certain financial balances and financial activity. The adequacy of a company's
actual capital is evaluated by a comparison to the risk-based capital results,
as determined by the formula. Companies below minimum risk-based capital
requirements are classified within certain levels, each of which determines a
specified level of regulatory attention applicable to a company. As of
December 31, 2003 and 2002, all of CNA's domestic insurance subsidiaries
exceeded the minimum risk-based capital requirements.
Subsidiaries with insurance operations outside the United States are also
subject to regulation in the countries in which they operate. CNA has
operations in the United Kingdom, Canada, and other countries. Information
related to regulation is set forth in MD&A included under Item 7.
Terrorism Insurance: CNA and the insurance industry incurred substantial
losses related to the September 11, 2001 World Trade Center disaster and
related events. For the most part, CNA believes the industry was able to
absorb the loss of capital from these losses, but the capacity to withstand
the effect of any additional terrorism events was significantly diminished.
Information related to terrorism is set forth in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Reinsurance: See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and Notes 1 and 19 of the Notes to
Consolidated Financial Statements, included in Item 8, for information related
to CNA's reinsurance activities.
12
Properties: CNA Plaza serves as the executive office for CNA and its
insurance subsidiaries. CNA owns or leases office space in various cities
throughout the United States and in other countries. The following table sets
forth certain information with respect to the principal office buildings owned
or leased by CNA:
Size
Location (square feet) Principal Usage
- ----------------------------------------------------------------------------------------------
Owned:
CNA Plaza 1,144,378 Principal executive offices of CNA
333 S. Wabash
Chicago, Illinois
100 CNA Drive 251,363 Life insurance offices (a)
Nashville, Tennessee
Leased:
40 Wall Street 168,723 Property and casualty insurance offices
New York, New York
2405 Lucien Way 178,744 Property and casualty insurance offices
Maitland, Florida
3500 Lacey Road 168,793 Property and casualty insurance offices
Downers Grove, Illinois
1100 Cornwall Road 112,926 Property and casualty insurance offices
Monmouth Junction, New Jersey
600 N Pearl Street 115,666 Property and casualty insurance offices
Dallas, Texas
675 Placentia Avenue 113,133 Property and casualty insurance offices
Brea, California
111 E Broad Street 110,411 Property and casualty insurance offices
Columbus, Ohio
(a) property to be transferred to Swiss Re subsequent to the sale of the individual life
insurance business expected to be completed on or before March 31, 2004.
LORILLARD, INC.
The Company's wholly owned subsidiary, Lorillard, Inc. ("Lorillard"), is
engaged, through its subsidiaries, in the production and sale of cigarettes.
The principal cigarette brand names of Lorillard are Newport, Kent, True,
Maverick and Old Gold. Lorillard's largest selling brand is Newport, the
second largest selling cigarette brand in the United States and the largest
selling brand in the menthol segment of the U.S. cigarette market in 2003.
Newport accounted for approximately 90.2% of Lorillard's sales in 2003.
Substantially all of Lorillard's sales are in the United States, Puerto Rico
and certain U.S. territories. Lorillard's major trademarks outside of the
United States were sold in 1977. Lorillard accounted for 19.96%, 22.23% and
21.13% of the Company's consolidated total revenue for the years ended
December 31, 2003, 2002 and 2001, respectively.
The major tobacco companies in the United States, including Lorillard,
continues to be faced with a number of issues that have impacted or may
adversely impact the in business, results of operations and financial
condition. These issues include substantial litigation seeking damages
aggregating into the billions of dollars, as well as other relief; substantial
annual payments and marketing and advertising restrictions provided for in the
settlement agreements with each of the 50 states and certain other
jurisdictions; the continuing contraction of the U.S. cigarette market;
competition from other major cigarette manufacturers and deep discount
manufacturers and resultant increases in industry-wide promotional expenses
and sales incentives; substantial and potentially increasing federal, state
and local excise taxes; regulation of the manufacture, sale, distribution,
advertising, labeling and use of tobacco products; and increasing sales of
counterfeit cigarettes in the United States. See Results of Operations-
Lorillard, and-Liquidity and Capital Resources-Lorillard included in Item 7 of
this Report. See also Item 3 of this Report, and Note 21 of the Notes to
Consolidated Financial Statements included in Item 8 of this Report.
13
Legislation and Regulation: Lorillard's business operations are subject to a
variety of federal, state and local laws and regulations governing, among
other things, publication of health warnings on cigarette packaging,
advertising and sales of tobacco products, restrictions on smoking in public
places and fire safety standards. Further, from time to time new legislation
or regulations are proposed and reports are published by government sponsored
committees and others recommending additional regulations of tobacco products.
Federal Regulation: The Federal Comprehensive Smoking Education Act, which
became effective in 1985, requires that cigarette packaging and advertising
display one of the following four warning statements, on a rotating basis: (1)
"SURGEON GENERAL's WARNING: Smoking Causes Lung Cancer, Heart Disease,
Emphysema, And May Complicate Pregnancy." (2) "SURGEON GENERAL's WARNING:
Quitting Smoking Now Greatly Reduces Serious Risks to Your Health." (3)
"SURGEON GENERAL's WARNING: Smoking By Pregnant Women May Result in Fetal
Injury, Premature Birth, and Low Birth Weight." (4) "SURGEON GENERAL's
WARNING: Cigarette Smoke Contains Carbon Monoxide." This law also requires
that each person who manufactures, packages or imports cigarettes shall
annually provide to the Secretary of Health and Human Services a list of the
ingredients added to tobacco in the manufacture of cigarettes. This list of
ingredients may be submitted in a manner that does not identify the company
that uses the ingredients or the brand of cigarettes that contain the
ingredients.
In addition, from time to time, bills have been introduced in Congress,
among other things, to end or limit the price supports for leaf tobacco; to
prohibit all tobacco advertising and promotion; to require new health warnings
on cigarette packages and advertising; to authorize the establishment of
various anti-smoking education programs; to provide that current federal law
should not be construed to relieve any person of liability under common or
state law; to permit state and local governments to restrict the sale and
distribution of cigarettes; concerning the placement of advertising of tobacco
products; to provide that cigarette advertising not be deductible as a
business expense; to prohibit the mailing of unsolicited samples of cigarettes
and otherwise to restrict the sale or distribution of cigarettes in retail
stores, by mail or over the internet; to impose an additional, or to increase
existing, excise taxes on cigarettes; to require that cigarettes be
manufactured in a manner that will cause them, under certain circumstances, to
be self-extinguishing; and to subject cigarettes to regulation in various ways
by the U.S. Department of Health and Human Services or other regulatory
agencies.
In 1996, the U.S. Food and Drug Administration published regulations that
would have extensively regulated the distribution, marketing and advertising
of cigarettes, including the imposition of a wide range of labeling,
reporting, record keeping, manufacturing and other requirements. Challenges to
the FDA's assertion of jurisdiction over cigarettes made by Lorillard and
other manufacturers were upheld by the Supreme Court in March 2000 when that
Court ruled that Congress did not give the FDA authority to regulate tobacco
products under the federal Food, Drug and Cosmetic Act.
Since the Supreme Court decision, various proposals and recommendations have
been made for additional federal and state legislation to regulate cigarette
manufacturers. Congressional advocates of FDA regulation have introduced
legislation that would give the FDA authority to regulate the manufacture,
sale, distribution and labeling of tobacco products to protect public health,
thereby allowing the FDA to reinstate its prior regulations or adopt new or
additional regulations. Proposals have also been introduced to end the federal
price support and quota system for tobacco growers and to compensate the
growers with payments to be funded by a fee, tax or other charge on tobacco
products to be paid by tobacco manufacturers. Recently, efforts have been made
to link the new FDA proposals with the buy-out of the federal tobacco price
support and quota system, which is intended to increase the likelihood of the
passage of both the FDA proposals and the buy-out.
In February of 2001, a committee convened by the Institute of Medicine, a
private, non-profit organization which advises the federal government on
medical issues, issued a report recommending that Congress enact legislation
enabling a suitable agency to regulate tobacco-related products that purport
to reduce exposure to one or more tobacco toxicants or to reduce risk of
disease, and to implement other policies designed to reduce the harm from
tobacco use. The report recommended regulation of all tobacco products,
including potentially reduced exposure products, known as PREPs.
In 2002 certain public health groups petitioned the FDA to assert
jurisdiction over several PREP type products that have been introduced into
the marketplace. These groups assert that claims made by manufacturers of
these products allow the FDA to regulate the manufacture, advertising and sale
of these products as drugs or medical devices under the Food Drug and Cosmetic
Act. The agency has received comments on these petitions but has taken no
action.
14
In late 2002 Philip Morris U.S.A., the largest U.S. manufacturer of
cigarettes, filed a request for rulemaking petition with the Federal Trade
Commission ("FTC") seeking changes in the existing FTC regulatory scheme for
measuring and reporting tar and nicotine to the federal government and for
inclusion in cigarette advertising. The agency procedures allow for interested
parties to submit comments on this proposal. The agency has received comments
on these petitions but has taken no action.
In 1986, the Surgeon General of the United States and the National Academy
of Sciences reported that environmental tobacco smoke ("ETS") exposes
nonsmokers to an increased risk of lung cancer and respiratory illness. In
addition, in 1993, the United States Environmental Protection Agency released
a report (the "EPA Risk Assessment") concluding that ETS is a human lung
carcinogen in adults, and causes respiratory effects in children, The EPA Risk
Assessment has not been used as a basis for any regulatory action by the EPA.
In May 2000, the Department of Health and Human Service's National Toxicology
Program listed ETS as "known to be a human carcinogen." Various public health
organizations have also issued statements on environmental tobacco smoke and
its health effects and many scientific papers on ETS have been published since
the EPA Risk Assessment, with varying conclusions.
Lorillard cannot predict the ultimate outcome of these proposals, reports
and recommendations, though if enacted, certain of these proposals could have
a material adverse effect on Lorillard's business and the Company's financial
position or results of operations in the future.
State and Local Regulation: In recent years, many state, local and municipal
governments and agencies, as well as private businesses, have adopted
legislation, regulations or policies which prohibit or restrict, or are
intended to discourage, smoking, including legislation, regulations or
policies prohibiting or restricting smoking in various places such as public
buildings and facilities, stores, restaurants and bars and on airline flights
and in the workplace. This trend has increased significantly since the release
of the EPA Risk Assessment. The following are examples of some of the more
significant state and local regulations affecting Lorillard's business:
. In September of 1997, the California Environmental Protection Agency
released a report (the "Cal/EPA Report") concluding that ETS causes
specified development, respiratory, carcinogenic and cardiovascular
effects including lung and nasal sinus cancer, heart disease, sudden
infant death syndrome, respiratory infections and asthma induction and
exacerbation in children. The Cal/EPA Report was subsequently released as
a monograph by the National Cancer Institute in November of 1999.
The California Air Resources Board is in the early stages of the process of
determining whether to identify ETS as a toxic air contaminant, or "TAC,"
under the Toxic Air Contaminant Identification and Control Act. A
subcommittee of that board has issued a draft report linking ETS with
certain diseases, and public comment on the report has been invited. If
California, on the basis of its assessments of risk and exposure,
identifies ETS as a TAC, California could initiate the control phase of the
Tanner Act, which involves adoption of measures to reduce or eliminate
emissions. These measures could include further restrictions
regarding venues where smoking is permitted or controls on product
emissions.
. The Commonwealth of Massachusetts has enacted legislation requiring each
manufacturer of cigarettes and smokeless tobacco sold in Massachusetts to
submit to the state's Department of Public Health ("DPH") an annual report
identifying for each brand sold certain "added constituents," and providing
nicotine yield ratings and other information for certain brands based on
regulations promulgated by the DPH. The State of Texas has implemented
legislation similar to the Massachusetts law. Neither legislation allows
for the public release of trade secret information.
. New York State has enacted legislation that requires the State's Office of
Fire Prevention and Control ("OFPC") to promulgate fire-safety standards
for cigarettes sold in New York and that cigarettes sold in New York meet
ignition propensity performance standards established by that agency. On
December 31, 2003, OFPC issued final Fire Safety Standards For Cigarettes
proposing performance and testing standards pursuant to the legislation.
The effective date of the regulations is June 28, 2004. Lorillard has
developed proprietary technology to comply with the standards and intends
to be able to comply by the effective date.
Other similar laws and regulations have been enacted or considered by other
state and local governments. Lorillard cannot predict the impact which these
regulations may have on Lorillard's business, though if enacted, they could
have a material adverse effect on Lorillard's business and the Company's
financial position or results of operations in the future.
15
Excise Taxes: Cigarettes are subject to substantial federal, state and local
excise taxes in the United States and, in general, such taxes have been
increasing. On January 1, 2002, the federal excise tax on cigarettes increased
by $2.50 per thousand cigarettes and is now $19.50 per thousand cigarettes (or
$0.39 per pack of 20 cigarettes). State excise taxes, which are levied upon
and paid by the distributors, are also in effect in the fifty states, the
District of Columbia and many municipalities. Increases in state excise taxes
on cigarette sales in 2003 ranged from $0.09 per pack to $0.70 per pack in 16
states plus the District of Columbia. The average state excise tax, including
the District of Columbia, increased to $0.73 per pack (of 20 cigarettes) in
2003 from $0.61 in 2002. Proposals for additional increases in federal, state
and local excise taxes continue to be considered. The combined state and
municipal taxes generally range from $0.025 to $3.00 per pack of cigarettes.
Advertising and Marketing: Lorillard advertises its products to adult
smokers in magazines, newspapers, direct mail and point-of-sale display
materials. In addition, Lorillard promotes its cigarette brands to adult
smokers through distribution of store coupons, retail price promotions, and
personal contact with distributors and retailers. Although Lorillard's sales
are made primarily to wholesale distributors rather than retailers,
Lorillard's sales personnel monitor retail and wholesale inventories, work
with retailers on displays and signs, and enter into promotional arrangements
with retailers from time to time.
As a general matter, Lorillard allocates its marketing expenditures among
brands on the basis of marketplace opportunity and profitable return. In
particular, Lorillard focuses its marketing efforts on the premium segment of
the U.S. cigarette industry, with a specific focus on Newport.
Advertising of tobacco products through television and radio has been
prohibited since 1971. In addition, on November 23, 1998, Lorillard and the
three other largest major cigarette manufacturers entered into a Master
Settlement Agreement ("MSA") with 46 states, the District of Columbia, the
Commonwealth of Puerto Rico and certain other U.S. territories to settle
certain health care cost recovery and other claims. These manufacturers had
previously settled similar claims brought by the four remaining states which
together with the MSA are generally referred to as the "State Settlement
Agreements." Under the State Settlement Agreements the participating cigarette
manufacturers agreed to severe restrictions on their advertising and promotion
activities. Among other things, the MSA prohibits the targeting of youth in
the advertising, promotion or marketing of tobacco products; bans the use of
cartoon characters in all tobacco advertising and promotion; limits each
tobacco manufacturer to one event sponsorship during any twelve-month period,
which may not include major team sports or events in which the intended
audience includes a significant percentage of youth; bans all outdoor
advertising of tobacco products with the exception of small signs at retail
establishments that sell tobacco products; bans tobacco manufacturers from
offering or selling apparel and other merchandise that bears a tobacco brand
name, subject to specified exceptions; prohibits the distribution of free
samples of tobacco products except within adult-only facilities; prohibits
payments for tobacco product placement in various media; and bans gift offers
based on the purchase of tobacco products without sufficient proof that the
intended gift recipient is an adult.
Many states, cities and counties have enacted legislation or regulations
further restricting tobacco advertising. There may be additional local, state
and federal legislative and regulatory initiatives relating to the advertising
and promotion of cigarettes in the future. Lorillard cannot predict the impact
of such initiatives on its marketing and sales efforts.
Lorillard has funded and plans to continue to fund a Youth Smoking
Prevention Program, which is designed to discourage youth from smoking. The
program has addressed not only youth, but also parents and, through the "We
Card" program, retailers, to prevent purchase of cigarettes by underage
purchasers. Lorillard has determined not to advertise its cigarettes in
magazines with large readership among people under the age of 18.
Distribution Methods: Lorillard sells its products primarily to
distributors, who in turn service retail outlets; chain store organizations;
and government agencies, including the U.S. Armed Forces. Upon completion of
the manufacturing process, Lorillard ships cigarettes to public distributing
warehouse facilities for rapid order fulfillment to wholesalers and other
direct buying customers. Lorillard retains a portion of its manufactured
cigarettes at its Greensboro central distribution center and Greensboro cold-
storage facility for future finished goods replenishment.
As of December 31, 2003, Lorillard had approximately 740 direct buying
customers servicing more than 400,000 retail accounts. Lorillard does not sell
cigarettes directly to consumers. During 2003, 2002 and 2001, sales made by
Lorillard to McLane Company, Inc., comprised 20%, 17% and 15%, respectively,
of Lorillard's revenues. No other customer accounted for more than 10% of
2003, 2002 or 2001 sales. Lorillard does not have any backlog orders.
16
Most of Lorillard's customers buy cigarettes on a next-day-delivery basis.
Approximately 90% of Lorillard's customers purchase cigarettes using
electronic funds transfer, which provides immediate payment to Lorillard.
Raw Materials and Manufacturing: In its production of cigarettes, Lorillard
uses burley leaf tobacco, and flue-cured leaf tobacco grown in the United
States and abroad, and aromatic tobacco grown primarily in Turkey and other
Near Eastern countries. A domestic supplier manufactures all of Lorillard's
reconstituted tobacco.
Lorillard purchases more than 99% of its domestic leaf tobacco from Dimon
International, Inc. Lorillard directs Dimon in the purchase of tobacco
according to Lorillard's specifications for quality, grade, yield, particle
size, moisture content and other characteristics. Dimon purchases and
processes the whole leaf and then dries and packages it for shipment to and
storage at Lorillard's Danville, Virginia facility. In the event that Dimon
becomes unwilling or unable to supply leaf tobacco to Lorillard, Lorillard
believes that it can readily obtain high-quality leaf tobacco from well-
established, alternative industry sources.
Due to the varying size and quality of annual crops and other economic
factors, including U.S. tobacco production controls administered by the United
States Department of Agriculture, tobacco prices have historically fluctuated.
The U.S. price supports that accompany production controls have inflated the
market price of tobacco. In addition, the transition in tobacco purchasing
from auction markets to direct farmer contracting may increase the market
price of domestically grown tobacco. However, Lorillard does not believe that
this increase, if any, will have a material effect on its business
Lorillard stores its tobacco in 29 storage warehouses on its 130-acre
Danville facility. To protect against loss, amounts of all types and grades of
tobacco are stored in separate warehouses. Because the process of aging
tobacco normally requires approximately two years, Lorillard maintains large
quantities of leaf tobacco at all times. Lorillard believes its current
tobacco supplies are adequately balanced for its present production
requirements. If necessary, Lorillard can purchase aged tobacco in the open
markets to supplement existing inventories.
Lorillard produces cigarettes at its Greensboro, North Carolina
manufacturing plant, which has a production capacity of approximately 185
million cigarettes per day and approximately 43 billion cigarettes per year.
Through various automated systems and sensors, Lorillard actively monitors all
phases of production to promote quality and compliance with applicable
regulations.
Prices: Lorillard believes that the volume of U.S. cigarette sales is
sensitive to price changes. Changes in pricing by Lorillard or other cigarette
manufacturers could have an adverse impact on Lorillard's volume of units
sold, which in turn could have an adverse impact on Lorillard's profits and
earnings. Lorillard makes independent pricing decisions based on a number of
factors. Lorillard cannot predict the potential adverse impact of price
changes on industry volume or Lorillard volume, on the mix between premium and
discount sales, on Lorillard's market share or on Lorillard's profits and
earnings. Lorillard has not increased its wholesale prices since March of
2002. In May of 2003, Lorillard lowered the wholesale list price of its
discount brand, Maverick, by $55.00 per thousand cigarettes ($1.10 per pack of
20 cigarettes) in an effort to reposition the brand to be more competitive in
the deep discount price cigarette segment.
Properties: Lorillard's manufacturing facility is located on approximately
80 acres in Greensboro, North Carolina. This 942,600 square-foot plant
contains modern high-speed cigarette manufacturing machinery. The Greensboro
facility also includes a warehouse with shipping and receiving areas totaling
54,800 square feet. In addition, Lorillard owns tobacco receiving and storage
facilities totaling approximately 1,500,000 square feet in Danville, Virginia.
Lorillard's executive offices are located in a 130,000 square-foot, four-story
office building in Greensboro. Its 93,800 square-foot research facility is
also located in Greensboro.
Lorillard's principal properties are owned in fee. With minor exceptions,
Lorillard owns all of the machinery it uses. Lorillard believes that its
properties and machinery are in generally good condition. Lorillard leases
sales offices in major cities throughout the United States, a cold-storage
facility in Greensboro and warehousing space in 27 public distributing
warehouses located throughout the United States.
Competition: The domestic U.S. market for cigarettes is highly competitive.
Competition is primarily based on a brand's price, positioning, consumer
loyalty, retail display, promotion, quality and taste. Lorillard's principal
competitors are the three other major U.S. cigarette manufacturers, Philip
Morris, R.J. Reynolds ("RJR") and Brown & Williamson ("B&W").
17
Lorillard believes its ability to compete even more effectively has been
restrained by the Philip Morris Retail Leaders program and could further be
restrained by the proposed combination of RJR and B&W discussed below. The
terms of Philip Morris' merchandising contracts preclude Lorillard from
obtaining visible space in the retail store to effectively promote its brands.
As a result in a large number of retail locations, Lorillard either has a
severely limited or no opportunity to competitively support its promotion
programs thereby limiting its sales potential.
Lorillard's 9.3% market share of the 2003 U.S. domestic cigarette industry
was fourth highest overall. Philip Morris, RJR and B&W accounted for
approximately 50.4%, 21.5% and 10.5%, respectively, of wholesale shipments in
2003. Among the four major manufacturers, Lorillard ranked third behind Philip
Morris and RJR with a 12.0% share of the premium segment in 2003.
On October 27, 2003, RJR, the second largest cigarette manufacturer in the
United States, and British American Tobacco announced that they have agreed to
combine the U.S. tobacco business of RJR with British American Tobacco's U.S.
tobacco business, B&W, the third largest cigarette manufacturer in the United
States. The closing of this combination is subject to various conditions,
including regulatory approvals.
If completed, the consolidation of these two competitors would result in
further concentration of the U.S. tobacco industry, with the top two
companies, Philip Morris USA and the newly created Reynolds American, having a
combined market share of approximately 80%. In addition, this transaction
would combine in one company the third and fourth leading menthol brands, Kool
and Salem, which have a combined share of the menthol segment of approximately
21%. This concentration of U.S. market share could make it more difficult for
Lorillard and others to compete for shelf space in retail outlets and could
impact price competition among menthol brands, either of which could have a
material adverse effect on the results of operations and financial condition
of the Company.
The following table sets forth cigarette sales data provided by the industry
and by Lorillard to Management Science Associates ("MSAI"), an independent
third-party database management organization that collects wholesale shipment
data from various cigarette manufacturers and provides analysis of market
share, unit sales volume and premium versus discount mix for individual
companies and the industry as a whole. MSAI's information relating to unit
sales volume and market share of certain of the smaller, primarily deep
discount, cigarette manufacturers is based on estimates derived by MSAI.
Lorillard management believes that volume and market share information for
these manufacturers are understated and, correspondingly, share information
for the larger manufacturers, including Lorillard, are overstated by MSAI. The
table below indicates the relative position of Lorillard in the U.S.
Industry Lorillard Lorillard
Calendar Year (000) (000) to Industry
- ------------------------------------------------------------------------------------------------
2003 371,525,000 34,431,000 9.27%
2002 391,404,000 35,444,000 9.05%
2001 406,304,000 37,626,000 9.26%
- ----------
MSAI divides the cigarette market into two price segments, the premium price
segment and the discount or reduced price segment. According to MSAI, the
discount segment share of market decreased from approximately 27.2% in 2002 to
26.1% in 2003. Virtually all of Lorillard's sales are in the premium price
segment where Lorillard's share amounted to approximately 12.0% in 2003, 11.8%
in 2002 and 11.5% in 2001, as reported by MSAI.
18
LOEWS HOTELS HOLDING CORPORATION
The subsidiaries of Loews Hotels Holding Corporation ("Loews Hotels"), a
wholly owned subsidiary of the Company, presently operate the following 20
hotels. Loews Hotels accounted for 1.74%, 1.53% and 1.49% of the Company's
consolidated total revenue for the years ended December 31, 2003, 2002 and
2001, respectively.
Number of
Name and Location Rooms Owned, Leased or Managed
- -----------------------------------------------------------------------------------------------
Loews Annapolis 220 Owned
Annapolis, Maryland
Loews Beverly Hills Hotels 137 Management contract expiring 2008 (a)
Beverly Hills, California
Loews Coronado Bay Resort 440 Land lease expiring 2034
San Diego, California
Loews Denver 185 Owned
Denver, Colorado
Don CeSar Beach Resort, a Loews Hotel 347 Management contract (a)(b)
St. Pete Beach, Florida
Hard Rock Hotel, 650 Management contract (c)
at Universal Orlando
Orlando, Florida
House of Blues Hotel, a Loews Hotel 370 Management contract expiring 2005 (a)
Chicago, Illinois
The Jefferson, a Loews Hotel 100 Management contract expiring 2010 (a)
Washington, D.C.
Loews Le Concorde 405 Land lease expiring 2069
Quebec City, Canada
Loews L'Enfant Plaza 370 Management contract expiring 2005 (a)
Washington, D.C.
Loews Miami Beach Hotel 790 Land lease expiring 2096
Miami Beach, Florida
Loews New Orleans Hotel 285 Management contract expiring 2018 (a)
New Orleans, Louisiana
Loews Philadelphia Hotel 585 Owned
Philadelphia, Pennsylvania
Portofino Bay Hotel, 750 Management contract (c)
at Universal Orlando, a Loews Hotel
Orlando, Florida
The Regency, a Loews Hotel 350 Land lease expiring 2013, with
New York, New York renewal option for 47 years
Royal Pacific Resort 1,000 Management contract (c)
at Universal Orlando, a Loews Hotel
Orlando, Florida
Loews Santa Monica Beach 340 Management contract expiring 2018,
Santa Monica, California with renewal option for 5 years (a)
Loews Vanderbilt Plaza 340 Owned
Nashville, Tennessee
Loews Ventana Canyon Resort 400 Management contract expiring 2009,
Tucson, Arizona with renewal options for 5 years (a)
Loews Hotel Vogue 140 Owned
Montreal, Canada
- ---------
(a) These management contracts are subject to termination rights.
(b) A Loews Hotels subsidiary is a 20% owner of the hotel, which is being operated by Loews
Hotels pursuant to a management contract.
(c) A Loews Hotels subsidiary is a 50% owner of these hotels located at the Universal Orlando
theme park, through a joint venture with Universal Studios and the Rank Group. The hotels
are constructed on land leased by the joint venture from the resort's owners and are being
operated by Loews Hotels pursuant to a management contract.
The hotels which are operated by Loews Hotels contain shops, a variety of
restaurants and lounges, and some contain parking facilities, swimming pools,
tennis courts and access to golf courses.
19
The hotels owned by Loews Hotels are subject to mortgage indebtedness
aggregating approximately $146.5 million at December 31, 2003 with interest
rates ranging from 3.1% to 6.3%, and maturing between 2004 and 2028. In
addition, certain hotels are held under leases which are subject to formula
derived rental increases, with rentals aggregating approximately $11.1 million
for the year ended December 31, 2003.
Competition from other hotels, motor hotels and inns, including facilities
owned by local interests and by national and international chains, is vigorous
in all areas in which Loews Hotels operates. The demand for hotel rooms in
many areas is seasonal and dependent on general and local economic conditions.
Loews Hotels properties also compete with facilities offering similar services
in locations other than those in which its hotels are located. Competition
among luxury hotels is based primarily on location and service. Competition
among resort and commercial hotels is based on price as well as location and
service. Because of the competitive nature of the industry, hotels must
continually make expenditures for updating, refurnishing and repairs and
maintenance, in order to prevent competitive obsolescence.
DIAMOND OFFSHORE DRILLING, INC.
Diamond Offshore Drilling Inc. ("Diamond Offshore"), is engaged, through its
subsidiaries, in the business of owning and operating drilling rigs that are
used primarily in the drilling of offshore oil and gas wells on a contract
basis for companies engaged in exploration and production of hydrocarbons.
Diamond Offshore operates 45 offshore rigs. Diamond Offshore accounted for
4.18%, 4.70% and 5.38% of the Company's consolidated total revenue for the
years ended December 31, 2003, 2002 and 2001, respectively.
Drilling Units and Equipment: Diamond Offshore currently owns and operates
45 mobile offshore drilling rigs (30 semisubmersible rigs, 14 jack-up rigs and
one drillship) and related equipment. Offshore rigs are mobile units that can
be relocated via either self-propulsion or the use of tugs enabling them to be
repositioned based on market demand.
Semisubmersible rigs are supported by large pontoons and are partially
submerged during drilling for greater stability. Semisubmersibles are
typically anchored in position and remain stable for drilling in the semi-
submerged floating position due in part to their wave transparency
characteristics at the water line. Semisubmersibles can also be held in
position through the use of a computer controlled thruster (dynamic-
positioning) system to maintain the rig's position over a drillsite. Diamond
Offshore has three such semisubmersible rigs with dynamic-positioning
capabilities.
Diamond Offshore owns and operates nine high specification semisubmersible
rigs. These semisubmersibles are larger than many other semisubmersibles, are
capable of working in deep water or harsh environments, and have other
advanced features. As of February 2, 2004, Diamond Offshore was actively
marketing 26 of its semisubmersible rigs. These rigs are currently located as
follows: nine in the U.S. Gulf of Mexico, four in Mexico, three in the North
Sea and three in Brazil, with the remaining rigs located in various foreign
markets.
The remaining four of Diamond Offshore's semisubmersible rigs are cold
stacked; two since March 2002 and two since December 2002. When Diamond
Offshore anticipates that a rig will be idle for an extended period of time,
it cold stacks the unit by ceasing to actively market the rig. This eliminates
all expenditures associated with keeping the rig ready to go to work.
Diamond Offshore owns and operates 14 jack-up rigs, 13 of which were being
actively marketed as of February 2, 2004. These rigs stand on the ocean floor
with their drilling platforms "jacked up" on support legs above the water.
They are used for drilling in water depths from 20 feet to 350 feet. Thirteen
of Diamond Offshore's jack-up rigs are cantilevered units capable of over
platform development drilling and workover as well as exploratory drilling.
Twelve of Diamond Offshore's jack-up rigs are currently located in the Gulf of
Mexico.
Diamond Offshore's drillship is self-propelled and designed to drill in deep
water. Shaped like a conventional vessel, it is the most mobile of the major
rig types. Diamond Offshore's drillship has dynamic-positioning capabilities
and is currently operating in Brazil.
Markets: Diamond Offshore's principal markets for its offshore contract
drilling services are the Gulf of Mexico, including the United States and
offshore Mexico, Europe, principally the U.K. and Norway, South America,
Africa, and Australia/Southeast Asia. Diamond Offshore actively markets its
rigs worldwide.
20
Diamond Offshore contracts to provide offshore drilling services vary in
their terms and provisions. Diamond Offshore often obtains its contracts
through competitive bidding, although it is not unusual for Diamond Offshore
to be awarded drilling contracts without competitive bidding. Drilling
contracts generally provide for a basic drilling rate on a fixed dayrate basis
regardless of whether or not such drilling results in a productive well.
Drilling contracts may also provide for lower rates during periods when the
rig is being moved or when drilling operations are interrupted or restricted
by equipment breakdowns, adverse weather or water conditions or other
conditions beyond the control of Diamond Offshore. Under dayrate contracts,
Diamond Offshore generally pays the operating expenses of the rig, including
wages and the cost of incidental supplies. Dayrate contracts have historically
accounted for a substantial portion of Diamond Offshore's revenues. In
addition, Diamond Offshore has worked some of its rigs under dayrate contracts
that include the ability to earn an incentive bonus based upon performance.
A dayrate drilling contract generally extends over a period of time covering
either the drilling of a single well, a group of wells (a "well-to-well
contract") or a stated term (a "term contract") and may be terminated by the
customer in the event the drilling unit is destroyed or lost or if drilling
operations are suspended for a specified period of time as a result of a
breakdown of equipment or, in some cases, due to other events beyond the
control of either party. In addition, certain of Diamond Offshore's contracts
permit the customer to terminate the contract early by giving notice and in
some circumstances may require the payment of an early termination fee by the
customer. The contract term in many instances may be extended by the customer
exercising options for the drilling of additional wells at fixed or mutually
agreed terms, including dayrates.
The duration of offshore drilling contracts is generally determined by
market demand and the respective management strategies of the offshore
drilling contractor and its customers. In periods of rising demand for
offshore rigs, contractors typically prefer well-to-well contracts that allow
contractors to profit from increasing dayrates. In contrast, during these
periods customers with reasonably definite drilling programs typically prefer
longer term contracts to maintain dayrate prices at a consistent level.
Conversely, in periods of decreasing demand for offshore rigs, contractors
generally prefer longer term contracts to preserve dayrates at existing levels
and ensure utilization, while customers prefer well-to-well contracts that
allow them to obtain the benefit of lower dayrates. If possible, Diamond
Offshore seeks to have a foundation of long-term contracts with a reasonable
balance of single-well, well-to-well and short-term contracts to minimize the
downside impact of a decline in the market while still participating in the
benefit of increasing dayrates in a rising market.
Customers: Diamond Offshore provides offshore drilling services to a
customer base that includes major and independent oil and gas companies and
government-owned oil companies. Several customers have accounted for 10.0% or
more of Diamond Offshore's annual consolidated revenues, although the specific
customers may vary from year to year. During 2003, Diamond Offshore performed
services for 52 different customers with Petroleo Brasileiro S.A.
("Petrobras") and BP accounting for 20.3% and 11.9% of Diamond Offshore's
annual total consolidated revenues, respectively. During 2002, Diamond
Offshore performed services for 46 different customers with Petrobras, BP, and
Murphy Exploration and Production Company accounting for 19.0%, 18.9% and
10.4% of Diamond Offshore's annual total consolidated revenues, respectively.
During 2001, Diamond Offshore performed services for 44 different customers
with BP and Petrobras accounting for 21.8% and 17.3% of Diamond Offshore's
annual total consolidated revenues, respectively. During periods of low demand
for offshore drilling rigs, the loss of a single significant customer could
have a material adverse effect on Diamond Offshore's results of operations.
Competition: The contract drilling industry is highly competitive and is
influenced by a number of factors, including the current and anticipated
prices of oil and natural gas, the expenditures by oil and gas companies for
exploration and development of oil and natural gas and the availability of
drilling rigs. In addition, demand for drilling services remains dependent on
a variety of political and economic factors beyond Diamond Offshore's control,
including worldwide demand for oil and natural gas, the ability of the
Organization of Petroleum Exporting Countries ("OPEC") to set and maintain
production levels and pricing, the level of production of non-OPEC countries
and the policies of the various governments regarding exploration and
development of their oil and natural gas reserves.
Customers often award contracts on a competitive bid basis, and although a
customer selecting a rig may consider, among other things, a contractor's
safety record, crew quality, rig location, and quality of service and
equipment, an oversupply of rigs can create an intensely competitive market in
which price is the primary factor in determining the selection of a drilling
contractor. In periods of increased drilling activity, rig availability often
becomes a consideration, particularly with respect to technologically
advanced units. Diamond Offshore believes that competition for drilling
contracts will continue to be intense in the foreseeable future. Contractors
are also able to adjust localized supply and
21
demand imbalances by moving rigs from areas of low utilization and dayrates to
areas of greater activity and relatively higher dayrates. Such movements,
reactivations or a decrease in drilling activity in any major market could
depress dayrates and could adversely affect utilization of Diamond Offshore's
rigs.
Governmental Regulation: Diamond Offshore's operations are subject to
numerous international, federal, state and local laws and regulations that
relate directly or indirectly to its operations, including certain regulations
controlling the discharge of materials into the environment, requiring removal
and clean-up under certain circumstances, or otherwise relating to the
protection of the environment. For example, Diamond Offshore may be liable for
damages and costs incurred in connection with oil spills for which it is held
responsible. Laws and regulations protecting the environment have become
increasingly stringent in recent years and may, in certain circumstances,
impose "strict liability" rendering a company liable for environmental damage
without regard to negligence or fault on the part of such company. Liability
under such laws and regulations may result from either governmental or citizen
prosecution. Such laws and regulations may expose Diamond Offshore to
liability for the conduct of or conditions caused by others, or for acts of
Diamond Offshore that were in compliance with all applicable laws at the time
such acts were performed. The application of these requirements or the
adoption of new requirements could have a material adverse effect on Diamond
Offshore.
The United States Oil Pollution Act of 1990 ("OPA '90"), and similar
legislation enacted in Texas, Louisiana and other coastal states, addresses
oil spill prevention and control and significantly expands liability exposure
across all segments of the oil and gas industry. OPA '90, such similar
legislation and related regulations impose a variety of obligations on Diamond
Offshore related to the prevention of oil spills and liability for damages
resulting from such spills. OPA '90 imposes strict and, with limited
exceptions, joint and several liability upon each responsible party for oil
removal costs and a variety of public and private damages.
Indemnification and Insurance: Diamond Offshore's operations are subject to
hazards inherent in the drilling of oil and gas wells such as blowouts,
reservoir damage, loss of production, loss of well control, cratering or
fires, the occurrence of which could result in the suspension of drilling
operations, injury to or death of rig and other personnel and damage to or
destruction of Diamond Offshore's, Diamond Offshore's customers' or a third
party's property or equipment. Damage to the environment could also result
from Diamond Offshore's operations, particularly through oil spillage or
uncontrolled fires. In addition, offshore drilling operations are subject to
perils peculiar to marine operations, including capsizing, grounding,
collision and loss or damage from severe weather. Diamond Offshore has
insurance coverage and contractual indemnification for certain risks, but
there can be no assurance that such coverage or indemnification will
adequately cover Diamond Offshore's loss or liability in certain circumstances
or that Diamond Offshore will continue to carry such insurance or receive such
indemnification.
Diamond Offshore's retention of liability for property damage is between
$1.0 and $2.5 million per incident, depending on the value of the equipment,
with an aggregate annual deductible of $5.0 million. In addition, Diamond
Offshore is self insured for 10% of its property damage losses.
Operations Outside the United States: Operations outside the United States
accounted for approximately 51.6%, 55.5% and 37.3% of Diamond Offshore's total
consolidated revenues for the years ended December 31, 2003, 2002 and 2001,
respectively. Diamond Offshore's non-U.S. operations are subject to certain
political, economic and other uncertainties not encountered in U.S.
operations, including risks of war and civil disturbances (or other risks that
may limit or disrupt markets), expropriation and the general hazards
associated with the assertion of national sovereignty over certain areas in
which operations are conducted. No prediction can be made as to what
governmental regulations may be enacted in the future that could adversely
affect the international drilling industry. Diamond Offshore's operations
outside the United States may also face the additional risk of fluctuating
currency values, hard currency shortages, controls of currency exchange and
repatriation of income or capital.
During 2003, Diamond Offshore entered into contracts to operate four of its
semisubmersible rigs offshore Mexico for Pemex-Exploracion Y Produccion, the
national oil company of Mexico. The terms of these contracts expose Diamond
Offshore to greater risks than it normally assumes, such as exposure to
greater environmental liability. While Diamond Offshore believes that the
financial terms of the contracts and Diamond Offshore's operating safeguards
in place mitigate these risks, there can be no assurance that Diamond
Offshore's increased risk exposure will not have a negative impact on Diamond
Offshore's future operations or financial results.
Properties: Diamond Offshore owns an eight-story office building located in
Houston, Texas containing approximately 182,000 net rentable square feet,
which is used for its corporate headquarters. Diamond Offshore also
22
owns two buildings totaling 39,000 square feet and 20 acres of land in New
Iberia, Louisiana for its offshore drilling warehouse and storage facility,
and a 13,000 square foot building and five acres of land in Aberdeen, Scotland
for its North Sea operations. In addition, Diamond Offshore leases various
office, warehouse and storage facilities in Louisiana, Australia, Brazil,
Indonesia, Scotland, Vietnam, the Netherlands, Malaysia, South Africa, West
Africa, Ecuador and Mexico to support its offshore drilling operations.
TEXAS GAS TRANSMISSION, LLC
The Company, through a wholly owned subsidiary, TGT Pipeline, LLC ("TGT")
acquired Texas Gas Transmission, LLC ("Texas Gas") from the Williams
Companies, Inc. in May of 2003. Texas Gas accounted for 0.87% of the Company's
consolidated total revenue for the year ended December 31, 2003.
Texas Gas owns and operates a natural gas pipeline system originating in the
Louisiana Gulf Coast area and in East Texas and running north and east through
Louisiana, Arkansas, Mississippi, Tennessee, Kentucky, Indiana and into Ohio,
with smaller diameter lines extending into Illinois. Texas Gas's direct market
area encompasses eight states in the South and Midwest, and includes the
Memphis, Tennessee; Louisville, Kentucky; Cincinnati, Ohio; and the Evansville
and Indianapolis, Indiana metropolitan areas. Texas Gas also has indirect
market access to the Northeast through interconnections with unaffiliated
pipelines.
Texas Gas's system, has a mainline delivery capacity of approximately 2.8
billion cubic feet (Bcf) of gas per day, is composed of approximately 5,800
miles of mainline, storage, and branch transmission pipelines and 31
compressor stations having a sea-level-rated capacity totaling approximately
556,000 horsepower.
Texas Gas owns and operates natural gas storage reservoirs in nine
underground storage fields located in Indiana and Kentucky. The storage
capacity of Texas Gas's certificated storage fields is approximately 178 Bcf
of gas, of which approximately 55 Bcf is working gas. Texas Gas owns a
majority of its storage gas which it uses, in part to meet operational
balancing needs on its system, in part to meet the requirements of Texas Gas's
firm and interruptible storage customers, and in part to meet the requirements
of Texas Gas's "No-Notice" transportation service, which allows Texas Gas's
customers to temporarily draw from Texas Gas's storage gas during the winter
season to be repaid in-kind during the following summer season. A small amount
of storage gas is also used to provide "Summer No-Notice" ("SNS")
transportation service, designed primarily to meet the needs of summer-season
electrical power generation facilities. SNS customers may temporarily draw
from Texas Gas's storage gas in the summer, to be repaid during the same
summer season. A large portion of the gas delivered by Texas Gas to its market
area is used for space heating, resulting in substantially higher daily
requirements during winter months.
Customers: In 2003, Texas Gas transported gas of 100 distribution companies
and municipalities for resale to residential, commercial and industrial end
users. Texas Gas provided transportation services to approximately 14
industrial customers located along its system. At December 31, 2003, Texas Gas
had transportation contracts with approximately 489 shippers. Transportation
shippers include distribution companies, municipalities, intrastate pipelines,
direct industrial users, electrical generators, marketers and producers. Texas
Gas's largest customer, Proliance Energy, LLC (Proliance), accounted for
approximately 19.6% of total operating revenue. Only one other customer, Atmos
Energy, with approximately 11.5%, accounted for over 10% of total operating
revenue in 2003. Texas Gas's firm transportation and storage agreements are
generally long-term agreements with various expiration dates and account for
the major portion of Texas Gas's business. Additionally, Texas Gas offers
interruptible transportation, short-term firm transportation and storage
services under agreements that are generally short-term.
Government Regulation: Texas Gas is subject to regulation by the Federal
Energy Regulatory Commission ("FERC") under the Natural Gas Act ("NGA") of
1938 and under the Natural Gas Policy Act of 1978, and as such, its rates and
charges for the transportation of natural gas in interstate commerce, the
extension, enlargement or abandonment of jurisdictional facilities, and its
accounting, among other things, are subject to regulation. Texas Gas's rates
are established primarily through the FERC ratemaking process. Key
determinants in the ratemaking process are (1) costs of providing service,
including depreciation rates, (2) allowed rate of return, including the equity
component of Texas Gas's capital structure, and (3) volume throughput
assumptions. The allowed rate of return is determined by the FERC in each rate
case. Rate design and the allocation of costs between the demand and commodity
rates also impact profitability. Texas Gas holds certificates of public
convenience and necessity issued by the FERC authorizing ownership and
operation of all pipelines, facilities and properties considered
jurisdictional for which certificates are required under the NGA.
23
At December 31, 2003, Texas Gas had no pending rate case proceedings and no
associated rate refunds. Texas Gas is required to file a rate case with the
FERC with rates to be effective no later than November 1, 2005, and, presently
Texas Gas does not plan to file a rate case prior to that time.
Texas Gas is also subject to the Natural Gas Pipeline Safety Act of 1968, as
amended by Title I of the Pipeline Safety Act of 1979, which regulates safety
requirements in the design, construction, operation and maintenance of
interstate natural gas pipelines and is subject to extensive federal, state
and local environmental laws and regulations, which affect Texas Gas's
operations, related to the construction and operation of its pipeline
facilities.
Competition: Texas Gas competes primarily with other interstate pipelines in
the transportation of natural gas, and natural gas competes with other forms
of energy available to Texas Gas's customers, including electricity, coal, and
fuel oils. The principal elements of competition among pipelines are rates,
terms of service, access to supply basins, and flexibility and reliability of
service. In addition, the FERC's continuing efforts to increase competition in
the natural gas industry are having the effect of increasing the natural gas
transportation options of Texas Gas's traditional customer base. As a result,
segmentation and capacity release have created an active secondary market,
which is increasingly competitive with Texas Gas.
Properties: Texas Gas's pipeline system is owned in fee, with certain
portions, such as the offshore areas, being held jointly with third parties.
However, a substantial portion of Texas Gas's system is constructed and
maintained pursuant to rights-of-way, easements, permits, and licenses or
consents on and across property owned by others. Texas Gas's compressor
stations, with appurtenant facilities, are located on lands owned in fee by
Texas Gas. Texas Gas owns its main office building and other facilities
located in Owensboro, Kentucky. Storage facilities are either owned or
contracted for under long-term leases.
During January 2004, Texas Gas held a non-binding open season to evaluate
market interest for the expansion of daily and seasonal storage capacity from
its natural gas storage complex. In the open season, Texas Gas proposed to add
additional compression at its Western Kentucky storage facilites capable of
incremental daily withdrawals up to 150,000 Mcf and seasonal storage capacity
up to 8.2 Bcf, with service starting by November 2005. Texas Gas is currently
reviewing responses received and working with parties that expressed interest
in this project.
BULOVA CORPORATION
Bulova Corporation ("Bulova") is engaged in the distribution and sale of
watches, clocks and timepiece parts for consumer use. Bulova accounted for
1.01%, 0.95% and 0.79% of the Company's consolidated total revenue for the
years ended December 31, 2003, 2002 and 2001, respectively.
Bulova's principal watch brands are Bulova, Caravelle, Wittnauer and
Accutron. Clocks are principally sold under the Bulova brand name. All watches
and substantially all clocks are purchased from foreign suppliers. Bulova's
principal markets are the United States, Canada and Mexico. Bulova's product
breakdown includes luxury watch lines represented by Wittnauer and Accutron, a
mid-priced watch line represented by Bulova, and a lower-priced watch line
represented by Caravelle. Bulova established a Swiss subsidiary, Bulova Swiss
SA, in the third quarter of 2002 to distribute product throughout Europe.
Bulova Swiss SA began selling Bulova products in Italy, Greece and the
Netherlands during the first quarter of 2003.
Properties: Bulova owns an 80,000 square foot facility in Woodside, New York
which it uses for executive and sales offices, watch distribution, service and
warehouse purposes and also owns a 91,000 square foot facility in Brooklyn,
New York, which it uses for clock service and warehouse purposes. Bulova also
owns 6,100 square feet of office space in Hong Kong which it uses for quality
control and sourcing purposes. Bulova leases 31,000 square foot facility in
Toronto, Canada, which it uses for watch and clock sales and service; a 27,000
square foot office and manufacturing facility in Ontario, Canada which it uses
for its grandfather clock operations. Bulova also leases facilities in Mexico,
Federal District, and Fribourg, Switzerland.
24
OTHER INTERESTS
A subsidiary of the Company, Majestic Shipping Corporation ("Majestic"),
owns a 49% common stock interest in Hellespont Shipping Corporation
("Hellespont"). Hellespont is engaged in the business of owning and operating
four 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.
EMPLOYEE RELATIONS
The Company, inclusive of its operating subsidiaries as described below,
employed approximately 22,700 persons at December 31, 2003 and considers its
employee relations to be satisfactory.
Lorillard employed approximately 3,200 persons. Approximately 1,200 of these
employees are represented by labor unions covered by three collective
bargaining agreements.
Lorillard has collective bargaining agreements covering hourly rated
production and service employees at various Lorillard plants with the Bakery,
Confectionery, Tobacco Workers and Grain Millers International Union, and the
National Conference of Fireman and Oilers/SEIU. Lorillard has experienced
satisfactory labor relations and provides a retirement plan, a deferred profit
sharing plan, and other benefits for its hourly paid employees who are
represented by the foregoing unions. In addition, Lorillard provides to its
salaried employees a retirement plan, group life, disability and health
insurance program and a savings plan.
Loews Hotels employed approximately 2,200 persons, approximately 700 of whom
are union members covered under collective bargaining agreements. Loews Hotels
has experienced satisfactory labor relations and provides comprehensive
benefit plans for its hourly paid employees.
The Company maintains a retirement plan, group life, disability and health
insurance program and a savings plan for executive office employees. Loews
Hotels non-union employees also participate in these benefit plans. Union
employees participate in benefit plans provided by collective bargaining
agreements.
CNA employed approximately 12,100 full-time equivalent employees and has
experienced satisfactory labor relations. CNA and its subsidiaries have
comprehensive benefit plans for substantially all of their employees,
including retirement plans, savings plans, disability programs, group life
programs and group health care programs.
Diamond Offshore employed approximately 3,740 persons including
international crew personnel furnished through independent labor contractors.
Diamond Offshore has experienced satisfactory labor relations and provides
comprehensive benefit plans for its employees. Diamond Offshore does not
currently consider the possibility of a shortage of qualified personnel to be
a material factor in its business.
Texas Gas employed approximately 700 persons. Certain of those employees
were covered by a collective bargaining agreement. Texas Gas has experienced
satisfactory labor relations and provides comprehensive benefit plans for its
employees. The International Chemical Workers Union Council of the United Food
and Commercial Workers International Union, Local 187C, represents 116 of
Texas Gas's 375 field employees. The current collective bargaining agreement
between Texas Gas and Local 187C expires on April 30, 2004.
Bulova and its subsidiaries employed approximately 560 persons,
approximately 150 of whom are union members. Bulova and its subsidiaries have
experienced satisfactory labor relations. Bulova provides comprehensive
benefit plans for substantially all employees.
AVAILABLE INFORMATION
The Company's website address is www.loews.com The Company makes available,
free of charge, through its website its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended, as soon as reasonably practicable
after such reports are electronically filed with or furnished to the
Securities and Exchange Commission ("SEC"). Copies of the Company's Code of
Business Conduct and Ethics, Corporate Governance
25
Guidelines, Audit Committee charter, Compensation Committee charter and
Nominating and Governance Committee charter have also been posted and are
available on the Company's website.
Item 2. Properties.
Information relating to the properties of Registrant and its subsidiaries is
contained under Item 1.
Item 3. Legal Proceedings.
1. Insurance Related. Information with respect to insurance related legal
-----------------
proceedings is incorporated by reference to Note 21, "Legal Proceedings -
Insurance Related" of the Notes to Consolidated Financial Statements included
in Item 8.
2. Tobacco Related. Approximately 4,275 product liability cases are pending
---------------
against cigarette manufacturers in the United States. Lorillard is a defendant
in approximately 3,875 of these cases. The Company is a defendant in six of
the pending cases. Information with respect to tobacco related legal
proceedings is incorporated by reference to Note 21, "Legal Proceedings -
Tobacco Related" of the Notes to Consolidated Financial Statements included in
Item 8. Additional information regarding tobacco related legal proceedings is
contained below and in Exhibit 99.01.
The pending product liability cases are comprised of the following types of
cases:
"Conventional product liability cases" are brought by individuals who allege
cancer or other health effects caused by smoking cigarettes, by using
smokeless tobacco products, by addiction to tobacco, or by exposure to
environmental tobacco smoke. Approximately 1,475 cases are pending, including
approximately 1,100 cases against Lorillard. The 1,475 cases include
approximately 1,000 cases pending in a single West Virginia court in which a
consolidated trial is scheduled for March 21, 2005. Lorillard is a defendant
in nearly 950 of the 1,000 consolidated West Virginia cases. The Company is a
defendant in two of the conventional product liability cases and is not a
party to any of the consolidated West Virginia cases.
"Class action cases" are purported to be brought on behalf of large numbers
of individuals for damages allegedly caused by smoking. Thirteen of these
cases are pending against Lorillard. The Company is a defendant in two of the
class action cases. An additional group of approximately 25 class action cases
are pending against other cigarette manufacturers and assert claims on behalf
of smokers of "light" cigarettes. Reference is made to Exhibit 99.01 to this
Report for a list of pending Class Action Cases in which Lorillard is a party.
"Reimbursement cases" are brought by or on behalf of entities who seek
reimbursement of expenses incurred in providing health care to individuals who
allegedly were injured by smoking. Plaintiffs in these cases have included the
U.S. federal government, U.S. state and local governments, foreign
governmental entities, hospitals or hospital districts, American Indian
tribes, labor unions, private companies, and private citizens suing on behalf
of taxpayers. Lorillard is a defendant in 11 of the 13 pending Reimbursement
cases. The Company is a defendant in one of the pending Reimbursement cases.
Reference is made to Exhibit 99.01 to this Report for a list of pending
Reimbursement Cases in which Lorillard is a party.
"Contribution cases" are brought by private companies, such as asbestos
manufacturers or their insurers, who are seeking contribution or indemnity for
court claims they incurred on behalf of individuals injured by their products
but who also allegedly were injured by smoking cigarettes. Lorillard is a
defendant in each of the seven pending Contribution cases. The Company is a
defendant in one of the pending Contribution cases. Reference is made to
Exhibit 99.01 to this Report for a list of pending Contribution cases in which
Lorillard is a party.
"Flight Attendant cases" are brought by non-smoking flight attendants
alleging injury from exposure to environmental smoke in the cabins of
aircraft. Plaintiffs in these cases may not seek punitive damages for injuries
that arose prior to January 15, 1997. Lorillard is a defendant in each of the
approximately 2,725 pending Flight Attendant cases. The Company is not a
defendant in any of the Flight Attendant cases.
Excluding the flight attendant and the consolidated West Virginia suits,
approximately 550 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 200 of the 550 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in six of the actions.
26
Other tobacco-related litigation includes "Tobacco Related Anti-Trust
Cases." Reference is made to Exhibit 99.01 to this Report for a list of
pending Tobacco Related Anti-Trust Cases in which Lorillard is a party.
Item 4. Submission of Matters to a Vote of Security Holders.
None
EXECUTIVE OFFICERS OF THE REGISTRANT
First
Became
Name Position and Offices Held Age Officer
- -----------------------------------------------------------------------------
Gary W. Garson Senior Vice President, General
Counsel and Secretary 57 1988
Herbert C. Hofmann Senior Vice President 61 1979
Peter W. Keegan Senior Vice President and Chief
Financial Officer 59 1997
Arthur L. Rebell Senior Vice President 62 1998
Andrew H. Tisch Office of the President and 54 1985
Chairman of the Executive
Committee
James S. Tisch Office of the President, 51 1981
President and Chief Executive
Officer
Jonathan M. Tisch Office of the President 50 1987
Preston R. Tisch Chairman of the Board 77 1960
Andrew H. Tisch and James S. Tisch are brothers, and are nephews of, and
Jonathan M. Tisch is a son of, Preston R. Tisch. None of the other officers or
directors of Registrant is related to any other.
All executive officers of Registrant, have been engaged actively and
continuously in the business of Registrant for more than the past five years.
Officers are elected and hold office until their successors are elected and
qualified, and are subject to removal by the Board of Directors.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
Price Range of Common Stock
Loews common stock
Loews Corporation's common stock is listed on the New York Stock Exchange.
The following table sets forth the reported high and low sales prices in each
calendar quarter of 2003 and 2002:
2003 2002
--------------------------------------------
High Low High Low
- ------------------------------------------------------------------------------------------------
First Quarter $47.90 $39.65 $62.10 $53.95
Second Quarter 49.02 38.25 62.30 52.00
Third Quarter 49.18 40.10 53.89 40.67
Fourth Quarter 49.48 38.80 45.62 37.50
27
Carolina Group stock
Carolina Group stock is listed on the New York Stock Exchange and trading of
the stock started on February 1, 2002. The following table sets forth the
reported high and low sales prices in each calendar quarter of 2003 and 2002:
2003 2002
- ------------------------------------------------------------------------------------------------
High Low High Low
- ------------------------------------------------------------------------------------------------
First Quarter $22.95 $18.00 $30.05 $27.70
Second Quarter 27.18 16.86 33.59 25.85
Third Quarter 28.10 20.70 27.25 17.35
Fourth Quarter 25.70 22.49 21.20 16.41
Dividend Information
The Company has paid quarterly cash dividends on Loews common stock in each
year since 1967. Regular dividends of $0.15 per share of Loews common stock
were paid in each calendar quarter of 2003 and 2002.
The Company paid quarterly cash dividends on Carolina Group stock of $0.445
per share beginning in the second quarter of 2002. The Company increased its
quarterly cash dividend on Carolina Group stock to $0.455 per share beginning
in the second quarter of 2003.
Approximate Number of Equity Security Holders
The Company has approximately 1,900 holders of record of Loews common stock
and 70 holders of record of Carolina Group stock.
28
Item 6. Selected Financial Data.
Year Ended December 31 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------
(In millions, except per share data)
Results of Operations:
Revenues $16,461.0 $17,456.5 $18,728.2 $20,633.0 $20,840.2
(Loss) income before taxes and minority
interest $(1,378.4) $ 1,640.7 $ (829.1) $ 3,135.9 $ 861.5
(Loss) income from continuing operations $ (666.1) $ 978.6 $ (547.7) $ 1,835.5 $ 472.6
Discontinued operations - net 55.4 (27.0) 13.9 13.1 12.6
Cumulative effect of changes in
accounting principles-net (39.6) (53.3) (157.9)
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (610.7) $ 912.0 $ (587.1) $1,848.6 $ 327.3
================================================================================================
(Loss) income attributable to:
Loews common stock:
(Loss) income from continuing
operations $ (781.3) $ 837.9 $ (547.7) $1,835.5 $ 472.6
Discontinued operations-net 55.4 (27.0) 13.9 13.1 12.6
Cumulative effect of changes in
accounting principles-net (39.6) (53.3) (157.9)
- ------------------------------------------------------------------------------------------------
Loews common stock (725.9) 771.3 (587.1) 1,848.6 327.3
Carolina Group stock 115.2 140.7
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (610.7) $ 912.0 $ (587.1) $1,848.6 $ 327.3
================================================================================================
(Loss) Income Per Share:
Loews common stock:
(Loss) income from continuing
operations $ (4.21) $ 4.46 $ (2.81) $ 9.24 $ 2.18
Discontinued operations - net 0.30 (0.14) 0.07 0.06 0.05
Cumulative effect of changes in
accounting principles-net (0.21) (0.27) (0.73)
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (3.91) $ 4.11 $ (3.01) $ 9.30 $ 1.50
================================================================================================
Carolina Group stock $ 2.76 $ 3.50
================================================================================================
Financial Position:
Investments $42,514.8 $40,136.7 $41,159.1 $41,332.7 $42,008.0
Total assets 77,880.9 70,515.6 75,001.0 71,588.7 70,628.2
Long-term debt 5,820.2 5,651.9 5,920.3 6,040.0 5,706.3
Shareholders' equity 11,054.3 11,235.2 9,429.3 10,969.1 9,783.8
Cash dividends per share:
Loews common stock 0.60 0.60 0.58 0.50 0.50
Carolina Group stock 1.81 1.34
Book value per share of
Loews common stock 60.92 61.68 49.24 55.62 46.82
Shares outstanding:
Loews common stock 185.45 185.44 191.49 197.23 208.96
Carolina Group stock 57.97 39.91
- ------------------------------------------------------------------------------------------------
29
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Management's discussion and analysis of financial condition and results of
operations is comprised of the following sections:
Page No.
--------
Overview
Consolidated Financial Results 32
Classes of Common Stock 33
Parent Company Structure 34
Critical Accounting Estimates 34
Results of Operations by Business Segment
CNA Financial
2003 charges 36
Reserves - Estimates and Uncertainties 38
Reinsurance 40
World Trade Center Event 43
Terrorism Insurance 44
Restructuring 45
Non-GAAP Financial Measures 47
Property and Casualty Segment 48
Group Segment 56
Life Segment 58
Other Insurance Segment 59
APMT Reserves 60
Lorillard
Results of Operations 70
Business Environment 73
Loews Hotels 74
Diamond Offshore 75
Texas Gas 77
Bulova 77
Corporate 77
Liquidity and Capital Resources
CNA Financial 78
Lorillard 84
Loews Hotels 85
Diamond Offshore 85
Texas Gas 86
Bulova 86
Majestic Shipping 86
Parent Company 87
Investments 88
Accounting Standards 98
Forward-Looking Statements Disclaimer 98
Supplemental Financial Information 101
OVERVIEW
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); the operation of an interstate natural gas transmission pipeline
system (Texas Gas Transmission, LLC ("Texas Gas"), a wholly owned subsidiary);
and the distribution and sale of watches and clocks (Bulova Corporation
("Bulova"), a 97% owned subsidiary). Unless the
30
context otherwise requires, the terms "Company," "Loews" and "Registrant" as
used herein mean Loews Corporation excluding its subsidiaries.
CNA Recent Developments
During 2003, CNA completed a strategic review of its operations and decided
to concentrate efforts on its property and casualty business. As a result of
this review, and 2003 charges of $1,667.4 million after tax and minority
interest ($2,845.0 million pretax) related to unfavorable net prior year
development and a $356.9 million ($610.0 million pretax) increase in the
provision for reinsurance and insurance receivables, a capital plan was
developed to replenish statutory capital of CNA's property and casualty
subsidiaries adversely impacted by these charges. A summary of the capital
plan, related actions, and other significant 2003 business decisions is
discussed below:
In order to assist CNA in replenishing statutory capital adversely impacted
by the 2003 charges discussed above, in November of 2003 Loews purchased
$750.0 million of a new series of CNA convertible preferred stock. Loews
committed additional capital support of up to $500.0 million by February 27,
2004 through the purchase of surplus notes in the event certain additions to
statutory capital were not achieved through asset sales. In addition, Loews
committed to an additional $150.0 million of capital support by March 31,
2004, in a form to be determined.
On December 31, 2003, CNA completed the sale of the majority of its Group
Benefits business to Hartford Financial Services Group, Inc. The business sold
included group life and accident, short and long term disability and certain
other products. CNA's group long term care and specialty medical businesses
were excluded from the sale. Consideration from the sale was approximately
$530.0 million, of which $485.0 million was received on December 31, 2003,
resulting in an investment loss on the sale of $116.4 million (after tax and
minority interest). See Note 14 of the Notes to Consolidated Financial
Statements included under Item 8 for further information.
In February of 2004, CNA entered into a definitive agreement to sell its
individual life insurance business to Swiss Re Life & Health America Inc. for
approximately $690.0 million. The business sold includes term, universal and
permanent life insurance policies and individual annuity products. The
transaction is expected to be completed on or before March 31, 2004, subject
to certain customary closing conditions and regulatory approvals. See Note 25
of the Notes to Consolidated Financial Statements included under Item 8 for
further information.
After consideration of the increase in statutory surplus resulting from the
sale of the Group Benefits business, Loews purchased $45.6 million of surplus
notes in February of 2004, pursuant to the capital plan. In addition, the sale
of CNA's individual life business is expected to result in an addition to
statutory surplus in excess of $400.0 million. However, the sale of the
individual life business was not consummated by February 26, 2004. As a
result, Loews purchased $300.0 million of additional surplus notes in February
of 2004. Following the consummation of the individual life sale, CNA plans to
seek approval from the insurance regulatory authority for the repayment of the
surplus notes purchased in relation to such sale, although no assurance can be
given that sale of the individual life business will be consummated or that
the regulatory approval will be obtained.
In addition to the asset sales described above, and as part of the decision
to focus on its property and casualty business, CNA withdrew from the assumed
reinsurance business during 2003. In October of 2003, CNA entered into an
agreement to sell the renewal rights for most of the treaty business of CNA Re
to Folksamerica. Under the terms of the transaction, Folksamerica will
compensate CNA based upon the amount of premiums renewed by Folksamerica over
the next two contract renewals. CNA will manage the run-off of its retained
liabilities.
The Group Operations business, individual life and annuity insurance
business and CNA Re absorbed approximately $150.0 million of shared corporate
overhead expenses that are allocated to all of CNA's businesses. CNA expects
that the 2004 consolidated net results will include an approximate $50.0
million after tax loss (before minority interest) for these three businesses,
primarily due to these corporate overhead expenses. The 2003 expense
initiative discussed below did not contemplate the sale or exit of these
businesses, and therefore the savings from this initiative will be partially
offset by these expenses. CNA is evaluating its corporate expense structure
and anticipates taking actions in 2004 that will reduce these expenses.
The primary components of the expense initiative are a reduction of the
workforce by approximately five percent, lower commissions and other
acquisition costs, principally related to workers compensation, and reduced
spending in other areas. As of December 31, 2003, CNA has achieved the
targeted workforce reduction and approximately $28.0
31
million of associated severance and related costs have been recorded in 2003.
Actions related to the commission and other acquisition expenses have begun to
be implemented in 2003 and will continue through 2004.
In February of 2004, CNA announced the decision to cease sales to new
customers in its structured settlement and institutional markets businesses.
Also, during 2003, CNA ceased sales to new customers in the individual and
group long term care businesses. CNA will continue to accept new deposits and
premiums only from existing customers for the institutional markets business
and will service its existing commitments on all businesses in which new sales
were ceased. These businesses will be managed as a run-off operation. CCC will
provide credit enhancement to Continental Assurance Company ("CAC") for
certain of CAC's investment and specialty medical products.
Acquisition of Texas Gas
In May of 2003 the Company, through a wholly owned subsidiary, TGT Pipeline,
LLC, acquired Texas Gas from The Williams Companies, Inc. The transaction
value was approximately $1.05 billion, which included $250.0 million of
existing Texas Gas debt. The results of Texas Gas have been included in the
Consolidated Financial Statements from the date of acquisition. The Company
funded the approximately $803.3 million balance of the purchase price,
including transaction costs and closing adjustments, with $528.3 million of
its available cash and $275.0 million of proceeds from an interim loan
incurred by Texas Gas.
Consolidated Financial Results
The following table summarizes the revenues, net (loss) income and earnings
per share information:
Year Ended December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Consolidated:
Revenues (a) $16,461.0 $17,456.5
Net (loss) income $ (610.7) $ 912.0
Per Share: (b)
(Loss) income per share of Loews common stock:
(Loss) income from continuing operations $ (4.21) $ 4.46
Discontinued operations-net 0.30 (0.14)
Cumulative effect of change in accounting
principle-net (0.21)
- ------------------------------------------------------------------------------------------------
Net (loss) income per share of Loews common
stock $ (3.91) $ 4.11
================================================================================================
Net income per share of Carolina Group stock $ 2.76 $ 3.50
================================================================================================
(a) Revenue includes premiums of $1,151.0 for the year ended December 31, 2002, related to the
National Postal Mail Handlers contract at CNA which was transferred on July 1, 2002.
(b) The Company has two classes of common stock, Loews common stock and Carolina Group stock,
issued in February 2002.
Net loss of $610.7 million for 2003 includes a gain from discontinued
operations of $55.4 million or $0.30 per share of Loews common stock related
to the sale of a hotel property, as compared to a loss from discontinued
operations of $27.0 million or $0.14 per share of Loews common stock in the
prior year primarily related to CNA's sale of its life operations in Chile.
Net income in 2002 also included a charge for accounting changes of $39.6
million or $0.21 per share of Loews common stock, related to accounting for
goodwill and other intangible assets at CNA.
The 2003 results reflect the charges at CNA Financial Corporation, the
Company's 90% owned subsidiary, for net prior year development of $1,667.4
million, net of tax and minority interest, which includes premium and claim
and allocated claim adjustment expense development. Results for 2003 also
include charges to increase bad debt reserves for insurance and reinsurance
receivables of $356.9 million.
The net prior year development consists of $1,202.0 million related to core
reserves and $465.4 million related to asbestos, environmental pollution and
mass tort ("APMT") reserves (after tax and minority interest). The net prior
year
32
development also resulted in additional cessions to CNA's reinsurance
contracts, including the corporate aggregate reinsurance treaties. These
additional cessions resulted in $60.3 million of interest expense (after tax
and minority interest), which is recorded as a reduction in investment income.
Consolidated loss from continuing operations for the year ended 2003 was
$666.1 million, compared to income of $978.6 million in the prior year. Loss
from continuing operations includes net investment gains of $338.3 million
(after tax and minority interest), compared to a loss of $116.7 million (after
tax and minority interest) in the prior year. The net loss reflects the
unfavorable net prior year premium and loss development and increase in bad
debt reserves recorded in 2003 as discussed above and lower results from
Lorillard, partially offset by the improvement in net investment gains.
Loss from continuing operations attributable to Loews common stock for the
year ended 2003 amounted to $781.3 million or $4.21 per share, compared to
income of $837.9 million or $4.46 per share in the prior year. Loss from
continuing operations includes net investment gains attributable to Loews
common stock of $339.7 million, compared to losses of $122.0 million in the
prior year.
Net income attributable to Carolina Group stock for the year ended 2003
amounted to $115.2 million or $2.76 per Carolina Group share, compared to
$140.7 million or $3.50 per share in the prior year.
Components of Net (Loss) Income
Year Ended December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
(Loss) income before net investment gains (losses)
attributable to Loews common stock $ (1,121.0) $ 959.9
Net investment gains (losses) 339.7 (122.0)
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing operations (781.3) 837.9
Discontinued operations-net (a) 55.4 (27.0)
Cumulative effect of change in accounting
principle-net (b) (39.6)
- ------------------------------------------------------------------------------------------------
Net (loss) income attributable to Loews common stock $ (725.9) $ 771.3
================================================================================================
(a) Includes a gain of $56.7 in the year ended December 31, 2003 from the sale of a hotel
property. The year ended December 31, 2002 includes a $31.0 loss from CNA's sale of its life
operations in Chile.
(b) Represents the effect of the adoption of SFAS No. 142, which was a change in accounting for
goodwill and other intangible assets at CNA.
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 ($2.0
billion outstanding at December 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 December 31, 2003, the outstanding Carolina Group stock represents a
33.43% economic interest in the economic performance of the Carolina Group.
The Loews Group consists of all the Company's assets and liabilities other
than the 33.43% economic interest represented by the outstanding Carolina
Group stock, and includes as an asset the notional, intergroup debt of the
Carolina Group.
The existence of separate classes of common stock could give rise to
occasions where the interests of the holders of Loews common stock and
Carolina Group stock diverge or conflict or appear to diverge or conflict.
Subject to its fiduciary duties, the Company's board of directors could, in
its sole discretion, from time to time, make determinations or implement
policies that affect disproportionately the groups or the different classes of
stock. For example, Loews's board of directors may decide to reallocate
assets, liabilities, revenues, expenses and cash flows between groups, without
the consent of shareholders. The board of directors would not be required to
select the option that would result in the highest value for holders of
Carolina Group stock.
33
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, the availability of sufficient
funds in such subsidiaries, applicable state laws, including in the case of
the insurance subsidiaries of CNA, laws and rules governing the payment of
dividends by regulated insurance companies. Claims of creditors of the
Company's subsidiaries will generally have priority as to the assets of such
subsidiaries over the claims of the Company and its creditors and stockholders
(see Liquidity and Capital Resources - CNA, below).
At December 31, 2003, the book value per share of Loews common stock was
$60.92, compared to $61.68 at December 31, 2002.
CRITICAL ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP") requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and the related
notes. Actual results could differ from those estimates.
The consolidated financial statements and accompanying notes have been
prepared in accordance with GAAP, applied on a consistent basis. The Company
continually evaluates the accounting policies and estimates used to prepare
the consolidated financial statements. In general, management's estimates are
based on historical experience, evaluation of current trends, information from
third party professionals and various other assumptions that are believed to
be reasonable under the known facts and circumstances.
The accounting policies discussed below are considered by management to be
critical to an understanding of the Company's consolidated 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 insurance policies where the reserving process is based
on actuarial estimates of the amount of loss, including amounts for known and
unknown claims. Long-duration contracts typically include traditional life
insurance and long term care products and are estimated using actuarial
estimates about mortality and morbidity as well as assumptions about expected
investment returns. Workers compensation lifetime claim reserves and accident
and health disability claim reserves are calculated using mortality and
morbidity assumptions based on CNA and industry experience, and are discounted
at interest rates that range from 4.0% to 6.5% at December 31, 2003. The
inherent risks associated with the reserving process are discussed below, in
Reserves - Estimates and Uncertainties. Additionally, a review of Results of
Operations for CNA's segment results, Environmental Pollution and Mass Tort
and
34
Asbestos Reserves, and Reserve Development sections 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 receivables in the Consolidated Balance Sheets.
The ceding of insurance does not discharge the primary liability of CNA. An
estimated allowance for doubtful accounts is recorded on the basis of
periodic evaluations of balances due from reinsurers, reinsurer solvency,
management's experience and current economic conditions. Further information
on reinsurance is provided in a review of Results of Operations for CNA's
segment results-Reinsurance that follows.
Tobacco and Other Litigation
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. Plaintiffs in most of the cases seek unspecified
amounts of compensatory damages and punitive damages, although some seek
damages ranging into the billions of dollars. Plaintiffs in some of the cases
seek treble damages, statutory damages, disgorgement of profits, equitable and
injunctive relief, and medical monitoring, among other damages.
Lorillard believes that it has valid defenses to the cases pending against
it. Lorillard also believes it has valid bases for appeal of the adverse
verdicts against it. To the extent the Company is a defendant in any of the
lawsuits, the Company believes that it is not a proper defendant in these
matters and has moved or plans to move for dismissal of all such claims
against it. While Lorillard intends to defend vigorously all tobacco products
liability litigation, it is not possible to predict the outcome of any of this
litigation. Litigation is subject to many uncertainties, and it is possible
that some of these actions could be decided unfavorably. Lorillard may enter
into discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
On May 21, 2003 the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeals also decertified the class
ordered during pre-trial proceedings. Plaintiffs are seeking review of the
case by the Florida Supreme Court. The Company and Lorillard believe that the
appeals court's decision should be upheld upon further appeals.
Except for the impact of the State Settlement Agreements as described in
Note 21 of the Notes to Consolidated Financial Statements included in Item 8
of this Report, management is unable to make a meaningful estimate of the
amount or range of loss that could result from an unfavorable outcome of
pending litigation and, therefore, no provision has been made in the
consolidated condensed financial statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially adversely affected by an unfavorable
outcome of certain pending or future litigation.
CNA is also involved in various legal proceedings that have arisen during
the ordinary course of business. CNA evaluates the facts and circumstances of
each situation and when CNA determines it necessary, a liability is estimated
and recorded.
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
35
impairment loss in the results of operations in the period in which the
determination occurred. See "Investments - CNA" in this MD&A and Note 2 of the
Notes to Consolidated Financial Statements included in Item 8 for information
related to the Company's impairment charges.
Securities in the parent company's investment portfolio that are not part of
its cash management activities are classified as trading securities in order
to reflect the Company's investment philosophy. These investments are carried
at fair value with the net unrealized gain or loss included in the
Consolidated Statements of Operations.
Individual Long-term Care Products
CNA's reserves and deferred acquisition costs for its individual long term
care product offerings are based on certain assumptions including morbidity,
policy persistency and interest rates. Actual experience may differ from these
assumptions. The recoverability of deferred acquisition costs and the adequacy
of the reserves are contingent on actual experience related to these key
assumptions and other factors including potential future premium increases and
future health care cost trends. The Company's results of operations and/or
equity may be materially, adversely affected if actual experience varies
significantly from these assumptions. For further information see the Life
Operations section of the MD&A.
Loans to National Contractor
CNA has made loans through a credit facility provided to a national
contractor to whom CNA Surety provides significant amounts of surety bond
insurance coverage. As of December 31, 2003, the Company has credit exposure
of $80.0 million under the credit facility. The credit facility was
established to help the contractor meet its liquidity needs. The contractor
has initiated restructuring efforts to reduce costs and improve cash flow and
is attempting to develop additional sources of funds. Based on the contactor's
restructuring efforts to date, CNA estimates that amounts due under the credit
facility are collectible. Therefore, no valuation allowance has been
established. Further information on this credit agreement is provided in the
Liquidity and Capital Resources section below.
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.
2003 Charges
The Company's 2003 net loss included CNA's significant reserve strengthening
as a result of reserve reviews. Significant items that contributed to CNA's
2003 net loss (after tax and minority interest) include:
. Net prior year development of $1,667.4 million after tax and minority
interest, which includes premium and claim and allocated claim adjustment
expense development. Of this amount, $1,202.0 million was recorded for
core reserves and $465.4 million was recorded for environmental pollution
and mass tort and asbestos ("APMT") reserves.
. Increase in the bad debt reserve for reinsurance receivables in the
amount of $215.3 million. This increase was recorded based on continuing
deterioration of reinsurer financial strength ratings. See the
Reinsurance section of this MD&A for a detailed discussion of this
charge.
. Increase in the bad debt reserve for insurance receivables in the amount
of $141.6 million in Standard Lines. See the Property and Casualty
discussion of results in the MD&A for a discussion of this charge.
. Increase in unallocated claim and claim adjustment expense ("ULAE")
reserves of $58.5 million. The increase was recorded in Standard Lines
($2.7 million), Specialty Lines ($16.2 million) and the Other Insurance
($39.6 million) segments.
36
The following table summarizes the pretax 2003 net year development by
segment.
Property
and Other
Casualty Insurance Total
- -----------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year claim and allocated claim
adjustment expense development excluding the impact
of the corporate aggregate reinsurance treaties:
Core (Non-APMT) $ 2,064.0 $ 86.0 $ 2,150.0
APMT 795.0 795.0
- -----------------------------------------------------------------------------------------------
Total 2,064.0 881.0 2,945.0
Ceded losses related to corporate aggregate reinsurance
treaties (643.0) (643.0)
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year development before
impact of premium development 1,421.0 881.0 2,302.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium development, excluding
impact of corporate aggregate reinsurance treaties 192.0 (7.0) 185.0
Ceded premiums related to corporate aggregate reinsurance
treaties 357.0 1.0 358.0
- ------------------------------------------------------------------------------------------------
Total premium development 549.0 (6.0) 543.0
- -----------------------------------------------------------------------------------------------
Total 2003 unfavorable net prior year development (pretax) $ 1,970.0 $ 875.0 $ 2,845.0
================================================================================================
Total 2003 unfavorable net prior year development
(after tax and minority interest) $ 1,281.0 $ 568.0 $ 1,849.0
================================================================================================
The following table summarizes the pretax 2002 net unfavorable prior
accident year development by segment.
Property
and Other
Casualty Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable (favorable) net prior year claim
and allocated claim adjustment expense development
excluding the impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 81.0 $ 23.0 $ 104.0
Ceded losses related to corporate aggregate reinsurance
treaties (148.0) (148.0)
- ------------------------------------------------------------------------------------------------
Pretax (favorable) unfavorable net prior year development
before impact of premium development (67.0) 23.0 (44.0)
- ------------------------------------------------------------------------------------------------
Premium development, excluding impact of corporate
aggregate reinsurance treaties (7.0) (3.0) (10.0)
Ceded premiums related to corporate aggregate reinsurance
treaties 100.0 1.0 101.0
- ------------------------------------------------------------------------------------------------
Total premium development 93.0 (2.0) 91.0
- -----------------------------------------------------------------------------------------------
Total 2002 unfavorable net prior year development (pretax) $ 26.0 $ 21.0 $ 47.0
===============================================================================================
Total 2002 unfavorable net prior year development
(after tax and minority interest) $ 17.0 $ 14.0 $ 31.0
===============================================================================================
37
The following table summarizes the pretax 2001 net unfavorable prior
accident year development by segment.
Property
and Other
Casualty Insurance Total
- -----------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year claim and allocated claim
adjustment expense development excluding the impact
of the corporate aggregate reinsurance treaties:
Core (Non-APMT) $1,578.0 $ 72.0 $ 1,650.0
APMT 1,241.0 1,241.0
- ------------------------------------------------------------------------------------------------
Total 1,578.0 1,313.0 2,891.0
Ceded losses related to corporate aggregate reinsurance
treaties (500.0) (500.0)
- ------------------------------------------------------------------------------------------------
Pretax unfavorable (favorable) net prior year development
before impact of premium development 1,078.0 1,313.0 2,391.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium development,
excluding impact of corporate aggregate reinsurance
treaties 779.0 9.0 788.0
Ceded premiums related to corporate aggregate reinsurance
treaties 230.0 230.0
- ------------------------------------------------------------------------------------------------
Total premium development 1,009.0 9.0 1,018.0
- ------------------------------------------------------------------------------------------------
Total 2001 unfavorable net prior year development (pretax) $2,087.0 $1,322.0 $ 3,409.0
================================================================================================
Total 2001 unfavorable net prior year development
(after tax and minority interest) $1,356.0 $ 859.0 $ 2,215.0
================================================================================================
Reserves - Estimates and Uncertainties
CNA maintains reserves to cover its estimated ultimate unpaid liability for
claim and claim adjustment expenses and future policy benefits, including the
estimated cost of the claims adjudication process, for claims that have been
reported but not yet settled and claims that have been incurred but not
reported. Claim and claim adjustment expense and future policy benefit
reserves are reflected as liabilities on the Consolidated Balance Sheets under
the heading "Insurance Reserves." Adjustments to prior year reserve estimates,
if necessary, are reflected in the results of operations in the period that
the need for such adjustments is determined.
The level of Insurance Reserves maintained by CNA represents management's
best estimate, as of a particular point in time, of what the ultimate
settlement and administration of claims will cost based on its assessment of
facts and circumstances known at that time. Insurance Reserves are not an
exact calculation of liability but instead are complex estimates that are
derived by CNA, generally utilizing a variety of actuarial reserve estimation
techniques, from numerous assumptions and expectations about future events,
both internal and external, many of which are highly uncertain.
Among the many uncertain future events about which CNA makes assumptions and
estimates, many of which have become increasingly unpredictable, are claims
severity, frequency of claims, mortality, morbidity, expected interest rates,
inflation, claims handling and case reserving policies and procedures,
underwriting and pricing policies, changes in the legal and regulatory
environment and the lag time between the occurrence of an insured event and
the time it is ultimately settled, referred to in the insurance industry as
the "tail." These factors must be individually considered in relation to CNA's
evaluation of each type of business. Many of these uncertainties are not
precisely quantifiable, particularly on a prospective basis, and require
significant management judgment.
Given the factors described above, it is not possible to quantify precisely
the ultimate exposure represented by claims and related litigation. As a
result, CNA regularly reviews the adequacy of its reserves and reassesses its
reserve estimates as historical loss experience develops, additional claims
are reported and settled and additional information becomes available in
subsequent periods.
In addition, CNA is subject to the uncertain effects of emerging or
potential claims and coverage issues that arise as industry practices and
legal, judicial, social and other environmental conditions change. These
issues have had, and may continue to have, a negative effect on CNA's business
by either extending coverage beyond the original underwriting intent or by
increasing the number or size of claims. Recent examples of emerging or
potential claims and coverage issues include:
38
. increases in the number and size of water damage claims, including those
related to expenses for testing and remediation of mold conditions;
. increases in the number and size of claims relating to injuries from
medical products, and exposure to lead;
. the effects of accounting and financial reporting scandals and other major
corporate governance failures which have resulted in an increase in the
number and size of claims, including director and officer and errors and
omissions insurance claims;
. class action litigation relating to claims handling and other practices;
. increases in the number of construction defect claims, including claims
for a broad range of additional insured endorsements on policies; and
. increases in the number of claims alleging abuse by members of the clergy
The impact of these and other unforeseen emerging or potential claims and
coverage issues is difficult to predict and could materially adversely affect
the adequacy of CNA's claim and claim adjustment expense reserves and could
lead to future reserve additions.
CNA's experience has been that establishing reserves for casualty coverages
relating to APMT claim and claim adjustment expenses is subject to
uncertainties that are greater than those presented by other claims.
Estimating the ultimate cost of both reported and unreported APMT claims is
subject to a higher degree of variability due to a number of additional
factors, including among others:
. coverage issues, including whether certain costs are covered under the
policies and whether policy limits apply;
. inconsistent court decisions and developing legal theories;
. increasingly aggressive tactics of plaintiffs' lawyers;
. the risks and lack of predictability inherent in major litigation;
. changes in the volume of asbestos and environmental pollution and mass
tort claims which cannot now be anticipated;
. continued increase in mass tort claims relating to silica and silica-
containing products;
. the impact of the exhaustion of primary limits and the resulting increase
in claims on any umbrella or excess policies that CNA has issued;
. the number and outcome of direct actions against CNA; and
. CNA's ability to recover reinsurance for asbestos and environmental
pollution and mass tort claims.
It is also not possible to predict changes in the legal and legislative
environment and the impact on the future development of APMT claims. This
development will be affected by future court decisions and interpretations, as
well as changes in applicable legislation. It is difficult to predict the
ultimate outcome of large coverage disputes until settlement negotiations near
completion and significant legal questions are resolved or, failing
settlement, until the dispute is adjudicated. This is particularly the case
with policyholders in bankruptcy where negotiations often involve a large
number of claimants and other parties and require court approval to be
effective. A further uncertainty exists as to whether a national privately
financed trust to replace litigation of asbestos claims with payments to
claimants from the
39
trust will be established and approved through federal legislation, and, if
established and approved, whether it will contain funding requirements in
excess of CNA's carried loss reserves.
Due to the factors described above, among others, establishing reserves for
APMT claim and claim adjustment expenses is subject to uncertainties that are
greater than those presented by other claims. Traditional actuarial methods
and techniques employed to estimate the ultimate cost of claims for more
traditional property and casualty exposures are less precise in estimating
claim and claim adjustment reserves for APMT, particularly in an environment
of emerging or potential claims and coverage issues that arise from industry
practices and legal, judicial and social conditions. Therefore, these
traditional actuarial methods and techniques are necessarily supplemented with
additional estimating techniques and methodologies, many of which involve
significant judgments that are required of management. Due to the inherent
uncertainties in estimating reserves for APMT claim and claim adjustment
expenses and the degree of variability due to, among other things, the factors
described above, CNA may be required to record material changes in its claim
and claim adjustment expense reserves in the future, should new information
become available or other developments emerge. See the Asbestos and
Environmental Pollution and Mass Tort Reserves section of this MD&A for
additional information relating to APMT claims and reserves.
CNA's recorded Insurance Reserves, including APMT reserves, reflect
management's best estimate as of a particular point in time based upon known
facts, current law and management's judgment. In light of the many
uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, CNA reviews its reserve
estimates on a regular basis and makes adjustments in the period that the need
for such adjustments is determined. These reviews have resulted in CNA
identifying information and trends that have caused CNA to increase its
reserves in prior periods and could lead to the identification of a need for
additional material increases in claim and claim adjustment expense reserves,
which could materially adversely affect the Company's results of operations
and equity and CNA's business, insurer financial strength and debt ratings
(see the Ratings section of this MD&A).
The following table presents estimated volatility in carried claim and claim
adjustment expense reserves for the property and casualty and Other Insurance
segments.
Gross
Carried Estimated
Loss Volatility in
December 31, 2003 Reserves Reserves
- ------------------------------------------------------------------------------------------------
(In millions, except %)
Standard Lines $12,983.0 +/- 7.0%
Specialty Lines 6,470.0 +/- 7.0%
CNA Re 2,288.0 +/- 10.0%
Other Insurance 7,046.0 +/- 25.0%
The estimated volatility noted above does not represent a range around the
actuarial point estimate of CNA's gross loss reserves, and it does not
represent the range of all possible outcomes. The volatility represents an
estimate of the inherent volatility associated with estimating loss reserves
for the specific type of business written by each segment. The primary
characteristics influencing the estimated level of volatility are the length
of the claim settlement period, changes in medical and other claim costs,
changes in the level of litigation or other dispute resolution processes,
changes in the legal environment and the potential for different types of
injuries emerging. Ceded reinsurance arrangements may reduce the volatility.
Since ceded reinsurance arrangements vary by year, volatility in gross
reserves may not result in comparable impacts to underwriting income or
equity.
Reinsurance
CNA assumes and cedes reinsurance to 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.
Property and Casualty reinsurance coverages are tailored to the specific
risk characteristics of each product line and CNA's retained amount varies by
type of coverage. Treaty reinsurance is purchased to protect specific lines of
business such as property, worker's compensation, and professional liability.
Corporate catastrophe reinsurance is also purchased
40
for property and worker's compensation exposure. Most treaty reinsurance is
purchased on an excess of loss basis. CNA also utilizes facultative
reinsurance in certain lines. 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 not remitted in cash is recorded as funds
withheld liabilities. CNA is required to increase the funds withheld balance
at stated interest crediting rates applied to the funds withheld balance or as
otherwise specified under the terms of the contract. The funds withheld
liability is reduced by any cumulative claim payments made by CNA in excess of
CNA's retention under the reinsurance contract. If the funds withheld
liability is exhausted, interest crediting will cease and additional claim
payments are recoverable from the reinsurer. The funds withheld liability is
recorded in reinsurance balances payable in the Consolidated Balance Sheets.
Interest cost on these contracts is credited during all periods in which a
funds withheld liability exists. Interest cost, which is included in other net
investment income, was $344.0, $239.0 and $241.0 million in 2003, 2002 and
2001. The amount subject to interest crediting rates on such contracts was
$2,789.0 and $2,766.0 million at December 31, 2003 and 2002. Certain funds
withheld reinsurance contracts, including the corporate aggregate reinsurance
treaties, require interest on additional premiums arising from ceded losses as
if those premiums were payable at the inception of the contract. The amount of
retroactive interest, included in the totals above, was $147.0, $10.0 and
$47.0 million in 2003, 2002 and 2001.
The amount subject to interest crediting on these funds withheld contracts
will vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. CNA expects that it will continue
to incur significant interest costs on these contracts for several years.
The ceding of insurance does not discharge the primary liability of CNA.
Therefore, a credit exposure exists with respect to property and casualty and
life reinsurance ceded to the extent that any reinsurer is unable to meet the
obligations or to the extent that the reinsurer disputes the liabilities
assumed under reinsurance agreements.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The allowance for doubtful
accounts was $572.6 and $195.7 million at December 31, 2003 and 2002. The
reserve increased by $377.0 million during 2003 in recognition of
deterioration of the financial strength ratings of several reinsurers,
including Trenwick Group Ltd. and Commercial Risk Reinsurance Company Ltd. In
addition, in the third quarter of 2003, CNA updated its reinsurance bad debt
model based on recently published studies of reinsurer insolvencies. While CNA
believes the allowance for doubtful accounts is adequate based on current
collateral and information currently available at the financial stability of
reinsurers failure of reinsurers to meet their obligations could have a
material adverse impact on the Company's results of operations and/or equity.
CNA attempts to mitigate its credit risk related to reinsurance by entering
into reinsurance arrangements only with reinsurers that have credit ratings
above certain levels and by obtaining substantial amounts of collateral. The
primary methods of obtaining collateral are through reinsurance trusts,
letters of credit and funds withheld balances. Such collateral was
approximately $5,255.0 and $4,754.0 million at December 31, 2003 and 2002. In
certain circumstances, including significant deterioration of a reinsurer's
financial strength ratings, CNA may engage in commutation discussions with
individual reinsurers. The outcome of such discussions may result in a lump
sum settlement that is less than the recorded receivable, net of any
applicable allowance for doubtful accounts. Losses arising from commutations
could have an adverse material impact on the Company's results of operations
or equity.
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 arises from reinsurance receivables from Gerling Global
("Gerling").
41
In 2003, CNA commuted all remaining ceded and assumed reinsurance contracts
with four Gerling entities. The commutations resulted in a pretax loss of
$109.0 million, which was net of a previously established allowance for
doubtful accounts of $47.0 million. CNA has no further exposure to the Gerling
companies that are in run-off. CNA estimates that these commutations will
reduce pretax interest expense related to these treaties by approximately
$11.0 million in 2004.
Amounts receivable from reinsurers were $16,254.0 and $12,696.0 million at
December 31, 2003 and 2002. Of these amounts, $813.0 and $957.0 million were
billed to reinsurers as of December 31, 2003 and 2002, as reinsurance
contracts generally require payment of claims by the ceding company before the
amount can be billed to the reinsurer. The remaining receivable relates to the
estimated case and incurred but not reported ("IBNR") reserves and future
reserves and future policyholder benefits ceded under reinsurance contracts.
CNA's largest recoverables from a single reinsurer at December 31, 2003,
including prepaid reinsurance premiums, were approximately $2,533.0, $2,033.0,
$1,172.0, $977.0, $760.0 and $629.0 million from subsidiaries of The Allstate
Corporation ("Allstate"), subsidiaries of Hannover Reinsurance ("Ireland")
Ltd., Hartford Life Group Insurance Company, American Reinsurance Company,
European Reinsurance Company of Zurich and subsidiaries of the Berkshire
Hathaway Group.
For 2002, CNA entered into a corporate aggregate reinsurance treaty covering
substantially all of CNA's property and casualty lines of business (the "2002
Cover"). Ceded premium related to the reinsurer's margin of $10.0 million was
recorded in 2002. No losses were ceded during 2002 under this contract, and
the 2002 Cover was commuted as of December 31, 2002.
CNA has an aggregate reinsurance treaty related to the 1999 through 2001
accident years that covers substantially all of CNA's property and casualty
lines of business (the "Aggregate Cover"). The Aggregate Cover provides for
two sections of coverage. These coverages attach at defined loss ratios for
each accident year. Coverage under the first section of the Aggregate Cover,
which is available for all accident years covered by the treaty, has a $500.0
million limit per accident year of ceded losses and an aggregate limit of $1.0
billion of ceded losses for the three accident years. The ceded premiums
associated with the first section are a percentage of ceded losses and for
each $500.0 million of limit the ceded premium is $230.0 million. The second
section of the Aggregate Cover, which only relates to accident year 2001,
provides additional coverage of up to $510.0 million of ceded losses for a
maximum ceded premium of $310.0 million. Under the Aggregate Cover, interest
charges on the funds withheld liability accrue at 8.0% per annum. The
aggregate loss ratio for the three-year period has exceeded certain thresholds
which requires additional premiums to be paid and an increase in the rate at
which interest charges are accrued. This rate will increase to 8.25% per annum
commencing in 2006.
During 2003, as a result of the unfavorable net prior year development
recorded related to accident years 2000 and 2001, the $500.0 million limit
related to the 2000 and 2001 accident years under the first section was fully
utilized and losses of $500.0 million were ceded under the first section of
the Aggregate Cover. In 2001, as a result of reserve additions including those
related to accident year 1999, the $500.0 million limit related to the 1999
accident year under the first section was fully utilized and losses of $510.0
million were ceded under the second section as a result of losses related to
the World Trade Center Disaster and related events ("WTC event"). The
aggregate limits for the Aggregate Cover have been fully utilized.
The impact of the Aggregate Cover was as follows:
Year ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premium $(258.0) $ (543.0)
Ceded claim and claim adjustment expenses 500.0 1,010.0
Interest charges (147.0) $(51.0) (81.0)
- ------------------------------------------------------------------------------------------------
Pretax (expense) benefit $ 95.0 $(51.0) $ 386.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $761.0 million of ceded losses.
42
The ceded premiums are a percentage of ceded losses. The ceded premium related
to full utilization of the $761.0 million of limit is $456.0 million. The CCC
Cover provides continuous coverage in excess of the second section of the
Aggregate Cover discussed above. During 2003, the CCC Cover was fully
utilized. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. If the aggregate
loss ratio would exceed these certain thresholds, then additional interest
charges on funds withheld would be approximately $27.0 million in 2004.
The impact of the CCC Cover was as follows:
Year ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premium $(100.0) $(101.0) $ (260.0)
Ceded claim and claim adjustment expenses 143.0 148.0 470.0
Interest charges (59.0) (37.0) (20.0)
- ------------------------------------------------------------------------------------------------
Pretax (expense) benefit $ (16.0) $ 10.0 $ 190.0
================================================================================================
The impact by operating segment of the Aggregate Cover and the CCC Cover was
as follows:
Years ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 73.0 $ (52.0) $ 381.0
Specialty Lines 6.0 2.0 33.0
CNA Re 2.0 12.0 162.0
- -----------------------------------------------------------------------------------------------
Total Property and Casualty 81.0 (38.0) 576.0
Corporate and Other (2.0) (3.0)
- ------------------------------------------------------------------------------------------------
Pretax impact benefit (expense) $ 79.0 $ (41.0) $ 576.0
================================================================================================
World Trade Center Event
During the third quarter of 2001, CNA recorded estimated incurred losses of
$468.0 million pretax, net of reinsurance, related to the WTC event. The loss
estimate was based on a total industry loss of $50.0 billion and included all
lines of insurance. This estimate took into account CNA's substantial
reinsurance agreements, including its catastrophe reinsurance program and
corporate reinsurance programs. CNA has closely monitored reported losses as
well as the collection of reinsurance on WTC event claims. During both 2003
and 2002, CNA reduced the reserves related to the WTC event in both the
property and casualty and group and life segments. See the segment discussions
of this MD&A for further information. As of December 31, 2003, CNA believes
its recorded reserves, net of reinsurance, for the WTC event are adequate.
43
The WTC event and related items comprising the amounts noted above are
detailed by segment in the following table.
Pretax
Corporate
Aggregate Total Total
Pretax Reinsurance Pretax After-tax
Year ended December 31, 2001 Gross Losses Net Impact* Benefit Impact Impact
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 375.0 $ 185.0 $ 108.0 $ 77.0 $ 44.0
Specialty Lines 214.0 30.0 12.0 18.0 11.0
CNA Re 662.0 410.0 139.0 271.0 154.0
- -----------------------------------------------------------------------------------------------
Total Property and Casualty 1,251.0 625.0 259.0 366.0 209.0
Group Operations 235.0 53.0 53.0 31.0
Life Operations 75.0 22.0 22.0 12.0
Corporate and Other 87.0 27.0 27.0 15.0
- ------------------------------------------------------------------------------------------------
Total $ 1,648.0 $ 727.0 $ 259.0 $468.0 $ 267.0
================================================================================================
*Pretax impact of the WTC event before corporate aggregate reinsurance
treaties. The pretax net impact includes $85.0 million of reinstatement and
additional premiums.
Terrorism Insurance
CNA and the insurance industry incurred substantial losses related to the
WTC event. For the most part, the industry was able to absorb the loss of
capital from these losses, but the capacity to withstand the effect of any
additional terrorism events was significantly diminished.
The Terrorism Risk Insurance Act of 2002 (the "Act") established a program
within the Department of the Treasury under which the federal government will
share the risk of loss by commercial property and casualty insurers arising
from future terrorist attacks. The Act expires on December 31, 2005. Each
participating insurance company must pay a deductible, ranging from 7.0% of
direct earned premiums from commercial insurance lines in 2003 to 15.0% in
2005, before federal government assistance becomes available. For losses in
excess of a company's deductible, the federal government will cover 90.0% of
the excess losses, while companies retain the remaining 10.0%. Losses covered
by the program will be capped annually at $100.0 billion; above this amount,
insurers are not liable for covered losses and Congress is to determine the
procedures for and the source of any payments. Amounts paid by the federal
government under the program over certain phased limits are to be recouped by
the Department of the Treasury through policy surcharges, which cannot exceed
3.0% of annual premium.
CNA is required to participate in the program, but it does not cover life or
health insurance products. State law limitations applying to premiums and
policies for terrorism coverage are not generally affected under the program.
The Act requires insurers to offer terrorism coverage through 2004. 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 through 2005, given the
unpredictability of the nature, targets, severity or frequency of potential
terrorist events, the Company's results of operations or equity could
nevertheless be materially adversely impacted by them. CNA is attempting to
mitigate this exposure through its underwriting practices, policy terms and
conditions (where applicable) and the use of reinsurance. In addition, under
state laws, CNA is generally prohibited from excluding terrorism exposure from
its primary workers compensation, individual life and group life and health
policies. 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 assumed reinsurance arrangements,
beginning with the January 1, 2002 renewal period, either exclude terrorism
coverage or significantly limit the level of coverage.
44
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.
As summarized in the following table, during 2001, CNA incurred $62.0
million pretax, or $35.0 million after tax and minority interest, of
restructuring and other related charges for the IT Plan. During 2002, $4.0
million pretax, or $2.6 million after tax and minority interest, of this
accrual was reduced. No restructuring and other related charges related to the
IT Plan were incurred in 2003.
Employee
Termination Impaired
and Related Asset Other
Benefit Costs Charges Costs Total
- -----------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 5.0 $ 1.0 $ 6.0
Specialty Lines 2.0 2.0
- ------------------------------------------------------------------------------------------------
Total Property and Casualty 7.0 1.0 8.0
Life Operations 17.0 17.0
Other Insurance 22.0 14.0 $ 1.0 37.0
- ------------------------------------------------------------------------------------------------
Total $ 29.0 $ 32.0 $ 1.0 $ 62.0
================================================================================================
In connection with the IT Plan, after the write-off of impaired assets, CNA
accrued $30.0 million of restructuring and other related charges in 2001 (the
"IT Plan Initial Accrual"). These charges primarily related to $29.0 million
of workforce reductions of approximately 260 positions gross and net and $1.0
million of other costs.
The following table summarizes the IT Plan Initial Accrual and the activity
in that accrual during 2001, 2002 and 2003.
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 (2.0) (2.0)
- ------------------------------------------------------------------------------------------------
Accrued costs at December 31, 2003 $ 3.0 $ 3.0
================================================================================================
45
The remaining 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.
As summarized in the following table, during 2001, CNA incurred $189.0
million pretax, or $109.4 million after tax and minority interest, of
restructuring and other related charges for the 2001 Plan. During 2002, $32.0
million pretax, or $18.4 million after tax and minority interest, of this
accrual was reduced. No restructuring and other related charges related to the
2001 Plan were incurred in 2003.
Employee
Termination Lease Impaired
and Related Termination Asset Other
Benefit Costs Costs Charges Costs Total
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines $ 40.0 $ 40.0
Specialty Lines 7.0 7.0
CNA Re 2.0 $ 4.0 6.0
- ------------------------------------------------------------------------------------------------
Total Property and Casualty 49.0 4.0 53.0
Group Operations 7.0 $ 35.0 42.0
Life Operations 3.0 $ 9.0 12.0
Corporate and Other 9.0 52.0 21.0 82.0
- ------------------------------------------------------------------------------------------------
Total $ 68.0 $ 56.0 $ 30.0 $ 35.0 $ 189.0
================================================================================================
All lease termination costs and impaired asset charges, except lease
termination costs incurred by operations in the United Kingdom and software
write-offs incurred by Life Operations, were charged to the Corporate and
Other segment because office closure and consolidation decisions were not
within the control of the other segments affected. Lease termination costs
incurred in the United Kingdom relate solely to the operations of CNA Re. All
other charges were recorded in the segment benefiting from the services or
existence of an employee or an asset.
In connection with the 2001 Plan, CNA accrued $189.0 million of these
restructuring and other related charges (the "2001 Plan Initial Accrual").
These charges include employee termination and related benefit costs, lease
termination costs, impaired asset charges and other costs.
46
The following table summarizes the 2001 Plan Initial Accrual and the
activity in that accrual during 2001, 2002 and 2003 by type of restructuring
cost.
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 December 31, 2001 66.0 56.0 30.0 152.0
Costs that did not require cash (1.0) (3.0) (9.0) (13.0)
Payments charged against liability (53.0) (12.0) (4.0) (69.0)
Reduction of accrual (10.0) (7.0) (15.0) (32.0)
- ------------------------------------------------------------------------------------------------
Accrued costs December 31, 2002 2.0 34.0 2.0 38.0
Costs that did not require cash (1.0) (1.0)
Payments charged against liability (2.0) (15.0) (17.0)
- -----------------------------------------------------------------------------------------------
Accrued costs December 31, 2003 $ 19.0 $ 1.0 $ 20.0
================================================================================================
Non-GAAP Financial Measures
This MD&A discusses certain GAAP and non-GAAP financial measures to provide
information used by management to monitor CNA's operating performance.
Management utilizes various financial measures to monitor CNA's insurance
operations and investment portfolio. Underwriting results, which are derived
from certain income statement amounts, are considered non-GAAP financial
measures and are used by management to monitor performance of CNA's insurance
operations. CNA's investment portfolio is monitored through analysis of
various quantitative and qualitative factors and certain decisions are made
related to the sale or impairment of investments that will produce realized
gains and losses. Net realized investment gains and losses, which are
comprised of after tax realized investment gains and losses net of
participating policyholders' and minority interests are a non-GAAP financial
measure.
Underwriting results are computed as net earned premiums less net incurred
claims and the cost incurred to settle these claims, acquisition expenses,
underwriting expenses and dividend expenses. Management uses underwriting
results and operating ratios to monitor its insurance operations' results
without the impact of certain factors, including investment income, other
revenues, other expenses, minority interest, income tax benefit (expense) and
net realized investment gains or losses. Management excludes these factors in
order to analyze the direct relationship between the net earned premiums and
the related claims and the cost incurred to settle these claims, acquisition
expenses, underwriting expenses and dividend expenses.
Management excludes after tax net realized investment gains or losses when
analyzing the insurance operations because net realized investment gains or
losses related to CNA's available-for-sale investment portfolio are largely
discretionary, except for losses related to other-than-temporary impairments,
and are generally driven by economic factors that are not necessarily
consistent with key drivers of underwriting performance.
Operating ratios are calculated using insurance results and are used by the
insurance industry and regulators such as state departments of insurance and
the National Association of Insurance Commissioners ("NAIC") for financial
regulation and as a basis of comparison among companies. The ratios discussed
in this MD&A are calculated using GAAP financial results and include the loss
and loss adjustment expense ratio ("loss ratio") as well as the expense,
dividend and combined ratios. The loss ratio is the percentage of net incurred
claim and claim adjustment expenses to net earned premiums. The expense ratio
is the percentage of underwriting and acquisition expenses, including the
amortization of deferred acquisition costs, to net earned premiums. The
dividend ratio is the ratio of dividends incurred to net earned premiums. The
combined ratio is the sum of the loss, expense and dividend ratios.
CNA's investment portfolio is monitored by management through analyses of
various factors including unrealized gains and losses on securities, portfolio
duration and exposure to interest rate, market and credit risk. Based on such
47
analyses, CNA may impair an investment security in accordance with its policy,
or sell a security. Such activities will produce realized gains and losses.
While management uses various non-GAAP financial measures to monitor various
aspects of CNA's performance, relying on any measure other than net income,
which is the most directly comparable GAAP measure to underwriting results and
realized gains and losses, is not a complete representation of financial
performance. Management believes that its process of evaluating performance
through the use of these non-GAAP financial measures provides a basis for
understanding the operations and the impact to net income as a whole.
Management also believes that investors find these non-GAAP financial measures
described above useful to help interpret the underlying trends and
performance, as well as to provide visibility into the significant components
of net income.
Throughout this MD&A, business segment results are discussed using
Underwriting Results, which as described above is a non-GAAP measure. The
following reconciliation provides the differences between Underwriting Loss
and Net (Loss) Income.
Year Ended December 31, 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Underwriting loss $ (2,540.0) $(439.0) $ (3,053.0)
Net investment income 695.0 795.0 974.0
Other revenues 321.0 471.0 468.0
Other expenses (293.0) (394.0) (467.0)
- ------------------------------------------------------------------------------------------------
(Loss) income, before income tax benefit
(expense), minority interest and net
realized investment gains (losses) (1,817.0) 433.0 (2,078.0)
Income tax benefit (expense) 717.0 (117.0) 697.0
Minority interest 116.2 (57.6) 156.2
- ------------------------------------------------------------------------------------------------
Operating (loss) income (983.8) 258.4 (1,224.8)
Realized investment gains (losses), net
of participating policyholders' and
minority interest 519.2 (77.5) 812.0
Income tax (expense) benefit on realized
investment gains (losses) (191.6) 45.2 (302.9)
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (656.2) $ 226.1 $ (715.7)
================================================================================================
Property and Casualty
In 2003, CNA conducted 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.
48
The following table summarizes key components of the property and casualty
segment operating results for the years ended December 31, 2003, 2002 and
2001.
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions, except%)
Net written premiums $ 7,089.0 $7,008.0 $ 5,459.0
Net earned premiums 6,945.0 6,838.0 5,010.0
Underwriting loss (2,540.0) (439.0) (3,053.0)
Investment income, net 695.0 795.0 974.0
Net (loss) income (656.2) 226.1 (715.7)
Ratios:
Loss and loss adjustment expense 95.1% 74.2% 113.3%
Expense 40.9 31.1 45.3
Dividend 1.6 1.1 2.3
- ------------------------------------------------------------------------------------------------
Combined 137.6% 106.4% 160.9%
================================================================================================
2003 Compared with 2002
Net written premiums for the property and casualty segment increased $81.0
million and net earned premiums increased $107.0 million in 2003 as compared
with 2002. These increases were due primarily to rate increases and increased
new business, primarily in Standard and Specialty Lines, offset by increased
ceded premiums, including premiums ceded to corporate aggregate and other
reinsurance treaties, as a result of unfavorable prior year development
recorded in 2003.
Standard Lines averaged rate increases of 16.0%, 27.0% and 17.0% in 2003,
2002 and 2001 for the contracts that renewed during those periods. Retention
rates of 72.0%, 68.0% and 76.0% were achieved for those contracts that were up
for renewal.
Specialty Lines averaged rate increases of 24.0%, 26.0% and 13.0% in 2003,
2002 and 2001 for the contracts that renewed during these years. Retention
rates of 79.0%, 76.0% and 78.0% were achieved for those contracts that were up
for renewal.
Net results decreased $882.3 million in 2003 as compared with 2002. The
decline in net results was due primarily to increased unfavorable net prior
year development of $1,139.7 million after tax and minority interest ($1,944.0
million pretax), a $49.6 million ($84.0 million pretax) increase in
catastrophe losses, a $220.9 million ($378.0 million pretax) increase in the
bad debt provision for insurance and reinsurance receivables, and a $53.2
million ($89.0 million pretax) increase in insurance related assessments. Net
results also include an $18.9 million ($33.0 million pretax) increase in
unallocated loss adjustment expense ("ULAE") reserves, increased dividend
development of $24.3 million ($42.0 million pretax), and, increased interest
expense of $81.1 million ($137.0 million pretax) related to additional
cessions to the corporate aggregate and other reinsurance treaties. These
items were partially offset by a $360.6 million increase in net realized
investment results, including increased limited partnership income, and
improved current accident year results.
The combined ratio increased 31.5 points and underwriting results decreased
$2,101.0 million in 2003 as compared with 2002. The loss ratio increased 21.2
points due principally to increased unfavorable net prior year development, as
discussed below, and $143.0 million of catastrophe losses, primarily related
to Hurricanes Isabel and Claudette, Texas tornados, and Midwest rain storms in
2003. Catastrophe losses were $59.0 million in 2002. Partially offsetting
these declines were improvements in the current net accident year loss ratio.
Unfavorable net prior year development of $1,970.0 million, including
$1,421.0 million of unfavorable claim and allocated claim adjustment expense
reserve development and $549.0 million of unfavorable premium development, was
recorded in 2003. Unfavorable net prior year reserve development of $26.0
million, including $67.0 million of favorable claim and allocated claim
adjustment expense reserve development and $93.0 million of unfavorable
premium development, was recorded for in 2002. The gross carried claim and
claim adjustment expense reserve was $21,741.0
49
and $16,205.0 million at December 31, 2003 and December 31, 2002. The net
carried claim and claim adjustment expense reserve was $16,828.0 and $11,997.0
million at December 31, 2003 and 2002.
Approximately $495.0 million of unfavorable claim and allocated claim
adjustment expense reserve development was recorded related to construction
defect claims in 2003. Based on analyses completed during the third quarter of
2003, it became apparent that the assumptions regarding the number of claims,
which were used to estimate the expected losses, were no longer appropriate.
The analyses indicated that the number of claims reported was higher than
expected primarily in Texas, Arizona, Nevada, Washington and Colorado. The
number of claims reported in states other than California during the first six
months of 2003 was almost 35.0% higher than the last six months of 2002. The
number of claims reported during the last six months of 2002 increased by less
than 10.0% from the first six months of 2002. In California, claims resulting
from additional insured endorsements increased throughout 2003. Additional
insured endorsements are regularly included on policies provided to
subcontractors. The additional insured endorsement names general contractors
and developers as additional insureds covered by the policy. Current
California case law (Presley Homes, Inc. v. American States Insurance Company,
(June 11, 2001) 90 Cal App. 4th 571, 108 Cal. Rptr. 2d 686) specifies that an
individual subcontractor with an additional insured obligation has a duty to
defend the additional insured in the entire action, subject to contribution or
recovery later. In addition, the additional insured is allowed to choose one
specific carrier to defend the entire action. These additional insured claims
can remain open for a longer period of time than other construction defect
claims because the additional insured defense obligation can continue until
the entire case is resolved. The unfavorable net prior year development
recorded related to construction defect claims was primarily related to
accident years 1999 and prior.
Unfavorable net prior year development of approximately $595.0 million,
including $518.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $77.0 million of unfavorable premium
development, was recorded for large account business including workers
compensation coverages in 2003. Many of the policies issued to these large
accounts include provisions tailored specifically to the individual accounts.
Such provisions effectively result in the insured being responsible for a
portion of the loss. An example of such a provision is a deductible
arrangement where the insured reimburses CNA for all amounts less than a
specified dollar amount. These arrangements often limit the aggregate amount
the insured is required to reimburse CNA. Analyses indicated that the
provisions that result in the insured being responsible for a portion of the
losses would have less of an impact due to the larger size of claims as well
as the increased number of claims. The net prior year development recorded was
primarily related to accident years 2000 and prior.
Approximately $98.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded in 2003
resulted from a program covering facilities that provide services to
developmentally disabled individuals. This net prior year development was due
to an increase in the size of known claims and increases in policyholder
defense costs. Recent data shows the average claim increasing at an annual
rate of approximately 20.0%. Prior data had shown average claim size to be
level. Similar to the average claim size, recent data shows the average
policyholder defense cost increasing at an annual rate of approximately 20.0%.
Prior data had shown average policyholder defense cost to be level. The net
prior year development recorded was primarily for accident years 2001 and
prior.
Approximately $40.0 million of unfavorable net prior year claim and
allocated claim adjustment expense development recorded in 2003 was for excess
workers compensation coverages due to increasing severity. The increase in
severity means that a higher percentage of the total loss dollars will be
CNA's responsibility since more claims will exceed the point at which CNA's
coverage begins. The reserve net prior year development recorded was primarily
for accident year 2000.
Approximately $73.0 million of unfavorable development recorded in 2003 was
the result of a commutation of all ceded reinsurance treaties with Gerling
Global Group of companies ("Gerling"), related to accident years 1999 through
2001, including $41.0 million of unfavorable claim and allocated claim
adjustment expense development and $32.0 million of unfavorable premium
development. Further information regarding this commutation is provided in the
Reinsurance section of the MD&A.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $40.0 million recorded in 2003 was
related to a program covering tow truck and ambulance operators, primarily
impacting the 2001 accident year. CNA had previously expected that loss ratios
for this business would be similar to its middle market commercial automobile
liability business. During 2002, CNA ceased writing business under this
program.
50
Approximately $25.0 million of unfavorable net prior year premium
development recorded in 2003 was related to a reevaluation of losses ceded to
a reinsurance contract covering middle market workers compensation exposures.
The reevaluation of losses led to a new estimate of the number and dollar
amount of claims that would be ceded under the reinsurance contract. As a
result of the reevaluation of losses, CNA recorded approximately $36.0 million
of unfavorable claim and allocated claim adjustment expense reserve
development, which was ceded under the contract. The net prior year
development was recorded for accident year 2000.
The following premium and claim and allocated claim adjustment expense
development was recorded in 2003 as a result of the elimination of
deficiencies and redundancies in reserve positions within the segment:
Unfavorable net prior year development of approximately $210.0 million related
to small and middle market workers compensation exposures and approximately
$110.0 million related to E&S lines was recorded in 2003. Offsetting these
increases was $210.0 million of favorable net prior year development in the
property line of business, including $79.0 million related to the WTC event.
Also, offsetting the unfavorable premium and claim and allocated claim
adjustment expense development was a $216.0 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties recorded in 2003. The
benefit is comprised of $485.0 million of ceded losses and $269.0 million of
ceded premiums for accident years 2000 and 2001.
Approximately $50.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded in 2003 was
related to increased severity in excess coverages provided to facilities
providing health care services. The increase in reserves is based on reviews
of individual accounts where claims had been expected to be less than the
point at which CNA's coverage applies. The current claim trends indicate that
the layers of coverage provided by CNA will be impacted. The reserve net prior
year development recorded was primarily for accident years 2001 and prior.
Approximately $68.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded in 2003 was
for surety coverages primarily related to workers compensation bond exposure
from accident years 1990 and prior and large losses for accident years 1999
and 2002. Approximately $21.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded in the
surety line of business in 2003 as the result of recent developments on one
large claim. Approximately $86.0 million of unfavorable net prior year claim
and allocated claim adjustment expense reserve development recorded in 2003
was related to directors and officers exposures in CNA Pro and Global Lines.
The unfavorable net prior year development was primarily due to securities
class action cases related to certain known corporate malfeasance cases and
investment banking firms. This net prior year development recorded was
primarily for accident years 2000 through 2002.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $75.0 million recorded in 2003 was
related to an adverse arbitration decision in 2003 involving a single large
property and business interruption loss. The decision was rendered against a
voluntary insurance pool in which CNA was a participant. The loss was caused
by a fire which occurred in 1995. CNA no longer participates in this pool.
Approximately $84.0 million of losses were recorded during 2003 as the
result of a commutation of ceded reinsurance treaties with Gerling, relating
to accident years 1999 through 2002. Further information regarding this
commutation is provided in the Reinsurance section of this MD&A. The following
net prior year development was recorded in 2003 as a result of the elimination
of deficiencies and redundancies in reserve positions within the segment. An
additional $50.0 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded related to medical
malpractice and long term care facilities. Partially offsetting this
unfavorable claim and allocated claim adjustment expense reserve development
was a $25.0 million underwriting benefit from cessions to corporate aggregate
reinsurance treaties. The benefit was comprised of $56.0 million of ceded
losses and $31.0 million of ceded premiums for accident years 2000 and 2001.
The unfavorable net prior year development for 2003 was primarily a result
of a general change in the pattern of how losses change over time as reported
by the companies that purchased reinsurance from CNA Re. Losses have continued
to show large increases for accident years in the late 1990s and into 2000 and
2001. These increases are greater than the increases indicated by patterns
from older accident years and have a similar effect on several lines of
business. Approximately $67.0 million unfavorable net prior year development
recorded in 2003 was related to proportional
51
liability exposures, primarily from multi-line and umbrella treaties in
accident years 1997 through 2001. Approximately $32.0 million of unfavorable
net prior year development recorded in 2003, was related to assumed financial
reinsurance for accident years 2001 and prior and approximately $24.0 million
of unfavorable net prior year development related to professional liability
exposures in accident years 2001 and prior.
CNA Re recorded an additional $15.0 million of unfavorable net prior year
development for construction defect related exposures. Because of the unique
nature of this exposure, losses have not followed expected development
patterns. The continued reporting of claims in California, the increase in the
number of claims from states other than California and a review of individual
ceding companies' exposure to this type of claim resulted in an increase in
the estimated reserve. Unfavorable net prior year claim and allocated claim
adjustment expense reserve development of approximately $25.0 million was
recorded primarily for directors and officers exposures. The unfavorable net
prior year development was a result of a claims review that was completed
during the second quarter of 2003. The unfavorable net prior year reserve
development was primarily due to securities class action cases related to
certain known corporate malfeasance cases and investment banking firms. The
unfavorable net prior year development recorded was for accident years 2000
and 2001.
The following premium and claim and allocated claim adjustment expense
development, was recorded in 2003 as a result of the elimination of
deficiencies and redundancies in the reserve positions of individual products
within the segment: Unfavorable net prior year premium and claim and allocated
claim adjustment expense development of approximately $42.0 million related to
Surety exposures, $32.0 million related to excess of loss liability exposures
and $12.0 million related to facultative liability exposures were recorded in
the third quarter of 2003.
Offsetting this unfavorable net prior year development was approximately
$55.0 million of favorable development related to the WTC event as well as a
$45.0 million underwriting benefit from cessions to corporate aggregate
reinsurance treaties recorded in 2003. The benefit from cessions to the
corporate aggregate reinsurance treaties was comprised of $102.0 million of
ceded losses and $57.0 million of ceded premiums for accident years 2000 and
2001. See the Reinsurance section of the MD&A for further discussion of CNA's
aggregate reinsurance treaties.
The following discusses net prior year development recorded in 2002.
Approximately $140.0 million of favorable prior year reserve development was
attributable to participation in the Workers Compensation Reinsurance Bureau
("WCRB"), a reinsurance pool, and residual markets. The favorable prior year
reserve development for WCRB was the result of information received from the
WCRB that reported the results of a recent actuarial review. This information
indicated that CNA's net required reserves for accident years 1970 through
1996 were $60.0 million less than the carried reserves. In addition, during
2002, CNA commuted accident years 1965 through 1969 for a payment of
approximately $5.0 million to cover carried reserves of approximately $13.0
million, resulting in further favorable net prior year claim and allocated
claim adjustment expense development of $8.0 million. The favorable residual
market net prior year development was the result of lower than expected paid
loss activity during recent periods for accident years dating back to 1984.
The paid losses during 2002 on prior accident years were approximately 60.0%
of the previously expected amount.
In addition, Standard Lines had favorable net prior year development,
primarily in the package liability and auto liability lines of business due to
new claims initiatives. These new claims initiatives, which included
specialized training on specific areas of the claims adjudication process,
enhanced claims litigation management, enhanced adjuster-level metrics to
monitor performance and more focused metric-based claim file review and
oversight, are expected to produce significant reductions in ultimate claim
costs. Based on management's best estimate of the reduction in ultimate claim
costs, approximately $100.0 million of favorable net prior year development
was recorded in 2002. Approximately one-half of this favorable development was
recorded in accident years prior to 1999, with the remainder of the favorable
reserve development recorded in accident years 1999 to 2001. Approximately
$50.0 million of favorable net prior year development during 2002 was recorded
in commercial automobile liability. Most of the favorable development was from
accident year 2000. An actuarial review completed during 2002 showed that
underwriting actions have resulted in reducing the number of commercial
automobile liability claims for recent accident years, especially the number
of large losses.
Approximately $45.0 million of favorable net prior year development was
recorded in property lines during 2002. The favorable net prior year
development was principally from accident years 1999 through 2001, and was the
result of the low number of large losses in recent years. Although property
claims are generally reported relatively quickly,
52
determining the ultimate cost of the claim can involve a significant amount of
time between the occurrence of the claim and settlement.
Offsetting these favorable net prior year reserve developments were
approximately $100.0 million of unfavorable premium development in middle
market workers compensation, approximately $70.0 million of unfavorable net
prior year claim and allocated claim adjustment expense development in
programs written in CNA E&S, approximately $30.0 million of unfavorable
reserve development on a contractors account package policy program and
approximately $20.0 million of unfavorable net prior year claim and allocated
claim adjustment expense development on middle market general liability
coverages.
A CNA E&S program, covering facilities that provide services to
developmentally disabled individuals, accounts for approximately $50.0 million
of the unfavorable net prior year development. The net prior year development
is due to an increase in the size of known claims and increases in
policyholder defense costs. These increases became apparent as the result of
an actuarial review completed during 2002, with most of the development from
accident years 1999 and 2000. The other program, which contributed to the CNA
E&S development, covers tow truck and ambulance operators in the 2000 and 2001
accident years. This program was started in 1999. CNA expected that loss
ratios for this business would be similar to its middle market commercial
automobile liability business. Reviews completed during 2002 resulted in
estimated loss ratios on the tow truck and ambulance business that are 25
points higher than the middle market commercial automobile liability loss
ratios.
The unfavorable net prior year premium development on contractors account
package policies was the result of a review completed during 2002. Since this
program is no longer being written, CNA expected that the change in reported
losses would decrease each quarterly period. However, in recent quarterly
periods, the change in reported losses has been higher than prior quarters,
resulting in the unfavorable reserve development.
Unfavorable net prior year reserve development of approximately $180.0
million was recorded for CNA HealthPro in 2002 and was driven principally by
medical malpractice excess products provided to hospitals and physicians and
coverages provided to long term care facilities, principally national for-
profit nursing homes. Approximately $100 million of the prior year unfavorable
reserve development was related to assumed excess products and loss portfolio
transfers, and was primarily driven by unexpected increases in the number of
excess claims in accident years 1999 and 2000. The percentage of total claims
greater than $1.0 million has increased by 33.0%, from less than 3.0% of all
claims to more than 4.0% of all claims. CNA HealthPro no longer writes assumed
excess products and loss portfolio transfers.
Approximately $50.0 million of the unfavorable net prior year development
was related to long term care facilities. The unfavorable net prior year
development was principally recorded for accident years 1997 through 2000. The
average value of claims closed during the first several months of 2002
increased by more than 50.0% when compared to claims closed during 2001. In
response to those trends, CNA HealthPro has reduced its writings of national
for-profit nursing home chains. Excess products provided to healthcare
institutions and physician coverages in a limited number of states were
responsible for the remaining development in CNA HealthPro. The unfavorable
net prior year development on excess products provided to institutions for
accident years 1996 through 1999 resulted from increases in the size of claims
experienced by these institutions. Due to the increase in the size of claims,
more claims were exceeding the point at which these excess products apply. The
unfavorable net prior year development on physician coverages was recorded for
accident years 1999 through 2001 in Oregon, California, Arizona and Nevada.
The average claim size in these states has increased by 20.0%, driving the
change in losses.
The marine business recorded unfavorable net prior year development of
approximately $65.0 million during 2002. Approximately $50.0 million of this
unfavorable net prior year development was due to participation in voluntary
pools. About half of the reserve development was recorded in accident years
1999 and 2000 with the remainder attributable to accident years prior to 1999.
The reserves were based on recommendations provided by the pools.
Participation in many of these pools has been discontinued. The remaining net
prior year development for the Marine business was due principally to
unfavorable reserve development on hull and liability coverages from accident
years 1999 and 2000 offset by favorable reserve development on cargo coverages
recorded for accident year 2001. Reviews completed during 2002 showed
additional reported losses on individual large accounts and other bluewater
business that drove the unfavorable hull and liability development.
53
Offsetting this unfavorable net prior year development was favorable net
prior year development in CNA Pro and for Enron related exposures. Programs
providing professional liability coverage to accountants, lawyers and realtors
primarily drove favorable net prior year reserve development of approximately
$110.0 million in CNA Pro. Reviews of this business completed during 2002
showed little activity for older accident years (principally prior to 1999),
which reduced the need for reserves on these years. The reported losses on
these programs for accident years prior to 1999 increased by approximately
$5.0 million during 2002. This increase compared to the total reserve at the
beginning of 2002 of approximately $180.0 million, net of reinsurance.
Additionally, favorable net prior year development of $20.0 million was
associated with the Enron settlement. CNA had established a $20.0 million
reserve for accident year 2001 for an excess layer associated with Enron
related surety losses; however the case was settled for less than the
attachment point of this excess layer.
Favorable net prior year development of $11.7 million after tax and minority
interest ($20.0 million pretax) was recorded in 2002 in relation to the Enron
exposures previously recorded as a charge of $27.0 million ($46.0 million
pretax) related to the bankruptcy filing of certain Enron entities in 2001.
These 2001 charges consisted of $15.3 million ($26.0 million pretax) of losses
in connection with surety exposures, including advance payment obligations
bonds and $11.7 million ($20.0 million pretax) of other operating expenses in
connection with collateralized debt obligations, a credit enhancement product.
The unfavorable net prior year development recorded in 2002 was the result
of an actuarial review completed during 2002 and was primarily recorded in the
directors and officers, professional liability errors and omissions, and
surety lines of business. Several large losses, as well as continued increases
in the overall average size of claims for these lines, have resulted in higher
than expected loss ratios.
During 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.
Approximately $95.0 million of CNA Re's net WTC loss estimate was attributable
to CNA Re U.K., which was sold in 2002. See the Reinsurance section of the
MD&A for further discussion of CNA's aggregate reinsurance treaties.
The expense ratio increased 9.8 points due to increased expenses and
decreased net earned premiums in 2003 as compared with 2002. Acquisition
expenses were unfavorably impacted by an increase in the bad debt expense
reserve for reinsurance receivables of $136.0 million. Based on CNA's credit
exposures to reinsurance receivables, an increase in the bad debt reserve was
deemed appropriate. CNA also recorded a $242.0 million increase in the bad
debt reserve for insurance receivables. The increase in the bad debt provision
for insurance receivables was primarily the result of a review of Professional
Employer Organization ("PEO") accounts as well as certain accounts that have
been turned over to third parties for collection. During 2002, Standard Lines
ceased writing coverages for PEO businesses, with the last contracts expiring
on June 30, 2003. The review analyzed losses and the related receivable
including the associated collateral held by CNA. Upon completion of the
review, it was determined that the ultimate loss estimates were larger than
previously expected, which increased the amount of uncollateralized
receivables. Based on these factors, an increase in the provision was
recorded.
Additionally, acquisition expenses increased as a result of an increase in
the accrual for certain insurance related assessments of $58.0 million which
were recorded in 2003. In addition, a $31.0 million reduction in the accrual
for certain insurance-related assessments resulting from changes in the basis
on which the assessments were calculated was recorded in 2002. Also increasing
the expense ratio was approximately $58.0 million of expenses related to
eBusiness in 2003. The 2002 eBusiness expenses were included in the Other
segment.
The dividend ratio increased 0.5 points in 2003 as compared with 2002 due to
increased net prior year unfavorable dividend development. An increase in
unfavorable dividend development of $42.0 million was primarily related to
workers compensation products. A review was completed in the third quarter
indicating paid dividend development that was higher than prior expectations.
This development was recorded for accident years 2002 and prior.
54
2002 Compared with 2001
Net written premiums for the Property and Casualty Segment increased
$1,549.0 million and net earned premiums increased $1,828.0 million for 2002
compared with 2001. These increases were primarily due to decreased ceded
premiums related to corporate aggregate and other reinsurance treaties, strong
rate increases, and increased new business across the Property and Casualty
Segments. The additional ceded premiums in 2001 related to corporate aggregate
and other reinsurance treaties was recorded for the unfavorable net prior year
development in 2001 and WTC Event.
Net results increased $941.8 million in 2002 as compared with 2001. The
increase in net results was due primarily to decreased unfavorable net prior
year development of $1,198.1 million after tax and minority interest ($2,061.0
million pretax) and a reduction of the accrual for restructuring and other
related charges.
In addition, net results in 2001 were adversely impacted by $44.7 million
after tax and minority interest losses related to the WTC event and $26.8
million after tax and minority interest for restructuring and other related
charges. Partially offsetting these improvements in 2002 net results was
decreased net investment results.
The combined ratio decreased 54.8 points and underwriting results increased
$2,614.0 million in 2002 as compared with 2001. The loss ratio decreased 39.4
points due principally to decreased unfavorable net prior year development and
improved current accident year ratios, as discussed below.
The discussion of the net prior year development recorded in 2002 was
included in the "2003 compared with 2002" section above.
Approximately $230.0 million of the unfavorable net prior year claim and
allocated claim adjustment expense development recorded in 2001 was a result
of several coverages provided to commercial entities. Reserve analyses
performed during 2001 showed unexpected increases in the size of claims for
several lines, including commercial automobile liability, general liability
and the liability portion of commercial multiple-peril coverages. In addition,
the number of commercial automobile liability claims was higher than expected
and several state-specific factors resulted in higher than anticipated losses,
including developments associated with commercial automobile liability
coverage in Ohio and general liability coverage provided to contractors in New
York. The unfavorable net prior year development was driven principally by
accident years 1997 through 2000. The remaining unfavorable net prior year
development affecting years prior to 1997 was driven principally by
construction defect claims as described below. The commercial automobile
liability analysis indicated increased ultimate claim and claim adjustment
expense across several accident years due to higher paid and reported claim
and claim adjustment expense resulting from several factors. These factors
include uninsured/underinsured motorists coverage in Ohio, a change in the
rate at which the average claim size was increasing and a lack of improvement
in the ratio of the number of claims per exposure unit, the frequency. First,
Ohio courts had significantly broadened the population covered through the
uninsured/underinsured motorists' coverage. The broadening of the population
covered by this portion of the policy, and the retrospective nature of this
broadening of coverage, resulted in additional claims for older years. Second,
in recent years, the average claim size had been increasing at less than a
2.0% annual rate. The available data indicated that the rate of increase was
closer to 8.0% with only a portion of this increase explainable by a change in
mix of business. Finally, the review completed during 2001 indicated that the
frequency for the 2000 accident year was 6.0% higher than 1999. Expectations
were that the 2000 frequency would show an improvement from the 1999 level.
The analyses of general liability and the liability portion of commercial
multiple-peril coverages showed several factors affecting these lines.
Construction defect claims in California and a limited number of other states
have had a significant impact. It was expected that the number of claims being
reported and the average size of those claims would fall quickly due to the
decrease in business exposed to those losses. However, the number of claims
reported during the first six months of 2001 increased from the number of
claims reported during the last six months of 2000. In addition to the effects
of construction defect claims, the average claim associated with New York
labor law has risen to more than $125,000 from less than $100,000, which was
significantly greater than previously expected.
Concurrent with CNA's review of loss reserves, CNA completed comprehensive
studies of estimated premium receivable accruals on retrospectively rated
insurance policies and involuntary market facilities. These studies included
ground-up reviews of retrospective premium accruals utilizing a more
comprehensive database of retrospectively rated contracts. This review
included application of the policy retrospective rating parameters to the
revised estimate of
55
ultimate loss ratio and consideration of actual interim cash settlement. This
study resulted in a change in the estimated retrospective premiums receivable
balances.
As a result of this review and changes in premiums associated with the
change in estimates for loss reserves, CNA recorded a pretax reduction in
premium accruals of $616.0 million. The studies included the review of all
such retrospectively rated insurance policies and the estimate of ultimate
losses.
Approximately $188.0 million of this amount resulted from a change in
estimate in premiums related to involuntary market facilities, which had an
offsetting impact on net losses and therefore had no impact on the net
operating results. More than one-half of the change in estimate in premiums
was attributable to accident years 1997 through 1999 with the remainder
attributable to accident years prior to 1992. Accruals for ceded premiums
related to reinsurance treaties other than the corporate aggregate reinsurance
treaties increased $83.0 million due to the reserve strengthening. This
increase in accruals for ceded premiums was principally recorded in accident
year 2000. The remainder of the increase in premium accruals relates to the
change in estimate of the amount of retrospective premium receivables as
discussed above, which were principally recorded in accident years prior to
1999.
Approximately $300.0 million of unfavorable net prior year development was
due to adverse experience in all other lines, primarily in coverages provided
to healthcare-related entities written by CNA HealthPro. The level of paid and
reported losses associated with coverages provided to national long term care
facilities were higher than expected. The long term care facility business had
traditionally been limited to local facilities. In recent years, CNA began to
provide coverage to large chains of long term care facilities. Original
assumptions were that these chains would exhibit loss ratios similar to the
local facilities. The most recent review of these large chains indicated an
overall loss ratio in excess of 500%. versus approximately 100% for the
remaining business. In addition, the average size of claims resulting from
coverages provided to physicians and institutions providing healthcare related
services increased more than expected. The review indicated that the average
loss had increased to over $330,000. Prior to this review, the expectation for
the average loss was approximately $250,000. Unfavorable net prior year
development of $240.0 million was recorded for accident years 1997 through
2000. The remaining unfavorable net prior year development was attributable to
accident years prior to 1997. An analysis of assumed reinsurance business
written by CNA Re showed that the paid and reported losses for recent accident
years were higher than expectations, which resulted in management recording
net unfavorable development on prior year loss reserves of approximately
$690.0 million. Because of the long and variable reporting pattern associated
with assumed reinsurance as well as uncertainty regarding possible changes in
the reporting methods of the ceding companies, the carried reserves for
assumed reinsurance were based mainly on the pricing assumptions until
experience emerged to show that the pricing assumptions are no longer valid.
The reviews completed during 2001, including analysis at the individual treaty
level, showed that the pricing assumptions were no longer appropriate. The
classes of business with the most significant changes included excess of loss
liability, professional liability and proportional and retrocessional
property. Approximately $470.0 million of the total unfavorable development
was from accident years 1998 through 2000, and approximately $150.0 million
was from accident years 1996 and 1997. The remaining $70.0 million of
unfavorable net prior year development was attributable to accident years
prior to 1996.
The expense ratio decreased 14.2 points primarily as a result of reduced
underwriting expenses resulting from decreased head count as a result of the
2001 Plan and other expense reduction initiatives and an increase in the net
earned premium base. The dividend ratio decreased 1.2 points due primarily to
favorable current accident year dividends in Standard Lines.
Group
Group Benefits offered group long term care and specialty medical products
and related services. Prior to the sale to Hartford, products had been
marketed through a nationwide operation of 31 sales offices, third-party
administrators, managing general agents and insurance consultants. See Note 14
of the Notes to Consolidated Financial Statements included under Item 8 for
further details of this transaction.
Federal Markets provided health insurance benefits to federal employees,
retirees and their families, insuring nearly one million members under the
National Postal Mail Handlers Union group benefits plan (the "Mail Handlers
Plan"). On July 1, 2002, CNA sold its federal health plan administrator,
Claims Administration Corporation, and transferred the Mail Handlers Plan to
First Health Group. As a result of this transaction, CNA recognized a $7.0
million pretax realized loss on the sale of Claims Administration Corporation
and $15.0 million of pretax non-recurring fee income related to the transfer
of the Mail Handlers Plan.
56
During February of 2004, CNA announced the decision to cease new sales in
its institutional markets business. CNA will continue to accept new deposits
and premiums only from existing customers for the institutional markets and
will service its existing commitments on all businesses in which new sales
were ceased. This business will be managed as a run-off operation. CCC will
provide credit enhancement to CAC for certain of CAC's investment and
specialty medical products.
During 2003, CNA also ceased new sales in its group long term care business.
CNA will continue to service its existing commitments, but new written
premiums will be minimal.
Also within Group Operations is CNA Trust, a limited operations bank located
in Costa Mesa, California, which provides full trustee and pension third-party
administrative services to the under 500-life employer markets. Products
include qualified and non-qualified plans and IRAs.
The variable products business was exited in the fourth quarter of 2001. In
July of 2002, CNA entered into an agreement, whereby The Phoenix Companies,
Inc. acquired the variable life and annuity business of VFL through a
coinsurance arrangement, with modified coinsurance on the separate accounts.
2003 Compared with 2002
Net earned premiums for Group Operations decreased $1,015.0 million in 2003
as compared with 2002. The decrease in net earned premiums was due primarily
to the transfer of the Mail Handlers Plan. The Mail Handlers Plan contributed
net earned premiums of $1,151.0 million in 2002. These premiums were partially
offset by premium growth in the disability, specialty medical, life and
accident and long term care products within Group Benefits due to increased
new sales and rate increases.
Net results decreased by $86.8 million in 2003 as compared with 2002. The
decrease in net results related primarily to increased net realized investment
losses including a loss of $116.4 million after-tax and minority interest
($172.9 million pretax) on the sale of the Group Benefits business, the
absence of net income related to the Mail Handlers Plan, including the non-
recurring fee income received from First Health Group in the third quarter of
2002 and a change in the discount rate on prior year disability and life
waiver of premium reserves from 6.5% to 6.0%, resulting in a $12.6 million
($22.0 million pretax) decrease in net income. The change in discount rate
reflects the decreasing portfolio yield and the current investment
environment. See the Investments section of this MD&A for further discussion
on net investment income and net realized gains (losses). These items were
partially offset by the absence of unfavorable net results related to the
variable products business which was sold to The Phoenix Companies, Inc. in
the third quarter of 2002, improved operating results in the single premium
group annuity product, increased favorable net prior year development related
to a $6.3 million after tax and minority interest release of WTC event
reserves, favorable results in the specialty medical line, and the impact of
premium growth within Group Benefits.
2002 Compared with 2001
Net earned premiums for Group Operations decreased $1,051.0 million for 2002
as compared with 2001. This decline was due primarily to the transfer of the
Mail Handlers Plan partially offset by an increase in premiums in the
disability and long term care products within Group Benefits. Net earned
premiums for the Mail Handlers Plan were $1,151.0 million as compared with
$2,218.0 million in 2001.
Net results increased by $7.3 million in 2002 as compared with 2001.
Included in the 2001 results were $30.6 million ($53.0 million pretax) of
losses related to the WTC event and $23.6 million ($42.0 million pretax)
related to restructuring and other related charges. The improvement in net
results also was due to growth in the disability and long term care products,
increased net investment income and diminished losses due to the exit of
unprofitable variable life and annuity lines of business. Net results also
improved due to favorable reserve development relating to the WTC event of
$3.6 million ($6.0 million pretax) recorded in 2002. Partially offsetting
these improvements was net unfavorable reserve strengthening in Group Benefits
due to unfavorable mortality trends and increased net realized losses in 2002.
See the Investments section of this MD&A for further discussion on net
investment income and net realized gains (losses).
57
Life
In 2003, Life Operations provided financial protection to individuals
through term life insurance, universal life insurance, individual long term
care insurance, annuities and other products. Life Operations has several
distribution relationships and partnerships including managing general
agencies, other independent agencies working with CNA life sales offices, a
network of brokers and dealers, and other independent insurance consultants.
In February of 2004, CNA entered into a definitive agreement to sell its
individual life insurance business to Swiss Re for approximately $690.0
million. The business sold includes term, universal and permanent life
insurance policies and individual annuity products. The transaction is
expected to be completed on or before March 31, 2004, subject to certain
customary closing conditions and regulatory approvals. See Note 25 of the
Notes to Consolidated Financial Statements included under Item 8 for further
information.
Also, in February of 2004, CNA ceased new sales in its structured settlement
business, but will continue to service existing commitments. This business
will be managed as a run-off operation.
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 decided to significantly reduce new sales of
this product and certain infrastructure costs.
Individual life primarily offers level premium term life insurance,
universal life insurance and related products. Single premium immediate
annuities as well as structured settlement annuities are also offered.
Individual long term care products provide reimbursement for covered nursing
home and home health care expenses incurred due to physical or mental
disability.
Other operations include operations in certain international markets and
life settlements contract business. CNA decided to cease purchasing new life
settlement policies indefinitely beginning in 2001 and ceased sale of new
policies in its international operations in 2002.
2003 Compared with 2002
Net earned premiums for Life Operations increased $99.0 million in 2003 as
compared with 2002. The increase in net earned premiums was due primarily to
higher sales of structured settlement annuities, growth in life insurance
products and rate increases on the individual long term care product inforce
blocks, partially offset by declines in new business primarily due to exiting
the individual long term care market.
Net results increased by $43.5 million in 2003 as compared with 2002. The
increase in net results related primarily to increased net realized investment
gains, the absence of the cumulative effect of a change in accounting
principle of $7.2 million recorded in 2002 relating to the write-down of
impaired goodwill. Partially offsetting these items were increases in
individual long term care reserves of $3.6 million after tax and minority
interest ($7.0 million pretax) due to increased severity and claim frequency.
The increase in reserves for individual long term care was $37.8 million in
2003 as compared with $31.3 million in 2002. Also partially offsetting the
improvements was the write-off of capitalized software costs of $8.0 million
pretax and lower net investment income. Also contributing to the decrease were
severance costs of $2.7 million after tax and minority interest ($4.0 million
pretax) related to the individual long term care product. See the Investments
section of this MD&A for further discussion on investment income, net and net
realized gains (losses).
2002 Compared with 2001
Net earned premiums increased $57.0 million in 2002 as compared with 2001
attributable primarily to growth in the individual long term care product
partially offset by sales declines in structured settlement annuities.
Net results decreased by $126.1 million in 2002 as compared with 2001. The
decrease in net results related primarily to increased net realized investment
losses, the cumulative effect of a change in accounting principle of $7.2
million recorded in 2002 relating to write-down of impaired goodwill, and a
$31.0 million loss from discontinued operations for the sale of CNA Vida,
CNA's life operations in Chile, to Consorcio Financiero S.A. ("Consorcio").
Included in the 2001
58
results were $16.7 million after tax and minority interest ($29.0 million
pretax) related to restructuring and other related charges and $12.3 million
($22.0 million pretax) related to the WTC event. Net results decreased due
primarily to net reserve strengthening for individual long term care of $20.7
million ($35.0 million pretax), unfavorable individual long term care
morbidity and increased costs related to the life settlement business in 2002.
These decreases were partially offset by higher net investment income, a
decrease in reinsurance charges, favorable reserve development relating to the
WTC event of $8.8 million ($15.0 million pretax) recorded in 2002 as compared
with 2001.
Other Insurance
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 and non-insurance operations and other operations.
2003 Compared with 2002
Revenues decreased $138.0 million in 2003 as compared with 2002. The
decrease in revenues was due primarily to reduced revenues from CNA UniSource
and reduced net earned premiums in group reinsurance of $117.0 million,
partially offset by increased pretax realized investment gains and increased
limited partnership income of $32.0 million.
Net results declined $563.0 million in 2003 as compared with 2002. The
decrease in net results was due primarily to a $499.5 million after tax and
minority interest ($854.0 million pretax) increase in unfavorable net prior
year development, primarily regarding APMT, a $39.7 million ($67.0 million
pretax) increase in ULAE reserves, a $9.0 million ($15.0 million pretax)
increase in certain insurance related assessments, and a $136.2 million
($232.0 million pretax) increase in the bad debt provision for reinsurance
receivables. The 2003 net results were favorably impacted by increased net
realized investment gains and the absences of $36.1 million ($62.0 million
pretax) of eBusiness expenses and a $16.2 million ($27.0 million pretax)
reduction of the accrual for restructuring and other related charges. See the
Investments section of this MD&A for further discussion of investment income
and net realized gains (losses).
The following discussion of unfavorable net prior year development includes
net unfavorable claim and allocated claim adjustment expense reserve
development and unfavorable premium development recorded in 2003 for Other
Insurance.
Unfavorable net prior year development of $875.0 million, including $881.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $6.0 million of favorable premium development was primarily
driven by unfavorable net prior year development of $795.0 million related to
APMT, discussed below. Unfavorable net prior year claim and allocated claim
adjustment expense reserve development of $50.0 million was recorded related
to CNA's past participation in several insurance pools which is part of the
group reinsurance run-off business. Unfavorable net prior year development of
$21.0 million, including $23.0 million of unfavorable claim and allocated
claim adjustment expense reserve development, and $2.0 million of favorable
premium development was recorded in 2002. The gross carried claim and claim
adjustment expense reserve was $7,046.0 and $4,847.0 million at December 31,
2003 and 2002. The net carried claim and claim adjustment expense reserve was
$2,624.0 and $2,002.0 million for December 31, 2003 and 2002.
The following discussion of unfavorable net prior year development includes
net unfavorable claim and allocated claim adjustment expense reserve
development and unfavorable premium development recorded in 2002 for
Other Insurance.
Personal insurance recorded unfavorable net prior year development of $35.0
million in 2002 on accident years 1997 through 1999. The unfavorable net prior
year development was principally due to continuing policyholder defense costs
associated with remaining open personal insurance claims. The unfavorable net
prior year development was partially offset by favorable reserve development
on other run-off business driven principally by financial and mortgage
guarantee coverages from accident years 1997 and prior. The favorable net
prior year development on financial and mortgage guarantee coverages resulted
from a review of the underlying exposures and the outstanding losses, which
showed that salvage and subrogation continues to be collected on these types
of claims, thereby reducing estimated future losses net of anticipated
reinsurance recoveries.
In accordance with the retroactive reinsurance agreement with Allstate, CNA
shares in indemnity and must begin to reimburse Allstate for claim and
allocated claim adjustment expenses if payments related to losses incurred
prior to
59
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's remaining obligation valued under this loss sharing
provision as of October 1, 2003 will be settled, under a time schedule
established by the parties, 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
exceeded $1.0 billion during the second quarter of 2003. The Company has
established reserves for its estimated liability under this loss sharing
arrangement.
2002 Compared with 2001
Total revenues decreased $150.0 million in 2002 as compared with 2001. This
decrease was due primarily to reduced revenues for CNA UniSource, due to the
exit of this business, reduced investment income and pretax realized
investment gains partially offset by increased net earned premiums in group
reinsurance.
Net results increased by $781.3 million in 2002 as compared with 2001. Net
results improved in 2002 as compared with 2001 primarily due to decreased
unfavorable net prior year development of $777.6 million after tax and
minority interest ($1,301.0 million pretax), reduced expenses for eBusiness
initiatives, improved results for group reinsurance and a $15.2 million ($27.0
million pretax) reduction in the accrual for restructuring and other related
charges recorded in 2002. In addition, net results in 2001 were adversely
impacted by $67.4 million ($119.0 million pretax) of restructuring and other
related charges and $14.9 million ($27.0 million pretax) of estimated losses
related to the WTC event for group reinsurance.
These increases were offset by lower net investment results, principally
resulting from a $5.4 million ($9.0 million pretax) decline in limited
partnership income, higher losses related to the run-off of CNA UniSource and
severance and other costs related to changes in senior management in 2002.
Unfavorable net prior year development of $21.0 million, including $23.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $2.0 million of favorable premium development, was
recorded in 2002 for Other Insurance. Unfavorable net prior year development
of $1,322.0 million, including $1,313.0 million of net unfavorable claim and
allocated claim adjustment expense reserve development and $9.0 million of
unfavorable premium development, was recorded in 2001 for Other Insurance. The
gross carried claim and claim adjustment expense reserve was $4,847.0 and
$5,043.0 million at December 31, 2002 and 2001. The net carried claim and
claim adjustment expense reserve was $2,002.0 and $2,110.0 million at December
31, 2002 and 2001.
The unfavorable net prior year development recorded in 2001 was primarily
attributable to $1,241.0 million of unfavorable development related to APMT.
APMT Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims.
Establishing reserves for APMT claim and claim adjustment expenses is
subject to uncertainties that are greater than those presented by other
claims. Traditional actuarial methods and techniques employed to estimate the
ultimate cost of claims for more traditional property and casualty exposures
are less precise in estimating claim and claim adjustment expense reserves for
APMT, particularly in an environment of emerging or potential claims and
coverage issues that arise from industry practices and legal, judicial, and
social conditions. Therefore, these traditional actuarial methods and
techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are
required of management. Accordingly, a high degree of uncertainty remains for
CNA's ultimate liability for APMT claim and claim adjustment expenses.
In addition to the difficulties described above, estimating the ultimate
cost of both reported and unreported APMT claims is subject to a higher degree
of variability due to a number of additional factors, including among others:
the number and outcome of direct actions against CNA; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
"joint and several" liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs' lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states to avoid the
application of tort reform statute effective dates; the possible enactment of
national federal legislation to address asbestos claims; a
60
further increase in asbestos and environmental pollution claims which cannot
now be anticipated; increase in number of mass tort claims relating to silica
and silica-containing products, and the outcome of ongoing disputes as to
coverage in relation to these claims; a further increase of claims and claims
payment that may exhaust underlying umbrella and excess coverage at
accelerated rates; and future developments pertaining to CNA's ability to
recover reinsurance for asbestos and environmental pollution claims.
CNA regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of CNA's APMT reserves. In performing its comprehensive ground up
analysis, CNA considers input from its professionals with direct
responsibility for the claims, inside and outside counsel with responsibility
for representation of CNA, and its actuarial staff. These professionals
review, among many factors, the policyholder's present and predicted future
exposures, including such factors as claims volume, trial conditions, prior
settlement history, settlement demands and defense costs; the impact of
asbestos defendant bankruptcies on the policyholder; the policies issued by
CNA, including such factors as aggregate or per occurrence limits, whether the
policy is primary, umbrella or excess, and the existence of policyholder
retentions and/or deductibles; the existence of other insurance; and
reinsurance arrangements.
With respect to other court cases and how they might affect CNA's reserves
and reasonable possible losses, the following should be noted. State and
federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers' obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers' loss control inspections of their insured' premises do not give
rise to a duty to warn third parties to the dangers of asbestos.
Examples of unfavorable developments include decisions limiting the
application of the "absolute pollution" exclusion; and decisions holding
carriers liable for defense and indemnity of asbestos and pollution claims on
a joint and several basis.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA after 1989. Due to the inherent uncertainties described above,
including the inconsistency of court decisions, the number of waste sites
subject to cleanup, and in the area of environmental pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
Due to the inherent uncertainties in estimating reserves for APMT claim and
claim adjustment expenses and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to CNA's
business, insurer financial strength, and debt ratings and the Company's
results of operations and equity. Due to, among other things, the factors
described above, it may be necessary for CNA to record material changes in its
APMT claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge.
The following table provides data related to CNA's asbestos, environmental
pollution and mass tort claim and claim adjustment expense reserves.
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Asbestos Mass Tort Asbestos Mass Tort
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 3,347.0 $ 839.0 $ 1,758.0 $ 830.0
Ceded reserves (1,580.0) (262.0) (512.0) (313.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 1,767.0 $ 577.0 $ 1,246.0 $ 517.0
================================================================================================
61
Asbestos
CNA's property and casualty insurance subsidiaries have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves many of the same limitations 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. The majority of asbestos
bodily injury claims are filed by persons exhibiting few, if any, disease
symptoms. It is estimated that approximately 90.0% of the current non-
malignant asbestos claimants do not meet the American Medical Association's
definition of impairment. Some courts, including the federal district court
responsible for pre-trial proceedings in all federal asbestos bodily injury
actions, have ordered that so-called "unimpaired" claimants may not recover
unless at some point the claimant's condition worsens to the point of
impairment.
Several factors are, in management's view, negatively impacting asbestos
claim trends. Plaintiff attorneys who previously sued entities who are now
bankrupt are seeking other viable targets. As a result, companies with few or
no previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended.
Additionally, plaintiff attorneys and trustees for future claimants are
demanding that policy limits be paid lump-sum into the bankruptcy asbestos
trusts prior to presentation of valid claims and medical proof of these
claims. The ultimate impact or success of this tactic remains uncertain.
Plaintiff attorneys and trustees for future claimants are also attempting to
devise claims payment procedures for bankruptcy trusts that would allow
asbestos claims to be paid under lax standards for injury, exposure, and
causation. This also presents the potential for exhausting policy limits in an
accelerated fashion.
As a result of bankruptcies and insolvencies, management has observed an
increase in the total number of policyholders with current asbestos claims as
additional defendants are added to existing lawsuits and are named in new
asbestos bodily injury lawsuits. New asbestos bodily injury claims have also
increased substantially in 2003.
As of December 31, 2003 and 2002, CNA carried approximately $1,767.0 and
$1,246.0 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables for reported and unreported asbestos-related claims.
Unfavorable asbestos-related net claim and claim adjustment expense reserve
development for 2003, 2002 and 2001 amounted to $642.0, $0.0 and $773.0
million. CNA paid asbestos-related claims, net of reinsurance, of $121.0,
$21.0 and $171.0 million during the years ended December 31, 2003, 2002 and
2001.
CNA had recorded $1,826.0 and $642.0 million in unfavorable gross and net
asbestos prior year reserve development for 2003, principally due to potential
losses from policies issued by CNA with high attachment points, which previous
exposure analysis indicated would not be reached. As part of its review
completed in the third quarter of 2003, CNA examined the claims filing trends
and the projected erosion rates of underlying primary and lower excess
insurance on open asbestos accounts to determine timeframes within which high
excess policies issued by CNA could be reached. Elevated claims volumes,
together with certain adverse court decisions affecting rapidity by which
asbestos claims are paid supported the conclusion that excess policies with
high attachment points previously thought not to be exposed may now
potentially be exposed.
In 2001, CNA noted the continued emergence of adverse loss experience across
several lines of business related to prior years. With respect to asbestos
reserves, throughout 2000, and into 2001, CNA experienced significant
increases in new asbestos bodily injury claims. In light of this development,
CNA formed the view that payments for asbestos claims could be higher in
future years than previously estimated. Moreover, in late 2000 through mid-
2001, industry sources such as rating agencies and actuarial firms released
analyses and studies commenting on the increase in claim volumes and other
asbestos liability developments.
62
Also in the 2000 to 2001 time period, a number of significant asbestos
defendants filed for bankruptcy, increasing the likelihood that excess layers
of insurance coverage could be called upon to indemnify policyholders and
creating the potential that novel legal doctrines could be employed. These
developments led CNA to the conclusion that its asbestos reserves required
strengthening of $773.0 million in 2001.
CNA has resolved a number of its large asbestos accounts by negotiating
structured settlement agreements. Structured settlement agreements provide for
payments over multiple years as set forth in each individual agreement. At
December 31, 2002, CNA had four structured settlement agreements with a
reserve, net of reinsurance of $118.0 million. Since December 31, 2002, CNA
has resolved five additional asbestos accounts through structured settlement
agreements. At December 31, 2003, CNA had structured settlement agreements
with nine of its policyholders for which it has future payment obligations
with a reserve, net of reinsurance, of $188.0 million related to remaining
payment obligations under these agreements. As to the nine structured
settlement agreements existing at December 31, 2003, payment obligations under
those settlement agreements are projected to terminate in 2016.
In 1985, 47 asbestos producers and their insurers, including CIC, executed
the Wellington Agreement. The agreement intended to resolve all issues and
litigation related to coverage for asbestos exposures. Under this agreement,
signatory insurers committed scheduled policy limits and made the limits
available to pay asbestos claims based upon coverage blocks designated by the
policyholders in 1985, subject to extension by policyholders. CIC was a
signatory insurer to the Wellington Agreement. At December 31, 2002, CNA had
fulfilled its Wellington Agreement obligations as to all but five accounts and
had recorded a reserve of $28.0 million, net of reinsurance, related to its
remaining Wellington obligations. At December 31, 2003, with respect to these
five remaining unpaid Wellington obligations, CNA has evaluated its exposure
and the expected reinsurance recoveries under these agreements and had a
recorded reserve of $23.0 million, net of reinsurance.
CNA has also used coverage in place agreements to resolve large asbestos
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
asbestos related liabilities. Claims payments are contingent on presentation
of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. At December 31, 2002, CNA had
estimated its exposure for its twenty-three coverage in place agreements at
$66.0 million, net of reinsurance. As of December 31, 2003, CNA had negotiated
thirty-two such agreements. Coverage in place agreements are evaluated based
on claims filings trends and severities. Due to adverse claims trends
described in this section, management has increased its estimate of exposure
under current coverage in place agreements. CNA has evaluated these
commitments and the expected reinsurance recoveries under these agreements and
had recorded a reserve of $109.0 million, net of reinsurance, related to
coverage in place agreements as of December 31, 2003.
CNA categorizes active asbestos accounts as large or small accounts. CNA
defines a large account as an active account with more than $100,000 of
cumulative paid losses. CNA made closing large accounts a significant
management priority. At December 31, 2002, CNA had 150 large accounts and has
a related reserve of $220.0 million, net of reinsurance. At December 31, 2003,
CNA has 160 large accounts with a collective reserve of $405.0 million, net of
reinsurance. Large accounts are typically accounts that have been long
identified as significant asbestos exposures. In its most recent ground up
reserve study, CNA observed that underlying layers of primary, umbrella and
lower layer excess policies were exhausting at accelerated rates due to
increased claims volumes, claims severities and increased defense expense
incurred in litigating claims. Those accounts where CNA had issued high excess
policies were evaluated in the study to determine potential impairment of the
high excess layers of coverage. Management concluded that high excess coverage
previously thought not to be exposed could potentially be exposed should
current adverse claim trends continue.
Small accounts are defined as active accounts with $100,000 or less
cumulative paid losses. At December 31, 2002, CNA had 939 small accounts with
recorded reserves of $90.0 million, net of reinsurance. At December 31, 2003,
CNA had 1,065 small accounts, approximately 83.7% of its total active asbestos
accounts and has increased its collective reserve to $147.0 million, net of
reinsurance, as of December 31, 2003. Small accounts are typically
representative of policyholders with limited connection to asbestos. As
entities which were historic targets in asbestos litigation continue to file
for bankruptcy protection, plaintiffs' attorneys are seeking other viable
targets. As a result, companies with few or no previous asbestos claims are
becoming targets in asbestos litigation and, nevertheless must be defended by
CNA under its policies. As claims filings continue to increase, costs incurred
in defending small accounts are expected to increase.
63
CNA also evaluates its asbestos liabilities arising from its assumed
reinsurance business and its participation in various pools. At December 31,
2002, CNA had recorded a $91.0 million reserve related to these asbestos
liabilities arising from CNA's assumed reinsurance obligations and CNA's
participation in pools, including Excess and Casualty Reinsurance Association
("ECRA"). At December 31, 2003, CNA has increased the reserves to $157.0
million, net of reinsurance, related to these liabilities.
At December 31, 2003, CNA's unassigned incurred but not reported ("IBNR")
reserve for asbestos was $684.0 million, net of reinsurance. This IBNR reserve
relates to potential development on accounts that have not settled and
potential future claims from unidentified policyholders. At December 31, 2002,
the unassigned IBNR reserve was $578.0 million, net of reinsurance.
The chart below depicts CNA's overall pending asbestos accounts and
associated reserves at December 31, 2003 and 2002.
Percent of
Number of Net Paid Losses Net Asbestos Asbestos
December 31, 2003 policyholders (Recoveries) Reserves Reserves
- -----------------------------------------------------------------------------------------------
(In millions of dollars)
Policyholders with settlement
agreements
Structured Settlements 9 $ 20.0 $ 188.0 10.6%
Wellington 5 2.0 23.0 1.3
Coverage in place 32 40.0 109.0 6.2
Fibreboard 1 1.0 54.0 3.1
- -----------------------------------------------------------------------------------------------
Total with settlement agreements 47 63.0 374.0 21.2
- ------------------------------------------------------------------------------------------------
Other policyholders with active
accounts
Large asbestos accounts 160 35.0 405.0 22.9
Small asbestos accounts 1,065 16.0 147.0 8.3
- ------------------------------------------------------------------------------------------------
Total other policyholders 1,225 51.0 552.0 31.2
- ------------------------------------------------------------------------------------------------
Assumed reinsurance and pools 7.0 157.0 8.9
Unassigned IBNR 684.0 38.7
- -----------------------------------------------------------------------------------------------
Total 1,272 $ 121.0 $ 1,767.0 100.0%
================================================================================================
December 31, 2002
- ------------------------------------------------------------------------------------------------
Policyholders with settlement
agreements
Structured Settlements 4 $ 12.0 $ 118.0 9.5%
Wellington 5 28.0 2.2
Coverage in place 23 (15.0) 66.0 5.3
Fibreboard 1 1.0 55.0 4.4
- ----------------------------------------------------------------------------------------------
Total with settlement agreements 33 (2.0) 267.0 21.4
- -----------------------------------------------------------------------------------------------
Other policyholders with active
accounts
Large asbestos accounts 150 (8.0) 220.0 17.7
Small asbestos accounts 939 16.0 90.0 7.2
- ------------------------------------------------------------------------------------------------
Total other policyholders 1,089 8.0 310.0 24.9
- ------------------------------------------------------------------------------------------------
Assumed reinsurance and pools 15.0 91.0 7.3
Unassigned IBNR 578.0 46.4
- -----------------------------------------------------------------------------------------------
Total 1,122 $ 21.0 $ 1,246.0 100.0%
================================================================================================
64
Some asbestos-related defendants have asserted that their policies issued by
CNA are not subject to aggregate limits on coverage. CNA has such claims from
a number of insureds. Some of these claims involve insureds facing exhaustion
of products liability aggregate limits in their policies, who have asserted
that their asbestos-related claims fall within so-called "non-products"
liability coverage contained within their policies rather than products
liability coverage, and that the claimed "non-products" coverage is not
subject to any aggregate limit. It is difficult to predict the ultimate size
of any of the claims for coverage purportedly not subject to aggregate limits
or predict to what extent, if any, the attempts to assert "non-products"
claims outside the products liability aggregate will succeed. CNA has
attempted to manage its asbestos exposure by aggressively seeking to settle
claims on acceptable terms. There can be no assurance that any of these
settlement efforts will be successful, or that any such claims can be settled
on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable
terms, CNA aggressively litigates the claim. Adverse developments with respect
to such matters could have a material adverse effect on the Company's results
of operations and/or equity.
Certain asbestos litigation in which CNA is currently engaged is described
below:
On February 13, 2003, CNA announced it had resolved asbestos related
coverage litigation and claims involving A.P. Green Industries, A.P. Green
Services and Bigelow - Liptak Corporation. Under the agreement, CNA is
required to pay $74.0 million, net of reinsurance recoveries, over a ten year
period. The settlement resolves CNA's liabilities for all pending and future
asbestos claims involving A.P. Green Industries, Bigelow - Liptak Corporation
and related subsidiaries, including alleged "non-products" exposures. The
settlement has received initial bankruptcy court approval and CNA expects to
procure confirmation of a bankruptcy plan containing an injunction to protect
CNA from any future claims.
CNA is engaged in insurance coverage litigation with underlying plaintiffs
who have asbestos bodily injury claims against the former Robert A. Keasbey
Company ("Keasbey") in New York state court (Continental Casualty Co. v.
Nationwide Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a
currently dissolved corporation, was a seller and installer of asbestos-
containing insulation products in New York and New Jersey. Thousands of
plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey's
involvement at a number of work sites is a highly contested issue. Therefore,
the defense disputes the percentage of valid claims against Keasbey. CNA
issued Keasbey primary policies for 1970-1987 and excess policies for 1972-
1978. CNA has paid an amount substantially equal to the policies' aggregate
limits for products and completed operations claims. Claimants against Keasbey
allege, among other things, that CNA owes coverage under sections of the
policies not subject to the aggregate limits, an allegation CNA vigorously
contests in the lawsuit.
CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. ("Burns & Roe"). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns &
Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District
of New Jersey, No. 00-41610. Burns & Roe provided engineering and related
services in connection with construction projects. At the time of its
bankruptcy filing, Burns & Roe faced approximately 11,000 claims alleging
bodily injury resulting from exposure to asbestos as a result of construction
projects in which Burns & Roe was involved. CNA allegedly provided primary
liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with
certain project-specific policies from 1964-1970.
CIC issued certain primary and excess policies to Bendix Corporation
("Bendix"), now part of Honeywell International, Inc. ("Honeywell"). Honeywell
faces approximately 73,000 pending asbestos bodily injury claims resulting
from alleged exposure to Bendix friction products. CIC's primary policies
allegedly covered the period from at least 1939 (when Bendix began to use
asbestos in its friction products) to 1983, although the parties disagree
about whether CIC's policies provided product liability coverage before 1940
and from 1945 to 1956. CIC asserts that it owes no further material
obligations to Bendix under any primary policy. Honeywell alleges that two
primary policies issued by CIC covering 1969-1975 contain occurrence limits
but not product liability aggregate limits for asbestos bodily injury claims.
CIC has asserted, among other things, which even if Honeywell's allegation is
correct, which CNA denies, its liability is limited to a single occurrence
limit per policy or per year, and in the alternative, a proper allocation of
losses would substantially limit its exposure under the 1969-1975 policies to
asbestos claims. These and other issues are being
65
litigated in Continental Insurance Co., et al. v. Honeywell International
Inc., No. MRS-L-1523-00 (Morris County, New Jersey).
Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
Ohio action, plaintiffs allege the defendants negligently performed duties
undertaken to protect the public from the effects of asbestos (Varner v. Ford
Motor Co., et al., (Cuyahoga County, Ohio)). Similar lawsuits have also been
filed in Texas against CNA, and other insurers and non-insurer corporate
defendants asserting liability for failing to warn of the dangers of asbestos
(Boson v. Union Carbide Corp., et al., (District Court of Nueces County,
Texas)). Many of the Texas claims have been dismissed as time-barred by the
applicable statute of limitations. In other claims, the Texas court recently
ruled that the carriers did not owe any duty to the plaintiffs or the general
public to advise on the effects of asbestos thereby dismissing these claims.
The time period for filing an appeal of this ruling has not expired and it
remains uncertain whether the plaintiffs' will continue to pursue their causes
of action.
CNA has been named in Adams v. Aetna, Inc., et al., (Circuit Court of
Kanawha County, West Virginia), a purported class action against CNA and other
insurers, alleging that the defendants violated West Virginia's Unfair Trade
Practices Act in handling and resolving asbestos claims against their
policyholders. A direct action has also been filed in Montana (Pennock, et al.
v. Maryland Casualty, et al., First Judicial District Court of Lewis & Clark
County, Montana) by eight individual plaintiffs (all employees of W.R. Grace &
Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the
State of Montana. This action alleges that the carriers failed to warn of or
otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R.
Grace vermiculite mining facility in Libby, Montana. The Montana direct action
is currently stayed because of W.R. Grace's pending bankruptcy.
CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and
it is extremely difficult to predict the outcome or ultimate financial
exposure represented by these matters. Adverse developments with respect to
any of these matters could have a material adverse effect on CNA's business,
insurer financial strength and debt ratings, and the Company's results of
operations and/or equity.
As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage;
limits and deductibles; the potential role of other insurance, particularly
underlying coverage below any CNA excess liability policies; and applicable
coverage defenses, including asbestos exclusions. Estimation of asbestos-
related claim and claim adjustment expense reserves involves a high degree of
judgment on the part of management and consideration of many complex factors,
including:
. inconsistency of court decisions, jury attitudes and future court
decisions
. specific policy provisions
. allocation of liability among insurers and insureds
. missing policies and proof of coverage
. the proliferation of bankruptcy proceedings and attendant uncertainties
. novel theories asserted by policyholders and their counsel
. the targeting of a broader range of businesses and entities as defendants
. the uncertainty as to which other insureds may be targeted in the future
and the uncertainties inherent in predicting the number of future claims
. volatility in claim numbers and settlement demands
66
. increases in the number of non-impaired claimants and the extent to which
they can be precluded from making claims
. the efforts by insureds to obtain coverage not subject to aggregate limits
. long latency period between asbestos exposure and disease manifestation
and the resulting potential for involvement of multiple policy periods for
individual claims
. medical inflation trends
. the mix of asbestos-related diseases presented, and
. the ability to recover reinsurance
CNA is also monitoring possible legislative reforms, including the possible
creation of a national privately financed trust, which if established 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
legislation will be enacted or, if it is, what will be the terms and
conditions of its establishment or its impact on CNA.
Environmental Pollution and Mass Tort
Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to cleanup. The insurance industry is involved in extensive litigation
regarding coverage issues. Judicial interpretations in many cases have
expanded the scope of coverage and liability beyond the original intent of the
policies. The Comprehensive Environmental Response Compensation and Liability
Act of 1980 ("Superfund") and comparable state statutes ("mini-Superfunds")
govern the cleanup and restoration of toxic waste sites and formalize the
concept of legal liability for cleanup and restoration by "Potentially
Responsible Parties" ("PRPs"). Superfund and the mini-Superfunds establish
mechanisms to pay for cleanup of waste sites if PRPs fail to do so and assign
liability to PRPs. The extent of liability to be allocated to a PRP is
dependent upon a variety of factors. Further, the number of waste sites
subject to cleanup is unknown. To date, approximately 1,200 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 modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 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.
As of December 31, 2003 and 2002, CNA carried approximately $577.0 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. Unfavorable net prior year environmental pollution and
mass tort net claim and claim adjustment expense reserve development for the
years ended December 31, 2003 and 2001 amounted to $153.0 and $468.0 million.
There was no unfavorable net prior year environmental pollution and mass tort
net claim and claim adjustment expense reserve development for the year ended
December 31, 2002. CNA paid environmental pollution-related claims and mass
tort-
67
related claims, net of reinsurance recoveries, of $93.0, $116.0 and $203.0
million for years ended December 31, 2003, 2002 and 2001.
CNA recorded $73.0 million in unfavorable net prior year environmental
pollution development in 2003. This increase was in part due to the emergence
of certain negative legal developments, including several court decisions
which have reduced the effectiveness of the absolute pollution exclusion by
limiting its application to traditional industrial pollution, and which have
increased the scope of damages compensable under policies of insurance and
emergence of Natural Resource Damage claims and other federal statutes.
CNA has made resolution of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating settlement agreements. In its settlements, CNA sought
to resolve those exposures and obtain the broadest release language to avoid
future claims from the same policyholders seeking coverage for sites or claims
that had not emerged at the time CNA settled with its policyholder. While the
terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad scope of the release provisions contained in those
settlement agreements should, in many cases, prevent future exposure from
settled policyholders. It remains uncertain, however, whether a court
interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the
agreements.
CNA classifies its environmental pollution accounts into several categories,
which include structured settlements, coverage in place agreements and active
accounts. At December 31, 2003, CNA has a structured settlement agreement with
one of its policyholders for which it has future payment obligations with a
recorded reserve of $12.0 million, net of reinsurance.
CNA has also used coverage in place agreements to resolve pollution
exposures. Claims payments are contingent on presentation of adequate
documentation of damages during the policy periods and other documentation
supporting the demand for claims payment. Coverage in place agreements may
have annual payment caps. At December 31, 2003, CNA had negotiated six such
agreements in which CNA committed coverage for payment of claims and claim
related adjustment expenses subject to documentation requirements as set forth
in the terms of each specific agreement. At December 31, 2003, CNA had a
recorded reserve of $8.0 million, net of reinsurance, related to coverage in
place agreements.
CNA categorizes active accounts as large or small accounts in the pollution
area. CNA defines a large account as an active account with more than $100,000
cumulative paid losses. CNA has 144 large accounts with a collective reserve
of $86.0 million, net of reinsurance, at December 31, 2003. CNA has made
closing large accounts a significant management priority. Small accounts are
defined as active accounts with $100,000 or less cumulative paid losses. CNA
had 432 small accounts with a collective reserve of $53.0 million, net of
reinsurance, at December 31, 2003.
CNA also evaluates its environmental pollution exposures arising from its
assumed reinsurance and its participation in various pools, including ECRA. At
December 31, 2003, CNA has a reserve of $38.0 million related to these
liabilities.
At December 31, 2003, CNA's unassigned IBNR reserve for environmental
pollution was $197.0 million, net of reinsurance. This IBNR reserve relates to
potential development on accounts that have not settled and potential future
claims from unidentified policyholders.
68
The table below depicts CNA's overall pending environmental pollution
accounts and associated reserves at December 31, 2003.
Environmental Percent of
Total Paid Pollution Environmental
Number of in 2003 Reserves Pollution Net
Policyholders (Net) 12/31/03 (Net) Reserve
- -----------------------------------------------------------------------------------------------
(In millions of dollars)
Policyholders with Settlement
Agreements
Structured Settlements 1 $ 17.0 $ 12.0 3.1%
Coverage In Place 6 3.0 8.0 2.0
- ------------------------------------------------------------------------------------------------
Total with Settlement Agreements 7 20.0 20.0 5.1
- -----------------------------------------------------------------------------------------------
Other Policyholders with Active
Accounts
Large Pollution Accounts 144 21.0 86.0 21.8
Small Pollution Accounts 432 14.0 53.0 13.5
- ------------------------------------------------------------------------------------------------
Total Other Policyholders 576 35.0 139.0 35.3
- ------------------------------------------------------------------------------------------------
Assumed Reinsurance & Pools 2.0 38.0 9.6
- ------------------------------------------------------------------------------------------------
Unassigned IBNR 197.0 50.0
- ------------------------------------------------------------------------------------------------
Total 583 $ 57.0 $ 394.0 100.0%
================================================================================================
CNA recorded $80.0 million in unfavorable mass tort net prior year
development in 2003, due in part to the elevated volume of silica claims. In
2003, CNA observed a marked increase in silica claims frequency in
Mississippi, where plaintiff attorneys appear to have filed claims to avoid
the effect of a tort reform. The most significant silica exposures identified
to date include a relatively small number of accounts with significant numbers
of new claims and substantial insurance limits issued by CNA. Establishing
claim and claim adjustment expense reserves for silica claims is subject to
uncertainties because of disputes concerning medical causation with respect to
certain diseases, including lung cancer, geographical concentration of the
lawsuits asserting the claims, and the large rise in the total number of
claims without underlying epidemiological developments suggesting an increase
in disease rates or plaintiffs. Moreover, judicial interpretations regarding
application of various tort defenses, including application of various
theories of joint and several liability, impede CNA's ability to establish
claim and claims adjustment expense reserves.
In 2001, CNA noted the continued emergence of adverse loss experience across
several lines of business related to prior years. With respect to
environmental pollution and mass tort reserves, commencing in 2000 and
continuing into the first and second quarters of 2001, CNA received a number
of new reported claims, some of which involved declaratory judgment actions
premised on court decisions purporting to expand insurance coverage for
pollution claims. In these decisions, several courts adopted rules of
insurance policy interpretation which established joint and several liability
for insurers consecutively on a risk during a period of alleged property
damage; and in other instances adopted interpretations of the "absolute
pollution exclusion," which weakened its effectiveness in most circumstances.
In addition to receiving new claims and declaratory judgment actions premised
upon these unfavorable legal precedents, these court decisions also impacted
CNA's pending environmental pollution and mass tort claims and coverage
litigation. During the Spring of 2001, CNA reviewed specific claims and
litigation, as well as general trends, and concluded reserve strengthening in
this area was necessary.
In the area of mass torts, several well-publicized verdicts arising out of
bodily injury cases related to allegedly toxic mold led to a significant
increase in mold-related claims in 2000 and the first half of 2001. CNA's
reserve increase in the second quarter of 2001 was caused in part by this
increased area of exposure.
69
Lorillard
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
2003 Compared with 2002
Revenues decreased by $548.4 million, or 14.3% and net income decreased by
$178.2 million, or 23.3% in 2003, as compared to 2002.
Net income in 2003 included charges of $17.1 and $17.5 million (in each
case, net of taxes) related to the tobacco growers settlement and an agreement
with the Brown & Williamson Corporation (the "B&W Agreement") which are
described in Liquidity and Capital Resources, below. Excluding these charges,
net income would have decreased by $143.6 million, or 18.8%, in 2003, as
compared to 2002.
The decrease in revenues and net income in 2003, as compared to 2002, is
primarily due to lower net sales of $542.1 million. Net sales revenue
decreased due to lower effective unit prices reflecting higher sales promotion
expenses (included in net sales) and decreased unit sales volume of
approximately $86.1 million, assuming prices were unchanged from the prior
year, partially offset by higher average wholesale unit prices due to
price/sales mix, which increased revenues by approximately $35.0 million. Unit
sales volume decreased 2.3% as compared to the prior year. Lorillard increased
promotional expenses in 2003 due to price pressure in response to higher
competitive premium brand promotional spending and continued increases in
excise taxes.
The decrease in net income in 2003, as compared to 2002, also reflects
charges for the tobacco growers settlement and the B&W Agreement, partially
offset by lower tobacco settlement costs related to 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 U.S. territories (together, the "State Settlement
Agreements"). The $277.0 million pretax decrease in tobacco settlement costs
in 2003, as compared to 2002, is due to the expiration of up-front payments
($164.5 million), lower charges for lower unit sales volume ($3.5 million) and
other adjustments ($109.0 million) under the State Settlement Agreements.
Lorillard's total (U.S. domestic, Puerto Rico and certain U.S. Territories)
gross unit sales volume decreased 2.4% in 2003, as compared to 2002. Domestic
wholesale volume decreased 2.8% in 2003, as compared to 2002. Total Newport
unit sales volume decreased by 0.1% in 2003, and domestic U.S. volume
decreased 0.6% in 2003, as compared to 2002. In addition to pricing pressure
due to the increases in state excise taxes and the competitive impact of deep
discount brands, Lorillard's volume in 2003 was affected by generally weak
economic conditions and ongoing limitations imposed by Philip Morris' retail
merchandising arrangements.
On May 5, 2003, Lorillard lowered the wholesale list price of its discount
brand, Maverick, by $55.00 per thousand cigarettes ($1.10 per pack of 20
cigarettes) in an effort to reposition the brand to be more competitive in the
deep discount price cigarette segment. Maverick accounted for 1.5% of
Lorillard's net unit sales in 2003, as compared to 1.7% in 2002.
Deep discount price brands are produced by manufacturers who are subject to
lower payment obligations under the State Settlement Agreements. This cost
advantage enables them to price their brands as much as 60% less than the list
price of premium brand offerings from the major cigarette manufacturers. Deep
discount price brands increased their market share in 2003 by 0.64 share
points to 8.32%.
Total Lorillard and Newport 2003 share of domestic wholesale shipments
compared favorably with the prior year due to wholesale inventory reductions
in 2002 following heavy purchases in advance of multiple state tax increases,
which tend to affect cigarette brands with large market shares, such as
Newport, more than others.
Lorillard's premium products sold as a percent of its total domestic volume
remained relatively flat in 2003 as compared to 2002.
Menthol cigarettes as a percent of the total industry remained relatively
flat. Newport, the industry's largest menthol brand, increased its share of
the menthol segment to 31.3% in the fourth quarter of 2003, versus 28.4% in
the fourth quarter of 2002. In 2003, Newport had an approximate 30.5% share of
the menthol segment, compared to 29.3% in 2002.
70
Newport, a premium brand, accounted for approximately 90.2% of Lorillard's
unit sales in 2003, as compared to approximately 88.2% in 2002.
Overall, domestic industry unit sales volume decreased 5.1% in 2003, as
compared to 2002. Lorillard domestic unit sales volume decreased 2.8% in 2003
as compared to 2002. Industry sales for premium brands were 73.9% of the total
domestic markets in 2003, as compared to 72.8% in 2002.
Lorillard recorded pretax charges of $785.2 and $1,062.2 million ($489.5 and
$646.1 million after taxes) for the years ended December 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.
Other operating expenses include the costs of litigating and administering
product liability claims, as well as other legal expenses. Lorillard's outside
legal fees and other external product liability defense costs were $93.7,
$100.2 and $109.5 million, for the years ended December 31, 2003, 2002 and
2001, respectively. Numerous factors affect product liability defense costs.
The principal factors are the number and types of cases filed, the number of
cases tried, the results of trials and appeals, the development of the law,
the application of new or different theories of liability by plaintiffs and
their counsel, and litigation strategy and tactics. See Note 21 of the Notes
to Consolidated Financial Statements included in Item 8 of this Report for
detailed information regarding tobacco litigation. The factors that have
influenced past product liability defense costs are expected to continue to
influence future costs. Although Lorillard does not expect that product
liability defense costs will increase significantly in the future, it is
possible that adverse developments in the factors discussed above, as well as
other circumstances beyond the control of Lorillard, could have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
2002 Compared with 2001
Revenues decreased by $111.6 million, or 2.8%, and net income increased by
$93.6 million, or 13.9%, in 2002 as compared to 2001. Net income for the year
ended December 31, 2001, included a charge of $121.0 million related to an
agreement with the class in the Engle case. See Note 21 of the Notes to
Consolidated Financial Statements included in Item 8 of this Report for
information with respect to the Engle action. Excluding this charge, net
income decreased by $27.3 million, or 3.4%, due to lower sales volume,
increased sales promotion costs and reduced investment income reflecting lower
invested cash balances and reduced yields on investments, partially offset by
increased unit prices and decreased tobacco settlement and legal expenses.
Revenues decreased due to lower net sales and reduced investment income. Net
sales decreased by $70.3 million in 2002 as compared to 2001, due to lower
unit sales volume of approximately $257.0 million, or 6.6%, assuming prices
were unchanged from the prior year. The decline in unit sales volume was
partially offset by higher average unit prices which increased revenues by
approximately $186.7 million, or 4.8%, including $93.0 million from an
increase in federal excise taxes effective January 1, 2002.
During 2002, Lorillard increased its net wholesale price of cigarettes by an
average of $6.71 per thousand cigarettes ($0.13 per pack of 20 cigarettes), or
5.6%, before the impact of any promotional activities. Federal excise taxes
are included in the price of cigarettes and on January 1, 2002, the federal
excise tax on cigarettes increased by $2.50 per thousand cigarettes ($0.05 per
pack of 20 cigarettes) to $19.50 per thousand cigarettes. State excise taxes,
including the District of Columbia, increased from an average of $0.43 per
pack (of 20 cigarettes) in 2001 to an average of $0.61 in 2002.
The increased unit prices reflect the increase in net wholesale prices,
partially offset by promotional expenses, mostly in the form of coupons and
other discounts provided to retailers and passed through to the consumer.
Increased promotional expenses in 2002, as compared to 2001, partially offset
the higher average unit prices in 2002.
Lorillard's overall unit sales volume decreased 6.3% in 2002 as compared to
2001. Newport's unit sales volume decreased by 2.8% in 2002. Continued
decreases in unit volume for Old Gold and Maverick in the discount segment
were also contributing factors. Old Gold and Maverick declines were due to
severe competitive price pressure from deep discount brands produced by
manufacturers who do not have the same financial payment obligations related
to the State
71
Settlement Agreements as does Lorillard and other major tobacco companies.
Additionally, volume in 2002 was affected by generally weak economic
conditions and ongoing limitations imposed by Philip Morris' retail
merchandising arrangements.
Deep discount price brands produced by manufacturers who are not obligated
by the same payment terms of the State Settlement Agreements have continued to
increase their market share by approximately one share point during 2002 to
7.17% of the U.S. domestic market.
Lorillard's share of domestic U.S. wholesale cigarette shipments was 9.05%
in 2002 as compared to 9.26% in 2001. Newport accounted for approximately
88.2% of Lorillard's unit sales and 89.1% of net sales revenue in 2002,
compared to 85.0% and 85.9%, respectively, in 2001. Newport's share of the
premium segment was 10.9% in 2002 as compared to 10.6% in 2001. Newport had
the highest share of the menthol segment of the market with an approximately
30.5% share of the category. Menthol comprised approximately 26.0% of total
domestic U.S. industry sales in 2002. Premium priced cigarette sales accounted
for 94.7% and 92.2% of Lorillard's total sales in 2002 and 2001.
Overall, industry unit sales volume decreased by 3.7% in 2002. Industry
sales for premium brands declined to 72.8% in 2002 as compared to 74.0% in
2001.
Lorillard recorded pretax charges of $1,062.2 and $1,140.4 million ($646.1
and $694.2 million after taxes), for the years ended December 31, 2002 and
2001, respectively, to record its obligations under various settlement
agreements. Lorillard's portion of ongoing adjusted settlement payments and
related legal fees are based on its share of domestic cigarette shipments in
the year preceding that in which the payment is due. Accordingly, Lorillard
records its portions of ongoing settlement payments as part of cost of
manufactured products sold as the related sales occur.
Selected Market Share Data
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
Lorillard's share of the domestic market (1) 9.27% 9.05% 9.26%
Lorillard's premium segment as a percentage
of its total domestic volume (1) 95.5% 94.7% 92.2%
Newport share of the domestic market (1) 8.34% 7.97% 7.84%
Newport share of the premium segment (1) 11.3% 10.9% 10.6%
Total menthol segment market share for the
industry (2) 26.70% 26.04% 25.78%
Newport's share of the menthol segment 30.5% 29.3% 29.6%
Newport as a percentage of Lorillard's (3):
Total volume 90.2% 88.2% 85.0%
Net sales 90.0% 89.1% 85.9%
Sources:
(1) Management Science Associates, Inc.
(2) Lorillard proprietary data
(3) Lorillard Shipment Reports
Unless otherwise specified, market share data in this MD&A is based on data
made available by Management Science Associates, Inc. ("MSAI"), an independent
third-party database management organization that collects wholesale shipment
data from various cigarette manufacturers and provides analysis of market
share, unit sales volume and premium versus discount mix for individual
companies and the industry as a whole. MSAI's information relating to unit
sales volume and market share of certain of the smaller, primarily deep
discount, cigarette manufacturers is based on estimates derived by MSAI.
72
Lorillard management believes that volume and market share information for
these manufacturers are understated and, correspondingly, share information
for the larger manufacturers, including Lorillard, are overstated by MSAI.
Business Environment
The tobacco industry in the United States, including Lorillard, continues to
be faced with a number of issues that have impacted 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. Pending litigation includes a
jury award in Florida of $16.3 billion in punitive damages against
Lorillard in Engle v. R.J. Reynolds Tobacco Company, et al., a judgment
which was vacated by the Florida Third District Court of Appeal in
September of 2003. Plaintiffs have appealed the appellate court's decision
to the Florida Supreme Court. The U.S. Department of Justice has also
brought an action against Lorillard and other tobacco companies. The
government seeks, pursuant to the federal Racketeer Influenced and Corrupt
Organization Act, or RICO, disgorgement of profits from the industry of
$280.0 billion that the government contends were earned as a consequence
of a RICO racketeering "enterprise," as well as various injunctive relief.
Trial of this matter is scheduled to begin during September of 2004.
See Item 3 - Legal Proceedings and Note 21 of the Notes to Consolidated
Financial Statements included in Item 8 of this Report for information
with respect to the Engle action and other litigation against cigarette
manufacturers and the State Settlement Agreements.
. Substantial annual payments by Lorillard, continuing in perpetuity, and
significant restrictions on marketing and advertising agreed to under the
terms of the State Settlement Agreements. The `State Settlement Agreements
impose a stream of future payment obligations on Lorillard and the other
major U.S. cigarette manufacturers and place significant restrictions on
their ability to market and sell cigarettes. The Company believes that the
implementation of the State Settlement Agreements will materially
adversely affect its consolidated results of operations and cash flows in
future periods. The degree of the adverse impact will depend, among other
things, on the rates of decline in U.S. cigarette sales in the premium and
discount segments, Lorillard's share of the domestic premium and discount
segment, and the effect of any resulting cost advantage of manufacturers
not subject to all of the payments of the State Settlement Agreements.
. On October 27, 2003, RJR, the second largest cigarette manufacturer in the
United States, and British American Tobacco announced that they have
agreed to combine the U.S. tobacco business of RJR with British American
Tobacco's U.S. tobacco business, B&W, the third largest cigarette
manufacturer in the United States. The closing of this combination is
subject to various conditions, including regulatory approvals. If
completed, the consolidation of these two competitors would result in
further concentration of the U.S. tobacco industry, with the top two
companies, Philip Morris USA and the newly created Reynolds American,
having a combined market share of approximately 80%. In addition, this
transaction would combine in one company the third and fourth leading
menthol brands, Kool and Salem, which have a combined share of the menthol
segment of approximately 21%. This concentration of U.S. market share
could make it more difficult for Lorillard and others to compete for shelf
space in retail outlets and could impact price competition among menthol
brands, either of which could have a material adverse effect on the
results of operations and financial condition of the Company.
. The continuing contraction of the U.S. cigarette market, in which
Lorillard currently conducts its only significant business. As a result of
price increases, restrictions on advertising and promotions, increases in
regulation and excise taxes, health concerns, a decline in the social
acceptability of smoking, increased pressure from anti-tobacco groups and
other factors, U.S. cigarette shipments among major U.S. cigarette
manufacturers have decreased at a compound annual rate of approximately
2.4% over the period 1983 through 2003 and approximately 4.3% over the
period from 1999 through 2003, as measured by MSAI. In 2003, domestic U.S.
cigarette industry volume declined by 5.1% as compared to 2002,
according to information provided by MSAI.
. Competition from deep discounters who enjoy competitive cost and pricing
advantages because they are not subject to the same payment obligations
under the State Settlement Agreements as Lorillard. Market share for
73
the deep discount brands decreased 0.30 share points from 8.40% in the
fourth quarter of 2002 to 8.10% in the fourth quarter of 2003, as
estimated by MSAI. In 2003, deep discount price brands increased their
market share by 0.64 share points to 8.32% as compared to 2002.
Lorillard's focus on the premium market and its obligations under the
State Settlement Agreements make it very difficult to compete successfully
in the deep discount market.
. Increases in industry-wide promotional expenses and sales incentives
implemented in response to declining unit volume, state excise tax
increases and increased competition among the four largest cigarette
manufacturers, including Lorillard, and smaller participants who have
gained market share in recent years, principally in the deep-discount
cigarette segment. As a result of increased competition based on the
retail price of brands and the related increased market share of deep
discounters described in the immediately preceding bullet, the ability of
Lorillard and the other major manufacturers to raise prices has been
adversely affected. In light of this environment, Lorillard has not
increased its wholesale prices since March of 2002. Increases by
manufacturers in wholesale and retail price promotional allowances also
effectively reduce the prices of many key brands. On May 5, 2003,
Lorillard lowered the wholesale list price of its discount brand,
Maverick, by $55.00 per thousand cigarettes ($1.10 per pack of 20
cigarettes) in an effort to reposition the brand to be more competitive in
the deep discount cigarette segment. Certain of Lorillard's major
competitors continue to promote their products through the use of
restrictive merchandising programs that Lorillard believes impede its
ability to compete for shelf space in retail outlets and make it difficult
to effectively communicate its promotions to consumers.
. Cigarettes are subject to substantial federal, state and local excise
taxes which are reflected in the retail price of cigarettes. These taxes
have increased substantially. In 1999, federal excise taxes were $0.24 per
pack and state excise taxes ranged from $0.025 to $1.00 per pack. In 2003,
federal excise taxes were $0.39 per pack and state excise taxes ranged
from $0.025 to $3.00 per pack. State excise tax increases ranging from
$0.09 per pack to $0.70 per pack have been implemented during 2003.
Proposals have been made and/or are pending to increase federal and
further increase 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
priced discount cigarettes rather than premium brands.
. Increases in actual and proposed state and local regulation of the tobacco
industry relating to the manufacture, sale, distribution, advertising,
labeling and use of tobacco products and government restrictions on
smoking.
. Substantial and increasing regulation of the tobacco industry and
governmental restrictions on smoking, including recent proposals to enact
legislation to grant the Food and Drug Administration ("FDA") authority to
regulate tobacco products under the Federal Food, Drug and Cosmetic Act.
Lorillard believes that the FDA proposals would, among other things,
provide Philip Morris with a competitive advantage.
. 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.
Loews Hotels
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
2003 Compared with 2002
Revenues increased by $19.6 million, or 7.4%, and income from continuing
operations increased by $2.5 million in 2003, as compared to 2002.
Revenues increased in 2003, as compared to 2002, due primarily to an
increase in revenue per available room, higher other hotel operating revenues,
and an increase in equity income from the Universal Orlando properties
reflecting the
74
opening of the Royal Pacific Hotel. Revenue per available room increased by
$6.73 or 5.7%, to $125.35, due to increased occupancy and average room rates.
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 in 2003 includes a gain from the sale of the Metropolitan Hotel
of approximately $56.7 million ($90.2 million pretax) reported as discontinued
operations. Income from continuing operations increased in 2003 due to the
increase in revenue per available room discussed above, partially offset by
higher operating costs and advertising expenses.
2002 Compared with 2001
Revenues and net income decreased by $14.0 and $6.3 million, or 5.0% and
42.0%, respectively, in 2002 as compared to 2001.
Revenues decreased in 2002 as compared to 2001, due primarily to a decline
in revenue per available room, reduced investment income, and lower other
hotel operating revenues. Revenue per available room decreased by $5.09, or
4.1%, to $118.63 due primarily to lower average room rates and reflects the
continued economic weakness and its impact on the travel industry.
Net income decreased in 2002 due to the lower revenues and pre-opening costs
incurred related to the Royal Pacific Hotel at Universal Orlando, partially
offset by improved operating results at the Universal Orlando properties and
lower interest expense.
Diamond Offshore
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 54% owned subsidiary of the Company.
Diamond Offshore's revenues vary based upon demand, which affects the number
of days the fleet is utilized and the dayrates earned. When a rig is idle,
generally no dayrate is earned and revenues will decrease. Revenues can also
increase or decrease as a result of the acquisition or disposal of rigs,
required surveys and shipyard upgrades. In order to improve utilization or
realize higher dayrates, Diamond Offshore may mobilize its rigs from one
market to another. During periods of unpaid mobilization, however, revenues
may be adversely affected. In response to changes in demand, Diamond Offshore
may withdraw a rig from the market by cold stacking it or may reactivate a rig
stacked previously, which may decrease or increase revenues, respectively.
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 in excess of costs incurred to mobilize an
offshore 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. Diamond Offshore has elected not to pursue contracts for
integrated services, which includes turnkey contracts, except in very limited
circumstances.
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 or "ready
stacked" 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
75
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.
Operating income is also negatively impacted when Diamond Offshore performs
certain regulatory inspections that are due every five years ("5-year survey")
for all of Diamond Offshore rigs. Operating revenue decreases because these
surveys are performed during scheduled down-time in a shipyard. Operating
expenses increase as a result of these surveys due to the cost to mobilize the
rigs to a shipyard, inspection costs incurred and repair and maintenance
costs. Repair and maintenance costs may be required resulting from the survey
or may have been previously planned to take place during this mandatory down-
time. The number of rigs undergoing a 5-year survey will vary from year to
year.
2003 Compared with 2002
Revenues decreased by $89.0 million, or 11.4%, in 2003, as compared to 2002.
Net loss in 2003 was $27.2 million, compared to net income of $14.1 million in
2002. Revenues in 2003 decreased due primarily to lower contract drilling
revenues of $72.1 million, losses on sales of marketable securities, as
compared to gains in the prior year, and reduced investment income.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $58.1 million in 2003, as compared to 2002. The decrease reflects
a decline in dayrates of $81.5 million and decreased utilization of $8.6
million, partially offset by revenues generated by the recent additions of the
Ocean Patriot and the Ocean Vanguard and the July 2003 completion of the
upgrade to high specification capabilities of the Ocean Rover amounting to
$25.4 million in 2003.
Revenues from jack-up rigs decreased $1.6 million, or 11.3%, in 2003 due
primarily to decreased utilization of $6.3 million, partially offset by
increased dayrates of $4.7 million as compared to 2002.
Investment income decreased by $17.8 million, or 59.7%, primarily due to
lower yields on cash and marketable securities and a reduction in invested
cash balances in 2003, as compared to 2002.
Net income decreased in 2003 due primarily to the lower dayrates earned by
semisubmersible rigs, losses on sales of marketable securities as compared to
gains in 2002, lower investment income and increased contract drilling
expenses. Results for 2003 were also negatively impacted by a reduced tax
benefit related to losses incurred by Diamond Offshore's rigs operating in
international markets, partially offset by lower depreciation expense.
In April of 2003, Diamond Offshore commissioned a study to evaluate the
economic lives of its drilling rigs. As a result of this study, Diamond
Offshore recorded changes in accounting estimates by increasing the estimated
service lives to 25 years for jack-ups and 30 years for semisubmersibles and
Diamond Offshore's drillship and by increasing salvage values to 5.0% for most
of its drilling rigs. The change in estimate was made to better reflect the
remaining economic lives and salvage values of Diamond Offshore's fleet. The
effect of this change in accounting estimate resulted in an increase to net
income of $10.2 million (after tax and minority interest) for the year ended
December 31, 2003.
2002 Compared with 2001
Revenues decreased by $197.2 million, or 20.1% and net income decreased by
$56.9 million, or 80.1%, respectively, in 2002 as compared to 2001. Revenues
decreased due primarily to lower contract drilling revenue of $161.1 million,
reduced investment income of $18.9 million, and lower revenues from
reimbursable expenses.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $95.4 million, or 9.7% in 2002 as compared to 2001. The decrease
reflects lower average dayrates ($60.7 million) and lower utilization ($70.4
million) partially offset by revenues generated by the Ocean Baroness ($35.7
million), which completed a conversion to a high specification semisubmersible
drilling unit and commenced operations in March of 2002.
Revenues from jack-up rigs decreased by $75.1 million, or 7.7%, due
primarily to decreased dayrates ($48.6 million) and lower utilization ($26.5
million) in 2002. Interest income decreased by $18.9 million, or 1.9%, in 2002
primarily due to a reduction in marketable securities held and lower interest
rates earned on cash and marketable securities in 2002 compared to 2001.
76
Net income decreased due primarily to the reduced revenues in 2002 as
discussed above, partially offset by lower interest expenses related to a
premium paid on early extinguishment of debt in 2001.
Texas Gas
Revenues and net income in 2003 reflect operations from May 17, 2003, the
date of acquisition. See Note 14 of the Notes to Consolidated Financial
Statements.
Bulova
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
2003 Compared with 2002
Revenues increased by $0.2 million, or 0.1%, in 2003 as compared to 2002.
Revenues increased due to higher levels of other income, partially offset by a
reduction in net sales. The decline in net sales reflects lower watch and
clock sales volume, partially offset by an increase in watch and clock unit
selling prices and improvements in the Accutron and Harley Davidson product
lines. Net income was consistent with the prior year due to a reduction in
environmental remediation costs and a lower effective income tax rate
resulting from a tax settlement, offset by increased production and other
operating costs.
2002 Compared with 2001
Revenues and net income increased by $19.5 and $1.7 million, or 13.3% and
16.8%, respectively, in 2002 compared to 2001. Revenues and net income
increased primarily as a result of the addition of the Wittnauer watch brand,
acquired in 2001, and the commencement in 2002 of the Harley Davidson watch
line resulting from a licensing agreement signed in 2001. An increase in clock
unit volume sales, partially offset by a decrease in Bulova's watch brand unit
volume, also contributed to the increase in revenues and net income. These
increases were partially offset by lower royalty income of $0.7 million and
decreased interest income of $0.7 million in 2002.
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 four 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 gains (losses) included in Corporate operations
are as follows:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Derivative instruments $ 32.0 $(14.1) $ 18.2
Equity securities, including short positions 86.4 (41.2) 69.1
Short-term investments (20.0) 73.3 28.5
Other 10.1 25.5 12.6
- ------------------------------------------------------------------------------------------------
108.5 43.5 128.4
Income tax expense (38.0) (16.1) (45.0)
Minority interest 2.1 (11.1) (8.3)
- ------------------------------------------------------------------------------------------------
Net gain $ 72.6 $ 16.3 $ 75.1
================================================================================================
77
2003 Compared with 2002
Exclusive of investment gains, revenues decreased by $29.0 million and net
loss increased by $17.9 million in 2003, as compared to 2002.
Revenues decreased in 2003 due primarily to lower investment income of $30.1
million, partially offset by higher results from shipping operations of $4.7
million. Net loss increased due to reduced investment income of $20.4 million,
partially offset by increased results from shipping operations of $3.2 million
in 2003. The decrease in investment income is primarily due to lower yields on
invested balances and a reduced investment portfolio reflecting the $528.7
million cash outlay in May of 2003 to acquire Texas Gas, partially offset by
dividends received from subsidiaries.
2002 Compared with 2001
Exclusive of investment gains (losses), revenues decreased $81.5 million and
net loss increased $51.3 million in 2002 compared to 2001. Revenues declined
due primarily to lower results from Majestic of $41.7 million reflecting
reduced demand and charter rates in the crude oil tanker markets, and lower
investment income of $41.6 million relating to reduced yields from invested
assets. The impact of the lower results from shipping operations and
investment income increased the net loss by $35.4 and $21.9 million,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
CNA Financial
Cash Flows
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 year ended December 31, 2003, net cash provided by operating
activities was $1,760.0 million as compared with net cash provided by
operating activities of $1,040.0 million in 2002. The increase in cash
provided by operating activities related primarily to a decrease in paid
claims and increased net premium collections in 2003 as compared with 2002.
For the year ended December 31, 2002, net cash provided by operating
activities was $1,040.0 million as compared with net cash used of $599.0
million in 2001. The improvement related primarily to federal tax refunds
received in 2002 as compared to taxes paid in 2001 and decreased net payments
for insurance claims.
Cash flows from investing activities include purchases and sales of
financial instruments, as well as the purchase and sale of businesses, land,
buildings, equipment and other assets not generally held for resale.
For the year ended December 31, 2003, net cash used for investing activities
was $2,133.0 million as compared with $1,488.0 million in 2002. Cash flows
used for investing related principally to purchases of fixed maturity
securities.
For the year ended December 31, 2002, net cash used for investing activities
was $1,488.0 million as compared with net cash used of $205.0 million in 2001.
Cash flows used by investing activities were related principally to increased
purchases of invested assets due to positive operating cash flow and cash
provided by financing activities.
Cash flows from financing activities include proceeds from the issuance of
debt or equity securities, outflows for repayment of debt and outlays to
reacquire equity instruments.
For the year ended December 31, 2003, net cash provided from financing
activities was $386.0 million as compared with $432.0 million in 2002. For the
year ended December 31, 2002, net cash provided from financing activities was
$432.0 million as compared with $783.0 million in 2001.
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.
78
CNA does not anticipate any liquidity problems resulting from these payments.
As of December 31, 2003, CNA has paid $712.0 million in claims and recovered
$436.0 million from reinsurers.
CNA's estimated gross pretax losses for the WTC event recorded in 2001, were
$1,648.0 million pretax ($958.3 million after-tax and minority interest). Net
pretax losses before the effect of corporate aggregate reinsurance treaties
were $727.0 million. Approximately 1.0%, 60.0% and 33.0% 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.
Effective January 30, 2001, CNA sold the 180 Maiden Lane, New York,
facility. The sale of this property provided additional liquidity to CNA with
net sale proceeds of $264.0 million.
Debt
CNA has a $250.0 million three-year bank credit facility with an April 30,
2004 expiration date. CNA has adequate capital resources to fund this
obligation.
CNA pays a facility fee to the lenders for having funds available for loans
under the three-year credit facility maturing April 30, 2004. The fee varies
based on the long term debt ratings of CNA. At December 31, 2003, the facility
fee on the three-year component was 25.0 basis points.
CNA pays interest on any outstanding debt/borrowings under the three-year
facility based on a rate determined using the long term debt ratings of CNA.
The interest rate is equal to the London Interbank Offering Rate ("LIBOR")
plus 75.0 basis points. Further, if CNA has outstanding loans greater than
50.0% of the amounts available under the three-year facility, CNA will also
pay a utilization fee of 12.5 basis points on such loans. At December 31, 2003
and 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 ("Moody's") downgrade of the CNA senior debt
rating from Baa2 to Baa3 on November 12, 2003, increased the facility fee on
the three-year component of the facility from 17.5 basis points to 25.0 basis
points. The applicable interest rate increased from LIBOR plus 57.5 basis
points to LIBOR plus 75.0 basis points. The utilization fee remained unchanged
on the three-year facility at 12.5 basis points.
On September 30, 2003, CNA Surety Corporation ("CNA Surety"), a 64.0% owned
and consolidated subsidiary of CNA, entered into a $50.0 million credit
agreement, which consisted of a $30.0 million, two-year revolving credit
facility and a $20.0 million two-year term loan, payable semi-annually at a
rate of $5.0 million. The credit agreement is an amendment to a $65.0 million
credit agreement, extending the revolving loan termination date from September
30, 2003 to September 30, 2005. The new revolving credit facility was fully
utilized at inception.
Under the new credit facility agreement, CNA Surety pays a facility fee of
35.0 basis points, interest at LIBOR plus 90 basis points, and for utilization
greater than 50.0% of the amount available to borrow an additional fee of 5.0
basis points. On the term loan, CNA Surety pays interest at LIBOR plus 62.5
basis points. At December 31, 2003, the weighted-average interest rate on the
$50.0 million of outstanding borrowings under the credit agreement, including
facility fees and utilization fees was 2.6%. Effective January 30, 2003, CNA
Surety entered into a swap agreement on the term loan portion of the agreement
which uses the 3-month LIBOR to determine the swap increment. As a result, the
effective interest rate on the $20.0 million in outstanding borrowings on the
term loan was 2.8% at December 31, 2003. On the $30.0 million revolving credit
agreement, the effective interest rate at December 31, 2003 was 2.6%.
The terms of CNA's and CNA Surety's credit facilities require CNA and CNA
Surety to maintain certain financial ratios and combined property and casualty
company statutory surplus levels. At December 31, 2003 and 2002, CNA and CNA
Surety were in compliance with all restrictive debt covenants, except for the
fixed charge coverage ratio which CNA Surety obtained a waiver from the
lenders effective September 30, 2003. The lenders amended the CNA Surety
Credit Facility to replace the fixed charge coverage ratio. As a result, CNA
and CNA Surety were in compliance with all restrictive debt covenants at
December 31, 2003.
Related Parties
CNA has entered into a credit agreement with a large national contractor
that undertakes projects for the construction of government and private
facilities. CNA Surety has provided significant
79
surety bond protection for projects by this contractor through surety bonds
underwritten by CCC or its affiliates to provide an $86.4 million credit
facility. The loans were provided by CNA to help the contractor meet its
liquidity needs. The credit facility and all loans under it will mature in
March of 2006. Advances under the credit facility bear interest at the prime
rate plus 6.0%. 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.
Loews and CNA have entered into a participation agreement, pursuant to which
Loews has purchased a participation interest in one-third of the loans and
commitments under the credit facility, on a dollar-for-dollar basis, up to a
maximum of $25.0 million. Although Loews does not have rights against the
contractor directly under the participation agreement, it shares recoveries
and certain fees under the facility proportionally with CNA.
In March of 2003, CNA purchased the contractor's outstanding bank debt for
$16.4 million. The contractor purchased the bank debt and retried it, with
$11.4 million of the purchase price being funded under the new credit facility
and $5.0 million from money loaned to the contractor by its shareholders.
Under its purchase agreement with the banks, CNA is also required to reimburse
the banks for any draws upon outstanding letters of credit issued by the banks
for the contractor's benefit. Of these letters of credit, a replacement due to
expire in August of 2004 remains in the amount of $3.4 million. Any CNA
reimbursements for draws upon the banks' letters of credit will become
obligations of the contractor to CNA as draws upon the credit facility. As of
December 31, 2003, $80.0 million was outstanding under the Credit Facility,
including deferred interest. As of February 27, 2004, $83.0 million was
outstanding under the credit facility, including deferred interested.
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 to CNA Surety arising from bonds issued to the contractor or assumed
are excluded from CNA Surety's $40.0 million excess of $20.0 million per
principal reinsurance program with unaffiliated reinsurers in place in 2002.
As a result, CNA Surety retains the first $60.0 million of losses on bonds
written with an effective date of September 30, 2002 and prior, and CCC will
incur 100.0% 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
October 31, 2003 has been limited to $20.0 million per bond. For bonds written
subsequent to November 1, 2003, and for bonds CNA Surety may write in 2004.
CNA Surety's exposure is limited to $14.5 million per bond subject to an
aggregate limit of $150.0 million under all such reinsurance contracts.
Effective January 1, 2004, CCC and CNA Surety entered into a $40.0 million
excess of $60.0 million reinsurance contract that provides coverage to CNA
Surety exclusively for the contractor. This reinsurance will be in effect
through December 31, 2004. The premium for this contract is $3.0 million, plus
an additional premium if a loss is ceded under it. Effective January 1, 2004
through December 31, 2004, CNA Surety and CCC also entered into a $50.0
million excess of $100.0 million contract that provides coverage to CNA Surety
for the contractor, as well as other CNA Surety risks. The premium for this
contract is $6.0 million plus an additional premium if a loss is ceded to this
contract.
Indemnification and subrogation rights, including rights to contract
proceeds on construction projects in the event of default, exist that reduce
CNA Surety's and ultimately CNA's exposure to loss. While CNA believes that
the contractor's restructuring efforts may be successful and provide
sufficient cash flow for its operations, the contractor's failure to achieve
its restructuring plan or perform its contractual obligations under the credit
facility and underlying all of CNA's surety bonds could have a material
adverse effect on the Company'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 minority interest could be up to $200.0
million. In addition, such failures could cause the full amount due under the
credit facility to be uncollectible.
Commitments, Contingencies and Guarantees
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. At December 31, 2003 and 2002 there were approximately $58.0
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
80
would be required to make payment on the letters of credit in question if the
primary obligor drew down on these letters of credit and failed to repay such
loans in accordance with the terms of the letters of credit. The maximum
potential amount of future payments that CNA could be required to pay under
these guarantees is approximately $30.0 million at December 31, 2003.
As of December 31, 2003 and 2002, CNA had committed approximately $154.0 and
$141.0 million to 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 had committed
approximately $51.0 million as of December 31, 2003 to future capital calls
from certain of its unconsolidated affiliates in exchange for an ownership
interest in such affiliates.
CNA holds an investment in a real estate joint venture that is accounted for
on the equity basis of accounting. In the normal course of business, CNA on a
joint and several basis with other unrelated insurance company shareholders
have committed to continue funding the operating deficits of this joint
venture. Additionally, CNA and the other unrelated shareholders, on a joint
and several basis, have guaranteed an operating lease for an office building,
which expires in 2016.
The guarantee of the operating lease is a parallel guarantee to the
commitment to fund operating deficits; consequently, the separate guarantee to
the lessor is not expected to be triggered as long as the joint venture
continues to be funded by its shareholders and continues to make its annual
lease payments.
In the event that the other parties to the joint venture are unable to meet
their commitments in funding the operations of this joint venture, CNA would
be required to assume the obligation for the entire office building operating
lease. The maximum potential future lease payments at December 31, 2003 that
CNA could be required to pay under this guarantee is approximately $347.0
million. If CNA was required to assume the entire lease obligation, CNA would
have the right to pursue reimbursement from the other shareholders and would
have the right to all sublease revenues.
CNA invests in multiple bank loan participations as part of its overall
investment strategy and has committed to additional future purchases and
sales. The purchase and sale of these investments are recorded on the date
that the legal agreements are finalized and cash settlement is made. As of
December 31, 2003, CNA had commitments to purchase $53.0 million and
commitments to sell $1.0 million of various bank loan participations.
In the course of selling business entities and assets to third parties, CNA
has agreed to indemnify purchasers for losses arising out of breaches of
representation and warranties with respect to the business entities or assets
being sold, including, in certain cases, losses arising from undisclosed
liabilities or certain named litigation. Such indemnification provisions
generally survive for periods ranging from nine months following the
applicable closing date to the expiration of the relevant statutes of
limitation. As of December 31, 2003, the aggregate amount of quantifiable
indemnification agreements in effect for sales of business entities and assets
was $580.0 million.
In addition, CNA has agreed to provide indemnification to third party
purchasers for certain losses associated with sold business entities or assets
that are not limited by a contractual monetary amount. As of December 31,
2003, CNA had outstanding unlimited indemnifications in connection with the
sales of certain of its business entities or assets for tax liabilities
arising prior to a purchaser's ownership of an entity or asset, defects in
title at the time of sale, employee claims arising prior to closing and in
some cases losses arising from certain litigation and undisclosed liabilities.
These indemnification agreements survive until the applicable statutes of
limitation expire, or until the agreed upon contract terms expire. As of
December 31, 2003, CNA has recorded approximately $16.0 million of liabilities
related to these indemnification agreements.
Cash and securities with carrying values of approximately $22.0 and $37.0
million were deposited with financial institutions as collateral for letters
of credit as of December 31, 2003 and 2002. In addition, cash and securities
were deposited in trusts with financial institutions to secure reinsurance
obligations with various third parties. The carrying values of these deposits
were approximately $118.0 and $70.0 million as of December 31, 2003 and 2002.
81
Regulatory Matters
CNA has established a plan to reorganize and streamline its U.S. property
and casualty insurance legal entity structure. One phase of this multi-year
plan was completed during 2003. This phase served to consolidate CNA's U.S.
property and casualty insurance risks into CCC, as well as realign the capital
supporting these risks. As part of this phase, CNA implemented in the fourth
quarter a 100.0% quota share reinsurance agreement, effective January 1, 2003,
ceding all of the net insurance risks of CIC and its 14 affiliated insurance
companies ("CIC Group") to CCC. Additionally, the ownership of the CIC Group
was transferred to CCC in the fourth quarter in order to properly align the
insurance risks with the supporting capital. In subsequent phases of this
plan, CNA will continue its efforts to reduce both the number of U.S. property
and casualty insurance entities it maintains and the number of states in which
such entities are domiciled. In order to facilitate the execution of this
plan, CNA, CCC and CIC have agreed to participate in a working group
consisting of several states of the National Association of Insurance
Commissioners.
In connection with the approval process for aspects of the reorganization
plan, CNA has agreed to undergo a state regulatory financial examination of
CIC as of December 31, 2003, including a review of insurance reserves by an
independent actuarial firm. CCC is also scheduled to undergo its routine state
regulatory financial examination as of December 31, 2003.
Pursuant to its participation in the working group referenced above, CNA has
agreed to certain time frames and informational provisions in relation to the
reorganization plan. CNA has also agreed that any proceeds from the sale of
any member of the CIC pool, net of transaction expenses, will be retained in
CIC or one of its subsidiaries until the dividend stipulation discussed below
expires.
Ratings
Ratings are an 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.
The actions that can be taken by rating agencies are changes in ratings or
modifiers. "On Review," "Credit Watch" and "Rating Watch" are modifiers used
by the ratings agencies to alert those parties relying on CNA's ratings of the
possibility of a rating change in the near term. Modifiers are utilized when
the agencies are uncertain as to the impact of a Company action or initiative,
which could prove to be material to the current rating level. Modifiers are
generally used to indicate a possible change in rating within 90 days.
"Outlooks" accompanied with ratings are additional modifiers used by the
rating agencies to alert those parties relying on CNA's ratings of the
possibility of a rating change in the longer term. The time frame referenced
in an outlook is not necessarily limited to ninety days as defined in the
Credit-Watch category.
The table below reflects the various group ratings issued by A.M. Best, S&P,
Moody's and Fitch as of February 12, 2004 for the Property and Casualty and
Life companies. The table also includes the ratings for CNA's senior debt and
Continental senior debt.
Insurance Financial Strength Ratings Debt Ratings
----------------------------------------------------------------------
Property & Casualty(a) Life CNA Continental
----------------------------------------------------------------------
CCC CIC Senior Senior
Group Group CAC(b) VFL(c) Debt Debt
----------------------------------------------------------------------
A.M. Best A A A- A bbb bbb-
Fitch A- A- A- A+ BBB- BBB-
Moody's A3 A3 Baa1 Baa1 Baa3 Baa3
S&P A- A- A A BBB- BBB-
82
(a) All modifiers for the property & casualty companies' insurance financial strength and
holding company debt ratings as evaluated by S&P are Credit Watch with negative
implications; the property & casualty companies' financial strength and holding company
debt ratings have a negative outlook from A. M. Best, Fitch and Moody's.
(b) S&P's modifier to CAC's rating is Credit Watch with negative implications; A.M. Best and
Moody's have a stable outlook while Fitch has a negative outlook on the CAC rating.
(c) VFL's rating modifiers are Under Review with Developing Implications, Rating Watch
Positive, On Review for Upgrade and Credit Watch Developing by A.M. Best, Fitch, Moody's
and S&P.
Following the February 5, 2004 announcement regarding the sale of CNA's
individual life and annuity business and the decision to cease new sales in
the structured settlement and institutional market business, the following
rating actions were taken on CNA's life insurance companies:
A.M. Best lowered the rating of CAC from A to A- and established a stable
outlook. VFL's rating outlook was changed from Negative to an Under Review
with Developing Implications. Fitch lowered the rating of CAC from A+ to A-
and kept a negative outlook. VFL's rating outlook was changed from Negative to
Rating Watch Positive. Moody's retained their Baa1 ratings on CAC and VFL. The
rating agency changed CAC's outlook from negative to stable and placed VFL's
rating On Review for Upgrade. Standard & Poor's did not change their A ratings
on CAC and VFL, but revised VFL's modifier to CreditWatch Developing from
CreditWatch with Negative Implications.
If CNA's insurance financial strength ratings were downgraded below current
levels,. CNA's business and the Company's results of operations could be
materially adversely affected. The severity of the impact on CNA's business is
dependent on the level of downgrade and, for certain products, which rating
agency takes the rating action. Among the adverse effects in the event of such
downgrading would be the inability to obtain a material volume of business
from certain major insurance brokers, the inability to sell a material volume
of CNA's insurance products to certain markets, and the required
collateralization of certain future payment obligations or reserves.
The Institutional Markets business unit of Group Operations, which was not
included in the sale of CNA's group benefits business to Hartford and provides
investment products to pension plan sponsors and other institutional
customers, would be significantly impacted by a downgrade of CAC/VFL.
CNA has entered into several settlement agreements and assumed reinsurance
contracts that require collateralization of future payment obligations and
assumed reserves if CNA's ratings or other specific criteria fall below
certain thresholds. The ratings triggers are generally more than one level
below CNA's February 12, 2004 ratings.
Dividend Paying Ability
CNA's ability to pay dividends and other credit obligations is significantly
dependent on receipt of dividends from its subsidiaries. The payment of
dividends to CNA by its insurance subsidiaries without prior approval of the
insurance department of each subsidiary's domiciliary jurisdiction is limited
by formula. Dividends in excess of these amounts are subject to prior approval
by the respective state insurance departments.
Dividends from CCC are subject to the insurance holding company laws of the
State of Illinois, the domiciliary state of CCC. Under these laws, ordinary
dividends, or dividends that do not require prior approval of the Illinois
Department of Insurance (the "Department"), may be paid only from earned
surplus, which is calculated by removing unrealized gains from unassigned
surplus. As of December 31, 2003, CCC is in a negative earned surplus
position. Until CCC is in a positive earned surplus position, all dividends
require prior approval of the Department. In January of 2004, the Department
approved an extraordinary dividend capacity in the amount of approximately
$312.0 million to be used to fund the CNA's 2004 debt service and principal
repayment requirements.
By agreement with the New Hampshire Insurance Department, the CIC Group may
not pay dividends to CCC until after January 1, 2006.
CNA's domestic insurance subsidiaries are subject to risk-based capital
requirements. Risk-based capital is a method developed by the NAIC to
determine the minimum amount of statutory capital appropriate for an insurance
company to support its overall business operations in consideration of its
size and risk profile. The formula for determining the amount of risk-based
capital specifies various factors, weighted based on the perceived degree of
risk, which are applied
83
to certain financial balances and financial activity. The adequacy of a
company's actual capital is evaluated by a comparison to the risk-based
capital results, as determined by the formula. Companies below minimum risk-
based capital requirements are classified within certain levels, each of which
requires specified corrective action. As of December 31, 2003 and 2002, all of
CNA's domestic insurance subsidiaries exceeded the minimum risk-based capital
requirements.
Lorillard
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. 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.
Lorillard believes that it has valid defenses to the cases pending against
it. Lorillard also believes it has valid bases for appeal of the adverse
verdicts against it. To the extent the Company is a defendant in any of the
lawsuits, the Company believes that it is not a proper defendant in these
matters and has moved or plans to move for dismissal of all such claims
against it. While Lorillard intends to defend vigorously all tobacco products
liability litigation, it is not possible to predict the outcome of any of this
litigation. Litigation is subject to many uncertainties, and it is possible
that some of these actions could be decided unfavorably. Lorillard may enter
into discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
On May 21, 2003 the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeals also decertified the class
ordered during pre-trial proceedings. Plaintiffs are seeking review of the
case by the Florida Supreme Court. The Company and Lorillard believe that the
appeals court's decision should be upheld upon further appeals.
Except for the impact of the State Settlement Agreements as described in
Note 21 of the Notes to Consolidated Financial Statements included in Item 8
of this Report, management is unable to make a meaningful estimate of the
amount or range of loss that could result from an unfavorable outcome of
pending litigation and, therefore, no provision has been made in the
consolidated financial statements for any unfavorable outcome. It is possible
that the Company's results of operations, cash flows and its financial
position could be materially adversely 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 2003 was
approximately $800.0 million.
See Item 3 - Legal Proceedings and Note 21 of the Notes to Consolidated
Financial Statements included in Item 8 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 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 for the
agreement by B&W and its affiliates to terminate all rights to use the
Lorillard name within 18 months.
On May 16, 2003, Lorillard and several other tobacco manufacturers and
tobacco leaf buyers, with the exception of R.J. Reynolds reached a settlement
with a class of U.S. tobacco growers and quota holders who filed suit alleging
antitrust violations in the purchasing of domestic tobacco leaf. Pursuant to
the settlement agreement, Lorillard has paid $20.0 million, and it will pay an
additional $7.5 million immediately before any trial against R.J. Reynolds or
five days after any settlement with R.J. Reynolds has been approved by the
court. In addition, Lorillard has committed to buy 20 million pounds of
domestic tobacco each year through 2013. Lorillard has also committed to
purchase at least 35% of its annual total requirements for flue-cured and
burley tobacco domestically for the same period.
84
Lorillard's marketable securities totaled $1,530.2 and $1,640.7 million at
December 31, 2003 and 2002, respectively. At December 31, 2003, fixed maturity
securities represented 89.6% of the total investment in marketable securities,
including 31.0% invested in Treasury Bills with an average duration of
approximately 3 months, 14.6% invested in overnight repurchase agreements and
54.4% invested in money market accounts.
The principal source of liquidity for Lorillard's business and operating
needs is internally generated funds from its operations. Lorillard's operating
activities resulted in a net cash inflow of approximately $685.0 million for
the year ended December 31, 2003, compared to $852.6 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
In July of 2003 Loews Hotels sold a New York City property, the Metropolitan
Hotel, and realized a gain of $56.7 million after taxes.
Funds from operations continue to exceed operating requirements. Funds for
other capital expenditures and working capital requirements are expected to be
provided from existing cash balances and operations.
Diamond Offshore
Diamond Offshore operates in an industry that is historically extremely
competitive and deeply cyclical. The demand for its services has traditionally
been highly correlated with the price of oil and natural gas. However the rise
in product prices throughout 2002 and 2003 did not yield the expected
improvements in utilization and dayrates for Diamond Offshore's equipment.
Cash provided by operating activities was $162.4 million in 2003, compared
to $288.3 million in 2002. The decline is primarily due to reduced net income
in 2003.
In March of 2003, Diamond Offshore completed the acquisition of the third-
generation semisubmersible drilling rig, Omega, renamed the Ocean Patriot for
$65.0 million. Diamond Offshore capitalized $63.5 million to rig equipment and
recorded $1.5 million to rig inventory.
During the year ended December 31, 2003, Diamond Offshore spent $102.7
million, including capitalized interest expense, for rig upgrades. These
expenditures were primarily for the deepwater upgrade of the Ocean Rover
($67.0 million) which was completed in July 2003, upgrades to six of Diamond
Offshore's jack-ups ($35.7 million) of which three were completed during 2002,
two were completed during 2003 and one was completed early in 2004.
Diamond Offshore has budgeted approximately $15.0 million during 2004 to
upgrade one of its high specification semisubmersible units, the Ocean
America, with capabilities making it more suitable for developmental drilling.
Diamond Offshore has budgeted $66.0 million for 2004 capital expenditures
associated with ongoing rig equipment replacement and enhancement programs and
other corporate requirements.
The upgrade of the Ocean Rover, which began in January of 2002, was
completed early in July of 2003 on time and under budget. The project,
originally budgeted to cost $200.0 million was completed for approximately
$188.0 million. The rig commenced its contract with Murphy Sabah Oil Company,
Ltd. on July 10, 2003 for a minimum three well drilling program offshore
Malaysia.
During the year ended December 31, 2003, Diamond Offshore spent $105.8
million in association with its ongoing rig equipment replacement and
enhancement programs and to meet other corporate requirements. These
expenditures included purchases of drill pipe, anchor chain, riser and other
drilling equipment.
85
On October 16, 2003, Diamond Offshore announced that its quarterly cash
dividend effective December 1, 2003, will be $0.0625 per share of common
stock. The dividend rate for previous quarters this year was $0.125 per share
of common stock. Diamond Offshore elected to reduce the dividend rate in order
to help maintain its strong liquidity position in light of recent earnings
declines.
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.
Texas Gas
In May of 2003, the Company acquired Texas Gas from The Williams Companies,
Inc. The transaction value was approximately $1.05 billion, which included
$250.0 million of existing Texas Gas debt. The Company funded the
approximately $803.3 million balance of the purchase price, including
transaction costs and closing adjustments, with $528.3 million of its
available cash and $275.0 million of proceeds from an interim loan incurred at
the subsidiary level immediately after the acquisition.
Upon completion of the acquisition, TGT Pipeline, LLC, a wholly owned
subsidiary of the Company and the immediate parent of Texas Gas, issued $185.0
million of 5.2% Notes due 2018 and Texas Gas issued $250.0 million of 4.6%
Notes due 2015. The net offering proceeds of approximately $431.0 million were
used to repay the $275.0 million interim loan and to retire approximately
$132.7 million principal amount of Texas Gas's existing $150.0 million of
8.625% Notes due 2004. Texas Gas intends to use the balance of the offering
proceeds, together with cash on hand, to retire the remaining 2004 notes.
Texas Gas funds its operations and capital requirements with cash flows from
operating activities. Funds from operations from the date of acquisition
through December 31, 2003 amounted to $61.5 million. At December 31, 2003,
cash and cash equivalents amounted to $19.2 million.
Bulova
For the year ended December 31, 2003, net cash from operations was $9.4
million as compared to net cash utilized of $7.6 million in 2002. The increase
in net cash flow is primarily the result of the lower inventory purchases.
Bulova's cash and cash equivalents, and short-term investments amounted to
$16.7 million at December 31, 2003, compared to $10.1 million at December 31,
2002.
Bulova and the Company have a credit agreement, which provides for unsecured
loans to Bulova by the Company from time to time, in principal amounts
aggregating up to $50.0 million. In September of 2003, Bulova borrowed $8.0
million, which was repaid in December of 2003. Prior to September, Bulova has
not utilized the credit agreement since 1995. The credit agreement has been
periodically extended and currently expires on December 31, 2005. Funds from
the credit agreement have been utilized to fund working capital requirements,
related primarily to inventory purchases. Bulova may require additional
working capital advances under this credit agreement for its international
expansion efforts.
Majestic Shipping
During 2002 subsidiaries of Hellespont acquired from a Korean shipyard three
new 442,500 deadweight ton, ultra-large crude carrying ships. A fourth such
ship was delivered in the second quarter of 2003. These subsidiaries were
purchased by Hellespont from Majestic at the Company's carrying value,
excluding pretax capitalized interest expense of $3.1 million, in March 2002.
In partial consideration for this purchase, Hellespont issued to Majestic a
promissory note in the principal amount of $57.5 million. As of December 31,
2003, $22.2 million principal amount remains outstanding. The total cost of
the four ships delivered amounted to approximately $371.5 million. The ships
were financed in part by
86
bank debt of $200.0 million, guaranteed by Hellespont. As of December 31,
2003, $188.8 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
The parent company's cash and investments at December 31, 2003 totaled $2.2
billion, as compared to $2.3 billion at December 31, 2002. The decline was
primarily due to cash outlays of approximately $528.3 million to purchase
Texas Gas in May of 2003 and $750.0 million to purchase CNA preferred stock in
November of 2003, partially offset by dividends received from its
subsidiaries.
As previously reported, in order to assist CNA in replenishing statutory
capital adversely impacted by the 2003 charges discussed above, in November of
2003 Loews purchased $750.0 million of a new series of CNA convertible
preferred stock. Loews committed additional capital support of up to $500.0
million by February 27, 2004 through the purchase of surplus notes of CCC in
the event certain additions to CCC's statutory capital are not achieved
through asset sales. In addition, Loews committed to an additional $150.0
million of capital support by March 31, 2004, in a form to be determined.
In February of 2004, the Company purchased $345.6 million of surplus notes
from CCC to increase CCC's statutory capital, of which $45.6 million was
purchased in connection with CNA's sale of its group benefits business and
$300.0 million was purchased since CNA did not sell its individual life
business prior to that time. However, CNA recently entered into an agreement,
which is subject to customary closing conditions and regulatory approvals, to
sell its individual life business and has estimated that this sale will result
in an addition to CCC's statutory surplus in excess of $400.0 million. If,
this sale is consummated, and the sale results in an increase in CCC's
statutory capital of $300.0 million or more, CNA has stated its intention to
seek approval from the insurance regulatory authority for the repayment of the
surplus notes purchased in relation to such sale, although no assurance can be
given that sale of the individual life business will be consummated or that
the regulatory approval will be obtained.
In December of 2002, the Company purchased from CNA $750.0 million of CNA
series H cumulative preferred stock (the "Preferred Issue"). CNA used $250.0
million of the proceeds from the Preferred Issue to prepay a $250.0 million
one-year bank term loan due April 29, 2003 and an additional $250.0 million
was contributed to CCC to improve its statutory surplus.
CNA completed a common stock rights offering in September of 2001,
successfully raising $1,006.0 million (40.3 million shares sold at $25.00 per
share). The Company purchased 38.3 million shares issued in connection with
the rights offering for $957.0 million.
The Company has an effective Registration Statement on Form S-3 registering
the future sale of its debt and/or equity securities, As of February 20, 2004,
approximately $1.1 billion of securities were available for issuance under
this shelf registration statement.
As of December 31, 2003, there were 185,447,050 shares of Loews common stock
outstanding and 57,965,000 shares of Carolina Group 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. These include the expansion of
existing businesses, full or partial acquisitions and dispositions, and
opportunities for efficiencies and economies of scale.
87
Contractual Cash Payment Obligations
The Company's contractual cash payment obligations are as follows:
Payments Due by Period
---------------------------------------------------------
Less than More than
December 31, 2003 Total 1 year 1-3 years 4-5 years 5 years
- ------------------------------------------------------------------------------------------------
Long-term debt $ 5,842.1 $ 293.2 $ 1,206.5 $1,523.5 $ 2,818.9
Capital lease obligations 33.2 2.7 6.4 8.1 16.0
Operating leases 472.0 81.9 128.5 90.0 171.6
Performance, bid customs and export 69.0 34.9 26.5 7.6
- ------------------------------------------------------------------------------------------------
Total $ 6,416.3 $ 412.7 $ 1,367.9 $1,629.2 $ 3,006.5
================================================================================================
In addition, as previously discussed, Lorillard has entered into the State
Settlement Agreements which impose a stream of future payment obligations on
Lorillard and the other major U.S. cigarette manufacturers. Lorillard's
portion of ongoing adjusted settlement payments and related legal fees are
based on its share of domestic cigarette shipments in the year preceding that
in which the payment is due. Payment obligations are not incurred until the
related sales occur.
INVESTMENTS
Investment activities of non-insurance companies include investments in
fixed income securities, equity securities including short sales, derivative
instruments and short-term investments, and are carried at fair value. Equity
securities, which are considered part of the Company's trading portfolio,
short sales and derivative instruments are marked to market and reported as
investment gains or losses in the Consolidated Statements of Operations.
The Company enters into short sales and invests in certain derivative
instruments for a number of purposes, including: (i) asset and liability
management activities, (ii) income enhancements for its portfolio management
strategy, and (iii) to benefit from anticipated future movements in the
underlying markets. If such movements do not occur as anticipated, then
significant losses may occur.
Monitoring procedures include senior management review of daily detailed
reports of existing positions and valuation fluctuations to ensure that open
positions are consistent with the Company's portfolio strategy.
Credit exposure associated with non-performance by the counterparties to
derivative instruments is generally limited to the uncollateralized fair value
of the asset related to the instruments recognized in the Consolidated Balance
Sheets. The Company mitigates the risk of non-performance by monitoring the
creditworthiness of counterparties and diversifying derivatives to multiple
counter-parties. The Company generally requires collateral from its derivative
investment counterparties depending on the amount of the exposure and the
credit rating of the counterparty..
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex, nor do the use of these instruments, in the
opinion of management, result in a higher degree of risk. See "Results of
Operations," "Quantitative and Qualitative Disclosures about Market Risk" and
Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of
this Report for additional information with respect to derivative instruments,
including recognized gains and losses on these instruments.
88
Insurance
Investment Income, Net
The significant components of CNA's investment income are presented in the
following table:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities $1,651.1 $1,854.1 $1,823.3
Short-term investments 63.2 62.2 134.7
Limited partnerships 220.6 (33.9) 47.3
Equity securities 18.8 65.4 37.0
Interest on funds withheld and other
deposits (343.8) (239.6) (241.4)
Other 84.4 81.6 113.5
- ------------------------------------------------------------------------------------------------
Total investment income 1,694.3 1,789.8 1,914.4
Investment expenses (47.6) (59.9) (58.3)
- ------------------------------------------------------------------------------------------------
Investment income, net $1,646.7 $1,729.9 $1,856.1
================================================================================================
CNA experienced lower net investment income in 2003 as compared with 2002.
This decrease was due primarily to lower investment yields on fixed maturity
securities and increased costs on funds withheld and other deposits. The
interest costs on funds withheld and other deposits increased principally as a
result of additional cessions to the corporate aggregate reinsurance and other
treaties due to adverse net prior year development recorded in 2003. See the
Reinsurance section of the MD&A for additional information for interest costs
on funds withheld and other deposits, which is included in net investment
income. This decrease in net investment income in 2003 was partially offset by
increased limited partnership income. Limited partnership income increased as
a result of improving equity markets and favorable conditions in the fixed
income markets.
CNA experienced lower net investment income in 2002 as compared with 2001.
The decrease was due primarily to decreased limited partnership results and
lower investment yields, partially offset by $34.0 million of dividend income
from Canary Wharf Group plc ("Canary Wharf"). The decline in limited
partnership income was primarily attributable to many of the same factors that
impacted the broader financial markets. Limited partnership investment
performance, particularly high yield bond and equity strategies, was adversely
affected by overall market volatility including concerns over corporate
accounting practices and credit deterioration.
The bond segment of the investment portfolio yielded 5.1% in 2003, 6.0% in
2002 and 6.4% in 2001.
89
Net Realized Investment Gains (Losses)
The components of CNA's net investment (losses) gains are presented in the
following table:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Investment gains (losses):
Fixed maturity securities:
U.S. government bonds $ (69.9) $ 391.6 $ 233.3
Corporate and other taxable bonds 380.5 (557.0) (5.3)
Tax-exempt bonds 96.7 48.0 53.9
Asset-backed bonds 41.7 36.5 75.6
Redeemable preferred stock (11.6) (27.9) (21.5)
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 437.4 (108.8) 336.0
Equity securities 114.5 (158.5) 1,094.9
Derivative securities 78.4 (52.1) (5.0)
Other invested assets, including dispositions (153.1) 65.2 (148.9)
Allocated to participating policyholders'
and minority interests (3.8) 2.0 (15.0)
- ------------------------------------------------------------------------------------------------
Total investment gains (losses) 473.4 (252.2) 1,262.0
Income tax (expense) benefit (179.2) 103.3 (445.4)
Minority interest (28.5) 15.9 (101.8)
- ------------------------------------------------------------------------------------------------
Net investment gains (losses) $ 265.7 $ (133.0) $ 714.8
================================================================================================
Net realized investment results increased $398.7 million (after tax and
minority interest) in 2003 as compared with 2002. This change was due
primarily to a reduction in impairment losses for other-than-temporary
declines in market values for fixed maturity and equity securities and
increased realized results related to fixed maturity and derivative
securities. Partially offsetting these increases in net realized investment
gains was a $116.4 million loss (after tax and minority interest) resulting
from the sale of the Group Benefits business. See the Group Operations section
of this MD&A for additional information on the sale of the Group Benefits
business. Impairment losses of $188.4 million (after tax and minority
interest) were recorded in 2003 across several sectors including the airline,
healthcare and energy industries. Impairment losses of $517.2 million (after
tax and minority interest) were recorded primarily in the telecommunications
sector in 2002.
Net realized investment results decreased $847.8 million (after tax and
minority interest) in 2002 as compared with 2001. This decline was due
primarily to the change in net realized gains (losses) on corporate and other
taxable bonds and equity securities. The $321.0 million (after tax and
minority interest) increase in realized loss on corporate and other taxable
bonds relates primarily to impairment charges of $377.0 million recorded in
various market sectors, the most significant being the telecommunication
sector. The $728.0 million change in net realized gains (losses) of equity
securities relates primarily to the Company's 2001 gain of $566.0 million for
the sale of Global Crossing Ltd. common stock ("Global Crossing") and closing
of the related hedge agreements. Also, during 2002, CNA completed the sale of
several businesses, including CNA Re U.K. Included in 2002 net realized
investment results was a $62.1 million gain resulting from the sale of CNA Re
U.K., which included a $34.1 million reduction of the previously recognized
impairment loss on CNA Re U.K. The impairment loss recorded in 2001 for the
sale of CNA Re U.K. and other subsidiaries was $162.0 million (after tax and
minority interest). Further details of these transactions are discussed below.
A primary objective in the management of the fixed maturity and equity
portfolios is to maximize total return relative to underlying liabilities and
respective liquidity needs. In achieving this goal, assets may be sold to take
advantage of market conditions or other investment opportunities or credit and
tax considerations. This activity will produce realized gains and losses.
CNA classifies its fixed maturity securities (bonds and redeemable preferred
stocks) and its equity securities as available-for-sale, and as such, they are
carried at fair value. The amortized cost of fixed maturity securities is
adjusted for amortization of premiums and accretion of discounts to maturity,
which is included in net investment income.
90
The following table provides further detail of gross realized gains and
losses on fixed maturity and equity securities:
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Net realized gains (losses) on fixed
maturity and equity securities:
Fixed maturity securities:
Gross realized gains $1,244.0 $1,009.0 $ 936.0
Gross realized losses (807.0) (1,118.0) (600.0)
- ------------------------------------------------------------------------------------------------
Net realized gains (losses) on fixed
maturity securities 437.0 (109.0) 336.0
Equity securities:
Gross realized gains 143.0 251.0 1,335.0
Gross realized losses (29.0) (409.0) (240.0)
- ------------------------------------------------------------------------------------------------
Net realized gains (losses) on
equity securities 114.0 (158.0) 1,095.0
- ------------------------------------------------------------------------------------------------
Net realized gains (losses) on fixed
maturity and equity securities $ 551.0 $ (267.0) $1,431.0
================================================================================================
The largest realized losses from sales of fixed maturities and equity
securities aggregated by issuer for the year ended December 31, 2003 totaled
$242.0 million. The following table provides details of those losses
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.
Fair Months in
Value Unrealized
Date of Loss Loss Prior
Issuer Description and Discussion Sale On Sale To Sale
- ------------------------------------------------------------------------------------------------
(In millions)
Various securities issued by the
United States Treasury.(a) $5,727.0 $173.0 0-6
Issues and sells mortgage backed
securities. Issuer was chartered
by United States Congress to
facilitate housing ownership for
low to middle income Americans.(a) 1,679.0 29.0 0-6
A food retailer of supermarkets and
discount stores in the U.S.
and Europe. Also supplies food to
institutional food service
companies.(b) 34.0 12.0 0-6
Savings bonds issued by the German
Federal Republic.(a) 627.0 11.0 0-6
A company which manufactures rubber
and rubber-related chemicals. They also
manufacture and distribute tires.(c) 23.0 9.0 Various, 0-24
A company which provides wholesale
financing and capital loans to auto
retail dealerships and vehicle leasing
companies.(d) 124.0 8.0 Various, 0-12
- ------------------------------------------------------------------------------
$8,214.0 $242.0
==============================================================================
(a) Volatility of interest rates prompted movement to other asset classes.
(b) The company is under investigation for accounting fraud. Losses relate to trades that took
place to reduce issuer exposure.
(c) These losses relate to trades that took place to reduce issuer exposure.
(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.
91
Valuation and Impairment of Investments
The following table details the carrying value of CNA's general and separate
account investment portfolios:
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
General account investments:
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 1,900.0 5.0% $ 1,376.0 3.9%
Asset-backed securities 8,757.0 23.0 8,208.0 23.2
States, municipalities and political subdivisions-
tax-exempt 7,970.0 20.9 5,074.0 14.4
Corporate securities 6,482.0 17.0 7,591.0 21.5
Other debt securities 3,264.0 8.6 3,827.0 10.8
Redeemable preferred stock 104.0 0.3 69.0 0.2
Options embedded in convertible debt securities 201.0 0.5 130.0 0.4
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 28,678.0 75.3 26,275.0 74.4
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 383.0 1.0 461.0 1.3
Non-redeemable preferred stock 144.0 0.4 205.0 0.6
- ------------------------------------------------------------------------------------------------
Total equity securities 527.0 1.4 666.0 1.9
- ------------------------------------------------------------------------------------------------
Short-term investments 7,538.0 19.8 7,008.0 19.9
Limited partnerships 1,117.0 2.9 1,060.0 3.0
Other investments 240.0 0.6 284.0 0.8
- ------------------------------------------------------------------------------------------------
Total general account investments $38,100.0 100.0% $35,293.0 100.0%
================================================================================================
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Separate account investments:
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 167.0 4.7% $ 166.0 5.3%
Asset-backed securities 761.0 21.4 869.0 27.8
Corporate securities 978.0 27.4 812.0 26.0
Other debt securities 202.0 5.8 165.0 5.3
Redeemable preferred stock 5.0 0.1 2.0 0.1
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 2,113.0 59.4 2,014.0 64.5
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 117.0 3.3 112.0 3.6
Non-redeemable preferred stock 6.0 0.2
- ------------------------------------------------------------------------------------------------
Total equity securities 117.0 3.3 118.0 3.8
- ------------------------------------------------------------------------------------------------
Short-term investments 496.0 13.9 276.0 8.8
Limited partnerships 419.0 11.8 327.0 10.5
Other investments 415.0 11.6 387.0 12.4
- ------------------------------------------------------------------------------------------------
Total separate account investments $ 3,560.0 100.0% $ 3,122.0 100.0%
================================================================================================
CNA's general and separate account investment portfolio consists primarily of
publicly traded government bonds, asset-backed securities, mortgage-backed
securities, short-term investments municipal bonds and corporate bonds.
92
Investments in the general account had a total net unrealized gain of
$1,348.0 million at December 31, 2003 compared with $887.0 million at December
31, 2002. The unrealized position at December 31, 2003 was composed of a net
unrealized gain of $1,114.0 million for fixed maturities, and net unrealized
gain of $234.0 million for equity securities. The unrealized position at
December 31, 2002 was composed of a net unrealized gain of $742.0 million for
fixed maturities, a net unrealized gain of $147.0 million for equity
securities and a net unrealized loss of $2.0 million for short-term
securities.
Unrealized gains (losses) on fixed maturity and equity securities are
presented in the following tables:
Gross Unrealized Losses
Cost or Gross ---------------------- Net
Amortized Unrealized Less than Greater than Unrealized
December 31, 2003 Cost Gains 12 Months 12 Months Gain
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies $ 1,823.0 $ 91.0 $ 10.0 $ 4.0 $ 77.0
Asset-backed securities 8,634.0 146.0 22.0 1.0 123.0
States, municipalities and political
subdivisions-tax-exempt 7,787.0 207.0 22.0 2.0 183.0
Corporate securities 6,061.0 475.0 40.0 14.0 421.0
Other debt securities 2,961.0 311.0 4.0 4.0 303.0
Redeemable preferred stock 97.0 7.0 7.0
Options embedded in convertible
debt securities 201.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 27,564.0 1,237.0 98.0 25.0 1,114.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 163.0 222.0 2.0 220.0
Non-redeemable preferred stock 130.0 16.0 2.0 14.0
- ------------------------------------------------------------------------------------------------
Total equity securities 293.0 238.0 4.0 234.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity
securities $ 27,857.0 $1,475.0 $ 102.0 $ 25.0 $1,348.0
================================================================================================
Cost or Net
Amortized Gross Unrealized Unrealized
December 31, 2002 Cost Gains Losses Gain (Loss)
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and obligations of
government agencies $ 1,266.0 $ 114.0 $ 4.0 $110.0
Asset-backed securities 7,888.0 336.0 16.0 320.0
States, municipalities and political subdivisions-
tax-exempt 4,966.0 151.0 43.0 108.0
Corporate securities 7,439.0 487.0 335.0 152.0
Other debt securities 3,780.0 284.0 237.0 47.0
Redeemable preferred stock 64.0 5.0 5.0
Options embedded in convertible debt Securities 130.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 25,533.0 1,377.0 635.0 742.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 310.0 166.0 15.0 151.0
Non-redeemable preferred stock 209.0 3.0 7.0 (4.0)
- ------------------------------------------------------------------------------------------------
Total equity securities 519.0 169.0 22.0 147.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities $26,052.0 $1,546.0 $657.0 $889.0
================================================================================================
93
CNA's investment policies for both the general and separate accounts
emphasize high credit quality and diversification by industry, issuer and
issue. Assets supporting interest rate sensitive liabilities are segmented
within the general account to facilitate asset/liability duration management.
At December 31, 2003, the carrying value of the general account fixed
maturities was $28,678.0 million, representing 75.3% of the total investment
portfolio. The net unrealized gain of this fixed maturity portfolio was
$1,114.0 million, comprising gross unrealized gains of $1,237.0 million and
gross unrealized losses of $123.0 million. Gross unrealized losses were across
various sectors, the largest of which was corporate bonds. Within corporate
bonds, the largest industry sectors were financial, consumer-cyclical, and
consumer-non-cyclical, which as a percentage of total gross unrealized losses
were 33.0%, 18.0% and 17.0%. Gross unrealized losses in any single issuer was
less than 1.0% of the carrying value of the total general account fixed
maturity portfolio.
The following table provides the composition of fixed maturity securities
with an unrealized loss in relation to the total of all fixed maturity
securities with an unrealized loss by contractual maturities.
Percent of
Percent of Unrealized
December 31, 2003 Market Value Loss
- ------------------------------------------------------------------------------------------------
Due in one year or less 1.0% 5.0%
Due after one year through five years 8.0 20.0
Due after five years through ten years 7.0 11.0
Due after ten years 35.0 45.0
Asset-backed securities 49.0 19.0
- ------------------------------------------------------------------------------------------------
Total 100.0% 100.0%
================================================================================================
The following table summarizes for fixed maturity and equity securities in
an unrealized loss position, the aggregate fair value and gross unrealized
loss by length of time those securities have been continuously in an
unrealized loss position.
Gross
Estimated Unrealized
December 31, 2003 Fair Value Loss
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Investment grade:
0-6 months $ 4,138.0 $ 50.0
7-12 months 834.0 36.0
13-24 months 76.0 11.0
Greater than 24 months 51.0 3.0
- ------------------------------------------------------------------------------------------------
Total investment grade 5,099.0 100.0
- ------------------------------------------------------------------------------------------------
Non-investment grade:
0-6 months 134.0 5.0
7-12 months 60.0 7.0
13-24 months 16.0 1.0
Greater than 24 months 105.0 10.0
- ------------------------------------------------------------------------------------------------
Total non-investment grade 315.0 23.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 5,414.0 123.0
- ------------------------------------------------------------------------------------------------
Equity securities:
0-6 months 23.0 2.0
7-12 months 10.0 2.0
13-24 months 3.0
Greater than 24 months 6.0
- ------------------------------------------------------------------------------------------------
Total equity securities 42.0 4.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities $ 5,456.0 $ 127.0
================================================================================================
94
A significant judgment in the valuation of investments is the determination
of when an other-than-temporary decline in value has occurred. CNA follows a
consistent and systematic process for impairing securities that sustain other-
than-temporary declines in value. CNA has established a committee responsible
for the impairment process. This committee, referred to as the Impairment
Committee, is made up of three officers appointed by CNA's Chief Financial
Officer. The Impairment Committee is responsible for analyzing watch list
securities on at least a quarterly basis. The watch list includes individual
securities that fall below certain thresholds or that exhibit evidence of
impairment indicators including, but not limited to, a significant adverse
change in the financial condition and near term prospects of the investment or
a significant adverse change in legal factors, the business climate or credit
ratings.
When a security is placed on the watch list, it is monitored for further
market value changes and additional news related to the issuer's financial
condition. The focus is on objective evidence that may influence the
evaluation of impairment factors.
The decision to impair a security incorporates both quantitative criteria
and qualitative information. The Impairment Committee considers a number of
factors including, but not limited to: (a) the length of time and the extent
to which the market value has been less than book value, (b) the financial
condition and near term prospects of the issuer, (c) the intent and ability of
CNA to retain its investment for a period of time sufficient to allow for any
anticipated recovery in value, (d) whether the debtor is current on interest
and principal payments and (e) general market conditions and industry or
sector specific factors.
The Impairment Committee's decision to impair a security is primarily based
on whether the security's fair value is likely to remain significantly below
its book value in light of all of the factors considered. For securities that
are impaired, the security is written down to fair value and the resulting
losses are recognized in realized gains/losses in the Consolidated Statements
of Operations.
Realized investment losses included $321.0, $890.0 and $129.0 million of
pretax impairment losses for the three years ended December 31, 2003, 2002 and
2001. The impairments were primarily the result of the continued credit
deterioration on specific issuers in the bond and equity markets and the
effects on such markets due to the overall slowing of the economy.
For the year ended December 31, 2003, the impairment losses recorded related
primarily to corporate bonds in the airline, healthcare and energy industries.
For the year ended December 31, 2002, the impairment losses recorded related
primarily to corporate bonds in the communications industry sectors including
$129.0 million related to WorldCom Inc., $74.0 million related to Adelphia
Communication Corporation, $60.0 million for Charter Communications, $57.0
million for AT&T Canada and $53.0 million for Telewest PLC.
For the year ended December 31, 2001, the impairment losses recorded related
primarily to corporate bonds and equities in the communications industry
sector including $31.0 million for MedicaLogic/Medscape, Inc. and $27.0
million for At Home Corporation.
If the deterioration in these industry sectors continues in future periods
and CNA continues to hold these seurities, CNA is likely to have additional
impairments in the future.
CNA's non-investment grade fixed maturity securities held as of December 31,
2003 that were in an unrealized loss position had a fair value of $315.0
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 December 31, 2003.
95
Fair Value as a
Percentage of Book Value
Estimated ------------------------------- Unrealized
December 31, 2003 Fair Value 90-99% 80-89% 70-79% <70% Loss
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Non- investment grade:
0-6 months $ 134.0 $ 2.0 $ 1.0 $ 2.0 $ 5.0
7-12 months 60.0 1.0 6.0 7.0
13-24 months 16.0 1.0 1.0
Greater than 24 months 105.0 4.0 1.0 $ 5.0 10.0
- ------------------------------------------------------------------------------------------------
Total non-investment grade $ 315.0 $ 8.0 $ 8.0 $ 5.0 $ 2.0 $ 23.0
================================================================================================
As part of the ongoing impairment monitoring process, the Impairment
Committee has evaluated the facts and circumstances based on available
information for each of these non-investment grade securities and determined
that no further impairments were necessary at December 31, 2003. This
determination was based on a number of factors that the Committee regularly
considers including, but not limited to: the issuers' ability to meet current
and future interest and principal payments, an evaluation of the issuers'
financial condition and near term prospects, the Company's sector outlook and
estimates of the fair value of any underlying collateral. In all cases where a
decline in value is judged to be temporary, CNA had the intent and ability to
hold these securities for a period of time sufficient to recover the book
value of its investment through a recovery in the market value of such
securities or by holding the securities to maturity. In many cases, the
securities held are matched to liabilities as part of ongoing asset/liability
duration management. As such the Impairment Committee continually assesses its
ability to hold securities for a time sufficient to recover any temporary loss
in value or until maturity. CNA maintains sufficient levels of liquidity so as
to not impact the asset/liability management process.
CNA's equity securities held as of December 31, 2003 that were in an
unrealized loss position had a fair value of $42.0 million. CNA's Impairment
Committee, under the same process as fixed maturity securities, monitors the
equity securities for other-than-temporary declines in value. In all cases
where a decline in value is judged to be temporary, CNA expects to recover the
book value of its investment through a recovery in the market value of the
security.
During the second quarter of 2001, CNA announced its intention to sell
certain businesses. The assets being held for disposition included CNA Re U.K.
and certain other businesses. Based upon the impairment analyses performed at
that time, CNA anticipated that it would realize losses in connection with
those planned sales. In determining the anticipated loss from these sales, CNA
estimated the net realizable value of each business being held for sale. An
estimated loss of $278.4 million (after tax and minority interest) was
initially recorded in the second quarter of 2001. This loss was reported in
realized investment gains/losses.
In the fourth quarter of 2001, CNA sold certain businesses as planned. The
realized loss applicable to these businesses recognized in 2001 was $33.1
million (after tax and minority interest). Revenues of these businesses
included in the year ended December 31, 2001 totaled approximately $30.0
million. These businesses contributed approximately $9.6 million (after tax
and minority interest) of net losses in the year ended December 31, 2001.
CNA regularly updates its impairment analyses and adjusts its loss as
necessary. Based on these updated analyses the impairment loss was reduced by
approximately $150.7 million (after tax and minority interest) in the fourth
quarter of 2001, primarily because the net assets of the businesses had been
significantly diminished by their operating losses, including unfavorable net
prior year development recognized by CNA Re U.K. in the fourth quarter of
2001. The reduction of the impairment was included in realized investment
gains/losses.
On October 31, 2002, CNA completed the sale of CNA Re U.K. to Tawa. The sale
includes business underwritten since inception by CNA Re U.K., except for
certain risks retained by CCC as discussed below. The purchase price was $1,
subject to adjustments based primarily upon the results of operations and
realized foreign currency losses of CNA Re U.K. Under the terms of the
purchase price adjustment, CCC is entitled to receive $5.0 million from Tawa
after Tawa is able to legally withdraw funds from the former CNA Re U.K.
entities; at December 31, 2003, CNA has received approximately $2.0 million.
CCC has also committed to contribute up to $5.0 million to the former CNA Re
U.K. entities over a four-year period beginning in 2010 should the Financial
Services Authority ("FSA") deem those entities
96
to be undercapitalized. The purchase price adjustment related to foreign
currency losses resulted in CNA contributing additional capital to CNA Re U.K.
of $11.0 million. As the sale and related agreements have now been completed,
CNA has finalized its impairment analysis based upon the terms of the
completed transactions and reduced the impairment loss by approximately $33.9
million (after tax and minority interest). The reduction of the impairment was
included in net realized investment gains in 2002.
Concurrent with the sale, several reinsurance agreements under which CCC had
provided retrocessional protection to CNA Re U.K. were terminated. As part of
the sale, CNA Re U.K.'s net exposure to all IGI Program liabilities was
assumed by CCC. Further, CCC is providing a $100.0 million stop loss cover
attaching at carried reserves on CNA Re U.K.'s 2001 underwriting year
exposures for which CCC received premiums of $25.0 million.
CNA Re U.K. had revenues of approximately $48.0 and $280.0 million for the
years ended December 31, 2002 and 2001. CNA Re U.K. had net losses of $19.7
and $327.3 million for the years ended December 31, 2002 and 2001. The assets
and liabilities of CNA Re U.K., including the effects of the concurrent
transactions, were approximately $2,442.0 and $2,357.0 million at the date of
sale and $2,557.0 and $2,541.0 million as of December 31, 2001.
Substantially all invested assets are marketable securities classified as
available-for-sale in the accompanying financial statements. Accordingly,
changes in fair value for these securities are reported in other comprehensive
income.
The general account portfolio consists primarily of high quality (rated BBB
or higher) bonds, 92.9% and 89.4% of which were rated as investment grade at
December 31, 2003 and 2002.
The following table summarizes the ratings of CNA's general account bond
portfolio at carrying value:
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
U.S. Government and affiliated agency
securities $ 2,818.0 9.9% $ 1,908.0 7.3%
Other AAA rated 12,779.0 44.7 10,856.0 41.4
AA and A rated 6,329.0 22.1 5,730.0 21.9
BBB rated 4,631.0 16.2 4,930.0 18.8
Non investment-grade 2,017.0 7.1 2,782.0 10.6
- ------------------------------------------------------------------------------------------------
Total $28,574.0 100.0% $26,206.0 100.0%
================================================================================================
At December 31, 2003 and 2002, approximately 97.0% of the general account
portfolio was U.S. Government agencies or was rated by Standard & Poor's
("S&P") or Moody's Investors Service ("Moody's"). The remaining bonds were
rated by other rating agencies or CNA management.
The following table summarizes the bond ratings of the investments
supporting CNA's separate account products, which guarantee principal and a
specified rate of interest:
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
U.S. Government and affiliated agency
securities $ 166.0 9.2% $ 161.0 8.6%
Other AAA rated 737.0 40.7 898.0 48.1
AA and A rated 374.0 20.7 327.0 17.5
BBB rated 443.0 24.5 414.0 22.2
Non investment-grade 89.0 4.9 68.0 3.6
- ------------------------------------------------------------------------------------------------
Total $ 1,809.0 100.0% $ 1,868.0 100.0%
================================================================================================
At December 31, 2003 and 2002, 98.0% and $99.0% of the separate account
portfolio was U.S. Government agencies or was rated by S&P or Moody's. The
remaining bonds were rated by other rating agencies or CNA management.
97
Non investment-grade bonds, as presented in the tables above, are high-yield
securities rated below BBB by bond rating agencies, as well as other unrated
securities that, in the opinion of management, are below investment-grade.
High-yield securities generally involve a greater degree of risk than
investment-grade securities. However, expected returns should compensate for
the added risk. This risk is also considered in the interest rate assumptions
for the underlying insurance products.
The carrying value of non-traded securities at December 31, 2003 was $270.0
million which represents 0.7% of the Company's total investment portfolio.
These securities were in a net unrealized gain position of $61.0 million at
December 31, 2003. Of the non-traded securities, 48.0% are priced by unrelated
third party sources.
Included in CNA's general account fixed maturity securities at December 31,
2003 are $8,757.0 million of asset-backed securities, at fair value,
consisting of approximately 37.0% in collateralized mortgage obligations
("CMOs"), 8.0% in corporate asset-backed obligations, 11.0% in U.S. Government
agency issued pass-through certificates and 44.0% in corporate mortgage-backed
pass-through certificates. The majority of CMOs held are actively traded in
liquid markets and are priced by broker-dealers.
The carrying value of the components of the general account short term
investment portfolio is presented in the following table:
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Commercial paper $4,458.0 $ 1,141.0
U.S. Treasury securities 1,068.0 2,756.0
Money market funds 1,230.0 2,161.0
Other 782.0 950.0
- ------------------------------------------------------------------------------------------------
Total short term investments $7,538.0 $ 7,008.0
================================================================================================
CNA invests in certain derivative financial instruments primarily to reduce
its exposure to market risk (principally interest rate, equity price and
foreign currency risk) and credit risk (risk of nonperformance of underlying
obligor). CNA considers the derivatives in its general account to be held for
purposes other than trading. Derivative securities are recorded at fair value
at the reporting date.
Most derivatives in separate accounts are held for hedging purposes. CNA
uses these derivatives to mitigate market risk by purchasing S&P 500 index
futures in a notional amount equal to the contract liability relating to Life
Operations' Index 500 guaranteed investment contract product.
ACCOUNTING STANDARDS
In July of 2003, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position ("SOP") 03-01, "Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and
for Separate Accounts". The SOP provides guidance on accounting and reporting
by insurance enterprises for certain nontraditional long-duration contracts
and for separate accounts. This SOP is effective for financial statements for
fiscal years beginning after December 15, 2003. SOP 03-01 may not be applied
retroactively to prior years' financial statements, and initial application
should be as of the beginning of an entity's fiscal year. The Company will
adopt SOP 03-01 as of January 1, 2004. The Company is in the process of
evaluating the effect of SOP 03-01.
FORWARD-LOOKING STATEMENTS DISCLAIMER
Investors are cautioned that certain statements contained in this document
as well as some statements in periodic press releases and some oral statements
made by officials of the Company and its subsidiaries during presentations
about the Company, are "forward-looking" statements within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking
statements include, without limitation, any statement that may project,
indicate or imply future results, events, performance or achievements, and may
contain the words "expect," "intend," "plan," "anticipate," "estimate,"
"believe," "will be," "will continue," "will likely result," and similar
expressions. In addition, any statement concerning future financial
performance (including future revenues, earnings or growth rates), ongoing
business
98
strategies or prospects, and possible actions by the Company or its
subsidiaries, which may be provided by management are also forward-looking
statements as defined by the Act.
Forward-looking statements are based on current expectations and projections
about future events and are inherently subject to a variety of risks and
uncertainties, many of which are beyond the Company's control, that could
cause actual results to differ materially from those anticipated or projected.
These risks and uncertainties include, among others:
Risks and uncertainties primarily affecting the Company and the Company's
insurance subsidiaries
. the impact of competitive products, policies and pricing, including the
ability to implement and maintain price increases;
. product and policy availability and demand and market responses, including
the effect of the absence of applicable terrorism legislation on
coverages;
. development of claims, the effect on loss reserves and additional charges
to earnings if loss reserves are insufficient, including among others,
loss reserves related to APMT exposure which are more uncertain and
therefore more difficult to estimate than loss reserves respecting
traditional property and casualty exposures;
. the impact of regular and ongoing insurance reserve reviews by CNA and
ongoing state regulatory exams of CNA's primary insurance company
subsidiaries, and CNA's responses to the results of those reviews and
exams;
. exposure to catastrophic events, natural and man-made, which are
inherently unpredictable, with a frequency or severity that exceeds CNA's
expectations and results in material losses;
. exposure to liabilities due to claims made by insured and others relating
to asbestos remediation and health-based asbestos impairments, and
exposure to liabilities for environmental pollution and mass tort claims;
. the possible creation through federal legislation of a national privately
financed trust to replace litigation of asbestos claims with payments to
claimants from the trust and the uncertain funding requirements of any
such trust, including requirements possibly in excess of CNA's established
loss reserve or carried loss reserve;
. the availability and adequacy of reinsurance and the creditworthiness and
performance of reinsurance companies under reinsurance contracts;
. limitations upon CNA's ability to receive dividends from its insurance
subsidiaries imposed by state regulatory agencies;
. regulatory limitations and restrictions upon CNA and its insurance
subsidiaries generally;
. the possibility of further changes in CNA's ratings by ratings agencies,
including the inability to obtain business from certain major insurance
brokers, the inability to sell CNA's insurance products to certain
markets, and the required collateralization of future payment obligations
as a result of such changes, and changes in rating agency policies and
practices;
. the effects of corporate bankruptcies and/or accounting restatements (such
as Enron and WorldCom) on the financial markets, and the resulting decline
in value of securities held and possible additional charges for
impairments;
. the effects of corporate bankruptcies and/or accounting restatements on
the markets for directors and officers and errors and omissions coverages;
. the effects of assessments and other surcharges for guaranty funds and
second-injury funds and other mandatory pooling arrangements; and
99
. the impact of the current economic climate on companies on whose behalf
CNA's subsidiaries have issued surety bonds;
Risks and uncertainties primarily affecting the Company and the Company's
tobacco subsidiaries
. health concerns, claims and regulations relating to the use of tobacco
products and exposure to environmental tobacco smoke;
. legislation, including actual and potential excise tax increases, and the
effects of tobacco litigation settlements on pricing and consumption
rates;
. continued intense competition from other cigarette manufacturers,
including increased promotional activity and the continued growth of the
deep- discount category;
. the continuing decline in volume in the domestic cigarette industry;
. increasing marketing and regulatory restrictions, governmental regulation
and privately imposed smoking restrictions,
. litigation, including risks associated with adverse jury and judicial
determinations, courts reaching conclusions at variance with the general
understandings of applicable law, bonding requirements and the absence of
adequate appellate remedies to get timely relief from any of the
foregoing;
. the impact of each of the factors described under Results of Operations-
Lorillard in the MD&A portion of this report;
Risks and uncertainties primarily affecting the Company and the Company's
energy subsidiaries
. the impact on worldwide demand for oil and natural gas and oil and gas
price fluctuations on exploration and production activity;
. costs and timing of rig upgrades;
. utilization levels and dayrates for offshore oil and gas drilling rigs;
. future demand for and supplies of natural gas impacting natural gas
pipeline transmission demand and rates;
. governmental or regulatory developments affecting natural gas
transmission, including rate making and other proceedings particularly
affecting the Company's gas transmission subsidiary;
Risks and uncertainties affecting the Company and its subsidiaries generally
. general economic and business conditions;
. changes in financial markets (such as interest rate, credit, currency,
commodities and equities markets) or in the value of specific investments;
. changes in domestic and foreign political, social and economic conditions,
including the impact of the global war on terrorism, the war in Iraq, the
future outbreak of hostilities and future acts of terrorism;
. the economic effects of the September 11, 2001 terrorist attacks, other
terrorist attacks and the war in Iraq;
. the impact of regulatory initiatives and compliance with governmental
regulations, judicial rulings and jury verdicts;
100
. the results of financing efforts; and
. the actual closing of contemplated transactions and agreements
Developments in any of these areas, which are more fully described elsewhere
in this Report, could cause the Company's results to differ materially from
results that have been or may be anticipated or projected. Forward-looking
statements speak only as of the date of this Report and the Company expressly
disclaims any obligation or undertaking to update these statements to reflect
any change in the Company's expectations or beliefs or any change in events,
conditions or circumstances on which any forward-looking statement is based.
SUPPLEMENTAL FINANCIAL INFORMATION
The following supplemental condensed financial information reflects the
financial position, results of operations and cash flows of Loews Corporation
with its investments in CNA and Diamond Offshore accounted for on an equity
basis rather than as consolidated subsidiaries. It does not purport to present
the financial position, results of operations and cash flows of the Company
in accordance with generally accepted accounting principles because it does
not comply with SFAS No. 94, "Consolidation of All Majority-Owned
Subsidiaries." Management believes, however, that this disaggregated financial
data enhances an understanding of the consolidated financial statements by
providing users with a format that management uses in assessing the Company.
See Notes 1 and 24 of the Notes to Consoldiated Financial Statements included
in Item 8.
Condensed Balance Sheet Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
December 31 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Current assets $ 1,306.3 $ 578.4
Investments, primarily short-term instruments 3,574.9 4,071.2
- ------------------------------------------------------------------------------------------------
Total current assets and investments in securities 4,881.2 4,649.6
Investment in CNA 8,254.8 8,513.8
Investment in Diamond Offshore 961.6 1,025.1
Other assets 2,373.4 1,434.6
- ------------------------------------------------------------------------------------------------
Total assets $16,471.0 $15,623.1
================================================================================================
Liabilities and Shareholders' Equity:
Current liabilities $ 2,052.5 $ 1,826.3
Long-term debt, less current maturities and
unamortized discount 2,973.1 2,440.2
Other liabilities 391.1 121.4
- ------------------------------------------------------------------------------------------------
Total liabilities 5,416.7 4,387.9
Shareholders' equity 11,054.3 11,235.2
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $16,471.0 $15,623.1
================================================================================================
101
Condensed Statements of Operations Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Manufactured products and other $ 3,858.5 $ 4,238.7 $ 4,334.0
Investment income 73.4 107.2 199.1
Investment gains 115.4 7.0 101.2
- ------------------------------------------------------------------------------------------------
Total 4,047.3 4,352.9 4,634.3
- ------------------------------------------------------------------------------------------------
Expenses:
Cost of manufactured products sold
and other 2,895.3 3,022.2 3,284.3
Interest 154.6 136.5 136.5
Income tax expense 375.7 471.8 467.7
- ------------------------------------------------------------------------------------------------
Total 3,425.6 3,630.5 3,888.5
- ------------------------------------------------------------------------------------------------
Income from operations 621.7 722.4 745.8
Equity in (loss) income of:
CNA (1,258.2) 230.4 (1,373.9)
Diamond Offshore (29.6) 25.8 80.4
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing operations (666.1) 978.6 (547.7)
Discontinued operations-net 55.4 (27.0) 13.9
Cumulative effect of changes in
accounting principles-net (39.6) (53.3)
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (610.7) $ 912.0 $ (587.1)
================================================================================================
102
Condensed Statements of Cash Flow Information
Loews Corporation and Subsidiaries
(Including CNA and Diamond Offshore on the Equity Method)
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Operating Activities:
Net (loss) income $ (610.7) $ 912.0 $ (587.1)
Adjustments to reconcile net (loss)
income to net cash provided by
operating activities:
Undistributed loss (earnings) of CNA
and Diamond Offshore 1,318.5 (190.1) 1,319.2
Cumulative effect of changes in
accounting principles (56.7) 39.6 53.3
Investment losses (gains) (115.4) (7.0) (101.2)
Other 144.7 (19.1) (48.5)
Changes in assets and liabilities-net 902.4 (251.0) 186.7
- ------------------------------------------------------------------------------------------------
Total 1,582.8 484.4 822.4
- ------------------------------------------------------------------------------------------------
Investing Activities:
Net (increase) decrease in investments (551.5) 338.3 243.6
Securities sold under agreements to
repurchase (480.4) 480.4
Purchase of CNA preferred stock (750.0) (750.0)
Purchases of CNA common stock (73.1) (978.7)
Purchase of Texas Gas Transmission (803.3)
Other (3.1) (52.0) (155.7)
- ------------------------------------------------------------------------------------------------
Total (2,107.9) (1,017.2) (410.4)
- ------------------------------------------------------------------------------------------------
Financing Activities:
Dividends paid to shareholders (191.8) (166.4) (112.5)
Increase (decrease) in long-term
debt-net 300.5 (1.5) (18.2)
Purchases of treasury shares (351.2) (282.2)
Issuance of common stock 399.7 1,070.1 0.4
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Total 508.4 551.0 (412.5)
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Net change in cash (16.7) 18.2 (0.5)
Cash, beginning of year 39.3 21.1 21.6
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Cash, end of year $ 22.6 $ 39.3 $ 21.1
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103
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is a large diversified financial services company. As such, it
and its subsidiaries have significant amounts of financial instruments that
involve market risk. The Company's measure of market risk exposure represents
an estimate of the change in fair value of its financial instruments. Changes
in the trading portfolio would be recognized as investment gains (losses) in
the Consolidated Statements of Operations. Market risk exposure is presented
for each class of financial instrument held by the Company at December 31,
assuming immediate adverse market movements of the magnitude described below.
The Company believes that the various rates of adverse market movements
represent a measure of exposure to loss under hypothetically assumed adverse
conditions. The estimated market risk exposure represents the hypothetical
loss to future earnings and does not represent the maximum possible loss nor
any expected actual loss, even under adverse conditions, because actual
adverse fluctuations would likely differ. In addition, since the Company's
investment portfolio is subject to change based on its portfolio management
strategy as well as in response to changes in the market, these estimates are
not necessarily indicative of the actual results which may occur.
Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy employed by the
Company and has responsibility to ensure that the investment positions are
consistent with that strategy and the level of risk acceptable to it. The
Company may manage risk by buying or selling instruments or entering into
offsetting positions.
Interest Rate Risk - The Company has exposure to interest rate risk
arising from changes in the level or volatility of interest rates. The Company
attempts to mitigate its exposure to interest rate risk by utilizing
instruments such as interest rate swaps, interest rate caps, commitments to
purchase securities, options, futures and forwards. The Company monitors its
sensitivity to interest rate risk by evaluating the change in the value of its
financial assets and liabilities due to fluctuations in interest rates. The
evaluation is performed by applying an instantaneous change in interest rates
by varying magnitudes on a static balance sheet to determine the effect such a
change in rates would have on the recorded market value of the Company's
investments and the resulting effect on shareholders' equity. The analysis
presents the sensitivity of the market value of the Company's financial
instruments to selected changes in market rates and prices which the Company
believes are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of the
Company's interest sensitive assets and liabilities that were held on December
31, 2003 and 2002 due to instantaneous parallel shifts in the yield curve of
100 basis points, with all other variables held constant.
The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Accordingly the
analysis may not be indicative of, is not intended to provide, and does not
provide a precise forecast of the effect of changes of market interest rates
on the Company's earnings or shareholders' equity. Further, the computations
do not contemplate any actions the Company could undertake in response to
changes in interest rates.
The Company's long-term debt, as of December 31, 2003 and 2002 is
denominated in U.S. Dollars. The Company's debt has been primarily issued at
fixed rates, and as such, interest expense would not be impacted by interest
rate shifts. The impact of a 100 basis point increase in interest rates on
fixed rate debt would result in a decrease in market value of $394.1 and
$374.6 million, respectively. A 100 basis point decrease would result in an
increase in market value of $460.5 and $440.1 million, respectively.
Equity Price Risk - The Company has exposure to equity price risk as a
result of its investment in equity securities and equity derivatives. Equity
price risk results from changes in the level or volatility of equity prices
which affect the value of equity securities or instruments that derive their
value from such securities or indexes. Equity price risk was measured assuming
an instantaneous 25% change in the underlying reference price or index from
its level at December 31, 2003 and 2002, with all other variable held
constant.
Foreign Exchange Rate Risk - Foreign exchange rate risk arises from the
possibility that changes in foreign currency exchange rates will impact the
value of financial instruments. The Company has foreign exchange rate exposure
when it buys or sells foreign currencies or financial instruments denominated
in a foreign currency. This exposure is mitigated by the Company's
asset/liability matching strategy and through the use of futures for those
instruments which are not matched. The Company's foreign transactions are
primarily denominated in Canadian Dollars, British Pounds and the European
Monetary Unit. The sensitivity analysis also assumes an instantaneous 20%
change in the foreign currency
104
exchange rates versus the U.S. Dollar from their levels at December 31, 2003
and 2002, with all other variables held constant.
Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in gold options. Commodity price risk results from
changes in the level or volatility of commodity prices that impact instruments
which derive their value from such commodities. Commodity price risk was
measured assuming an instantaneous change of 20% from their levels at December
31, 2003 and 2002.
The following tables present the Company's market risk by category (equity
markets, interest rates, foreign currency exchange rates and commodity prices)
on the basis of those entered into for trading purposes and other than trading
purposes.
Trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
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December 31 2003 2002 2003 2002
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(Amounts in millions)
Equity markets (1):
Equity securities $ 339.1 $ 430.7 $(85.0) $ (108.0)
Options - purchased 22.2 23.7 2.0 3.0
- written (4.0) (19.2) (1.0) 2.0
Short sales (118.4) (200.7) 30.0 50.0
Limited partnership investments 73.5 (18.0)
Separate accounts - Equity securities (a) 0.1 6.3 (2.0)
- Other invested assets 419.1 326.5 (7.0) (5.0)
Interest rate (2):
Futures - short (5.0)
Interest rate swaps 25.0 (7.1) (1.0) (31.0)
Separate accounts - Fixed maturities 304.3 145.4 4.0 3.0
- Short term investments 413.7 166.6
Gold (3):
Options - purchased 1.4 0.6 8.0 14.0
- written (0.8) (0.7) (12.0) (20.0)
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Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) a decrease in equity
prices of 25%, (2) a decrease in interest rates of 100 basis points and (3) a decrease in
gold prices of 20%. Adverse changes on options which differ from those presented above
would not necessarily result in a proportionate change to the estimated market
risk exposure.
(a) In addition, the Separate Accounts carry positions in equity index futures. A decrease in
equity prices of 25% would result in market risk amounting to $(277.0) and $(151.0)
at December 31, 2003 and 2002, respectively. This market risk would be offset by decreases
in liabilities to customers under variable insurance contracts.
105
Other than trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
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December 31 2003 2002 2003 2002
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(Amounts in millions)
Equity markets (1):
Equity securities:
General accounts (a) $ 526.9 $ 666.1 $ (129.0) $ (166.0)
Separate accounts 116.5 112.0 (29.0) (28.0)
Limited partnership investments 1,261.6 1,156.9 (69.0) (133.0)
Separate accounts - Other
invested assets 414.8 387.3 (104.0) (97.0)
Interest rate (2):
Fixed maturities (a) (b) 28,781.3 27,433.7 (1,979.0) (1,650.0)
Short-term investments (a) 11,264.6 10,161.7 (5.0) (6.0)
Other invested assets 237.8 241.3
Other derivative securities 5.0 18.0 (105.0) (47.0)
Separate accounts (a):
Fixed maturities 1,809.2 1,868.1 (114.0) (96.0)
Short term investments 81.8 109.5
Long-term debt (5,871.0) (5,558.0)
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Note: The calculation of estimated market risk exposure is based on assumed adverse changes in
the underlying reference price or index of (1) a decrease in equity prices of 25% and (2)
an increase in interest rates of 100 basis points.
(a) Certain securities are denominated in foreign currencies. An assumed 20% decline in the
underlying exchange rates would result in an aggregate foreign currency exchange rate risk
of $(152.0) and $(148.0) at December 31, 2003 and 2002, respectively.
(b) Certain fixed maturities positions include options embedded in convertible debt
securities. A decrease in underlying equity prices of 25% would result in market risk
amounting to $(32.0) and $(24.0) at December 31, 2003 and 2002, respectively.
106
Item 8. Financial Statements and Supplementary Data.
Financial Statements and Supplementary Data are comprised of the following
sections:
Page
No.
----
Consolidated Balance Sheets 108
Consolidated Statements of Operations 110
Consolidated Statements of Shareholders' Equity 111
Consolidated Statements of Cash Flows 112
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies 114
2. Investments 123
3. Fair Value of Financial Instruments 127
4. Derivative Financial Instruments 128
5. Earnings Per Share 133
6. Loews and Carolina Group Consolidating Condensed Financial Information 134
7. Receivables 142
8. Property, Plant and Equipment 142
9. Claim and Claim Adjustment Expense Reserves
Asbestos, Environmental Pollution and Mass Tort ("APMT") Reserves
Net Prior Year Development 143
10. Leases 158
11. Income Taxes 159
12. Long-term Debt 160
13. Comprehensive Income (Loss) 163
14. Significant Transactions 163
15. Restructuring and Other Related Charges 167
16. Discontinued Operations 168
17. Statutory Accounting Practices 169
18. Benefit Plans 170
19. Reinsurance 176
20. Quarterly Financial Data (unaudited) 179
21. Legal Proceedings
Insurance Related 180
Tobacco Related 181
22. Commitments and Contingencies 191
23. Business Segments 194
24. Consolidating Financial Information 199
25. Subsequent Event 203
107
Loews Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
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Assets:
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December 31 2003 2002
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(Dollar amounts in millions, except per share data)