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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
--------------
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
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LOEWS CORPORATION
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(Exact name of registrant as specified in is charter)
Delaware 13-2646102
- ------------------------------- -------------------
(State of other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087
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(Address of principal executive offices) (Zip Code)
(212) 521-2000
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
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Class Outstanding at April 27, 2001
- -------------------------- -----------------------------
Common stock, $1 par value 197,239,900 shares
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1
INDEX
Part I. Financial Information Page No.
--------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets--
March 31, 2001 and December 31, 2000 . . . . . . . . . . . 3
Consolidated Condensed Statements of Income--
Three months ended March 31, 2001 and 2000 . . . . . . . . 4
Consolidated Condensed Statements of Cash Flows--
Three months ended March 31, 2001 and 2000 . . . . . . . . 5
Notes to Consolidated Condensed Financial Statements . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . 34
Item 3. Quantitative and Qualitative Disclosures about Market
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Part II. Other Information
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . 51
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 55
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
--------------------
Loews Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
- ------------------------------------------------------------------------------
(Amounts in millions of dollars) March 31, December 31,
2001 2000
--------------------------
Assets:
Investments:
Fixed maturities, amortized cost of
$26,961.8 and $27,167.5 . . . . . . . . . . $27,317.7 $27,244.3
Equity securities, cost of $1,434.7 and
$1,462.5 . . . . . . . . . . . . . . . . . 2,580.5 2,682.5
Other investments . . . . . . . . . . . . . 1,620.1 1,368.5
Short-term investments . . . . . . . . . . . 10,863.2 9,100.3
--------------------------
Total investments . . . . . . . . . . . . 42,381.5 40,395.6
Cash . . . . . . . . . . . . . . . . . . . . . 181.9 195.2
Receivables-net . . . . . . . . . . . . . . . 16,212.1 15,301.6
Property, plant and equipment-net . . . . . . 3,017.9 3,206.3
Deferred income taxes . . . . . . . . . . . . 351.1 404.0
Goodwill and other intangible assets-net . . . 359.8 378.7
Other assets . . . . . . . . . . . . . . . . . 4,697.5 4,291.3
Deferred acquisition costs of insurance
subsidiaries . . . . . . . . . . . . . . . . 2,436.2 2,417.8
Separate Account business . . . . . . . . . . 3,885.9 4,286.6
--------------------------
Total assets . . . . . . . . . . . . . . $73,523.9 $70,877.1
==========================
Liabilities and Shareholders' Equity:
Insurance reserves and claims . . . . . . . . $38,755.2 $39,054.3
Payable for securities purchased . . . . . . . 1,511.3 971.4
Securities sold under repurchase agreements . 3,037.3 1,308.4
Long-term debt, less unamortized discount . . 5,887.1 6,040.0
Other liabilities . . . . . . . . . . . . . . 6,361.6 5,817.4
Separate Account business . . . . . . . . . . 3,885.9 4,286.6
--------------------------
Total liabilities . . . . . . . . . . . . 59,438.4 57,478.1
Minority interest . . . . . . . . . . . . . . 2,292.1 2,207.9
Shareholders' equity . . . . . . . . . . . . . 11,793.4 11,191.1
--------------------------
Total liabilities and shareholders'
equity . . . . . . . . . . . . . . . . . $73,523.9 $70,877.1
==========================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Income
- ------------------------------------------------------------------------------------------------
(In millions, except per share data) Three Months Ended March 31,
2001 2000
----------------------------
Revenues:
Insurance premiums . . . . . . . . . . . . . . . . . . . . $2,530.1 $2,768.9
Investment income, net of expenses . . . . . . . . . . . . 593.0 594.9
Investment gains (losses) . . . . . . . . . . . . . . . . . 407.4 (140.3)
Manufactured products (including excise taxes of $150.7 and
$158.8). . . . . . . . . . . . . . . . . . . . . . . . . . 1,069.6 1,013.5
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 503.9 418.7
---------------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . 5,104.0 4,655.7
---------------------------
Expenses:
Insurance claims and policyholders' benefits . . . . . . . 2,110.5 2,343.4
Amortization of deferred acquisition costs . . . . . . . . 423.6 393.0
Cost of manufactured products sold . . . . . . . . . . . . 546.6 545.8
Other operating expenses . . . . . . . . . . . . . . . . . 1,013.1 946.7
Interest . . . . . . . . . . . . . . . . . . . . . . . . . 86.3 88.4
---------------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . 4,180.1 4,317.3
---------------------------
923.9 338.4
---------------------------
Income tax . . . . . . . . . . . . . . . . . . . . . . . . 328.6 114.2
Minority interest . . . . . . . . . . . . . . . . . . . . 69.7 40.6
---------------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . 398.3 154.8
---------------------------
Income before cumulative effect of changes in accounting
principles . . . . . . . . . . . . . . . . . . . . . . . . . 525.6 183.6
Cumulative effect of changes in accounting principles-net . . (53.3)
---------------------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 472.3 $ 183.6
===========================
Net income per share:
Income before cumulative effect of changes in accounting
principles . . . . . . . . . . . . . . . . . . . . . . . . $ 2.67 $ .90
Cumulative effect of changes in accounting principles-net . (.27)
---------------------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 2.40 $ .90
===========================
Weighted average number of shares outstanding . . . . . . . . 197.2 203.2
===========================
See accompanying Notes to Consolidated Condensed Financial Statements.
4
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
- ------------------------------------------------------------------------------------------------
(Amounts in millions) Three Months Ended March 31,
2001 2000
----------------------------
Operating Activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 472.3 $ 183.6
Adjustments to reconcile net income to net cash used by
operating activities-net . . . . . . . . . . . . . . . . (321.6) 249.8
Cumulative effect of changes in accounting principles . . 53.3
Changes in assets and liabilities-net:
Reinsurance receivable . . . . . . . . . . . . . . . . . (140.1) (1,011.8)
Other receivables . . . . . . . . . . . . . . . . . . . (154.0) 41.7
Prepaid reinsurance premiums . . . . . . . . . . . . . . (219.8) (126.3)
Deferred acquisition costs . . . . . . . . . . . . . . . (25.7) (116.5)
Insurance reserves and claims . . . . . . . . . . . . . (265.8) 916.5
Other liabilities . . . . . . . . . . . . . . . . . . . 412.3 (113.5)
Trading securities . . . . . . . . . . . . . . . . . . . 160.2 (129.2)
Other-net . . . . . . . . . . . . . . . . . . . . . . . 8.9 (20.5)
----------------------------
(20.0) (126.2)
----------------------------
Investing Activities:
Purchases of fixed maturities . . . . . . . . . . . . . . (28,249.6) (11,586.5)
Proceeds from sales of fixed maturities . . . . . . . . . 21,907.6 12,544.3
Proceeds from maturities of fixed maturities . . . . . . . 6,656.7 585.1
Securities sold under agreements to repurchase . . . . . . 1,728.9 1,456.0
Purchase of equity securities . . . . . . . . . . . . . . (312.2) (620.7)
Proceeds from sales of equity securities . . . . . . . . . 305.3 613.8
Change in short-term investments . . . . . . . . . . . . . (1,707.7) (2,143.6)
Purchases of property, plant and equipment . . . . . . . . (102.3) (333.9)
Proceeds from sales of property, plant and equipment . . . 261.0 31.8
Change in other investments . . . . . . . . . . . . . . . (273.9) 78.4
----------------------------
213.8 624.7
----------------------------
Financing Activities:
Dividends paid to shareholders . . . . . . . . . . . . . . (24.6) (25.7)
Dividends paid to minority interests . . . . . . . . . . . (7.9) (9.4)
Purchases of treasury shares . . . . . . . . . . . . . . . (288.7)
Purchases of treasury shares by subsidiaries . . . . . . . (38.3)
Issuances of long-term debt . . . . . . . . . . . . . . . 25.0
Principal payments on long-term debt . . . . . . . . . . . (154.0) (7.9)
Redemption of CNA preferred stock . . . . . . . . . . . . (79.0)
Receipts credited to policyholders . . . . . . . . . . . . .8 1.3
Withdrawals of policyholders account balances . . . . . . (20.8) (37.6)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . (.6) (.1)
----------------------------
(207.1) (460.4)
----------------------------
Net change in cash . . . . . . . . . . . . . . . . . . . . . (13.3) 38.1
Cash, beginning of period . . . . . . . . . . . . . . . . . 195.2 183.9
----------------------------
Cash, end of period . . . . . . . . . . . . . . . . . . . . $ 181.9 $ 222.0
============================
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
Notes to Consolidated Condensed Financial Statements
- ------------------------------------------------------------------------------
(Dollars in millions, except per share data)
1. General:
Reference is made to the Notes to Consolidated Financial Statements in
the 2000 Annual Report to Shareholders which should be read in conjunction
with these consolidated condensed financial statements.
Accounting Changes
In the first quarter of 2001, the Company adopted the Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and
Hedging Activities and SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities (collectively referred to as
SFAS No. 133). The initial adoption of SFAS No. 133 did not have a
significant impact on the equity of the Company; however, adoption of SFAS
No. 133 resulted in a decrease to first quarter 2001 earnings of $53.3,
net of taxes and minority interest of $33.0 and $8.0, respectively. Of
this transition amount, approximately $50.5, net of taxes and minority
interest, related to CNA's investments and investment-related derivatives.
Because CNA already carried its investment and investment-related
derivatives at fair value through other comprehensive income, there was an
equal and offsetting favorable adjustment of $50.5 to shareholders' equity
(accumulated other comprehensive income). See Note 2 for a complete
discussion of the Company's adoption of these accounting pronouncements.
On January 1, 2001, the Company adopted the Codification of Statutory
Accounting Principles ("Codification") for preparing its statutory-basis
financial statements. Codification, which is intended to standardize
regulatory accounting and reporting to state insurance departments, is
effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted
practices. The states in which CNA's insurance subsidiaries conduct
business required adoption of Codification (with certain modifications)
for the preparation of statutory financial statements effective January 1,
2001. The Company's adoption of Codification, as modified, resulted in an
increase in statutory capital and surplus as of January 1, 2001 by
approximately $175.0, which primarily relates to deferred tax assets
offset by insurance-related assessments and pension-related liabilities.
Additionally, CNA's property-casualty companies implemented a change,
effective January 1, 2001, in the timing of recording written premiums for
policies with future effective dates. This change was made in conjunction
with changes required by Codification related to the recording of written
premiums. The effect of this change was to reduce net written premiums by
$113.0 for the three months ended March 31, 2001. This change has no
impact on net earned premiums or net income.
Stock Split
On February 20, 2001, the Board of Directors declared a two-for-one
stock split, by way of a stock dividend, effective March 21, 2001. All
share and per share data have been restated to retroactively reflect the
stock split.
6
Comprehensive Income
Comprehensive income includes all changes to shareholders' equity,
including net income, except those resulting from investments by
shareholders and distributions to shareholders. For the three months ended
March 31, 2001 and 2000, comprehensive income totaled $624.9 and $188.2,
respectively. Comprehensive income includes net income, unrealized
appreciation (depreciation) and foreign currency translation gains or
losses.
Net Income Per Share
Companies with complex capital structures are required to present basic
and diluted earnings per share. Basic earnings per share excludes dilution
and is computed by dividing net income by the weighted average number of
common shares outstanding for the period. Diluted earnings per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. At March 31, 2001, earnings per common share assuming dilution is
the same as basic earnings per share because the impact of securities that
could potentially dilute basic earnings per common share is insignificant.
Stock Option Plan
In 2000, shareholders approved the Loews Corporation 2000 Stock Option
Plan (the "Plan"). The aggregate number of shares of Common Stock for
which options may be granted under the Plan is 2,000,000; and the maximum
number of shares of Common Stock with respect to which options may be
granted to any individual in any calendar year is 400,000. The exercise
price per share may not be less than the fair market value of the Common
Stock on the date of grant. Pursuant to the Plan, on January 24, 2001,
options were granted for a total of 270,600 shares of Common Stock at an
exercise price of $46.71 per share. These options vest ratably over a four
year period and expire in ten years. The Company has elected to follow
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees" and related interpretations in accounting for its
employee stock options and awards. Under APB No. 25, no compensation
expense is recognized when the exercise price of options equals the fair
value (market price) of the underlying stock on the date of grant.
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 2001.
During the first quarter of 2001, CNA reclassified equity method income
from limited partnership investments. This income was previously
classified in investment gains and is now classified in net investment
income. The after-tax impact of this reclassification on net operating
income before investment gains was an increase of $20.9 and $31.3 for the
three months ended March 31, 2001 and 2000.
2. Derivative Financial Instruments
As discussed in Note 1, effective January 1, 2001, the Company accounts
for derivative instruments and hedging activities in accordance with SFAS
No. 133. A derivative is typically defined as an instrument whose value is
"derived" from an underlying instrument, index or rate, has a notional
amount, and can be net settled. Derivatives include, but are not limited
7
to, the following types of investments: interest rate swaps, interest rate
caps and floors, put and call options, warrants, swaptions, futures,
forwards and commitments to purchase securities and combinations of the
forgoing. Derivatives embedded within non-derivative instruments (such as
call options embedded in convertible bonds) must be split from the host
instrument and accounted for under SFAS No. 133 when the embedded
derivative is not clearly and closely related to the host instrument. In
addition, non-investment instruments, including certain types of insurance
contracts that have historically not been considered derivatives, can be
derivatives or contain embedded derivatives under SFAS No. 133.
SFAS No. 133 requires that all derivative instruments be recorded in the
balance sheet at fair value. If certain conditions are met, a derivative
may be specifically designated as a hedge of exposures to changes in fair
value, cash flows or foreign currency exchange rates. The accounting for
changes in the fair value of a derivative instrument depends on the
intended use of the derivative and the nature of any hedge designation
thereon. The Company's accounting for changes in the fair value of
derivative instruments is as follows:
Nature of Hedge Designation Derivative's Change in Fair Value
Reflected in:
- --------------------------- -----------------------------------
No hedge designation Realized investment gains (losses).
Fair value Realized investment gains (losses),
along with the change in fair value
of the hedged asset or liability.
Cash flow Other comprehensive income, with
subsequent reclassification to
earnings when the hedged transaction,
asset or liability impacts earnings.
Foreign currency Consistent with fair value or a cash
flow hedge above, depending on the
nature of the hedging relationship.
Changes in the fair value of derivatives held in CNA's separate accounts
are reflected in separate account earnings. Because separate account
investments are generally carried at fair value with changes therein
reflected in separate account earnings, hedge accounting is generally not
applicable to separate account derivatives.
Use of Derivatives
Investment activities of non-insurance companies include investments in
derivative instruments which are marked to market and reported as
investment gains or losses in the income statement.
The Company invests in certain derivative instruments for a number of
purposes, including; (i) for its asset and liability management
activities, (ii) for income enhancements for its portfolio management
8
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.
The Company does not believe that any of the derivative instruments
utilized by it are unusually complex, nor do these instruments contain
imbedded leverage features which would expose the Company to a higher
degree of risk.
CNA invests in derivative financial instruments in the normal course of
business, primarily to reduce its exposure to market risk (principally
interest rate risk, equity stock price risk and foreign currency risk)
stemming from various assets and liabilities. CNA's principal objective
under such market risk strategies is to achieve the desired reduction in
economic risk, even if the position will not receive hedge accounting
treatment. CNA may also use derivatives for purposes of income
enhancement, primarily via the sale of covered call options.
CNA's use of derivatives is limited by statutes and regulations
promulgated by the various regulatory bodies to which it is subject, and
by its own derivative policy. The derivative policy limits which personnel
are authorized to initiate derivative transactions. The policy prohibits
the use of derivatives with a maturity greater than eighteen months,
unless the derivative is matched with assets or liabilities having a
longer maturity. The policy prohibits the use of derivatives containing
greater than one-to-one leverage with respect to changes in the underlying
price, rate or index. Also, the policy prohibits the use of borrowed
funds, including funds obtained through repurchase transactions, to engage
in derivative transactions.
Credit exposure associated with non-performance by the counterparties to
derivative instruments is generally limited to the gross fair value of the
asset related to the instruments recognized in the consolidated condensed
balance sheets. The Company mitigates the risk of non-performance by using
multiple counterparties and by monitoring their creditworthiness. The
Company generally requires collateral from its derivative investment
counterparties depending on the amount of the exposure and the credit
rating of the counterparty.
Risk Management Strategies Regarding Market Risk
The Company has exposure to economic losses due to interest rate risk
arising from changes in the level of, or volatility of, interest rates.
The Company attempts to mitigate its exposure to interest rate risk
through active portfolio management, which includes rebalancing its
existing portfolios or assets and liabilities, as well as changing the
characteristics of investments to be purchased or sold in the future. In
addition, various derivative financial instruments are used to modify the
interest rate risk exposures of certain assets and liabilities. These
strategies include the use of interest rate swaps, interest rate caps and
floors, options, futures, forwards, and commitments to purchase
securities. These instruments are generally used to lock in interest rates
or unrealized gains, to shorten or lengthen durations of fixed maturity
securities or investment contracts, or to hedge (on an economic basis)
interest rate risks associated with investments, variable rate debt and
9
life insurance liabilities. As of the adoption date and March 31, 2001,
none of the Company's holdings of these types of instruments have been
designated as hedges of specific assets or liabilities, and therefore do
not currently qualify for hedge accounting under generally accepted
accounting principles ("GAAP").
The Company is exposed 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 which derive their
value from such securities. The Company attempts to mitigate its exposure
to such risks by limiting its investment in any one security or index. The
Company may also manage this risk by utilizing instruments such as
options, swaps, futures and collars to protect appreciation in securities
held. CNA uses derivatives in one of its separate accounts to mitigate
equity price risk associated with its indexed group annuity contracts by
purchasing Standard & Poor's 500 ("S&P 500") index futures contracts in a
notional amount equal to the contract holder liability, which is
calculated using the S&P 500 rate of return.
Foreign exchange rate risk arises from the possibility that changes in
foreign currency exchange rates will impact the value of financial
instruments denominated in a foreign currency. The Company's foreign
transactions are primarily denominated in Canadian Dollars, British Pounds
and the European Monetary Unit. The Company manages this risk via
asset/liability matching and through the use of foreign currency futures
and/or forwards. As of the adoption date and March 31, 2001, none of the
Company's holdings of foreign currency derivatives have been designated as
hedges of specific assets or liabilities, and therefore do not currently
qualify for hedge accounting under GAAP.
A summary of the aggregate contractual or notional amounts and estimated
fair values related to derivative financial instruments follows. The
contractual or notional amounts are used to calculate the exchange of
contractual payments under the agreements and are not representative of
the potential for gain or loss on these instruments. Interest rates,
equity prices and foreign currency exchange rates affect the fair value of
derivatives. The fair values generally represent the estimated amounts
that CNA would expect to receive or pay upon termination of the contracts
at the reporting date. Dealer quotes are available for substantially all
of CNA's derivatives. For derivative instruments not actively traded, fair
values are estimated using values obtained from independent pricing
services, costs to settle or quoted market prices of comparable
instruments.
10
Derivative Financial Instruments
The Company's investments in derivative instruments are as follows:
Contractual/
Notional Fair Value Asset
March 31, 2001 Value (Liability)
- -------------------------------------------------------------------------------------------
Equity markets:
Options
Purchased-Global Crossing $1,000.0 $ 944.0
-other 123.5 19.3
Written-Global Crossing 1,256.0 (244.0)
-other 929.1 (16.4)
Index futures-long 2.6
Equity warrants 15.0 3.0
Collateralized debt obligation liabilities 170.0 (16.0)
Options embedded in convertible debt securities 869.0 161.0
Separate Accounts-options purchased 79.0
-options written 87.0 (1.0)
-equity index futures - long 821.0
Interest rate risk:
Commitments to purchase government
and municipal securities 343.0
Interest rate caps 500.0 1.0
Futures-long 685.4
-short 318.4
Foreign currency forwards 114.0
Separate Accounts-commitments to purchase
government and municipal
securities 65.0 1.0
-futures-short 26.0
Commodities:
Gold:
Options-purchased 232.6 14.0
-written 160.0 (3.6)
Other 354.6 (2.1)
- -------------------------------------------------------------------------------------------
Total $8,151.2 $860.2
===========================================================================================
11
Immediately following adoption of SFAS No. 133 on January 1, 2001, the
Company's derivative instrument holdings were as follows:
Contractual/
Notional Fair Value Asset
January 1, 2001 Value (Liability)
- -------------------------------------------------------------------------------------------
Equity markets:
Options
Purchased-Global Crossing $1,000.0 $ 664.0
-other 173.0 23.7
Written-Global Crossing 1,256.0 (1.0)
-other 269.6 (17.5)
Index futures- short 2.3
Equity warrants 10.0 4.0
Collateralized debt obligation liabilities 170.0 (18.0)
Options embedded in convertible debt securities 845.0 231.0
Separate Accounts-options purchased 110.0
-options written 118.0 (1.0)
-equity index futures-long 996.0 (13.0)
Interest rate risk:
Interest rate caps 500.0 1.0
Futures-long 229.0
-short 806.2
Foreign currency forwards 13.0
Separate Accounts-commitments to purchase
government and municipal
securities 111.0 1.0
-futures-short 76.0
Commodities:
Gold:
Options-purchased 232.5 11.8
Other 8.6
- -------------------------------------------------------------------------------------------
Total $6,926.2 $886.0
===========================================================================================
Collateralized debt obligations represent a credit enhancement product
that is typically structured in the form of a swap. CNA has determined
that this product is a derivative under SFAS No. 133. CNA is no longer
writing this product. Options embedded in convertible debt securities are
classified as fixed maturity securities in the Consolidated Condensed
Balance Sheets, consistent with the host instruments.
Fair Value Hedge
As of the adoption date, and as of March 31, 2001, CNA's collar position
related to its investment in Global Crossing Ltd. ("Global Crossing")
common stock was the only derivative position that has been designated as
a hedge for accounting purposes. The nature of the transition adjustment
related to this hedge was such that the $962.0 unrealized gain that
existed on the Global Crossing common stock when the hedge was established
has been preserved in accumulated other comprehensive income.
The effectiveness of this hedge is measured based on changes in the
intrinsic value of the collar in relation to changes in the fair value of
the Global Crossing common stock. Changes in the time value component of
the collar's fair value are excluded from the hedge designation and
12
measurement of the effectiveness. For the three months ended March 31,
2001, the Global Crossing hedge was 100% effective. The change in the time
value component of the collar was a pre-tax gain of $21.0 for the three
months ended March 31, 2001, and has been recorded as an investment gain
in the Consolidated Condensed Statements of Income.
3. Reinsurance:
The effects of reinsurance on earned premiums are shown in the following
table:
Direct Assumed Ceded Net
-------------------------------------------
Three Months Ended March 31, 2001
-------------------------------------------
Property and casualty . . . . . . . . . . . . $ 2,021.0 $ 310.0 $ 866.0 $ 1,465.0
Accident and health . . . . . . . . . . . . . 876.0 56.0 61.0 871.0
Life . . . . . . . . . . . . . . . . . . . . 291.0 77.0 174.0 194.0
-------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 3,188.0 $ 443.0 $1,101.0 $ 2,530.0
===========================================
Three Months Ended March 31, 2000
-------------------------------------------
Property and casualty . . . . . . . . . . . . $ 2,117.0 $ 519.0 $ 961.0 $ 1,675.0
Accident and health . . . . . . . . . . . . . 919.0 63.0 107.0 875.0
Life . . . . . . . . . . . . . . . . . . . . 282.0 58.0 121.0 219.0
-------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 3,318.0 $ 640.0 $1,189.0 $ 2,769.0
===========================================
In 1999, CNA entered into an aggregate excess-of-loss reinsurance treaty
related to the 1999 through 2001 accident years covering substantially all
of CNA's property-casualty lines of business (the "Aggregate Cover"). CNA
has two sections of coverage under the terms of the Aggregate Cover. These
coverages attach at defined loss ratios for each accident year. Coverage
under the first section of the Aggregate Cover, which is available for all
accident years covered by the contract, has annual limits of $500.0 with
an aggregate limit of $1,000.0. The second section of the Aggregate Cover,
which is available for accident year 2001, provides coverage up to $510.0
of losses for a maximum premium of $310.0. In the first quarter of 2001,
CNA triggered the coverage under the second section of the Aggregate Cover
for the 2001 accident year. As a result, CNA ceded $42.0 in premium and
$39.0 of loss and loss adjustment expenses, and recorded an interest
charge of $6.0 on the funds withheld balance.
In 2001, CNA entered into a one-year aggregate excess-of-loss reinsurance
treaty related to the 2001 accident year covering substantially all
property-casualty lines of business in the Continental Casualty Company
pool (the "CCC Cover"). Ceded premiums in the amount of $1.0 were recorded
for the CCC Cover. The loss protection provided by the CCC Cover has an
aggregate limit of $750.0 to $825.0 depending on premium volume. The CCC
13
Cover provides continuous coverage in excess of the triggered coverage in
the second section of the Aggregate Cover discussed above.
4. Receivables:
The Company's receivables are comprised of the following:
March 31, December 31,
2001 2000
-----------------------
Reinsurance . . . . . . . . . . . . . . . . . $ 9,537.4 $ 9,397.3
Other insurance . . . . . . . . . . . . . . . 5,078.5 5,026.3
Security sales . . . . . . . . . . . . . . . 1,239.9 470.5
Accrued investment income . . . . . . . . . . 393.4 424.3
Other . . . . . . . . . . . . . . . . . . . . 289.4 331.9
-----------------------
Total . . . . . . . . . . . . . . . . . 16,538.6 15,650.3
Less allowance for doubtful accounts and cash
discounts . . . . . . . . . . . . . . . . . 326.5 348.7
-----------------------
Receivables-net . . . . . . . . . . . . $16,212.1 $15,301.6
=======================
5. Shareholders' equity:
March 31, December 31,
2001 2000
-----------------------
Preferred stock, $.10 par value,
Authorized--100,000,000 shares
Common stock, $1 par value:
Authorized--400,000,000 shares
Issued and outstanding-197,239,900 and
197,228,000 shares . . . . . . . . . . . . $ 197.2 $ 197.2
Additional paid-in capital . . . . . . . . . 47.6 45.6
Earnings retained in the business . . . . . . 10,639.3 10,191.6
Accumulated other comprehensive income . . . 909.3 756.7
-----------------------
Total shareholders' equity . . . . . . . . . $11,793.4 $11,191.1
=======================
6. Restructuring and Other Related Charges:
At December 31, 2000, the remaining accrued restructuring and other
related charges consisted of $7.0 of lease termination costs. During the
first quarter of 2001, approximately $2.0 of these accrued costs were
paid.
14
7. Significant Transactions:
Individual Life Reinsurance Transaction
Effective December 31, 2000, CNA completed a transaction with Munich
American Reassurance Company ("MARC"), whereby MARC acquired CNA's
individual life reinsurance business ("CNA Life Re") via an indemnity
reinsurance agreement. CNA will continue to accept and retrocede business
on existing CNA Life Re contracts until such time that CNA and MARC are
able to execute novations of each of CNA Life Re's assumed and retroceded
reinsurance contracts.
MARC assumed approximately $294.0 of liabilities (primarily future
policy benefits and claim reserves) and approximately $209.0 in assets
(primarily uncollected premiums and deferred policy acquisition costs).
The net gain from the reinsurance transaction, which is subject to certain
post-closing adjustments, has been recorded as deferred revenue and will
be recognized in income over the next 12 to 18 months as CNA Life Re's
assumed contracts are novated to MARC.
The CNA Life Re business contributed net earned premiums of $49.0 and
pre-tax operating income of $10.0 for the three months ended March 31,
2000.
8. Business Segments:
Loews Corporation is a holding company. Its subsidiaries are engaged in
the following lines of business: property, casualty and life insurance
(CNA Financial Corporation, an 87% 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 53% owned subsidiary); and the distribution and
sale of watches and clocks (Bulova Corporation, a 97% owned subsidiary).
Each operating entity is responsible for the operation of its specialized
business and is headed by a chief executive officer having the duties and
authority commensurate with that position.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies in Note 1 of the Notes
to Consolidated Financial Statements in the Annual Report on Form 10-K for
the year ended December 31, 2000. In addition, CNA does not maintain a
distinct investment portfolio for each of its insurance segments, and
accordingly, allocation of assets to each segment is not performed.
Therefore, investment income and investment gains (losses) are allocated
based on each segment's carried insurance reserves, as adjusted.
15
The following tables set forth the Company's consolidated revenues and
income by business segment:
Three Months Ended
March 31,
-----------------------
2001 2000
-----------------------
Revenues (a):
CNA Financial:
Property and casualty . . . . . . . . . . . . . . . . . . . $ 2,160.9 $ 2,223.5
Life . . . . . . . . . . . . . . . . . . . . . . . . . . . 532.3 395.4
Group . . . . . . . . . . . . . . . . . . . . . . . . . . . 873.5 933.2
Other Insurance . . . . . . . . . . . . . . . . . . . . . . 45.0 (61.0)
-----------------------
Total CNA Financial . . . . . . . . . . . . . . . . . . . . 3,611.7 3,491.1
Lorillard . . . . . . . . . . . . . . . . . . . . . . . . . . 1,066.1 997.7
Loews Hotels . . . . . . . . . . . . . . . . . . . . . . . . 84.8 78.5
Diamond Offshore . . . . . . . . . . . . . . . . . . . . . . 224.4 190.5
Bulova . . . . . . . . . . . . . . . . . . . . . . . . . . . 32.9 36.3
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . 84.1 (138.4)
-----------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,104.0 $ 4,655.7
=======================
Income before taxes, minority interest and cumulative
effect of changes in accounting principles:
CNA Financial:
Property and casualty . . . . . . . . . . . . . . . . . . . $ 376.5 $ 232.8
Life . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.5 53.6
Group . . . . . . . . . . . . . . . . . . . . . . . . . . . 27.4 17.5
Other Insurance . . . . . . . . . . . . . . . . . . . . . . 13.3 (95.2)
-----------------------
Total CNA Financial . . . . . . . . . . . . . . . . . . . . 550.7 208.7
Lorillard . . . . . . . . . . . . . . . . . . . . . . . . . . 270.5 252.1
Loews Hotels . . . . . . . . . . . . . . . . . . . . . . . . 8.7 14.5
Diamond Offshore . . . . . . . . . . . . . . . . . . . . . . 47.2 44.8
Bulova . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 4.9
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . 42.5 (186.6)
-----------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 923.9 $ 338.4
=======================
Net income (a):
CNA Financial:
Property and casualty . . . . . . . . . . . . . . . . . . . $ 217.8 $ 136.5
Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75.2 30.8
Group . . . . . . . . . . . . . . . . . . . . . . . . . . . 16.8 10.7
Other Insurance . . . . . . . . . . . . . . . . . . . . . . 3.1 (54.1)
-----------------------
Total CNA Financial .. . . . . . . . . . . . . . . . . . . . 312.9 123.9
Lorillard . . . . . . . . . . . . . . . . . . . . . . . . . . 164.4 155.5
Loews Hotels . . . . . . . . . . . . . . . . . . . . . . . . . 5.5 9.2
Diamond Offshore . . . . . . . . . . . . . . . . . . . . . . 14.7 13.8
Bulova . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 2.7
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . 25.7 (121.5)
-----------------------
525.6 183.6
Cumulative effect of changes in accounting principles - net . (53.3)
-----------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 472.3 $ 183.6
=======================
16
(a) Investment gains (losses) included in Revenues and Net income are as follows:
Three Months Ended
March 31,
-----------------------
2001 2000
-----------------------
Revenues:
CNA Financial:
Property and casualty . . . . . . . . . . . . . . . . . $ 209.4 $ 45.6
Life . . . . . . . . . . . . . . . . . . . . . . . . . 68.4 (10.2)
Group . . . . . . . . . . . .. . . . . . . . . . . . . . 7.4 3.2
Other Insurance . . . . . . . . . . . . . . . . . . . . 85.5 (5.3)
-----------------------
Total CNA Financial . . . . . . . . . . . . . . . . . . . 370.7 33.3
Corporate and other . . . . . . . . . . . . . . . . . . . 36.7 (173.6)
-----------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $ 407.4 $(140.3)
=======================
Net income:
CNA Financial:
Property and casualty . . . . . . . . . . . . . . . . . $ 115.9 $ 25.5
Life . . . . . . . . . . . . . . . . . . . . . . . . . . 38.5 (6.1)
Group . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 1.8
Other Insurance . . . . . . . . . . . . . . . . . . . . 48.2 (2.9)
-----------------------
Total CNA Financial . . . . . . . . . . . . . . . . . . . 206.7 18.3
Corporate and other . . . . . . . . . . . . . . . . . . . 22.0 (112.8)
-----------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $ 228.7 $ (94.5)
=======================
9. Legal Proceedings and Contingent Liabilities:
INSURANCE RELATED
Tobacco Litigation
- ------------------
Four insurance subsidiaries of CNA are defendants in a lawsuit arising
out of policies allegedly issued to Liggett Group, Inc. ("Liggett"). The
lawsuit was filed by Liggett and its current parent, Brooke Group Holding
Inc., in the Delaware Superior Court, New Castle County, on January 26,
2000. The lawsuit, which involves numerous insurers, concerns coverage
issues relating to a number of tobacco-related claims (currently over
1,100 pending) asserted against Liggett over the past 20 years. However,
Liggett only began submitting claims for coverage under the policies in
January 2000. CNA believes its coverage defenses are strong. Based on
facts and circumstances currently known, management believes that the
ultimate outcome of the pending litigation should not materially affect
the financial condition or results of operations of the Company.
IGI Contingency
- ---------------
In 1997, CNA Reinsurance Company Limited ("CNA Re Ltd.") entered into an
arrangement with IOA Global, Ltd. ("IOA"), an independent managing general
agent based in Philadelphia, Pennsylvania, to develop and manage a book of
accident and health coverages. Pursuant to this arrangement, IGI
17
Underwriting Agencies, Ltd. ("IGI"), a personal accident reinsurance
managing general underwriter, was appointed to underwrite and market the
book under the supervision of IOA. Between April 1, 1997 and December 1,
1999, IGI underwrote a number of reinsurance arrangements with respect to
personal accident insurance worldwide ("the IGI Program"). Under various
arrangements, CNA Re Ltd. both assumed risks as a reinsurer and also ceded
a substantial portion of those risks to other companies, including other
CNA insurance subsidiaries and ultimately to a group of reinsurers
participating in a reinsurance pool known as the Associated Accident and
Health Reinsurance Underwriters ("AAHRU") Facility. CNA's Group Operations
business unit participated as a pool member in the AAHRU Facility in
varying percentages between 1997 and 1999.
CNA has undertaken a review of the IGI Program and, among other things,
has determined that a small portion of the premiums assumed under the IGI
Program related to United States workers' compensation "carve-out"
business. CNA is aware that a number of reinsurers with workers'
compensation carve-out insurance exposure have disavowed their obligations
under various legal theories. If one or more such companies are successful
in avoiding or reducing their liabilities, then it is likely that CNA's
liability will also be reduced. Moreover, based on information known at
this time, CNA reasonably believes it has strong grounds for avoiding a
substantial portion of its United States workers' compensation carve-out
exposure through legal action.
As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. CNA believes it has valid and enforceable
reinsurance contracts with the AAHRU Facility and other reinsurers with
respect to the IGI Program, including the United States workers'
compensation carve-out business. It is likely that certain reinsurers will
dispute their liabilities to CNA; however, CNA is unable to predict the
extent of such potential disputes at this time. Legal actions could
result, and the resolution of any such actions could take years.
Based on CNA's review of the entire IGI Program, CNA has established
reserves for its estimated exposure under the program and an estimate for
recoverables from retrocessionaires.
CNA is pursuing a number of loss mitigation strategies. Although the
results of these various actions to date support the recorded reserves,
the estimate of ultimate losses is subject to considerable uncertainty. As
a result of these uncertainties, the results of operations in future years
may be adversely affected by potentially significant reserve additions.
Management does not believe that any such future reserve additions will be
material to the equity of the Company.
Environmental Pollution and Other Mass Tort and Asbestos Reserves
- -----------------------------------------------------------------
CNA's property-casualty insurance companies have potential exposures
related to environmental pollution and other mass tort and asbestos
claims.
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.
18
The Comprehensive Environmental Response Compensation and Liability Act
of 1980 ("Superfund") and comparable state statutes ("mini-Superfunds")
govern the cleanup and restoration of toxic waste sites and formalize the
concept of legal liability for cleanup and restoration by "Potentially
Responsible Parties" ("PRPs"). Superfund and the mini-Superfunds establish
mechanisms to pay for cleanup of waste sites if PRPs fail to do so, and to
assign liability to PRPs. The extent of liability to be allocated to a PRP
is dependent on a variety of factors. Further, the number of waste sites
subject to cleanup is unknown. To date, approximately 1,500 cleanup sites
have been identified by the Environmental Protection Agency ("EPA") on its
National Priorities List ("NPL"). The addition of new cleanup sites to the
NPL has slowed in recent years. 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. 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 an absolute
pollution exclusion. CNA and the insurance industry are disputing coverage
for many such claims. Key coverage issues include whether cleanup costs
are considered damages under the policies, trigger of coverage, allocation
of liability among triggered policies, applicability of pollution
exclusions and owned property exclusions, the potential for joint and
several liability and the definition of an occurrence. To date, courts
have been inconsistent in their rulings on these issues.
A number of proposals to reform Superfund have been made by various
parties. However, no reforms were enacted by Congress during 2000, and it
is unclear what positions the 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.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
cleanup, and the standards for cleanup and liability, the ultimate
liability of CNA for environmental pollution claims may vary substantially
from the amount currently recorded.
The following table provides data related to CNA's environmental
pollution and other mass tort and asbestos-related claim and claim
adjustment expense reserves.
19
March 31, 2001 December 31, 2000
-------------------------------------------------
Environmental Environmental
Pollution Pollution
and Other Mass and Other Mass
Tort Asbestos Tort Asbestos
-------------------------------------------------
Gross reserves . . . . . . . . . . . $ 408.0 $ 816.0 $ 493.0 $ 848.0
Less ceded reserves . . . . . . . . (132.0) (206.0) (146.0) (245.0)
-------------------------------------------------
Net reserves . . . . . . . . . . . . $ 276.0 $ 610.0 $ 347.0 $ 603.0
=================================================
As of March 31, 2001 and December 31, 2000, CNA carried approximately
$276.0 and $347.0 of claim and claim expense reserves, net of reinsurance
recoverables, for reported and unreported environmental pollution and
other mass tort claims. Unfavorable environmental pollution and other mass
tort net claim and claim adjustment expense reserve development for the
three months ended March 31, 2001 amounted to $3.0. There was no
environmental pollution and other mass tort net claim and claim adjustment
expense reserve development for the three months ended March 31, 2000.
CNA's property-casualty insurance subsidiaries also have exposure to
asbestos claims. Estimation of asbestos claim and claim adjustment expense
reserves involves many of the same limitations discussed above for
environmental pollution claims, such as inconsistency of court decisions,
specific policy provisions, allocation of liability among insurers,
missing policies and proof of coverage. CNA continues to see a rise in
asbestos-related claims volume and believes that this phenomenon is driven
by factors such as intensive advertising campaigns by plaintiff lawyers
and the emergence of new defendants such as distributors of asbestos
containing products.
As of March 31, 2001 and December 31, 2000, CNA carried approximately
$610.0 and $603.0 of net claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported asbestos-related
claims. Unfavorable asbestos net claim and claim adjustment expense
reserve development for the three months ended March 31, 2001 and 2000
amounted to $21.0 and $27.0.
The results of operations in future years may continue to be adversely
affected by environmental pollution and other mass tort and asbestos net
claim and claim adjustment expenses. Management will continue to monitor
these liabilities and make further adjustments as warranted.
NON-INSURANCE
TOBACCO RELATED
Lawsuits continue to be filed with increasing frequency against
Lorillard and other manufacturers of tobacco products. Approximately 4,875
product liability cases are pending against cigarette manufacturers in the
United States. Of these, approximately 1,225 cases are pending in a West
Virginia court and approximately 3,040 cases are brought by flight
attendants alleging injury from exposure to environmental tobacco smoke in
the cabins of aircraft. Lorillard is a defendant in all of the flight
20
attendant suits served to date and is a defendant in most of the cases
pending in West Virginia.
Excluding the flight attendant and West Virginia suits, approximately
575 product liability cases are pending against U.S. cigarette
manufacturers. Of these 575 cases, Lorillard is a defendant in
approximately 260. The Company is a defendant in approximately 65 actions,
although it has not received service of process of approximately 35 of
them.
Tobacco litigation includes various types of claims. In these actions,
plaintiffs claim substantial compensatory, statutory and punitive damages,
as well as equitable and injunctive relief, in amounts ranging into the
billions of dollars. These claims are based on a number of legal theories
including, among other things, theories of negligence, fraud,
misrepresentation, strict liability, breach of warranty, enterprise
liability, civil conspiracy, intentional infliction of harm, violation of
consumer protection statutes, violation of anti-trust statutes, and
failure to warn of the allegedly harmful and/or addictive nature of
tobacco products.
Some cases have been brought by individual plaintiffs who allege cancer
and/or other health effects claimed to have resulted from an individual's
use of cigarettes and/or smokeless tobacco products, addiction to smoking,
or exposure to environmental tobacco smoke ("Conventional Product
Liability Cases"). Approximately 4,350 such actions are pending against
Lorillard, including most of the cases filed in West Virginia and each of
the pending flight attendant cases. In other cases, plaintiffs have
brought claims as purported class actions on behalf of large numbers of
individuals for damages allegedly caused by smoking ("Class Actions").
Approximately 30 such cases are pending against Lorillard. In other cases,
plaintiffs are governmental entities or entities such as labor unions,
private companies, hospitals or hospital districts, Indian Tribes, or
private citizens suing on behalf of taxpayers. Plaintiffs in these cases
seek reimbursement of health care costs allegedly incurred as a result of
smoking, as well as other alleged damages ("Reimbursement Cases").
Approximately 50 such cases are pending, including suits brought by the
U.S. federal government and the governments of several foreign nations or
states of foreign nations. In addition, there are claims for contribution
and/or indemnity in relation to asbestos claims filed by asbestos
manufacturers or the insurers of asbestos manufacturers ("Claims for
Contribution"). Approximately 25 such actions are pending. Lorillard is
named as a defendant in each of the pending actions, although it has
received service of process of only ten of the pending suits as of May 1,
2001.
In addition to the above, claims have been brought against Lorillard
seeking damages resulting from alleged exposure to asbestos fibers which
were incorporated, for a limited period of time, ending more than forty
years ago, into filter material used in one brand of cigarettes
manufactured by Lorillard ("Filter Cases"); approximately 20 such actions
are pending.
SETTLEMENT OF STATE REIMBURSEMENT LITIGATION - On November 23, 1998,
Lorillard, Philip Morris Incorporated, Brown & Williamson Tobacco
Corporation and R.J. Reynolds Tobacco Company (the "Original Participating
Manufacturers") entered into a Master Settlement Agreement (the "MSA")
with 46 states, the District of Columbia, the Commonwealth of Puerto Rico,
Guam, the U.S. Virgin Islands, American Samoa and the Commonwealth of the
21
Northern Mariana Islands (collectively, the "Settling States") to settle
the asserted and unasserted health care cost recovery and certain other
claims of those states. The Original Participating Manufacturers had
previously settled similar claims brought by Mississippi, Florida, Texas
and Minnesota (together with the Master Settlement Agreement (the "State
Settlement Agreements").
The State Settlement Agreements provide that it is not an admission or
concession or evidence of any liability or wrongdoing on the part of any
party, and was entered into by the Original Participating Manufacturers to
avoid the further expense, inconvenience, burden and uncertainty of
litigation.
Lorillard recorded pre-tax charges of $279.2 and $260.1 for the three
months ended March 31, 2001 and 2000, respectively, to account for its
obligations under the State Settlement Agreements. Lorillard's portion of
ongoing adjusted payments and legal fees is based on its share of domestic
cigarette shipments in the year preceding that in which the payment is
due. Accordingly, Lorillard records its portions of ongoing settlement
payments as part of cost of manufactured products sold as the related
sales occur.
The State Settlement Agreements require that the domestic tobacco
industry make annual payments in the following amounts, subject to
adjustment for several factors, including inflation, market share and
industry volume: 2001, $9,900.0; 2002, $11,300.0; 2003, $10,900.0; 2004
through 2007, $8,400.0; and thereafter, $9,400.0. In addition, the
domestic tobacco industry is required to pay settling plaintiffs'
attorneys' fees, subject to an annual cap of $500.0, as well as additional
amounts of $250.0 per annum for 2001 through 2003. These payment
obligations are the several and not joint obligations of each settling
defendant.
The State Settlement Agreements also include provisions relating to
significant advertising and marketing restrictions, public disclosure of
certain industry documents, limitations on challenges to tobacco control
and underage use laws, and other provisions.
The Original Participating Manufacturers have also, as part of the
Master Settlement Agreement, committed to work cooperatively with the
tobacco grower community to address concerns about the potential adverse
economic impact on that community. On January 21, 1999, the Original
Participating Manufacturers reached an agreement in principle to establish
a $5,150.0 trust fund payable over 12 years to compensate the tobacco
growing communities in 11 states. Payments to the trust fund are to be
allocated among the Original Participating Manufacturers according to
their relative market share of domestic cigarette shipments, except that
Philip Morris will pay more than its market share in the first year of the
agreement but will have its payment obligations reduced in years 11 and 12
to make up for the overpayment. Lorillard's payments under the agreement
will total approximately $515.0. All payments will be adjusted for
inflation, changes in the unit volume of domestic cigarette shipments, and
for the effect of any new increases in state or federal excise taxes on
tobacco products which benefits the growing community.
The Company believes that the State Settlement Agreements will
materially adversely affect its cash flows and operating income in future
years. The degree of the adverse impact will depend, among other things,
on the rates of decline in United States cigarette sales in the full price
22
and discount segments, Lorillard's share of the domestic full price and
discount cigarette segments, and the effect of any resulting cost
advantage of manufacturers not subject to payments under the State
Settlement Agreements. Almost all domestic manufacturers have agreed to
become subject to the terms of the Master Settlement Agreement.
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 4,725
cases pending against manufacturers of tobacco products in United States
federal and state courts in which individuals allege they or their
decedents have been injured due to smoking cigarettes, due to exposure to
environmental tobacco smoke, due to use of smokeless tobacco products, or
due to nicotine dependence. Approximately 1,225 of these are individual
cases pending in West Virginia. Approximately 3,040 of these cases have
been filed by flight attendants purportedly injured by their exposure to
environmental tobacco smoke in the aircraft cabin. Lorillard is a
defendant in approximately 4,350 of these cases, including most of the
cases pending in West Virginia, as well as all of the pending flight
attendant cases. The Company is a defendant in fifteen of the cases filed
by individuals, although nine of them have not been served on the Company.
The Company is not a defendant in any of the flight attendant cases or in
any of the conventional cases pending in West Virginia.
Plaintiffs in most of these cases seek unspecified amounts in
compensatory and punitive damages. Plaintiffs in the flight attendant
cases may not seek punitive damages as to injuries that arose prior to
January 15, 1997. Plaintiffs in most of the West Virginia suits seek
unspecified amounts of actual damages and punitive damages.
On April 5, 2001, a jury in the Circuit Court, Eleventh Judicial
Circuit, Dade County, Florida returned a verdict in favor of Lorillard and
the other defendants in the case of Fontana v. Philip Morris Incorporated,
et al. Plaintiff alleged injury as a result of her exposure to
environmental tobacco smoke in the cabin of aircraft in which she was
employed as a flight attendant. Plaintiff has filed a motion for ruling on
her reserved motions for mis-trial and a motion for new trial. Plaintiff
also has filed a motion for judgment notwithstanding the verdict as to her
damages claim.
Since January 1, 1999, a total of 14 trials have been held involving 17
cases filed by individual plaintiffs. Lorillard was a defendant in four of
the cases. The Company was not a defendant in any of the cases tried to
date since January 1, 1999. Juries returned verdicts in favor of the
defendants in the four cases tried against Lorillard. In the 14 remaining
cases, verdicts were returned in favor of the defendants in 10 of the
matters. Juries found in plaintiffs' favor in the remaining four cases. In
these four verdicts, juries awarded plaintiffs a total of $153.2 in actual
damages and punitive damages. One of the four verdicts was vacated when
the trial court granted defendant's motion for new trial. Plaintiff in
that action had been awarded $.2 in actual damages. In two of the four
cases, the courts have reduced the verdicts to $26.5 (from $51.5) and
$32.8 (from $80.3), respectively. In the fourth case, the jury awarded
plaintiffs $21.2. Appeals are pending in each of these actions. To date
during 2001, juries have returned verdicts in favor of the defendants in
four cases. Lorillard was a defendant in two of the matters. As of May 1,
2001, trial was proceeding in two cases in which neither the Company nor
Lorillard were defendants. Several additional cases are scheduled for
trial during 2001 against U.S. cigarette manufacturers and manufacturers
of smokeless tobacco products. Lorillard is a defendant in some of these
actions. As of May 1, 2001, trial dates were pending in approximately 20
23
of the cases filed by flight attendants. In addition, trial has been
scheduled to begin during March 2002 in the cases brought by approximately
1,225 West Virginia smokers or users of smokeless tobacco products. These
cases are presently scheduled to be tried pursuant to a multi-part trial
plan.
During 2001, another cigarette manufacturer, Brown & Williamson Tobacco
Corporation, paid $1.1 in damages and interest to a former smoker and his
spouse for injuries they allegedly incurred as a result of smoking. Carter
v. Brown & Williamson Tobacco Corporation (Circuit Court, Duval County,
Florida, filed February 10, 1995). In a 1996 trial, the jury awarded
plaintiffs a total of $.8 in actual damages at trial. Plaintiffs did not
seek punitive damages. In a 1998 decision, the Florida Court of Appeal
reversed the judgment, holding that plaintiffs' claims were barred by the
statute of limitations. The Florida Supreme Court, however, reinstated the
jury's damages award during 2000 and denied Brown & Williamson's motion
for rehearing during 2001. Brown & Williamson has filed a petition for
writ of certiorari with the U.S. Supreme Court from this case. Lorillard
was not a defendant in this matter.
The California Supreme Court is reviewing decisions by the California
Court of Appeals as to whether amendments to a California statute bars
claims against cigarette manufacturers if the claims accrued between 1988
and 1998. Several cases against cigarette manufacturers, including
Lorillard, have been dismissed based on application of the statute in
question.
CLASS ACTIONS - There are approximately 50 purported class actions
pending against cigarette manufacturers and other defendants. Lorillard is
a defendant in approximately 30 of the approximately 50 cases seeking
class certification. The Company is a defendant in seven of the purported
class actions, although it has not received service of one of them.
Lorillard also is a defendant in each of these seven actions. Two
additional cases naming both the Company and Lorillard as defendants have
not been served on any of the parties. Many of the purported class actions
are in the pre-trial, discovery stage. Most of the suits seek class
certification on behalf of residents of the states in which the cases have
been filed, although some suits seek class certification on behalf of
residents of multiple states. Plaintiffs in the purported class actions
seek class certification on behalf of individuals who smoked cigarettes or
were exposed to environmental tobacco smoke.
Various courts have ruled on motions for class certification in smoking
and health-related cases. In twelve state court cases, which were pending
in five states and the District of Columbia, courts have denied
plaintiffs' class certification motions. In another thirteen cases,
cigarette manufacturers have defeated motions for class certification
before either federal trial courts or courts of appeal from cases pending
in eleven states and the Commonwealth of Puerto Rico. The denial of class
certification in a New York federal court case, however, was due to the
court's interest in preserving judicial resources for a potentially
broader class certification ruling in In re Simon (II) Litigation,
discussed below. In six cases in which Lorillard is a defendant,
plaintiffs' motions for class certification have been granted and appeals
either have been rejected at the interlocutory stage, appeals have not yet
been considered, or the plaintiffs' claims were resolved through a
settlement agreement. These six cases are Broin (which was the matter
concluded by the settlement agreement), Engle, Scott, Blankenship, Daniels
and Brown.
24
Theories of liability asserted in the purported class actions include a
broad range of product liability theories, including those based on
consumer protection statutes and fraud and misrepresentation. Plaintiffs
seek damages in each case that range from unspecified amounts to the
billions of dollars. Most plaintiffs seek punitive damages and some seek
treble damages. Plaintiffs in many of the cases seek medical monitoring.
Plaintiffs in several of the purported class actions are represented by a
well-funded and coordinated consortium of approximately 60 law firms from
throughout the United States.
Trial began during July 1998 in the case of Engle v. R.J. Reynolds
Tobacco Co., et al. (Circuit Court, Dade County, Florida, filed May 5,
1994). The trial court, as amended by the Florida Court of Appeal, granted
class certification on behalf of Florida residents and citizens, and
survivors of such individuals, who have suffered injury or have died from
medical conditions allegedly caused by their addiction to cigarettes
containing nicotine.
The case is being tried in three phases. The first phase involved
consideration of certain issues claimed to be "common" to the members of
the class and their asserted causes of action.
On July 7, 1999, the jury returned a verdict against defendants at the
conclusion of the first phase. The jury found, among other things, that
cigarette smoking is addictive and causes lung cancer and a variety of
other diseases, that the defendants concealed information about the health
risks of smoking, and that defendants' conduct "rose to a level that would
permit a potential award or entitlement to punitive damages." The verdict
permitted the trial to proceed to a second phase. The jury was not asked
to award damages in the Phase One verdict.
By order dated July 30, 1999 and supplemented on August 2, 1999
(together, the "order"), the trial judge amended the trial plan in respect
to the manner of determining punitive damages. The order provided that the
jury will determine punitive damages, if any, on a lump-sum dollar amount
basis for the entire qualified class. The Third District of the Florida
Court of Appeal rejected as premature defendants' appeals from these
rulings, and the Florida Supreme Court declined to review the orders at
this time.
The first portion of Phase Two of the trial began on November 1, 1999
before the same jury that returned the verdict in Phase One. In the first
part of Phase Two, the jury determined issues of specific causation,
reliance, affirmative defenses, and other individual-specific issues
related to the claims of three named plaintiffs and their entitlement to
damages, if any.
On April 7, 2000, the jury found in favor of the three plaintiffs and
awarded them a total of $12.5 in economic damages, pain and suffering
damages and damages for loss of consortium. After awarding damages to one
of the three plaintiffs, the jury appeared to find that his claims were
barred by the statute of limitations. The purported final judgment entered
by the trial court on November 6, 2000 reflected the damages award, and
held only a portion of this plaintiff's claims were barred by the statute
of limitations.
The second part of Phase Two of the trial began on May 22, 2000 and was
heard by the same jury that heard the trial's prior phases. The second
part of the trial's Phase Two considered evidence as to the punitive
25
damages to be awarded to the class. On July 14, 2000, the jury awarded a
total of $145,000.0 in punitive damages against all defendants, including
$16,250.0 against Lorillard.
On November 6, 2000, the Circuit Court of Dade County, Florida, entered
a purported final judgment in favor of the plaintiffs that reflects the
jury's three verdicts in favor of the plaintiffs. The court's purported
final judgment also denied various of defendants' post-trial motions,
which included a motion for new trial and a motion seeking reduction of
the punitive damages award. Lorillard has noticed an appeal from the
purported final judgment to the Third District of the Florida Court of
Appeal and has posted its appellate bond in the amount of $104.0 pursuant
to recent Florida legislation limiting the amount of an appellate bond
required to be posted in order to stay execution of a judgment for
punitive damages in a certified class action. Although this legislation is
intended to apply to the Engle case, Lorillard cannot predict the outcome
of any challenges to the possible application or constitutionality of this
legislation. In the event this legislation is challenged and found to be
invalid, Lorillard could be required to post a bond in an amount not
capable of being bonded, resulting in execution of the judgment before it
could be set aside on appeal. Lorillard believes that such a result would
be unconstitutional and would also violate Florida law. Lorillard intends
to take all appropriate steps to seek to prevent this scenario from
occurring and believes these efforts should be successful.
Now that the jury has awarded punitive damages and a purported final
judgment has been entered, it is unclear how the August 2, 1999 order will
be implemented. The August 2, 1999 order provides that the lump-sum
punitive damage amount, if any, will be allocated equally to each class
member and acknowledges that the actual size of the class will not be
known until the last case has withstood appeal, i.e., the punitive damage
amount, if any, determined for the entire qualified class, would be
divided equally among those plaintiffs who are ultimately successful. The
order does not address whether defendants would be required to pay the
punitive damage award, if any, prior to a determination of claims of all
class members, which is Phase Three of the trial plan, a process that
could take years to conclude. The purported final judgment entered by the
court on November 6, 2000 directs that the amounts awarded by the jury are
to be paid immediately. Phase Three would address potentially hundreds of
thousands of other class members' claims, including issues of specific
causation, reliance, affirmative defenses and other individual-specific
issues regarding entitlement to damages, in individual trials before
separate juries.
Lorillard remains of the view that the Engle case should not have been
certified as a class action. That certification is inconsistent with the
overwhelming majority of federal and state court decisions which have held
that mass smoking and health claims are inappropriate for class treatment.
Lorillard has challenged the class certification, as well as other
numerous legal errors that it believes occurred during the trial. The
Company and Lorillard believe that an appeal of these issues on the merits
should prevail.
Trial began during January 2001 in the case of Blankenship v. R.J.
Reynolds Tobacco Company, et al. (Circuit Court, Ohio County, West
Virginia) but a mistrial was declared while plaintiffs were presenting
their evidence. Retrial has been scheduled to begin on September 5, 2001.
Shortly before trial began, the court granted class certification on
behalf of West Virginia residents who desire to participate in a medical
26
monitoring plan. The West Virginia Supreme Court declined to review
defendants' writ from the class certification ruling. Lorillard is a
defendant in the action. The case is to be tried under a multi-part trial
plan.
Trial is scheduled to begin during June 2001 in the case of Scott v. The
American Tobacco Company, et al. (District Court, Orleans Parish,
Louisiana). The trial court has certified a class for purposes of medical
monitoring and smoking cessation claims comprised of residents of the
State of Louisiana who desire to participate in medical monitoring or
smoking cessation programs and who began smoking prior to September 1,
1988, or who allege that defendants undermined compliance with the
warnings on cigarette packages. The case is scheduled to be tried under a
three-part trial plan. Lorillard is a defendant in the suit. Defendants
have filed a writ application with the Louisiana Supreme Court for review
of the trial plan and for decertification of the class.
During December 2000, the Superior Court of San Diego County, California
issued an order in the case of Daniels v. Philip Morris, Incorporated, et
al. that granted plaintiffs' motion for class certification on behalf of
California residents who, while minors, smoked at least one cigarette
between April 1994 and December 31, 1999. Defendants have filed a petition
for writ of prohibition from the class certification ruling with the
California Supreme Court. Trial in this matter is scheduled to begin
during March 2002, although the parties have agreed to a continuance until
May 2002. Lorillard is a defendant in this action.
During April 2001, the Superior Court of San Diego County, California
issued an oral ruling in the case of Brown v. The American Tobacco
Company, Inc., et al., in which it granted in part plaintiff's motion for
class certification and certified a class comprised of residents of
California who smoked at least one of defendants' cigarettes during the
"applicable" class period and who were exposed to defendants' marketing
and advertising activities in California. Certification was granted as to
plaintiff's claims that defendants violated California Business and
Professions Code Sections 17200 and 17500. The court denied the motion for
class certification as to plaintiff's claims under the California Legal
Remedies Act. The court has postponed entering a final ruling on the class
certification in order to receive briefs with respect to the time frame
encompassed by "the applicable class period." The court is scheduled to
issue its ruling during July 2001.
On October 10, 1997, the parties to Broin v. Philip Morris Companies,
Inc., et al. (Circuit Court, Dade County, Florida, October 31, 1991), a
class action brought on behalf of flight attendants claiming injury as a
result of exposure to environmental tobacco smoke, executed a settlement
agreement which was approved by the trial court on February 3, 1998.
Pursuant to the settlement agreement, among other things, Lorillard and
three other U.S. cigarette manufacturers paid approximately $300.0 to
create and endow a research institute to study diseases associated with
cigarette smoke. In addition, the settlement agreement permits the
plaintiff class members to file individual suits, but these individuals
may not seek punitive damages for injuries that arose prior to January 15,
1997. As of May 1, 2001, approximately 3,040 such cases were pending
against Lorillard and three other U.S. cigarette manufacturers before the
Circuit Court of Dade County, Florida. The time for virtually all class
members to file suits pursuant to the settlement agreement has expired.
27
During October 2000, the Circuit Court of Dade County, Florida entered
an order that may be construed to hold that the flight attendants are not
required to prove the substantive liability elements of their claims for
negligence, strict liability and breach of implied warranty in order to
recover damages. The court further ruled that the trials of these suits
are to address whether the plaintiffs' alleged injuries were caused by
their exposure to environmental tobacco smoke and, if so, the amount of
damages to be awarded. It is not clear how the trial judges will apply
this order. Defendants have noticed an appeal from the October 2000 order
to the Third District of the Florida Court of Appeal. As of May 1, 2001,
one of the flight attendant cases has been tried. On April 5, 2001 a jury
in the Circuit Court, Eleventh Judicial Circuit, Dade County, Florida
returned a verdict in favor of Lorillard and the other defendants in the
case of Fontana v. Philip Morris Incorporated, et al. Plaintiff has filed
post-trial motions that contests the verdict. As of May 1, 2001,
approximately 20 additional flight attendant cases were scheduled for
trial during 2001.
REIMBURSEMENT CASES - In addition to the cases settled by State Settlement
Agreements described above, approximately 50 other suits are pending,
comprised of cases brought by the U.S. federal government, county
governments, city governments, unions, Indian tribes, hospitals or
hospital districts, private companies and foreign governments filing suit
in U.S. courts, in which plaintiffs seek recovery of funds allegedly
expended by them to provide health care to individuals with injuries or
other health effects allegedly caused by use of tobacco products or
exposure to cigarette smoke. These cases are based on, among other things,
equitable claims, including injunctive relief, indemnity, restitution,
unjust enrichment and public nuisance, and claims based on antitrust laws
and state consumer protection acts. Plaintiffs seek damages in each case
that range from unspecified amounts to the billions of dollars. Most
plaintiffs seek punitive damages and some seek treble damages. Plaintiffs
in many of the cases seek medical monitoring. Lorillard is named as a
defendant in most such actions. The Company is named as a defendant in 21
of the pending reimbursement cases, although it has not received service
of five of these matters.
U.S. Federal Government Action - The federal government of the United
States filed a reimbursement suit on September 22, 1999 in the United
States District Court for the District of Columbia against Lorillard,
other U.S. cigarette manufacturers, some parent companies and two trade
associations. The Company is not a defendant in this action. Plaintiff
asserts claims under the Medical Care Recovery Act, the Medicare Secondary
Payer provisions of the Social Security Act, and the Racketeer Influenced
and Corrupt Organizations Act. The government alleges in the complaint
that it has incurred costs of more than $20,000.0 annually in providing
health care costs under certain federal programs, including Medicare,
military and veterans' benefits programs, and the Federal Employee Health
Benefits Program. The federal government seeks to recover an unspecified
amount of health care costs, and various types of declaratory relief,
including disgorgement of profits, injunctive relief and declaratory
relief that defendants are liable for the government's future costs of
providing health care resulting from the defendants' alleged wrongful
conduct.
During September 2000, the court granted in part and denied in part
defendants' motion to dismiss the complaint. The court dismissed
plaintiff's claims asserted under the Medical Care Recovery Act as well as
those under Medicare as Secondary Payer Act. The court denied the motion
28
as to plaintiff's claims under the Racketeering Influenced and Corrupt
Organizations Act. Plaintiff is seeking modification of the trial court's
order as it relates to the dismissal of the Medical Care Recovery Act
claim. In an amended complaint filed during February 2001, plaintiff
attempted to plead with greater specificity the claims dismissed by the
court in the September 2000 ruling. In addition, the Cherokee Nation Tribe
has filed a motion for intervention and a proposed complaint in
intervention on behalf of a purported nationwide class of Indian tribes.
The court has not ruled on the motions.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - Cases
have been brought in U.S. courts by the nations of Belize, Bolivia,
Ecuador, Guatemala, Honduras, Kyrgyz, Nicaragua, Panama, the Russian
Federation, Tajikistan, Thailand, Ukraine and Venezuela, as well as by the
Brazilian States of Espirito Santo, Goias, Mato Grosso do Sul, Piaui, Rio
de Janeiro, Sao Paolo and Tocantins, and the Canadian Province of Ontario.
Both the Company and Lorillard have been named as defendants in the cases
filed by Belize, Bolivia, Ecuador, Honduras, Kyrgyz, the Russian
Federation, Tajikistan, Ukraine and Venezuela, the seven Brazilian states
and the Province of Ontario, Canada. The Company has not received service
of process of the case filed by Honduras, Venezuela or the State of Sao
Paolo, Brazil. The suits filed by Ecuador, Kyrgyz, Thailand have been
voluntarily dismissed by the plaintiffs. The cases filed by Guatemala,
Nicaragua, Ukraine and the Province of Ontario, Canada are pending on
appeal following the entry of orders granting defendants' motions to
dismiss the complaints. Each of the remaining cases is in the pre-trial,
discovery stage.
In 1977, Lorillard sold its major trademarks outside of the United
States and the international sales business in cigarettes associated with
those brands. Performance by Lorillard of obligations under the 1977
agreement was guaranteed by the Company. Lorillard and the Company have
received notice from Brown & Williamson Tobacco Corporation, which claims
to be a successor to the purchaser, that indemnity will be sought under
certain indemnification provisions of the 1977 agreement with respect to
suits brought by various of the foregoing foreign jurisdictions, and in
certain cases brought in foreign countries by individuals concerning
periods prior to June 1977 and during portions of 1978.
Reimbursement Cases by Indian Tribes - Indian Tribes are the plaintiffs
in six pending reimbursement suits. Most of these cases have been filed in
tribal courts. Lorillard is a defendant in each of the cases. The Company
is not named as a defendant in any of the pending tribal cases. Each of
the pending cases is in the pre-trial, discovery stage.
Reimbursement Cases By Private Companies and Health Plans or Hospitals
and Hospital Districts - Three cases are pending against cigarette
manufacturers in which the plaintiffs are private companies, including
not-for-profit insurance companies. Lorillard is a defendant in each of
the pending cases. The Company has not been named as a defendant in any of
the pending private company cases. Trial is proceeding in one of the
suits, the case of Blue Cross and Blue Shield of New Jersey, which is
pending in the U.S. District Court for the Eastern District of New York.
One of the cases was filed in New York by eight German insurance
companies. In addition, two suits filed by hospitals or hospital districts
are pending. One of the cases is brought on behalf of approximately 175
hospitals operating in the state of New York. Lorillard is named as a
defendant in both of the pending hospital or hospital district cases. The
29
Company is not named as a defendant in either of the pending hospital or
hospital district cases.
Reimbursement Cases By Labor Unions - Approximately 20 reimbursement
suits are pending in various federal or state courts in which the
plaintiffs are labor unions, their trustees or their trust funds.
Lorillard is a defendant in each of these suits. The Company is a
defendant in two of the pending suits. Thirteen of the approximately 20
cases are on appeal from final judgments entered in defendants' favor by
the trial courts. Ten of the thirteen cases on appeal are from a single
ruling in favor of the defendants by a single New York state court. The
remaining three cases on appeal are from rulings in defendants' favor by
state courts in California, Michigan and the District of Columbia.
Approximately 60 union cases have been dismissed in recent years. Some of
these cases were dismissed voluntarily, while others were dismissed as a
result of defendants' dispositive motions. Appeals were sought from some
of these dismissal rulings and defendants have prevailed in each of these
appeals to date. The Second, Third, Fifth, Seventh, Eighth, Ninth and
Eleventh Circuit Courts of Appeal have found in favor of the defendants in
each of the appeals from dismissal orders entered by the federal trial
courts that were submitted to them, and the U.S. Supreme Court has denied
petitions for writ of certiorari that sought review of some of these
decisions. Several cases pending in state courts also have been dismissed.
Each of the cases pending before trial courts is in the pre-trial,
discovery stage.
Eastern District of New York Litigation - On April 18, 2000, a federal
judge in the Eastern District of New York issued an order that
consolidates, for settlement purposes only, ten pending cases involving
Lorillard as well as other industry defendants. These cases include three
contribution cases (Falise v. The American Tobacco Company, et al., H.K.
Porter Company, Inc. v. The American Tobacco Company, Inc., et al. and
Raymark Industries, Inc. v. The American Tobacco Company, Inc., et al.),
two union cases (Bergeron, et al. v. Philip Morris, Inc., et al. and The
National Asbestos Workers Medical Fund, et al. v. Philip Morris
Incorporated, et al.), one private company case (Blue Cross and Blue
Shield of New Jersey, Inc., et al. v. Philip Morris, Incorporated, et
al.), two smoking and health class actions that have been served on
defendants (Decie v. The American Tobacco Company, Inc., et al. and Simon
v. Philip Morris Incorporated, et al.), one smoking and health class
action in which none of the defendants have received service of process
(Ebert v. Philip Morris, Incorporated, et al.) and one case that contains
elements of both a smoking and health class action and a private citizen
reimbursement case (Mason v. The American Tobacco Company, Inc., et al.).
The judge's order directed the parties to select a mediator or special
master in order to facilitate settlement discussions and also invited the
federal government to join in the settlement discussions. On July 31,
2000, the federal judge orally proposed the formation of a national
punitive damages class action for the purposes of settlement. Pursuant to
the judge's proposal, Lorillard entered into discussions with a committee
of counsel representing a broad-based group of plaintiffs in an effort to
arrive at a comprehensive settlement of all exemplary and punitive damage
claims, including claims involved in the Engle class action in Florida
described above. The parties have been unable to reach an understanding
and the negotiations have been suspended.
The federal judge directed that a combined suit be filed encompassing
all of the claims pending before him that name cigarette manufacturers as
defendants, the case of In re Simon (II) Litigation (U.S. District Court,
30
Eastern District, New York, filed September 6, 2000). The Company is a
defendant in this proceeding. During March 2001, the court heard argument
of plaintiffs' motion for class certification, plaintiffs' motion for
appointment of class counsel, and defendants' motion to dismiss the
complaint. In a November 2000 ruling, the court stated that "Simon II
should be triable without appreciable delay should it be certified." To
date, a trial date has not been set in this matter.
To date during 2001, a trial was held in one of the contribution cases,
Falise. However, as noted below a mistrial was declared due to the
inability of the jury to reach a verdict. The court has not scheduled re-
trial of this matter. As of May 1, 2001, trial was proceeding in the
private company case, Blue Cross and Blue Shield of New Jersey. Several
Blue Cross and Blue Shield plans are plaintiffs in this action, but the
proceeding trial is addressing the claims of only one of them, Empire Blue
Cross and Blue Shield.
CONTRIBUTION CLAIMS - In addition to the foregoing cases, 23 cases are
pending in which private companies seek recovery of funds expended by them
to individuals whose asbestos disease or illness was alleged to have been
caused in whole or in part by smoking-related illnesses. Lorillard is
named as a defendant in each action, although it has not received service
of process of thirteen of them. The Company is named as a defendant in 17
of the cases but has not received service of process of 13 of them.
Fourteen of the 23 cases have been filed since December 1, 2000, including
five initiated since April 1, 2001. During January of 2001, a mistrial was
declared during jury deliberations in the case of Falise, et al. v. The
American Tobacco Company, et al. (U.S. District Court, Eastern District,
New York), which was filed by the Trustees of the Johns Manville Trust. To
date, retrial of this case has not been scheduled. Two other cases are set
for trial during 2001. Trial in the case of Owens Corning v. R.J. Reynolds
Tobacco Company, et al., pending in the Circuit Court of Jefferson County,
Mississippi, is scheduled to begin during June 2001. Trial in the case of
Fibreboard Corporation and Owens Corning v. R.J. Reynolds Tobacco Company,
et al., pending in the Superior Court of Alameda County, California, is
scheduled to begin during July 2001. The remaining cases are in the pre-
trial, discovery stage.
FILTER CASES - A number of cases have been filed against Lorillard
seeking damages for cancer and other health effects claimed to have
resulted from exposure to asbestos fibers which were incorporated, for a
limited period of time, ending more than forty years ago, into the filter
material used in one of the brands of cigarettes manufactured by
Lorillard. Approximately 20 such cases are pending in federal and state
courts against Lorillard. The Company is not a defendant in any of the
pending actions. Allegations of liability include negligence, strict
liability, fraud, misrepresentation and breach of warranty. Plaintiffs in
most of these cases seek unspecified amounts in compensatory and punitive
damages. Trials have been held in fifteen such cases. Five such trials
have been held since 1999. Juries have returned verdicts in favor of
Lorillard in 11 of the 15 trials. Four verdicts have been returned in
plaintiffs' favor, including in one of the two cases tried during 1999 and
in one of the three cases tried during 2000. In the 1999 trial in which a
jury found in favor of the plaintiffs, plaintiffs were awarded $2.2 in
actual damages. In the one trial in 2000 in which the jury found in
plaintiffs' favor, the jury awarded plaintiffs $1.1 in actual damages and
the case was settled prior to a determination of punitive damages.
31
TOBACCO-RELATED ANTITRUST CASES - Wholesalers and Direct Purchasers
Suits - Lorillard and other domestic and international cigarette
manufacturers and their parent companies, including the Company, were
named as defendants in nine separate federal court actions brought by
tobacco product wholesalers for violations of U.S. antitrust laws and
international law. The complaints allege that defendants conspired to fix
the price of cigarettes to wholesalers since 1988 in violation of the
Sherman Act. These actions seek certification of a class including all
domestic and international wholesalers similarly affected by such alleged
conduct, and damages, injunctive relief and attorneys' fees. These actions
were consolidated for pre-trial purposes in the U.S. District Court for
the Northern District of Georgia. The Court has granted class
certification for a four-year class (beginning in 1996 and ending in 2000)
of domestic direct purchasers. The Company has been voluntarily dismissed
without prejudice from all direct purchaser cases.
Indirect Purchaser Suits - Approximately 30 suits are pending in various
state courts alleging violations of state antitrust laws which permit
indirect purchasers, such as retailers and consumers, to sue under price
fixing or consumer fraud statutes. Approximately 18 states permit such
suits. Lorillard is a defendant in each of these indirect purchaser cases.
One indirect purchaser suit, in Arizona, has been dismissed in its
entirety. The Company was also named as a defendant in most of these
indirect purchaser cases but has been voluntarily dismissed without
prejudice from all of them.
Tobacco Growers Suit - DeLoach v. Philip Morris Inc., et al. (U.S.
District Court, Middle District of North Carolina, filed February 16,
2000). Lorillard is named as a defendant in a lawsuit that, after several
amendments, alleges only antitrust violations. The other major domestic
tobacco companies are also presently named as defendants, and the
plaintiffs have now added the major leaf buyers as defendants. This case
was originally filed in U.S. District Court, District of Columbia, and
transferred to a North Carolina federal court upon motion by the
defendants. Plaintiffs seek certification of a class including all tobacco
growers and quota holders (the licenses that a farmer must either own or
rent to sell the crop), who sold tobacco or held quota under the federal
tobacco leaf price support program since February 1996. The plaintiffs'
claims relate to the conduct of the companies in the purchase of tobacco
through the auction system under the federal program. The suit seeks an
unspecified amount of actual damages, trebled under the antitrust laws,
and injunctive relief.
* * * *
While Lorillard intends to defend vigorously all litigation which may be
brought against it, it is not possible to predict the outcome of any of
this litigation. Litigation is subject to many uncertainties. An
unfavorable verdict has been returned and judgment has been entered
against Lorillard in the Engle case, described above, and it is possible
that additional cases could be decided unfavorably to Lorillard.
In addition, adverse developments in relation to smoking and health,
including the release in 1998 of industry documents, have received
widespread media attention. These developments may reflect adversely on
the tobacco industry and, together with possible adverse outcomes in
pending cases, could have adverse effects on the ability of Lorillard and
other cigarette manufacturers to prevail in smoking and health litigation
and could prompt the filing of additional litigation.
32
Lorillard believes that it has valid defenses to the cases pending
against it as well as valid bases for appeal of the adverse verdict
against it and Lorillard will continue to maintain a vigorous defense in
all such litigation. Lorillard may enter into discussions in an attempt to
settle particular cases if it believes it is appropriate to do so.
Except for the impact of the State Settlement Agreements as described
above, management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of pending
litigation. It is possible that the Company's results of operations or
cash flows in a particular quarterly or annual period or its financial
position could be materially adversely affected by an unfavorable outcome
of certain pending litigation.
OTHER LITIGATION - The Company and its subsidiaries are also parties to
other litigation arising in the ordinary course of business. The outcome
of this other litigation will not, in the opinion of management,
materially affect the Company's results of operations or equity.
10. In the opinion of Management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as
of March 31, 2001 and December 31, 2000 and the results of operations and
changes in cash flows for the three months ended March 31, 2001 and 2000.
Results of operations for the first three months of each of the years is
not necessarily indicative of results of operations for that entire year.
33
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
---------------------------------------------------------------------
OVERVIEW
Loews Corporation reported net income for the 2001 first quarter of $472.3
million or $2.40 per share compared to $183.6 million or $.90 per share in the
2000 first quarter. Net income in the first quarter of 2001 includes net
investment gains of $228.7 million or $1.16 per share compared to net
investment losses of $94.5 million or $.47 per share in the comparable period
of the prior year. Net income in the first quarter of 2001 also includes a
charge for accounting changes of $53.3 million or $.27 per share, related to
accounting for derivative instruments at the CNA subsidiary.
Net operating income, which excludes net investment gains and losses and
accounting changes, for the quarter ended March 31, 2001 was $296.9 million or
$1.51 per share compared to $278.1 million or $1.37 per share in 2000.
Gross revenues amounted to $5.1 billion in the first quarter of 2001,
compared to $4.7 billion in the comparable period of the prior year.
At March 31, 2001, the Company had a book value of $59.79 per share compared
to a book value of $56.74 per share at December 31, 2000.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
CNA Financial
- -------------
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is an 87% owned subsidiary of the Company.
Property and Casualty
- ---------------------
The property and casualty segment is comprised of the following operating
units of CNA: Agency Market Operations, Risk Management, Specialty
Operations, Global Operations and Reinsurance Operations.
Net earned premiums for the property-casualty segment decreased $208.0
million, or 12.3%, to $1,478.0 million for the first three months of 2001
compared with the same period in 2000. This decline was comprised of decreases
in Agency Market Operations of $102.0 million, Specialty Operations of $18.0
million, Risk Management of $15.0 million and Reinsurance Operations of $84.0
million. These decreases were partially offset by an increase in net earned
premiums for Global Operations of $11.0 million.
The decrease in net earned premiums of Agency Market Operations was
partially due to the continued effort to re-underwrite business and obtain
adequate rates for exposures underwritten. Also, the premium decline was
partially due to $24.0 million in additional ceded premiums related to
accident year 2001 excess-of-loss reinsurance treaties. The net earned
premiums declined for Specialty Operations related principally to active
decisions to renew only those accounts which meet current underwriting
guidelines supporting the ongoing commitment to underwriting discipline,
especially in the dental professionals and physicians products.
34
Net earned premiums for Risk Management decreased as a result of a continued
focus on re-underwriting the book of business. Reinsurance Operations also
experienced a decrease in net earned premiums that reflects decisions not to
renew contracts, especially multi-year contracts, that management believed did
not meet its underwriting profitability targets. These contracts included
credit and bond, London market lineslip insurance and European casualty
facultative lines of business. The increase in net earned premiums for Global
Operations was driven by growth in the commercial casualty and property lines
in the European operations, as well as growth in the vehicle warranty line.
These increases were partially offset by declines in the equipment maintenance
warranty line of business and increased ceded premiums in the surety lines.
Underwriting results for the property-casualty segments remained relatively
flat for the first three months of 2001 as compared with the same period in
2000. Excluding the $37.0 million (pre-tax) effect of the non-recurring ceding
commission included in 2000 related to the sale of Personal Insurance to
Allstate, underwriting results improved $36.0 million, most notably in
Commercial Insurance. The combined ratio increased 1.4 percentage points for
the property-casualty segment to 111.4% for the first three months of 2001 as
compared with the same period in 2000. Although total operating expenses have
decreased, the expense and dividend ratio increased 3.3 percentage points to
37.1% due to the reduced net earned premium base. The loss ratio decreased 1.9
percentage points to 74.3% for the first three months of 2001 as compared with
the same period in 2000 as a result of improved current year loss experience
in Commercial Insurance and increased rate and improved experience in the Risk
Management casualty line of business. These improvements were partially offset
by Global Operations' adverse loss experience in the marine lines and adverse
development in the surety lines.
Net operating income decreased $9.1 million in the first three months of
2001 as compared with the same period in 2000, primarily driven by decreased
net investment income.
During the first quarter of 2001, CNA reclassified equity method income from
limited partnership investments. This income was previously classified in
investment gains, net of tax and minority interest, and is now classified in
net investment income. The after-tax impact of this reclassification on net
operating income for the property-casualty segment was $24.4 and $27.9 million
in the first three months of 2001 and 2000, respectively.
Group
- -----
Net earned premiums for Group Operations decreased $65.0 million, or 7.4%,
to $818.0 million for the first three months of 2001 as compared with the same
period in 2000. Net earned premiums declined $49.0 million as a result of the
sale of the Life Reinsurance business on December 31, 2000 and $37.0 million
in group reinsurance as a result of terminating contracts with unprofitable
independent underwriting agencies. These declines were partially offset by
growth of $18.0 million in Group Benefits lines of business.
Net operating income increased by $3.8 million in the first quarter of 2001
as compared with the same period in 2000. This improvement is a result of
exiting unprofitable lines of business and lower expenses in Federal Markets,
which more than offset the sale of Life Reinsurance.
The after-tax impact of the reclassification of limited partnership on net
operating income for Group Operations was $.9 and $1.7 million in the first
three months of 2001 and 2000, respectively.
35
Life
- ----
Sales volume for Life Operations declined $409.0 million, or 40.2%, to
$609.0 million for the first three months of 2001 as compared with the same
period in 2000. Sales volume decreased primarily in institutional products and
variable annuity sales influenced in part by the decline in the stock market.
Sales to institutional markets tend to be "large case" institutional markets'
sales, which can be sporadic, opportunistic and sensitive to independent
agency ratings, and as such can be volatile over short periods. This decrease
was partially offset by a growing in-force block of business in Long Term Care
products and increased international annuity sales. Net earned premiums
increased $36.0 million, or 17.0%, to $248.0 million for the first three
months of 2001 as compared with the same period in 2000. This improvement is
primarily attributable to the growing block of in-force business and increased
new sales in Long Term Care, improved sales of structured settlements in the
Retirement Services line and increased annuity sales internationally.
Net operating income for the first three months of 2001 was slightly lower
than net operating income for the same period in 2000. This decrease was due
to decreased investment income, partially offset by improved investment
performance in the Index 500 product sold to institutions and favorable
results in both the Individual Life and Long Term Care business.
The after-tax impact of the reclassification of limited partnership earnings
on net operating income for Life Operations was a $5.2 million decrease in the
first three months of 2001 and a $1.7 million increase for the same period in
2000.
Lorillard
- ---------
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
Revenues and net income increased by $68.4 and $8.9 million, or 6.9% and
5.7%, respectively, for the three months ended March 31, 2001, as compared to
the corresponding period of the prior year.
The increase in revenue is primarily composed of an increase of
approximately $111.1 million, or 11.1%, due to higher average unit prices,
partially offset by a decrease of approximately $51.7 million, or 5.2%,
reflecting lower unit sales volume for the three months ended March 31, 2001,
as compared to the corresponding period of the prior year. Net investment
income contributed $11.2 million to the increased revenues.
Lorillard's unit sales volume decreased by 3.9% for the quarter ended March
31, 2001, while Newport's unit sales volume increased by 5.0% primarily as a
result of the introduction of the Newport Medium line extension and
strengthened promotional support, as compared to the corresponding period of
the prior year. The decrease in Lorillard's overall unit sales volume reflects
lower unit sales of its Maverick and Old Gold brands in the discount market
segment. This decline reflects increased competition in the discount segment
and continued limitations imposed by certain competitors merchandising
arrangements and general competitive conditions. Overall, industry unit sales
volume is down by 3.7% through the quarter ended March 31, 2001.
Lorillard's market share was 9.57% for the quarter ended March 31, 2001 and
9.79% for the year ended December 31, 2000. Newport, a full price brand,
accounted for 83.6% of Lorillard's unit sales for the quarter ended March 31,
36
2001. Newport's market share of the full price industry volume was 10.7% for
the quarter ended March 31, 2001 and 10.5% for year ended December 31, 2000.
Full price brand sales have increased from an average of 68.6% of industry
sales during 1994 to an average of 73.6% during 2000. At March 31, 2001, full
price brands represent 74.6% of industry sales.
Lorillard recorded pre-tax charges of $279.2 and $260.1 million for the
three months ended March 31, 2001 and 2000 ($170.0 and $155.5 million after
taxes), respectively, to accrue its obligations under various settlement
agreements. Lorillard's portion of ongoing adjusted payments and legal fees is
based on its share of domestic cigarette shipments in the year preceding that
in which the payment is due. Accordingly, Lorillard records its portions of
ongoing settlement payments as part of cost of manufactured products sold as
the related sales occur. Funds required to meet the industry payment
obligations have been provided by Lorillard's operating activities. See Note 9
of the Notes to Consolidated Condensed Financial Statements in Part I.
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 United States
cigarette sales in the full price and discount segments, Lorillard's share of
the domestic full price and discount segments, and the effect of any resulting
cost advantage of manufacturers not subject to the Master Settlement
Agreement.
Loews Hotels
- ------------
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Revenues increased by $6.3 million, or 8.0%, and net income decreased by
$3.7 million, or 40.2%, for the three months ended March 31, 2001, as compared
to the corresponding period of the prior year.
Revenues increased primarily due to revenues from the Philadelphia hotel
which commenced operations in spring of 2000. Net income declined due to lower
occupancy rates and increased depreciation and interest expenses related to
the Philadelphia hotel.
Diamond Offshore
- ----------------
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 53% owned subsidiary of the Company.
Revenues and net income increased by $33.9 and $.9 million, or 17.8% and
6.5%, respectively, for the three months ended March 31, 2001, as compared to
the corresponding period of the prior year. Revenues and net income included a
gain from the sale of a drilling rig of $13.9 and $4.7 million, respectively,
for the three months ended March 31, 2000.
Revenues from high specification floaters and other semisubmersible rigs
increased by $12.3 million, or 6.5%, due primarily to the revenue generated by
the Ocean Confidence, which began a five-year drilling program in the Gulf of
Mexico on January 5, 2001 after completion of a conversion to a high
specification semisubmersible drilling unit ($14.1 million), and increases in
dayrates ($4.6 million) for the three months ended March 31, 2001, as compared
37
to the corresponding period of the prior year. Revenues from jackup rigs
increased by $22.4 million, or 11.8%, due to increased dayrates ($19.1
million) and increased utilization rates ($3.7 million).
Net income for the three months ended March 31, 2001 increased due primarily
to the increased revenues discussed above, partially offset by increased
interest and depreciation expenses.
Bulova
- ------
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
Revenues and net income decreased by $3.4 and $.3 million, or 9.4% and
11.1%, respectively, for the three months ended March 31, 2001, as compared to
the corresponding period of the prior year. Revenues decreased due primarily
to lower unit sales volume, partially offset by higher watch unit prices. Net
income decreased due to the lower revenues, partially offset by improved gross
margins attributable to Bulova's product sales mix within its brands.
Corporate
- ---------
Corporate operations consist primarily of investment income, including
investment gains (losses) from the Company's investment portfolio, as well as
equity earnings from investment in a shipping operation, corporate interest
expenses and other corporate administrative costs.
38
The components of investment gains (losses) included in Corporate operations
are as follows:
Three Months Ended
March 31,
-------------------
2001 2000
-------------------
(In millions)
Revenues:
Derivative instruments (1) . . . . . . . . . . . . $ 8.2 $(111.6)
Fixed maturities . . . . . . . . . . . . . . . . . 7.3 2.3
Equity securities, including short positions (1) . 13.1 (60.9)
Short-term investments, primarily U.S. government
securities . . . . . . . . . . . . . . . . . . . (.1) (1.5)
-------------------
28.5 (171.7)
Income tax (expense) benefit . . . . . . . . . . . . (10.0) 60.1
-------------------
Net income (loss) . . . . . . . . . . . . . . . $ 18.5 $(111.6)
===================
(1) Includes gains (losses) on short sales, equity index futures and
options aggregating $16.9 and $(142.0), for the three months ended
March 31, 2001 and 2000, respectively. The Company has maintained short
positions in the form of futures or options - most recently as put
options - since 1996. Substantially all of the index short positions
were closed during the second quarter of 2000. See Item 3,
"Quantitative and Qualitative Disclosures About Market Risk."
Exclusive of securities transactions, revenues increased by $22.3 million
and net income increased $17.1 million for the three months ended March 31,
2001, as compared to the corresponding period of the prior year, due primarily
to increased equity income from the Company's investment in a shipping joint
venture and increased investment income, as compared to the prior year.
Shipping revenues were $11.3 million for the three months ended March 31,
2001, as compared to a loss in the comparable period of the prior year.
Liquidity and Capital Resources:
- -------------------------------
CNA Financial
- -------------
The principal operating cash flow sources of CNA's property/casualty and
life insurance subsidiaries are premiums and investment income. The primary
operating cash flow uses are payments for claims, policy benefits and
operating expenses.
For the three months ended March 31, 2001, net cash used in operating
activities was $123.0 million as compared with $492.0 million for the same
period in 2000. The improvement related primarily to decreased net outflows
39
from underwriting activities, including decreased paid losses, partially
offset by decreased Federal income tax refunds.
For the three months ended March 31, 2001, net cash inflows from investment
activities was $272.0 million as compared with $672.0 million for the same
period in 2000. Cash flows from investing activities were principally related
to purchases and sales of invested assets. Cash inflows decreased from the
prior year as invested asset purchases increased. 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 $277.0 million.
For the three months ended March 31, 2001, net cash used in financing
activities was $170.0 million as compared with $154.0 million for the same
period in 2000. Cash flows from financing activities include proceeds from the
issuance of debt or equity instruments, outflows for dividends or repayment of
debt and outlays to reacquire equity instruments.
As of April 30, 2001, CNA replaced its $750.0 million revolving credit
facility (the "Prior Facility") with a new $500.0 million revolving credit
facility (the "New Facility"). No loans were outstanding under either the
Prior Facility or the New Facility. The Prior Facility was scheduled to expire
on May 10, 2001. The New Facility is split into two parts, a $250.0 million
component with a 364-day expiration date (with an option by CNA to turn this
part of the New Facility into a one-year term loan) and a $250.0 million
component with a 3-year expiration date. CNA pays a facility fee to the
lenders of the New Facility for having funds available for loans under both
components. The facility fee on the 364-day component is 12.5 basis points
(which is the same as the fee on the Prior Facility) while the fee on the 3-
year component is 15 basis points. In addition to the facility fees, if CNA
borrows under the New Facility at its current debt rating, it will pay an
interest rate on outstanding loans equal to the London Interbank Offering Rate
("LIBOR") plus 50 basis points for the 364-day component and LIBOR plus 47.5
basis points for the 3-year component. If CNA has outstanding loans equaling
more than 50% of the amounts available under the New Facility, CNA also will
pay a utilization fee of 12.5 basis points on such loans. The New Facility
will be used for general corporate purposes including supporting the
commercial paper program. During the first three months of 2001, CNA reduced
its commercial paper borrowings by $127.0 million and letters of credit by
$161.0 million.
Lorillard
- ---------
Lorillard and other cigarette manufacturers continue to be confronted with
an increasing level of litigation and regulatory issues. Lawsuits continue to
be filed with increasing frequency against Lorillard and other manufacturers
of tobacco products. Approximately 4,875 product liability cases are pending
against cigarette manufacturers in the United States. Of these, approximately
1,225 cases are pending in a West Virginia court, and approximately 3,040
cases are brought by flight attendants alleging injury from exposure to
environmental tobacco smoke in the cabins of aircraft. Lorillard is a
defendant in all of the flight attendant suits served to date and is a
defendant in most of the cases pending in West Virginia.
On July 14, 2000, the jury in Engle v. R.J. Reynolds Tobacco Co., et al.
awarded a total of $145.0 billion in punitive damages against all defendants,
including $16.3 billion against Lorillard. Lorillard remains of the view that
the Engle case should not have been certified as a class action. That
certification is inconsistent with the overwhelming majority of federal and
40
state court decisions which have held that mass smoking and health claims are
inappropriate for class treatment. Lorillard has challenged class
certification, as well as other numerous legal errors that it believes
occurred during the trial. The Company and Lorillard believe that an appeal of
these issues on the merits should prevail.
Lorillard has noticed an appeal from the purported final judgment to the
Third District of the Florida Court of Appeal and has posted its appellate
bond in the amount of $104.0 million pursuant to recent Florida legislation
limiting the amount of an appellate bond required to be posted in order to
stay execution of a judgment for punitive damages in a certified class action.
Although this legislation is intended to apply to the Engle case, Lorillard
cannot predict the outcome of any challenges to the possible application or
constitutionality of this legislation. In the event this legislation is
challenged and found to be invalid, Lorillard could be required to post a bond
in an amount not capable of being bonded, resulting in execution of the
judgment before it could be set aside on appeal. Lorillard believes that such
a result would be unconstitutional and would also violate Florida law.
Lorillard intends to take all appropriate steps to prevent this scenario from
occurring and believes these efforts should be successful.
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.
See "Results of Operations" and Note 9 of the Notes to Consolidated Condensed
Financial Statements for additional information regarding this settlement and
litigation matters.
The United States federal excise tax on cigarettes is presently $17 per
1,000 cigarettes ($.34 per pack of 20 cigarettes). The federal excise tax on
cigarettes is scheduled to increase by $2.50 per 1,000 cigarettes in the year
2002. Various states have proposed, and certain states have recently passed,
increases in their state tobacco excise taxes. Such actions may adversely
affect Lorillard's volume, operating revenues and operating income.
Loews Hotels
- ------------
Loews Hotels is developing one hotel with its partners at Universal Orlando
in Florida, which is scheduled to open in 2002. Capital expenditures in
relation to this hotel project are being funded by a combination of equity
from Loews Hotels and its partners, and mortgages.
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
- ----------------
During the first quarter of 2001, oil and natural gas prices remained above
historical averages. The persistence of higher than average product prices has
resulted in improving dayrates and utilization in all of the markets in which
Diamond Offshore competes. Assuming higher than average product prices
continue, at least in the short term, Diamond Offshore expects continued
growth for the offshore drilling industry.
Diamond Offshore's domestic jack-up market, which improved in 2000 as
independent operators acted quickly to take advantage of high natural gas
41
prices, has remained robust during the first quarter of 2001. Diamond Offshore
believes the outlook for this market is for continued strength.
Diamond Offshore has been encouraged by the improvement in the market for
its semisubmersible rig fleet, especially for intermediate water-depth
semisubmersible offshore rigs, which lagged behind the recovery experienced in
the jack-up market in 2000. Diamond Offshore anticipates the revival of
dayrates and utilization in this market to continue in 2001.
Historically, the offshore drilling industry has been highly competitive and
cyclical, and Diamond Offshore cannot predict the extent to which the current
favorable conditions may continue. A decline in oil or gas prices could reduce
demand for Diamond Offshore's drilling services and adversely affect both
utilization and dayrates.
On April 6, 2001, Diamond Offshore redeemed all of its outstanding 3.75%
Convertible Subordinated Notes (the "Notes") in accordance with the indenture
under which the Notes were issued. Prior to April 6, 2001, $12.4 million
principal amount of the Notes had been converted into 307,071 shares of
Diamond Offshore's common stock at the stated conversion price of $40.50 per
share. The remaining $387.6 million principal amount of the Notes was redeemed
at 102.08% of the principal amount, plus accrued interest, for a total cash
payment of $397.7 million.
On April 11, 2001, Diamond Offshore issued $460.0 million principal amount
of 1.5% convertible senior debentures (the "1.5% Debentures") due April 15,
2031. The 1.5% Debentures are convertible into shares of Diamond Offshore's
common stock at an initial conversion rate of 20.3978 shares per each $1,000
principal amount, subject to adjustment in certain circumstances. Upon
conversion, Diamond Offshore has the right to deliver cash in lieu of shares
of its common stock. The transaction resulted in net proceeds of approximately
$449.2 million. Diamond Offshore will pay contingent interest to holders of
the 1.5% Debentures during any six-month period commencing after April 15,
2008 if the average market price of a 1.5% Debenture for a measurement period
preceding such six-month period equals 120% or more of the principal amount of
such 1.5% Debenture and Diamond Offshore pays a regular cash dividend during
such six-month period. The contingent interest payable per $1,000 principal
amount of 1.5% Debentures in respect of any quarterly period will equal 50% of
regular cash dividends paid by Diamond Offshore per share on its common stock
during that quarterly period multiplied by the conversion rate. Diamond
Offshore may redeem all or a portion of the 1.5% Debentures at any time on or
after April 15, 2008 at a price equal to 100% of the principal amount.
During the first quarter of 2001, Diamond Offshore expended $19.8 million,
including capitalized interest expense, primarily for the Ocean Baroness and
Ocean Nomad rig upgrades. During 2001, Diamond Offshore expects to spend
approximately $145.0 million for rig upgrade capital expenditures with $125.0
million projected for the deepwater upgrade of the Ocean Baroness.
The initial estimated cost for the deepwater upgrade of the Ocean Baroness
is approximately $180.0 million with an expected delivery date in the first
quarter of 2002. During the first quarter of 2001, Diamond Offshore expended
$8.2 million for the deepwater upgrade of the Ocean Baroness.
During the first quarter of 2001, Diamond Offshore expended $14.0 million in
association with its continuing rig enhancement program and to meet other
corporate requirements. Diamond Offshore has budgeted $106.0 million for 2001
42
capital expenditures associated with its continuing rig enhancement program
and other corporate requirements.
Bulova
- ------
Funds from operations continue to exceed operating requirements. Bulova's
cash and cash equivalents, and investments amounted to $30.1 million at March
31, 2001, as compared to $16.9 million at December 31, 2000. Funds for other
capital expenditures and working capital requirements are expected to be
provided from operations.
Majestic Shipping
- -----------------
As previously reported in the Company's 2000 Annual Report on Form 10-K, a
subsidiary and an affiliate of the Company have entered into agreements for
newbuilding of eight supertankers, the total cost of the eight ships is
estimated to amount to approximately $660.0 million. The financing for these
ships will be provided by equity contributions by the Company and Hellespont
Shipping Corporation, and bank debt supported by the Company.
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 income statement.
The Company enters into short sales and invests in certain derivative
instruments for a number of purposes, including; (i) for its asset and
liability management activities, (ii) for 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.
The credit exposure associated with these instruments is generally limited
to the positive market value of the instruments and will vary based on changes
in market prices. The Company enters into these transactions with large
financial institutions and considers the risk of nonperformance to be remote.
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex, nor do these instruments contain imbedded
leverage features which would expose the Company to a higher degree of risk.
See "Results of Operations" and "Quantitative and Qualitative Disclosures
about Market Risk" for additional information with respect to derivative
instruments, including recognized gains and losses on these instruments. See
also Note 4 of the Notes to Consolidated Financial Statements in the 2000
Annual Report on Form 10-K.
43
Insurance
- ---------
A summary of CNA's general account investments, at carrying value, are as
follows:
Change in
Unrealized
March 31, December 31, Gains
2001 2000 (Losses)
----------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies . $ 7,225.0 $ 5,298.0 $ (5.0)
Asset-backed securities . . . . . . . 5,708.0 7,623.0 27.0
Tax exempt securities . . . . . . . . 2,219.0 3,349.0 (32.0)
Taxable securities . . . . . . . . . 11,677.0 10,328.0 252.0
Redeemable preferred stock . . . . . 56.0 54.0
---------------------------------
Total fixed maturity securities . 26,885.0 26,652.0 242.0
Equity securities . . . . . . . . . . . 2,368.0 2,412.0 (100.0)
Short-term and other investments . . . 7,833.0 6,058.3
---------------------------------
Total . . . . . . . . . . . . . . $37,086.0 $35,122.3 $ 142.0
=================================
March 31, December 31,
2001 2000
------------------------
(In millions)
Short-term and other investments:
Commercial paper . . . . . . . . . . . . . . . . $ 4,074.0 $ 3,290.6
Money market funds . . . . . . . . . . . . . . . 1,467.0 620.4
U.S. Treasury securities . . . . . . . . . . . . 355.0 382.9
Others . . . . . . . . . . . . . . . . . . . . . 335.0 428.7
Other investments . . . . . . . . . . . . . . . . . 1,602.0 1,335.7
---------------------
Total short-term and other
investments . . . . . . . . . . . . . . . . . $ 7,833.0 $ 6,058.3
=====================
CNA's general and separate account investment portfolio consists primarily
of publicly traded government bonds, asset-backed securities, mortgage-backed
securities, municipal bonds and corporate bonds.
Total net unrealized gains of the general account investments was $1,549.0
million at March 31, 2001 compared with $1,310.0 million at December 31, 2000.
The unrealized position at March 31, 2001 was composed of an unrealized gain
44
of $345.0 million for fixed maturities, and an unrealized gain of $1,204.0
million for equity securities.
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.
The general account portfolio consists primarily of high quality (rated BBB
or higher) bonds, 92.0% and 93.0% of which are rated as investment grade at
March 31, 2001 and December 31, 2000.
At March 31, 2001 and December 31, 2000, approximately 99.0% and 98.0% of
the general account portfolio are U.S. Government agencies or were rated by
Standard & Poor's or Moody's Investors Service. The remaining bonds were rated
by other rating agencies, outside brokers or Company management.
Below investment grade bonds 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.
Included in CNA's general account fixed maturity securities at March 31,
2001 are $5,708.0 million of asset-backed securities, at fair value,
consisting of approximately 43.0% in collateralized mortgage obligations
("CMOs"), 31.0% in U.S. government agency issued pass-through certificates,
20.0% in corporate asset-backed obligations and 6.0% in corporate mortgage-
backed pass-through certificates. The majority of CMOs held are actively
traded in liquid markets and are priced by broker-dealers.
Short-term investments at March 31, 2001 and December 31, 2000 primarily
consisted of commercial paper and money market funds.
CNA invests in certain derivative financial instruments primarily to reduce
its exposure to market risk (principally interest rate, equity price and
foreign currency risk). 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.
Certain Derivatives in separate accounts are held for trading 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 the first quarter of 2001, the Company adopted the Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS
No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities (collectively referred to as SFAS No. 133). The Company's initial
adoption of SFAS No. 133 did not have a significant impact on the equity of
the Company; however, adoption of SFAS No. 133 resulted in a decrease to first
quarter 2001 earnings of $53.3 million after tax and minority interest. Of
this transition amount, approximately $50.5 million, net of taxes and minority
interest, related to CNA's investments and investment-related derivatives.
45
Because CNA already carried its investment and investment-related derivatives
at fair value through other comprehensive income, there was an equal and
offsetting favorable adjustment of $50.5 million, after tax and minority
interest, to shareholders' equity (accumulated other comprehensive income).
See Note 2 of the Notes to Consolidated Condensed Financial Statements for a
complete discussion of the Company's adoption of these accounting
pronouncements.
On January 1, 2001, the Company adopted the Codification of Statutory
Accounting Principles ("Codification") for preparing statutory-basis financial
statements. Codification, which is intended to standardize regulatory
accounting and reporting to state insurance departments, is effective January
1, 2001. However, statutory accounting principles will continue to be
established by individual state laws and permitted practices. The states in
which CNA's insurance subsidiaries conduct business required adoption of
Codification (with certain modifications) for the preparation of statutory
financial statements effective January 1, 2001. The Company's adoption of
Codification, as modified, resulted in an increase in statutory capital and
surplus as of January 1, 2001 by approximately $175.0 million, which primarily
relates to deferred tax assets offset by insurance-related assessments and
pension-related liabilities.
Additionally, CNA's property-casualty companies implemented a change,
effective January 1, 2001, in the timing of recording written premiums for
policies with future effective dates. This change was made in conjunction with
changes required by Codification related to the recording of written premiums.
The effect of this change was to reduce net written premiums by $113.0 million
for the three months ended March 31, 2001. This change has no impact on net
earned premiums or net income.
Forward-Looking Statements
- --------------------------
When included in this Report, the words "believes," "expects," "intends,"
"anticipates," "estimates," and analogous expressions are intended to identify
forward-looking statements. Such statements inherently are subject to a
variety of risks and uncertainties that could cause actual results to differ
materially from those projected. Such risks and uncertainties include, among
others, the impact of competitive products, policies and pricing; product and
policy demand and market responses; development of claims and the effect on
loss reserves; the performance of reinsurance companies under reinsurance
contracts; general economic and business conditions; changes in financial
markets (interest rate, credit, currency, commodities and equities) or in the
value of specific investments; changes in foreign, political, social and
economic conditions; regulatory initiatives and compliance with governmental
regulations; changes in foreign and domestic oil and gas exploration and
production activity, and expenditures related to rig conversion and upgrade;
changes in rating agency policies and practices, the results of financing
efforts, and agreements and various other matters and risks, many of which are
beyond the Company's control.
The tobacco industry continues to be subject to health concerns relating to
the use of tobacco products and exposure to environmental tobacco smoke,
legislation, including actual and potential excise tax increases, increasing
marketing and regulatory restrictions, governmental regulation, privately
imposed smoking restrictions, litigation, including risks associated with
adverse jury and judicial determinations, courts reaching conclusions at
variance with the general understandings of applicable law, bonding
requirements and the absence of adequate appellate remedies to get timely
46
relief from any of the foregoing, and the effects of price increases related
to concluded tobacco litigation settlements and excise tax increases on
consumption rates. 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 projected by or on behalf of
the Company. These forward-looking statements speak only as of the date of
this Report. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with
regard thereto or any change in events, conditions or circumstances on which
any statement is based.
Item 3. 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 income statement. Market risk exposure is presented for each class of
financial instrument held by the Company at March 31, 2001 and December 31,
2000, 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.
47
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
- ------------------------------------------------------------------------------------------------
March 31, December 31, March 31, December 31,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities $ 194.3 $ 248.2 $ 49.0 $(62.0)
Options - purchased 18.1 22.7 (11.0) 4.0
- written (12.4) (17.5) (3.0) (3.0)
Index futures - long 1.0
- short 1.0
Short sales (217.5) (201.1) (54.0) 50.0
Separate Accounts - Equity securities (a) 3.0 2.7 1.0 (1.0)
- Other invested assets 371.3 404.3 7.0 (7.0)
Interest rate (2):
Futures - long (56.0) 17.0
- short 24.0 (52.0)
Separate Accounts - Fixed maturity
securities 287.8 410.1 (17.0) 19.0
Commodities:
Gold (3):
Options - purchased 14.0 11.8 (14.0) (12.0)
- written (3.6) 4.0
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed adverse changes
in the underlying reference price or index of (1) an increase in equity prices of 25%
at March 31, 2001 and a decrease in equity prices of 25% at December 31, 2000, (2) an
increase in interest rates of 100 basis points at March 31, 2001 and a decrease in
interest rates of 100 basis points at December 31, 2000 and (3) an increase 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 $(201.0) and $(245.0)
at March 31, 2001 and December 31, 2000, respectively. This market risk would be offset
by decreases in liabilities to customers under variable insurance contracts.
Historically, the most significant areas of market risk in the Company's
trading portfolio result from positions held in S&P futures contracts, short
sales of certain equity securities and put options purchased on the S&P 500
index. The Company enters into these positions primarily to benefit from
anticipated future movements in the underlying markets that Company management
expects to occur. If such movements do not occur or if the market moves in the
opposite direction from what management expects, significant losses may occur.
The Company has maintained short positions, in the form of futures or options
- - most recently as put options - since 1996. Substantially all of these index
short positions were closed during the second quarter of 2000.
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
48
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.
Other than trading portfolio:
Other than trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
- ------------------------------------------------------------------------------------------------
March 31, December 31, March 31, December 31,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities:
General accounts (a) $ 2,367.9 $ 2,411.6 $ (337.0) $ (456.0)
Separate accounts 180.7 212.4 (45.0) (53.0)
Other invested assets 1,340.0 1,333.0 (137.0) (112.0)
Separate Accounts - Other Invested Assets 437.7 443.4 (109.0) (111.0)
Interest rate (2):
Fixed maturities (a) 27,317.7 27,244.3 (1,450.0) (1,458.0)
Short-term investments (a) 10,863.2 9,100.3 (4.0) (4.0)
Other derivative securities 4.2 2.1 26.0 1.0
Separate Accounts (a):
Fixed maturities 2,200.3 2,292.5 (117.0) (118.0)
Short-term investments 155.8 150.4
Long-term debt (5,633.6) (5,747.0)
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed adverse changes in
the underlying reference price or index of (1) a decrease in equity prices of 25% and (2)
an increase in interest rates of 100 basis points.
(a) Certain securities are denominated in foreign currencies. An assumed 20% decline in the
underlying exchange rates would result in an aggregate foreign currency exchange rate
risk of $(554.0) and $(581.0) at March 31, 2001 and December 31, 2000, 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 March 31, 2001 and
December 31, 2000, with all other variables held constant.
Interest Rate Risk - The Company has exposure to interest rate risk, arising
from changes in the level or volatility of interest rates. The Company
attempts to mitigate its exposure to interest rate risk by utilizing
instruments such as interest rate swaps, interest rate caps, commitments to
purchase securities, options, futures and forwards. The Company monitors its
sensitivity to interest rate risk by evaluating the change in the value of its
financial assets and liabilities due to fluctuations in interest rates. The
evaluation is performed by applying an instantaneous change in interest rates
of 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
49
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 March
31, 2001 and December 31, 2000 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, including interest rates swap agreements, as
of March 31, 2001 and December 31, 2000 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 $343.8 and $352.0 million at March 31, 2001 and
December 31, 2000, respectively. A 100 basis point decrease would result in an
increase in market value of $389.6 and $398.8 million at March 31, 2001 and
December 31, 2000, respectively.
The sensitivity analysis assumes an instantaneous shift in market interest
rates changing by 100 basis points from their levels at March 31, 2001 and
December 31, 2000, with all other variables 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 exchange rates versus the U.S. Dollar from
their levels at March 31, 2001 and December 31, 2000, 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 March
31, 2001 and December 31, 2000.
50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
-----------------
1. CNA is involved in various lawsuits including environmental pollution
claims. Information involving such lawsuits is incorporated by reference to
Note 9 of the Notes to Consolidated Condensed Financial Statements in Part I.
2. As noted in Item 3 Legal Proceedings of the Company's Report on Form 10-K
for the year ended December 31, 2000, Lorillard is defendant in various
lawsuits seeking damages for cancer and health effects claimed to have
resulted from the use of cigarettes or from exposure to tobacco smoke.
Information involving such lawsuits is incorporated by reference to such Item
3 Legal Proceedings. The Company is a defendant in some of these cases.
Material developments in relation to the foregoing are described below and
incorporated by reference to Note 9 of the Notes to Consolidated Condensed
Financial Statements in Part I.
CONVENTIONAL PRODUCT LIABILITY CASES -
Trial is proceeding in the Superior Court of Los Angeles County, California
in the case of Boeken v. Philip Morris Incorporated. Neither the Company nor
Lorillard are defendants in this matter.
Trial is proceeding in the Superior Court of Middlesex County, New Jersey in
the case of Mehlman v. Philip Morris, Inc., et al. Neither the Company nor
Lorillard are defendants in this matter.
On April 5, 2001, a jury in the Circuit Court, Eleventh Judicial Circuit,
Dade County, Florida returned a verdict in favor of Lorillard and the other
defendants in the case of Fontana v. Philip Morris Incorporated, et al.
Plaintiff alleged injury as a result of her exposure to environmental tobacco
smoke in the cabin of aircraft in which she was employed as a flight
attendant. Plaintiff has filed a motion for ruling on her reserved motions for
mis-trial and a motion for new trial. Plaintiff also has filed a motion for
judgment notwithstanding the verdict as to her damages claim.
CLASS ACTIONS -
In the case of Aksamit v. Brown & Williamson Tobacco Corporation, et al.
(U.S. District Court, South Carolina, filed November 20, 1997), plaintiffs
have voluntarily dismissed the suit without prejudice.
In the case of Arnitz v. Philip Morris Incorporated, et al. (Circuit Court,
Hillsborough County, Florida, filed June 6, 2000), plaintiff has withdrawn his
class certification claims and has dismissed Lorillard from the suit.
In the case of Avallone v. The American Tobacco Company, et al. (Superior
Court, Middlesex County, New Jersey, filed April 23, 1998), the court has
entered an order dismissing the action. The Company was a defendant in the
case.
In the case of Badillo v. American Tobacco Company, et al. (U.S. District
Court, Nevada, filed October 8, 1997), the court has heard argument of
plaintiffs' motion for class certification. The Company is a defendant in the
case.
51
In the case of Blankenship v. American Brands, Inc., et al. (Circuit Court,
Ohio County, West Virginia, filed January 31, 1997), the court has denied
defendants' motion for class decertification. The court has scheduled re-trial
of this matter to begin during September 2001.
In the case of Brown v. The American Tobacco Company, et al. (Superior
Court, San Diego County, California, filed June 10, 1997), the court granted
in part plaintiff's motion for class certification and certified a class
comprised of residents of California who smoked at least one of defendants'
cigarettes during the "applicable" class period and who were exposed to
defendants' marketing and advertising activities in California. Certification
was granted as to plaintiff's claims that defendants violated California
Business and Professions Code Sections 17200 and 17500. The court denied the
motion for class certification as to plaintiff's claims under the California
Legal Remedies Act. The court has postponed entering a final ruling on the
class certification in order to receive briefs with respect to the time frame
encompassed by "the applicable class period." The court is scheduled to issue
its ruling during July 2001.
In the case of Daniels v. Philip Morris Companies, Inc., et al. (Superior
Court, San Diego County, California, filed April 2, 1998), defendants have
filed a writ proceeding with the California Supreme Court to review the trial
court's order that granted plaintiffs' motion for class certification.
In the case of Guillory v. American Brands, Inc., et al. (U.S. District
Court, Northern District, Illinois, filed June 10, 1997), the court has denied
plaintiffs' motion for class certification. Plaintiffs have sought leave to
pursue an interlocutory appeal from this ruling.
In the case of National Tobacco Consumers Group Number 2 v. R.J. Reynolds
Tobacco Company, et al. (U.S. District Court, Massachusetts, filed July 18,
2000), plaintiff has voluntarily dismissed the action.
In the case of Nwanze v. Philip Morris Companies Inc., et al. (U.S. District
Court, Southern District, New York, filed September 29, 1997), the U.S. Court
of Appeals for the Second Circuit has affirmed the final judgment entered by
the trial court in defendants' favor. The Company was a defendant in the case.
In the case of Perry v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, Tennessee, filed September 30, 1996), the court has
granted defendants' motion to dismiss the complaint for failure to state a
claim. The deadline for plaintiffs to notice an appeal from the ruling has not
expired.
In the case of Richardson v. Philip Morris Incorporated, et al. (Circuit
Court, Baltimore City, Maryland, filed May 24, 1996), the court has entered an
order dismissing the action.
In the case of Scott v. The American Tobacco Company, et al. (District
Court, Orleans Parish, Louisiana, filed May 24, 1996), defendants have filed a
writ application with the Louisiana Supreme Court that seeks decertification
of the class ordered by the trial court and review of the trial court's trial
plan. The case is scheduled to be tried pursuant to a three-part trial plan
beginning on June 18, 2001.
52
REIMBURSEMENT CASES -
U.S. State and Local Governmental Reimbursement Cases -
In the case of State of Missouri v. American Tobacco Company, Inc., et al.
(Circuit Court, City of St. Louis, Missouri, filed May 12, 1997), judgment has
become final pursuant to the MSA.
Reimbursement Cases filed by Foreign Governments in U.S. Courts -
In the case of The Kyrgyz Republic v. The Brooke Group Ltd., Inc., et al.
(U.S. District Court, Southern District, Florida, filed January 22, 2001), the
court has entered the parties' stipulation of dismissal without prejudice. The
Company was a defendant in the case.
In the case of The Republic of Ecuador v. Philip Morris Companies, Inc., et
al. (Circuit Court, Eleventh Judicial Circuit, Dade County, Florida, filed
January 21, 2000), plaintiff has voluntarily dismissed the suit without
prejudice. The Company was a defendant in the case.
The following additional Reimbursement Case by Foreign Governments in U.S.
Courts has been filed:
The case of The Republic of Belize v. Philip Morris Companies, Inc., et al.
(Circuit Court, Eleventh Judicial Circuit, Dade County, Florida, filed April
5, 2001). The Company is a defendant in the case.
Reimbursement Cases by Labor Unions -
In the case of National Asbestos Workers, et al. v. Philip Morris
Incorporated, et al. (U.S. District Court, Eastern District, New York, filed
February 27, 1998), the court has vacated its schedule that set the case for
trial during September 2001. Another trial date has not been set. The Company
is a defendant in the case.
In the case of Oberle (Trustees of the Connecticut Pipe Trades Health Fund),
et al. v. Philip Morris, Inc., et al. (U.S. District Court, Connecticut, filed
July 1, 1997), the court granted defendants' motion to dismiss the complaint.
The deadline for plaintiffs to notice an appeal has not expired.
The following additional Reimbursement Case by Labor Unions has been filed:
The case of Obra Social del Personal de la Industria del Vestido, et al. v.
American Tobacco Co., Inc., et al. (Superior Court, District of Columbia,
filed March 23, 2001).
Reimbursement Cases by Private Companies and Health Plans -
In the case of Blue Cross and Blue Shield of New Jersey, Inc., et al. v.
Philip Morris, Incorporated, et al. (U.S. District Court, Eastern District,
New York, filed April 29, 1998), trial is proceeding as to the claims of one
of the plan plaintiffs, Empire Blue Cross and Blue Shield.
In the case of Regence Blueshield, et al. v. Philip Morris, Incorporated, et
al. (U.S. District Court, Western District, Washington, filed April 29, 1998),
the U.S. Court of Appeals for the Ninth Circuit has denied plaintiffs' motion
for reconsideration of its ruling that affirmed the dismissal of the case.
53
Eastern District of New York Litigation -
On March 15, 2001, the court heard argument of the parties' various motions
and took them under advisement in In re Simon (II) Litigation, the case being
used by the court as a mechanism to explore possible settlements of punitive
damages claims. The motions included plaintiffs' motion for class
certification, plaintiffs' motion for approval of class counsel, and
defendants' motion to dismiss the complaint. Plaintiffs seek certification of
eight separate sub-classes. The putative sub-classes include individual
smokers; individuals with pending product liability actions; multi-employer
health benefit plans; non-governmental third party payors; and asbestos
entities.
Trial is proceeding in the case of Blue Cross and Blue Shield of New Jersey,
Inc., et al. v. Philip Morris, Incorporated, et al., as to the severed claims
of one of the plan plaintiffs, Empire Blue Cross and Blue Shield.
CONTRIBUTION CLAIMS -
The following additional Contribution Claims have been filed:
The case of Asbestos Claims Management Corporation, et al. v. RJR Nabisco,
Inc., et al. (Circuit Court, Claiborne County, Mississippi, filed April 18,
2001). The Company is a defendant in the case. As of May 1, 2001, neither the
Company nor Lorillard had received service of process.
The case of Combustion Engineering, Inc., et al. v. RJR Nabisco, Inc., et
al. (Circuit Court, Claiborne County, Mississippi, filed April 18, 2001). The
Company is a defendant in the case. As of May 1, 2001, neither the Company nor
Lorillard had received service of process.
The case of Gasket Holdings, et al. v. RJR Nabisco, Inc., et al. (Circuit
Court, Jefferson County, Mississippi, filed December 18, 2000). The Company is
a defendant in the case. As of May 1, 2001, neither the Company nor Lorillard
has received service of process.
The case of Gasket Holdings, et al. v. RJR Nabisco, Inc., et al. (Circuit
Court, Claiborne County, Mississippi, filed April 18, 2001). The Company is a
defendant in the case. As of May 1, 2001, neither the Company nor Lorillard
had received service of process.
The case of Owens-Illinois, Inc., et al. v. R.J. Reynolds Tobacco Company,
et al. (Circuit Court, Sharkey County, Mississippi, filed December 15, 2000).
The case of T&N, Ltd., et al. v. RJR Nabisco, Inc., et al. (Circuit Court,
Claiborne County, Mississippi, filed April 18, 2001). The Company is a
defendant in the case. As of May 1, 2001, neither the Company nor Lorillard
had received service of process.
The case of W.R. Grace & Co. Conn., et al. v. RJR Nabisco, Inc., et al.
(Circuit Court, Jefferson County, Mississippi, filed April 24, 2001). The
Company is a defendant in the case. As of May 1, 2001, neither the Company nor
Lorillard had received service of process.
54
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits--
None
(b) Current reports on Form 8-K --
On January 9, 2001, Registrant filed a report on Form 8-K regarding the
issuance of a press release stating that a subsidiary exercised its final
option for the new construction of a supertanker.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
LOEWS CORPORATION
-------------------------
(Registrant)
Dated: May 3, 2001 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
(Duly authorized officer
and principal financial
officer)
55
1