Unassociated Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

S
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
   
THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006
OR

£
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
   
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From  ____________  to  _____________

Commission File Number 1-6541

LOEWS CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
13-2646102
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)

667 Madison Avenue, New York, N.Y. 10021-8087
(Address of principal executive offices) (Zip Code)

(212) 521-2000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Loews Common Stock, par value $0.01 per share
 
New York Stock Exchange
Carolina Group Stock, par value $0.01 per share
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.

 
Yes
X
 
No
   

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 
Yes
   
No
X
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 
Yes
X
 
No
   

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ].

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

Large accelerated filer
X
 
Accelerated filer
   
Non-accelerated filer
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 
Yes
   
No
X
 
 
The aggregate market value of voting and non-voting common equity held by non-affiliates as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $20,106,000,000.

As of February 9, 2007, there were 543,461,657 shares of Loews common stock and 108,334,056 shares of Carolina Group stock outstanding.

Documents Incorporated by Reference:

Portions of the Registrant’s definitive proxy statement intended to be filed by Registrant with the Commission prior to April 30, 2007 are incorporated by reference into Part III of this Report.
 


1

 
LOEWS CORPORATION

INDEX TO ANNUAL REPORT ON
FORM 10-K FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION

For the Year Ended December 31, 2006


Item
No.
PART I
Page
No.
     
1
 
Business
3
 
   
Carolina Group Tracking Stock
3
 
   
CNA Financial Corporation
4
 
   
Lorillard, Inc.
11
 
   
Boardwalk Pipeline Partners, LP
16
 
   
Diamond Offshore Drilling, Inc.
19
 
   
Loews Hotels Holding Corporation
23
 
   
Bulova Corporation
24
 
   
Available information
25
 
1
A
Risk Factors
25
 
1
B
Unresolved Staff Comments
55
 
2
 
Properties
55
 
3
 
Legal Proceedings
55
 
4
 
Submission of Matters to a Vote of Security Holders
56
 
   
Executive Officers of the Registrant
57
 
         
   
PART II
   
         
5
 
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
   
   
Purchases of Equity Securities
57
 
   
Management’s Report on Internal Control Over Financial Reporting
61
 
   
Reports of Independent Registered Public Accounting Firm
62
 
6
 
Selected Financial Data
64
 
7
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
65
 
7
A
Quantitative and Qualitative Disclosures about Market Risk
125
 
8
 
Financial Statements and Supplementary Data
129
 
9
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
225
 
9
A
Controls and Procedures
225
 
9
B
Other Information
225
 
         
   
PART III
   
         
   
Certain information called for by Part III (Items 10, 11, 12, 13 and 14) has been omitted as Registrant intends to file with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year a definitive Proxy Statement pursuant to Regulation 14A.
   
         
   
PART IV
   
         
15
 
Exhibits and Financial Statement Schedules
226
 

2

 
PART I

Unless the context otherwise requires, references in this report to “Loews Corporation,” “we,” “our,” “us” or like terms refer to the business of Loews Corporation excluding its subsidiaries.

Item 1. Business.

We are a holding company. Our subsidiaries are engaged in the following lines of business:

 
·
commercial property and casualty insurance (CNA Financial Corporation, an 89% owned subsidiary);

 
·
production and sale of cigarettes (Lorillard, Inc., a wholly owned subsidiary);

 
·
operation of interstate natural gas transmission pipeline systems (Boardwalk Pipeline Partners, LP, an 80% owned subsidiary);

 
·
operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 51% owned subsidiary);

 
·
operation of hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary); and

 
·
distribution and sale of watches and clocks (Bulova Corporation, a wholly owned subsidiary).

Please read information relating to our major business segments from which we derive revenue and income contained in Note 23 of the Notes to Consolidated Financial Statements, included in Item 8.

CAROLINA GROUP TRACKING STOCK

We have a two class common stock structure, our common stock and our Carolina Group stock. Carolina Group stock, commonly called a tracking stock, reflects the economic performance of a defined group of our assets and liabilities, referred to as the Carolina Group. Please read Note 6 of the Notes to Consolidated Financial Statements, included in Item 8.

We have attributed the following assets and liabilities to the Carolina Group:

 
·
our 100% stock ownership interest in Lorillard, Inc.;
 
 
·
notional, intergroup debt owed by the Carolina Group to the Loews Group, which we describe below, bearing interest at the annual rate of 8.0% and, subject to optional prepayment, due December 31, 2021 (as of February 9, 2007, $1.2 billion was outstanding); 
 
 
·
any and all liabilities, costs and expenses of ours, and our subsidiaries, including Lorillard, Inc. and the subsidiaries and predecessors of Lorillard, Inc., arising out of or related to tobacco or otherwise arising out of the past, present or future business of Lorillard, Inc. or its subsidiaries or predecessors, or claims arising out of or related to the sale of any businesses previously sold by Lorillard, Inc. or its subsidiaries or predecessors, in each case, whether grounded in tort, contract, statute or otherwise, whether pending or asserted in the future;

 
·
all net income or net losses arising from the assets and liabilities that are reflected in the Carolina Group and all net proceeds from any disposition of those assets, in each case, after deductions to reflect dividends paid to holders of Carolina Group stock or credited to the Loews Group in respect of its intergroup interest; and

 
·
any acquisitions or investments made from assets reflected in the Carolina Group.

As of February 9, 2007, there were 108,334,056 shares of Carolina Group stock outstanding representing a 62.3% economic interest in the Carolina Group.

3

 
Item 1. Business
Carolina Group Tracking Stock - (Continued)


The Loews Group consists of all of our assets and liabilities other than the 62.3% economic interest in the Carolina Group represented by the outstanding Carolina Group stock, and includes as an asset the notional intergroup debt of the Carolina Group referred to above.

The creation of the Carolina Group and the issuance of Carolina Group stock does not change our ownership of Lorillard, Inc. or Lorillard, Inc.’s status as a separate legal entity. The Carolina Group and the Loews Group are notional groups that are intended to reflect the performance of the defined sets of assets and liabilities of each group. The Carolina Group and the Loews Group are not separate legal entities and the attribution of our assets and liabilities to the Loews Group or the Carolina Group does not affect title to the assets or responsibility for the liabilities so attributed.

Each outstanding share of Carolina Group Stock has 3/10 of a vote per share. Holders of our common stock and of Carolina Group stock are shareholders of Loews Corporation and are subject to the risks related to an equity investment in us.

CNA FINANCIAL CORPORATION

CNA Financial Corporation (together with its subsidiaries, “CNA”) was incorporated in 1967 and is an insurance holding company. CNA’s property and casualty insurance operations are conducted by Continental Casualty Company (“CCC”), incorporated in 1897, and its affiliates, and The Continental Insurance Company (“CIC”), organized in 1853, and its affiliates. CIC became a subsidiary of CNA in 1995 as a result of the acquisition of The Continental Corporation (“Continental”). CNA accounted for 57.96%, 61.59% and 65.16% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.

CNA serves a wide variety of customers, including small, medium and large businesses, associations, professionals, and groups and individuals with a broad range of insurance and risk management products and services.

CNA’s insurance products primarily include property and casualty coverages. CNA services include risk management, information services, warranty and claims administration. CNA products and services are marketed through independent agents, brokers, managing general agents and direct sales.

CNA’s core business, property and casualty insurance operations, is reported in two business segments: Standard Lines and Specialty Lines. CNA’s non-core operations are managed in two segments: Life and Group Non-Core and Other Insurance. These segments are managed separately because of differences in their product lines and markets.

Standard Lines

Standard Lines works with an independent agency distribution system and network of brokers to market a broad range of property and casualty insurance products and services to small, middle-market and large businesses domestically and abroad. The Standard Lines operating model focuses on underwriting performance, relationships with selected distribution sources and understanding customer needs.

Standard Lines includes Property, Casualty and CNA Global.

Property: Property provides standard and excess property coverage, as well as marine coverage and boiler and machinery to a wide range of businesses.

Casualty: Casualty provides standard casualty insurance products such as workers’ compensation, general and product liability and commercial auto coverage through traditional products to a wide range of businesses. Most insurance programs are provided on a guaranteed cost basis; however, Casualty has the capability to offer specialized, loss-sensitive insurance programs to those customers viewed as higher risk and less predictable in exposure.

Excess & Surplus (“E&S”): E&S is included in Casualty. E&S provides specialized insurance and other financial products for selected commercial risks on both an individual customer and program basis. Customers insured by E&S are generally viewed as higher risk and less predictable in exposure than those covered by standard insurance markets. E&S’s products are distributed throughout the United States through specialist producers, program agents and Property and Casualty’s agents and brokers.

4

 
Item 1. Business
CNA Financial Corporation - (Continued)


Property and Casualty (“P&C”): P&C’s field structure consists of 33 branch locations across the country organized into 4 regions. Each branch provides the marketing, underwriting and risk control expertise on the entire portfolio of products. The Centralized Processing Operation for small and middle-market customers, located in Maitland, Florida, handles policy processing and accounting, and also acts as a call center to optimize customer service. The claims structure consists of a centralized claim center designed to efficiently handle property damage and medical only claims and 18 claim office locations around the country handling the more complex claims. Also, Standard Lines provides total risk management services relating to claim and information services to the large commercial insurance marketplace, through a wholly owned subsidiary, ClaimsPlus, Inc., a third party administrator.

CNA Global: CNA Global consists of subsidiaries operating in Europe, Latin America, Canada and Hawaii. These affiliates offer property and casualty insurance to small and medium size businesses and capitalize on strategic indigenous opportunities.

Specialty Lines

Specialty Lines provides professional, financial and specialty property and casualty products and services through a network of brokers, managing general underwriters and independent agencies. Specialty Lines provides solutions for managing the risks of its clients, including architects, lawyers, accountants, healthcare professionals, financial intermediaries and public and private corporations. Product offerings also include surety and fidelity bonds and vehicle and equipment warranty services.

Specialty Lines includes the following business groups: US Specialty Lines, Surety and Warranty.

US Specialty Lines provides management and professional liability insurance and risk management services, primarily in the United States. This group provides professional liability coverages to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. US Specialty Lines also provides directors and officers (“D&O”), employment practices, fiduciary and fidelity coverages. Specific areas of focus include small and mid-size firms as well as privately held firms and not-for-profit organizations where tailored products for this client segment are offered. Products within US Specialty Lines are distributed through brokers, agents and managing general underwriters.

US Specialty Lines, through CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products, which include professional liability as well as associated standard property and casualty coverages, are distributed on a national basis through a variety of channels including brokers, agents and managing general underwriters. Key customer segments include long term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size and large healthcare facilities and delivery systems.

Surety: Surety consists primarily of CNA Surety and its insurance subsidiaries and offers small, medium and large contract and commercial surety bonds. CNA Surety provides surety and fidelity bonds in all 50 states through a combined network of independent agencies. CNA owns approximately 63% of CNA Surety.

Warranty: Warranty provides vehicle warranty service contracts that protect individuals and businesses from the financial burden associated with mechanical breakdown, or maintenance.

Life and Group Non-Core

The Life and Group Non-Core segment primarily includes the results of the life and group lines of business that have either been sold or placed in run-off. CNA sold its individual life business on April 30, 2004 and its specialty medical business on January 6, 2005. The segment includes operating results for these businesses in periods prior to the sales, the realized gain/loss from the sales and the effects of the shared corporate overhead expenses which continue to be allocated to the segment. CNA continues to service its existing individual long term care commitments, its payout annuity business and its pension deposit business. CNA also manages a block of group reinsurance and life settlement contracts. These businesses are being managed as a run-off operation. CNA’s group long term care and Index 500 products, while considered non-core, continue to be actively marketed.

5

 
Item 1. Business
CNA Financial Corporation - (Continued)


Other Insurance

Other Insurance includes the results of certain property and casualty lines of business placed in run-off. CNA Re, formerly a separate property and casualty operating segment, is in run-off and is included in the Other Insurance segment. This segment also includes the results related to the centralized adjusting and settlement of asbestos and environmental pollution and mass tort (“APMT”) claims, as well as the results of CNA’s participation in voluntary insurance pools and various non-insurance operations. Other operations also include interest expense on corporate borrowings and intercompany eliminations.

Please read Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations by Business Segment - CNA Financial” for information with respect to each segment.

Supplementary Insurance Data

The following table sets forth supplementary insurance data:
 
Year Ended December 31
 
2006
 
2005
 
2004
 
(In millions, except ratio information)
             
               
Trade Ratios - GAAP basis (a):
             
Loss and loss adjustment expense ratio
   
75.7
%
 
89.4
%
 
74.6
%
Expense ratio
   
30.0
   
31.2
   
31.5
 
Dividend ratio
   
0.3
   
0.3
   
0.2
 
Combined ratio
   
106.0
%
 
120.9
%
 
106.3
%
                     
Trade Ratios - Statutory basis (a):
                   
Loss and loss adjustment expense ratio
   
78.7
%
 
92.2
%
 
78.1
%
Expense ratio
   
30.2
   
30.0
   
27.2
 
Dividend ratio
   
0.2
   
0.5
   
0.6
 
Combined ratio
   
109.1
%
 
122.7
%
 
105.9
%
                     
Individual Life and Group Life Insurance Inforce:
                   
Individual Life
 
$
9,866.0
 
$
10,711.0
 
$
11,566.0
 
Group Life
   
5,787.0
   
9,838.0
   
45,079.0
 
Total
 
$
15,653.0
 
$
20,549.0
 
$
56,645.0
 
                     
Other Data - Statutory basis (preliminary) (b):
                   
Property and casualty companies’ capital and surplus (c) 
 
$
8,137.0
 
$
6,940.0
 
$
6,998.0
 
Life companies’ capital and surplus
   
687.0
   
627.0
   
1,177.0
 
Property and casualty companies’ written premiums to surplus
                   
Ratio
   
0.9
   
1.0
   
1.0
 
Life Company’s capital and surplus-percent to total liabilities
   
38.9
%
 
33.1
%
 
56.0
%
Participating policyholders-percent of gross life insurance inforce
   
4.4
%
 
3.5
%
 
1.4
%

(a)
Trade ratios reflect the results of CNA’s property and casualty insurance subsidiaries. Trade ratios are industry measures of property and casualty underwriting results. The loss and loss adjustment expense ratio is the percentage of net incurred claim and claim adjustment expenses and the expenses incurred related to uncollectible reinsurance receivables to net earned premiums. The primary difference in this ratio between accounting principles generally accepted in the United States of America (“GAAP”) and statutory accounting practices (“SAP”) is related to the treatment of active life reserves (“ALR”) related to long term care insurance products written in property and casualty insurance subsidiaries. For GAAP, ALR is classified as claim and claim adjustment expense reserves whereas for SAP, ALR is classified as unearned premium reserves. The expense ratio, using amounts determined in accordance with GAAP, is the percentage of underwriting and acquisition expenses (including the amortization of deferred acquisition expenses) to net earned premiums. The expense ratio, using amounts determined in accordance with SAP, is the percentage of acquisition and underwriting expenses (with no deferral of acquisition expenses) to net written premiums. The dividend ratio, using amounts determined in accordance with GAAP, is the ratio of dividends incurred to net earned premiums. The dividend ratio, using amounts determined in accordance with SAP, is the ratio of dividends paid to net earned premiums. The combined ratio is the sum of the loss and loss adjustment expense, expense and dividend ratios.

6

 
Item 1. Business
CNA Financial Corporation - (Continued)


(b)
Other data is determined in accordance with SAP. Life and group statutory capital and surplus as a percent of total liabilities is determined after excluding separate account liabilities and reclassifying the statutorily required Asset Valuation Reserve to surplus.
(c)
Surplus includes the property and casualty companies’ equity ownership of the life company’s capital and surplus.

The following table displays the distribution of gross written premiums for CNA’s operations by geographic concentration.

Year Ended December 31
 
2006
 
2005
 
2004
 
               
California
   
9.6
%
 
9.0
%
 
9.3
%
Florida
   
7.9
   
7.1
   
7.1
 
New York
   
7.3
   
7.9
   
7.9
 
Texas
   
5.9
   
5.7
   
5.4
 
New Jersey
   
4.4
   
3.8
   
5.3
 
Illinois
   
4.1
   
4.2
   
5.1
 
Pennsylvania
   
3.4
   
4.2
   
4.7
 
United Kingdom
   
3.2
   
2.8
   
2.3
 
Missouri
   
3.0
   
2.8
   
1.4
 
Massachusetts
   
2.4
   
3.3
   
3.2
 
All other states, countries or political subdivisions (a) 
   
48.8
   
49.2
   
48.3
 
     
100.0
%
 
100.0
%
 
100.0
%

(a)
No other individual state, country or political subdivision accounts for more than 3.0% of gross written premiums.

Approximately 7.1%, 6.1% and 5.0% of CNA’s gross written premiums were derived from outside of the United States for the years ended December 31, 2006, 2005 and 2004. Premiums from any individual foreign country excluding the United Kingdom were not significant.

Property and Casualty Claim and Claim Adjustment Expenses

The following loss reserve development table illustrates the change over time of reserves established for property and casualty claim and claim adjustment expenses at the end of the preceding ten calendar years for CNA’s property and casualty insurance operations. The table excludes CNA’s life subsidiaries, and as such, the carried reserves will not agree to the Consolidated Financial Statements included under Item 8. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to the originally reported reserve liability. The third section, reading down, shows re-estimates of the originally recorded reserves as of the end of each successive year, which is the result of CNA’s property and casualty insurance subsidiaries’ expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest re-estimated reserves to the reserves originally established, and indicates whether the original reserves were adequate or inadequate to cover the estimated costs of unsettled claims.

7

 
Item 1. Business
CNA Financial Corporation - (Continued)


The loss reserve development table for property and casualty companies is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. Additionally, the development amounts in the table below are the amounts prior to consideration of any related reinsurance bad debt allowance impacts.
 
   
Schedule of Loss Reserve Development
 
Year Ended December 31
 
1996
 
1997
 
1998
 
1999(a)
 
2000
 
2001(b)
 
2002(c)
 
2003
 
2004
 
2005
 
2006
 
(In millions of dollars)
                                                                   
                                                                     
Originally reported gross
                                                                   
 reserves for unpaid claim
                                                                   
 and claim adjustment                                                                    
 expenses
   
29,559
   
28,731
   
28,506
   
26,850
   
26,510
   
29,649
   
25,719
   
31,284
   
31,204
   
30,694
   
29,459
 
Originally reported ceded
                                                                   
 recoverable
   
5,385
   
5,056
   
5,182
   
6,091
   
7,333
   
11,703
   
10,490
   
13,847
   
13,682
   
10,438
   
8,078
 
Originally reported net
                                                                   
 reserves
                                                                   
 for unpaid claim and claim
                                                                   
 adjustment expenses
   
24,174
   
23,675
   
23,324
   
20,759
   
19,177
   
17,946
   
15,229
   
17,437
   
17,522
   
20,256
   
21,381
 
Cumulative net paid as of:
                                                                   
 One year later
   
5,851
   
5,954
   
7,321
   
6,547
   
7,686
   
5,981
   
5,373
   
4,382
   
2,651
   
3,442
   
-
 
 Two years later
   
9,796
   
11,394
   
12,241
   
11,937
   
11,992
   
10,355
   
8,768
   
6,104
   
4,963
   
-
   
-
 
 Three years later
   
13,602
   
14,423
   
16,020
   
15,256
   
15,291
   
12,954
   
9,747
   
7,780
   
-
   
-
   
-
 
 Four years later
   
15,793
   
17,042
   
18,271
   
18,151
   
17,333
   
13,244
   
10,870
   
-
   
-
   
-
   
-
 
 Five years later
   
17,736
   
18,568
   
20,779
   
19,686
   
17,775
   
13,922
   
-
   
-
   
-
   
-
   
-
 
 Six years later
   
18,878
   
20,723
   
21,970
   
20,206
   
18,970
   
-
   
-
   
-
   
-
   
-
   
-
 
 Seven years later
   
20,828
   
21,649
   
22,564
   
21,231
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Eight years later
   
21,609
   
22,077
   
23,453
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Nine years later
   
21,986
   
22,800
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Ten years later
   
22,642
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
Net reserves re-estimated as of:
                                                                   
 End of initial year
   
24,174
   
23,675
   
23,324
   
20,759
   
19,177
   
17,946
   
15,229
   
17,437
   
17,522
   
20,256
   
21,381
 
 One year later
   
23,970
   
23,904
   
24,306
   
21,163
   
21,502
   
17,980
   
17,650
   
17,671
   
18,513
   
20,588
   
-
 
 Two years later
   
23,610
   
24,106
   
24,134
   
23,217
   
21,555
   
20,533
   
18,248
   
19,120
   
19,044
   
-
   
-
 
 Three years later
   
23,735
   
23,776
   
26,038
   
23,081
   
24,058
   
21,109
   
19,814
   
19,760
   
-
   
-
   
-
 
 Four years later
   
23,417
   
25,067
   
25,711
   
25,590
   
24,587
   
22,547
   
20,384
   
-
   
-
   
-
   
-
 
 Five years later
   
24,499
   
24,636
   
27,754
   
26,000
   
25,594
   
22,983
   
-
   
-
   
-
   
-
   
-
 
 Six years later
   
24,120
   
26,338
   
28,078
   
26,625
   
26,023
   
-
   
-
   
-
   
-
   
-
   
-
 
 Seven years later
   
25,629
   
26,537
   
28,437
   
27,009
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Eight years later
   
25,813
   
26,770
   
28,705
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Nine years later
   
26,072
   
26,997
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
 Ten years later
   
26,305
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
Total net (deficiency)
                                                                   
  redundancy
   
(2,131
)
 
(3,322
)
 
(5,381
)
 
(6,250
)
 
(6,846
)
 
(5,037
)
 
(5,155
)
 
(2,323
)
 
(1,522
)
 
(332
)
 
-
 
                                                                     
Reconciliation to gross
                                                                   
 re-estimated reserves:
                                                                   
  Net reserves re-estimated
   
26,305
   
26,997
   
28,705
   
27,009
   
26,023
   
22,983
   
20,384
   
19,760
   
19,044
   
20,588
   
-
 
  Re-estimated ceded
                                                                   
    recoverable
   
7,619
   
6,953
   
7,469
   
9,810
   
10,541
   
15,939
   
15,298
   
13,722
   
12,624
   
10,094
   
-
 
Total gross re-estimated
                                                                   
  reserves
   
33,924
   
33,950
   
36,174
   
36,819
   
36,564
   
38,922
   
35,682
   
33,482
   
31,668
   
30,682
   
-
 
                                                                     
Net (deficiency) redundancy
                                                                   
 related to:
                                                                   
  Asbestos claims
   
(2,461
)
 
(2,361
)
 
(2,120
)
 
(1,544
)
 
(1,479
)
 
(707
)
 
(707
)
 
(65
)
 
(11
)
 
-
   
-
 
  Environmental and mass tort
                                                                   
   claims
   
(807
)
 
(834
)
 
(618
)
 
(722
)
 
(716
)
 
(256
)
 
(263
)
 
(117
)
 
(116
)
 
(63
)
 
-
 
 Total asbestos, environmental
                                                                   
  and mass tort
   
(3,268
)
 
(3,195
)
 
(2,738
)
 
(2,266
)
 
(2,195
)
 
(963
)
 
(970
)
 
(182
)
 
(127
)
 
(63
)
 
-
 
 Other claims
   
1,137
   
(127
)
 
(2,643
)
 
(3,984
)
 
(4,651
)
 
(4,074
)
 
(4,185
)
 
(2,141
)
 
(1,395
)
 
(269
)
 
-
 
Total net (deficiency)
                                                                   
  redundancy
   
(2,131
)
 
(3,322
)
 
(5,381
)
 
(6,250
)
 
(6,846
)
 
(5,037
)
 
(5,155
)
 
(2,323
)
 
(1,522
)
 
(332
)
 
-
 
(a)
Ceded recoverable includes reserves transferred under retroactive reinsurance agreements of $784.0 as of December 31, 1999.
(b)
Effective January 1, 2001, CNA established a new life insurance company, CNA Group Life Assurance Company (“CNAGLA”). Further, on January 1, 2001 approximately $1,055.0 of reserves were transferred from CCC to CNAGLA.
(c)
Effective October 31, 2002, CNA sold CNA Reinsurance Company Limited (“CNA Re U.K.”). As a result of the sale, net reserves were reduced by approximately $1,316.0.

8

 
Item 1. Business
CNA Financial Corporation - (Continued)


Please read information relating to CNA’s property and casualty claim and claim adjustment expense reserves and reserve development set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), and in Notes 1 and 9 of the Notes to Consolidated Financial Statements, included in Item 8.

Investments

Please read Item 7, MD&A - Investments and Notes 1, 2, 3 and 4 of the Notes to Consolidated Financial Statements, included in Item 8.

Other

Competition: The property and casualty insurance industry is highly competitive both as to rate and service. CNA’s consolidated property and casualty subsidiaries compete not only with other stock insurance companies, but also with mutual insurance companies, reinsurance companies and other entities for both producers and customers. CNA must continuously allocate resources to refine and improve its insurance products and services.

Rates among insurers vary according to the types of insurers and methods of operation. CNA competes for business not only on the basis of rate, but also on the basis of availability of coverage desired by customers, ratings and quality of service, including claim adjustment services.

There are approximately 2,400 individual companies that sell property and casualty insurance in the United States. CNA’s consolidated property and casualty subsidiaries ranked as the 13th largest property and casualty insurance organization and CNA is the seventh largest commercial insurance writer in the United States based upon 2005 statutory net written premiums.

Regulation: The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative powers relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports and regulating solvency and the type and amount of investments permitted. Such regulatory powers also extend to premium rate regulations, which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries, intercompany transfers of assets may be subject to prior notice or approval by the state insurance regulators, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer or payment.

Insurers are also required by the states to provide coverage to insureds who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. CNA’s share of these involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state.

Further, insurance companies are subject to state guaranty fund and other insurance-related assessments. Guaranty fund and other insurance-related assessments are levied by the state departments of insurance to cover claims of insolvent insurers.

Reform of the U.S. tort liability system is another issue facing the insurance industry. Over the last decade, many states have passed some type of reform. In recent years, for example, significant state general tort reforms have been enacted in Georgia, Ohio, Mississippi and South Carolina. Specific state legislation addressing state asbestos reform has been passed in Ohio, Georgia, Florida and Texas. A few more states will be considering such legislation in the coming year. Although these states’ legislatures have begun to address their litigious environments, some reforms are being challenged in the courts and it will take some time before they are finalized. Even though there has been some tort reform success, new causes of action and theories of damages continue to be proposed in state court actions or by legislatures. As a result of this unpredictability in the law, insurance underwriting and rating is expected to continue to be difficult in commercial lines, professional liability and some specialty coverages.

9

 
Item 1. Business
CNA Financial Corporation - (Continued)


Although the federal government and its regulatory agencies do not directly regulate the business of insurance, federal legislative and regulatory initiatives can impact the insurance industry in a variety of ways. These initiatives and legislation include tort reform proposals; proposals addressing natural catastrophe exposures, terrorism risk mechanisms; and various tax proposals affecting insurance companies. In 1999, Congress passed the Financial Services Modernization or “Gramm-Leach-Bliley” Act (“GLB Act”), which repealed portions of the Glass-Steagall Act and enabled closer relationships between banks and insurers. Although “functional regulation” was preserved by the GLB Act for state oversight of insurance, additional financial services modernization legislation could include provisions for an alternate federal system of regulation for insurance companies.

In addition, CNA’s domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the National Association of Insurance Commissioners (“NAIC”) to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the risk-based capital results, as determined by the formula. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 2006 and 2005, all of CNA’s domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.

Subsidiaries with insurance operations outside the United States are also subject to regulation in the countries in which they operate. CNA has operations in the United Kingdom, Canada and other countries.

Properties: The 333 S. Wabash Avenue building, located in Chicago, Illinois and owned by Continental Assurance Company (“CAC”), a wholly-owned subsidiary of CCC, serves as the executive office for CNA and its insurance subsidiaries. CNA owns or leases office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to the principal office buildings owned or leased by CNA:

Location
Size
(square feet)
 
Principal Usage
       
333 S. Wabash
904,990
 
Principal executive offices of CNA
Chicago, Illinois
     
401 Penn Street
171,406
 
Property and casualty insurance offices
Reading, Pennsylvania
     
2405 Lucien Way
147,815
 
Property and casualty insurance offices
Maitland, Florida
     
40 Wall Street
110,131
 
Property and casualty insurance offices
New York, New York
     
675 Placentia Avenue
  78,655
 
Property and casualty insurance offices
Brea, California
     
600 N. Pearl Street
  75,544
 
Property and casualty insurance offices
Dallas, Texas
     
1100 Cornwall Road
  74,067
 
Property and casualty insurance offices
Monmouth Junction, New Jersey
     
3175 Satellite Boulevard
  48,696
 
Property and casualty insurance offices
Duluth, Georgia
     
405 Howard Street
  47,195
 
Property and casualty insurance offices
San Francisco, California
     
4150 N. Drinkwater Boulevard
  37,799
 
Property and casualty insurance offices
Scottsdale, Arizona
     

CNA leases its office space described above except for the Chicago, Illinois building and the Reading, Pennsylvania building, which are owned.

10

 
Item 1. Business
 


LORILLARD, INC.

Lorillard, Inc. (“Lorillard”) is engaged, through its subsidiaries, in the production and sale of cigarettes. The principal cigarette brand names of Lorillard are Newport, Kent, True, Maverick and Old Gold. Lorillard’s largest selling brand is Newport, the second largest selling cigarette brand in the United States and the largest selling brand in the menthol segment of the U.S. cigarette market in 2006. Newport accounted for approximately 91.8% of Lorillard’s sales volume in 2006.

Substantially all of Lorillard’s sales are in the United States, Puerto Rico and certain U.S. territories. Lorillard’s major trademarks outside of the United States were sold in 1977. Lorillard accounted for 21.54%, 22.70% and 22.22% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.

Legislation and Regulation: Lorillard’s business operations are subject to a variety of federal, state and local laws and regulations governing, among other things, publication of health warnings on cigarette packaging, advertising and sales of tobacco products, restrictions on smoking in public places and fire safety standards. New legislation and regulations are proposed and reports are published by government sponsored committees and others recommending additional regulation of tobacco products.

Lorillard cannot predict the ultimate outcome of these proposals, reports and recommendations. If they are enacted, certain of these proposals could have a material adverse effect on Lorillard’s business and our financial position or results of operations in the future.

Federal Regulation: The Federal Comprehensive Smoking Education Act, which became effective in 1985, requires that cigarette packaging and advertising display one of the following four warning statements, on a rotating basis:

(1) “SURGEON GENERAL’S WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy.”

(2) “SURGEON GENERAL’S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health.”

(3) “SURGEON GENERAL’S WARNING: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth Weight.”

(4) “SURGEON GENERAL’S WARNING: Cigarette Smoke Contains Carbon Monoxide.”

This law also requires that each person who manufactures, packages or imports cigarettes shall annually provide to the Secretary of Health and Human Services a list of the ingredients added to tobacco in the manufacture of cigarettes. This list of ingredients may be submitted in a manner that does not identify the company that uses the ingredients or the brand of cigarettes that contain the ingredients.

In addition, bills have been introduced in Congress, including those that would:

 
·
prohibit all tobacco advertising and promotion;

 
·
require new health warnings on cigarette packages and advertising;

 
·
authorize the establishment of various anti-smoking education programs;

 
·
provide that current federal law should not be construed to relieve any person of liability under common or state law;

 
·
permit state and local governments to restrict the sale and distribution of cigarettes;

 
·
direct the placement of advertising of tobacco products;

 
·
provide that cigarette advertising not be deductible as a business expense;

11

 
Item 1. Business
Lorillard, Inc. - (Continued)


 
·
prohibit the mailing of unsolicited samples of cigarettes and otherwise to restrict the sale or distribution of cigarettes in retail stores, by mail or over the internet;

 
·
impose an additional, or increase existing, excise taxes on cigarettes;
 
 
·
require that cigarettes be manufactured in a manner that will cause them, under certain circumstances, to be self-extinguishing; and
 
 
·
subject cigarettes to regulation in various ways by the U.S. Department of Health and Human Services or other regulatory agencies.

In 1996, the U.S. Food and Drug Administration (“FDA”) published regulations that would have extensively regulated the distribution, marketing and advertising of cigarettes, including the imposition of a wide range of labeling, reporting, record keeping, manufacturing and other requirements. Challenges to the FDA’s assertion of jurisdiction over cigarettes made by Lorillard and other manufacturers were upheld by the U.S. Supreme Court in March of 2000 when that Court ruled that Congress did not give the FDA authority to regulate tobacco products under the federal Food, Drug and Cosmetic Act.

Since the Supreme Court decision, various proposals and recommendations have been made for additional federal and state legislation to regulate cigarette manufacturers, including a bill introduced by Congress in February 2007. Congressional advocates of FDA regulation proposed legislation that would give the FDA regulatory authority over the manufacture, sale, distribution and labeling of tobacco products to protect public health. The legislation would allow the FDA to reinstate its prior regulations or adopt new or additional regulations.

In February of 2001, a committee of the Institute of Medicine, a private, non-profit organization which advises the federal government on medical issues, convened and issued a report recommending that Congress enact legislation. The committee suggested enabling a suitable agency to regulate tobacco-related products that purport to reduce exposure to tobacco toxicants or reduce risk of disease, and implement other policies designed to reduce the harm from tobacco use. The report recommended regulation of all tobacco products, including potentially reduced exposure products, known as PREPs.

In 2002, certain public health groups petitioned the FDA to assert jurisdiction over several PREP type products that have been introduced into the marketplace. These groups assert that claims made by manufacturers of these products allow the FDA to regulate the manufacture, advertising and sale of these products as drugs or medical devices under the Food Drug and Cosmetic Act. The agency has received comments on these petitions but has taken no action.

In late 2002 Philip Morris U.S.A., the largest U.S. manufacturer of cigarettes, filed a request for rulemaking petition with the Federal Trade Commission (“FTC”) seeking changes in the existing FTC regulatory scheme for measuring and reporting tar and nicotine to the federal government and for inclusion in cigarette advertising. The agency has received comments on these petitions but has taken no action.

Environmental tobacco smoke: Various publications and studies by governmental entities have reported that environmental tobacco smoke (“ETS”) presents health risks. In addition, public health organizations have issued statements on the adverse health effects of ETS, and scientific papers have been published that address the health problems associated with ETS exposure. Various cities and municipalities have restricted public smoking in recent years, and these restrictions have been based at least in part on the publications regarding the health risks believed to be associated with ETS exposure.

The governmental entities that have published these reports have included the Surgeon General of the United States, first in 1986 and again in 2006. The 2006 report, for instance, concluded that there is no risk-free level of exposure to ETS; see “Risks Related to Us and Our Subsidiary, Lorillard, Inc.” of this Report for a discussion of the report issued in 2006 by the United States Surgeon General. In 2000, the Department of Health and Human Services listed ETS as a known human carcinogen. In 1993, the United States Environmental Protection Agency concluded that ETS is a human lung carcinogen in adults and causes respiratory effects in children.

12

 
Item 1. Business
Lorillard, Inc. - (Continued)


Agencies of state governments also have issued publications regarding ETS, including reports by California entities that were published in 1997, 1999 and 2006. In the 2006 study, the California Air Resources Board determined that ETS is a toxic air contaminant. Based on these or other findings, public health concerns regarding ETS could lead to the imposition of additional restriction on public smoking, including bans.

State and Local Regulation: Many state, local and municipal governments and agencies, as well as private businesses, have adopted legislation, regulations or policies which prohibit or restrict, or are intended to discourage, smoking, including legislation, regulations or policies prohibiting or restricting smoking in various places such as public buildings and facilities, stores, restaurants and bars and on airline flights and in the workplace. This trend has increased significantly since the release of the EPA’s report regarding ETS in 1993.

Two states, Massachusetts and Texas, have enacted legislation requiring each manufacturer of cigarettes sold in those states to submit an annual report identifying for each brand sold certain “added constituents,” and providing nicotine yield ratings and other information for certain brands. Neither law allows for the public release of trade secret information.

A New York law requires cigarettes sold in that state to meet a mandated standard for ignition propensity, which became effective in June of 2004. Lorillard developed proprietary technology to comply with the standards and was compliant by the effective date. Since the passage of the New York law, an additional five states have passed similar laws utilizing the same technical standards. The effective dates of these laws range from May of 2006 to January 2008.

Other similar laws and regulations have been enacted or considered by other state and local governments. Lorillard cannot predict the impact which these regulations may have on Lorillard’s business, though if enacted, they could have a material adverse effect on Lorillard’s business and our financial position or results of operations in the future.

Excise Taxes and Assessments: Cigarettes are subject to substantial federal, state and local excise taxes in the United States and, in general, such taxes have been increasing. The federal excise tax on cigarettes is $19.50 per thousand cigarettes (or $0.39 per pack of 20 cigarettes). State excise taxes, which are levied upon and paid by the distributors, are also in effect in the fifty states, the District of Columbia and many municipalities. Increases in state excise taxes on cigarette sales in 2006 ranged from $0.05 per pack to $1.00 per pack in six states and two municipalities. The average state excise tax increased to $0.96 per pack (of 20 cigarettes) in 2006 from $0.92 in 2005. Proposals for additional increases in federal, state and local excise taxes continue to be considered. The combined state and municipal taxes range from $0.07 to $3.66 per pack of cigarettes.

A federal law enacted in October 2004 repealed the federal supply management program for tobacco growers and compensated tobacco quota holders and growers with payments to be funded by an assessment on tobacco manufacturers and importers. Cigarette manufacturers and importers are responsible for paying 96.3% of a $10.14 billion payment to tobacco quota holders and growers over a ten-year period. The law provides that payments will be based on shipments for domestic consumption.

Advertising and Marketing: Lorillard advertises its products to adult smokers in magazines, newspapers, direct mail and point-of-sale display materials. In addition, Lorillard promotes its cigarette brands to adult smokers through distribution of store coupons, retail price promotions, and personal contact with distributors and retailers. Although Lorillard’s sales are made primarily to wholesale distributors rather than retailers, Lorillard’s sales personnel monitor retail and wholesale inventories, work with retailers on displays and signs, and enter into promotional arrangements with retailers regularly.

Lorillard allocates its marketing expenditures among brands on the basis of marketplace opportunity and profitable return. In particular, Lorillard focuses its marketing efforts on the premium segment of the U.S. cigarette industry, with a specific focus on Newport.

Advertising of tobacco products through television and radio has been prohibited since 1971. In addition, on November 23, 1998, Lorillard and the three other largest cigarette manufacturers entered into a Master Settlement Agreement (“MSA”) with 46 states, the District of Columbia, the Commonwealth of Puerto Rico and certain other U.S. territories to settle certain health care cost recovery and other claims. These manufacturers had previously settled similar claims brought by the four remaining states which together with the MSA are generally referred to as the “State
 
13

 
Item 1. Business
Lorillard, Inc. - (Continued)

 
Settlement Agreements.” Under the State Settlement Agreements, the participating cigarette manufacturers agreed to severe restrictions on their advertising and promotion activities. Among other things, the MSA:
 
 
·
prohibits the targeting of youth in the advertising, promotion or marketing of tobacco products;

 
·
bans the use of cartoon characters in all tobacco advertising and promotion;

 
·
limits each tobacco manufacturer to one event sponsorship during any twelve-month period, which may not include major team sports or events in which the intended audience includes a significant percentage of youth;

 
·
bans all outdoor advertising of tobacco products with the exception of small signs at retail establishments that sell tobacco products;

 
·
bans tobacco manufacturers from offering or selling apparel and other merchandise that bears a tobacco brand name, subject to specified exceptions;

 
·
prohibits the distribution of free samples of tobacco products except within adult-only facilities;

 
·
prohibits payments for tobacco product placement in various media; and

 
·
bans gift offers based on the purchase of tobacco products without sufficient proof that the intended gift recipient is an adult.

Many states, cities and counties have enacted legislation or regulations further restricting tobacco advertising. There may be additional local, state and federal legislative and regulatory initiatives relating to the advertising and promotion of cigarettes in the future. Lorillard cannot predict the impact of such initiatives on its marketing and sales efforts.

Lorillard funds a Youth Smoking Prevention Program, which is designed to discourage youth from smoking by promoting parental involvement and assisting parents in discussing the issue of smoking with their children. Lorillard is also a founding and principal member of the Coalition for Responsible Tobacco Retailing which through its “We Card” program trains retailers in how to prevent the purchase of cigarettes by underage persons. In addition, Lorillard has adopted guidelines established by the National Association of Attorneys General to restrict advertising in magazines with large readership among people under the age of 18.

Distribution Methods: Lorillard sells its products primarily to distributors, who in turn service retail outlets; chain store organizations; and government agencies, including the U.S. Armed Forces. Upon completion of the manufacturing process, Lorillard ships cigarettes to public distribution warehouse facilities for rapid order fulfillment to wholesalers and other direct buying customers. Lorillard retains a portion of its manufactured cigarettes at its Greensboro central distribution center and Greensboro cold-storage facility for future finished goods replenishment.

As of December 31, 2006, Lorillard had approximately 633 direct buying customers servicing more than 400,000 retail accounts. Lorillard does not sell cigarettes directly to consumers. During 2006, 2005 and 2004, sales made by Lorillard to McLane Company, Inc., comprised 23%, 21% and 20%, respectively, of Lorillard’s revenues. No other customer accounted for more than 10% of 2006, 2005 or 2004 sales. Lorillard does not have any backlog orders.

Most of Lorillard’s customers buy cigarettes on a next-day-delivery basis. Approximately 90% of Lorillard’s customers purchase cigarettes using electronic funds transfer, which provides immediate payment to Lorillard.

Raw Materials and Manufacturing: In its production of cigarettes, Lorillard uses domestic and foreign grown burley and flue-cured leaf tobaccos, as well as aromatic tobaccos grown primarily in Turkey and other Near Eastern countries. A domestic supplier manufactures all of Lorillard’s reconstituted tobacco.

Lorillard purchases more than 90% of its domestic leaf tobacco from Alliance One International, Inc. Lorillard directs Alliance One in the purchase of tobacco according to Lorillard’s specifications for quality, grade, yield, particle size, moisture content, and other characteristics. Alliance One purchases and processes the whole leaf and then dries and packages it for shipment to and storage at Lorillard’s Danville, Virginia facility. If Alliance One becomes unwilling or
 
14

 
Item 1. Business
Lorillard, Inc. - (Continued)

 
unable to supply leaf tobacco to Lorillard, Lorillard believes that it can readily obtain high-quality leaf tobacco from well-established, alternative industry sources.
 
Due to the varying size and quality of annual crops and other economic factors, tobacco prices have historically fluctuated. In 2004, a federal law eliminated historical U.S. price supports that accompanied production controls which inflated the market price of U.S. tobacco. Lorillard believes the elimination of production controls and price supports has favorably impacted the cost of U.S. tobacco.

Lorillard stores its tobacco in 29 storage warehouses on its 130-acre Danville, Virginia facility. To protect against loss, amounts of all types and grades of tobacco are stored in separate warehouses. Because of the aging requirements for tobacco, Lorillard maintains large quantities of leaf tobacco at all times. Lorillard believes its current tobacco supplies are adequately balanced for its present production requirements. If necessary, Lorillard can purchase aged tobacco in the open market to supplement existing inventories.

Lorillard produces cigarettes at its Greensboro, North Carolina manufacturing plant, which has a production capacity of approximately 185 million cigarettes per day and approximately 43 billion cigarettes per year. Through various automated systems and sensors, Lorillard actively monitors all phases of production to promote quality and compliance with applicable regulations.

Prices: Lorillard believes that the volume of U.S. cigarette sales is sensitive to price changes. Changes in pricing by Lorillard or other cigarette manufacturers could have an adverse impact on Lorillard’s volume of units sold and consequently on Lorillard’s profits and earnings. Lorillard makes independent pricing decisions based on a number of factors. Lorillard cannot predict the potential adverse impact of price changes on the following:

 
·
industry volume or Lorillard volume,

 
·
the mix between premium and discount sales,

 
·
Lorillard’s market share or

 
·
Lorillard’s profits and earnings.

In addition, Lorillard and other cigarette manufacturers engage in significant promotional activities. These sales promotion costs are accounted for as a reduction in net sales revenue and therefore impact average prices.

Properties: Lorillard’s manufacturing facility is located on approximately 80 acres in Greensboro, North Carolina. This 942,600 square-foot plant contains modern high-speed cigarette manufacturing machinery. The Greensboro facility also includes a warehouse with shipping and receiving areas totaling 54,800 square feet. In addition, Lorillard owns tobacco receiving and storage facilities totaling approximately 1,400,000 square feet in Danville, Virginia. Lorillard’s executive offices are located in a 130,000 square-foot, four-story office building in Greensboro. Its 93,800 square-foot research facility is also located in Greensboro.

Lorillard’s principal properties are owned in fee. With minor exceptions, Lorillard owns all of the machinery it uses. Lorillard believes that its properties and machinery are in generally good condition. Lorillard leases sales offices in major cities throughout the United States, a cold-storage facility in Greensboro and warehousing space in 21 public distributing warehouses located throughout the United States.

Competition: The domestic U.S. market for cigarettes is highly competitive. Competition is primarily based on a brand’s price, including level of discounting and other promotional activities, positioning, consumer loyalty, retail display, quality and taste. Lorillard’s principal competitors are the two other major U.S. cigarette manufacturers, Philip Morris (“PM”) and Reynolds American Inc. (“RAI”).

Lorillard believes its ability to compete even more effectively has been restrained by the Philip Morris Retail Leaders program and the combination of RJ Reynolds Tobacco Company (“RJR”) and Brown & Williamson (“B&W”) in 2004. The terms of Philip Morris’ merchandising contracts may effectively limit Lorillard from obtaining visible space in the

15

 
Item 1. Business
Lorillard, Inc. - (Continued)

 
retail store to effectively promote its brands. As a result, in a large number of retail locations, Lorillard either has a severely limited or no opportunity to competitively support its promotion programs which limits its sales potential.
 
Lorillard’s 9.7% market share of the 2006 U.S. domestic cigarette industry was third highest overall. Philip Morris and RAI accounted for approximately 49.2% and 27.9%, respectively, of wholesale shipments in 2006. Among the three major manufacturers, Lorillard ranked third behind Philip Morris and RAI with a 12.7% share of the premium segment in 2006.

Please read Item 1A, Risk Factors and Item 7, MD&A - Results of Operations - Lorillard for information regarding the business environment, including selected market share data for Lorillard.

BOARDWALK PIPELINE PARTNERS, LP

Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”) is engaged in the interstate transportation and storage of natural gas. Boardwalk Pipeline accounted for 3.45%, 3.57% and 1.74% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.

In November of 2005, Boardwalk Pipeline completed an initial public offering of 15,000,000 common units representing a 14.5% limited partnership interest. We owned 53,256,122 common and 33,093,878 subordinated units representing an aggregate 83.5% limited partner interest, and a wholly owned subsidiary of ours became the general partner of Boardwalk Pipeline and owns a 2.0% general partnership interest and all of Boardwalk Pipeline’s incentive distribution rights, which entitle the general partner to an increasing percentage of the cash that is distributed by Boardwalk Pipeline in excess of $0.4025 per unit per quarter.

In the fourth quarter of 2006, Boardwalk Pipeline sold an additional 6,900,000 common units at a price of $29.65 per unit in a public offering and received net proceeds of $195.2 million. In addition, we contributed $4.2 million to maintain our 2.0% general partner interest. As a result, as of December 31, 2006, we own 80.2% of Boardwalk Pipeline.

Boardwalk Pipeline owns and operates two interstate natural gas pipeline systems, with approximately 13,400 miles of pipeline, directly serving customers in 11 states and indirectly serving customers throughout the northeastern and southeastern United States through numerous interconnections with unaffiliated pipelines. In 2006, its pipeline systems transported approximately 1,340 billion cubic feet (“Bcf”) of gas. Average daily throughput on its pipeline systems during 2006 was approximately 3.7 Bcf. Boardwalk Pipeline’s natural gas storage facilities are comprised of 11 underground storage fields located in four states with aggregate working gas capacity of approximately 146.0 Bcf.

Boardwalk Pipeline conducts all of its operation through two subsidiaries:

 
·
Texas Gas Transmission, LLC (“Texas Gas”) operates approximately 5,900 miles of natural gas pipeline located in Louisiana, Texas, Arkansas, Mississippi, Tennessee, Kentucky, Indiana, Ohio, and Illinois having a peak-day delivery capacity of approximately 3.2 Bcf per day, and nine natural gas storage fields located in Indiana and Kentucky with aggregate designated working gas capacity of approximately 63.0 Bcf.

 
·
Gulf South Pipeline, LP (“Gulf South”) operates approximately 7,500 miles of natural gas pipeline, located in Texas, Louisiana, Mississippi, Alabama and Florida having a peak-day delivery capacity of approximately 3.5 Bcf per day, and two natural gas storage fields located in Louisiana and Mississippi with aggregate designated working gas capacity of approximately 83.0 Bcf.

Boardwalk Pipeline transports and stores natural gas for a broad mix of customers, including local distribution companies (“LDC”s), municipalities, interstate and intrastate pipelines, direct industrial users, electric power generation plants, marketers and producers.

Seasonality: Boardwalk Pipeline’s revenues are seasonal in nature and are affected by weather and natural gas price volatility. Weather impacts natural gas demand for power generation and heating purposes, which in turn influences the value of transportation and storage across its pipeline systems. Colder than normal winters or warmer than normal summers typically result in increased pipeline transportation revenues. Natural gas prices are also volatile, influencing drilling and production which can affect revenues from Boardwalk Pipeline’s storage and parking and lending (“PAL”)
 
16

 
Item 1. Business
Boardwalk Pipeline Partners, LP - (Continued)
 
 
services. Peak demand for natural gas occurs during the winter months, caused by the heating load. During 2006, approximately 56.8% of Boardwalk’s total operating revenues were realized in the first and fourth calendar quarters.
 
Regulation: The Federal Energy Regulatory Commission (the “FERC”) regulates pipelines under the Natural Gas Act of 1938 (“NGA”) and the Natural Gas Policy Act of 1978. FERC regulates, among other things, the rates and charges for the transportation and storage of natural gas in interstate commerce, the extension, enlargement or abandonment of jurisdictional facilities, and the financial accounting of certain regulated pipeline companies. These rates are designed based on certain assumptions to allow Boardwalk Pipeline the opportunity to recover its costs and earn a reasonable return on equity, however, there is no assurance that Boardwalk Pipeline will recover these costs from its customers. Gulf South is permitted to charge market-based storage rates pursuant to authority granted by the FERC. Boardwalk Pipeline is also regulated by the United States Department of Transportation (“DOT”) under the Natural Gas Pipeline Safety Act of 1968, as amended by Title I of the Pipeline Safety Act of 1979, which regulates safety requirements in the design, construction, operation and maintenance of interstate natural gas pipelines.

Where required, Texas Gas and Gulf South hold certificates of public convenience and necessity issued by the FERC covering their facilities, activities and services. The FERC also prescribes accounting treatment for items for regulatory purposes and may periodically audit the books and records of Texas Gas and Gulf South.

The maximum rates that may be charged by Boardwalk Pipeline for gas transportation and, in the case of Texas Gas, for storage services, are established through FERC ratemaking process. Key determinants in the rate-making process are the costs of providing service, the allowed rate of return on capital investments, volume throughput assumptions, the allocation of costs and the rate design. The allowed rate of return must be approved by the FERC in each rate case. Texas Gas filed a rate case in 2005 which was settled in the second quarter of 2006. Texas Gas has no obligation to file a new rate case and is prohibited from placing new rates into effect prior to November 1, 2010. Gulf South has no obligation to file a new rate case.

Boardwalk Pipeline’s operations are also subject to extensive federal, state and local laws and regulations relating to protection of the environment. These laws include, for example:

 
·
the Clean Air Act, and analogous state laws which impose obligations related to air emissions;

 
·
the Water Pollution Control Act, commonly referred to as the Clean Water Act, and analogous state laws which regulate discharge of wastewaters from our facilities into state and federal waters;

 
·
the Comprehensive Environmental Response, Compensation and Liability Act commonly referred to as CERCLA, or the Superfund law, and analogous state laws which regulate the cleanup of hazardous substances; and

 
·
the Resource Conservation and Recovery Act, and analogous state laws which impose requirements for the handling and discharge of solid and hazardous waste.

Competition: Boardwalk Pipeline competes with numerous intrastate and interstate pipelines throughout its service territory to provide transportation and storage services for its customers. Competition is particularly strong in the Midwest and Gulf Coast states where Boardwalk Pipeline competes with numerous existing pipelines and several new pipeline projects that are under way, including the proposed Rockies Express Pipeline that would transport natural gas from northern Colorado to eastern Ohio; the Heartland Gas Pipeline currently being constructed in Indiana; the proposed Mid-Continent Express pipeline that would transport gas from Texas to Alabama; and the proposed Southeast Header Supply System that would transport gas from Perryville, Louisiana to markets in Florida. The principal elements of competition among pipelines are rates, terms of service, access to supply and flexibility and reliability of service. In addition, regulators’ continuing efforts to increase competition in the natural gas industry have increased the natural gas transportation options of Boardwalk Pipeline’s traditional customers. As a result, segmentation and capacity release have created an active secondary market which increasingly competes with its pipeline services, particularly on its Texas Gas system.

Boardwalk Pipeline’s business is, in part, dependent on the volumes of natural gas consumed in the United States. Boardwalk Pipeline’s competitors attempt to either attract new supply to their pipelines or attach new load to their
 
17

 
Item 1. Business
Boardwalk Pipeline Partners, LP - (Continued)
 
 
pipelines, including those that are currently connected to markets served by Boardwalk Pipeline. Boardwalk Pipeline competes with these entities to maintain current business levels and to serve new demand and markets. In addition, natural gas competes with other forms of energy available to its customers, including electricity, coal and fuel oils.
 
Expansion Projects: Boardwalk Pipeline has constructed a 20.5 mile segment of 42-inch pipeline from Carthage, Texas to Keatchie, Louisiana which was placed in service in December of 2006. The current capacity of this loop is 120.0 MMcf per day.

Boardwalk Pipeline is pursuing a pipeline expansion project consisting of 242 miles of 42-inch pipeline from DeSoto Parish in western Louisiana to near Harrisville, Mississippi and approximately 110,000 horsepower of new compression. The expansion would add approximately 1.7 Bcf per day of new transmission capacity to the Gulf South pipeline system. The natural gas to be transported on this expansion will originate primarily from the Barnett Shale and Bossier Sands producing regions of East Texas. The expansion will transport natural gas to new interstate pipeline interconnects in the Perryville, Louisiana area and existing pipeline interconnects with other pipelines east of the Mississippi River. This project is supported by binding precedent agreements with customers who have contracted, on a long-term basis (with a weighted average term of approximately 7 years), for 1.3 Bcf per day from Carthage, Texas with an option for an additional 100.0 MMcf per day. On September 1, 2006, Boardwalk Pipeline filed a certificate application relating to this project with the FERC. Boardwalk Pipeline expects this project to be in service during the fall of 2007.

Boardwalk Pipeline is pursuing construction of a new interstate pipeline that will begin near Sherman, Texas and proceed to the Perryville, Louisiana area. The project will be owned by a new subsidiary, which is referred to as Gulf Crossing Pipeline, and will consist of approximately 355 miles of 42-inch pipeline having capacity of up to approximately 1.6 Bcf per day. Additionally, Gulf Crossing Pipeline will enter into: (i) an operating lease for at least 1.1 Bcf per day of capacity on the Gulf South system (including on the Southeast Expansion and a portion of the East Texas and Mississippi Expansion) to make deliveries to an interconnect with Transcontinental Pipe Line Company (“Transco”) in Choctaw County, Alabama and (ii) an operating lease with a third-party intrastate pipeline which will bring certain gas supplies to its system. This project is supported by binding agreements with customers who have contracted for 1.1 Bcf per day of capacity under firm contracts having terms of 5 to 10 years (with a weighted-average term of approximately 9.8 years), and options with certain of these customers for an additional 350.0 MMcf per day of capacity. Boardwalk Pipeline anticipates making the required filings with the FERC by July of 2007 and for the project to be in service during the fourth quarter of 2008. Boardwalk Pipeline is in negotiations with one of the foundation shippers supporting this project concerning the purchase of 49.0% of the equity of Gulf Crossing Pipeline.

Boardwalk Pipeline is pursuing a pipeline expansion extending the Gulf South pipeline system from near Harrisville, Mississippi to an interconnect with Transco in Choctaw County, Alabama which will enhance its ability to deliver gas to the Northeast through other pipeline interconnects. This expansion will consist of approximately 112 miles of 42-inch pipeline having initial capacity of approximately 1.2 Bcf per day expandable to as much as 2.0 Bcf per day to accommodate volumes expected to come from the Gulf Crossing leased capacity discussed above. In addition, Gulf South has executed an operating lease with Destin Pipeline Company to access markets in Florida. This project is supported by binding agreements with customers who have contracted for 660.0 MMcf per day of capacity under firm contracts having terms of 5 to 10 years (with a weighted-average term of 9.2 years), as well as the capacity leased to Gulf Crossing discussed above. The certificate filing was made with the FERC in December of 2006 and the project is anticipated to be in service during first quarter of 2008.

Boardwalk Pipeline is pursuing the construction of two laterals connected to its Texas Gas pipeline system to transport gas from the Fayetteville Shale area in Arkansas to markets directly and indirectly served by Texas Gas. The Fayetteville Lateral, consisting of approximately 165 miles of 36-inch pipeline is anticipated to have an initial design capacity of 800.0 MMcf per day and a maximum design capacity of 1.1 Bcf per day. This lateral will originate in Conway County, Arkansas and proceed southeast through the Bald Knob, Arkansas area to an interconnect with Texas Gas’s pipeline in Coahoma County, Mississippi. The Greenville Lateral, consisting of approximately 95 miles of pipeline with an initial design capacity of 750.0 MMcf per day, will originate at Texas Gas’s mainline near Greenville, Mississippi and proceed east to the Kosciusko, Mississippi area. The Greenville Lateral will allow customers to access additional markets primarily in the Midwest, Northeast and Southeast, including the Henry Hub. Construction of both laterals is supported by a binding precedent agreement with Southwestern Energy Services Company, a wholly owned subsidiary of Southwestern Energy Company. The proposed extensions are subject to FERC approval. In December of 2006, the FERC granted Texas Gas’s request to initiate the pre-filing process for this project and Boardwalk Pipeline anticipates
 
18

 
Item 1. Business
Boardwalk Pipeline Partners, LP - (Continued)
 
 
making the required certificate filings with the FERC in June of 2007. Boardwalk Pipeline expects the project to be in service during the first quarter of 2009.
 
The total cost of the pipeline expansion projects discussed above is expected to be approximately $3.3 billion (before taking into account equity that would be contributed by the purchaser of a 49.0% interest in Gulf Crossing referred to above). Boardwalk Pipeline constantly seeks to optimize these projects to reduce the overall cost. However the actual cost to complete these projects may exceed Boardwalk Pipeline’s current estimate as a result of, among other things, higher labor and material costs due to the large number of pipeline projects under way throughout the industry or Boardwalk Pipeline’s need to expand pipeline capacity if it contracts for additional volumes. For a further discussion of the risks associated with these projects, please read the section on Risk Factors in Item 1A of this Report.

In December of 2006, the FERC issued a certificate approving Texas Gas’s Phase II storage expansion project which will expand the working gas capacity in its western Kentucky storage complex by approximately 9.0 Bcf. This project is supported by binding commitments from customers to contract on a long-term basis for the full additional capacity at Texas Gas’s maximum applicable rate. Boardwalk Pipeline expects this project to cost approximately $40.7 million and to be in service by November of 2007. In December of 2006, Texas Gas commenced an open season related to a potential third expansion of its storage facilities. Texas Gas has signed one precedent agreement for 2.0 Bcf of capacity. The ultimate size of the Phase III storage expansion will be determined, in part, by the open season. The Phase III storage expansion is subject to the FERC approvals, including potential market-based rate authority for the new additional storage capacity being created. Phase I of this project which expanded working gas capacity by approximately 8.0 Bcf was completed and in service in November of 2005.

Boardwalk Pipeline is currently developing an additional storage cavern near Napoleonville, Louisiana. During mining operations, certain issues have arisen causing the mining of the cavern to be suspended. Boardwalk Pipeline is continuing to conduct operational integrity tests on the caverns. The tests are on-going but have been delayed due to lack of equipment availability needed to complete the testing. If the test results are favorable, Boardwalk Pipeline expects the storage facilities to be in service perhaps as early as 2008 with working gas capacity of 2.0 Bcf, reduced from 6.0 Bcf as originally designed. If the test results are not favorable, Boardwalk Pipeline will consider the options it has available, including developing a new cavern or the sale or abandonment of the project.

Properties: Boardwalk Pipeline and Texas Gas are headquartered in approximately 108,000 square feet of office space in Owensboro, Kentucky in a building that is owned by Texas Gas. Gulf South has its headquarters in approximately 55,000 square feet of leased office space located in Houston, Texas. Due to recent expansion activities, and the expiration in May of 2007 of the lease for Gulf South’s current office space, Gulf South has signed a new ten-year lease for approximately 74,000 square feet of office space in a new location in Houston, Texas. Gulf South will begin moving in the new headquarters in April of 2007. Boardwalk Pipeline’s operating subsidiaries own their respective pipeline systems in fee. A substantial portion of these systems is constructed and maintained on property owned by others pursuant to rights-of-way, easements, permits, licenses or consents.

DIAMOND OFFSHORE DRILLING, INC.

Diamond Offshore Drilling Inc. (“Diamond Offshore”), is engaged, through its subsidiaries, in the business of owning and operating drilling rigs that are used in the drilling of offshore oil and gas wells on a contract basis for companies engaged in exploration and production of hydrocarbons. Diamond Offshore owns 44 offshore rigs and also has two premium jack-up rigs currently under construction. Diamond Offshore accounted for 11.74%, 8.07% and 5.49% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.

Diamond Offshore owns and operates 30 semisubmersible rigs. Semisubmersible rigs consist of an upper working and living deck resting on vertical columns connected to lower hull members. Such rigs operate in a “semi-submerged” position, remaining afloat, off bottom, in a position in which the lower hull is approximately 55 feet to 90 feet below the water line and the upper deck protrudes well above the surface. Semisubmersible rigs are typically anchored in position and remain stable for drilling in the semi-submerged floating position due in part to their wave transparency characteristics at the water line. Semisubmersible rigs can also be held in position through the use of a computer controlled thruster (“dynamic-positioning”) system to maintain the rig’s position over a drillsite. Three semisubmersible rigs in Diamond Offshore’s fleet have this capability.

19

 
Item 1. Business
Diamond Offshore Drilling, Inc. - (Continued)


Diamond Offshore owns and operates nine high-specification semisubmersible rigs. These high specification semisubmersible rigs have high-capacity deck loads and are generally capable of working in water depths of 4,000 feet or greater or in harsh environments and have other advanced features, as compared to intermediate semisubmersible rigs. As of January 29, 2007, seven of the nine high-specification semisubmersible rigs were located in the U.S. Gulf of Mexico (“GOM”), while the remaining two high-specification semisubmersible rigs were located offshore Brazil and Malaysia.

Diamond Offshore owns and operates 21 intermediate semisubmersible rigs which generally work in maximum water depths up to 4,000 feet and many have diverse capabilities that enable them to provide both shallow and deep water service in the U.S. and in other markets outside the U.S. As of January 29, 2007, Diamond Offshore had 19 intermediate semisubmersible rigs, drilling in various offshore locations around the world. Five of these intermediate semisubmersible rigs were located in the GOM; three were located offshore Mexico or in the Mexican GOM; four were located in the North Sea, two were located offshore Australia, two were located offshore Brazil and one was located offshore each of New Zealand, Vietnam and Egypt.

In 2006, Diamond Offshore began a major upgrade of the Ocean Monarch, a Victory-class semisubmersible that it acquired in August 2005 for $20.0 million. The modernized rig is being designed to operate in up to 10,000 feet of water in a moored configuration for an estimated cost of approximately $300.0 million. Through December 31, 2006, Diamond Offshore had spent $33.9 million related to this project. The Ocean Monarch is expected to be ready for deepwater service in the fourth quarter of 2008.

In addition, the shipyard portion of the upgrade of the Ocean Endeavor has been completed. The rig is currently undergoing sea trials and commissioning. The unit will remain in Singapore until the arrival of a heavy-lift vessel, anticipated late in the first quarter of 2007, which will return the rig to the GOM. The Ocean Endeavor is expected to commence drilling operations in the GOM in mid-2007. Diamond Offshore estimates that the total cost of the upgrade will be approximately $253.0 million of which $208.4 million had been spent through December 31, 2006.

Diamond Offshore owns and operates 13 jack-up drilling rigs. Jack-up rigs are mobile, self-elevating drilling platforms equipped with legs that are lowered to the ocean floor until a foundation is established to support the drilling platform. The rig hull includes the drilling rig, jacking system, crew quarters, loading and unloading facilities, storage areas for bulk and liquid materials, heliport and other related equipment. Diamond Offshore’s jack-up rigs are used for drilling in water depths from 20 feet to 350 feet. The water depth limit of a particular rig is principally determined by the length of the rig’s legs. A jack-up rig is towed to the drillsite with its hull riding in the sea, as a vessel, with its legs retracted. Once over a drillsite, the legs are lowered until they rest on the seabed and jacking continues until the hull is elevated above the surface of the water. After completion of drilling operations, the hull is lowered until it rests in the water and then the legs are retracted for relocation to another drillsite.

As of January 29, 2007, nine of Diamond Offshore’s jack-up rigs were located in the GOM. Six of those rigs are independent-leg cantilevered units, two are mat-supported cantilevered units, and one is a mat-supported slot unit. Of Diamond Offshore’s four remaining jack-up rigs, three are internationally based and are independent-leg cantilevered rigs; one was located offshore Indonesia, one was located offshore Africa and the other rig was located offshore Qatar. Diamond Offshore’s remaining jack-up rig was located in the Mexican GOM and is also an independent-leg cantilever unit.

In the second quarter of 2005, Diamond Offshore entered into agreements to construct two high-performance, premium jack-up rigs. The two new drilling units, the Ocean Scepter and the Ocean Shield, are being constructed in Brownsville, Texas and Singapore, respectively, at an aggregate expected cost of approximately $320.0 million, including drill pipe and capitalized interest, of which $176.1 million had been spent through December 31, 2006. Each newbuild jack-up rig will be equipped with a 70-foot cantilever package, capable of drilling depths of up to 35,000 feet and have a hook load capacity of two million pounds. Diamond Offshore expects delivery of both of these units during the first quarter of 2008.

Diamond Offshore has one drillship, the Ocean Clipper, which was located offshore Brazil as of January 29, 2007. Drillships, which are typically self-propelled, are positioned over a drillsite through the use of either an anchoring system or a dynamic-positioning system similar to those used on certain semisubmersible rigs. Deep water drillships compete in many of the same markets as do high-specification semisubmersible rigs.

20

 
Item 1. Business
Diamond Offshore Drilling, Inc - (Continued)


Markets: The principal markets for Diamond Offshore’s contract drilling services are the following:

 
·
the Gulf of Mexico, including the United States and Mexico;

 
·
Europe, principally in the United Kingdom, or U.K., and Norway;

 
·
the Mediterranean Basin, including Egypt, Libya and Tunisia; and other parts of Africa;

 
·
South America, principally in Brazil;

 
·
Australia and Asia, including Malaysia, Indonesia and Vietnam; and

 
·
the Middle East, including Kuwait, Qatar and Saudi Arabia.

Diamond Offshore actively markets its rigs worldwide. From time to time Diamond Offshore’s fleet operates in various other markets throughout the world as the market demands.

Diamond Offshore believes its presence in multiple markets is valuable in many respects. For example, Diamond Offshore believes that its experience with safety and other regulatory matters in the U.K. has been beneficial in Australia and in the Gulf of Mexico, while production experience gained through Brazilian and North Sea operations has potential application worldwide. Additionally, Diamond Offshore believes its performance for a customer in one market segment or area enables it to better understand that customer’s needs and better serve that customer in different market segments or other geographic locations.

Diamond Offshore’s contracts to provide offshore drilling services vary in their terms and provisions. Diamond Offshore typically obtains its contracts through competitive bidding, although it is not unusual for Diamond Offshore to be awarded drilling contracts without competitive bidding. Drilling contracts generally provide for a basic drilling rate on a fixed dayrate basis regardless of whether or not such drilling results in a productive well. Drilling contracts may also provide for lower rates during periods when the rig is being moved or when drilling operations are interrupted or restricted by equipment breakdowns, adverse weather conditions or other conditions beyond the control of Diamond Offshore. Under dayrate contracts, Diamond Offshore generally pays the operating expenses of the rig, including wages and the cost of incidental supplies. Historically, dayrate contracts have accounted for a substantial portion of Diamond Offshore’s revenues. In addition, from time to time, Diamond Offshore’s dayrate contracts may also provide for the ability to earn an incentive bonus from its customers based upon performance.

A dayrate drilling contract generally extends over a period of time covering either the drilling of a single well or a group of wells, which Diamond Offshore refers to as a well-to-well contract, or a fixed term, which Diamond Offshore refers to as a term contract, and may be terminated by the customer in the event the drilling unit is destroyed or lost or if drilling operations are suspended for a period of time as a result of a breakdown of equipment or, in some cases, due to other events beyond the control of either party to the contract. In addition, certain of Diamond Offshore’s contracts permit the customer to terminate the contract early by giving notice, and in some circumstances may require the payment of an early termination fee by the customer. The contract term in many instances may also be extended by the customer exercising options for the drilling of additional wells or for an additional length of time, generally at competitive market rates and mutually agreeable terms at the time of the extension.

Customers: Diamond Offshore provides offshore drilling services to a customer base that includes major and independent oil and gas companies and government-owned oil companies. Several customers have accounted for 10.0% or more of Diamond Offshore’s annual consolidated revenues, although the specific customers may vary from year to year. During 2006, Diamond Offshore performed services for 51 different customers with Anadarko Petroleum Corporation (which acquired Kerr-McGee Oil & Gas Corporation, or Kerr-McGee, in mid-2006) and Petroleo Brasileiro S.A., (“Petrobas”) accounting for 10.6% and 10.4% of Diamond Offshore’s annual consolidation revenues, repectively. During 2005, Diamond Offshore performed services for 53 different customers with Petrobras and Kerr McGee, accounting for 10.7% and 10.3% of Diamond Offshore’s annual total consolidated revenues, respectively. During 2004, Diamond Offshore performed services for 53 different customers with Petrobras and PEMEX-Exploracion Y
 
21

 
Item 1. Business
Diamond Offshore Drilling, Inc. - (Continued)

 
Produccion, or PEMEX, accounting for 12.6% and 10.5% of Diamond Offshore’s annual total consolidated revenues, respectively.
 
Competition: The offshore contract drilling industry is highly competitive and is influenced by a number of factors, including current and anticipated prices of oil and natural gas, expenditures by oil and gas companies for exploration and development of oil and natural gas and the availability of drilling rigs.

Governmental Regulation: Diamond Offshore’s operations are subject to numerous international, U.S., state and local laws and regulations that relate directly or indirectly to Diamond Offshore’s operations, including regulations controlling the discharge of materials into the environment, requiring removal and clean-up under some circumstances, or otherwise relating to the protection of the environment.

Operations Outside the United States: Diamond Offshore’s operations outside the United States accounted for approximately 43.0%, 45.0% and 56.0% of Diamond Offshore’s total consolidated revenues for the years ended December 31, 2006, 2005 and 2004, respectively.

Properties: Diamond Offshore owns an eight-story office building containing approximately 182,000 net rentable square feet on approximately 6.2 acres of land located in Houston, Texas, where Diamond Offshore has its corporate headquarters, two buildings totaling 39,000 square feet and 20 acres of land in New Iberia, Louisiana, for its offshore drilling warehouse and storage facility, and a 13,000 square foot building and five acres of land in Aberdeen, Scotland, for its North Sea operations. Additionally, Diamond Offshore currently leases various office, warehouse and storage facilities in Louisiana, Australia, Brazil, Indonesia, Norway, The Netherlands, Malaysia, Qatar, Singapore and Mexico to support its offshore drilling operations.

22

 
Item 1. Business
 


LOEWS HOTELS HOLDING CORPORATION

The subsidiaries of Loews Hotels Holding Corporation (“Loews Hotels”), our wholly owned subsidiary, presently operate the following 18 hotels. Loews Hotels accounted for 2.07%, 2.19% and 2.07% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.
 
 
Number of
 
Name and Location
Rooms
Owned, Leased or Managed
     
Loews Annapolis
220
   
Owned
Annapolis, Maryland
     
Loews Coronado Bay Resort
440
   
Land lease expiring 2034
San Diego, California
     
Loews Denver
185
   
Owned
Denver, Colorado
     
Don CeSar Beach Resort, a Loews Hotel
347
   
Management contract (a)(b)
St. Pete Beach, Florida
     
Hard Rock Hotel,
650
   
Management contract (c)
at Universal Orlando
     
Orlando, Florida
     
Loews Lake Las Vegas Hotel
493
   
Management contract (d)
Henderson, Nevada
       
Loews Le Concorde
405
   
Land lease expiring 2069
Quebec City, Canada
     
Loews Miami Beach Hotel
790
   
Owned
Miami Beach, Florida
     
Loews New Orleans Hotel
285
   
Management contract expiring 2018 (a)
New Orleans, Louisiana
     
Loews Philadelphia Hotel
585
   
Owned
Philadelphia, Pennsylvania
     
The Madison, a Loews Hotel
353
   
Management contract expiring 2021 (a)
Washington, D.C.
       
Portofino Bay Hotel,
750
   
Management contract (c)
at Universal Orlando, a Loews Hotel
     
Orlando, Florida
     
The Regency, a Loews Hotel
350
   
Land lease expiring 2013, with renewal option
New York, New York
     
for 47 years
Royal Pacific Resort
1,000
   
Management contract (c)
at Universal Orlando, a Loews Hotel
     
Orlando, Florida
     
Loews Santa Monica Beach
340
   
Management contract expiring 2018, with
Santa Monica, California
     
renewal option for 5 years (a)
Loews Vanderbilt Plaza
340
   
Owned
Nashville, Tennessee
     
Loews Ventana Canyon Resort
400
   
Management contract expiring 2019 (a)
Tucson, Arizona
     
Loews Hotel Vogue
140
   
Owned
Montreal, Canada
   

(a)
These management contracts are subject to termination rights.
(b)
A Loews Hotels subsidiary is a 20% owner of the hotel, which is being operated by Loews Hotels pursuant to a management contract.
(c)
A Loews Hotels subsidiary is a 50% owner of these hotels located at the Universal Orlando theme park, through a joint venture with Universal Studios and the Rank Group. The hotels are constructed on land leased by the joint venture from the resort’s owners and are being operated by Loews Hotels pursuant to a management contract.
(d)
A Loews Hotels subsidiary is a 25% owner of the hotel, which is being operated by Loews Hotels pursuant to a management contract.

23

 
Item 1. Business
Loews Hotels Holding Corporation - (Continued)


The hotels owned by Loews Hotels are subject to mortgage indebtedness totaling approximately $236.0 million at December 31, 2006 with interest rates ranging from 4.5% to 6.3%, and maturing between 2007 and 2028. In addition, certain hotels are held under leases which are subject to formula derived rental increases, with rentals aggregating approximately $6.4 million for the year ended December 31, 2006.

Competition from other hotels and lodging facilities is vigorous in all areas in which Loews Hotels operates. The demand for hotel rooms in many areas is seasonal and dependent on general and local economic conditions. Loews Hotels properties also compete with facilities offering similar services in locations other than those in which its hotels are located. Competition among luxury hotels is based primarily on location and service. Competition among resort and commercial hotels is based on price as well as location and service. Because of the competitive nature of the industry, hotels must continually make expenditures for updating, refurnishing and repairs and maintenance, in order to prevent competitive obsolescence.

BULOVA CORPORATION

Bulova Corporation (“Bulova”) is engaged in the distribution and sale of watches and clocks for consumer use. Bulova accounted for 1.17%, 1.16% and 1.16% of our consolidated total revenue for the years ended December 31, 2006, 2005 and 2004, respectively.

Bulova’s principal watch brands are Bulova, Caravelle, Wittnauer and Accutron. Clocks are principally sold under the Bulova brand name. All watches and substantially all clocks are purchased from foreign suppliers. Bulova’s principal markets are the United States, Canada and Mexico. Bulova’s product breakdown includes luxury watch lines represented by Wittnauer and Accutron, a mid-priced watch line represented by Bulova, and a lower-priced watch line represented by Caravelle.

Properties: Bulova owns an 80,000 square foot facility in Woodside, New York which it uses for executive and sales offices, watch distribution, service and warehouse purposes. Bulova also owns 6,100 square feet of office space in Hong Kong which it uses for quality control and sourcing purposes. Bulova leases a 31,000 square foot facility in Toronto, Canada, which it uses for watch and clock sales and service; and a 27,000 square foot office and manufacturing facility in Ontario, Canada which it uses for its grandfather clock operations. Bulova also leases facilities in Mexico City, Mexico, and Fribourg, Switzerland.

EMPLOYEE RELATIONS

Including our operating subsidiaries as described below, we employed approximately 21,600 persons at December 31, 2006. We, and our subsidiaries, have experienced satisfactory labor relations.

CNA employed approximately 9,800 employees.

Lorillard employed approximately 2,800 persons. Approximately 1,000 of these employees are represented by labor unions covered by three collective bargaining agreements.

Boardwalk Pipeline employed approximately 1,150 persons, approximately 90 of which are covered by a collective bargaining agreement.

Diamond Offshore employed approximately 4,800 persons including international crew personnel furnished through independent labor contractors.

Loews Hotels employed approximately 2,200 persons, approximately 760 of whom are union members covered under collective bargaining agreements.

Bulova employed approximately 500 persons, approximately 150 of whom are union members.

24

 
Item 1. Business
 


AVAILABLE INFORMATION

Our website address is www.loews.com. We make available, free of charge, through the website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after these reports are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). Copies of our Code of Business Conduct and Ethics, Corporate Governance Guidelines, Audit Committee charter, Compensation Committee charter and Nominating and Governance Committee charter have also been posted and are available on our website.

Item 1A.  RISK FACTORS.

Our business faces many risks. We have described below some of the more significant risks which we and our subsidiaries face. There may be additional risks that we do not yet know of or that we do not currently perceive to be significant that may also impact our business or the business of our subsidiaries.

Each of the risks and uncertainties described below could lead to events or circumstances that have a material adverse effect on our business, results of operations, cash flows, financial condition or equity and/or the business, results of operations, financial condition or equity of one or more of our subsidiaries. In addition, the risks and uncertainties described below relating to our Carolina Group stock and our Lorillard subsidiary could lead to a material loss in the value of the Carolina Group stock.

You should carefully consider and evaluate all of the information included in this Report and any subsequent reports we may file with the SEC or make available to the public before investing in any securities issued by us. Our subsidiaries, CNA Financial Corporation, Diamond Offshore Drilling, Inc. and Boardwalk Pipeline Partners, LP, are public companies and file reports with the SEC. You are also cautioned to carefully review and consider the information contained in the reports filed by those subsidiaries before investing in any of their securities.

We are a holding company and derive substantially all of our cash flow from our subsidiaries.

We rely upon our invested cash balances and distributions from our subsidiaries to generate the funds necessary to meet our obligations and to declare and pay any dividends to holders of our common stock and Carolina Group stock. Our subsidiaries are separate and independent legal entities and have no obligation, contingent or otherwise, to make funds available to us, whether in the form of loans, dividends or otherwise. The ability of our subsidiaries to pay dividends to us is also subject to, among other things, the availability of sufficient funds in such subsidiaries, applicable state laws, including in the case of the insurance subsidiaries of CNA, laws and rules governing the payment of dividends by regulated insurance companies. Claims of creditors of our subsidiaries will generally have priority as to the assets of such subsidiaries over our claims and our creditors and shareholders.

In prior years, we have restated our financial results and identified material weaknesses in our internal control over financial reporting.

In May of 2005, we restated our financial results for prior years to correct CNA’s accounting for several reinsurance contracts, primarily with a former affiliate, and to correct CNA’s equity accounting for that affiliate. In February of 2006, we restated our financial results for prior years to correct the accounting for discontinued operations acquired by CNA in its merger with The Continental Corporation in 1995. In addition, in March of 2006, we restated our financial results for prior years to correct classification errors within our Consolidated Statements of Cash Flows.

As a result of the foregoing restatements, we identified material weaknesses in our internal control over financial reporting as of December 31, 2004 and 2005, respectively. We also determined that our internal control over financial reporting as of such dates was not effective. Our system of internal control over financial reporting is a process designed to provide reasonable assurance to our management, Audit Committee and Board of Directors regarding the reliability of our financial reporting and the preparation and fair presentation of our published financial statements. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, and the implementing rules of the Securities and Exchange Commission,
 
25

 
Item 1A. Risk Factors
 

 
the periodic reports we file with the SEC include information on our system of disclosure controls and procedures, as well as our overall internal control over financial reporting.
 
While we have remediated the referenced material weaknesses, if we fail to maintain effective internal control over financial reporting, we could be scrutinized by regulators in a manner that extends beyond the SEC’s requests for information relating to the restatements (as further described in the CNA risk factor titled CNA is responding to subpoenas, interrogatories and inquiries relating to insurance brokers and agents, contingent commissions and bidding practices, and certain finite-risk insurance products below). We could also be scrutinized by securities analysts and investors. As a result of this scrutiny, we could suffer a loss of public confidence in our financial reporting capabilities and thereby face adverse effects on our business and the market price of our securities.

Risks Related to an Investment in Our Carolina Group Stock

We cannot be certain that we will continue to pay dividends on our Carolina Group stock.

Determinations as to the future dividends on Carolina Group stock primarily will depend on the dividends paid to us by our subsidiaries, our capital requirements and other factors that our board of directors considers relevant. The amount of dividends that legally could be paid on Carolina Group stock if the Carolina Group were a separate Delaware corporation may be greater than the amount actually available for the payment of dividends under Delaware law and our charter. Furthermore, our ability to pay dividends on Carolina Group stock may be reduced by dividends that we pay on our common stock.

Our board of directors reserves the right to declare and pay dividends on Carolina Group stock, and could, in its sole discretion, declare and pay dividends, or refrain from declaring and paying dividends, on Carolina Group stock. Our board of directors may take such actions regardless of the amounts available for the payment of dividends on Carolina Group stock, the amount of prior dividends declared on Carolina Group stock, the voting or liquidation rights of Carolina Group stock, or any other factor.

The independence of the board of directors of Lorillard, Inc. and the board of directors of its wholly owned subsidiary, Lorillard Tobacco Company, may affect Lorillard’s payment of dividends to us and thereby inhibit our ability or willingness to pay dividends and make other distributions on our Carolina Group stock.

Our ability and willingness to pay dividends and make other distributions on Carolina Group stock, including dividends and distributions following a disposition of substantially all of the assets attributed to the Carolina Group, will depend on a number of factors, including whether the independent board of directors of Lorillard Tobacco Company causes Lorillard Tobacco Company to declare and pay dividends to its parent, Lorillard, Inc. and whether, in turn, the independent board of directors of Lorillard, Inc. causes Lorillard, Inc. to declare and pay dividends to us. In the event that Lorillard Tobacco Company or Lorillard, Inc. does not distribute its earnings, we are unlikely to pay dividends on Carolina Group stock. To the extent Lorillard, Inc. does not distribute net proceeds following the sale of substantially all of the assets attributed to the Carolina Group, we will not be required to apply the net proceeds to pay dividends to holders of Carolina Group stock or redeem shares of Carolina Group stock.

We expect that the boards of directors of each of Lorillard, Inc. and Lorillard Tobacco Company will continue to function independently of us and will direct the operations and management of the assets and businesses of those corporations, respectively. None of the individuals currently serving as directors of Lorillard, Inc. or Lorillard Tobacco Company are officers, directors or employees of Loews Corporation. Notwithstanding our right, as sole shareholder, to elect and remove directors of Lorillard, Inc., we have no present intention to remove any person currently serving as a director of Lorillard, Inc. Moreover, we expect that in the event of any future vacancies on the board of directors of Lorillard, Inc., we will nominate individuals who are not officers, directors or employees of Loews Corporation to fill such vacancies.

We have allocated to the Carolina Group any liabilities or expenses that we incur as a result of tobacco-related litigation.

The Carolina Group has been allocated any and all liabilities, costs and expenses of us and Lorillard, Inc. and the subsidiaries and predecessors of Lorillard, Inc., arising out of or related to tobacco or otherwise arising out of the past,
 
26

 
Item 1A. Risk Factors
 
 
 
present or future business of Lorillard, Inc. or its subsidiaries or predecessors, or claims arising out of or related to the sale of any businesses previously sold by Lorillard, Inc. or its subsidiaries or predecessors, in each case, whether grounded in tort, contract, statute or otherwise, whether pending or asserted in the future.
 
Accordingly, we and/or Lorillard may make decisions with respect to litigation and settlement strategies designed to obtain our dismissal or release from tobacco-related litigation or liabilities. Such decisions and strategies could result, for example, in limitations on payment of dividends by Lorillard to us or an increase in Lorillard’s exposure in such litigation.

The Engle Agreement may affect Lorillard’s payment of dividends to us and thereby inhibit our ability or willingness to pay dividends on our Carolina Group stock.

Under the Engle Agreement if Lorillard, Inc. does not maintain a balance sheet net worth of at least $921.2 million, the stay pursuant to the agreement would terminate. Because dividends from Lorillard, Inc. to us are deducted from the balance sheet net worth of Lorillard, Inc., the Engle Agreement may affect the payment of dividends by Lorillard, Inc. to us. For a description of the Engle Agreement, please read MD&A under Item 7 and Note 20 of the Notes to Consolidated Financial Statements included in Item 8.

Holders of our common stock and Carolina Group stock are shareholders of one company and, therefore, financial impacts on one group could affect the other group.

Holders of our common stock and holders of Carolina Group stock are all common shareholders of Loews Corporation and are subject to risks associated with an investment in a single company. Financial effects arising from one group that affect our consolidated results of operations or financial condition could, if significant, affect the market price of the class of common shares relating to the other group. In addition, if we or any of our subsidiaries were to incur significant indebtedness on behalf of one group, including indebtedness incurred or assumed in connection with an acquisition or investment, it could affect the credit rating of us and our subsidiaries taken as a whole. This, in turn, could increase our borrowing costs. Net losses of either group and dividends or distributions on shares of any class of common or preferred stock will reduce the funds legally available for payment of future dividends on Carolina Group stock.

The complex nature of the terms of our Carolina Group stock, or confusion in the marketplace about what a tracking stock is, could materially adversely affect the market price of Carolina Group stock.

Tracking stocks like Carolina Group stock are more complex than traditional common stock and are not directly or entirely comparable to common stock of stand-alone companies or companies that have been spun off by their parent companies. The complex nature of the terms of Carolina Group stock, and the potential difficulties investors may have in understanding these terms, may materially adversely affect the market price of Carolina Group stock. Examples of these terms include:
 
 
·
the discretion of our board of directors to make determinations that may affect Carolina Group stock and our common stock differently;

 
·
our redemption and/or exchange rights under particular circumstances; and

 
·
the disparate voting rights of Carolina Group stock and our common stock.
 
Confusion in the marketplace about what a tracking stock is and what it is intended to represent, and/or investors’ reluctance to invest in tracking stocks, could materially adversely affect the market price of Carolina Group stock.

Holders of our common stock and Carolina Group stock generally vote together as a single class.

Holders of Carolina Group stock generally do not have the right to vote separately as a class. Holders of Carolina Group stock have the right to vote as a separate class only to the extent required by Delaware law. We have not held, and do not plan to hold, separate meetings for holders of Carolina Group stock.

27

 
Item 1A. Risk Factors
 


Holders of our common stock will have significantly greater voting power than holders of our Carolina Group stock with respect to any matter as to which all of our common shares vote together as one class.

Each share of our common stock has one vote. Each share of Carolina Group stock is entitled to 3/10 of a vote, which is disproportionately less than the economic interest represented by each share of Carolina Group stock. When a vote is taken on any matter as to which all of our common shares are voting together as one class, holders of our common stock will have significantly greater voting power than holders of Carolina Group stock. As of February 9, 2007, holders of our common stock controlled approximately 94.4% of our combined voting power and holders of Carolina Group stock controlled approximately 5.6% of our combined voting power. The voting power of Carolina Group stock is subject to adjustment for stock splits, stock dividends and combinations with respect to either class of stock.

Holders of our Carolina Group stock may have interests different from holders of our common stock.

The existence of separate classes of our common stock could give rise to occasions when the interests of the holders of our common stock and Carolina Group stock diverge or conflict or appear to diverge or conflict. Subject to its fiduciary duties, our board of directors could, in its sole discretion, from time to time, make determinations or implement policies that disproportionately affect the groups or the different classes of stock. Our board of directors is not required to select the option that would result in the highest value for the holders of Carolina Group stock. Examples include determinations by our board of directors to:

 
·
pay or omit the payment of dividends on our common stock or Carolina Group stock;

 
·
redeem shares of Carolina Group stock;

 
·
approve dispositions of our assets attributed to either group;

 
·
reallocate funds or assets between groups and determine the amount and type of consideration paid therefore;

 
·
allocate business opportunities, resources and personnel;

 
·
allocate the proceeds of issuances of Carolina Group stock either to the Loews Group, with a corresponding reduction in the intergroup interest, if and to the extent there is an intergroup interest, or to the combined attributed net assets of the Carolina Group;

 
·
formulate public policy positions for us;

 
·
establish relationships between the groups;

 
·
make financial decisions with respect to one group that could be considered to be detrimental to the other group; and

 
·
settle or otherwise seek to resolve actual or potential litigation against us in ways that might adversely affect Lorillard.
 
Any such decisions by our board of directors could have or be perceived to have a negative effect on the Carolina Group and could have a negative effect on the market price of Carolina Group stock.

If our Carolina Group stock is not treated as a class of our common stock, several adverse federal income tax consequences will result.

It is possible that the issuance of Carolina Group stock could be characterized as property other than our stock for U.S. federal income tax purposes. Such characterization could require us to recognize taxable gain with respect to the issuance of Carolina Group stock and the Carolina Group would be responsible for any tax liability attributable thereto. In addition, we would likely no longer be able to file a consolidated U.S. federal income tax return with the Carolina Group. These tax liabilities, if they arise, would likely have a material adverse effect on us and the Carolina Group.

28

 
Item 1A. Risk Factors
 


Changes in the tax law or in the interpretation of current tax law may result in redemption of the Carolina Group stock or cessation of the issuance of shares of Carolina Group stock.

If there are adverse tax consequences to us or the Carolina Group resulting from the issuance of Carolina Group stock, it is possible that we would not issue shares of Carolina Group stock even if we would otherwise choose to do so. This possibility could affect the value of Carolina Group stock then outstanding. Furthermore, we are entitled to redeem Carolina Group stock for either (1) cash in an amount equal to 105% of the average market price per share of Carolina Group stock or (2) our common stock having a value equal to 100% of the ratio of the average market price per share of Carolina Group stock to the average market price per share of our common stock, if, based upon the opinion of tax counsel, there are adverse federal income tax law developments related to Carolina Group stock. In each case, the average market price would be determined over a specified 20 trading day period.

Our board of directors may, at any time until the 90th day after the disposition of 80% of the assets attributed to the Carolina Group, redeem shares of our Carolina Group stock.

Our board of directors may, at any time until the 90th day after the disposition of 80% of the assets attributed to the Carolina Group, redeem all outstanding shares of Carolina Group stock for either (1) cash in an amount equal to 120% of the average market price per share of Carolina Group stock or (2) our common stock having a value equal to 115% of the ratio of the average market price per share of Carolina Group stock to the average market price per share of our common stock. In each case, the average market price would be determined over a specific 20 trading day period. A decision to redeem the Carolina Group stock could be made at a time when either or both of our common stock and Carolina Group stock may be considered to be overvalued or undervalued. In addition, a redemption would preclude holders of Carolina Group stock from retaining their investment in a security intended to reflect separately the economic performance of the Carolina Group. It would also give holders of shares of converted Carolina Group stock an amount of consideration that may be less than the amount of consideration a third-party buyer pays or would pay for all or substantially all of the net assets attributed to the Carolina Group.

If we choose to redeem our Carolina Group stock for cash, holders of Carolina Group stock may have taxable gain or taxable income.

We may, under certain circumstances, redeem Carolina Group stock for cash. If we choose to do so, holders of Carolina Group stock would generally be subject to tax on the excess, if any, of the total consideration they receive for their Carolina Group stock over their adjusted basis in their Carolina Group stock.

Our board of directors does not owe a separate duty to holders of Carolina Group stock.

Principles of Delaware law established in cases involving differing treatment of two classes of capital stock or two groups of holders of the same class of capital stock provide that a board of directors owes an equal duty to all shareholders regardless of class or series, and does not have separate or additional duties to either group of shareholders. Thus, holders of Carolina Group stock who believe that a determination by our board of directors has a disparate impact on their class of stock may not be able to obtain a remedy for such a claim.

Our board of directors may change the Carolina Group policy statement without shareholder approval.

In connection with the initial issuance of Carolina Group stock, our board of directors adopted the Carolina Group policy statement to govern the relationship between the Loews Group and the Carolina Group. Our board of directors may modify, suspend or rescind the policies set forth in the Carolina Group policy statement or make additions or exceptions to them, in the sole discretion of our board of directors, without approval of our shareholders. Our board of directors may also adopt additional policies, depending upon the circumstances. Any changes to our policies could have a negative effect on the holders of Carolina Group stock.

Our directors’ and officers’ disproportionate ownership of our common stock compared to our Carolina Group stock may give rise to conflicts of interest.

Our directors and officers own shares of our common stock and have been awarded stock options with respect to shares of our common stock. As of February 9, 2007 our directors and executive officers beneficially owned
 
29

 
Item 1A. Risk Factors
 
 
 
approximately 38.2 million shares of our common stock and no shares of Carolina Group stock, which represents approximately 6.6% of our combined voting power. Accordingly, our directors and officers could have an economic incentive to favor the Loews Group over the Carolina Group.
 
Because it is possible for an acquiror to obtain control of us by purchasing shares of our common stock without purchasing any shares of our Carolina Group stock, holders of Carolina Group stock may not share in any takeover premium.

Because holders of our common stock have significantly greater voting power than holders of Carolina Group stock, a potential acquiror could acquire control of us by acquiring shares of our common stock without purchasing any shares of Carolina Group stock. As a result, holders of Carolina Group stock might not share in any takeover premium and Carolina Group stock may have a lower market price than it would have if there were a greater likelihood that holders of Carolina Group stock would share in any takeover premium.

Holders of our Carolina Group stock may receive less consideration upon a sale of the assets attributed to the Carolina Group than if the Carolina Group were a separate company.

Assuming the assets attributed to the Carolina Group represent less than substantially all of our assets as a whole, our board of directors could, in its sole discretion and without shareholder approval, approve sales and other dispositions of any amount of our assets attributed to the Carolina Group because the Delaware General Corporation Law requires shareholder approval only for a sale or other disposition of all or substantially all of the assets of the entire company. Similarly, the boards of directors of Lorillard, Inc. or its subsidiaries could decide to sell or otherwise dispose of the operating and other assets reflected in the financial statements of the Carolina Group without the approval of holders of Carolina Group stock.

If 80% or more of the assets attributed to the Carolina Group are sold, we may take one of the following actions, and if we receive any net proceeds from the sale and determine not to retain all of such proceeds as tobacco contingency reserves, we must take one of the following actions:

 
·
pay a special dividend to holders of Carolina Group stock in an amount equal to their pro rata share of the net proceeds (subject to reduction for repayment of notional debt, amounts not distributed from Lorillard to us and the creation by us of reserves for tobacco-related contingent liabilities and future costs) from the disposition in the form of cash and/or securities (other than our common stock);

 
·
redeem shares of Carolina Group stock for cash and/or securities (other than our common stock) in an amount equal to the pro rata share of the net proceeds (subject to reduction for repayment of notional debt) from the disposition of all of the assets attributable to the Carolina Group;

 
·
redeem shares of Carolina Group stock for shares of our common stock at a 15% premium based on the respective market values of Carolina Group stock and our common stock during the 20 consecutive trading days ending on the 5th trading day prior to announcement of the sale; or

 
·
take some combination of the actions described above.
 
Our board of directors has the discretion to choose from the foregoing options. The value of the consideration paid to holders of Carolina Group stock in the different scenarios described above could be significantly different. Our board of directors would not be required to select the option that would result in the distribution with the highest value to the holders of Carolina Group stock.

If, on the 91st day following the sale of 80% or more of the assets attributed to the Carolina Group, we have not redeemed all of the outstanding shares of Carolina Group stock and Lorillard subsequently distributes to us any previously undistributed portion of the net proceeds and/or we subsequently release any amount of net proceeds previously retained by us as a reserve for tobacco-related contingent liabilities or future costs, we will distribute the pro rata share of such amounts to holders of Carolina Group stock. At any time after:

 
·
Lorillard has distributed to us all previously undistributed portions of the net proceeds;

30

 
Item 1A. Risk Factors
 


 
·
no amounts remain in reserve in respect of tobacco-related contingent liabilities and future costs; and

 
·
the only asset remaining in the Carolina Group is cash and/or cash equivalents,

then we may redeem all of the outstanding shares of Carolina Group stock for cash in an amount equal to the greater of (1) the pro rata share of the remaining assets of the Carolina Group and (2) $0.001 per share of Carolina Group stock.

If the Carolina Group were a separate, independent company and its shares were acquired by another person, some of the costs of that sale, including corporate level taxes, might not be payable in connection with that acquisition. As a result, shareholders of a separate, independent company might receive an amount greater than the net proceeds that would be received by the holders of Carolina Group stock. In addition, we cannot assure that the net proceeds per share of Carolina Group stock received by its holder in connection with any redemption following a sale of Carolina Group assets will be equal to or greater than the market value per share of Carolina Group stock prior to or after announcement of a sale of assets reflected in the Carolina Group. Nor can we assure that, where consideration is based on the market value of Carolina Group stock, the market value will be equal to or greater than the net proceeds per share of Carolina Group stock.

We may cause a mandatory exchange of our Carolina Group stock.

We may exchange all outstanding shares of Carolina Group stock for shares of one or more of our qualifying subsidiaries. Such an exchange would result in the qualifying subsidiary or subsidiaries becoming a separate public company and the holders of Carolina Group stock owning shares directly in that subsidiary or those subsidiaries. If we choose to exchange shares of Carolina Group stock in this manner, the market value of the common stock received in that exchange could be less than the market value of Carolina Group stock exchanged.

If we are liquidated, amounts distributed to holders of our Carolina Group stock may not reflect the value of the assets attributed to the Carolina Group.

In the event we are liquidated, we would determine the liquidation rights of the holders of Carolina Group stock in accordance with the market capitalization of the outstanding shares of the Loews Group and the Carolina Group at a specified time prior to the time of liquidation. However, the relative market capitalization of the outstanding shares of each group may not correctly reflect the value of the net assets remaining and attributed to the groups after satisfaction of outstanding liabilities. Accordingly, the holders of Carolina Group stock could receive less consideration upon liquidation than they would if the groups were separate entities.

Risks Related to Us and Our Subsidiary, CNA Financial Corporation

If CNA determines that loss reserves are insufficient to cover its estimated ultimate unpaid liability for claims, CNA may need to increase its loss reserves.

CNA maintains loss reserves to cover its estimated ultimate unpaid liability for claims and claim adjustment expenses for reported and unreported claims and for future policy benefits. Reserves represent CNA management’s best estimate at a given point in time. Insurance reserves are not an exact calculation of liability but instead are complex estimates derived by CNA, generally utilizing a variety of reserve estimation techniques, from numerous assumptions and expectations about future events, many of which are highly uncertain, such as estimates of claims severity, frequency of claims, mortality, morbidity, expected interest rates, inflation, claims handling and case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time of its ultimate settlement. Many of these uncertainties are not precisely quantifiable and require significant management judgment. As trends in underlying claims develop, particularly in so-called “long tail” or long duration coverages, CNA is sometimes required to add to our reserves. This is called unfavorable development and results in a charge to our earnings in the amount of the added reserves, recorded in the period the change in estimate is made. These charges can be substantial and can have a material adverse effect on our results of operations and equity. Please read additional information on CNA’s reserves included in MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

31

 
Item 1A. Risk Factors
 


CNA is subject to uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social, and other environmental conditions change. These issues have had, and may continue to have, a negative effect on CNA’s business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims, resulting in further increases in CNA’s reserves which can have a material adverse effect on our results of operations and equity. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict. Examples of emerging or potential claims and coverage issues include:

 
·
increases in the number and size of claims relating to injuries from medical products;

 
·
the effects of accounting and financial reporting scandals and other major corporate governance failures, which have resulted in an increase in the number and size of claims, including director and officer and errors and omissions insurance claims;

 
·
class action litigation relating to claims handling and other practices;

 
·
construction defect claims, including claims for a broad range of additional insured endorsements on policies;

 
·
clergy abuse claims, including passage of legislation to reopen or extend various statutes of limitations; and

 
·
mass tort claims, including bodily injury claims related to silica, welding rods, benzene, lead and various other chemical exposure claims.

In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, CNA reviews and changes its reserve estimates in a regular and ongoing process as experience develops and further claims are reported and settled. In addition, CNA periodically undergoes state regulatory financial examinations, including review and analysis of its reserves. If estimated reserves are insufficient for any reason, the required increase in reserves would be recorded as a charge against CNA’s earnings for the period in which reserves are determined to be insufficient. These charges can be substantial and can materially adversely affect our results of operations and equity.

Loss reserves for asbestos, environmental pollution and mass torts are especially difficult to estimate and may result in more frequent and larger additions to these reserves.

CNA’s experience has been that establishing reserves for casualty coverages relating to APMT claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims. Estimating the ultimate cost of both reported and unreported asbestos, environmental pollution and mass tort claims is subject to a higher degree of variability due to a number of additional factors, including among others:

 
·
coverage issues, including whether certain costs are covered under the policies and whether policy limits apply;

 
·
inconsistent court decisions and developing legal theories;

 
·
increasingly aggressive tactics of plaintiffs’ lawyers;

 
·
the risks and lack of predictability inherent in major litigation;

 
·
changes in the volume of asbestos, environmental pollution and mass tort claims which cannot now be anticipated;

 
·
continued increases in mass tort claims relating to silica and silica-containing products;

 
·
the impact of the exhaustion of primary limits and the resulting increase in claims on any umbrella or excess policies CNA has issued;

 
·
the number and outcome of direct actions against CNA;

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Item 1A. Risk Factors
 


 
·
CNA’s ability to recover reinsurance for these claims; and

 
·
changes in the legal and legislative environment in which CNA operates.

As a result of this higher degree of variability, CNA has necessarily supplemented traditional actuarial methods and techniques with additional estimating techniques and methodologies, many of which involve significant judgment on the part of management. Consequently, CNA may periodically need to record changes in its claim and claim adjustment expense reserves in the future in these areas in amounts that may be material. The sections below provide more details involving the specific factors affecting CNA’s estimation of reserves for casualty coverages relating to environmental pollution and asbestos. Please read information on APMT included in MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

Environmental pollution claims.  The estimation of reserves for environmental pollution claims is complicated by the assertion by many policyholders of claims for defense costs and indemnification. CNA and others in the insurance industry are disputing coverage for many such claims. Key coverage issues in these claims include:

 
·
whether cleanup costs are considered damages under the policies (and accordingly whether CNA would be liable for these costs);

 
·
the trigger of coverage, and the allocation of liability among triggered policies;

 
·
the 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, thus adding to the uncertainty of the outcome of many of these claims.

Further, the scope of federal and state statutes and regulations determining liability and insurance coverage for environmental pollution liabilities have been the subject of extensive litigation. In many cases, courts have expanded the scope of coverage and liability for cleanup costs beyond the original intent of CNA’s insurance policies. In addition, the standards for cleanup in environmental pollution matters are unclear, the number of sites potentially subject to cleanup under applicable laws is unknown and the impact of various proposals to reform existing statutes and regulations is difficult to predict.

Asbestos claims. The estimation of reserves for asbestos claims is particularly difficult for many of the same reasons discussed above for environmental pollution claims, as well as:

 
·
inconsistency of court decisions and jury attitudes, as well as future court decisions;

 
·
specific policy provisions;

 
·
allocation of liability among insurers and insureds;

 
·
missing policies and proof of coverage;

 
·
the proliferation of bankruptcy proceedings and attendant uncertainties;

 
·
novel theories asserted by policyholders and their legal counsel;

 
·
the targeting of a broader range of businesses and entities as defendants;

33

 
Item 1A. Risk Factors
 


 
·
uncertainties in predicting the number of future claims and which other insureds may be targeted in the future;

 
·
volatility in claim numbers and settlement demands;

 
·
increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims;

 
·
the efforts by insureds to obtain coverage that is not subject to aggregate limits;

 
·
the long latency period between asbestos exposure and disease manifestation, as well as the resulting potential for involvement of multiple policy periods for individual claims;

 
·
medical inflation trends;

 
·
the mix of asbestos-related diseases presented; and

 
·
the ability to recover reinsurance.

In addition, a number of CNA’s insureds have asserted that their claims against CNA for insurance are not subject to aggregate limits on coverage. If these insureds are successful in this regard, CNA’s potential liability for their claims would be unlimited. Some of these insureds contend that their asbestos claims fall within the so-called “non-products” liability coverage within their policies, rather than the products liability coverage, and that this “non-products” liability coverage is not subject to any aggregate limit. It is difficult to predict the extent to which these claims will succeed and, as a result, the ultimate size of these claims.

Catastrophe losses are unpredictable.

Catastrophe losses are an inevitable part of CNA’s business. Various events can cause catastrophe losses, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather and fires, and their frequency and severity are inherently unpredictable. In addition, longer-term natural catastrophe trends may be changing and new types of catastrophe losses may be developing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain, and snow. For example, in 2005, CNA experienced substantial losses from Hurricanes Katrina, Rita and Wilma and in 2004, CNA experienced substantial losses from Hurricanes Charley, Frances, Ivan and Jeanne. The extent of CNA’s losses from catastrophes is a function of both the total amount of its insured exposures in the affected areas and the severity of the events themselves. In addition, as in the case of catastrophe losses generally, it can take a long time for the ultimate cost to CNA to be finally determined. As its claim experience develops on a particular catastrophe, CNA may be required to adjust reserves, or take additional unfavorable development, to reflect its revised estimates of the total cost of claims. CNA believes that it could incur significant catastrophe losses in the future. Please read information on catastrophe losses included in the MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

CNA’s key assumptions used to determine reserves and deferred acquisition costs for its long term care product offerings could vary significantly.

CNA’s reserves and deferred acquisition costs for its long term care product offerings are based on certain key assumptions including morbidity, which is the frequency and severity of illness, sickness and diseases contracted, policy persistency, which is the percentage of policies remaining in force, interest rates, and/or future health care cost trends. If actual experience differs from these assumptions, the deferred acquisition costs may not be fully recovered and the reserves may not be adequate, requiring CNA to add to reserves, or take unfavorable development.

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High levels of retained overhead expenses associated with business lines in run-off negatively impact CNA’s operating results.

During the past few years, CNA ceased offering certain insurance products relating principally to its life, group and reinsurance segments. Many of these business lines were sold, others have been placed in run-off and, as a result, revenue will progressively decrease. CNA’s results of operations have been materially, adversely affected by the high levels of retained overhead expenses associated with these run-off operations, and will continue to be so affected if CNA is not successful in eliminating or reducing these costs.

CNA’s premium writings and profitability are affected by the availability and cost of reinsurance.

CNA purchases reinsurance to help manage its exposure to risk. Under CNA’s reinsurance arrangements, another insurer assumes a specified portion of CNA’s claim and claim adjustment expenses in exchange for a specified portion of policy premiums. Market conditions determine the availability and cost of the reinsurance protection CNA purchases, which affects the level of CNA’s business and profitability, as well as the level and types of risk CNA retains. If CNA is unable to obtain sufficient reinsurance at a cost CNA deems acceptable, CNA may be unwilling to bear the increased risk and would reduce the level of CNA’s underwriting commitments. Please read information on Reinsurance included in MD&A under Item 7 and Note 18 of the Notes to Consolidated Financial Statements included under Item 8.

CNA may not be able to collect amounts owed to it by reinsurers.

CNA has significant amounts recoverable from reinsurers which are reported as receivables in the balance sheets and estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves. The ceding of insurance does not, however, discharge CNA’s primary liability for claims. As a result, CNA is subject to credit risk relating to its ability to recover amounts due from reinsurers. Certain of CNA’s reinsurance carriers have experienced deteriorating financial conditions or have been downgraded by rating agencies. In addition, reinsurers could dispute amounts which CNA believes are due to it. If CNA is not able to collect the amounts due to it from reinsurers, its claims expenses will be higher. Please read information on reinsurance included in the MD&A under Item 7 and Note 18 of the Notes to Consolidated Financial Statements included under Item 8.

Rating agencies may downgrade their ratings for CNA in the future, and thereby adversely affect CNA’s ability to write insurance at competitive rates or at all.

Ratings are an increasingly important factor in establishing the competitive position of insurance companies. CNA’s insurance company subsidiaries, as well as its public debt, are rated by four major rating agencies, namely, A.M. Best Company, Inc., Standard & Poor’s Rating Services, Moody’s Investors Service, Inc. and Fitch, Inc. Ratings reflect the rating agency’s opinions of an insurance company’s financial strength, capital adequacy, operating performance, strategic position and ability to meet its obligations to policyholders and debtholders. Agency ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating.

Due to the intense competitive environment in which CNA operates, the uncertainty in determining reserves and the potential for CNA to take material unfavorable development in the future, and possible changes in the methodology or criteria applied by the rating agencies, the rating agencies may take action to further lower CNA’s ratings in the future. If CNA’s property and casualty insurance financial strength ratings were downgraded below current levels, its business and results of operations could be materially adversely affected. The severity of the impact on our business is dependent on the level of downgrade and, for certain products, which rating agency takes the rating action. Among the adverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain major insurance brokers, the inability to sell a material volume of our insurance products to certain markets, and the required collateralization of certain future payment obligations or reserves.

In addition, CNA believes that a lowering of our debt ratings by certain of the rating agencies could result in an adverse impact on CNA’s ratings, independent of any change in CNA’s circumstances. CNA has entered into several settlement agreements and assumed reinsurance contracts that require collateralization of future payment obligations and assumed reserves if its ratings or other specific criteria fall below certain thresholds. The ratings triggers are generally
 
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more than one level below CNA’s current ratings. Please read information on our ratings included in the MD&A under Item 7.
 
CNA is subject to capital adequacy requirements and, if it does not meet these requirements, regulatory agencies may restrict or prohibit CNA from operating its business.

Insurance companies such as CNA are subject to risk-based capital standards set by state regulators to help identify companies that merit further regulatory attention. These standards apply specified risk factors to various asset, premium and reserve components of CNA’s statutory capital and surplus reported in CNA’s statutory basis of accounting financial statements. Current rules require companies to maintain statutory capital and surplus at a specified minimum level determined using the risk-based capital formula. If CNA does not meet these minimum requirements, state regulators may restrict or prohibit CNA from operating its business. If CNA is required to record a charge against earnings in connection with a change in estimates or circumstances, CNA may violate these minimum capital adequacy requirements unless it is able to raise sufficient additional capital. Examples of events leading CNA to record a charge against earnings include impairment of its investments or unexpectedly poor claims experience.

CNA’s insurance subsidiaries, upon whom CNA depends for dividends in order to fund its working capital needs, are limited by state regulators in their ability to pay dividends.

CNA Financial Corporation is a holding company and is dependent upon dividends, loans and other sources of cash from its subsidiaries in order to meet its obligations. Dividend payments, however, must be approved by the subsidiaries’ domiciliary state departments of insurance and are generally limited to amounts determined by formula, which varies by state. The formula for the majority of the states is the greater of 10% of the prior year statutory surplus or the prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to the date of payment. Some states, however, have an additional stipulation that dividends cannot exceed the prior year’s earned surplus. If CNA is restricted, by regulatory rule or otherwise, from paying or receiving inter-company dividends, CNA may not be able to fund its working capital needs and debt service requirements from available cash. As a result, CNA would need to look to other sources of capital, which may be more expensive or may not be available at all.

CNA is responding to subpoenas, interrogatories and inquiries relating to insurance brokers and agents, contingent commissions and bidding practices, and certain finite-risk insurance products.

Along with other companies in the industry, CNA has received subpoenas, interrogatories and inquiries from: (i) California, Connecticut, Delaware, Florida, Hawaii, Illinois, Michigan, Minnesota, New Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina, West Virginia and the Canadian Council of Insurance Regulators concerning investigations into practices including contingent compensation arrangements, fictitious quotes, and tying arrangements; (ii) the SEC, the New York State Attorney General, the United States Attorney for the Southern District of New York, the Connecticut Attorney General, the Connecticut Department of Insurance, the Delaware Department of Insurance, the Georgia Office of Insurance and Safety Fire Commissioner and the California Department of Insurance concerning reinsurance products and finite insurance products purchased and sold by CNA; (iii) the Massachusetts Attorney General and the Connecticut Attorney General concerning investigations into anti-competitive practices; and (iv) the New York State Attorney General concerning declinations of attorney malpractice insurance. CNA continues to respond to these subpoenas, interrogatories and inquiries to the extent they are still open.

Subsequent to receipt of the SEC subpoena, CNA produced documents and provided additional information at the SEC’s request. In addition, the SEC and representatives of the United States Attorney’s Office for the Southern District of New York conducted interviews with several of CNA’s current and former executives relating to the restatement of its financial results for 2004, including CNA’s relationship with and accounting for transactions with an affiliate that were the basis for the restatement. The SEC also requested information relating to our restatement in 2006 of prior period results. It is possible that CNA’s analyses of, or accounting treatment for, finite reinsurance contracts or discontinued operations could be questioned or disputed by regulatory authorities. As a result, further restatements of CNA’s financial results are possible.

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CNA’s investment portfolio, which is a key component of its overall profitability, may suffer reduced returns or losses, especially with respect to its equity in various limited partnership net assets which are often subject to greater leverage and volatility.

Investment returns are an important part of CNA’s overall profitability. General economic conditions, stock market conditions, fluctuations in interest rates, and many other factors beyond CNA’s control can adversely affect the returns and the overall value of its equity investments and its ability to control the timing of the realization of investment income. In addition, any defaults in the payments due to CNA for its investments, especially with respect to liquid corporate and municipal bonds, could reduce CNA’s investment income and realized investment gains or could cause CNA to incur investment losses. Further, CNA invests a portion of its assets in equity investments, primarily through limited partnerships, which are subject to greater volatility than its fixed income investments. In some cases, these limited partnerships use leverage and are thereby subject to even greater volatility. Although limited partnership investments generally provide higher expected return, they present greater risk and are more illiquid than CNA’s fixed income investments. As a result of these factors, CNA may not realize an adequate return on its investments, may incur losses on sales of its investments and may be required to write down the value of its investments.

CNA may be adversely affected by the cyclical nature of the property and casualty business.

The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates.

Risks Related to Us and Our Subsidiary, Lorillard, Inc.

Lorillard is a defendant in approximately 2,840 tobacco-related lawsuits, which are extremely costly to defend, and which could result in substantial judgments against Lorillard.

Numerous legal actions, proceedings and claims arising out of the sale, distribution, manufacture, development, advertising, marketing and claimed health effects of cigarettes are pending against Lorillard, and it is likely that similar claims will continue to be filed for the foreseeable future. Settlements and victories by plaintiffs in highly publicized cases against Lorillard and other tobacco companies, together with acknowledgments by Lorillard and other tobacco companies regarding the health effects of smoking, may stimulate further claims. In addition, adverse outcomes in pending cases could have adverse effects on the ability of Lorillard to prevail in smoking and health litigation.

Approximately 2,840 tobacco-related cases are pending against Lorillard in the United States. Punitive damages, often in amounts ranging into the billions of dollars, are specifically pleaded in a number of cases in addition to compensatory and other damages. It is possible that the outcome of these cases, individually or in the aggregate, could result in bankruptcy. It is also possible that Lorillard may be unable to post a surety bond in an amount sufficient to stay execution of a judgment in jurisdictions that require such bond pending an appeal on the merits of the case. Even if Lorillard is successful in defending some or all of these actions, these types of cases are very expensive to defend. A material increase in the number of pending claims could significantly increase defense costs.

Further, adverse decisions in actions against tobacco companies other than Lorillard could have an adverse impact on the industry, including Lorillard. For example, in 2006 the Oregon Supreme Court affirmed the verdict in Williams v. Philip Morris USA, Inc., in which plaintiff was awarded approximately $525,000 in compensatory damages and $79.5 million in punitive damages, a ratio of more than 150:1. The Oregon Supreme Court had determined that the ratio of punitive to compensatory damages was not inconsistent with U.S. Supreme Court precedents in this area. In February of 2007, the U.S. Supreme Court vacated that decision on other grounds and returned Williams to the Oregon Supreme Court for further consideration. Lorillard is not a party to Williams. Please read information included in MD&A under Item 7 and Note 20 of the Notes to Consolidated Financial Statements included in Item 8.

A substantial judgment has been rendered against Lorillard in the Scott litigation.

In June of 2004, the court entered a final judgment in favor of the plaintiffs in Scott v. The American Tobacco Company, et al. (District Court, Orleans Parish, Louisiana, filed May 24, 1996), a class action on behalf of certain cigarette smokers resident in the State of Louisiana. The jury awarded plaintiffs approximately $591.0 million to fund
 
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cessation programs for Louisiana smokers. The court’s final judgment also reflected its award of prejudgment interest. During February of 2007, the Louisiana Court of Appeal issued a ruling that, among other things, reduced the amount of the award by approximately $312.0 million; struck the award of prejudgment interest, which totaled approximately $440.0 million as of December 31, 2006; and ruled that the only class members who are eligible to participate in the smoking cessation program are those who began smoking by September 1, 1988, and whose claims accrued by September 1, 1988. The Louisiana Court of Appeal has returned the case to the trial court for further proceedings. Lorillard’s share of any judgment has not been determined. It is possible that the parties will seek further review of this decision. For additional information on the Scott case, please read Note 20 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
 
The verdict returned in the federal government’s reimbursement case, while not final, could impose significant financial burdens on Lorillard and adversely affect future sales and profits.

During August of 2006, a final judgment and remedial order was entered in United States of America v. Philip Morris USA, Inc., et al. (U.S. District Court, District of Columbia, filed September 22, 1999). Lorillard is one of the defendants in the case. Although the verdict did not award monetary damages to the plaintiff, the final judgment and remedial order granted equitable relief and imposes a number of requirements on the defendants. Such requirements include, but are not limited to, corrective statements by defendants related to the health effects of smoking. The remedial order also would place certain prohibitions on the manner in which defendants market their cigarette products and would eliminate any use of “lights” or similar product descriptors. It is likely that the remedial order, including the prohibitions on the use of the descriptors relating to low tar cigarettes, will negatively affect Lorillard’s future sales and profits. Defendants, including Lorillard, have noticed appeals from the final judgment and the remedial order. Plaintiff also has noticed an appeal from the final judgment. Defendants have received a stay of the judgment and remedial order from the District of Columbia Court of Appeal that will remain in effect while the appeal is proceeding. As a result of the government’s appeal, it is possible that certain of the government’s claims or damages could be reinstated. While trial was underway, the District of Columbia Court of Appeals ruled that plaintiff may not seek disgorgement of profits, but this appeal was interlocutory in nature and could be reconsidered in the present appeal. Prior to trial, the government had estimated that it was entitled to approximately $280.0 billion from the defendants for its disgorgement of profits claim. In addition, the government sought during trial more than $10.0 billion for the creation of nationwide smoking cessation, public education and counter-marketing programs. In its 2006 verdict, the trial court declined to award such relief. It is possible that these claims could be reinstated on appeal. Please read Note 20 of the Notes to Consolidated Financial Statements included in Item 8 of this Report for detailed information regarding tobacco litigation.

Lorillard is a defendant in a case that has been certified as a nationwide class action and that could result in a substantial verdict.

Schwab v. Philip Morris USA, Inc., et al. (U.S. District Court, Eastern District, New York, filed May 11, 2004), has been certified by a federal judge as a nationwide class action on behalf of individuals who purchased “lights” cigarettes. Plaintiffs’ claims in Schwab are based on defendants’ alleged RICO violations in the manufacture, marketing and sale of “lights” cigarettes. Plaintiffs have estimated damages to the class to be in the hundreds of billions of dollars. Any damages awarded to the plaintiffs based on defendants’ violation of the RICO statute would be trebled. The federal court of appeals has agreed to review the class certification order, and it has stayed all activity before the trial court until the appeal is concluded. Please read Note 20 of the Notes to Consolidated Financial Statements included in Item 8 of this Report for detailed information regarding tobacco litigation.

The Florida Supreme Court’s approval of an order vacating a $16.3 billion judgment against Lorillard in the Engle litigation is not final.

Engle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida, filed May 5, 1994) was certified as a class action on behalf of Florida residents, and survivors of Florida residents, who were injured or died from medical conditions allegedly caused by addiction to cigarettes. During 2000, a jury awarded the certified class approximately $16.3 billion in punitive damages against Lorillard. This award was part of a verdict against other major tobacco companies that totaled $145.0 billion in punitive damages. The verdict bears interest at the rate of 10.0% per year. During 2006, the Florida Supreme Court affirmed the 2003 holding of an intermediate appellate court that the $145.0 billion punitive damages award must be vacated. The Florida Supreme Court also determined that the case could not
 
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