================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------- -------------
Commission file number 1-6541
------
LOEWS CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-2646102
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087
----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(212) 521-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------- ---------
Class Outstanding at November 7, 1997
- -------------------------- -------------------------------
Common stock, $1 par value 115,000,000 shares
================================================================================
Page 1
INDEX
Part I. Financial Information Page No.
--------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets--
September 30, 1997 and December 31, 1996 ...................... 3
Consolidated Condensed Statements of Income--
Three and nine months ended September 30, 1997 and 1996 ....... 4
Consolidated Condensed Statements of Cash Flows--
Nine months ended September 30, 1997 and 1996 ................. 5
Notes to Consolidated Condensed Financial Statements ............ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 36
Part II. Other Information
Item 1. Legal Proceedings ......................................... 58
Item 6. Exhibits and Reports on Form 8-K .......................... 58
Page 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
--------------------
<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
- --------------------------------------------------------------------------------
(Amounts in millions of dollars) September 30, December 31,
1997 1996
-----------------------------
<S> <C> <C>
Assets:
Investments:
Fixed maturities, amortized cost of $29,206.6
and $29,319.3 ................................ $29,583.5 $29,478.3
Equity securities, cost of $1,065.6 and $981.8 1,179.7 1,136.3
Other investments ............................. 1,023.2 997.9
Short-term investments ........................ 10,311.9 8,304.9
-----------------------------
Total investments .......................... 42,098.3 39,917.4
Cash ............................................ 409.2 305.7
Receivables-net ................................. 13,831.5 13,427.1
Property, plant and equipment-net ............... 2,492.9 2,225.1
Deferred income taxes ........................... 928.2 1,138.0
Goodwill and other intangible assets-net ........ 708.5 562.4
Other assets .................................... 1,817.5 1,697.2
Deferred policy acquisition costs of insurance
subsidiaries ................................... 2,223.5 1,854.2
Separate Account business ....................... 6,012.1 6,120.9
-----------------------------
Total assets ............................... $70,521.7 $67,248.0
=============================
Liabilities and Shareholders' Equity:
Insurance reserves and claims ................... $40,630.7 $39,980.1
Accounts payable and accrued liabilities ........ 1,963.1 3,110.9
Payable for securities purchased ................ 1,907.7 966.4
Securities sold under repurchase agreements ..... 1,176.0 548.3
Long-term debt, less unamortized discount ....... 5,727.1 4,370.7
Deferred credits and participating policyholders'
equity ......................................... 1,537.4 1,538.6
Separate Account business ....................... 6,012.1 6,120.9
-----------------------------
Total liabilities .......................... 58,954.1 56,635.9
Minority interest ............................... 2,266.0 1,880.9
Shareholders' equity ............................ 9,301.6 8,731.2
-----------------------------
Total liabilities and shareholders' equity . $70,521.7 $67,248.0
=============================
See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>
Page 3
<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Income
- -------------------------------------------------------------------------------------------------
(Amounts in millions, except per share data) Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
---------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Insurance premiums:
Property and casualty ................. $2,488.8 $2,592.8 $ 7,488.7 $ 7,579.2
Life .................................. 846.3 841.3 2,538.8 2,466.3
Investment income, net of expenses ...... 583.7 591.3 1,803.5 1,826.8
Investment gains (losses) ............... 1.5 166.4 (265.1) 656.6
Manufactured products (including excise
taxes of $131.8, $125.5, $366.2 and
$356.8) ................................ 674.8 620.9 1,841.4 1,730.1
Other ................................... 516.3 403.6 1,392.3 1,046.4
--------------------------------------------------
Total ................................ 5,111.4 5,216.3 14,799.6 15,305.4
--------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits ............................... 2,854.5 2,839.6 8,607.0 8,400.9
Amortization of deferred policy
acquisition costs ...................... 621.3 511.5 1,737.5 1,568.5
Cost of manufactured products sold ...... 272.0 260.7 770.1 742.6
Selling, operating, advertising and
administrative expenses ................ 859.3 882.8 2,401.4 2,406.2
Interest ................................ 88.3 79.7 239.4 240.3
--------------------------------------------------
Total ................................ 4,695.4 4,574.3 13,755.4 13,358.5
--------------------------------------------------
416.0 642.0 1,044.2 1,946.9
--------------------------------------------------
Income taxes ............................ 134.3 194.6 330.4 639.7
Minority interest ....................... 84.1 58.8 213.1 171.1
--------------------------------------------------
Total ................................ 218.4 253.4 543.5 810.8
--------------------------------------------------
Net income ................................ $ 197.6 $ 388.6 $ 500.7 $ 1,136.1
==================================================
Net income per share ...................... $ 1.72 $ 3.37 $ 4.35 $ 9.75
==================================================
Cash dividends per share .................. $ .25 $ .25 $ .75 $ .75
==================================================
Weighted average number of shares
outstanding .............................. 115.0 115.2 115.0 116.5
==================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>
Page 4
<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
- --------------------------------------------------------------------------------
(Amounts in millions) Nine Months Ended September 30,
1997 1996
-------------------------------
<S> <C> <C>
Operating Activities:
Net income ................................... $ 500.7 $ 1,136.1
Adjustments to reconcile net income to net
cash provided by operating activities-net ... 784.2 (126.3)
Changes in assets and liabilities-net:
Reinsurance receivable ..................... 498.6 (104.2)
Other receivables .......................... (486.5) (859.7)
Deferred policy acquisition costs .......... (369.3) (284.5)
Insurance reserves and claims .............. 662.2 292.6
Accounts payable and accrued liabilities ... (1,146.7) 597.4
Trading securities ......................... (598.6) (53.5)
Other-net .................................. (95.2) (327.6)
---------------------------
(250.6) 270.3
---------------------------
Investing Activities:
Purchases of fixed maturities ................ (30,956.4) (24,783.0)
Proceeds from sales of fixed maturities ...... 30,131.3 25,758.4
Proceeds from maturities of fixed maturities . 1,667.8 1,657.9
Change in securities sold under repurchase
agreements .................................. 627.7 (171.6)
Purchases of equity securities ............... (854.2) (513.1)
Proceeds from sales of equity securities ..... 937.5 649.9
Change in short-term investments ............. (1,963.4) (2,158.8)
Purchases of property, plant and equipment ... (533.1) (351.2)
Change in other investments .................. 40.1 297.8
---------------------------
(902.7) 386.3
---------------------------
Financing Activities:
Dividends paid to shareholders ............... (86.3) (87.4)
Purchases of treasury shares ................. (215.7)
Issuance of long-term debt ................... 1,634.1 9.5
Principal payments on long-term debt ......... (206.4) (323.0)
Net change in revolving line of credit ....... (63.0) 55.0
Net change in short-term debt ................ (9.9) (7.7)
Receipts credited to policyholders ........... 6.7 11.6
Withdrawals of policyholder account balances . (18.4) (33.7)
---------------------------
1,256.8 (591.4)
---------------------------
Net change in cash ............................. 103.5 65.2
Cash, beginning of period ...................... 305.7 241.7
---------------------------
Cash, end of period ............................ $ 409.2 $ 306.9
===========================
See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>
Page 5
Loews Corporation and Subsidiaries
Notes to Consolidated Condensed Financial Statements
- --------------------------------------------------------------------------------
(Dollars in millions, except per share data)
1. Reference is made to Notes to Consolidated Financial Statements in the 1996
Annual Report to Shareholders which should be read in conjunction with these
consolidated condensed financial statements.
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 1997.
2. CNA assumes and cedes insurance with other insurers and reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, to provide greater
diversification of risk and to minimize exposures on larger risks. The
reinsurance coverages are tailored to the specific risk characteristics of
each product line with CNA's retained amount varying by type of coverage.
Generally, reinsurance coverage for property risks is on an excess of loss,
per risk basis. Liability coverages are generally reinsured on a quota share
basis in excess of CNA's retained risk.
The ceding of insurance does not discharge the primary liability of the
original insurer. CNA places reinsurance with other carriers only after
careful review of the nature of the contract and a thorough assessment of
the reinsurers' credit quality and claim settlement performance. Further,
for carriers that are not authorized reinsurers in its states of domiciles,
CNA receives collateral, primarily in the form of bank letters of credit.
The effects of reinsurance on earned premiums, are as follows:
<TABLE>
<CAPTION>
% %
Direct Assumed Ceded Net Assumed Direct Assumed Ceded Net Assumed
--------------------------------------------------------------------------------------
Nine Months Ended September 30,
--------------------------------------------------------------------------------------
---------------- 1997 -------------------- ---------------- 1996 -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Life ....... $ 648.6 $ 91.9 $ 90.0 $ 650.5 14.1% $ 515.9 $ 87.3 $ 33.1 $ 570.1 15.3%
Accident and
health .... 2,802.5 73.6 115.0 2,761.1 2.7 2,580.3 183.0 112.4 2,650.9 6.9
Property and
casualty .. 6,086.9 1,077.9 548.9 6,615.9 16.3 6,702.2 1,055.5 933.2 6,824.5 15.5
--------------------------------------------------------------------------------------
Total .... $9,538.0 $1,243.4 $ 753.9 $10,027.5 12.4% $9,798.4 $1,325.8 $1,078.7 $10,045.5 13.2%
======================================================================================
<CAPTION>
Three Months Ended September 30,
--------------------------------------------------------------------------------------
---------------- 1997 -------------------- ---------------- 1996 -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Life ....... $ 213.2 $ 31.4 $ 33.3 $ 211.3 14.9% $ 162.0 $ 30.1 $ 17.9 $ 174.2 17.3%
Accident and
health .... 946.4 16.3 49.8 912.9 1.8 921.9 93.6 79.2 936.3 10.0
Property and
casualty .. 1,783.4 517.9 90.4 2,210.9 23.4 2,453.1 52.7 182.2 2,323.6 2.3
--------------------------------------------------------------------------------------
Total .... $2,943.0 $ 565.6 $ 173.5 $ 3,335.1 17.0% $3,537.0 $ 176.4 $ 279.3 $ 3,434.1 5.1%
======================================================================================
</TABLE>
Page 6
Insurance claims and policyholders' benefits are net of reinsurance
recoveries of $223.7, $406.3, $617.7 and $1,010.3 for the three and nine
months ended September 30, 1997 and 1996, respectively.
In the above table, life premium revenue is primarily from long duration
contracts and the property and casualty earned premium is from short
duration contracts. Approximately three quarters of accident and health
earned premiums are from short duration contracts.
3. The Company's receivables are comprised of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---------------------------
<S> <C> <C>
Reinsurance .................................. $ 6,031.4 $ 6,530.0
Other insurance .............................. 6,500.5 5,942.5
Security sales ............................... 713.0 299.7
Accrued investment income .................... 434.7 534.3
Other ........................................ 459.4 412.0
---------------------------
Total ................................. 14,139.0 13,718.5
Less allowance for doubtful accounts and
cash discounts .............................. 307.5 291.4
---------------------------
Receivables-net ....................... $13,831.5 $13,427.1
===========================
</TABLE>
4. On September 16, 1997, the Company issued $1,150.0 principal amount of 3
1/8% Exchangeable Subordinated Notes due 2007 (the "Notes"). The Notes are
exchangeable into shares of common stock of Diamond Offshore Drilling, Inc.
at any time from October 1, 1998 until maturity at an exchange rate of
15.3757 shares per one thousand dollar principal amount of Notes (equivalent
to an exchange price of $65.04 per share). The Company may elect cash
settlement in lieu of delivering Diamond Offshore common stock. The Notes
are redeemable in whole or in part at September 15, 2002 at 101.6%, and
decreasing percentages thereafter.
5. Shareholders' equity:
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
----------------------------
<S> <C> <C>
Preferred stock, $.10 par value,
Authorized--100,000,000 shares
Common stock, $1 par value:
Authorized--400,000,000 shares
Issued and outstanding--115,000,000 shares . $ 115.0 $ 115.0
Additional paid-in capital ................... 165.8 165.8
Earnings retained in the business ............ 8,631.2 8,216.8
Unrealized appreciation ...................... 389.6 233.6
--------------------------
Total ................................. $9,301.6 $8,731.2
==========================
</TABLE>
Page 7
6. Legal Proceedings and Contingent Liabilities-
INSURANCE RELATED
Fibreboard Litigation
---------------------
CNA's primary property and casualty subsidiary, Continental Casualty Company
("Casualty"), has been party to litigation with Fibreboard Corporation
("Fibreboard") involving coverage for certain asbestos-related claims and
defense costs (San Francisco Superior Court, Judicial Council Coordination
Proceeding 1072). As described below, Casualty, Fibreboard, another insurer
(Pacific Indemnity, a subsidiary of the Chubb Corporation), and a
negotiating committee of asbestos claimant attorneys (collectively referred
to as "Settling Parties") have reached a Global Settlement (the "Global
Settlement") which is subject to court approval, to resolve all future
asbestos-related bodily injury claims involving Fibreboard.
Casualty, Fibreboard and Pacific Indemnity have also reached an agreement
(the "Trilateral Agreement"), on a settlement to resolve the coverage
litigation and provides funding for Fibreboard's asbestos claims in the
event the Global Settlement does not obtain final court approval.
On July 27, 1995, the United States District Court for the Eastern District
of Texas entered judgment approving the Global Settlement Agreement and the
Trilateral Agreement. As expected, appeals were filed as respects both of
these decisions. On July 25, 1996, a panel of the United States Fifth
Circuit Court of Appeals in New Orleans affirmed the judgment approving the
Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment
approving the Trilateral Agreement by a 3 to 0 vote. Petitions for rehearing
by the panel and suggestions for rehearing by the entire Fifth Circuit Court
of Appeals as respects the decision on the Global Settlement Agreement were
denied. Two petitions for certiorari were filed in the Supreme Court as
respects the Global Settlement Agreement. On June 27, 1997, the Supreme
Court granted these petitions, vacated the Fifth Circuit's judgment as
respects the Global Settlement Agreement, and remanded to the Fifth Circuit
for reconsideration in light of the Supreme Court's decision in Amchem
Products Co. v. Windsor. The Fifth Circuit has not yet rendered a decision
on this remand.
No further appeal was filed with respect to the Trilateral Agreement;
therefore, court approval of the Trilateral Agreement has become final.
Global Settlement - On April 9, 1993, Casualty and Fibreboard entered into
an agreement pursuant to which, among other things, the parties agreed to
use their best efforts to negotiate and finalize a global class action
settlement with asbestos-related bodily injury and death claimants.
On August 27, 1993, the Settling Parties reached an agreement in principle
for an omnibus settlement to resolve all future asbestos-related bodily
injury claims involving Fibreboard. The Global Settlement Agreement was
executed on December 23, 1993. The agreement calls for contribution by
Casualty and Pacific Indemnity of an aggregate of $1,530.0 to a trust fund
for a class of all future asbestos claimants, defined generally as those
persons whose claims against Fibreboard were neither filed nor settled
before August 27, 1993. An additional $10.0 is to be contributed to the fund
by Fibreboard. As indicated above, the Global Settlement approval is
presently before the Fifth Circuit on remand by order of the Supreme Court
vacating the Fifth Circuit's previous decision approving the Global
Settlement. There is limited precedent for settlements which determine the
rights of future claimants to seek relief.
Page 8
Through September 30, 1997, Casualty, Fibreboard and plaintiff attorneys had
reached settlements with respect to approximately 135,620 claims, for an
estimated settlement amount of approximately $1,617.9 plus any applicable
interest. Final court approval of the Trilateral Agreement obligates
Casualty to pay under these settlements. Approximately $1,588.9 including
interest was paid through September 30, 1997, including approximately $590.0
paid in the fourth quarter of 1996 and the first quarter of 1997 as a result
of the Trilateral Agreement becoming final. As described above, such
payments have been partially recovered from Pacific Indemnity. Casualty may
negotiate other agreements for unsettled claims.
Final court approval of the Trilateral Agreement and its implementation has
eliminated any further material exposure with respect to the Fibreboard
matter, and subsequent reserve adjustments, if any, will not materially
affect the results of operations or equity of the Company.
Tobacco Litigation
------------------
CNA's primary property/casualty subsidiaries have been named as defendants
as part of a "direct action" lawsuit, Richard P. Ieyoub v. The American
Tobacco Company, et al., filed by the Attorney General for the State of
Louisiana, in state court, Calcasieu Parish, Louisiana. In that suit, filed
against certain tobacco manufacturers and distributors (the "Tobacco
Defendants") and over 100 insurance companies, the State of Louisiana seeks
to recover medical expenses allegedly incurred by the State as a result of
tobacco-related illnesses.
The original suit was filed on March 13, 1996, against the Tobacco
Defendants only. The insurance companies were added to the suit in March
1997 under a "direct action" statute in Louisiana. Under the direct action
statute, the Louisiana Attorney General is pursuing liability claims against
the Tobacco Defendants and their insurers in the same suit, even though none
of the Tobacco Defendants has made a claim for insurance coverage.
Recently, the United States District Court for the Western District of
Louisiana, Lake Charles Division, granted a petition to remove this
litigation to the federal district court. The district court's decision is
currently on appeal to the United States Fifth Circuit Court of Appeals.
During the pending appeal, all proceedings in state court and in the federal
district court are stayed. Because of the uncertainties inherent in
assessing the risk of liability at this very early stage of the litigation,
management is unable to make a meaningful estimate of the amount or range of
any loss that could result from an unfavorable outcome of the pending
litigation. However, management believes that the ultimate outcome of the
pending litigation should not materially affect the results of operations or
equity of the Company.
Environmental Pollution and Asbestos - Related Claims
-----------------------------------------------------
The CNA property/casualty insurance companies have potential exposures
related to environmental pollution and asbestos-related claims.
Environmental pollution clean-up is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to clean-up. The insurance industry is involved in extensive
litigation regarding coverage issues. Judicial interpretations in many cases
have expanded the scope of coverage and liability beyond the original intent
of the policies.
Page 9
The Comprehensive Environmental Response Compensation and Liability Act of
1980 ("Superfund") and comparable state statutes ("mini-Superfund") govern
the clean-up and restoration of abandoned toxic waste sites and formalize
the concept of legal liability for clean-up and restoration by potentially
responsible parties ("PRP's"). Superfund and the mini-Superfunds
(Environmental Clean-up Laws or "ECLs") establish mechanisms to pay for
clean-up of waste sites if PRP's fail to do so, and to assign liability to
PRP's. The extent of liability to be allocated to a PRP is dependent on a
variety of factors. Further, the number of waste sites subject to clean-up
is unknown. To date, approximately 1,300 clean-up sites have been identified
by the Environmental Protection Agency on its National Priorities List. On
the other hand, the Congressional Budget Office is estimating that there
will be 4,500 National Priority List sites, and other estimates project as
many as 30,000 sites that will require clean-up under ECLs. Very few sites
have been subject to clean-up to date. The extent of clean-up necessary and
the assignment of liability has not been established.
CNA and the insurance industry are disputing coverage for many such claims.
Key coverage issues include whether Superfund response costs are considered
damages under the policies, trigger of coverage, applicability of pollution
exclusions, the potential for joint and several liability and definition of
an occurrence. Similar coverage issues exist for clean-up of waste sites not
covered under Superfund. To date, courts have been inconsistent in their
rulings on these issues.
A number of proposals to reform Superfund have been made by various parties.
Despite Superfund taxing authority having expired at the end of 1995, no
reforms have yet been enacted by Congress. While the current Congress may
address this issue, no predictions can be made as to what legislation, if
any, will result. If there is legislation, and in some circumstances even if
there is no legislation, the federal role in environmental clean-up may be
materially reduced in favor of state action. Substantial changes in the
federal statute or the activity of the EPA may cause states to reconsider
their environmental clean-up statutes and regulations. There can be no
meaningful prediction of the pattern of regulation that would result.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
clean-up, and the standards for clean-up and liability, the ultimate
exposure to CNA for environmental pollution claims cannot be meaningfully
quantified.
Claim and claim expense reserves represent management's estimates of
ultimate liabilities based on currently available facts and case law.
However, in addition to the uncertainties previously discussed, additional
issues related to, among other things, specific policy provisions, multiple
insurers and allocation of liability among insurers, consequences of conduct
by the insured, missing policies and proof of coverage make quantification
of liabilities exceptionally difficult and subject to adjustment based on
new data.
As of September 30, 1997 and December 31, 1996, CNA carried approximately
$824.0 and $907.8, respectively, of claim and claim expense reserves, net of
reinsurance recoverables, for reported and unreported environmental
pollution claims. The reserves relate to claims for accident years 1988 and
prior, which coincides with CNA's adoption of the Simplified Commercial
General Liability coverage form which included an absolute pollution
exclusion. There was no unfavorable reserve development for the nine months
ended September 30, 1997 and 1996.
CNA has exposure to asbestos-related claims, including those attributable to
Page 10
the Fibreboard claim (see discussion above). Estimation of asbestos-related
claim reserves encounter many of the same limitations discussed above for
environmental pollution claims such as inconsistency of court decisions,
specific policy provisions, multiple insurers and allocation of liability
among insurers, missing policies and proof of coverage.
As of September 30, 1997 and December 31, 1996, CNA carried approximately
$1,415.0 and $1,506.2, respectively, of claim and claim expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-
related claims. Unfavorable reserve development for the nine months ended
September 30, 1997 and 1996 totaled $40.0 and $38.0, respectively.
The following table provides additional data related to CNA's environmental
pollution and asbestos-related claims reserves.
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
----------------------------------------------------
Environmental Environmental
Pollution Asbestos Pollution Asbestos
----------------------------------------------------
<S> <C> <C> <C> <C>
Gross reserves:
Reported claims ................... $288.0 $1,431.0 $ 288.9 $1,551.4
Unreported claims ................. 577.0 101.0 714.0 94.0
------------------------------------------------
865.0 1,532.0 1,002.9 1,645.4
Less reinsurance recoverable ........ (41.0) (117.0) (95.1) (139.2)
------------------------------------------------
Net reserves ...................... $824.0 $1,415.0 $ 907.8 $1,506.2
================================================
</TABLE>
The results of operations in future years may continue to be adversely
affected by environmental pollution and asbestos claims and claim expenses.
Management will continue to monitor potential liabilities and make further
adjustments as warranted.
NON-INSURANCE
Tobacco Litigation
------------------
Lawsuits are being filed with increasing frequency against Lorillard and
other manufacturers of tobacco products seeking damages for cancer and other
health effects claimed to have resulted from an individual's use of
cigarettes, "addiction" to smoking, or exposure to environmental tobacco
smoke. Tobacco litigation includes claims brought by individual plaintiffs
("Conventional Product Liability Cases"); claims brought as class actions on
behalf of a large number of individuals ("Class Actions") for damages
allegedly caused by smoking; claims brought on behalf of governmental
entities and others, including private citizens suing on behalf of
taxpayers, labor unions and Indian Tribes, seeking, among other alleged
damages, reimbursement of health care costs allegedly incurred as a result
of smoking ("Reimbursement Cases"); and claims for contribution and/or
indemnity of asbestos claims by one asbestos manufacturer. In addition,
claims have been brought against Lorillard seeking damages resulting from
exposure to asbestos fibers which had been incorporated, for a limited
period of time, ending more than forty years ago, into filter material used
in one brand of cigarettes manufactured by Lorillard ("Filter Cases").
There has been a substantial increase in the number of cases filed. For
Page 11
instance, eight suits seeking class certification that name Lorillard and/or
the Company as defendants were filed and served during the last two quarters
of 1996; at least thirty such suits (some of which have not been served)
have been filed during the first three quarters of 1997. Thirteen
reimbursement suits were filed by state or local governmental entities
during the last two quarters of 1996; at least thirty reimbursement suits
have been filed by governmental entities during the first three quarters of
1997 (some of which have not been served) as well as suits by five Indian
Tribes and thirty-one suits by unions, some of which have not been served.
Conventional product liability cases also have been filed with greater
frequency in recent years. During 1994, approximately 30 such suits were
filed and served against U.S. cigarette manufacturers, including Lorillard.
Approximately 140 such suits were filed and served during 1995.
Approximately 340 such suits were filed and served during 1996. During the
first three quarters of 1997, approximately 410 such suits have been filed
and served on the major U.S. cigarette manufacturers, including Lorillard,
and other defendants, including the Company.
In these actions, plaintiffs claim substantial compensatory, statutory and
punitive damages in amounts ranging into the billions of dollars. These
claims are based on a number of legal theories including, among other
things, theories of negligence, fraud, misrepresentation, strict liability,
breach of warranty, enterprise liability, civil conspiracy, intentional
infliction of harm, violation of consumer protection statutes, and failure
to warn of the allegedly harmful and/or addictive nature of tobacco
products. As noted below, some cases are scheduled for trial prior to the
conclusion of the first quarter of 1998.
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 565 cases
filed by individual plaintiffs against manufacturers of tobacco products
pending in the United States federal and state courts in which individuals
allege they or their decedents have been injured due to smoking cigarettes,
due to exposure to environmental tobacco smoke, or due to nicotine
dependence. Lorillard is a defendant in approximately 175 of these cases.
The Company is a defendant in nine of these cases.
Plaintiffs in these cases seek unspecified amounts in compensatory and
punitive damages in many cases, and in other cases damages are stated to
amount to as much as $100.0 in compensatory damages and $600.0 in punitive
damages.
On August 9, 1996 the jury in Carter v. Brown & Williamson Tobacco
Corporation (District Court, Duval County, Florida), returned a verdict in
favor of the plaintiffs and awarded them $0.8 in actual damages. Brown &
Williamson Tobacco Corporation, the only defendant in the case, has
appealed. The trial court has awarded plaintiffs' counsel $1.7 in attorneys'
fees.
On May 5, 1997, the jury in Dana Raulerson, as personal representative of
the estate of Jean Connor, deceased, v. R.J. Reynolds Tobacco Company
(District Court, Duval County, Florida), returned a verdict in favor of the
defendant R.J. Reynolds Tobacco Company. The jury determined that there was
no liability on the part of R.J. Reynolds Tobacco Company in the death of
Jean Connor. Plaintiff did not notice an appeal from the judgment that
ensued from the verdict.
On September 26, 1997, a jury in the case of Gordon v. R.J. Reynolds Tobacco
Company, et al. (Superior Court, Middlesex County, Massachusetts), returned
a special verdict favorable to the defendants, which included Lorillard. The
court entered judgment in favor of the defendants. Trial was held on the
limited issue of the cigarettes smoked by the decedent and the time period
Page 12
in which she smoked them. Plaintiff has filed a motion for new trial, which
is pending.
On October 31, 1997, a jury in the case of Karbiwnyk v. R.J. Reynolds
Tobacco Company (District Court, Duval County, Florida) returned a verdict
in favor of the defendant, R.J. Reynolds Tobacco Company. The jury
determined that there had not been negligence on the part of R.J. Reynolds
Tobacco Company and that the cigarettes manufactured by R.J. Reynolds and
smoked by the plaintiff were not unreasonably dangerous and defective and
were not a legal cause of loss, injury or damage to the plaintiff. The
deadline for plaintiff to seek review of the verdict has not expired.
CLASS ACTIONS - In addition to the foregoing cases, there are 53 purported
class actions pending against cigarette manufacturers, and other defendants,
including the Company. Most of the suits seek class certification on behalf
of residents of the states in which the cases have been filed, although some
suits seek class certification on behalf of residents of multiple states.
All but one of the purported class actions seek class certification on
behalf of individuals who smoked cigarettes or were exposed to environmental
tobacco smoke. One case seeks class certification on behalf of individuals
who have paid insurance premiums to Blue Cross and Blue Shield
organizations.
Theories of liability asserted in the purported class actions include a
broad range of product liability theories, including those based on consumer
protection statutes and fraud and misrepresentation. Plaintiffs seek damages
in each case that range from unspecified amounts to the billions of dollars.
Most plaintiffs seek punitive damages and some seek treble damages.
Plaintiffs in many of the cases seek medical monitoring. Plaintiffs in
several of the purported class actions are represented by a well-funded and
coordinated consortium of over 60 law firms from throughout the United
States. Lorillard is a defendant in 46 of the 53 cases seeking class
certification. Lorillard is a defendant in each purported class action
listed below unless expressly stated to the contrary. The Company is a
defendant in 21 of the purported class actions. Plaintiffs in several of the
twenty-one cases have indicated they plan to submit orders voluntarily
dismissing the Company. Unless otherwise noted, the purported class actions
are in the pre-trial, discovery stage.
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, October 31, 1991). This case is a class action on behalf of flight
attendants claiming injury as a result of exposure to environmental tobacco
smoke in the cabins of the aircraft. Jury selection commenced on June 2,
1997. Trial began on July 14, 1997. On October 10, 1997, the parties
executed a settlement agreement, which has been preliminarily approved on an
interim basis by the court. The settlement agreement requires Lorillard and
three other cigarette manufacturers jointly to pay $300.0 in three annual
installments to create and endow a research institute to study diseases
associated with cigarette smoke. The amount to be paid by Lorillard is to be
based upon each of the four settling defendants' share of the United States
market for the sale of cigarettes. In 1997, Lorillard presently has
approximately 8.8% of the cigarette market in the United States. Based on
this calculation, Lorillard is expected to pay approximately $26.0 of the
proposed settlement amount. The plaintiff class members are permitted to
file individual suits under the settlement agreement. Defendants would
retain all defenses against the individual claims asserted, but assume the
burden of proof for the basic question of whether environmental tobacco
smoke can cause certain diseases. Plaintiffs in these individual suits may
not seek punitive damages for injuries that arose prior to January 15, 1997
which enabled them to be members of the class. The manufacturers agreed not
to assert a statute of limitations defense to any suit filed by a class
Page 13
member if such a suit is filed within one year after final approval of the
settlement by the court. The defendants that executed the settlement
agreement, including Lorillard, agreed to pay fees and expenses of the
attorneys who represented plaintiffs in an amount not to exceed $49.0.
Lorillard's share of this amount is expected to be approximately $4.3. At
this time one class member has filed an objection to the settlement. The
court is expected to schedule a hearing to address this and other issues
relating to the proposed settlement.
Castano v. The American Tobacco Company, et al. (U.S. District Court,
Eastern District, Louisiana, filed March 29, 1994). The U.S. District Court
for the Eastern District of Louisiana granted plaintiffs' motion for class
certification on behalf of U.S. residents who alleged nicotine dependency.
This order subsequently was reversed by the U.S. Court of Appeals for the
Fifth Circuit, and the class action ordered by the District Court was
decertified. The Court of Appeals directed the District Court to dismiss
plaintiffs' class action allegations. The Company is a defendant in the
case.
Granier v. The American Tobacco Company, et al. (U.S. District Court,
Eastern District, Louisiana, filed September 26, 1994).
Harris v. The American Tobacco Company, et al. (U.S. District Court, Middle
District, Pennsylvania, filed March 1, 1996). The Company was a defendant in
the case. The court entered an order on its own motion that dismissed the
class action allegations. The court granted defendants' motions to dismiss
and entered final judgment in their favor.
Engle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County,
Florida, filed May 5, 1994). Class certification has been granted as to
Florida citizens who allege they, or their survivors, have, have had or have
died from diseases and medical conditions caused by smoking cigarettes. The
Florida Supreme Court has denied defendants' appeal. Trial is scheduled to
begin on February 9, 1998.
Norton v. RJR Nabisco Holdings Corporation, et al. (Superior Court, Madison
County, Indiana, filed May 3, 1996). The Company is a defendant in the case.
Richardson v. Philip Morris Incorporated, et al. (Circuit Court, Baltimore
City, Maryland, filed May 24, 1996). The court heard argument on plaintiffs'
motion for class certification on October 14, 1997 and took the issue under
advisement.
Scott v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Louisiana, filed May 24, 1996). The Company is a defendant in the
case. Class certification has been granted by the Circuit Court of Orleans
Parish, Louisiana on behalf of Louisiana citizens who require medical
monitoring. Defendants have removed the case to U.S. District Court, Eastern
District, Louisiana and have asked the federal court to reconsider the state
court's class certification order.
Small v. Lorillard, et al., Hoskins v. R.J. Reynolds, et al., Frosina v.
Philip Morris, et al., Hoberman v. Brown & Williamson, et al., and Zito v.
American Tobacco, et al. (Supreme Court, New York County, New York, filed
June 19, 1996). Small is the only one of these cases to name Lorillard as a
defendant. The court granted plaintiffs' motions for class certification and
certified a class to be comprised of "All residents of the State of New York
who, on or after June 19, 1980, have smoked cigarettes manufactured by the
manufacturing defendants, and who bought those cigarettes in New York."
Trial is scheduled to begin on February 2, 1998, in one of the five cases
listed above. Plaintiffs have not indicated which case will be tried first.
Page 14
Reed v. Philip Morris Incorporated, et al. (Superior Court, District of
Columbia, filed June 21, 1996). The Company is a defendant in the case. The
court denied plaintiff's motion for class certification on August 18, 1997.
Barnes v. The American Tobacco Company, et al. (U.S. District, Eastern
District, Pennsylvania, filed August 8, 1996). The Company is a defendant in
the case. The court denied plaintiffs' initial motion for class
certification. Plaintiffs were permitted to amend their complaint. The
court granted plaintiffs' renewed motion for class certification but
subsequently reversed that order and granted defendants' motion for summary
judgment. Plaintiffs have noticed an appeal from the court's rulings.
Lyons v. The American Tobacco Company, et al. (U.S. District Court, Southern
District, Alabama, filed August 8, 1996).
Chamberlain v. The American Tobacco Company, et al. (U.S. District Court,
Northern District, Ohio, filed August 14, 1996). The Company is a defendant
in the case.
Masepohl v. American Tobacco Company, Inc., et al. (U.S. District Court,
Minnesota, filed September 4, 1996). The Company is a defendant in the case.
Perry v. The American Tobacco Company, et al. (Circuit Court, Coffee County,
Tennessee, filed September 30, 1996). Plaintiffs seek class certification on
behalf of individuals who have paid medical insurance premiums to a Blue
Cross and Blue Shield organization.
Connor v. The American Tobacco Company, et al. (Second Judicial District
Court, Bernalillo County, New Mexico, filed October 10, 1996). The Company
was named as a defendant but has been voluntarily dismissed.
Ruiz v. The American Tobacco Company, et al. (U.S. District Court, Puerto
Rico, filed October 23, 1996). The court heard argument on plaintiffs'
motion for class certification on October 6, 1997 and took the issue under
advisement.
Hansen v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Arkansas, filed November 4, 1996). The Company is a defendant in
the case.
McCune v. American Tobacco Company, et al. (U.S. District Court, West
Virginia, filed January 31, 1997). The Company is a defendant in the case.
Baker v. American Tobacco Company, et al. (Circuit Court, Wayne County,
Michigan, filed February 4, 1997).
Woods (formerly known as Ingle) v. Philip Morris Incorporated, et al. (U.S.
District Court, Southern District, West Virginia, filed February 4, 1997).
Emig v. American Tobacco Company, et al. (U.S. District Court, Kansas, filed
February 6, 1997). The Company is a defendant in the case.
Peterson v. American Tobacco Company, et al. (U.S. District Court, Hawaii,
filed February 6, 1997). The Company is a defendant in the case.
Walls v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Oklahoma, filed February 6, 1997).
Selcer v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Nevada, filed March 3, 1997). The Company is a defendant in the case.
Page 15
Insolia v. Philip Morris Incorporated, et al. (Circuit Court, Rock County,
Wisconsin, filed April 18, 1997).
Geiger v. The American Tobacco Company, et al. (Supreme Court, Queens
County, New York, filed April 30, 1997). Plaintiffs' motion for class
certification was granted on an interim basis on July 24, 1997 and the court
certified a class comprised of New York residents who allege lung cancer or
throat cancer as a result of smoking cigarettes. Defendants have noticed an
appeal from the ruling.
Cole v. The Tobacco Institute, Inc., et al. (U.S. District Court, Eastern
District, Texas, Texarkana Division, filed May 5, 1997).
Clay v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Southern District, Illinois, Benton Division, filed May 22, 1997).
Anderson v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Eastern District, Tennessee, filed May 23, 1997). The Company is a defendant
in the case.
Taylor v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Eastern District, Michigan; filed May 23, 1997).
Lyons v. Brown & Williamson Tobacco Corporation, et al. (United States
District Court, Northern District, Georgia, filed May 27, 1997). The Company
is a defendant in the case.
Cosentino v. Philip Morris Incorporated, et al. (Superior Court, Middlesex
County, New Jersey, filed May 28, 1997). The Company is a defendant in the
case.
Enright v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed May 28, 1997). The Company is a defendant in the
case.
Tepper v. Philip Morris Incorporated, et al. (Superior Court, Bergen County,
New Jersey, filed May 28, 1997). The Company is a defendant in the case.
Langdeau v. The American Tobacco Company, et al. (Tribal Court, Lower Brule
Sioux Tribe, filed June 4, 1997).
Thomas v. American Tobacco Company, Inc., et al. (filed in Circuit Court,
Wayne County, Michigan; removed to U.S. District Court, Eastern District,
Michigan; filed June 6, 1997). The Company was a defendant in the case.
Plaintiff voluntarily dismissed the action on October 8, 1997.
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San
Diego County, California, filed June 10, 1997). The Company is a defendant
in the case.
Lippincott v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed June 13, 1997). The Company is a defendant in the
case.
Brammer v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Southern District, Iowa; filed June 20, 1997). The Company is a defendant in
the case.
Knowles v. The American Tobacco Company, et al. (U.S. District Court,
Eastern District, Louisiana, filed June 30, 1997). The Company is a
defendant in the case.
Page 16
Daley v. American Brands, Inc., et al. (Circuit Court, Cook County,
Illinois, filed July 7, 1997). The Company is a defendant in the case.
Piscitello v. Philip Morris, Incorporated, et al. (Superior Court, Middlesex
County, New Jersey, filed July 28, 1997). The Company is a defendant in the
case. To date, none of the defendants have received service of process.
Azorsky v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Western District, Pennsylvania, filed August 15, 1997).
McCauley v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Northern District, Georgia, filed August 27, 1997).
Nwanze v. Philip Morris Companies Inc., et al. (U.S. District Court,
Southern District, New York, filed on September 29, 1997). The Company is
named as a defendant in the action.
Bush v. Philip Morris Incorporated, et al. (U.S. District Court, Eastern
District, Texas, filed September 10, 1997).
Badillo v. American Tobacco Company, et al. (U.S. District Court, Nevada,
filed October 8, 1997). The Company is named as a defendant in the action.
To date, none of the defendants have received service of process.
Three additional purported pending class actions have been commenced against
other companies and are not pending against either Lorillard or the Company.
Class certification has been denied by the U.S. District Court for the
Western District of Missouri in one of the cases, Smith v. Brown &
Williamson Tobacco Corporation. The other two suits purportedly were filed
due to the Liggett Settlement, discussed below (Fletcher v. Liggett, pending
in Circuit Court, Mobile County, Alabama, and Walker v. Liggett, pending in
U.S. District Court, West Virginia). See "Liggett Settlement." In the case
of Walker v. Liggett, the United States District Court for the Southern
District of West Virginia issued an order on August 5, 1997 that denied
plaintiff's motion for class certification. The August 5, 1997, order also
vacated the court's order of May 15, 1997 that granted preliminary approval
of plaintiff's motion for class certification.
REIMBURSEMENT CASES - In addition to the above, approximately 90 actions are
pending in which governmental entities, private citizens, or other
organizations, including labor unions and Indian Tribes, seek recovery of
funds expended by them to provide health care to individuals with injuries
or other health effects allegedly caused by use of tobacco products or
exposure to cigarette smoke. These cases are based on, among other things,
equitable claims, including indemnity, restitution, unjust enrichment and
public nuisance, and claims based on antitrust laws and state consumer
protection acts. Plaintiffs seek damages in each case that range from
unspecified amounts to the billions of dollars. Most plaintiffs seek
punitive damages and some seek treble damages. Plaintiffs in many of the
cases seek medical monitoring. Lorillard is named as a defendant in all such
actions. The Company is named as a defendant in 17 of them.
State Or Local Governmental Reimbursement Cases - Suits have been filed by
40 states, the Commonwealth of Puerto Rico, the Territory of Guam and the
Republic of The Marshall Islands. Defendants have not received service of
process of one of the cases. Cities, counties or other local governmental
entities have filed eight such suits, all of which have been served. The
Company has been named as a defendant in thirteen cases filed by state or
local governmental entities. Unless otherwise noted, each pending
reimbursement suit is in the pre-trial, discovery stage.
Page 17
Moore v. The American Tobacco Company, et al. (Chancery Court, Jackson
County, Mississippi, filed May 23, 1994). On July 2, 1997, Lorillard and
other defendants entered into a memorandum of understanding with the State
of Mississippi with regard to an agreement in principle to settle this case.
See "Settlements of Reimbursement Cases" below.
McGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha
County, West Virginia, filed September 20, 1994 by the West Virginia
Attorney General and state agencies). The court has granted defendants'
motion to dismiss eleven of the fourteen counts of the complaint and has
held that two of the plaintiffs in the action, the West Virginia Public
Employee Insurance Agency and West Virginia Department of Health and Human
Services, lack standing to sue for personal injuries. Plaintiffs have
noticed an appeal from the ruling. The Company is a defendant in the case.
State of Minnesota, et al. v. Philip Morris Incorporated, et al., (District
Court, Ramsey County, Minnesota, filed August 17, 1994). Blue Cross and Blue
Shield of Minnesota ("Blue Cross") also is plaintiff in the case. The
Minnesota Supreme Court has issued an order ruling that plaintiff Blue Cross
does not have standing to pursue tort claims against the defendants. The
Minnesota Supreme Court's order permits Blue Cross to proceed with its
claims that defendants violated antitrust and consumer protection statutes.
The Minnesota Supreme Court's order permits Blue Cross to pursue its
equitable claims for injunctive relief but bars Blue Cross from pursuing
money damages for the equitable claims. Trial is scheduled to begin on
January 19, 1998.
The State of Florida, et al. v. The American Tobacco Company, et al.
(Circuit Court, Palm Beach County, Florida, filed February 21, 1995). On
August 25, 1997, Lorillard and other defendants entered into a memorandum of
understanding with the State of Florida which settled the State's claims for
monetary damages. See "Settlements of Reimbursement Cases" below.
Commonwealth of Massachusetts v. Philip Morris Inc., et al. (Superior Court,
Middlesex County, Massachusetts, filed December 19, 1995).
Ieyoub v. The American Tobacco Company, et al. (U.S. District Court, Western
District, Louisiana, filed March 13, 1996 by the Louisiana Attorney
General). The Company is a defendant in the case.
The State of Texas v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, Texas, filed March 28, 1996). The court granted in
part defendants' motions to dismiss plaintiff's claims for violation of
federal and state anti-trust laws, claims for violation of the Texas
Deceptive Trade Practices/Consumer Protection Act, and claims for
restitution, unjust enrichment, public nuisance, and negligent performance
of a voluntary undertaking. Trial is expected to be held in late 1997 or
early 1998.
State of Maryland v. Philip Morris Incorporated, et al. (Circuit Court,
Baltimore City, Maryland, filed May 1, 1996). The court has granted in part
defendants' motion to dismiss and has dismissed nine of the thirteen counts
of the complaint.
State of Washington v. The American Tobacco Company, et al. (Superior Court,
King County, Washington, filed June 5, 1996). The court has granted in part
defendants' motion to dismiss and dismissed all of plaintiff's claims except
anti-trust, violations of the Washington Consumers' Protection Act statutes
and conspiracy. Plaintiff has noticed an appeal from portions of the ruling.
City and County of San Francisco, et al. v. Philip Morris Incorporated, et
Page 18
al. (U.S. District Court, Northern District, California, filed June 6, 1996
by various California cities and counties). The court has dismissed
plaintiffs' breach of implied warranty claim and has dismissed plaintiffs'
conspiracy claim as a separate cause of action.
State of Connecticut v. Philip Morris Incorporated, et al. (Superior Court,
Litchfield District, Connecticut, filed July 18, 1996).
County of Los Angeles v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, San Diego County, filed August 5, 1996). The court has sustained
defendants' demurrer to plaintiff's fraud claim.
State of Arizona v. The American Tobacco Company, et al. (Superior Court,
Maricopa County, Arizona, filed August 20, 1996). The court has dismissed
plaintiff's claims of breach of assumed duty, performance of another's duty,
unjust enrichment and restitution, negligence per se, public nuisance and,
as to the claims that were dismissed, conspiracy. The court has dismissed
without prejudice plaintiffs' claims asserted under the Racketeering
Influenced and Corrupt Organizations Act.
State of Kansas v. R.J. Reynolds Tobacco Company, et al. (District Court,
Shawnee County, Kansas, filed August 20, 1996).
Kelley v. Philip Morris Incorporated, et al. (Circuit Court, Ingham County,
Michigan, filed August 21, 1996 by the Attorney General of Michigan). The
court has dismissed plaintiff's claims of violation of the Michigan
Antitrust Reform Act, punitive damages and ad damnum allegations. The court
ruled that plaintiff is permitted to seek exemplary damages rather than
punitive damages.
State of Oklahoma, et al. v. R.J. Reynolds Tobacco Company, et al. (District
Court, Cleveland County, Oklahoma, filed August 22, 1996). The Company is a
defendant in the case.
People of the State of California v. Philip Morris Incorporated, et al.
(Superior Court, San Francisco County, California, filed September 5, 1996
by various California counties and cities and local chapters of various
medical societies and associations). The court has granted in part
plaintiffs' demurrer to various of the affirmative defenses asserted by the
defendants.
State of New Jersey v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, Middlesex County, New Jersey, filed September 10, 1996).
State of Utah v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Central Division, Utah, filed September 30, 1996). The Company is a
defendant in the case.
City of New York, et al. v. The Tobacco Institute, et al. (U.S. District
Court, Southern District, New York, filed October 17, 1996).
People of the State of Illinois v. Philip Morris, Inc., et al. (Circuit
Court, Cook County, Illinois, filed November 12, 1996).
State of Iowa v. R.J. Reynolds Tobacco Company, et al. (District Court,
Fifth Judicial District, Polk County, Iowa, filed November 27, 1996). The
Company is a defendant in the case. The court granted in part defendants'
motion to dismiss and dismissed plaintiff's claims of tort liability for
deception, breach of a duty voluntarily assumed, disgorgement of profits and
indemnity. Plaintiff has noticed an appeal from the ruling.
Page 19
County of Erie v. The Tobacco Institute, Inc., et al. (Supreme Court, Erie
County, New York, filed January 14, 1997).
State of New York v. The American Tobacco Company, et al. (U.S. District
Court, Southern District, New York, filed January 21, 1997).
State of Hawaii v. Brown & Williamson Tobacco Corporation, et al. (Circuit
Court, First Circuit, Hawaii, filed January 31, 1997). The Company is a
defendant in the case.
State of Wisconsin v. Philip Morris Incorporated, et al. (Circuit Court,
Dane County, Wisconsin, filed February 5, 1997).
State of Indiana v. Philip Morris Incorporated, et al. (Superior Court,
Marion County, Indiana, filed February 19, 1997).
State of Alaska v. Philip Morris, Incorporated, et al. (Superior Court,
First Judicial District, Alaska, filed April 14, 1997).
County of Cook v. Philip Morris, Incorporated, et al. (Circuit Court, Cook
County, Illinois, filed April 18, 1997).
Commonwealth of Pennsylvania v. Philip Morris, Inc., et al. (Court of Common
Pleas, Philadelphia County, Pennsylvania, filed April 23, 1997).
State of Arkansas v. The American Tobacco Company, et al. (Sixth Division,
Chancery Court, Pulaski County, Arkansas, filed May 5, 1997). To date, none
of the defendants have received service of process.
State of Montana v. Philip Morris, Incorporated, et al. (First Judicial
Court, Lewis and Clark County, Montana, filed May 5, 1997).
State of Ohio v. Philip Morris, Incorporated, et al. (Court of Common Pleas,
Franklin County, Ohio, filed on May 8, 1997).
State of Missouri v. American Tobacco Company, Inc., et al. (Circuit Court,
City of St. Louis, Missouri, filed May 12, 1997). The Company is a defendant
in the case.
State of South Carolina v. Brown & Williamson Tobacco Corporation, et al.
(Court of Common Pleas, Richland County, South Carolina, filed May 12,
1997). The Company is a defendant in the case.
State of Nevada v. Philip Morris, Incorporated, et al. (Second Judicial
District, Washoe County, Nevada, filed May 21, 1997). The Company is a
defendant in the case.
University of South Alabama v. The American Tobacco Company, et al. (U.S.
District Court, Southern District, Alabama; filed May 23, 1997). The Company
is a defendant in the case. The court granted a motion to dismiss filed by
the Attorney General of Alabama and entered judgment in favor of the
defendants. Plaintiff noticed an appeal from the judgment to the U.S. Court
of Appeals for the Fifth Circuit.
State of New Mexico v. The American Tobacco Company, et al. (First Judicial
District Court, Santa Fe County, New Mexico, filed May 27, 1997). The
Company was named as a defendant but has been voluntarily dismissed.
City of Birmingham, Alabama, and The Greene County Racing Commission v. The
American Tobacco Company, et al. (U.S. District Court, Northern District,
Alabama; filed May 28, 1997). The Company is a defendant in the case.
Page 20
Unpingco, et al. v. The American Tobacco Company, et al. (United States
District Court, Territory of Guam, filed May 29, 1997).
State of Vermont v. Philip Morris, Incorporated, et al. (Superior Court,
Chittenden County, Vermont, filed May 29, 1997).
State of New Hampshire v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, Merrimack County, New Hampshire, filed June 4, 1997).
State of Colorado v. R.J. Reynolds Tobacco Co., et al. (District Court, City
and County of Denver, Colorado, filed June 5, 1997).
State of Oregon v. The American Tobacco Company, et al. (Circuit Court,
Multnomah County, Oregon, filed June 9, 1997).
State of Idaho v. Philip Morris, Inc., et al. (District Court, Fourth
Judicial District, Ada County, Idaho, filed June 9, 1997).
People of the State of California v. Philip Morris, Inc., et al. (Superior
Court, Sacramento County, California, filed June 12, 1997).
State of Maine v. Philip Morris, Incorporated, et al. (Superior Court,
Kennebec County, Maine, filed June 17, 1997).
Rossello, et al. v. Brown & Williamson Tobacco Corporation, et al. (United
States District Court, Puerto Rico, filed June 17, 1997).
State of Rhode Island v. American Tobacco Company, Inc., et al. (Superior
Court, Providence, Rhode Island, filed June 17, 1997). The Company is a
defendant in the case.
Citizens of the Republic of the Marshall Islands v. The American Tobacco
Company, et al. (United States District Court, Hawaii, filed June 18, 1997).
Plaintiff voluntarily dismissed the action without prejudice on July 29,
1997.
State of Georgia v. Philip Morris, Inc., et al. (Superior Court, Fulton
County, Georgia, filed August 29, 1997).
Republic of the Marshall Islands v. The American Tobacco Company, et al.
(High Court, Republic of the Marshall Islands, filed October 20, 1997).
The governmental entities pursuing the foregoing efforts are doing so at the
urging and with the assistance of well known members of the plaintiffs bar
who have been meeting with attorneys general in other states to encourage
them to file similar suits.
Lorillard, other cigarette manufacturers and others have commenced suits in
eight states that seek declaratory judgment or injunctive relief as to the
authority of the states or state agencies to commence Reimbursement Cases or
to retain private counsel under a contingent fee contract to pursue such
actions. Nine such cases have been filed to date, in the states of Alaska,
Connecticut, Florida, Hawaii, Maryland, Massachusetts, New Jersey, Texas and
Utah. The case in Hawaii is scheduled for trial on December 9, 1997. The
suits in Connecticut and Maryland are on appeal following entry of orders
that dismissed the actions in favor of the defendant governmental entities.
The suits in Florida and Utah were concluded by orders not favorable to the
interests of the plaintiff cigarette manufacturers. The suits in
Massachusetts and Texas have been stayed until the reimbursement suits filed
by the respective states are resolved.
Page 21
Private Citizens' Reimbursement Cases - There are five suits pending in
which plaintiffs are private citizens suing on behalf of taxpayers of their
respective states. Governmental entities have filed reimbursement suits in
two of the five states. Lorillard is a defendant in each of the five cases.
The Company was named as a defendant in each of the five cases but has been
dismissed from one of them. Private citizens have filed two reimbursement
suits on behalf of all U.S. taxpayers. The Company is named as a defendant
in each of these cases. Each of these cases is in the pre-trial, discovery
stage.
Crozier v. The American Tobacco Company, et al. (Circuit Court, Montgomery
County, Alabama, filed August 8, 1996). The Company is a defendant in the
case. The court has entered an order granting in part defendants' motion to
dismiss the complaint and dismissed plaintiffs' claims asserted on behalf of
the State of Alabama.
Coyne v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Ohio, filed September 17, 1996). The Company is a defendant in the
case.
White v. Philip Morris, Inc., et al. (U.S. District Court, Southern
District, Mississippi, filed April 18, 1997). The Company is a defendant in
the case. To date, none of the defendants have received service of process,
although one defendant filed an answer to the complaint and removed the case
to federal court.
Beckom, et al., ex. rel. State of Tennessee and Tennessee taxpayers v. The
American Tobacco Company, et al. (U.S. District Court, Eastern District,
Tennessee; filed May 8, 1997). The Company is a defendant in the case.
Woods v. The American Tobacco Company, et al. (Superior Court, Wake County,
North Carolina, filed July 10, 1997). The Company was named as defendant in
the case but has been voluntarily dismissed.
Goodpasture v. American Tobacco Company, Inc., et al. (U.S. District Court,
Kansas, filed October 15, 1997). The Company is named as a defendant in the
case. To date, none of the defendants have received service of process.
Moore v. American Tobacco Company, et al. (U.S. District Court, Kansas,
filed October 15, 1997). The Company is named as a defendant in the case. To
date, none of the defendants have received service of process.
Reimbursement Cases By Indian Tribes - Indian Tribes have filed five
reimbursement suits in their tribal courts, although one of these cases has
been dismissed. Lorillard is a defendant in each of the cases. The Company
is not named as a defendant in any of the five tribal suits filed to date.
Each of the pending cases is in the pre-trial, discovery stage.
The Lower Brule Sioux Tribe v. The American Tobacco Company, et al. (Tribal
Court, Lower Brule Sioux Tribe, filed on an unknown date, first amended
complaint filed May 28, 1997).
The Crow Tribe v. The American Tobacco Company, et al. (Tribal Court, Crow
Tribe, filed June 10, 1997).
Muscogee Creek Nation v. The American Tobacco Company, et al. (District
Court, Muscogee Creek Nation, Okmulgee District, filed June 20, 1997).
Chehalis Tribe v. The American Tobacco Company, et al. (Chehalis Tribal
Court, Chehalis Indian Reservation, Oakville, Washington, filed June 23,
1997). Plaintiffs voluntarily dismissed the case on October 30, 1997.
Page 22
Crow Creek Sioux Tribe v. The American Tobacco Company, et al. (Tribal
Court, Crow Creek Sioux Tribe, filed September 14, 1997).
Reimbursement Cases By Labor Unions - Labor unions have filed thirty-one
reimbursement suits in various states throughout the nation in federal or
state courts, although four of them have not been served to date. One of the
suits has been dismissed. Lorillard is named as a defendant in each of the
suits filed to date by unions. The Company is not a defendant in any of the
cases filed to date by unions. Each of these cases is in the pre-trial,
discovery stage.
Stationary Engineers Local 39 Health and Welfare Trust Fund v. Philip
Morris, Inc., et al. (U.S. District Court, Northern District, California,
filed April 25, 1997.
Iron Workers Local Union No. 17 Insurance Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Northern District, Ohio, Eastern
Division, filed May 20, 1997).
Northwest Laborers-Employers Health and Security Trust Fund, et al. v.
Philip Morris, Inc., et al. (U.S. District Court, Western District,
Washington, filed May 21, 1997).
Central Illinois Carpenters Health and Welfare Trust Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Southern District, Illinois;
filed May 30, 1997).
Massachusetts Laborers Health and Welfare Fund v. Philip Morris Inc., et al.
(U.S. District Court, Massachusetts; filed June 2, 1997).
Hawaii Health and Welfare Trust Fund for Operating Engineers v. Philip
Morris, Inc., et al. (U.S. District Court, Hawaii, filed June 13, 1997).
Oregon Laborers -- Employers Health and Welfare Trust Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Oregon; filed June 18, 1997).
Laborers Local 17 Health and Benefit Fund and The Transport Workers Union
New York City Private Bus Lines Health Benefit Trust v. Philip Morris, Inc.,
et al. (U.S. District Court, Southern District, New York, filed June 19,
1997).
Ark-La-Miss Laborers Welfare Fund v. Philip Morris, Inc., et al. (U.S.
District Court, Eastern District, Louisiana, filed June 20, 1997). This
action has been consolidated with the case of Asbestos Workers Local 53
Health and Welfare Fund and Its Trustees, et al.
Iowa Laborers District Council Health and Welfare Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Central District, Iowa, Southern
Division, first amended complaint filed June 20, 1997). None of the
defendants received service of process. Plaintiffs voluntarily dismissed the
action without prejudice.
Kentucky Laborers District Council Health and Welfare Trust Fund v. Hill &
Knowlton, Inc., et al. (U.S. District Court, Western District, Kentucky,
Louisville Division, filed June 20, 1997).
United Federation of Teachers Welfare Fund, et al. v. Philip Morris, Inc.,
et al. (U.S. District Court, Southern District, New York, filed June 25,
1997).
Connecticut Pipe Trades Health Fund and International Brotherhood of
Page 23
Electrical Workers Local 90 Benefit Plan v. Philip Morris, Inc., et al.
(U.S. District Court, Connecticut, filed July 1, 1997).
Seafarers Welfare Plan and United Industrial Workers Welfare Plan v. Philip
Morris, Inc., et al. (U.S. District Court, Maryland, Southern Division,
filed July 2, 1997).
Laborers and Operating Engineers Utility Agreement Health and Welfare Trust
Fund for Arizona v. Philip Morris Incorporated, et al. (U.S. District Court,
Arizona, filed July 7, 1997).
West Virginia Laborers Pension Fund v. Philip Morris, Inc., et al. (U.S.
District Court, Southern District, West Virginia, Huntington Division, filed
July 11, 1997).
Rhode Island Laborers Health and Welfare Fund v. Philip Morris Incorporated,
et al. (U.S. District Court, Rhode Island, filed on or about July 20, 1997).
Eastern States Health and Welfare Fund, et al. v. Philip Morris, Inc., et
al. (Supreme Court, New York County, New York, filed July 28, 1997).
Asbestos Workers Local 53 Health and Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Louisiana, filed August
15, 1997). This action has been consolidated with the case of Ark-La-Miss
Laborers Welfare Fund.
Steamfitters Local Union No. 420 Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Pennsylvania, filed
August 21, 1997).
Construction Laborers of Greater St. Louis Welfare Fund, et al. v. Philip
Morris, Inc., et al. (filed in Circuit Court, City of St. Louis, Missouri,
removed to U.S. District Court, Eastern District, Missouri, filed September
2, 1997).
Southeast Florida Laborers District Council Health and Welfare Trust Fund v.
Philip Morris, Inc., et al. (U.S. District Court, Southern District,
Florida, filed September 11, 1997).
West Virginia--Ohio Valley Area International Brotherhood of Electrical
Workers Welfare Fund v. The American Tobacco Company, et al. (filed in
Circuit Court, Kanawha County, West Virginia, removed to U.S. District
Court, West Virginia, filed September 11, 1997).
Teamsters Union No. 142, Health and Welfare Trust Fund and Sheet Metal
Workers Local Union No. 20 Welfare and Benefit Fund and its trustees on
behalf of itself and all other similarly situated v. Philip Morris
Incorporated, et al. (filed in Circuit Court, St. Joseph County, Indiana,
removed to U.S. District Court, Northern District, Indiana, filed September
12, 1997).
Operating Engineers Local 12 Health and Welfare Trust v. American Tobacco
Company, et al. (Superior Court, Los Angeles County, California, filed
September 16, 1997).
Puerto Rican ILGWU Health & Welfare Fund v. Philip Morris Inc., et al.
(Supreme Court, New York County, New York, filed September 17, 1997). To
date, none of the defendants have received service of process.
New Jersey Carpenters Health Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, New Jersey, filed September 25, 1997).
Page 24
New Mexico and West Texas Multi-Craft Health and Welfare Trust Fund, et al.
v. Philip Morris, Inc., et al. (Second Judicial District Court, Bernalillo
County, New Mexico, filed October 10, 1997). To date, none of the defendants
have received service of process.
Central States Joint Board Health and Welfare Trust Fund v. Philip Morris,
Inc., et al. (Circuit Court, Cook County, Illinois, filed October 20, 1997).
To date, Lorillard has not received service of process.
International Brotherhood of Teamsters Local 734 v. Philip Morris, Inc., et
al. (Circuit Court, Cook County, Illinois, filed October 20, 1997). To date,
Lorillard has not received service of process.
Texas Carpenters Health Benefit Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, Eastern District, Texas, filed October 31, 1997). To
date, Lorillard has not received service of process.
CONTRIBUTION CLAIMS - Asbestos companies have filed suit against cigarette
manufacturers in three cases seeking damages or contribution and/or
indemnity. Raymark Industries, Inc. has filed two suits, one in the Circuit
Court of Duval County, Florida (subsequently removed to the U.S. District
Court for the Northern District of Florida) and in the U.S. District Court
for the Northern District of Georgia. Raymark Industries, Inc. seeks payment
of asbestos claims in amounts specified to be in excess of $400 in each
complaint. The Company and Lorillard have been served in the Florida case.
To date, neither the Company nor Lorillard have received service of process
in the Georgia action. Asbestos companies Fibreboard Corporation and Owens
Corning jointly filed suit in the Superior Court of Alameda County,
California. Plaintiffs seek unspecified amounts in actual damages and
punitive damages. The Company is not named as a defendant in the action
filed by Fibreboard Corporation and Owens Corning. To date, none of the
defendants have received service of process.
FILTER CASES - A number of cases have been filed against Lorillard seeking
damages for cancer and other health effects claimed to have resulted from
exposure to asbestos fibers which were incorporated, for a limited period of
time, ending more than forty years ago, into the filter material used in one
of the brands of cigarettes manufactured by Lorillard. Fifteen such cases
are pending in federal and state courts against Lorillard. Allegations of
liability against Lorillard include negligence, strict liability, fraud,
misrepresentation and breach of warranty. Plaintiffs seek unspecified
amounts in compensatory and punitive damages in many cases, and in other
cases damages are stated to amount to as much as $10.0 in compensatory
damages and $100.0 in punitive damages. In the one case of this type that
has been tried during 1997, the jury returned a verdict in favor of
Lorillard. Trials were held in three cases of this type during 1996. In two
of the cases, the juries returned verdicts in favor of Lorillard. In the
third case, the jury returned a verdict in favor of plaintiffs. The verdict
requires Lorillard to pay the amount of $.14, although the award
subsequently was reduced to $.07. Lorillard has noticed an appeal to the
California Court of Appeals. Trials were held in three cases of this type
during 1995. In two of the cases, the juries returned verdicts in favor of
Lorillard. In the third case, the jury returned a verdict in favor of
plaintiffs. The verdict requires Lorillard to pay an amount between $1.8 and
$2.0 in actual and punitive damages. The precise amount to be paid by
Lorillard will be determined at a later date if the verdict withstands
review by appellate courts. The California Court of Appeals affirmed the
judgment in favor of the plaintiffs. The California Supreme Court declined
to accept review of the appeal requested by Lorillard and Hollingsworth &
Vose.
Page 25
In addition to the foregoing litigation, one pending case, Cordova v.
Liggett Group, Inc., et al. (Superior Court, San Diego County, California,
filed May 12, 1992), alleges that Lorillard and other named defendants,
including other manufacturers of tobacco products, engaged in unfair and
fraudulent business practices in connection with activities relating to the
Council for Tobacco Research-USA, Inc., of which Lorillard is a sponsor, in
violation of a California state consumer protection law by misrepresenting
to or concealing from the public information concerning the health aspects
of smoking. Plaintiff seeks an injunction ordering defendants to undertake a
"corrective advertising campaign" in California to warn consumers of the
health hazards associated with smoking, to provide restitution to the public
for funds "unlawfully, unfairly, or fraudulently" obtained by defendants,
and to "disgorge" all revenues and profits acquired as a result of
defendants' "unlawful, unfair and/or fraudulent business practices."
LIGGETT SETTLEMENT - On March 20, 1997, Liggett Group, Inc. and its parent
company, Brooke Group, Ltd., Inc. ("Liggett"), and the Attorneys General for
twenty-two states, announced that they had reached agreement (the "Liggett
Settlement") to settle the reimbursement suits pending in those states. The
proposed settlements reportedly will require Liggett: to pay to the twenty-
two states an aggregate of 25% of its pre-tax profits annually for the next
twenty-five years, plus a one time payment of as much as an aggregate of
$25.0; to acknowledge that cigarette smoking is addictive (Liggett has
supplemented the warning notices it places on its cigarette packages to
reflect that acknowledgment); to acknowledge that cigarette smoking causes
disease; to acknowledge that cigarette companies have targeted marketing
programs towards minors; and to cooperate in suits against the other
cigarette manufacturers by releasing Liggett documents to the Attorneys
General and to allow its employees to testify in these matters. The Liggett
Settlement also purports to be on behalf of "all persons who, prior to or
during the term of [the Liggett Settlement], have smoked cigarettes or have
used other tobacco products and have suffered or claim to have suffered
injury as a consequence thereof."
On March 20, 1997, Lorillard and three other cigarette manufacturers filed
suit in the Superior Court of Forsyth County, North Carolina against
Liggett. The court entered a temporary restraining order on March 20, 1997
that prohibits Liggett and certain persons related to it or acting in
concert with it from misusing or disclosing any privileged or confidential
information relating to plaintiffs, or involving matters in which plaintiffs
and Liggett share a common interest and resulting from communications
between counsel for plaintiffs and Liggett. The court further directed
Liggett to appear before the court to identify for an in camera inspection
all documents Liggett has disclosed; to show cause why Liggett and certain
related persons should not be enjoined from disclosing the privileged or
confidential information pending trial in this action; and to disclose to
the court under seal the identity of the individuals to whom Liggett has
disclosed the confidential and privileged information to date. Liggett has
noticed an interlocutory appeal from a preliminary injunction entered by the
trial court.
DOCUMENT DISCOVERY ISSUES - Plaintiffs in a number of the cases pending
against the tobacco industry, including cases against Lorillard and the
Company, have challenged the claims of attorney-client and joint-defense
privilege made by defendants as to documents sought by plaintiffs in the
course of discovery. These challenges include, among other things,
allegations that privileged documents are subject to the so-called
crime/fraud exception, which negates the privilege as to documents found to
have been prepared in furtherance of a crime or fraud. Pursuant to the
Liggett Settlement described above, Liggett has submitted numerous documents
from its files to courts and defendants in several of the Reimbursement
Page 26
Cases and in other cases as well. Liggett has also served descriptive logs
of such documents on counsel for plaintiffs and defendants in those cases.
Defendants have reviewed the Liggett logs and the Liggett documents to
determine which Liggett documents are subject to a joint-defense privilege
claim by other defendants. Plaintiffs in several of these cases have sought
court review of such Liggett documents as to which other defendants claim a
joint-defense privilege, and documents from the files of other defendants as
to which a privilege is claimed, to determine the applicability of the
privilege and crime/fraud exception to such documents.
In the case of Butler v. Philip Morris, Inc., et al., a Conventional Product
Liability Case, Liggett has, by order of the court, submitted documents in
its possession that are subject to claims of joint-defense privilege or
other protection from discovery, for in camera review and determination by
the court as to the validity of such claims. In addition, a Special Master
in the Butler case has reviewed documents for which defendants claim
privilege and which relate to Special Projects of the Council for Tobacco
Research to determine the validity of the claims of privilege and the
applicability of the crime/fraud exception to such documents. The Special
Master has filed conclusions under seal, which will be considered by the
court before an order on the issue is entered. The court issued an order
denying defendants' objections to the Special Master's Report and
Recommendation. Butler is a conventional product liability case pending in a
state court in Mississippi alleging injury to an individual from exposure to
environmental tobacco smoke. The Company and Lorillard are defendants in
this case. Trial in this case is scheduled to begin on June 8, 1998.
In the State of Florida v. The American Tobacco Company, et al., a
Reimbursement Case, on April 14, 1997, the court issued an order finding
that eight documents in an initial set of 13 documents submitted to it by
Liggett and to which other defendants claim a joint-defense privilege, were
subject to the crime/fraud exception, and therefore should be produced to
plaintiffs. Defendants in that case have appealed that ruling to the Fourth
District Court of Appeals. The Court of Appeals has entered orders affirming
the trial court's ruling and denying defendants' motion for reconsideration
or, in the alternative, for certification of the order to the Florida
Supreme Court. Accordingly, those eight documents have been released to the
public and have received substantial media attention. Additional documents
from the files of Liggett, and other defendants, have been found to be non-
privileged or subject to the crime/fraud exception. Appeals of such rulings
were pending before the Court of Appeal.
In State of Minnesota v. Philip Morris Incorporated, et al., a Reimbursement
Case, the district court issued an order on May 9, 1997, ordering that
documents provided to the court by Liggett, and as to which other defendants
claim a joint-defense privilege, be reviewed by a Special Master to
determine the validity of the privilege claims as to them, and whether the
crime/fraud exception applies to those documents. In addition, the court
ordered that the Special Master determine the applicability of the
crime/fraud exception to all documents to which defendants claim the
attorney-client or joint-defense privilege. The court ordered that the
approximately 220,000 documents be divided into several categories and
considered by category and not individually. The Special Master issued a
Report and Recommendation that many of the Liggett documents are subject to
the "crime-fraud" exception, including documents relating to the Council for
Tobacco Research "Special Projects," special accounts and tobacco industry
consultants. The Special Master also recommended that documents regarding
youth advertising and press releases, company statements and company
positions are not privileged in the first instance. The court has heard
argument on defendants' exceptions to the Special Master's Report and
Recommendation and took the matter under advisement. The Special Master
Page 27
convened hearings on October 15-18, 1997 as to whether documents produced by
defendants other than Liggett are privileged and, if so, whether they are
subject to the crime-fraud exception to any asserted privileges. The Special
Master took the matter under advisement.
In State of Kansas v. R.J. Reynolds Tobacco Company, et al., a Reimbursement
Case, the district court issued an order on October 15, 1997 directing that
approximately 2,500 documents produced by Liggett be released to the
plaintiff. The remaining defendants had contended that the documents were
barred from disclosure due to the joint defense privilege, but the court
ruled that the common law, joint defense privilege is not recognized in
Kansas. Defendants have asked the court to alter or amend the October 15,
1997 order, or to stay its implementation.
DEFENSES
One of the defenses raised by Lorillard in certain cases is preemption by
the Federal Cigarette Labeling and Advertising Act (the "Labeling Act"). In
the case of Cipollone v. Liggett Group, Inc., et al., the United States
Supreme Court, in a plurality opinion issued on June 24, 1992, held that the
Labeling Act as enacted in 1965 does not preempt common law damage claims
but that the Labeling Act, as amended in 1969, does preempt claims against
tobacco companies arising after July 1, 1969, which assert that the tobacco
companies failed to adequately warn of the alleged health risks of
cigarettes, sought to undermine or neutralize the Labeling Act's mandatory
health warnings, or concealed material facts concerning the health effects
of smoking in their advertising and promotion of cigarettes. The Supreme
Court held that claims against tobacco companies based on fraudulent
misrepresentation, breach of express warranty, or conspiracy to misrepresent
material facts concerning the alleged health effects of smoking are not
preempted by the Labeling Act. The Supreme Court in so holding did not
consider whether such common law damage actions were valid under state law.
The effect of the Supreme Court's decision on pending and future cases
against Lorillard and other tobacco companies will likely be the subject of
further legal proceedings. Additional litigation involving claims such as
those held to be preempted by the Supreme Court in Cipollone could be
encouraged if legislative proposals to eliminate the federal preemption
defense, pending in Congress since 1991, are enacted. It is not possible to
predict whether any such legislation will be enacted.
Lorillard believes that it has a number of defenses to pending cases, in
addition to defenses based on preemption described above, and Lorillard will
continue to maintain a vigorous defense in all such litigation. These
defenses, where applicable, include, among others, statutes of limitations
or repose, assumption of the risk, comparative fault, the lack of proximate
causation, and the lack of any defect in the product alleged by a plaintiff.
Lorillard believes that some or all of these defenses may, in many of the
pending or anticipated cases, be found by a jury or court to bar recovery by
a plaintiff. Application of various defenses, including those based on
preemption, are likely to be the subject of further legal proceedings in the
Class Action cases and in the Reimbursement Cases.
PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES
On June 20, 1997, together with other companies in the United States tobacco
industry, Lorillard entered into a Memorandum of Understanding to support
the adoption of federal legislation and any necessary ancillary undertakings
incorporating the features described in the proposed resolution attached to
the Memorandum of Understanding (together, the "Resolution"). The Resolution
can be implemented only by federal legislation. If enacted into law, the
legislation would resolve many of the regulatory and litigation issues
Page 28
affecting the United States tobacco industry thereby reducing uncertainties
facing the industry.
The Resolution is the subject of continuing review and comment by the White
House, the Congress, the public health community and other interested
parties. The White House and certain members of the public health community
have expressed concern with certain aspects of the Resolution and certain
members of Congress have offered or indicated that they may offer
alternative legislation. There can be no assurance that federal legislation
in the form of the Resolution will be enacted, that it will be enacted
without modification that is materially adverse to Lorillard, that any
modification would be acceptable to Lorillard or that, if enacted, the
legislation would not face legal challenges. If such a comprehensive
resolution were to be implemented, the Company believes that its
consolidated results of operations and financial position would be
materially adversely affected. The degree of the adverse impact would
depend, among other things, on the final form of implementing federal
legislation, the rates of decline in United States cigarette sales in the
premium and discount segments and Lorillard's share of the domestic premium
and discount cigarette segments. Moreover, the negotiation and signing of
the Resolution could affect other federal, state and local regulation of the
United States tobacco industry.
The Resolution includes provisions relating to advertising and marketing
restrictions, product warnings and labeling, access restrictions, licensing
of tobacco retailers, the adoption and enforcement of "no sales to minors"
laws by states, surcharges against the industry for failure to achieve
underage smoking reduction goals (summarized below), regulation of tobacco
products by the Food and Drug Administration (the "FDA"), public disclosure
of industry documents and research, smoking cessation programs, compliance
programs by the industry, public smoking and smoking in the workplace,
enforcement of the Resolution, industry payments (summarized below) and
litigation (summarized below). The complete text of the Resolution has been
filed with the Securities and Exchange Commission as Exhibit 10 to the
Company's Current Report on Form 8-K filed June 24, 1997. That complete text
is incorporated herein by reference, and the summary contained herein is
qualified by reference to that complete text.
Industry Payments
-----------------
The Resolution would require participant manufacturers to make substantial
payments in the year of implementation and thereafter ("Industry Payments").
Participating manufacturers would be required to make an aggregate $10,000
initial Industry Payment on the date federal legislation implementing the
terms of the Resolution is signed. This Industry Payment would be based on
relative market capitalizations and Lorillard currently estimates that its
share of the initial Industry Payment would be approximately $750.
Thereafter, the companies would be required to make specified annual
Industry Payments determined and allocated among the companies based on
volume of domestic sales as long as the companies continue to sell tobacco
products in the United States. These Industry Payments, which would begin on
December 31 of the first full year after implementing federal legislation is
signed, would be in the following amounts (at 1996 volume levels): year 1:
$8,500; year 2: $9,500; year 3: $11,500; year 4: $14,000; and each year
thereafter; $15,000. These Industry Payments would be increased by the
greater of 3% or the previous year's inflation rate determined with
reference to the Consumer Price Index. The Industry Payments would increase
or decrease in proportion to changes from 1996 domestic sales volume levels.
Volume declines would be measured based on adult sales volume figures;
volume increases would be measured by total sales volume. If sales volume
Page 29
declines but the industry's domestic net operating profit exceeds base year
inflation-adjusted levels, the reduction in the annual Industry Payment due
to volume decline, if any, would be offset to the extent of 25% of the
increased profit. At current levels of sales and prior to any adjustment for
inflation, the Resolution would require total Industry Payments of $368,500
over the first 25 years (subject to credits described below in connection
with potential civil tort liability).
The Industry Payments would be separate from any surcharges required under
the "look back" provision discussed below under the heading "Surcharge for
Failure to Achieve Underage Smoking Reduction Goals." The Industry Payments
would receive priority and would not be dischargeable in any bankruptcy or
reorganization proceeding and would be the obligation only of entities
manufacturing and selling tobacco products in the United States (and not
their affiliated companies). The Resolution provides that all payments by
the industry would be ordinary and necessary business expenses in the year
of payment, and no part thereof would be either in settlement of an actual
or potential liability for a fine or penalty (civil or criminal) or the cost
of a tangible or intangible asset. The Resolution would provide for the
pass-through to consumers of the annual Industry Payments in order to
promote the maximum reduction in underage use.
Surcharge for Failure to Achieve
Underage Smoking Reduction Goals
--------------------------------
The Resolution would impose surcharges on the industry if required
reductions in underage smoking are not achieved. A "look back" provision
would require the following reductions in the incidence of underage smoking
from estimated levels over the past decade:, 30% in the fifth and sixth
years after enactment of implementing federal legislation, 50% in the
seventh, eighth and ninth years, and 60% in the tenth year, with incidence
remaining at such reduced levels thereafter. For any year in which these
required reductions are not met, the FDA must impose a mandatory surcharge
on the participating members of the cigarette industry based upon an
approximation of the present value of the profit the companies would earn
over the lives of the number of underage consumers in excess of the required
reduction. The annual surcharge would be $80 (as adjusted for changes in
population and cigarette profitability) for each percentage point by which
the reduction in underage smoking falls short of the required reductions (as
adjusted to prevent double counting of persons whose smoking has already
resulted in the imposition of a surcharge in previous years). The annual
surcharge would be subject to a $2,000 annual cap (as adjusted for
inflation). The surcharge would be the joint and several obligation of
participating manufacturers allocated among participating manufacturers
based on their market share of the United States cigarette industry and
would be payable on or before July 1 of the year in which it is assessed.
Manufacturers could receive a partial refund of this surcharge (up to 75%)
only after paying the assessed amount and only if they could thereafter
prove to the FDA that they had fully complied with the Resolution, had taken
all reasonably available measures to reduce youth tobacco usage and had not
acted to undermine the achievement of the reduction goals.
Effects on Litigation
---------------------
If enacted, the federal legislation provided for in the Resolution would
settle present attorney general health care cost recovery actions (or
similar actions brought by or on behalf of any governmental entity), parens
patriae and smoking and health class actions and all "addiction"/dependence
claims and would bar similar actions from being maintained in the future.
Page 30
However, the Resolution provides that no stay applications will be made in
pending governmental actions without the mutual consent of the parties. On
July 2 and August 25, 1997, together with other companies in the United
States tobacco industry, Lorillard entered into Memoranda of Understanding
with the States of Mississippi and Florida, respectively, with respect to
those states' health care cost recovery actions. See Mississippi Settlement
and Florida Settlement discussed below. Lorillard may enter into discussions
with certain other states with health care cost recovery actions scheduled
to be tried this year with regard to the postponement or settlement of such
actions pending the enactment of the legislation contemplated by the
Resolution. No assurance can be given whether a postponement or settlement
will be achieved, or, if achieved, as to the terms thereof. The Resolution
would not affect any smoking and health class action or any health care cost
recovery action that is reduced to final judgment before implementing
federal legislation is effective.
Under the Resolution, the rights of individuals to sue the tobacco industry
would be preserved, as would existing legal doctrine regarding the types of
tort claims that can be brought under applicable statutory and case law
except as expressly changed by implementing federal legislation. Claims,
however, could not be maintained on a class or other aggregated basis and
could be maintained only against tobacco manufacturing companies (and not
their retailers, distributors or affiliated companies). In addition, all
punitive damage claims based on past conduct would be resolved as part of
the Resolution and future claimants could seek punitive damages only with
respect to claims predicated upon conduct taking place after the effective
date of implementing federal legislation. Finally, except with respect to
actions pending as of June 9, 1997, third-party payor (and similar) claims
could be maintained only based on subrogation of individual claims. Under
subrogation principles, a payor of medical costs can seek recovery from a
third party only by "standing in the shoes" of the injured party and being
subject to all defenses available against the injured party.
The Resolution contemplates that participating tobacco manufacturers would
enter into a joint sharing agreement for civil liabilities relating to past
conduct. Judgments and settlements arising from tort actions would be paid
as follows: (i) The Resolution would set an annual aggregate cap equal to
33% of the annual base Industry Payment (including any reductions for volume
declines). (ii) Any judgments or settlements exceeding the cap in a year
would roll over into the next year. (iii) While judgments and settlements
would run against the defendant, they would give rise to an 80-cents-on-the-
dollar credit against the annual Industry Payment. (iv) Finally, any
individual judgments in excess of $1 would be paid at the rate of $1 per
year unless every other judgment and settlement could first be satisfied
within the annual aggregate cap. In all circumstances, however, the
companies would remain fully responsible for costs of defense and certain
costs associated with the fees of attorneys representing certain plaintiffs
in the litigation that would be settled by the Resolution.
SETTLEMENTS OF REIMBURSEMENT CASES - Together with other companies in the
United States tobacco industry, Lorillard has entered into memoranda of
understanding with the State of Mississippi and the State of Florida setting
forth the principal terms and conditions of agreements in principal to
settle and resolve with finality many or all of these present and future
claims in the reimbursement cases brought against the industry by those
States. These settlements resulted in a pre-tax charge to earnings of $79.0
in the third quarter of 1997. In addition, a settlement was reached in the
Broin case resulting in a pre-tax charge to earnings of $30.3 in the third
quarter of 1997 (see "Broin v. Philip Morris Companies, Inc. et al." above).
MISSISSIPPI - The memorandum of understanding with the State of Mississippi
Page 31
(the "Mississippi Settlement") was entered into on July 2, 1997 and a
settlement agreement between the parties was signed on October 17, 1997.
Under that agreement, the parties agree to petition the Chancery Court of
Jackson County, Mississippi to adjourn all further proceedings in
contemplation of their final resolution and termination pursuant to the
Mississippi Settlement and the settlement agreement contemplated thereby.
Under the Mississippi Settlement the parties agree that the settlement
agreement will include the terms summarized below.
The settling defendants have deposited $170, representing the State's
estimate of its share of the $10,000 initial payment under the Resolution,
in an escrow account ("the Escrow"). This amount was allocated among the
settling defendants in accordance with their relative market capitalization,
which resulted in a payment by Lorillard of approximately $13 on July 15,
1997. In addition, a payment was made in July 1997 to private lawyers and
the State for litigation expenses pursuant to the Mississippi Settlement.
Beginning December 31, 1998, the settling defendants will pay into the
Escrow 1.7% of that portion of the annual Industry Payments under the
Resolution which is contemplated to be paid to the states. These payments,
which are not offset by potential credits for civil tort liability and which
would be adjusted, among other things, for changes in volume as provided in
the Resolution discussed above, could result in payments by the industry to
the State of Mississippi of $68 with respect to 1998 and $76.6 with respect
to 1999. These amounts could increase to $136 with respect to 2003 and could
continue at that level thereafter. The settling defendants will also
reimburse the State's expenses and those of its attorneys, currently
estimated to be $15 and will be responsible for the attorneys' fees of
counsel for Mississippi (which will be set by a panel of arbitrators). Each
of these payments would be allocated among the settling defendants in
accordance with their relative volume of domestic cigarette sales.
If legislation implementing the Resolution or its substantial equivalent is
enacted, the settlement agreement will remain in place, but the terms of the
federal legislation will supersede the settlement agreement and the
foregoing payment amounts will be adjusted so that the State would receive
the same payment as it would receive under the Resolution. Similar provision
is made in the event of multiple settlements of non-federal governmental
health care cost recovery actions, provided that Mississippi is entitled to
treatment at least as relatively favorable as such other non-federal
governmental entities. If the Resolution is not implemented, then the
Mississippi Settlement will remain in place as negotiated with the State.
As a result of a provision contained in the Memorandum of Understanding with
the State of Mississippi and in the Settlement Agreement between the parties
signed on October 17, 1997, the State of Mississippi is entitled to receive
its pro-rata share of payments made to the State of Florida (see "Florida"
below) to support a Pilot Program by the State to reduce the use of tobacco
products by persons under the age of 18 years. A payment of $61.8 was made
by the settling defendants on October 20, 1997 for this Pilot Program;
Lorillard's share of this payment was $5.4 based on its relative share of
the industry's volume of domestic cigarette sales. The settling defendants
also agreed to discontinue all tobacco product billboards, transit and
stadium advertisements in Mississippi, as they had agreed to do under the
Florida settlement.
FLORIDA - The memorandum of understanding with the State of Florida (the
"Florida Settlement") was entered into on August 25, 1997. On that same
date, the Circuit Court presiding over the Florida action entered an Order
Approving And Adopting Settlement Agreement As An Enforceable Order With the
Court. Under the Florida Settlement, the parties agree to dismiss all
Page 32
claims for monetary damages asserted in the Florida litigation. The claims
for non-economic relief are not dismissed and the parties agree that the
court retains jurisdiction over Florida's claims for non-economic injunctive
relief. Trial on remaining non-economic relief claims will proceed only if
the Resolution or a substantially equivalent federal program is not enacted
by June 1, 1998. If the Resolution or substantially equivalent federal
program is not enacted by June 1, 1998, the parties may, with the court's
permission, commence any appropriate pre-trial proceedings relevant to the
trial of the claims for non-economic relief. The court has set a trial date
on the remaining non-economic claims for September 8, 1998. If the
Resolution or substantially equivalent federal program is enacted, the
remaining claims shall be dismissed with prejudice. The terms of the Florida
Settlement are consistent with the terms of the Resolution and are
summarized below.
The settling defendants agree to discontinue all billboards and transit
advertisements of tobacco products in Florida; to support legislative
initiatives to enact new laws and administrative initiatives to promulgate
new rules intended to effectuate the prohibition of the sale of cigarettes
in vending machines (except in adult only locations and facilities); to
strengthen the civil penalties for the sales of tobacco products to children
under the age of 18; and to strengthen the civil penalties for possession of
tobacco products by children under the age of 18.
The settling defendants, on September 15, 1997, deposited $550 into an
escrow account for the benefit of the State of Florida. This payment
represents Florida's good faith estimate of that State's share of the
$10,000 initial payment contemplated under the Resolution. This amount was
allocated among the settling defendants in accordance with their relative
market capitalization, which resulted in a payment by Lorillard of
approximately $40. In addition, on September 15, 1997 the Settling
Defendants also paid a sum of $200 into an escrow agreement to support a
pilot program by the State of Florida. The pilot program is to be aimed at
reducing the use of tobacco products by persons under the age of 18. The
pilot program is to last two years and Florida may only spend $100 per each
twelve month period. These amounts were allocated among the Settling
Defendants in accordance with their relative volume of domestic cigarettes
sales, which resulted in a payment by Lorillard of approximately $17.4 on
September 15, 1997.
Beginning September 15, 1998, the Settling Defendants will pay into an
escrow account, for the benefit of Florida, the respective pro rata share of
5.5% of that portion of the annual industry payments under the Resolution.
The payments, which will be adjusted upward by the greater of 3% or the
consumer price index applied each year on the previous year, beginning with
the first annual payment could result in payments by the Settling Defendants
to Florida of $220 with respect to 1998, $247.5 with respect to 1999, $275
with respect to year 2000, $357.5 with respect to years 2001 and 2002, and
$440 with respect to year 2003 and could continue at that level thereafter.
Such payments will be decreased or increased, as the case may be, in
accordance with decreases or increases in volume of domestic tobacco product
volume sales as provided in the Resolution. Notwithstanding the foregoing
calculations, on September 15, 1998, the Settling Defendants shall pay $220
without adjustment. Each of these payments will be allocated among the
Settling Defendants in accordance with their relative volume of domestic
cigarette sales.
If legislation implementing the Resolution or its substantial equivalent is
enacted, the Florida Settlement Agreement will remain in place, but the
terms of the federal legislation will supersede the Florida Settlement
Agreement except for the pilot program. The foregoing payment amounts will
Page 33
be adjusted such that Florida would receive the same payment as it would
receive under the Resolution or its substantial equivalent. A similar
provision is made in the event of multiple settlements of non-federal
governmental health care cost recovery actions, provided that Florida is
entitled to treatment at least as relatively favorable as such other non-
federal governmental entities. If the Resolution is not implemented, then
the Settlement Agreement will remain in place as negotiated with the State
of Florida.
On September 30, 1997, the Settling Defendants paid to the attorney general
of Florida $10 for costs and expenses attributable to the litigation. The
Settling Defendants also paid $12 into the escrow account for the benefit of
the State of Florida's private counsel for their costs and expenses. The
settling defendants, after appropriate documentation, shall pay the amount
of costs and expenses in excess above the $22 previously paid or shall
receive a refund or credit if the total costs and expenses are less than
$22. The settling defendants also agree to pay, separately and apart from
the foregoing, reasonable attorneys fees to private counsel. If the
Resolution or substantially equivalent federal program is enacted, the
amount of such fees will be set by a panel of independent arbitrators
subject to an appropriate annual cap on all such payments. In the event the
Resolution or substantial equivalent is not enacted, fees for plaintiff's
attorneys in Florida will be awarded, subject to the appropriate annual cap,
by three independent arbitrators selected by the parties.
A dispute has arisen between the State of Florida and some of its private
counsel regarding the payment of attorneys fees. The private attorneys are
dissatisfied with the attorney fee provisions under the Florida Settlement
and have filed attorneys liens seeking to enforce a contingency fee contract
they claim to have with the State of Florida. The Circuit Court has quashed
the charging liens and directed the parties and their counsel to comply with
the provisions for obtaining reasonable attorneys' fees in the Florida
Settlement.
* * * *
Smoking and health related litigation has been brought by plaintiffs against
Lorillard and other manufacturers of tobacco products for many years. While
Lorillard intends to defend vigorously all such actions which may be brought
against it, it is not possible to predict the outcome of any of this
litigation. Litigation is subject to many uncertainties, and it is possible
that some of these actions could be decided unfavorably.
Many of the recent developments in relation to smoking and health discussed
above have received wide-spread media attention. These developments may
reflect adversely on the tobacco industry and could have adverse effects on
the ability of Lorillard and other cigarette manufacturers to prevail in
smoking and health litigation.
Except for the effect of the Resolution if implemented as described above,
management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending litigation. It
is possible that the Company's results of operations or cash flows in a
particular quarterly or annual period or its financial position could be
materially affected by an unfavorable outcome of certain pending litigation.
Page 34
Other Litigation
----------------
The Company and its subsidiaries are also parties to other litigation
arising in the ordinary course of business. The outcome of this other
litigation will not, in the opinion of management, materially affect the
Company's results of operations or equity.
7. On September 30, 1997, a subsidiary of CNA merged with Capsure Holdings
Corp. to form a new company, CNA Surety Corporation. CNA owns approximately
62% of the outstanding shares on a fully diluted basis. As a result of this
transaction, the Company recognized a gain of $88.8 from issuance of its
subsidiary's common stock.
8. In the opinion of Management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as of
September 30, 1997 and December 31, 1996 and the results of operations for
the three and nine months and changes in cash flows for the nine months
ended September 30, 1997 and 1996, respectively.
Results of operations for the third quarter and the first nine months of
each of the years is not necessarily indicative of results of operations for
that entire year.
Page 35
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
-----------------------------------------------------------------------
Liquidity and Capital Resources:
- -------------------------------
Insurance
- ---------
Property and casualty and life insurance operations are wholly owned
subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 84% owned
subsidiary of the Company--
For the first nine months of 1997, statutory surplus of the property and
casualty insurance subsidiaries increased $435.0 million to $6.8 billion. The
statutory surplus of the life insurance subsidiaries remained at approximately
$1.2 billion, when compared to December 31, 1996.
The liquidity requirements of CNA have been met primarily by funds generated
from operations. The principal cash flow sources of CNA's property and casualty
and life insurance subsidiaries are premiums, investment income, and sales and
maturities of investments. The primary operating cash flow uses are payments for
claims, policy benefits and operating expenses.
CNA's operating activities generated net negative cash flows of approximately
$359.2 and $65.0 million for the nine months ended September 30, 1997 and 1996,
respectively. Negative cash flows in 1997 are primarily the result of
substantial claim payments resulting from the settlement of the Fibreboard
litigation. CNA believes that future liquidity needs will be met primarily by
cash generated from operations.
Net cash flows from operations are invested in marketable securities.
Investment strategies employed by CNA's insurance subsidiaries consider the cash
flow requirements of the insurance products sold and the tax attributes of the
various types of marketable investments.
CNA and the insurance industry are exposed to liability for environmental
pollution, primarily related to toxic waste site clean-up. See Note 6 of the
Notes to Consolidated Condensed Financial Statements for further discussion of
environmental pollution exposures.
Cigarettes
- ----------
Lorillard, Inc. and subsidiaries ("Lorillard")--
Lorillard and other cigarette manufacturers continue to be confronted with an
increasing level of litigation and regulatory issues.
The volume of lawsuits against Lorillard and other manufacturers of tobacco
products seeking damages for cancer and other health effects claimed to have
resulted from an individual's use of cigarettes, "addiction" to smoking, or
exposure to environmental tobacco smoke has increased substantially in 1997. See
Note 6 of the Notes to Consolidated Condensed Financial Statements. In a number
of cases, the Company is named as a defendant. Tobacco litigation includes
claims brought by individual plaintiffs and claims brought as class actions on
behalf of a large number of individuals for damages allegedly caused by smoking;
and claims brought on behalf of governmental entities, private citizens, or
other organizations seeking reimbursement of health care costs allegedly
Page 36
incurred as a result of smoking. In addition, claims have been brought against
Lorillard seeking damages resulting from exposure to asbestos fibers which had
been incorporated, for a limited period of time, ending more than forty years
ago, into filter material used in one brand of cigarettes manufactured by
Lorillard. In the foregoing actions, plaintiffs claim substantial compensatory
and punitive damages in amounts ranging into the billions of dollars.
In the third quarter of 1997, Lorillard, together with other companies in the
United States tobacco industry, reached agreements to settle certain tobacco
related litigation. See "Settlements of Reimbursement Cases" and "Broin v.
Philip Morris Companies, Inc. et al." in Note 6 of the Notes to Consolidated
Condensed Financial Statements.
FDA REGULATIONS
The Food and Drug Administration ("FDA") has published regulations (the "FDA
Regulations") severely restricting cigarette advertising and promotion and
limiting the manner in which tobacco products can be sold. The FDA premised its
regulations on the need to reduce smoking by underage youth and young adults.
The FDA Regulations become effective in stages, as follows:
(i) Regulations regarding underage youth smoking, effective February 28,
1997. These regulations make unlawful the sale by retail merchants of
cigarettes to anyone under age 18. These regulations also require retail
merchants to request proof of age for any person under age 27 who
attempts to purchase cigarettes.
(ii) Regulations regarding advertising and billboards, effective August 28,
1997. These regulations limit all cigarette advertising to a black and
white, text only format in most publications and outdoor advertising such
as billboards. The regulations also prohibit billboards advertising
cigarettes within 1,000 feet of a school or playground, require that the
established name for the product ("Cigarettes") and an intended use
statement ("A Nicotine-Delivery Device For Persons 18 or Older") be
included on all cigarette packaging and advertising, ban the use of
cigarette brand names, logos and trademarks on premium items and prohibit
the furnishing of any premium item in consideration for the purchase of
cigarettes or the redemption of proofs-of-purchase coupons.
(iii) Regulations prohibiting the use of cigarette brand names to sponsor
sporting and cultural events, effective August 28, 1998.
The FDA has announced that it will contract with states to jointly enforce the
FDA Regulations. State regulations narrower in scope and not inconsistent with
the FDA Regulations may be exempt from the pre-emptive effect of the federal
rules and be enforced concurrently.
Lorillard and other cigarette manufacturers have filed a lawsuit, Coyne Beahm,
Inc., et al. v. United States Food & Drug Administration, et al., in the United
States District Court for the Middle District of North Carolina challenging the
FDA's assertion of jurisdiction over cigarettes and seeking both preliminary and
permanent injunctive relief. On April 25, 1997, the Court granted, in part, and
denied, in part, plaintiffs' motion for summary judgment. The Court partially
ruled in favor of the defendants, holding that if an adequate factual foundation
is established, the FDA has the authority to regulate tobacco products as
medical devices under the Federal Food, Drug & Cosmetic Act, may impose
restrictions regarding access to tobacco products by persons under the age of
18, and may impose labeling requirements on tobacco products' packaging. The
Court, however, partially ruled in favor of the plaintiffs, holding that the FDA
is not authorized to regulate the promotion or advertisement of tobacco
products. The Court also stayed the effective date for the FDA Regulations which
Page 37
were to take effect on August 28, 1997 pending appeal. Both the plaintiffs and
the defendants have filed an appeal of the District Court's ruling to the Fourth
Circuit Court of Appeals, and oral argument before this Court was heard on
August 11, 1997.
PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES
On June 20, 1997, together with other companies in the United States tobacco
industry, Lorillard entered into a Memorandum of Understanding to support the
adoption of federal legislation and any necessary ancillary undertakings,
incorporating the features described in the proposed resolution attached to the
Memorandum of Understanding.
The Memorandum of Understanding, and the proposed resolution (together, the
"Resolution") resulted from negotiations with state attorneys general,
representatives of the public health community and attorneys representing
plaintiffs in certain smoking and health litigation. The Resolution contains
certain regulatory and legislative provisions with which the industry does not
necessarily agree, but which the industry has agreed to accept in the interest
of achieving the Resolution. The Resolution can be implemented only by federal
legislation. If enacted into law, the legislation would resolve many of the
regulatory and litigation issues affecting the United States tobacco industry
thereby reducing uncertainties facing the industry.
The Resolution is the subject of continuing review and comment by the White
House, Congress, the public health community and other interested parties. The
White House and certain members of the public health community have expressed
concern with certain aspects of the Resolution and certain members of Congress
have offered or indicated that they may offer alternative legislation. There can
be no assurance that federal legislation in the form of the Resolution will be
enacted or that it will be enacted without modification that is materially
adverse to Lorillard or that any modification would be acceptable to Lorillard
or that, if enacted, the legislation would not face legal challenges. In any
event, the Company believes implementation of the Resolution would materially
adversely affect its consolidated results of operations and financial position.
The degree of the adverse impact would depend, among other things, on the final
form of implementing federal legislation, the rates of decline in United States
cigarette sales in the premium and discount segments and Lorillard's share of
the domestic premium and discount cigarette segments. Moreover, the negotiation
and signing of the Resolution could affect other federal, state and local
regulation of the United States tobacco industry.
The following summary of the Resolution is qualified by reference to the
complete text, which has been filed with the Securities and Exchange Commission
as Exhibit 10 to the Company's Current Report on Form 8-K filed June 24, 1997,
and which is incorporated herein by reference. Certain terms of the Resolution
would apply to all tobacco products sold in the United States; certain terms
would apply only to tobacco manufacturers that consent to participate in the
Resolution; other terms would apply only to non-consenting manufacturers.
Advertising and Marketing Restrictions
The Resolution would incorporate certain regulations previously promulgated by
the Food and Drug Administration (the "FDA") and add additional restrictions to
curtail tobacco product advertising and marketing.
Among other things, it would:
(i) Prohibit the use of human images and cartoon characters, such as Joe
Camel and the Marlboro man, in all tobacco-product advertising.
Page 38
(ii) Ban all outdoor tobacco-product advertising, including advertising in
enclosed stadia and advertising inside a retail establishment that is
directed outside.
(iii) Except for advertising in adult-only facilities or adult publications,
limit tobacco-product advertising to black text on a white background.
(iv) Ban sponsorships (including concerts and sporting events) in the name,
logo or selling message of a tobacco brand.
(v) Ban all non-tobacco merchandise (such as caps, jackets and bags)
bearing the name, logo or selling message of a tobacco brand.
(vi) Ban offers of non-tobacco items or gifts based on proof of purchase of
tobacco products.
(vii) Ban direct or indirect payments for tobacco product placement in
movies, television programs and video games.
(viii) Prohibit direct and indirect payments to "glamorize" tobacco use in
media appealing to minors, including live and recorded music
performances.
(ix) Prohibit tobacco-product advertising on the Internet unless designed
to be inaccessible in or from the United States.
In addition, the Resolution would require that use of currently employed
product descriptors such as "low tar" and "light" be accompanied by a mandatory
health disclaimer in advertisements, and would prohibit the use of any new
descriptors embodying express or implied health claims unless approved by the
FDA. The FDA would also have the corresponding power, but not the obligation, to
modify advertising restrictions with respect to tobacco products that it
concludes present sufficiently reduced health risks. Exemplars of all new
advertising and tobacco product labeling would be submitted to the FDA for its
ongoing review.
Warnings and Labeling
The Resolution would mandate a new set of rotating warnings to be placed on
packages of tobacco products with greater prominence than previous warnings (25%
of the front of cigarette packs at the top of the pack). The new rotating
warnings would also appear in all advertisements and would occupy 20% of press
advertisements. Cigarette packs would also carry the FDA mandated statement of
intended use ("Nicotine Delivery Device").
Access Restrictions
The Resolution would restrict access to tobacco products by minors. Without
preventing state and local governments from imposing stricter measures, the
Resolution would incorporate regulations previously promulgated by the FDA that
restrict access to tobacco products and would also add additional restrictions.
Taken together, these access restrictions would include the following:
(i) Setting a minimum age of 18 to purchase tobacco products.
(ii) Requiring retailers to check photo identification of anyone under 27
years of age.
(iii) Establishing a requirement of face-to-face transactions for all sales
of tobacco products.
Page 39
(iv) Banning the sale of tobacco products from opened packages, requiring a
minimum package size of 20 cigarettes, and banning the sampling of
tobacco products.
(v) Banning the distribution of tobacco products through the mail except
for sales subject to proof of age (with subsequent FDA review to
determine if minors are obtaining tobacco products through the mail).
(vi) Imposing retailer compliance obligations to ensure that all displays,
advertising, labeling, and other items conform with all applicable
requirements.
(vii) Banning all sales of tobacco products through vending machines.
(viii) Banning self-service displays of tobacco products except in adult-only
facilities.
Licensing of Tobacco Retailers
The Resolution would require that any entity that sells tobacco products
directly to consumers obtain a license. Sellers would be subject to monetary
penalties and suspension or loss of their licenses if they do not comply with
the access restrictions. The federal government and state and local authorities
would enforce these access and licensing provisions through funding provided by
Industry Payments, as defined below under the heading "Industry Payments".
State Enforcement
The Resolution would require states to adopt "no sales to minors" laws and
would contain economic incentives for the states to enforce such laws. If a
state does not meet "no sales to minors" performance targets, the FDA may refuse
to pay that state certain funds otherwise payable under the Resolution. To
comply with the "no sales to minors" law, the state must achieve compliance rate
results of 75% by the fifth year after enactment of federal legislation, 85% by
the seventh year and 90% by the tenth year and each year thereafter. Compliance
would be measured as a percentage of random, unannounced compliance checks in
which the retailer refused to sell tobacco products to minors. Funds withheld
from states for failure to achieve the performance targets would, in turn, be
reallocated to those states that demonstrated superior "no sales to minors"
enforcement records.
Surcharge for Failure to Achieve Underage Smoking Reduction Goals
The Resolution would impose surcharges on the industry if required reductions
in underage smoking are not achieved. A "look back" provision would require the
following reductions in the incidence of underage smoking from estimated levels
over the past decade: 30% in the fifth and sixth years after enactment of
implementing federal legislation, 50% in the seventh, eighth and ninth years,
and 60% in the tenth year, with incidence remaining at such reduced levels
thereafter.
For any year in which these required reductions are not met, the FDA must
impose a mandatory surcharge on the participating members of the cigarette
industry based upon an approximation of the present value of the profit the
companies would earn over the lives of the number of underage consumers in
excess of the required reduction. The annual surcharge would be $80 million (as
adjusted for changes in population and cigarette profitability) for each
percentage point by which the reduction in underage smoking falls short of the
required reductions (as adjusted to prevent double counting of persons whose
smoking has already resulted in the imposition of a surcharge in previous
years). The annual surcharge would be subject to a $2 billion annual cap (as
Page 40
adjusted for inflation). The surcharge would be the joint and several obligation
of participating manufacturers allocated among participating manufacturers based
on their market share of the United States cigarette industry and would be
payable on or before July 1 of the year in which it is assessed. Manufacturers
could receive a partial refund of this surcharge (up to 75%) only after paying
the assessed amount and only if they could thereafter prove to the FDA that they
had fully complied with the Resolution, had taken all reasonably available
measures to reduce youth tobacco usage and had not acted to undermine the
achievement of the reduction goals. The FDA would use the surcharges to fund its
administrative costs and to fund grants to states for additional efforts to
reduce underage smoking.
Regulation
Under the Resolution, the FDA would oversee the development, manufacturing,
marketing and sale of tobacco products in the United States, including FDA
approval of ingredients and imposition of standards for reducing or eliminating
the level of certain constituents, including nicotine.
Under the Resolution, tobacco would continue to be categorized as a "drug" and
a "device" under the Food, Drug and Cosmetic Act. The FDA's authority to
regulate tobacco products as "restricted medical devices" would be explicitly
recognized and tobacco products would be classified as a new subcategory of
Class II devices.
For a period of at least twelve years after implementing legislation is
effective, the FDA would be permitted, subject to certain procedures and
judicial review, to adopt performance standards that require the modification of
existing tobacco products, including the gradual reduction, but not the
elimination, of nicotine yields, and the possible elimination of other
constituents or components of the tobacco product, based upon a finding that the
modification: (i) will result in a significant reduction of the health risks
associated with such products to consumers thereof; (ii) is technologically
feasible; and (iii) will not result in the creation of a significant demand for
contraband or other tobacco products that do not meet the performance standards.
The Resolution would also require, effective three years after implementing
legislation is effective, that no cigarette sold in the United States can exceed
a 12 mg. "tar" yield, using the Federal Trade Commission's presently existing
methodology to determine "tar" yields.
Beginning twelve years after implementing legislation becomes effective, the
FDA would be permitted to set performance standards that exceed those discussed
above, including the elimination of nicotine and the elimination of other
constituents or other demonstrated harmful components of tobacco products, based
upon a finding that: (i) the safety standard will result in a significant
overall reduction of the health risks to tobacco consumers as a group; (ii) the
modification is technologically feasible; and (iii) the modification will not
result in the creation of a significant demand for contraband or other tobacco
products that do not meet the performance standards. An FDA determination to
eliminate nicotine would have to be based upon a preponderance of the evidence
and be subject to judicial review and a two-year phase-in to permit
Congressional review.
The Resolution would require disclosure of non-tobacco ingredients to the FDA,
require manufacturers to submit within five years a safety assessment for
non-tobacco ingredients currently used, and require manufacturers to obtain the
FDA's preapproval for any new non-tobacco ingredients. The FDA would have
authority to disapprove an ingredient's safety. The Resolution also outlines
legislation that would require companies to notify the FDA of technology they
develop or acquire that reduces the risk from tobacco products and that would
Page 41
mandate cross-licensing of technology that the FDA determines reduces the risk
from tobacco products and that would authorize the FDA to mandate the
introduction of "less hazardous tobacco products" that are technologically
feasible.
The Resolution would subject the tobacco industry to "good manufacturing
practice" standards, including requirements regarding quality control systems,
FDA inspections and record-keeping and reporting.
Public Disclosure
The Resolution would require the tobacco industry to disclose to the public
previously confidential internal laboratory research as well as certain other
documents relating to smoking and health, "addiction" or nicotine dependency,
"safer or less hazardous" cigarettes and underage tobacco use and marketing. The
Resolution would also require the industry to disclose all such internal
laboratory research generated in the future. The Resolution would provide
protection for proprietary information and applicable privileges, and would
establish a streamlined process by which interested persons could contest claims
of privilege.
Cessation Programs
The Resolution would authorize the Secretary of Health and Human Services to
accredit smoking cessation programs and techniques that the agency determines to
be potentially effective.
Compliance Programs
Participating tobacco manufacturers would be required to create, and to update
each year, plans to ensure compliance with all applicable laws and regulations,
to identify ways to reduce underage use of tobacco products, and to provide
internal incentives for reducing underage use and for developing products with
"reduced risk".
Participating manufacturers would also be required to implement compliance
programs setting compliance standards and procedures for employees and agents
that are reasonably capable of reducing violations. These programs must assign
to specific high-level personnel the overall responsibility for overseeing
compliance, forbid delegation of substantial discretionary authority to
individuals who have shown a propensity to disregard corporate policies,
establish training or equivalent means of educating employees and agents, and
institute appropriate disciplinary measures and steps to respond to violations
and prevent similar ones from recurring.
Participating manufacturers would be required to promulgate corporate
principles that express and explain the company's commitment to compliance,
reduction of underage tobacco use, and development of "reduced risk" tobacco
products. They would be required to work with retail organizations on
compliance, including retailer compliance checks and financial incentives for
compliance, and disband certain industry associations and only form new ones
subject to regulatory oversight.
Participating manufacturers would be subject to fines and penalties for
breaching any of these obligations. Companies would be required to direct their
employees to report known or alleged violations to the company compliance
officer, who in turn would be required to provide reports to the FDA. Finally,
companies would be prohibited from taking adverse action against "whistle
blowers" who report violations to the government.
Page 42
Public Smoking
The Resolution would mandate minimum federal standards governing smoking in
public places or at work (with states and localities retaining power to impose
stricter requirements). These restrictions, which would be enforced by the
Occupational Safety and Health Administration, would:
(i) Restrict indoor smoking in "public facilities" to ventilated areas
with systems that exhaust the air directly to the outside, maintain
the smoking area at "negative pressure" compared with adjoining areas
and do not recirculate the air inside the public facility.
(ii) Ensure that no employee may be required to enter a designated smoking
area while smoking is occurring.
(iii) Exempt restaurants (other than fast food restaurants) and bars,
private clubs, hotel guest rooms, casinos, bingo parlors, tobacco
merchants and prisons.
Enforcement
Violations of the Resolution's terms would carry civil and criminal penalties
based upon the penalty provisions of the Food, Drug and Cosmetic Act and, where
applicable, the provisions of the United States criminal code. Special enhanced
civil penalties of up to ten times the penalties applicable to similar
violations by drug companies would attach to violations of the obligations to
disclose research about health effects and information about the toxicity of
non-tobacco ingredients.
Terms of the Resolution would be embodied in state consent decrees, giving the
states concurrent enforcement powers. State enforcement could not impose
obligations or requirements beyond those imposed by the Resolution (except where
the Resolution specifically does not preempt additional state-law obligations)
and would be limited to the penalties specified in the Resolution and by
prohibition of duplicative penalties.
Industry Payments
The Resolution would require participating manufacturers to make substantial
payments in the year of implementation and thereafter ("Industry Payments").
Participating manufacturers would be required to make an aggregate $10 billion
initial Industry Payment on the date federal legislation implementing the terms
of the Resolution is signed. This Industry Payment would be based on relative
market capitalizations and Lorillard currently estimates that its share of the
initial Industry Payment would be approximately $750 million which would be
funded from a combination of available cash and borrowings. Thereafter, the
companies would be required to make specified annual Industry Payments
determined and allocated among the companies based on volume of domestic sales
as long as the companies continue to sell tobacco products in the United States.
These Industry Payments, which would begin on December 31 of the first full year
after implementing federal legislation is signed, would be in the following
amounts (at 1996 volume levels): year 1: $8.5 billion; year 2: $9.5 billion;
year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15
billion. These Industry Payments would be increased by the greater of 3% or the
previous year's inflation rate determined with reference to the Consumer Price
Index. The Industry Payments would increase or decrease in proportion to changes
from 1996 domestic sales volume levels. Volume declines would be measured based
on adult sales volume figures; volume increases would be measured by total sales
volume. If sales volume declines but the industry's domestic net operating
profit exceeds base year inflation-adjusted levels, the reduction in the annual
Industry Payment due to volume decline, if any, would be offset to the extent of
Page 43
25% of the increased profit. At current levels of sales and prior to any
adjustment for inflation, the Resolution would require total Industry Payments
of $368.5 billion over the first 25 years (subject to credits described below in
connection with potential civil tort liability).
The Industry Payments would be separate from any surcharges required under the
"look back" provision discussed above under the heading "Surcharge for Failure
to Achieve Underage Smoking Goals". The Industry Payments would receive priority
and would not be dischargeable in any bankruptcy or reorganization proceeding
and would be the obligation only of entities selling tobacco products in the
United States (and not their affiliated companies). The Resolution provides that
all payments by the industry would be ordinary and necessary business expenses
in the year of payment, and no part thereof would be either in settlement of an
actual or potential liability for a fine or penalty (civil or criminal) or the
cost of a tangible or intangible asset. The Resolution would provide for the
pass-through to consumers of the annual Industry Payments in order to promote
the maximum reduction in underage use.
The Industry Payments would be made to a central federal authority and then
allocated among various programs and entities to provide funds for federal and
state enforcement efforts; federal, state and local governments' health benefit
programs; public benefits to resolve past punitive damages claims that might be
asserted in private litigation; the expenses related to the administration of
federal legislation enacted pursuant to the Resolution; and a variety of public
and private non-profit efforts to discourage minors from beginning to use
tobacco products and to assist current tobacco consumers to quit, including
research, public education campaigns, individual cessation programs, and impact
grants.
Effects on Litigation
If enacted, the federal legislation provided for in the Resolution would
settle present state-wide Reimbursement Cases (or similar actions brought by or
on behalf of any governmental entity), parens patriae and smoking and health
class actions and all "addiction"/dependence claims and would bar similar
actions from being maintained in the future. However, the Resolution provides
that no stay applications will be made in pending governmental actions without
the mutual consent of the parties. On July 2 and August 25, 1997, together with
other companies in the United States tobacco industry, Lorillard entered into
Memoranda of Understanding with the States of Mississippi and Florida,
respectively, with respect to those states' health care cost recovery actions.
Lorillard may enter into discussions with certain other states with
Reimbursement Cases scheduled to be tried this year with regard to the
postponement or settlement of such actions pending the enactment of the
legislation contemplated by the Resolution. No assurance can be given whether a
postponement or settlement will be achieved, or, if achieved, as to the terms
thereof. The Resolution would not affect any smoking and health class action or
any Reimbursement Case that is reduced to final judgment before implementing
federal legislation is effective.
Under the Resolution, the rights of individuals to sue the tobacco industry
would be preserved, as would existing legal doctrine regarding the types of tort
claims that can be brought under applicable statutory and case law except as
expressly changed by implementing federal legislation. Claims, however, could
not be maintained on a class or other aggregated basis and could be maintained
only against tobacco manufacturing companies (and not their retailers,
distributors or affiliated companies). In addition, all punitive damage claims
based on past conduct would be resolved as part of the Resolution and future
claimants could seek punitive damages only with respect to claims predicated
upon conduct taking place after the effective date of implementing federal
legislation. Finally, except with respect to actions pending as of June 9, 1997,
Page 44
third-party payor (and similar) claims could be maintained only based on
subrogation of individual claims. Under subrogation principles, a payor of
medical costs can seek recovery from a third party only by "standing in the
shoes" of the injured party and being subject to all defenses available against
the injured party.
The Resolution contemplates that participating tobacco manufacturers would
enter into a joint sharing agreement for civil liabilities relating to past
conduct. Judgments and settlements arising from tort actions would be paid as
follows: (i) The Resolution would set an annual aggregate cap equal to 33% of
the annual base Industry Payment (including any reductions for volume declines).
(ii) Any judgments or settlements exceeding the cap in a year would roll over
into the next year. (iii) While judgments and settlements would run against the
defendant, they would give rise to an 80-cents-on-the-dollar credit against the
annual Industry Payment. (iv) Finally, any individual judgments in excess of $1
million would be paid at the rate of $1 million per year unless every other
judgment and settlement could first be satisfied within the annual aggregate
cap. In all circumstances, however, the companies would remain fully responsible
for costs of defense and certain costs associated with the fees of attorneys
representing certain plaintiffs in the litigation that would be settled by the
Resolution.
Non-participating Manufacturers
The Resolution would contain certain measures to ensure that non-participating
manufacturers are not free to undercut the Resolution by selling tobacco
products at lower prices because they were not making the Industry Payments.
See Note 6 of the Notes to Consolidated Condensed Financial Statements for
information with respect to tobacco related litigation.
PROPOSED FEDERAL EXCISE TAX INCREASE
The United States federal excise tax on cigarettes was $12 per 1,000
cigarettes ($0.24 per pack of 20 cigarettes). In early August of 1997, the
United States Congress approved and the President signed into law an increase in
the federal excise tax on cigarettes of $7.50 per 1,000 cigarettes ($0.15 per
pack of 20 cigarettes). This increase is phased in at a rate of $5.00 per 1,000
cigarettes in the year 2000 and an additional $2.50 per 1,000 cigarettes in the
year 2002. Such action may adversely affect Lorillard's volume, operating
revenues and operating income.
Offshore drilling
- -----------------
For the first nine months of 1997, Diamond Offshore's cash provided by
operating activities amounted to $243.7 million, compared to $152.8 million in
1996. The significant improvement in operating cash flow reflects the current
conditions in the offshore drilling industry, namely improved dayrates and an
increasing number of term contracts for rigs in certain markets.
Diamond Offshore expects to spend approximately $189.2 million during 1997 for
rig upgrades, including approximately $162.5 million for expenditures in
conjunction with the upgrades of three rigs for deep water drilling in the Gulf
of Mexico. Diamond Offshore expended $152.4 million on these projects during the
nine months ended September 30, 1997. In addition, Diamond Offshore expects to
spend approximately $25.0 million for a cantilever conversion project on a jack-
up rig, and approximately $15.0 million for leg strengthening and other
modifications for another jack-up rig. Approximately $3.7 and $1.0 million has
been expended through September 30, 1997 on these projects, respectively.
Diamond Offshore has also budgeted $70.7 million for 1997 capital expenditures
Page 45
associated with its continuing rig enhancement program, spare equipment and
other corporate requirements. During the first nine months of 1997, $53.0
million was expended on this program.
Diamond Offshore recently entered into a letter of intent with a major oil
company for a five-year commitment in the Gulf of Mexico, following conversion
of an accommodation vessel to a drilling unit capable of operating in harsh
environments and ultra-deep water. The preliminary estimate of conversion cost
is approximately $190.0 million. The cash required to fund rig upgrades and
Diamond Offshore's continuing rig enhancement program is anticipated to be
provided by its operating cash flow, as well as available cash on hand.
In April 1997, Diamond Offshore completed a public offering of 1.25 million
shares of its common stock for net proceeds of approximately $82.3 million.
Diamond Offshore used these funds to acquire the Polyconfidence, a
semisubmersible accommodation vessel currently working in the U.K. sector of the
North Sea for approximately $81.0 million. As a result of the public offering,
the Company's ownership interest in Diamond Offshore declined to 50.3% and the
Company recorded a pre-tax gain of approximately $29.1 million in the second
quarter of 1997.
Corporate
- ----------
On September 16, 1997, the Company issued $1,150.0 million principal amount of
3 1/8% Exchangeable Subordinated Notes due 2007. See Note 4 of the Notes to
Consolidated Condensed Financial Statements.
Page 46
Investments:
- -----------
Insurance
- ---------
A summary of CNA's general account fixed maturity securities portfolio and
short-term investments are as follows:
<TABLE>
<CAPTION>
Change in
September 30, December 31, Unrealized
1997 1996 Gains
-------------------------------------
(In millions)
<S> <C> <C> <C>
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies . $12,046.4 $ 9,835.3 $ 58.7
Asset-backed securities ............. 4,762.9 6,292.3 68.8
Tax exempt securities ............... 4,831.1 4,951.2 52.0
Taxable ............................. 6,528.4 6,641.8 24.5
--------------------------------
Total fixed maturity securities. 28,168.8 27,720.6 204.0
Stocks ................................ 862.6 859.1 1.4
Short-term and other investments....... 7,847.9 6,830.7 40.2
Derivative security investments ....... 3.3 2.0
--------------------------------
Total .......................... $36,882.6 $35,412.4 $ 245.6
================================
Short-term investments:
Commercial paper .................... $ 2,446.1 $ 3,207.3
Money markets ....................... 1,528.3 746.0
Security repurchase collateral ...... 1,185.3 100.5
Escrow .............................. 1,098.7 1,062.2
Others .............................. 585.9 737.7
Other investments ..................... 1,003.6 977.0
-----------------------
Total short-term and other
investments ................... $ 7,847.9 $ 6,830.7
=======================
</TABLE>
CNA's general account investment portfolio is managed to maximize after tax
investment return, while minimizing credit risks, with investments concentrated
in high quality securities to support its insurance operations.
CNA has the capacity to hold its fixed maturity portfolio to maturity.
However, securities may be sold as part of CNA's asset/liability strategies or
to take advantage of investment opportunities generated by changing interest
rates, tax and credit considerations, or other similar factors. Accordingly,
fixed maturity securities are classified as available for sale.
CNA has a securities lending program where securities are loaned to third
parties, primarily major brokerage firms. Borrowers of these securities must
deposit 100% of the fair value of the securities if the collateral is cash, or
102% if the collateral is securities. Cash deposits from these transactions are
invested in short-term investments (primarily commercial paper). CNA continues
to receive the interest on loaned debt securities, as beneficial owner, and
Page 47
accordingly, loaned debt securities are included within fixed maturity
securities. The liabilities for securities sold subject to repurchase agreements
are recorded at their contractual repurchase amounts.
In addition to interest rate swaps used to convert CNA's debt to acquire The
Continental Insurance Company from a variable rate to a fixed rate, CNA holds
derivative financial instruments for purposes of enhancing income and total
return. The derivative securities are marked-to-market with valuation changes
reported as investment gains and losses. CNA's investment in, and risk in
relation to, derivative securities are not significant.
The general account portfolio consists primarily of high quality (BBB or
higher) marketable fixed maturity securities, approximately 94% of which are
rated as investment grade. At September 30, 1997, tax exempt securities and
short-term investments, excluding collateral for securities sold under
repurchase agreements, comprised approximately 13% and 15%, respectively, of the
general account's total investment portfolio compared to 14% and 16%,
respectively, at December 31, 1996. Historically, CNA has maintained short-term
assets at a level that provided for liquidity to meet its short-term
obligations, as well as reasonable contingencies and anticipated claim payout
patterns. At September 30, 1997, the major components of the short-term
investment portfolio consist primarily of high grade commercial paper and U.S.
Treasury bills. Collateral for securities sold under repurchase agreements
increased $1,084.8 million from December 31, 1996 to $1,185.3 million at
September 30, 1997.
As of September 30, 1997, the market value of CNA's general account
investments in fixed maturities was $28.2 billion and was greater than amortized
cost by approximately $385.0 million. This compares to a market value of $27.7
billion and $181.0 million of net unrealized investment gains at December 31,
1996. The gross unrealized investment gains and losses for the fixed maturity
securities portfolio at September 30, 1997, were $507.5 and $122.5 million,
respectively, compared to $443.8 and $262.8 million, respectively, at December
31, 1996. The increase in unrealized investment gains is attributable, in large
part, to decreases in interest rates which have a positive effect on bond
values.
Net unrealized investment gains on general account fixed maturities at
September 30, 1997 include net unrealized investment losses on high yield
securities of $25.3 million, compared to net unrealized investment gains of
$41.0 million at December 31, 1996. High yield securities are bonds rated as
below investment grade by bond rating agencies, plus private placements and
other unrated securities which, in the opinion of management, are below
investment grade (below BBB). Fair values of high yield securities in the
general account were $1.8 billion at September 30, 1997 as compared to $2.0
billion at December 31, 1996.
At September 30, 1997, total Separate Account business cash and investments
amounted to approximately $5.9 billion with taxable fixed maturity securities
representing approximately 83% of the Separate Accounts' portfolio.
Approximately 75% of Separate Account investments are used to fund guaranteed
investments for which CNA's life insurance affiliate guarantees principal and a
specified return to the contract holders. The duration of fixed maturity
securities included in the guaranteed investment portfolio are matched
approximately with the corresponding payout pattern of the guaranteed investment
contracts. The fair value of all fixed maturity securities in the guaranteed
investment portfolio was $4.0 billion at September 30, 1997 compared to $3.8
billion at December 31, 1996. At September 30, 1997, fair value was greater than
amortized cost by approximately $42.6 million. This compares to an unrealized
loss of approximately $0.7 million at December 31, 1996. The gross unrealized
investment gains and losses for the guaranteed investment fixed maturity
Page 48
securities portfolio at September 30, 1997 were $66.0 and $23.4 million,
respectively, compared to $55.0 and $55.7 million, respectively, at December 31,
1996.
The carrying value of high yield securities in the guaranteed investment
portfolio was $543.4 million at September 30, 1997 and approximated market
value, compared to $472.0 million at December 31, 1996. Net unrealized
investment losses on such high yield securities were $6.0 million at December
31, 1996.
High yield securities (below BBB) generally involve a greater degree of risk
than that of investment grade securities. Expected returns should, however,
compensate for the added risk. The risk is also considered in the interest rate
assumptions in the underlying insurance products. At September 30, 1997, CNA's
investment in high yield bonds, including Separate Accounts, was approximately
4.0% of its total assets. In addition, CNA's investment in mortgage loans and
investment real estate are substantially below the industry average,
representing less than one quarter of one percent of its total assets.
Included in CNA's fixed maturity securities at September 30, 1997 (general and
guaranteed investment portfolios) are $7.3 billion of asset-backed securities,
consisting of approximately 54.0% in collateralized mortgage obligations
("CMO's"), 9.0% in corporate asset-backed obligations, and 37.0% in U.S.
government issued pass-through certificates. The majority of CMO's held are U.S.
government agency issues, which are actively traded in liquid markets and are
priced monthly by broker-dealers. At September 30, 1997, the fair value of
asset-backed securities was more than amortized cost by approximately $90.7
million, compared to net unrealized investment losses of $5.0 million at
December 31, 1996. CNA limits the risks associated with interest rate
fluctuations and prepayment by concentrating its CMO investments in early
planned amortization classes with relatively short principal repayment windows.
Over the last few years, much concern has been raised regarding the quality of
insurance company invested assets. At September 30, 1997, 47.0% of the general
account's fixed maturity securities portfolio was invested in U.S. government
securities, 30.0% in other AAA rated securities and 12.0% in AA and A rated
securities. CNA's guaranteed investment portfolio includes fixed maturity
securities which are comprised of 2.0% U.S. government securities, 61.0% in
other AAA rated securities and 13.0% in AA and A rated securities. These ratings
are primarily from Standard and Poor's.
CNA, its subsidiaries and Separate Accounts, invest from time to time in
certain derivative financial instruments to increase investment returns and to
reduce the impact of changes in interest rates on certain corporate borrowings.
Financial instruments used for such purposes include interest rate swaps, put
and call options, commitments to purchase securities, futures and forwards.
The fair values associated with these instruments are generally affected by
changes in interest rates and the stock market. The credit exposure associated
with these instruments is generally limited to the unrealized fair value of the
instruments and will vary based on changes in market prices. The risk of default
depends on the creditworthiness of the counterparty to the instrument.
The fair value of derivatives generally reflects the estimated amounts that
CNA would receive or pay upon termination of the contracts at the reporting
date. Dealer quotes are available for substantially all of CNA's derivatives.
For securities not actively traded, fair values are estimated using values
obtained from independent pricing services, costs to settle, or quoted market
prices of comparable instruments.
Unrealized investment gains and losses on derivative securities, except for
Page 49
the interest rate swaps associated with corporate borrowings, are reflected as
part of investment gains and losses in the income statement. Unrealized gains or
losses related to changes in the value of the interest rate swaps associated
with corporate borrowings are not recognized.
One Separate Account product is an indexed group annuity contract for
institutional investors which guarantees the S&P 500 rate of return plus 25
basis points. Deposits are taken for a 3 year period with no payout until the
end of the period. CNA hedges the contract liability by purchasing S&P 500
futures contracts in a notional amount equal to the original deposit and
investing the remaining cash in a variety of short term strategies. The futures
contracts are rolled quarterly, and the number of contracts is adjusted
periodically to approximate the future liability to the customer. As of
September 30, 1997, CNA held 1,303 S&P 500 futures contracts with a notional
value of $622 million. This position hedged a liability to depositors in a
nearly equal amount.
Other
- -----
Investment activities of non-insurance companies include investments in fixed
maturities securities, equity securities, derivative instruments and short-term
investments. Equity securities which are considered part of the Company's
trading portfolio, and derivative instruments are marked-to-market and reported
as investment gains or losses in the income statement. The remaining securities
are carried at fair value with net unrealized losses of $7.9 and $22.4 million
at September 30, 1997 and December 31, 1996, respectively.
The Company invests in certain derivative instruments for income enhancements
as part of its portfolio management strategy. These instruments include various
swaps, forwards and futures contracts as well as both purchased and written
options. These investments subject the Company to market risk for positions
where the Company does not hold an offsetting security. The Company controls
this risk through monitoring procedures which include daily detailed reports of
existing positions and valuation fluctuations. These reports are reviewed by
members of senior management to ensure that open positions are consistent with
the Company's portfolio strategy.
The credit exposure associated with these instruments is generally limited to
the positive market value of the instruments and will vary based on changes in
market prices. The Company enters into these transactions with large financial
institutions and considers the risk of nonperformance to be remote.
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex or volatile, nor do these instruments contain
imbedded leverage features which would expose the Company to a higher degree of
risk. See "Results of Operations -- Other," below, for information with respect
to the impact of derivative instruments on results of operations. See Note 4 of
the Notes to Consolidated Financial Statements in the 1996 Annual Report on Form
10-K for additional information with respect to derivative instruments.
Page 50
Results of Operations:
- ----------------------
Revenues decreased by $104.9 and $505.8 million, or 2.0% and 3.3%, and net
income decreased by $191.0 and $635.4 million, or 49.2% and 55.9%, respectively,
for the quarter and nine months ended September 30, 1997 as compared to the
prior year. The following table sets forth the major sources of the Company's
consolidated revenues and net income.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------------
1997 1996 1997 1996
-----------------------------------------------------
(In millions)
<S> <C> <C> <C> <C>
Revenues (a):
Property and casualty insurance ....... $3,286.7 $3,246.0 $ 9,618.7 $ 9,693.0
Life insurance ........................ 1,029.8 1,012.5 3,059.4 2,993.1
Cigarettes ............................ 648.9 594.2 1,769.7 1,671.3
Hotels ................................ 57.3 52.7 164.3 148.4
Offshore drilling ..................... 256.4 178.0 698.0 435.8
Watches and clocks .................... 34.4 34.7 92.3 84.2
Investment income-net (non-insurance
companies) ........................... (198.4) 106.3 (592.6) 300.6
Other and eliminations-net ............ (3.7) (8.1) (10.2) (21.0)
----------------------------------------------------
$5,111.4 $5,216.3 $14,799.6 $15,305.4
====================================================
Net income (a):
Property and casualty insurance ....... $ 199.9 $ 172.7 $ 484.3 $ 554.4
Life insurance ........................ 45.8 38.3 122.9 133.2
Cigarettes ............................ 72.4 124.3 275.4 315.4
Hotels ................................ 6.6 3.4 15.7 5.1
Offshore drilling ..................... 36.4 12.9 93.8 33.4
Watches and clocks .................... 3.0 3.8 5.7 5.1
Investment income-net (non-insurance
companies) ........................... (129.8) 67.8 (390.4) 192.9
Corporate interest expense ............ (17.2) (18.2) (49.6) (53.0)
Unallocated corporate expense and
other-net ............................ (19.5) (16.4) (57.1) (50.4)
----------------------------------------------------
$ 197.6 $ 388.6 $ 500.7 $ 1,136.1
====================================================
Page 51
(a) Includes investment (losses) gains as follows:
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------
1997 1996 1997 1996
----------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Property and casualty insurance ....... $ 192.6 $ 71.6 $ 338.6 $351.4
Life insurance ........................ 48.1 32.6 120.6 134.6
Investment income-net ................. (239.2) 62.2 (724.3) 170.6
----------------------------------------------------
$ 1.5 $166.4 $(265.1) $656.6
====================================================
Net income:
Property and casualty insurance ....... $ 106.7 $ 44.0 $ 186.2 $195.7
Life insurance ........................ 24.6 18.6 61.5 66.5
Investment income-net ................. (155.1) 40.0 (472.4) 110.9
----------------------------------------------------
$ (23.8) $102.6 $(224.7) $373.1
====================================================
</TABLE>
Insurance
- ---------
Property and casualty revenues, excluding investment gains, decreased by $80.3
and $61.5 million, or 2.5% and 0.7%, for the quarter and nine months ended
September 30, 1997, as compared to the same period a year ago.
Property and casualty premium revenues decreased by $104.0 and $90.5 million,
or 4.0% and 1.2%, for the quarter and nine months ended September 30, 1997, from
the prior year's comparable period. The decrease is due primarily to a reduction
in premium in the involuntary risk business, primarily workers' compensation, of
$70 and $285 million for the quarter and nine months ended September 30, 1997,
compared with the same periods in the prior year. These reductions are a result
of improved loss experience in the involuntary risk business. Net investment
income decreased by $13.2 and $41.8 million, or 3.0% and 3.0%, for the quarter
and nine months ended September 30, 1997, compared with the same periods in the
prior year. The decrease reflects reduced operating cash flow and a movement to
lower market yields. The fixed maturities segment of the investment portfolio
yielded 6.3% in the nine months of 1997 compared with 6.6% for the same period a
year ago.
Life insurance revenues, excluding investment gains, increased by $1.8 and
$80.3 million, or 0.2%,and 2.8%, as compared to the same period a year ago. Life
premium revenues increased by $5.0 and $72.5 million, or 0.6% and 2.9%, for the
quarter and nine months ended September 30, 1997. Individual life operations
increased approximately $45.0 million due to continued growth in sales and
renewal premiums in the Viaterm life product. Group life operations increased
approximately $80 million with increases in the Federal Employees Health Benefit
Program, group medical, and specialty risks. The increase in premiums for these
products is primarily offset by a drop in group reinsurance premium. Life net
investment income increased $2.6 and $10.5 million, or 2.6% and 3.6%, for the
quarter and nine months ended September 30, 1997, compared to the same periods a
year ago, due to a larger asset base generated from increased operating cash
flows. The fixed maturities segment, which is the primary investment segment, of
the life investment portfolio yielded 6.3% in the first nine months of 1997
compared with 6.7% for the same period a year ago.
Property and casualty underwriting losses for the quarter and nine months
Page 52
ended September 30, 1997 were $273.4 and $843.8 million, compared to $249.0 and
$783.0 million for the same period in 1996. The GAAP combined ratio for the nine
months ended September 30, 1997 was 108.9% as compared to 108.6% for the
comparable period in 1996. GAAP expense ratios were 29.9% and 31.0% for the nine
months ended September 30, 1997 and 1996, respectively. There was profitability
improvement in the personal insurance lines, both in the private passenger and
homeowner lines. However, continued competitive pressures on virtually all other
segments of the insurance market, particularly in the commercial insurance
market, resulted in continued deterioration of the loss ratio. Pre-tax
catastrophe losses were approximately $78.5 million for the nine months ended
September 30, 1997 as compared to $280.2 million in 1996.
CNA, consistent with sound insurance reserving practices, regularly adjusts
its reserve estimates in subsequent reporting periods as new facts and
circumstances emerge that indicate the previous estimates need to be modified.
These adjustments, referred to as "reserve development" are inevitable given the
complexities of the reserving process and are recorded in the income statement
in the period the need for the adjustments becomes apparent.
Loss and loss adjustment expense reserve development for the nine months ended
September 30, 1997 and 1996 was favorable and aggregated $297 and $142 million,
respectively (including the effects of unfavorable reserve development for
asbestos related claims - see Note 6 of the Notes to Consolidated Condensed
Financial Statements). Favorable loss reserve development was partially offset
by unfavorable premium development, which aggregated $165 and $21 million for
the nine months ended September 30, 1997 and 1996, respectively. Loss reserve
development for the nine months ended September 30, 1997 reflects continued
favorable claim frequency (rate of claim occurrence) and severity (average cost
per claim) experience, principally in the workers' compensation line of business
as well as favorable experience in the surety line of business. In addition,
involuntary risk exposures have developed to be less than previously
anticipated, which reduced both premium and losses associated with the residual
market pool participation, principally for workers' compensation. These trends
reflect the positive effects of changes in workers' compensation laws, moderate
increases in medical costs and a generally strong economy in which individuals
return to the workplace more quickly.
The components of CNA's investment gains are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------
1997 1996 1997 1996
--------------------------------------------------
(In millions)
<S> <C> <C> <C> <C>
Bonds:
U.S. Government ....................... $ 54.2 $(10.4) $103.2 $102.0
Tax exempt ............................ 23.8 64.2 26.0 109.0
Asset-backed .......................... 8.3 1.8 17.5 23.1
Taxable ............................... 18.2 4.0 102.2 13.5
--------------------------------------------------
Total bonds ........................ 104.5 59.6 248.9 247.6
Stocks .................................. 17.9 19.0 57.2 148.2
Derivative instruments .................. 2.3 (.7) 1.6 11.3
Separate Accounts and other (1) ......... 112.3 31.4 167.3 80.0
--------------------------------------------------
Total investment gains ............. $237.0 $109.3 $475.0 $487.1
==================================================
(1) Includes $88.8 for the three and nine months ended September 30, 1997 from issuance of subsidiary's
stock. See Note 7 of the Notes to Consolidated Condensed Financial Statements.
Page 53
</TABLE>
CNA's primary property and casualty subsidiary, Continental Casualty Company,
is party to litigation with Fibreboard Corporation involving coverage for
certain asbestos-related claims and defense costs (see Note 6 of the Notes to
Consolidated Condensed Financial Statements).
Cigarettes
- ----------
Revenues increased by $54.7 and $98.4 million, or 9.2% and 5.9%, and net
income decreased by $51.9 and $40.0 million, or 41.8% and 12.7%, respectively,
for the quarter and nine months ended September 30, 1997 as compared to the
corresponding periods of the prior year.
The increase in revenues is primarily composed of an increase of approximately
$32.9 and $50.5 million, or 5.6% and 3.1%, due to higher unit sales volume and
an increase of approximately $21.0 and $52.8 million, or 3.6% and 3.2%,
reflecting higher average unit prices for the quarter and nine months ended
September 30, 1997, respectively, as compared to the prior year. These increases
were partially offset by lower investment income for the nine months ended
September 30, 1997. Net income decreased by $67.0 million for the quarter and
nine months ended September 30, 1997 as a result of the settlement of tobacco
litigation in Mississippi and Florida. In addition, net income declined due to
increased legal expenses, partially offset by the improved revenues.
Virtually all of Lorillard's sales are in the full price brand category.
Discount brand sales have decreased from an average of 37% of industry sales
during 1993 to an average of 28% during 1996. At September 30, 1997, they
represented 27.2% of industry sales.
Hotels
- ------
Revenues increased by $4.6 and $15.9 million, or 8.7% and 10.7%, and net
income increased by $3.2 and $10.6 million for the quarter and nine months ended
September 30, 1997, as compared to the prior year, due primarily to improved
occupancy rates at the Loews Monte Carlo hotel, as well as higher average room
rates at Loews Hotels New York properties.
Offshore drilling
- -----------------
Revenues increased by $78.4 and $262.2 million and net income increased by
$23.5 and $60.4 million, respectively, for the quarter and nine months ended
September 30, 1997, as compared to the prior year.
Revenues from semisubmersible rigs increased by $71.7 and $225.6 million, or
40.3% and 51.8%, for the quarter and nine months ended September 30, 1997. These
increases reflect additional revenues ($60.5 million for the nine months ended
September 30, 1997) from eight semisubmersible rigs acquired through Arethusa,
higher dayrates ($50.9 and $107.8 million) recognized by semisubmersible rigs
located in the North Sea and the Gulf of Mexico, and increased utilization
($19.0 and $57.8 million) resulting primarily from the completion of major
upgrades on three drilling rigs. Revenues from jackup rigs increased by $12.1
and $54.3 million, or 6.8% and 12.5%, due to additional rigs acquired through
Arethusa ($13.0 million for the nine months ended September 30, 1997) and
improvements in dayrates in the Gulf of Mexico ($13.9 and $42.8 million).
Net income for the quarter and nine months ended September 30, 1997 increased
due primarily to the higher revenues discussed above, partially offset by
Page 54
increased operating costs and depreciation expense related to the drilling rigs
acquired from Arethusa, and an increased provision for minority interest as a
result of the dilutive effect to the Company of Diamond Offshore's issuance of
common stock in April 1996 and May 1997.
Watches and clocks
- ------------------
Revenues decreased by $0.3 and increased $8.1 million and net income decreased
by $0.8 and increased $0.6 million, respectively, for the quarter and nine
months ended September 30, 1997 as compared to the prior year.
Revenues decreased for the quarter ended September 30, 1997 due primarily to a
credit of $0.4 million recorded in the third quarter of 1996 related to an
adjustment of employee benefit liabilities. Revenues also declined as a result
of lower watch sales volume, partially offset by increased watch unit prices.
Revenues increased for the nine months ended September 30, 1997 due primarily to
increased watch unit prices and sales volume, partially offset by the $0.4
million credit recorded in the prior year.
Net income decreased for the quarter ended September 30, 1997 due primarily to
credits amounting to $1.1 million recorded in the third quarter of 1996 related
to employee benefits adjustments. In addition watch unit sales volume declined,
partially offset by an improved product sales mix. Net income increased for the
nine months ended September 30, 1997 due primarily to the increased revenues
discussed above, partially offset by the credits recorded in 1996 and higher
brand support advertising in 1997.
Other
- -----
Revenues decreased by $300.3 and $882.4 million and net loss increased by
$199.7 and $586.6 million, respectively, for the quarter and nine months ended
September 30, 1997 as compared to the prior year.
Page 55
The components of investment (losses) gains included in Investment income-net
are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
-------------------------------------
(In millions)
<S> <C> <C> <C> <C>
Revenues:
Derivative instruments (1) ............ $(187.7) $ 39.7 $(568.4) $(63.2)
Gain on issuance of subsidiary's stock 29.1 186.6
Equity securities, including short
positions ............................ (46.1) 1.1 (195.4) 16.7
Other ................................. (5.4) 21.4 10.4 30.5
-----------------------------------
(239.2) 62.2 (724.3) 170.6
Income tax benefit (expense) ............ 83.8 (21.6) 253.5 (59.5)
Minority interest ....................... .3 (.6) (1.6) (.2)
-----------------------------------
Net (loss) income .................. $(155.1) $ 40.0 $(472.4) $110.9
===================================
</TABLE>
(1) Includes losses on equity index futures and options aggregating $202.5,
$9.2, $588.7 and $119.3 for the quarter and nine months ended September
30, 1997 and 1996, respectively. The Company has continued to maintain
these positions and, since September 30, 1997, has experienced positive
investment results from its open contracts on these equity index
positions.
Exclusive of securities transactions, revenues increased $1.1 and $12.5
million, or 3.1% and 11.5%, for the quarter and nine months ended September 30,
1997 due primarily to increased investment interest income. Net loss increased
by $4.6 and $3.3 million for the quarter and nine months ended September 30,
1997 due primarily to a lower allocation of parent company charges, partially
offset by increased investment income and lower corporate interest expense.
Accounting Standards
- --------------------
In January 1997, the Securities and Exchange Commission expanded existing
disclosure requirements with respect to certain derivative instruments. The new
rules require enhanced descriptions in the accounting policies footnote to the
financial statements and also require qualitative and quantitative disclosure
outside the financial statements regarding market risk related to derivative
instruments. The rules are effective for fiscal years ended after June 15, 1997
and will not have a significant impact on the Company.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings per Share." This Statement establishes standards for
computing and presenting earnings per share ("EPS"), which simplifies the
computations originally established in APB Opinion No. 15, and makes them
Page 56
comparable to international EPS standards. It replaces the presentation of
primary EPS with basic EPS, which excludes the concept of common stock
equivalents. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures
and requires a reconciliation between the two computations. This Statement is
effective for financial statements issued for periods ending after December 15,
1997 and will not have an impact on the Company.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure," which codifies standards for disclosing information
about an entity's capital structure. This Statement has no impact on the
Company.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes accounting standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. This
Statement is effective for fiscal years beginning after December 15, 1997. This
Statement will not have a significant impact on the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
interim and annual financial statements. It requires that those enterprises
report a measure of segment profit or loss, certain specific revenue and expense
items, and segment assets, and that the enterprises reconcile the total of those
amounts to the general-purpose financial statements. It also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. This Statement is effective for financial statements for
periods beginning after December 15, 1997 and will affect the Company's segment
disclosure.
Forward-Looking Information
- ---------------------------
When included in this Report, the words "expects," "intends," "anticipates,"
"estimates," and analogous expressions are intended to identify forward-looking
statements. Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
projected. Such risks and uncertainties include, among others, general economic
and business conditions, competition, changes in financial markets (credit,
currency, commodities and stocks), changes in foreign, political, social and
economic conditions, regulatory initiatives and compliance with governmental
regulations, judicial decisions and rulings in smoking and health litigation,
changes in foreign and domestic oil and gas exploration and production activity,
customer preferences and various other matters, many of which are beyond the
Company's control. These forward-looking statements speak only as of the date of
this Report. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any
statement is based.
Page 57
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
-----------------
1. CNA is involved in various lawsuits in the ordinary course of business.
Information involving such lawsuits is incorporated by reference to Note 6 of
the Notes to Consolidated Condensed Financial Statements in Part I.
2. Lorillard is involved in various lawsuits involving tobacco products
seeking damages for cancer and other health effects claimed to have resulted
from the use of cigarettes or from exposure to tobacco smoke. Information
involving such lawsuits is incorporated by reference to Note 6 of the Notes to
Consolidated Condensed Financial Statements in Part I.
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits--
(3.01) By-Laws
(27) Financial Data Schedule for the nine months ended September 30,
1997.
(b) Current reports on Form 8-K--
The Company filed a report on Form 8-K on August 25, 1997 stating that
together with other companies in the United States tobacco industry, the
Company's subsidiary, Lorillard Tobacco Company, entered into a Settlement
Agreement with the State of Florida to settle and resolve with finality all
present and future economic claims by the State and its subdivisions relating to
the use of or exposure to tobacco products.
The Company filed a report on Form 8-K on September 16, 1997 stating it had
entered an agreement to sell $1,000,000,000 principal amount of its 3 1/8%
exchangeable subordinated notes due September 15, 2007 and granted a 30-day
option to the underwriters to purchase up to an additional $150,000,000
principal amount of the notes to cover over-allotments.
The Company also filed a report on Form 8-K on September 19, 1997 stating that
it had completed the sale of $1,150,000,000 principal amount of its 3 1/8%
exchangeable subordinated notes due September 15, 2007.
Page 58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
LOEWS CORPORATION
-----------------
(Registrant)
Dated: November 14, 1997 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
(Duly authorized officer
and principal financial
officer)
Page 59
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 409,200
<SECURITIES> 41,075,100
<RECEIVABLES> 14,139,000
<ALLOWANCES> 307,500
<INVENTORY> 278,900
<CURRENT-ASSETS> 0
<PP&E> 3,743,100
<DEPRECIATION> 1,250,200
<TOTAL-ASSETS> 70,521,700
<CURRENT-LIABILITIES> 0
<BONDS> 5,727,100
0
0
<COMMON> 115,000
<OTHER-SE> 9,186,600
<TOTAL-LIABILITY-AND-EQUITY> 70,521,700
<SALES> 1,841,400
<TOTAL-REVENUES> 14,799,600
<CGS> 770,100
<TOTAL-COSTS> 11,114,600
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 239,400
<INCOME-PRETAX> 1,044,200
<INCOME-TAX> 330,400
<INCOME-CONTINUING> 500,700
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 500,700
<EPS-PRIMARY> 4.35
<EPS-DILUTED> 0
</TABLE>
