================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 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)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Common Stock, par value $1.00 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X].
Indicate by check mark whether the registrant (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
-------- --------
As at March 13, 1998, 115,000,000 shares of Common Stock of the Registrant
were outstanding and the aggregate market value of voting stock held by
non-affiliates was approximately $7,729,582,000.
Documents Incorporated by Reference:
Portions of the Loews Corporation Notice of Annual Meeting of Stockholders and
Proxy Statement dated March 26, 1998 are incorporated by reference into Part
III. (Registrant intends to file a definitive proxy statement with the
Commission prior to April 30, 1998.)
================================================================================
1
LOEWS CORPORATION
INDEX TO ANNUAL REPORT ON
FORM 10-K FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
For the Year Ended December 31, 1997
<TABLE>
<CAPTION>
Item Page
No. PART I No.
- ---- ----
<S> <C> <C>
1 BUSINESS ............................................................ 3
CNA Financial Corporation ......................................... 3
Lorillard, Inc. ................................................... 13
Loews Hotels Holding Corporation .................................. 24
Diamond Offshore Drilling, Inc. ................................... 25
Bulova Corporation ................................................ 28
Other Interests ................................................... 28
2 PROPERTIES .......................................................... 29
3 LEGAL PROCEEDINGS ................................................... 29
4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................. 46
EXECUTIVE OFFICERS OF THE REGISTRANT ................................ 46
PART II
5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS ............................................................ 46
6 SELECTED FINANCIAL DATA ............................................. 47
7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS .............................................. 48
7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .......... 71
8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ......................... 74
9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE ............................................... 116
PART III
Information called for by Part III has been omitted as Registrant
intends to file with the Securities and Exchange Commission not later
than 120 days after the close of its fiscal year a definitive Proxy
Statement pursuant to Regulation 14A.
PART IV
14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ..... 116
</TABLE>
2
PART I
Item 1. Business.
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property, casualty and life insurance (CNA
Financial Corporation, an 84% owned subsidiary); the production and sale of
cigarettes (Lorillard, Inc., a wholly owned subsidiary); the operation of hotels
(Loews Hotels Holding Corporation, a wholly owned subsidiary); the operation of
offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 50.3%
owned subsidiary); and the distribution and sale of watches and clocks (Bulova
Corporation, a 97% owned subsidiary).
Unless the context otherwise requires, the terms "Company" and "Registrant" as
used herein mean Loews Corporation excluding its subsidiaries.
Information relating to the major business segments from which the Company's
consolidated revenues and income are derived is contained in Note 19 of the
Notes to Consolidated Financial Statements, included in Item 8.
CNA FINANCIAL CORPORATION
CNA Financial Corporation ("CNA") was incorporated in 1967 as the parent
company of Continental Casualty Company ("CCC"), incorporated in 1897, and
Continental Assurance Company ("CAC") incorporated in 1911. In 1975, CAC became
a wholly owned subsidiary of CCC. On May 10, 1995, CNA acquired all the
outstanding common stock of The Continental Corporation ("CIC") and it became a
wholly owned subsidiary of CNA. CIC, a New York corporation incorporated in
1968, is an insurance holding company. Its principal subsidiary, The Continental
Insurance Company, was organized in 1853. The principal business of CIC is the
ownership of a group of property/casualty insurance companies.
CNA is a holding company whose primary subsidiaries consist of
property/casualty and life insurance companies, collectively CNA. CNA's
property/casualty insurance operations are conducted by CCC and its affiliates,
and CIC and its affiliates. Life insurance operations are conducted by CAC and
its life insurance affiliates. CNA's principal business is insurance conducted
through its insurance subsidiaries. As multiple-line insurers, CNA underwrites
property, casualty, life, and accident and health coverages as well as pension
products and annuities. CNA's principal market for insurance products is the
United States. CNA accounted for 84.79%, 83.33%, and 78.75% of the Company's
consolidated total revenue for the years ended December 31, 1997, 1996 and 1995,
respectively.
The following provides information regarding CNA's property/casualty insurance
and life insurance operations.
PROPERTY/CASUALTY INSURANCE
CNA's property/casualty group is comprised of commercial business, personal
lines of insurance, involuntary risks and other related businesses.
Customers of the commercial business include large national corporations,
small- and medium-sized businesses, groups and associations, and professionals.
Coverages are written primarily through traditional insurance contracts under
which risk is transferred to the insurer. Many large commercial account policies
are written under retrospectively-rated contracts which are experience-rated.
Premiums for such contracts may be adjusted, subject to limitations set by
contract, based on loss experience of the insureds. Other experience-rated
policies include provisions for dividends based on loss experience. Experience-
rated contracts reduce but do not eliminate risk to the insurer. Commercial
lines also includes reinsurance assumed from other insurance companies and
certain group accident and health insurance coverages.
Commercial business includes such lines as workers' compensation, general
liability and commercial automobile, professional and specialty, multiple peril,
and accident and health coverages as well as reinsurance. Professional and
specialty coverages include liability coverage for architects and engineers,
lawyers, accountants, medical and dental professionals; directors and officers
liability; and other specialized coverages. The major components of CNA's
property/casualty commercial business are professional and specialty coverages,
general liability and commercial automobile, and workers' compensation, which
accounted for 17%, 17% and 16%, respectively, of 1997 premiums earned.
The property/casualty group markets personal lines of insurance, primarily
automobile and homeowners coverages sold to individuals under monoline and
package policies.
3
CNA is required by the various states in which it does business to provide
coverage for risks that would not otherwise be considered under CNA's
underwriting standards. CNA's share of involuntary risks is mandatory and
generally a function of its share of the voluntary market by line of insurance
in each state. Involuntary risks include mandatory participation in residual
markets, statutory assessments for insolvencies of other insurers, and other
similar charges.
The property/casualty group also provides other related services including
loss control, policy administration and claim administration services under
service contracts for fees. Such services are provided primarily in the workers'
compensation market.
The following table sets forth supplemental data on a GAAP basis, except where
indicated, for the property/casualty business:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996
1995(a)
- --------------------------------------------------------------------------------
(In millions of dollars)
<S> <C> <C> <C>
Commercial Premiums Earned:
Professional and specialty ......... $ 1,688.0 $ 1,845.0 $ 1,558.0
General liability and commercial
automobile ........................ 1,682.0 1,754.0 1,649.0
Workers' compensation .............. 1,845.0 1,543.0 1,476.0
Reinsurance and other .............. 1,083.0 1,189.0 974.0
Multiple peril ..................... 1,058.0 1,047.0 870.0
Accident and health ................ 1,062.0 919.0 699.0
- --------------------------------------------------------------------------------
$ 8,418.0 $ 8,297.0 $ 7,226.0
================================================================================
Personal Premiums Earned:
Personal lines packages ............ $ 1,085.0 $ 1,063.0 $ 782.0
Monoline automobile and property
coverages ......................... 440.0 367.0 325.0
Accident and health ................ 126.0 106.0 108.0
- --------------------------------------------------------------------------------
$ 1,651.0 $ 1,536.0 $ 1,215.0
================================================================================
Involuntary Risks Premiums Earned (b):
Workers' compensation .............. $ (249.0) $ 198.0 $ 178.0
Private passenger automobile ....... 66.0 58.0 80.0
Commercial automobile .............. 25.0 36.0 20.0
Property and multiple peril ........ 16.0 2.0 6.0
- --------------------------------------------------------------------------------
$ (142.0) $ 294.0 $ 284.0
================================================================================
Net Investment and Other Income:
Commercial ......................... $ 2,172.0 $ 2,074.0 $ 1,713.0
Personal ........................... 209.0 222.0 231.0
Involuntary risks .................. 43.0 94.0 104.0
- --------------------------------------------------------------------------------
$ 2,424.0 $ 2,390.0 $ 2,048.0
================================================================================
Underwriting (Loss) Income:
Commercial ......................... $(1,421.0) $ (853.0) $ (921.0)
Personal ........................... 124.0 (184.0) (102.0)
Involuntary risks .................. 135.0 (106.0) (99.0)
- --------------------------------------------------------------------------------
$(1,162.0) $(1,143.0) $(1,122.0)
================================================================================
4
Trade Ratios-GAAP basis (c):
Loss ratio ........................ 77.1% 76.4% 77.9%
Expense ratio ...................... 31.3% 30.9% 29.4%
Combined ratio (before policyholder
dividends) ........................ 108.4% 107.3% 107.3%
Policyholder dividend ratio ........ .5% 1.6% 3.0%
Trade Ratios-Statutory basis (c):
Loss ratio ......................... 77.5% 76.8% 78.6%
Expense ratio ...................... 30.7% 30.6% 29.2%
Combined ratio (before policyholder
dividends) ........................ 108.2% 107.4% 107.8%
Policyholder dividend ratio ........ .8% 1.4% 2.1%
Other Data-Statutory basis (d):
Capital and surplus ................ $7,123.0 $6,349.0 $5,696.0
Written to surplus ratio ........... 1.4 1.6 1.7
- ----------------
(a) Premiums earned, net investment income and underwriting loss includes the
results of CIC since May 10, 1995.
(b) Property/casualty involuntary risks include mandatory participation in
residual markets, statutory assessments for insolvencies of other insurers and
other similar charges.
(c) GAAP trade ratios in 1995 reflect the results of CCC and its
property/casualty insurance subsidiaries for the entire year, along with the
results of CIC since May 10, 1995. Statutory trade ratios reflect the results of
CCC, and its property/casualty insurance subsidiaries and CIC since January 1,
1995. Trade ratios are industry measures of property/casualty underwriting
results. The loss ratio is the percentage of incurred claim and claim adjustment
expenses to premiums earned. Under generally accepted accounting principles, the
expense ratio is the percentage of underwriting expenses, including the change
in deferred acquisition costs, to premiums earned. Under statutory accounting
principles, the expense ratio is the percentage of underwriting expenses (with
no deferral of acquisition costs) to premiums written. The combined ratio is the
sum of the loss and expense ratios. The policyholder dividend ratio is the ratio
of dividends incurred to premiums earned.
(d) Other data is determined on the statutory basis of accounting. In
addition, dividends of $175.0, $545.0 and $325.0 million were paid to CNA by CCC
in 1997, 1996 and 1995, respectively. Property/casualty insurance subsidiaries
have received, or will receive, reimbursement from CNA for general management
and administrative expenses, unallocated loss adjustment expenses and investment
expenses of $199.0, $195.0 and $197.0 million in 1997, 1996 and 1995,
respectively.
</TABLE>
5
The following table displays the distribution of gross written premium:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
New York ............................... 9.9% 9.3% 10.3%
California ............................. 8.8 8.5 9.7
Texas .................................. 6.2 6.0 6.5
Pennsylvania ........................... 5.1 4.9 5.4
Florida ................................ 4.8 4.2 4.1
Illinois ............................... 4.4 5.3 5.2
New Jersey ............................. 4.3 4.1 4.6
All other states, countries or political
subdivisions (a) ...................... 48.0 46.8 44.4
Reinsurance assumed:
Voluntary ............................ 9.7 9.1 7.8
Involuntary .......................... (1.2) 1.8 2.0
- --------------------------------------------------------------------------------
100.0% 100.0% 100.0%
================================================================================
- ---------------
(a) No other state, country or political subdivision accounts for more than
3.0% of gross written premium.
</TABLE>
The following loss reserve development table illustrates the change over time
of reserves established for property/casualty claims and claims expense at the
end of various calendar years. The first section shows the reserves as
originally reported at the end of the stated year. The second section, reading
down, shows the cumulative amounts paid as of the end of successive years with
respect to that reserve liability. The third section, reading down, shows
reestimates of the original recorded reserve as of the end of each successive
year which is the result of CNA's property/casualty insurance subsidiaries'
expanded awareness of additional facts and circumstances that pertain to the
unsettled claims. The last section compares the latest reestimated reserve to
the reserve originally established, and indicates whether the original reserve
was adequate or inadequate to cover the estimated costs of unsettled claims.
The loss reserve development table is cumulative and, therefore, ending
balances should not be added since the amount at the end of each calendar year
includes activity for both the current and prior years.
6
<TABLE>
<CAPTION>
Schedule of Property/Casualty Loss Reserve Development
- --------------------------------------------------------------------------------------------------------------
Year Ended December 31 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
(a) (a) (a) (a) (a) (a) (a) (b) (c) (d)
- --------------------------------------------------------------------------------------------------------------
(In millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Gross reserves for
unpaid claim and
claim expenses ...... - - - 16,530 17,712 20,034 20,812 21,639 31,044 29,395 28,240
Ceded recoverable ..... - - - 3,440 3,297 2,867 2,491 2,705 6,089 5,660 4,995
- --------------------------------------------------------------------------------------------------------------
Net reserves for
unpaid claim and
claim expenses ....... 8,045 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245
Net Paid (Cumulative)
as of:
One year later ...... 1,763 2,040 2,670 3,285 3,411 3,706 3,629 3,656 6,510 5,851 -
Two years later ..... 2,961 3,622 4,724 5,623 6,024 6,354 6,143 7,087 10,485 - -
Three years later ... 4,031 4,977 6,294 7,490 7,946 8,121 8,764 9,195 - - -
Four years later .... 5,007 6,078 7,534 8,845 9,218 10,241 10,318 - - - -
Five years later .... 5,801 6,960 8,485 9,726 10,950 11,461 - - - - -
Six years later ..... 6,476 7,682 9,108 11,207 11,951 - - - - - -
Seven years later ... 7,061 8,142 10,393 12,023 - - - - - - -
Eight years later ... 7,426 9,303 11,086 - - - - - - - -
Nine years later .... 8,522 9,924 - - - - - - - - -
Ten years later ..... 9,097 - - - - - - - - - -
Net Reserves
Reestimated as of:
End of initial year . 8,045 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245
One year later ...... 8,086 9,737 11,336 12,984 16,032 17,757 18,250 18,922 24,864 23,479 -
Two years later ..... 8,345 9,781 11,371 14,693 16,810 17,728 18,125 18,500 24,294 - -
Three years later ... 8,424 9,796 13,098 15,737 16,944 17,823 17,868 18,008 - - -
Four years later .... 8,516 11,471 14,118 15,977 17,376 17,765 17,511 - - - -
Five years later .... 10,196 12,496 14,396 16,440 17,329 17,560 - - - - -
Six years later ..... 11,239 12,742 14,811 16,430 17,293 - - - - - -
Seven years later ... 11,480 13,167 14,810 16,551 - - - - - - -
Eight years later ... 11,898 13,174 14,995 - - - - - - - -
Nine years later .... 11,925 13,396 - - - - - - - - -
Ten years later ..... 12,203 - - - - - - - - - -
- --------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy ........... (4,158) (3,844) (3,728) (3,461) (2,878) (393) 810 926 661 256 -
==============================================================================================================
Reconciliation to
Gross Reestimated
Reserves:
Net reserves
reestimated ....... 12,203 13,396 14,995 16,551 17,293 17,560 17,511 18,008 24,294 23,479 -
Reestimated ceded
recoverable ....... - - - 2,939 2,672 2,085 1,904 2,405 6,560 6,108 -
- --------------------------------------------------------------------------------------------------------------
Total gross
reestimated reserves - - - 19,490 19,965 19,645 19,415 20,413 30,854 29,587 -
==============================================================================================================
Net (Deficiency)
Redundancy Related to:
Asbestos claims ..... (3,073) (3,017) (2,919) (2,785) (2,738) (1,049) (449) (414) (156) (105) -
Environmental claims (1,000) (997) (970) (960) (914) (869) (423) (243) (65) -
- --------------------------------------------------------------------------------------------------------------
Total asbestos and
environmental ...... (4,073) (4,014) (3,889) (3,745) (3,652) (1,918) (872) (657) (221) (105) -
Other ............... (85) 170 161 284 774 1,525 1,682 1,583 882 361 -
- --------------------------------------------------------------------------------------------------------------
Total net (deficiency)
redundancy ........... (4,158) (3,844) (3,728) (3,461) (2,878) (393) 810 926 661 256 -
==============================================================================================================
- ----------------
(a) Reflects reserves of CNA, excluding CIC reserves which were acquired on May
10, 1995. Accordingly, the reserve development (net reserves recorded at the end
of the year, as initially estimated, less net reserves reestimated as of
subsequent years) does not include CIC.
(b) Reserve development related to the 1994 reserves of CNA, excluding CIC, as
determined by the balances in this column, plus adverse reserve development of
$134 million related to the reserves of CIC, acquired on May 10, 1995, which are
not reflected in this column, were recorded by CNA in 1995 and subsequent
periods.
(c) Includes CIC gross reserves of $9.7 billion and net reserves of $6.1 billion
acquired on May 10, 1995 and subsequent development thereon.
(d) Includes gross reserves of acquired companies of $74 million.
</TABLE>
See Notes 1 and 9 of the Notes to Consolidated Financial Statements, included
in Item 8, for information regarding property/casualty claim and claim expenses
including reserve development for asbestos and environmental claims.
7
LIFE INSURANCE
CNA's life insurance operations market individual and group insurance products
through licensed agents, most of whom are independent contractors, who sell life
and/or group insurance for CNA and other companies on a commission basis.
Insurance products are also marketed through other distribution channels such as
banks, direct marketing and the Internet.
The individual insurance products consist primarily of term, universal life,
and fixed and variable annuity products. Group insurance products include life,
accident and health consisting primarily of major medical and hospitalization,
and pension products, such as guaranteed investment contracts and annuities.
CNA's life insurance products are designed and priced using assumptions CNA
management believes to be reasonably conservative for mortality, morbidity,
persistency, expense levels and investment results. Underwriting practices that
CNA management believes are prudent are followed in selecting the risks that
will be insured. Further, actual experience related to pricing assumptions is
monitored closely so that prospective adjustments to these assumptions may be
implemented as necessary. CNA mitigates the risk related to persistency by
including contractual surrender charge provisions in its ordinary life and
annuity policies in the first five to ten years, thus providing for the recovery
of acquisition expenses. The investment portfolios supporting interest sensitive
products, including universal life and individual annuities, are managed
separately to minimize surrender and interest rate risk.
Profitability in the health insurance business continues to be impacted by
intense competition and rising medical costs. CNA has pursued expense reduction
through increases in automation and other productivity improvements. Further,
increasing costs of health care have resulted in a continued market shift away
from traditional forms of health coverage toward managed care products and
experience-rated plans. CNA's ability to compete in this market will be
increasingly dependent on its ability to control costs through managed care
techniques, innovation, and quality customer-focused service in order to
properly position CNA in the evolving health care environment.
The following table sets forth supplemental data on a GAAP basis, except where
indicated, for the life insurance business:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(In millions of dollars)
<S> <C> <C> <C>
Individual Premiums:
Life and annuities .................. $ 642.0 $ 629.0 $ 497.0
Accident and health ................. 3.0 2.0 33.0
- --------------------------------------------------------------------------------
$ 645.0 $ 631.0 $ 530.0
================================================================================
Group Premiums:
Accident and health (a) ............. $2,527.0 $2,548.0 $2,190.0
Life and annuities .................. 263.0 195.0 313.0
- --------------------------------------------------------------------------------
$2,790.0 $2,743.0 $2,503.0
================================================================================
Net Investment Income and Other Income:
Individual .......................... $ 297.0 $ 292.0 $ 247.0
Group ............................... 236.0 214.0 198.0
- --------------------------------------------------------------------------------
$ 533.0 $ 506.0 $ 445.0
================================================================================
Operating Income Before Income Tax:
Individual .......................... $ 88.0 $ 101.0 $ 65.0
Group ............................... 65.0 70.0 95.0
- --------------------------------------------------------------------------------
$ 153.0 $ 171.0 $ 160.0
================================================================================
8
Gross Life Insurance in Force:
Individual (b) ...................... $239,843 $172,213 $113,901
Group ............................... 71,755 64,796 52,145
- --------------------------------------------------------------------------------
$311,598 $237,009 $166,046
================================================================================
Other Data-Statutory Basis (c):
Capital and surplus ................. $1,223.0 $1,163.0 $1,128.0
Capital and surplus-percent of total
liabilities ........................ 22.4% 25.5% 28.2%
Participating policyholders'-percent
of gross life insurance in force ... .7% .5% .6%
- --------------
(a) Group accident and health premiums including contracts involving U.S.
government employees and their dependents amounted to approximately $2.1, $2.1
and $1.9 billion in 1997, 1996 and 1995, respectively.
(b) Lapse ratios, for individual life insurance, as measured by surrenders and
withdrawals as a percentage of average ordinary life insurance in force, were
6.4%, 7.2% and 9.4% in 1997, 1996 and 1995, respectively.
(c) Other Data is determined on the basis of statutory accounting practices.
Life insurance subsidiaries have received reimbursement from CNA for general
management and administrative expenses and investment expenses of $18.0, $29.0
and $21.0 million in 1997, 1996 and 1995, respectively. Statutory capital and
surplus as a percent of total liabilities is determined after excluding Separate
Account liabilities and reclassifying the statutorily required Asset Valuation
and Interest Maintenance Reserves as surplus.
</TABLE>
Guaranteed Investment Contracts
CAC writes the majority of its group pension products as guaranteed investment
contracts in a fixed Separate Account, which is permitted by Illinois insurance
statutes. CAC guarantees principal and a specified return to guaranteed
investment contract holders. This guarantee affords the contract holders
additional security, in the form of CAC's general account surplus.
CNA manages the liquidity and interest rate risks on the guaranteed investment
contract portfolio by managing the duration of fixed maturity securities
included in the investment portfolio supporting the guaranteed investment
contracts with the corresponding payout pattern of the contracts, and assessing
market value surrender charges on the majority of the contracts.
9
The table below shows a comparison of the duration of assets and contracts,
weighted average investment yield, weighted average interest crediting rates and
withdrawal characteristics of the guaranteed investment contract portfolio.
<TABLE>
<CAPTION>
December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Duration in years:
Assets ............................. 3.74 3.12 3.12
Contracts .......................... 3.63 3.16 2.98
- --------------------------------------------------------------------------------
Difference ...................... .11 (.04) .14
================================================================================
Weighted average investment yield .... 6.81% 7.44% 7.58%
================================================================================
Weighted average interest crediting
rates ............................... 6.78% 7.32% 7.45%
================================================================================
Withdrawal Characteristics:
With market value adjustment ....... 97% 95% 92%
Non-withdrawable ................... 3 5 8
- --------------------------------------------------------------------------------
Total ........................... 100% 100% 100%
================================================================================
</TABLE>
As shown above, the weighted average investment yields at December 31, 1997,
1996 and 1995 were more than the weighted average interest crediting rates.
During 1997, general market interest rates were lower which led to an increase
in the market value of CNA's fixed maturity securities. As a result of this
increase, CNA was able to realize significant capital gains on its investment
portfolio. However, the interest rates on fixed maturity securities purchased in
this market had a lower yield which led to a narrowing of the spread between
investment yields and crediting rates.
INVESTMENTS
See Note 2 of the Notes to Consolidated Financial Statements, included in Item
8, for information regarding the investment portfolio.
OTHER
Competition: All aspects of the insurance business are highly competitive. CNA
competes with a large number of stock and mutual insurance companies and other
entities for both producers and customers and must continuously allocate
resources to refine and improve insurance products and services. There are
approximately 3,400 individual companies that sell property/casualty insurance
in the United States. CNA's consolidated property/casualty subsidiaries ranked
as the third largest property/casualty insurance organization based upon 1996
statutory net written premium. There are approximately 1,700 companies selling
life insurance in the United States. CAC is ranked as the twenty-second largest
life insurance organization based on 1996 consolidated statutory premium volume.
Dividends by Insurance Subsidiaries: The payment of dividends to CNA by its
insurance affiliates (without prior approval) of the affiliates' domiciliary
state insurance commissioners is limited to amounts determined by formula in
accordance with the accounting practices prescribed or permitted by the states'
insurance departments. This formula varies by state. The formula for the
majority of states is the greater of 10% of prior year statutory surplus or
prior year statutory net income, less the aggregate of all dividends paid during
the twelve months prior to the date of payment. Some states, however, have an
additional stipulation that dividends cannot exceed the prior year's surplus.
Based upon the various state formulas, approximately $677.0 million in dividends
can be paid to CNA by its insurance affiliates in 1998 without prior approval.
All dividends must be reported to the domiciliary insurance department prior to
declaration and payment.
10
Regulation: The insurance industry is subject to comprehensive and detailed
regulation and supervision throughout the United States. Each state has
established supervisory agencies with broad administrative powers relative to
licensing insurers and agents, approving policy forms, establishing reserve
requirements, fixing minimum interest rates for accumulation of surrender values
and maximum interest rates of policy loans, prescribing the form and content of
statutory financial reports, regulating solvency and the type and amount of
investments permitted. Regulatory powers also extend to premium rate regulations
which require that rates not be excessive, inadequate or unfairly
discriminatory. In addition to regulation of dividends by insurance subsidiaries
discussed above, intercompany transfers of assets may be subject to prior notice
or approval, depending on the size of such transfers and payments in relation to
the financial position of the insurance affiliates making the transfer.
Insurers are also required by the states to provide coverage to insureds who
would not otherwise be considered eligible by the insurers. Each state dictates
the types of insurance and the level of coverage which must be provided to such
involuntary risks. CNA's share of these involuntary risks is mandatory and
generally a function of its share of the voluntary market by line of insurance
in each state.
Reform of the nation's tort reform system is another issue facing the
insurance industry. Although federal standards would create more uniform laws,
tort reform supporters still look primarily to the states for passage of reform
measures. Over the last decade, many states have passed some type of reform, but
more recently, state courts have modified or overturned a significant number of
these reforms. Additionally, new causes of action and theories of damages are
more frequently proposed in state courts or legislatures. Continued
unpredictability in the law means that insurance underwriting and rating is
difficult in commercial lines, professional liability, and some specialty
coverages.
Environmental clean-up remains the subject of both federal and state
regulation. Last year Congress and the Clinton Administration failed to reach an
agreement on efforts to overhaul the federal Superfund hazardous waste program.
The legislative stalemate was the result of a failure by Superfund stakeholders
and Congress to reach a compromise on clean-up standards, the repeal of
retroactive liability and methodology for financing future clean-up costs.
Although Superfund reform continues to be listed as one of Congress' legislative
priorities, at this time CNA cannot predict if any reform will be enacted. 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 concerning clean-up of hazardous waste. Judicial interpretations
in many cases have expanded the scope of coverage and liability beyond the
original intent of the policies. See Note 9 of the Notes to Consolidated
Financial Statements, included in Item 8, for further discussion.
In recent years, increased scrutiny of state regulated insurer solvency
requirements by certain members of the U.S. Congress, resulted in the National
Association of Insurance Commissioners developing industry minimum Risk-Based
Capital ("RBC") requirements. The RBC requirements establish a formal state
accreditation process designed to more closely regulate for solvency, minimize
the diversity of approved statutory accounting and actuarial practices, and
increase the annual statutory statement disclosure requirements.
11
The RBC formulas are designed to identify an insurer's minimum capital
requirements based upon the inherent risks (e.g., asset default, credit and
underwriting) of its operations. In addition to the minimum capital
requirements, the RBC formula and related regulations identify various levels of
capital adequacy and corresponding actions that the state insurance departments
should initiate. The level of capital adequacy below which insurance departments
would take action is defined as the Company Action Level. As of December 31,
1997, all of CNA's property/casualty and life insurance affiliates have adjusted
capital amounts in excess of Company Action Levels.
Reinsurance: See Notes 1 and 17 of the Notes to Consolidated Financial
Statements, included in Item 8, for information related to CNA's reinsurance
business.
Properties: CNA Plaza serves as the executive office for CNA and its insurance
subsidiaries. An adjacent building (located at 55 E. Jackson Blvd.) is partially
situated on grounds under leases expiring in 2058. CNA leases office space in
various cities throughout the United States and in other countries. The
following table sets forth certain information with respect to the principal
office buildings owned or leased by CNA:
<TABLE>
<CAPTION>
Size
Location (square feet) Principal Usage
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Owned:
CNA Plaza 1,144,378 Principal Executive Offices of CNA
333 S. Wabash
Chicago, Illinois
180 Maiden Lane 1,091,570(1) Property/Casualty Insurance Offices
New York, New York
55 E. Jackson Blvd. 440,292(2) Principal Executive Offices of CNA
Chicago, Illinois
401 Penn Street 251,691 Property/Casualty Insurance Offices
Reading, Pennsylvania
100 CNA Drive 251,363 Life Insurance Offices
Nashville, Tennessee
Leased:
7361 Calhoun Place 224,725 Life Insurance Offices
Rockville, Maryland
200 S. Wacker Drive 219,285 Property/Casualty Insurance Offices
Chicago, Illinois
1111 E. Broad St. 183,019 Property/Casualty Insurance Offices
Columbus, Ohio
333 Glen Street 157,825 Property/Casualty Insurance Offices
Glen Falls, New York
1100 Cornwall Road 147,884 Property/Casualty Insurance Offices
Monmouth Junction, New Jersey
600 North Pearl Street 139,151 Property/Casualty Insurance Offices
Dallas, Texas
111 Congressional Blvd. 118,215 Property/Casualty Insurance Offices
Indianapolis, Indiana
1431 Opus Place 106,151 Property/Casualty Insurance Offices
Downers Grove, Illinois
2401 Pleasant Valley 102,376 Property/Casualty Insurance Offices
York, Pennsylvania
</TABLE>
(1) Property occupied by 46% of CNA or its subsidiaries.
(2) Approximately 28% is rented to non-affiliates.
12
LORILLARD, INC.
The Company's wholly owned subsidiary, Lorillard, Inc. ("Lorillard"), is
engaged, through its subsidiaries, in the production and sale of cigarettes. The
principal cigarette brand names of Lorillard are Newport and Kent. Lorillard's
largest selling brand is Newport, which accounted for approximately 76% of
Lorillard's sales in 1997.
Substantially all of Lorillard's sales are in the United States. Lorillard's
major trademarks outside of the United States were sold in 1977. Lorillard
accounted for 12.00%, 10.84% and 11.00% of the Company's consolidated total
revenue for the years ended December 31, 1997, 1996 and 1995, respectively.
For a number of years reports of the asserted harmful health effects of
cigarette smoking have engendered significant adverse publicity for the
cigarette industry, have caused a decline in the social acceptability of
cigarette smoking and have resulted in the implementation of numerous
restrictions on the marketing, advertising and use of cigarettes. Along with
significant increases in federal and state excise taxes on cigarettes, these
actions have, and are likely to continue to have, an adverse effect on cigarette
sales.
PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES
A large number of lawsuits, including lawsuits brought by individual
plaintiffs ("Conventional Product Liability Cases"), purported class actions
("Class Actions") and lawsuits brought on behalf of states, state agencies and
union trust funds ("Reimbursement Cases") have been commenced against Lorillard
and other tobacco manufacturers seeking substantial compensatory and punitive
damages for adverse health effects claimed to have resulted from cigarette
smoking or exposure to tobacco smoke. Lorillard and other companies in the
United States tobacco industry have settled Reimbursement Cases brought by the
States of Mississippi, Florida and Texas on terms consistent with the proposed
resolution discussed below. The Mississippi action was settled in July 1997,
Florida was settled in September 1997 and Texas was settled in January 1998. For
information with respect to such litigation, see Item 3 of this Report.
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 "Proposed Resolution"). The Proposed
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 Proposed 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 Proposed Resolution. Certain
members of Congress have offered or indicated that they may offer alternative
legislation. Currently, over thirty bills have been introduced in Congress
regarding the issues raised in the Proposed Resolution, including bills seeking
more stringent regulation of the tobacco industry by the Food and Drug
Administration (the "FDA") and bills to increase the federal excise tax on
tobacco products. Several of these bills seek to increase the payments by the
tobacco industry from the levels reflected in the Proposed Resolution and deny
the industry any form of relief from civil litigation. No bill currently
introduced would adopt the Proposed Resolution as agreed to. There can be no
assurance that federal legislation in the form of the Proposed Resolution will
be enacted, 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 Proposed 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 Proposed Resolution could affect
other federal, state and local regulation of the United States tobacco industry.
13
The Proposed 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, regulation of tobacco products by 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 Proposed Resolution, industry payments and
litigation. The complete text of the Proposed 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.
Advertising and Marketing Restrictions: The Proposed Resolution would
incorporate certain regulations previously promulgated by 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.
(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 Proposed 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.
14
Warnings and Labeling: The Proposed 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 Proposed Resolution would restrict access to tobacco
products by minors. Without preventing state and local governments from imposing
stricter measures, the Proposed 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.
(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 Proposed 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 Proposed 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 Proposed 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 Proposed
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.
15
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
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 Proposed 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 Proposed 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 Proposed 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 Proposed 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 Proposed 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 Proposed 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 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 Proposed Resolution would subject the tobacco industry to "good
manufacturing practice" standards, including requirements regarding quality
control systems, FDA inspections and record-keeping and reporting.
16
Public Disclosure: The Proposed 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 Proposed Resolution would also require the industry to
disclose all such internal laboratory research generated in the future. The
Proposed 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 Proposed 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.
Public Smoking: The Proposed 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.
17
Enforcement: Violations of the Proposed 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 Proposed 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 Proposed
Resolution (except where the Proposed Resolution specifically does not preempt
additional state-law obligations) and would be limited to the penalties
specified in the Proposed Resolution and by prohibition of duplicative
penalties.
Industry Payments: The Proposed 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 Proposed 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 (to be reduced for initial payments made to Florida,
Mississippi and Texas pursuant to settlements, see Item 3 - "Settlements of
Reimbursement Cases") which would be funded from a combination of available cash
and borrowings, if required. 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 25% of the increased
profit. At current levels of sales and prior to any adjustment for inflation,
the Proposed 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 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 selling
tobacco products in the United States (and not their affiliated companies). The
Proposed 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
Proposed 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 Proposed 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.
18
Effects on Litigation: If enacted, the federal legislation provided for in the
Proposed 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
Proposed 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, and January 16, 1998, together with other companies in the
United States tobacco industry, Lorillard entered into Memoranda of
Understanding with the States of Mississippi, Florida and Texas, respectively,
with respect to those states' health care cost recovery actions. See
"Settlements of Reimbursement Cases" discussed in Item 3., below. 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
Proposed Resolution. No assurance can be given whether a postponement or
settlement will be achieved, or, if achieved, as to the terms thereof. The
Proposed 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 Proposed 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 Proposed
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 Proposed 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 Proposed 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 Proposed Resolution.
Non-participating Manufacturers: The Proposed Resolution would contain certain
measures to ensure that non-participating manufacturers are not free to undercut
the Proposed Resolution by selling tobacco products at lower prices because they
were not making the Industry Payments.
BUSINESS OPERATIONS
Legislation and Regulation: Federal Legislation - The Federal Comprehensive
Smoking Education Act, which became effective in 1985, requires the use on
cigarette packaging and advertising of one of the following four warning
statements, on a rotating basis: (1) "SURGEON GENERAL'S WARNING: Smoking Causes
Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy." (2)
"SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks
to Your Health." (3) "SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May
Result in Fetal Injury, Premature Birth, and Low Birth Weight." (4) "SURGEON
GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide." Four shortened
versions of these statements are required, on a rotating basis, for use on
billboards. This law also requires that each person who manufactures, packages
or imports cigarettes shall annually provide to the Secretary of Health and
Human Services a list of the ingredients added to tobacco in the manufacture of
cigarettes. Such list of ingredients may be submitted in a manner which does not
identify the company which uses the ingredients or the brand of cigarettes which
contain the ingredients.
19
Prior to the effective date of the Federal Comprehensive Smoking Education
Act, federal law had, since 1965, required that cigarette packaging bear a
warning statement which from 1970 to 1985 was as follows: "Warning: The Surgeon
General Has Determined That Cigarette Smoking Is Dangerous to Your Health." In
addition, in 1972 Lorillard and other cigarette manufacturers had agreed,
pursuant to consent orders entered into with the Federal Trade Commission
("FTC"), to include this health warning statement in print advertising, on
billboards and on certain categories of point-of-sale display materials relating
to cigarettes. In addition, advertising of cigarettes has been prohibited on
radio and television since 1971.
From time to time, bills have been introduced in Congress (in addition to the
more than 30 bills discussed above, under "Proposed Resolution of Certain
Regulatory and Litigation Issues," above), among other things, to end or limit
the price supports for leaf tobacco; to prohibit all tobacco advertising and
promotion; to require new health warnings on cigarette packages and advertising;
to subject cigarettes generally to regulation under the Consumer Products Safety
Act or the Food, Drug and Cosmetics Act; to authorize the establishment of
various anti-smoking education programs; to provide that current federal law
should not be construed to relieve any person of liability under common or state
law; to permit state and local governments to restrict the sale and distribution
of cigarettes and the placement of billboard and transit advertising of tobacco
products; to provide that cigarette advertising not be deductible as a business
expense; to prohibit the mailing of unsolicited samples of cigarettes and
otherwise to restrict the sale or distribution of cigarettes; to impose an
additional excise tax on cigarettes; to require that cigarettes be manufactured
in a manner that will cause them, under certain circumstances, to be self-
extinguishing; and to subject cigarettes to regulation in various ways by the
U.S. Department of Health and Human Services, including regulation by the Food
and Drug Administration.
In 1995, Congress passed legislation prohibiting the sale of cigarettes by
vending machines on certain federal property, and the General Services
Administration has published implementing regulations. In January 1996, the
Substance Abuse and Mental Health Services Administration("SAMHSA") issued final
regulations implementing a 1992 law (Section 1926 of the Public Health Service
Act), which requires the states to enforce their minimum sales-age laws as a
condition of receiving federal substance abuse block grants.
Food and Drug Administration Regulation of Tobacco Products - On August 28,
1996, the FDA published regulations (the "FDA Regulations") in final form
severely restricting cigarette advertising and promotion and limiting the manner
in which tobacco products can be sold. In enacting the FDA Regulations, the FDA
determined that nicotine is a drug and that cigarettes are a nicotine delivery
system and, accordingly, subject to FDA regulatory authority as medical devices.
The FDA premised its regulations on the need to reduce smoking by underage youth
and young adults. The FDA Regulations were to become effective in stages, as
follows:
(i) Regulations regarding minimum sales age, effective February 28, 1997.
These regulations make unlawful the sale of cigarettes to anyone under age 18.
These regulations also require proof of age to be demanded from any person under
age 27 who attempts to purchase cigarettes.
(ii) Regulations regarding advertising and billboards, vending machines, self-
service displays, sampling premiums, and package labels, which were to be
effective August 28, 1997. These regulations limit all cigarette advertising to
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
("Nicotine - Delivery Device For Persons 18 or Older") be included on all
cigarette packages and advertising, ban vending machine sales, product sampling,
and 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 use of cigarette brand names to sponsor sporting
and cultural events and requiring cigarette manufacturers to comply with certain
stringent FDA regulations (known as "good manufacturing practices") governing
the manufacture and distribution of medical devices, which were to be 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.
20
Lorillard and other cigarette manufacturers have filed a lawsuit 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 (Liggett Group has agreed to withdraw from this
lawsuit). The complaint in the case, Coyne Beahm, Inc., et al. v. United States
Food & Drug Administration, et al., asserts that the FDA lacks authority to
regulate cigarettes and that the proposed rules violate the Federal Food, Drug
and Cosmetic Act, the Federal Cigarette Labeling and Advertising Act and the
United States Constitution. Lawsuits challenging the FDA's rule making also have
been filed in the same court by several smokeless tobacco manufacturers, several
national advertising trade associations and the National Association of
Convenience Stores.
The plaintiffs have moved for summary judgment on jurisdictional, statutory
and First Amendment grounds. The Court granted, in part, and denied in part,
plaintiffs' motion for summary judgment. The Court held 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, also held 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 relating to advertising and promotion of
tobacco products, but allowed the access restrictions to take effect as of
February 27, 1997. Both the plaintiffs' and the defendants have filed an appeal
of the District Court's ruling to the Fourth Circuit Court of Appeals.
Environmental Tobacco Smoke - Studies with respect to the alleged health risk
to nonsmokers of environmental tobacco smoke ("ETS") have received significant
publicity. In 1986, the Surgeon General of the United States and the National
Academy of Sciences reported that ETS puts nonsmokers at an increased risk of
lung cancer and respiratory illness. In January 1993, the United States
Environmental Protection Agency released a report (the "EPA Risk Assessment")
concluding that ETS is a human lung carcinogen in adults, causes increased
respiratory tract disease, middle ear disorders and increases the severity and
frequency of asthma in children.
In recent years, many federal, state, local and municipal governments and
agencies, as well as private businesses, have adopted legislation or regulations
which prohibit or restrict, or are intended to discourage, smoking, including
legislation or regulations prohibiting or restricting smoking in various places
such as public buildings and facilities, stores and restaurants, on domestic
airline flights and in the workplace, and the sale of cigarettes in vending
machines. This trend has increased significantly since the release of the EPA
Risk Assessment. Additional laws, regulations and policies intended to prohibit,
restrict or discourage smoking are being proposed or considered by various
federal, state and local governments, agencies and private businesses with
increasing frequency.
In 1994, the Occupational Safety and Health Administration published a
proposed rule on air quality in indoor workplaces. The proposed rule would
require employers in the United States to prohibit smoking indoors or to
restrict smoking to a separate room with outside exhaust and negative air
pressure. A period of public comment on the proposed rules has ended. Hearings
on the proposed rules were conducted in late 1994 and early 1995. It is
impossible at this time to predict whether or in what form the proposed rules
will be adopted.
Fire Safe Cigarettes - A 1984 federal law established a Technical Study Group
to conduct a study and report to the Congress regarding the technical and
commercial feasibility of developing cigarettes that will have a minimum
propensity to ignite upholstered furniture or mattresses. The Technical Study
Group concluded in 1987 that it was technically feasible and may be commercially
feasible to develop such cigarettes. In accordance with a 1990 federal law the
Consumer Product Safety Commission issued a report in August 1993, concluding
that, while it is practicable to develop a performance standard to reduce
cigarette ignition propensity, it is unclear that such a standard will
effectively address the number of cigarette ignited fires. Several states also
have considered legislation authorizing or directing the establishment of
cigarette fire-safety standards from time to time. Currently, New York and
Oregon are considering such legislation.
Ingredient Disclosure - On August 2, 1996, the Commonwealth of Massachusetts
enacted legislation requiring each manufacturer of cigarettes and smokeless
tobacco sold in Massachusetts to submit to the Department of Public Health
("DPH") an annual report, beginning in 1997, (1) identifying for each brand sold
certain "added constituents," and (2) providing nicotine yield ratings and other
information for certain brands based on regulations promulgated by the DPH. The
legislation provides for the public release of this information, which includes
flavorings and other trade secret ingredients used in cigarettes.
21
In 1996, the cigarette and smokeless tobacco manufacturers filed suit in
federal district court in Boston challenging the legislation. Philip Morris,
Inc., et al., v. Harshbarger, Civil Action No. 96-11599-GAO (D. Mass.) and
United States Tobacco Company v. Harshbarger, Civil Action No. 96-11619-GAO (D.
Mass.). On December 10, 1997, the court issued a preliminary injunction,
enjoining the required submission of ingredient data to the DPH. The requirement
to submit the nicotine yield ratings and other information was not enjoined, and
the cigarette and smokeless tobacco manufacturers submitted their data to the
DPH on December 15, 1997.
The Commonwealth of Massachusetts has appealed the district court's
preliminary injunction, and the case in chief is now before the district court
on cross motions for summary judgment.
Any impact on Lorillard from the legislation and its implementing regulations
cannot now be predicted. If the manufacturers ultimately are required to
disclose their trade secrets to the DPH and the DPH then discloses them to the
public, further litigation seeking compensation for the taking of the
manufacturers' property may ensue.
Other similar laws and regulations have been enacted or considered by other
state governments, and could have a material adverse effect on the financial
condition and results of operations of the Company if implemented without
adequate provisions to protect the manufacturers' trade secrets from being
disclosed.
Advertising and Sales Promotion: Lorillard's principal brands are advertised
and promoted extensively. Introduction of new brands, brand extensions and
packings require the expenditures of substantial sums for advertising and sales
promotion, with no assurance of consumer acceptance. The advertising media
presently used by Lorillard include magazines, newspapers, out-of-home
advertising, direct mail and point-of-sale display materials. Sales promotion
activities are conducted by distribution of samples and store coupons,
point-of-sale display advertising, advertising of promotions in print media, and
personal contact with distributors, retailers and consumers. All of these
activities would be severely affected by the new FDA Regulations (see "Food and
Drug Administration Regulation of Tobacco Products," above) and the Proposed
Resolution (see "Proposed Resolution of Certain Regulatory and Litigation
Issues," above).
Distribution Methods: Lorillard distributes its products through direct sales
to distributors, who in turn service retail outlets, and through chain store
organizations and vending machine operators, many of whom purchase their
requirements directly, and by direct sales to the U.S. Armed Forces. Lorillard's
tobacco products are stored in public warehouses throughout the country to
provide for rapid distribution to customers.
Lorillard has approximately 1,500 direct customers and is not dependent on any
one customer or group of customers. Lorillard does not have any backlog orders.
Tobacco and Tobacco Prices: The two main classes of tobacco grown in the
United States are flue-cured tobacco, grown mostly in Virginia, North Carolina,
South Carolina, Georgia and Florida; and burley, grown mostly in Kentucky and
Tennessee. Lorillard purchases flue-cured tobacco and burley tobacco for use in
cigarettes. Most of the tobacco of these classes used by Lorillard is purchased
by commission buyers at tobacco auctions. Lorillard also purchases various types
of Near Eastern tobacco, grown in Turkey and eight other Near Eastern countries.
In addition, Lorillard purchases substantial quantities of aged tobacco from
various sources, including cooperatives financed under the Commodity Credit
Corporation program, to supplement tobacco inventories.
Due to the varying size and quality of annual crops and other economic
factors, tobacco prices in the past have been subject to fluctuation. Among the
economic factors are federal government control of acreage and poundage in the
flue-cured producing areas and poundage control in the burley areas. These
controls together with support prices have substantially affected the market
prices of tobacco. The approximate average auction prices per pound for
flue-cured tobacco were $1.837 in 1996 and $1.722 in 1997 and for burley tobacco
were $1.920 in 1996 and $1.902 in 1997. The prices paid by Lorillard have
generally been consistent with this trend. Lorillard believes that its current
leaf inventories are adequately balanced for its present production
requirements. Because the process of aging tobacco normally requires
approximately two years, Lorillard at all times has on hand large quantities of
leaf tobacco. See Note 1 of the Notes to Consolidated Financial Statements,
included in Item 8, for inventory costing method.
Prices: In March 1997, September 1997 and January 1998, Lorillard increased
the wholesale price of its cigarettes by $2.50, $3.50 and $1.25 per thousand in
the aggregate, respectively.
22
Taxes: Federal excise taxes included in the price of cigarettes are $12.00 per
thousand 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 thousand
cigarettes ($0.15 per pack of 20 cigarettes). This increase is phased in at a
rate of $5.00 per thousand cigarettes in the year 2000 and an additional $2.50
per thousand cigarettes in the year 2002. Excise taxes, which are levied upon
and paid by the distributors, are also in effect in the fifty states, the
District of Columbia and many municipalities. Various states have proposed, and
certain states have recently passed, increases in their state tobacco excise
taxes. The state taxes generally range from 2.5 cents to $1.00 per package of
twenty cigarettes.
Properties: The properties of Lorillard are employed principally in the
processing and storage of tobacco and in the manufacture and storage of
cigarettes. Its principal properties are owned in fee. With minor exceptions,
all machinery used by Lorillard is owned by it. All properties are in good
condition. Lorillard's manufacturing plant is located on approximately 79 acres
in Greensboro, North Carolina. This 942,600 square foot plant contains modern
high speed cigarette manufacturing machinery. A warehouse was added in early
1995 with shipping and receiving areas totaling 54,800 square feet. Lorillard
also has facilities for receiving and storing leaf tobacco in Danville,
Virginia, containing approximately 1,500,000 square feet. A modern research
facility containing approximately 82,000 square feet is also located at
Greensboro.
Lorillard leases sales offices in major cities throughout the United States.
In May 1997 Lorillard relocated its New York executive office to a 130,000
square-foot, four-story office building in Greensboro, North Carolina. This move
allowed Lorillard to consolidate its operations in Greensboro, the site of its
manufacturing facility.
Competition: Substantially all of Lorillard's products are sold within the
United States in highly competitive markets where its principal competitors are
the four other major U.S. cigarette manufacturers (Philip Morris, R.J. Reynolds
("RJR"), Brown & Williamson and Liggett Group). According to the Maxwell
Consumer Report, a quarterly statistical survey of the cigarette industry, in
calendar year 1997 Lorillard ranked fourth in the industry with an 8.7% share of
the market. Philip Morris and RJR accounted for approximately 48.7% and 24.2%,
respectively, of the U.S. cigarette market, according to the Maxwell Consumer
Report.
The following table sets forth cigarette sales in the United States by the
industry and by Lorillard, as reported in the Maxwell Consumer Report. This
table indicates the relative position of Lorillard in the industry:
<TABLE>
<CAPTION>
Industry Lorillard Lorillard
Calendar Year (000) (000) to Industry
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
1997 ................................. 482,530,000 41,830,000 8.7%
1996 ................................. 483,300,000 40,400,000 8.4%
1995 ................................. 481,100,000 38,580,000 8.0%
</TABLE>
- ---------------
The Bureau of Alcohol, Tobacco and Firearms reports Lorillard's share of total
taxable factory removals of all cigarettes to be 8.3% and 7.9% for 1996 and
1995, respectively. Data for 1997 is not currently available.
The Maxwell Consumer Report divides the cigarette market into two price
segments, the premium price segment and the discount or reduced price segment.
According to the Maxwell Consumer Report the reduced price segment decreased in
1997 to approximately 27.6% from approximately 28.5% of the market in 1996.
Virtually all of Lorillard's sales are in the premium price segment where
Lorillard's share amounted to approximately 11.0% in 1996 and 1997, according to
the Maxwell Consumer Report.
23
LOEWS HOTELS HOLDING CORPORATION
The subsidiaries of Loews Hotels Holding Corporation ("Loews Hotels"), a
wholly owned subsidiary of the Company, presently operate the following 14
hotels. Loews Hotels accounted for 1.10%, .98% and 1.17% of the Company's
consolidated total revenue for the years ended December 31, 1997, 1996 and 1995,
respectively.
<TABLE>
<CAPTION>
Number of
Rooms (Year
Name and Location Type Opened) Owned, Leased or Managed
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loews Annapolis Luxury Hotel 217 Owned
Annapolis, Maryland (1986(2))
Loews Coronado Bay Resort Luxury Hotel 450 Management contract expiring 2011,
San Diego, California (1991) with renewal options for 10 years (3)
Loews Giorgio Luxury Hotel 197 Owned
Denver, Colorado (1986(2))
Howard Johnson Hotel (1) Commercial Hotel 300 Owned
New York, New York (1962)
Loews Le Concorde Luxury Hotel 424 Land lease expiring 2069
Quebec City, Canada (1974(2))
Loews L'Enfant Plaza Luxury Hotel 372 Management contract expiring 2003 (3)
Washington, D.C. (1973)
Loews Monte Carlo Resort Hotel 622 Lease expiring 2002, with renewal
Monte Carlo, Monaco (1975) options for 20 years
Loews New York First Class Hotel 765 Owned
New York, New York (1961)
Days Hotel (1) Commercial Hotel 366 Owned
New York, New York (1962)
The Regency, a Loews Hotel Luxury Hotel 496 Land Lease expiring 2013, with
New York, New York (1963) renewal option for 47 years
Loews Santa Monica Beach Luxury Hotel 350 Management contract expiring 2018,
Santa Monica, California (1989) with a renewal options for 5 years(3)
Loews Vanderbilt Plaza Luxury Hotel 342 Owned
Nashville, Tennessee (1984(2))
Loews Ventana Canyon Resort Resort Hotel 398 Management contract expiring 2004,
Tucson, Arizona (1984) with renewal options for 10 years (3)
Loews Hotel Vogue Luxury Hotel 154 Owned
Montreal, Canada (1990(2))
- -------------
(1) Operated by Loews Hotels under license agreements pursuant to which Loews
Hotels pays royalty fees on sales, as defined in the agreements, for the
use of the respective trade names, trademarks and other rights.
(2) The Le Concorde, Giorgio, Vanderbilt Plaza, Annapolis and Vogue Hotels
were acquired by Loews Hotels in 1987, 1989, 1989, 1990 and 1995,
respectively.
(3) These management contracts are subject to termination rights.
</TABLE>
24
A Loews Hotels subsidiary is presently constructing an 800 room convention
center hotel in Miami Beach, Florida. The hotel is being constructed on land
leased from the Miami Beach Redevelopment Agency under a 100 year ground lease.
The hotel is expected to open in late 1998. In addition, a Loews Hotels
subsidiary has entered into an agreement to develop and construct three hotels
having an aggregate of approximately 2,400 rooms at Universal City Florida, an
approximately 840 acre world class entertainment resort in Orlando, Florida, as
part of a joint venture with Universal Studios, Inc. and the Rank Group, Plc,
owners of the resort. The hotels would be constructed on land leased by the
joint venture from the resort's owners and would be operated by Loews Hotels.
The first hotel is expected to open in 1999.
The hotels which are operated by Loews Hotels contain shops, a variety of
restaurants and lounges, and some contain parking facilities, swimming pools,
tennis courts and access to golf courses.
The hotels owned by Loews Hotels are subject to mortgage indebtedness
aggregating approximately $41.5 million at December 31, 1997 with interest rates
ranging from 7.4% to 9.0% and maturing between 1999 and 2002. In addition,
certain hotels are held under leases which are subject to formula derived rental
increases, with rentals aggregating approximately $7.1 million for the year
ended December 31, 1997.
Competition from other hotels, motor hotels and inns, including facilities
owned by local interests and by national and international chains, is vigorous
in all areas in which Loews Hotels operates. The demand for hotel rooms in many
areas is seasonal and dependent on general and local economic conditions. Loews
Hotels properties also compete with facilities offering similar services in
locations other than those in which the company's hotels are located.
Competition among luxury hotels is based primarily on location and service.
Competition among resort and commercial hotels is based on price as well as
location and service. Because of the competitive nature of the industry, hotels
must continually make expenditures for updating, refurnishing and repairs and
maintenance, in order to prevent competitive obsolescence.
DIAMOND OFFSHORE DRILLING, INC.
Diamond Offshore Drilling Inc. ("Diamond Offshore"), is engaged, through its
subsidiaries, in the business of owning and operating drilling rigs that are
used primarily in drilling of offshore oil and gas wells on a contract basis for
companies engaged in exploration and production of hydrocarbons. Diamond
Offshore operates 46 offshore rigs. Diamond Offshore accounted for 4.85%, 3.17%
and 1.82% of the Company's consolidated total revenue for the years ended
December 31, 1997, 1996 and 1995, respectively.
Drilling Units and Equipment: Diamond Offshore currently owns and operates 46
mobile offshore drilling rigs (30 semisubmersible rigs, 15 jackup rigs and one
drillship) and related equipment. Offshore rigs are mobile units that can be
relocated via either self propulsion or by the use of tugs enabling them to be
repositioned based on market demand.
Semisubmersible rigs are supported by large pontoons and are partially
submerged during drilling for greater stability. They are generally designed for
deep water depths of up to 5,000 feet. Diamond Offshore owns and operates three
fourth-generation semisubmersible rigs and three fourth-generation deep water
conversions. These rigs are equipped with advanced drilling equipment, are
capable of operations in deep water or harsh environments, and command high
premiums from operators. Diamond Offshore's 30 semisubmersible rigs are
currently located as follows: 16 in the Gulf of Mexico, four in the North Sea,
four in Brazil and the remaining rigs are located in various foreign markets.
25
Jackup rigs stand on the ocean floor with their drilling platforms "jacked up"
on support legs above the water. They are used extensively for drilling in water
depths from 20 feet to 350 feet. Seven of Diamond Offshore's jackup rigs are
cantilevered rigs capable of over platform development drilling and workover as
well as exploratory drilling. Of Diamond Offshore's 15 jackup rigs, 12 are
currently located in the Gulf of Mexico.
Diamond Offshore's drillship is self-propelled and designed to drill in deep
water. Shaped like a conventional vessel, it is the most mobile of the major rig
types. Diamond Offshore's drillship was upgraded in 1997 with dynamic-
positioning capabilities and other enhancements and is operating in the deep
water market of the Gulf of Mexico.
Markets: Diamond Offshore's principal markets for its offshore contract
drilling services are the Gulf of Mexico, Europe, including principally the U.K.
sector of the North Sea, South America, Africa, and Australia/Southeast Asia.
Diamond Offshore actively markets its rigs worldwide.
Diamond Offshore's contracts to provide offshore drilling services vary in
their terms and provisions. Diamond Offshore often obtains its contracts through
competitive bidding, although it is not unusual for Diamond Offshore to be
awarded drilling contracts without competitive bidding. Drilling contracts
generally provide for a basic drilling rate on a fixed dayrate basis regardless
of whether such drilling results in a productive well. Drilling contracts may
also provide for lower rates during periods when the rig is being moved or when
drilling operations are interrupted or restricted by equipment breakdowns,
adverse weather or water conditions or other conditions beyond the control of
Diamond Offshore. Under dayrate contracts, Diamond Offshore generally pays the
operating expenses of the rig, including wages and the cost of incidental
supplies. Dayrate contracts have historically accounted for a substantial
portion of Diamond Offshore's revenues. In addition, Diamond Offshore has worked
some of its rigs under dayrate contracts pursuant to which the customer also
agrees to pay Diamond Offshore an incentive bonus based upon performance.
A dayrate drilling contract generally extends over a period of time covering
either the drilling of a single well, a group of wells (a "well-to-well
contract") or a stated term (a "term contract") and may be terminated by the
customer in the event the drilling unit is destroyed or lost or if drilling
operations are suspended for a specified period of time as a result of a
breakdown of major equipment or, in some cases, due to other events beyond the
control of either party. In addition, certain of Diamond Offshore's contracts
permit the customer to terminate the contract early by giving notice and in some
circumstances may require the payment of an early termination fee by the
customer. The contract term in many instances may be extended by the customer
exercising options for the drilling of additional wells at fixed or mutually
agreed terms, including dayrates.
The duration of offshore drilling contracts is generally determined by market
demand and the respective management strategy of the offshore drilling
contractor and its customers. In periods of rising demand for offshore rigs,
contractors typically prefer well-to-well contracts that allow contractors to
profit from increasing dayrates. In contrast, during these periods customers
with reasonably definite drilling programs typically prefer longer term
contracts to maintain dayrate prices at the lowest level possible. Conversely,
in periods of decreasing demand for offshore rigs, contractors generally prefer
longer term contracts to preserve dayrates at existing levels and ensure
utilization, while the customers prefer well-to-well contracts that allow them
to obtain the benefit of lower dayrates. Under current conditions, Diamond
Offshore seeks to have a foundation of long-term contracts with a reasonable
balance of single well, well-to-well and short-term contracts to minimize the
downside impact of a decline in the market while still participating in the
benefit of increasing dayrates in a rising market.
Customers: Diamond Offshore provides offshore drilling services to a customer
base that includes major and independent oil and gas companies and government-
owned oil companies. Occasionally, several customers have accounted for 10.0
percent or more of Diamond Offshore's annual consolidated revenues, although the
specific customers may vary from year to year. During 1997, Diamond Offshore
performed services for approximately 50 different customers and Shell companies
(including domestic and foreign affiliates) ("Shell") accounted for 14.3 percent
of Diamond Offshore's annual total consolidated revenues. During 1996, Diamond
Offshore performed services for approximately 80 different customers and Shell
and British Petroleum companies (including domestic and foreign affiliates)
("BP") accounted for 13.8 percent and 13.5 percent of Diamond Offshore's annual
total consolidated revenues, respectively. During 1995, Diamond Offshore
performed services for approximately 90 different customers and BP accounted for
16.5 percent of Diamond Offshore's annual total consolidated revenues.
Management believes that at current levels of activity Diamond Offshore has
alternative customers for its services such that the loss of a single customer
would not have a material adverse effect on Diamond offshore.
26
Competition: The contract drilling industry is highly competitive. Customers
often award contracts on a competitive bid basis, and although a customer
selecting a rig may consider, among other things, a contractor's safety record,
crew quality and quality of service and equipment, the historical oversupply of
rigs has created an intensely competitive market in which price is the primary
factor in determining the selection of a drilling contractor. However, due to
the escalation of drilling activity, rig availability has, in some cases, also
become a consideration, particularly with respect to fourth-generation and other
technologically advanced units. Diamond Offshore believes that competition for
drilling contracts will continue to be intense in the foreseeable future.
Contractors are also able to adjust localized supply and demand imbalances by
moving rigs from areas of low utilization and dayrates to areas of greater
activity and relatively higher dayrates. Such movements or reactivations or a
decrease in drilling activity in any major market could depress dayrates and
could adversely affect utilization of Diamond Offshore's rigs.
In addition, the recent improvement in the current results of operations and
prospects for the offshore contract drilling industry as a whole has led to
increased rig construction and enhancement programs by Diamond offshore's
competitors. A significant increase in the supply of technologically advanced
rigs capable of drilling in deep water may have an adverse effect on the average
operating dayrates for Diamond Offshore's rigs, particularly its more advanced
semisubmersible units, and on the overall utilization level of Diamond
Offshore's fleet. In such case, Diamond Offshore's results of operations would
be adversely affected.
Governmental Regulation: Diamond offshore's operations are subject to numerous
federal, state and local laws and regulations that relate directly or indirectly
to its operations, including certain regulations controlling the discharge of
materials into the environment, requiring removal and clean-up under certain
circumstances, or otherwise relating to the protection of the environment. For
example, Diamond Offshore may be liable for damages and costs incurred in
connection with oil spills for which it is held responsible. Laws and
regulations protecting the environment have become increasingly stringent in
recent years and may in certain circumstances impose "strict liability"
rendering a company liable for environmental damage without regard to negligence
or fault on the part of such company. Liability under such laws and regulations
may result from either governmental or citizen prosecution. Such laws and
regulations may expose Diamond Offshore to liability for the conduct of or
conditions caused by others, or for acts of Diamond Offshore that were in
compliance with all applicable laws at the time such acts were performed. The
application of these requirements or the adoption of new requirements could have
a material adverse effect on Diamond Offshore.
The United States Oil Pollution Act of 1990 ("OPA '90") and similar
legislation enacted in Texas, Louisiana and other coastal states address oil
spill prevention and control and significantly expand liability exposure across
all segments of the oil and gas industry. OPA '90, such similar legislation and
related regulations impose a variety of obligations on Diamond Offshore related
to the prevention of oil spills and liability for damages resulting from such
spills. OPA '90 imposes strict and, with limited exceptions, joint and several
liability upon each responsible party for oil removal costs and a variety of
public and private damages.
Indemnification and Insurance: Diamond Offshore's operations are subject to
hazards inherent in the drilling of oil and gas wells such as blowouts,
reservoir damage, loss of production, loss of well control, cratering or fires,
the occurrence of which could result in the suspension of drilling operations,
injury to or death of rig and other personnel and damage to or destruction of
Diamond Offshore's, Diamond Offshore's customer's or a third party's property or
equipment. Damage to the environment could also result from Diamond Offshore's
operations, particularly through oil spillage or uncontrolled fires. In
addition, offshore drilling operations are subject to perils peculiar to marine
operations, including capsizing, grounding, collision and loss or damage from
severe weather. Diamond Offshore has insurance coverage and contractual
indemnification for certain risks, but there can be no assurance that such
coverage or indemnification will adequately cover Diamond Offshore's loss or
liability in many circumstances or that Diamond Offshore will continue to carry
such insurance or receive such indemnification.
Properties: Diamond Offshore owns an eight-story office building located in
Houston, Texas containing approximately 182,000 net rentable square feet, which
is used for its corporate headquarters. A portion of the building is currently
occupied by other tenants under leases which expire through 2005. Diamond
Offshore also owns an 18,000 square foot building and 20 acres of land in New
Iberia, Louisiana for its offshore drilling warehouse and storage facility, and
a 13,000 square foot building and five acres of land in Aberdeen, Scotland for
its North Sea operations. In addition, Diamond Offshore leases additional
office, warehouse and storage facilities and lots in Louisiana, Scotland,
Australia, Brazil and various other foreign locations to support its offshore
drilling operations.
27
BULOVA CORPORATION
Bulova Corporation ("Bulova") is engaged in the distribution and sale of
watches, clocks and timepiece parts for consumer use. Bulova accounted for .64%,
.64% and .59% of the Company's consolidated total revenue for the years ended
December 31, 1997, 1996 and 1995, respectively.
Bulova's principal watch brands are Bulova, Caravelle, Accutron and
Sportstime. Clocks are principally sold under the Bulova brand name. All watches
and clocks are purchased from foreign suppliers. Bulova's principal markets are
the United States and Canada. In most other areas of the world Bulova has
appointed licensees who market watches under Bulova's trademarks in return for a
royalty. The business is seasonal, with the greatest sales coming in the third
and fourth quarters in expectation of the holiday selling season. The business
is intensely competitive. The principal methods of competition are price,
styling, product availability, aftersale service, warranty and product
performance.
Properties: Bulova owns an 80,000 square foot plant in Woodside, New York
which is used for its principal executive and sales office, watch distribution,
service and warehouse purposes, and leases a 71,000 square foot plant in
Maspeth, New York for clock service and warehouse purposes and a 25,000 square
foot plant in Toronto, Canada for watch and clock sales and service.
OTHER INTERESTS
A subsidiary of the Company owns a 49% common stock interest in a joint
venture which is engaged in the business of owning and operating six large crude
oil tankers that are used primarily to transport crude oil from the Persian Gulf
to a limited number of ports in the Far East, Northern Europe and the United
States.
EMPLOYEE RELATIONS
The Company, inclusive of its operating subsidiaries as described below,
employed approximately 35,900 persons at December 31, 1997 and considers its
employee relations to be satisfactory.
Lorillard employed approximately 3,700 persons at December 31, 1997.
Approximately 1,100 of these employees are represented by labor unions under
separate contracts with many local unions expiring at varying times and
severally renegotiated and renewed.
Lorillard has collective bargaining agreements covering hourly rated
production and service employees at various Lorillard plants with the Tobacco
Workers International Union, the International Brotherhood of Firemen and
Oilers, and the International Association of Machinists. Lorillard has
experienced satisfactory labor relations and provides a retirement plan, a
deferred profit sharing plan, and other benefits for its hourly paid employees
who are represented by the foregoing unions. In addition, Lorillard provides to
its salaried employees a retirement plan, group life, disability and health
insurance program and a savings plan.
Loews Hotels employed approximately 2,850 persons at December 31, 1997,
approximately 1,850 of whom are union members covered under collective
bargaining agreements. Loews Hotels has experienced satisfactory labor relations
and provides comprehensive benefit plans for its hourly paid employees.
The Company maintains a retirement plan, group life, disability and health
insurance program and a savings plan for salaried employees. Loews Hotels
salaried employees also participate in these benefit plans.
CNA and its subsidiaries employ approximately 24,700 full-time equivalent
employees and has experienced satisfactory labor relations. CNA has never had
work stoppages due to labor disputes. CNA and its subsidiaries have
comprehensive benefit plans for substantially all of their employees, including
retirement plans, savings plans, disability programs, group life programs and
group health care programs.
Diamond Offshore employed approximately 4,000 persons at December 31, 1997,
approximately 80 of whom are union members. Diamond Offshore has experienced
satisfactory labor relations and provides comprehensive benefit plans for its
employees.
28
Bulova and its subsidiaries employ approximately 430 persons, approximately
130 of whom are union members. Bulova and its subsidiaries have experienced
satisfactory labor relations. Bulova has comprehensive benefit plans for
substantially all employees.
Item 2. Properties.
Information relating to the properties of Registrant and its subsidiaries is
contained under Item 1.
Item 3. Legal Proceedings.
1. CNA is involved in various lawsuits involving environmental pollution
claims and litigation with Fibreboard Corporation. Information involving such
lawsuits is incorporated by reference to Notes 9 and 18 of the Notes to
Consolidated Financial Statements included in Item 8.
NON-INSURANCE
Tobacco Litigation
- ------------------
Lawsuits continue to be 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 for damages allegedly caused by smoking ("Class Actions");
claims brought on behalf of governmental entities and others, including private
citizens suing on behalf of taxpayers, labor unions, Indian Tribes and private
companies, 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 asbestos
manufacturers ("Claims for Contribution"). 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").
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.
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 "Proposed Resolution"). The Proposed
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. (See Item 1 - Lorillard, Inc. - "Proposed Resolution of
Certain Regulatory and Litigation Issues.")
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 600 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 200 of these cases. The Company is a defendant in 15
cases, eight of which have not been served.
29
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 million in compensatory damages and $600.0 million in
punitive damages.
On March 19, 1998, the jury in Dunn v. RJR Nabisco Holdings Corporation, et
al. (Superior Court, Delaware County, Indiana, filed May 28, 1993) returned a
unanimous verdict in favor of the defendant cigarette manufacturers and their
parent entities, including the Company, in the trial of a suit brought by the
family of a woman who died of cancer, allegedly caused by exposure to
environmental tobacco smoke. Plaintiffs have 30 days from the entry of judgment
to appeal the jury's 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 in which she smoked
them. Plaintiff has filed a motion for new trial, which is pending.
During 1997, juries returned verdicts in favor of the defendants in trials in
two smoking and health cases in which Lorillard was not a party, Connor v. R.J.
Reynolds Tobacco Company (verdict returned May 5, 1997) and Karbiwnyk v. R.J.
Reynolds Tobacco Company (verdict returned October 31, 1997) (both cases were
tried in the Circuit Court of Duval County, Florida). Appeals are not pending in
either case.
An attorney who represents plaintiffs in a class action pending in Illinois
has filed a motion to consolidate and transfer all tobacco lawsuits pending in
U.S. federal courts to the U.S. Judicial Panel for Multidistrict Litigation.
CLASS ACTIONS - There are 58 purported class actions pending against cigarette
manufacturers and other defendants, including the Company. Two of the 58 cases
have not been served. 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 54 of the 58 cases seeking class certification. The Company is a
defendant in 23 of the purported class actions, one of which has not been
served. Many of the purported class actions are in the pre-trial, discovery
stage.
30
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, October 31, 1991). On October 10, 1997, the parties to this class
action brought on behalf of flight attendants claiming injury as a result of
exposure to environmental tobacco smoke executed a settlement agreement which
was finally approved by the court on February 3, 1998. The settlement agreement
requires Lorillard and three other cigarette manufacturers jointly to pay $300.0
million 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. 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 million of the
proposed settlement amount. The plaintiff class members are permitted to file
individual suits, but these individuals may not seek punitive damages for
injuries that arose prior to January 15, 1997 which enabled them to be members
of the class. The defendants that executed the settlement agreement agreed to
pay a total of $49.0 million as fees and expenses of the attorneys who
represented plaintiffs. Certain of the absent class members objected to the
settlement agreement and some have noticed an appeal from the February 3, 1998
order.
Castano, et al. v. The American Tobacco Company, Inc. et al. (U.S. District
Court, Eastern District, Louisiana, March 29, 1994). This case was initiated as
a class action on behalf of nicotine dependent smokers in the United States.
During 1998, Lorillard Tobacco Company and certain other cigarette manufacturer
defendants agreed with the plaintiffs to dismiss this action without prejudice
and to toll the statute of limitations as to plaintiffs' claims. Lorillard
Tobacco Company paid $1.0 million to reimburse the costs and expenses of
plaintiffs' counsel. This amount will be credited against any award of costs and
expenses incurred in connection with this suit that plaintiffs' counsel may
obtain in the future as a result of the federal legislation implementing the
Proposed Resolution, or against any judgment or settlements that such counsel
may obtain in the future in similar actions.
Granier v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Louisiana, filed September 26, 1994).
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.
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). During January of 1998, the court granted
plaintiffs' motion for class certification on behalf of Maryland residents who
had, presently have, or died from diseases, medical conditions or injuries
caused by smoking cigarettes or using smokeless tobacco products; nicotine
dependent persons in Maryland who have purchased and used cigarettes and
smokeless tobacco products manufactured by the defendants; and Maryland
residents who require medical monitoring. The court has not ruled on defendants'
motion for reconsideration of the class certification order.
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 on behalf of Louisiana citizens who
require medical monitoring. Defendants have noticed on appeal from the class
certification order with the Louisiana Court of Appeals.
Small v. Lorillard Tobacco Company, Inc., et al., Hoskins v. R.J. Reynolds
Tobacco Company, et al., Frosina v. Philip Morris Incorporated, et al., Hoberman
v. Brown & Williamson Tobacco Corporation, et al., and Zito v. American Tobacco
Company, 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. Small
formerly was known as Mroczowski. Plaintiffs' motions for class certification on
behalf of New York residents who are nicotine dependent has been granted.
Defendants in the five actions have noticed appeals from the orders that granted
class certification.
Reed v. Philip Morris Incorporated, et al. (Superior Court, District of
Columbia, filed June 21, 1996). The court has denied plaintiff's motion for
class certification.
31
Barnes v. The American Tobacco Company, et al. (U.S. District, Eastern
District, Pennsylvania, filed August 8, 1996). The District Court has vacated
its prior order that granted class certification on behalf of Pennsylvania
smokers who require medical monitoring. The court also granted defendants'
motion for summary judgment. Plaintiffs have noticed an appeal from both orders
to the U.S. Court of Appeals for the Third Circuit.
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.
Thompson 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).
Ruiz v. The American Tobacco Company, et al. (U.S. District Court, Puerto
Rico, filed October 23, 1996). The court denied plaintiffs' motion for class
certification.
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. Parties have completed briefing of plaintiffs' motion for class
certification. The court has indicated to the parties that it will rule on the
class certification motion without hearing argument.
McCune v. American Tobacco Company, et al. (Circuit Court, Kanawha County,
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 v. Philip Morris Incorporated, et al. (Circuit Court, McDowell County,
West Virginia, filed February 4, 1997).
Green 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.
White v. Philip Morris, Inc. et al. (Chancery Court, Jefferson County,
Mississippi, filed April 18, 1997). The Company is a defendant in the case.
Insolia v. Philip Morris Incorporated, et al. (Circuit Court, Rock County,
Wisconsin, filed April 21, 1997). The court has scheduled trial in this matter
to begin on February 1, 1999.
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 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 class certification
ruling to the Appellate Division of the New York Supreme Court.
32
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). Trial in this
matter is scheduled to begin on August 17, 1998.
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. (Circuit Court, Wayne
County, Michigan, filed May 23, 1997).
Lyons v. Brown & Williamson Tobacco Corporation, et al. (U.S. 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).
Enright v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed May 28, 1997).
Tepper v. Philip Morris Incorporated, et al. (Superior Court, Bergen County,
New Jersey, filed May 28, 1997).
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San Diego
County, California, filed June 10, 1997).
Lippincott v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed June 13, 1997).
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.
Daley v. American Brands, Inc., et al. (U.S. District Court, Northern
District, 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.
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 15, 1997). The court entered an
order sua sponte that dismissed plaintiffs' class action allegations.
Bush v. Philip Morris Incorporated, et al. (U.S. District Court, Eastern
District, Texas, filed September 10, 1997).
Nwanze v. Philip Morris Companies Inc., et al. (U.S. District Court, Southern
District, New York, filed September 29, 1997). The Company is a defendant in the
case.
33
Badillo v. American Tobacco Company, et al. (U.S. District Court, Nevada,
filed October 8, 1997). The Company is a defendant in the case.
Newborn v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Western District, Tennessee, filed October 9, 1997).
Young v. The American Tobacco Company, et al. (Civil District Court, Orleans
Parish, Louisiana, filed November 12, 1997). The Company is a defendant in the
case.
Aksamit v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, South Carolina, filed November 20, 1997). The Company is a defendant in
the case. Trial is scheduled to begin on August 20, 1998.
DiEnno v. Liggett Group, Inc., et al. (District Court, Clark County, Nevada,
filed December 22, 1997).
McCauley v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Southern District, Georgia, filed December 31, 1997). To date, none of
the defendants have received service of process.
Herrera v. The American Tobacco Company, et al. (U.S. District Court, Central
District, Utah, filed January 28, 1998). The Company is a defendant in the case.
Jackson v. Philip Morris Incorporated, et al. (U.S. District Court, Central
District, Utah, filed on or about February 13, 1998). The Company is a defendant
in the case.
Parsons v. AC&S, et al. (Circuit Court, Kanawha County, West Virginia, filed
February 27, 1998). The Company is a defendant in the case. To date, none of the
defendants have received service of process.
REIMBURSEMENT CASES - Approximately 110 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 19 of them.
State Or Local Governmental Reimbursement Cases - To date, suits filed by 41
states, the Commonwealth of Puerto Rico, and the Republic of The Marshall
Islands are pending. In addition, cities, counties or other local governmental
entities have filed eight such suits. The Company is a defendant in 15 cases
filed by state or local governmental entities. Since January 1, 1997, cases
brought by Florida, Mississippi and Texas have been settled (see "Settlements of
Reimbursement Cases"). Trial for the case brought by the State of Minnesota
began on January 20, 1998 and is proceeding. Many of the pending Reimbursement
Cases are in the pre-trial, discovery stage.
The governmental entities pursuing the Reimbursement Cases 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.
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 which settled the State's claims for monetary damages. See
"Settlements of Reimbursement Cases" below.
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. Trial began on
January 20, 1998 and is proceeding.
34
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 Company is a defendant in the case.
The State of Florida, et al. v. The American Tobacco Company, et al. (Circuit
Court, Palm Beach County, Florida, filed February 21, 1995). The trial court
granted the Company's motion to dismiss. The Florida Court of Appeal affirmed
the order dismissing the Company. On August 25, 1997, Lorillard Tobacco Company
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). The court has
scheduled trial in this matter to begin on February 1, 1999.
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). On January 16, 1998,
Lorillard Tobacco Company and other defendants entered into a Memorandum of
Understanding with the State of Texas which settled the State's claims for
monetary damages. See "Settlements of Reimbursement Cases" below. Certain Texas
counties and some Texas hospital districts have filed motions to intervene and
for declaratory judgment in order to contest the settlement. The court has not
ruled on the motions to date.
State of Maryland v. Philip Morris Incorporated, et al. (Circuit Court,
Baltimore City, Maryland, filed May 1, 1996). The court has scheduled the case
for trial on January 5, 1999.
State of Washington v. The American Tobacco Company, et al. (Superior Court,
King County, Washington, filed June 5, 1996). The court has scheduled the case
for trial on September 14, 1998.
City and County of San Francisco, et al. v. Philip Morris Incorporated, et al
(U.S. District Court, Northern District, California, filed June 6, 1996 by
various California cities and counties).
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 scheduled a bench
trial to begin on February 5, 1999 in this matter and in two other cases that
assert allegations that defendants violated certain provisions of the California
Business and Professions Code. Immediately after the completion of the bench
trial, the court will convene a jury as to the remainder of the plaintiff's
claims in County of Los Angeles.
State of Arizona v. The American Tobacco Company, et al. (Superior Court,
Maricopa County, Arizona, filed August 20, 1996). The court has scheduled the
case for trial on October 7, 1998.
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).
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. The court has scheduled the case for trial on November
12, 1998.
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 scheduled the case for trial on March
1, 1999.
35
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. (Supreme Court, New
York County, 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.
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. (Supreme Court, New
York County, New York, filed January 21, 1997). The Company is a defendant in
the case.
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).
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).
36
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. Plaintiff noticed an appeal to the U.S. Court of
Appeals for the Fifth Circuit from the trial court's order that dismissed the
action.
State of New Mexico v. The American Tobacco Company, et al. (First Judicial
District Court, Santa Fe County, New Mexico, filed May 27, 1997).
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.
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 Idaho v. Philip Morris, Inc., et al. (District Court, Fourth Judicial
District, Ada County, Idaho, filed June 9, 1997).
State of Oregon v. The American Tobacco Company, et al. (Circuit Court,
Multnomah County, Oregon, 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. (U.S.
District Court, Puerto Rico, filed June 17, 1997). The Company is a defendant in
the case.
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.
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 Company is
a defendant in the case.
State of South Dakota and South Dakota Department of Social Services v. Philip
Morris, Inc., et al. (Circuit Court, Sixth Judicial Circuit, Hughes County,
South Dakota filed February 23, 1998).
Private Citizens' Reimbursement Cases - There are five suits pending in which
plaintiffs are private citizens. Four of the suits have been filed by private
citizens on behalf of taxpayers of their respective states, although
governmental entities have filed a reimbursement suit in one of the four states.
The Company is a defendant in three of the five pending private citizen
Reimbursement Cases. Lorillard is a defendant in each of the 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 suit is on behalf of taxpayers of Alabama.
37
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. The suit is on behalf of taxpayers of Ohio. The court has granted
defendants' motion to dismiss. The plaintiffs have noticed an appeal from the
court's order granting a motion to dismiss.
Beckom 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.
The suit is on behalf of taxpayers of Tennessee.
Mason v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Texas, filed December 23, 1997). The suit is on behalf of taxpayers of
the U.S. as to funds expended by the Medicaid program.
The State of North Carolina, et al. v. The American Tobacco Company, et al.
(U.S. District Court, Middle District, North Carolina, filed February 13, 1998).
Reimbursement Cases By Indian Tribes - Indian Tribes have filed five
reimbursement suits in their tribal courts, one of which 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).
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 approximately 47
reimbursement suits in various states in federal or state courts, although two
of them have not been served to date. 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). The court has scheduled trial in this matter to begin on February
22, 1999.
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). The court has granted plaintiffs' motion for class certification
on behalf of "all existing jointly-administered and collectively bargained-for
health and welfare trusts in [the State of] Washington, and/or the trustees of
such entities, that have provided or paid for health care and/or addiction
treatment costs or services for employees or other beneficiaries." The court has
denied defendants' motion for certification of an interlocutory appeal of the
class certification order.
Massachusetts Laborers Health and Welfare Fund v. Philip Morris Inc., et al.
(U.S. District Court, Massachusetts, filed June 2, 1997).
Central Laborers Welfare Fund, et al. v. Philip Morris, Inc., et al. (U.S.
District Court, Southern District, Illinois, filed on or about June 9, 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).
38
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).
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).
Oregon Laborers -- Employers Health and Welfare Trust Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Oregon, filed June 20, 1997). The
court has scheduled the case for trial on an unspecified day during January
1999.
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
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 July 20, 1997).
Eastern States Health and Welfare Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, Southern District, 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. (U.S. District Court, Eastern District, Missouri, filed
September 2, 1997).
Arkansas Carpenters Health & Welfare Fund v. Philip Morris, Inc., et al. (U.S.
District Court, Eastern District, Arkansas, filed September 4, 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. (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 v. Philip Morris Incorporated, et
al. (U.S. District Court, Northern District, Indiana, filed September 12, 1997).
39
Operating Engineers Local 12 Health and Welfare Trust v. American Tobacco
Company, et al. (U.S. District Court, Central District, California, filed
September 16, 1997).
Puerto Rican ILGWU Health & Welfare Fund v. Philip Morris Inc., et al. (U.S.
District Court, Southern District, New York, filed September 17, 1997).
New Jersey Carpenters Health Fund, et al. v. Philip Morris, Inc., et al. (U.S.
District Court, New Jersey, filed September 25, 1997).
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).
Central States Joint Board v. Philip Morris, Inc., et al. (U.S. District
Court, Northern District, Illinois, filed October 20, 1997).
International Brotherhood of Teamsters Local 734 v. Philip Morris, Inc., et
al. (U.S. District Court, Northern District, Illinois, filed October 20, 1997).
Texas Carpenters Health Benefit Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, Eastern District, Texas, Beaumont Division, filed October
31, 1997).
United Food and Commercial Workers Unions and Employers Health and Welfare
Fund, et al. v. Philip Morris, Inc., et al. (U.S. District Court, Northern
District, Alabama, filed November 13, 1997).
B.A.C. Local 32 Insurance Trust Fund, et al. v. Philip Morris, Incorporated,
et al. (U.S. District Court, Eastern District, Michigan, filed November 14,
1997).
Screen Actors Guild-Producers Health Plan, et al. v. Philip Morris, Inc., et
al. (Superior Court, Los Angeles County, California, filed November 20, 1997).
IBEW Local 25 Health and Benefit Fund v. Philip Morris, Inc. et al. (U.S.
District Court, Southern District, New York, filed November 25, 1997).
IBEW Local 363 Welfare Fund v. Philip Morris, Inc., et al. (U.S. District
Court, Southern District, New York, filed November 25, 1997).
Local 138, 138A and 138B International Union of Operating Engineers Welfare
Fund v. Philip Morris, Inc., et al. (U.S. District Court, Southern District, New
York, filed November 25, 1997).
Local 840, International Brotherhood of Teamsters Health and Insurance Fund v.
Philip Morris, Inc., et al. (U.S. District Court, Southern District, New York,
filed November 25, 1997).
Long Island Council of Regional Carpenters Welfare Fund v. Philip Morris,
Inc., et al. (U.S. District Court, Southern District, New York, filed November
25, 1997).
Day Care Council - Local 205 D.C. 1707 Welfare Fund v. Philip Morris, Inc., et
al. (U.S. District Court, Southern District, New York, filed December 8, 1997).
Local 1199 Home Care Industry Benefit Fund v. Philip Morris, Inc., et al.
(U.S. District Court, Southern District, New York, filed December 8, 1997).
Local 1199 National Benefit Fund for Health and Human Services Employees v.
Philip Morris, Inc., et al. (U.S. District Court, Southern District, New York,
filed December 8, 1997).
Operating Engineers Local 324 Health Care Fund, et al. v. Philip Morris, Inc.,
et al. (U.S. District Court, Michigan, filed December 30, 1997). To date, none
of the defendants have received service of process.
40
Carpenters & Joiners Welfare Fund, et al. v. Philip Morris Incorporated, et
al. (U.S. District Court, Minnesota, filed December 31, 1997).
Steamfitters Local Union No. 614 Health & Welfare Fund, et al. v. Philip
Morris, Inc., et al. (Circuit Court, Thirteenth Judicial District, Tennessee,
filed January 7, 1998).
Belk, et al., Trustees of IBEW-NECA Local 505 Health and Welfare Fund v.
Philip Morris, Inc., et al. (Circuit Court, Mobile County, Alabama, filed
February 19, 1998).
Reimbursement Cases By Private Companies - Private companies have filed one
Reimbursement Case to date, although it has not been served. Lorillard is named
as a defendant in the case filed by private companies. The Company is not a
defendant in the case filed by private companies.
Group Health Plan, Inc., et al. v. Philip Morris Incorporated, et al.
(District Court, Second Judicial District, Ramsey County, Minnesota, filed March
11, 1998). To date, none of the defendants have received service of process.
CONTRIBUTION CLAIMS - In addition to the foregoing cases, six cases are
pending in which private companies seek recovery of funds expended by them to
individuals whose asbestos disease or illness was alleged to have been caused in
whole or in part by smoking-related illnesses. Three of the cases have not been
served. Lorillard is named as a defendant in each action. The Company is named
as a defendant in two of the cases, including one that has not been served. Each
of these cases is in the pre-trial, discovery stage.
Raymark Industries v. R.J. Reynolds Tobacco Company, et al. (U.S. States
District Court, Middle District, Florida, filed September 15, 1997). The Company
is a defendant in the case. To date, neither Lorillard nor the Company have
received service of process.
Raymark Industries v. Brown & Williamson Tobacco Corporation, et al. (U.S.
States District Court, Northern District, Georgia, filed September 15, 1997).
The Company is a defendant in the case.
Fibreboard Corporation and Owens-Corning v. The American Tobacco Company, et
al. (Superior Court, Alameda County, California, filed December 11, 1997).
Keene Creditors Trust v. Brown & Williamson Tobacco Corporation, et al.
(Supreme Court, New York County, New York, filed December 19, 1998). The Company
is a defendant in the case.
Falise, et al., as Trustees of the Manville Personal Injury Settlement Trust
v. The American Tobacco Company, et al. (U.S. District Court, Eastern District,
New York, filed December 31, 1997).
H.K. Porter Company v. B.A.T. Industries, PLC, et al. (U.S. District Court,
Southern District, New York, filed December 31, 1997). To date, none of the
defendants have received service of process.
Raymark Industries v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Duval
County, Florida, filed December 31, 1997). 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. Seventeen such cases are
pending in federal and state courts. Allegations of liability 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 $15.0
million in compensatory damages and $100.0 million 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, which Lorillard has appealed, requires Lorillard to pay
the amount of $140,000, although the award subsequently was reduced to $70,000.
41
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, which was upheld on appeal. The
Company has paid the compensatory judgment award, trial costs and interest
thereon in the amount of $1.6 million on December 30, 1997. The Company has
filed a petition for writ of certiorari to the United States Supreme Court as to
the punitive damage award, which is pending.
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. The court
has scheduled a bench trial to begin on February 5, 1999 in this matter and in
two other cases that assert allegations that defendants violated certain
provisions of the California Business and Professions Code.
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 made by Lorillard and other companies in the tobacco
industry that certain documents sought by plaintiffs are protected from
disclosure by the attorney-client privilege and work product protection. These
challenges include, among other things, allegations that such documents do not
contain legal advice or were not prepared for litigation purposes and, thus, are
not privileged or protected as attorney work product. Certain plaintiffs in
these cases have also alleged that defendants' privileged documents should be
discoverable pursuant to the so-called crime/fraud exception which negates the
privilege as to documents found to have been related to and prepared in
furtherance of an alleged crime or fraud.
Various courts have addressed these issues and have arrived at differing
conclusions as to whether the privilege for some of defendants' documents should
be maintained. Some of these rulings are final and, as a result, certain
documents as to which defendants have claimed a privilege have been released to
plaintiffs.
In addition, on December 5, 1997, certain documents as to which defendants had
claimed privilege were provided to the Chairman of the House Commerce Committee
in response to a subpoena. These documents were subsequently made available on
the Internet.
On February 19, 1998, the Committee subpoenaed an additional approximately
39,000 documents which Lorillard and other companies in the tobacco industry
have asserted to be privileged. These documents are the subject of a March 7,
1998 ruling in the Reimbursement Case brought by the State of Minnesota, in
which the judge ordered that the documents should be released on the basis of
the crime/fraud exception. Defendants have exhausted their appeals through the
state's judicial system and are seeking a stay of the ruling at the U.S. Supreme
Court.
Under the Proposed Resolution, Lorillard and the other companies in the
tobacco industry agreed to establish an industry-funded document depository to
allow public viewing of certain industry documents. In recent Congressional
testimony, representatives of the tobacco companies offered to make tens of
millions of pages of documents public prior to the enactment of any
comprehensive legislation to demonstrate their commitment to the principles set
forth in the Proposed Resolution. On February 27, 1998, Lorillard and other
companies in the tobacco industry posted on the Internet the first installment
of these documents for public access. In addition, the court in the
Reimbursement Case brought by the State of Minnesota has granted defendants'
request to allow public access to the document depository established in that
case. The publicly available materials will not include documents containing
trade secret information, certain personnel and third party information, or
documents for which attorney-client privilege or work product doctrine claims
have been asserted.
Tobacco industry documents have generated extensive media coverage recently
and have become a focal point in the litigation. The Company cannot predict the
effect disclosure of these documents may have on pending litigation or
Congressional consideration of the Proposed Resolution.
SETTLEMENTS OF REIMBURSEMENT CASES - In furtherance of the Proposed
Resolution, Lorillard and other companies in the United States tobacco industry
(the "Settling Defendants") have settled Reimbursement Cases brought by the
States of Mississippi, Florida and Texas on terms consistent with the Proposed
Resolution. The Mississippi action was settled in July 1997, Florida was settled
in September 1997 and Texas was settled in January 1998. These settlements
resulted in a pre-tax charge to earnings of $163.4 million in 1997.
42
Under the Mississippi settlement agreement, the Settling Defendants paid
$170.0 million representing Mississippi's estimated share of the $10.0 billion
initial payment under the Proposed Resolution, and paid an additional $15.0
million to reimburse Mississippi and its private counsel for out-of-pocket
costs. The Settling Defendants also paid approximately $62.0 million to support
a pilot program aimed at reducing the use of tobacco products by persons under
the age of eighteen. Lorillard's share of all the foregoing payments,
approximately $19.5 million, was charged to expense in 1997.
Beginning December 31, 1998, the Settling Defendants will pay Mississippi
amounts based on its anticipated share of the annual industry payments under the
Proposed Resolution. These payments, which (except for the payment with respect
to 1998) will be adjusted as provided in the Proposed Resolution, are estimated
to be $68.0 million with respect to 1998 and will increase annually thereafter
to an estimated $136.0 million by 2003, continuing at that level thereafter, and
will be allocated among the Settling Defendants in accordance with their
relative unit volume of domestic tobacco product sales.
Under the Florida settlement agreement, the Settling Defendants paid $550.0
million, representing Florida's estimated share of the $10.0 billion initial
payment under the Proposed Resolution, and also reimbursed Florida's expenses
and those of its private counsel. The Settling Defendants also paid $200.0
million to support a pilot program by Florida aimed at reducing the use of
tobacco products by persons under the age of eighteen. Lorillard's share of all
the foregoing payments, approximately $59.5 million, was charged to expense in
1997.
On September 15, 1998, and annually thereafter on December 31, the Settling
Defendants will make ongoing payments to Florida in the following estimated
amounts - 1998: $220 million; 1999: $247.5 million; 2000: $275 million; 2001:
$357.5 million; 2002: $357.5 million; and each year thereafter $440 million.
These amounts are projected to approximate that portion of the annual industry
payments under the Proposed Resolution which is contemplated to be paid to
Florida. These payments (except for the payment with respect to 1998) will be
adjusted as provided in the Proposed Resolution and will be allocated among the
Settling Defendants in accordance with their relative unit volume of domestic
tobacco product sales.
Under the Texas settlement agreement, the Settling Defendants agreed to pay
Texas an up-front payment of $725.0 million in 1998, representing Texas's
estimated share of the $10.0 billion initial payment under the Proposed
Resolution, and agreed to reimburse Texas and its private counsel for expenses
in the estimated amount of $45.0 million. The Settling Defendants also agreed to
pay Texas $264.0 million to support a pilot program aimed at reducing the use of
tobacco by persons under the age of eighteen. Lorillard's share of all of the
foregoing payments, approximately $84.4 million, was charged to expense in 1997.
Several counties and hospital districts in the State of Texas have moved to
intervene in this action to amend and/or limit the operation of the court's
judgment approving the settlement. In addition, the Governor of Texas has also
moved to intervene and has filed a notice of appeal with respect to the judgment
in this action. It is unclear what effect these actions would have upon the
Texas settlement agreement.
Beginning in November and December 1998, and on December 31 of each subsequent
year, the Settling Defendants will pay Texas 7.25% of the annual industry
payments contemplated to be paid to the states under the Proposed Resolution.
These payments, which (except for the payments with respect to 1998) will be
adjusted as provided in the Proposed Resolution, will be in the following
estimated amounts - 1998: $290.0 million; 1999: $326.0 million; 2000: $363.0
million; 2001: $471.0 million; 2002: $471.0 million; and 2003 and each year
thereafter: $580.0 million. These payments will be allocated among the Settling
Defendants in accordance with their relative unit volume of domestic tobacco
product sales.
The Settling Defendants have also agreed to pay reasonable attorney's fees of
private contingency fee counsel of Mississippi, Florida and Texas as set by a
panel of independent arbitrators. Each of these payments would be allocated
among the Settling Defendants in accordance with their relative unit volume of
domestic tobacco product sales and will be subject to an aggregate national
annual cap of $500.0 million. Certain of Florida's private contingency fee
counsel have challenged the attorneys' fees provision set forth in the Florida
settlement agreement, arguing that the settlement agreement has no effect on
their rights under their contingency fee agreement with Florida. In November
1997, the court ordered all parties to comply with the provisions for obtaining
attorneys' fees, as set forth in the settlement agreement. Certain contingency
fee counsel are appealing this ruling. One of these contingency fee counsel has
filed suit against certain companies in the tobacco industry, although not
Lorillard, alleging, among other things, tortious interference with such
counsel's contingency fee agreement with the State.
43
If legislation implementing the Proposed Resolution or its substantial
equivalent is enacted, the settlements will remain in place, but the terms of
the federal legislation will supersede the settlement agreements (except for the
terms of the pilot programs and payments thereunder, the initial payments and
the annual payments with respect to 1998), and the other payments described
above will be adjusted so that Mississippi, Florida and Texas will receive the
same payments as they would receive under such legislation.
If the Settling Defendants enter into any future pre-verdict settlement
agreement with a non-federal governmental plaintiff on more favorable terms
(after due consideration of relevant differences in population or other
appropriate factors), Mississippi, Florida and Texas will obtain treatment at
least as relatively favorable as such governmental plaintiff.
If the federal legislation implementing the Proposed Resolution or its
substantial equivalent is enacted, the parties contemplate that Mississippi,
Florida and Texas and any other state that has made an exceptional contribution
to secure resolution of these matters may apply to a panel of independent
arbitrators for reasonable compensation for its efforts in securing the Proposed
Resolution. The Settling Defendants have agreed not to oppose applications for
$75.0 million by Mississippi, $250.0 million by Florida and $329.5 by Texas,
subject to a nationwide annual cap for all such payments of $100.0 million.
Finally, the Settlement agreements provide that they are not an admission or
concession or evidence of any liability or wrongdoing on the part of any party,
and were entered into by the Settling Defendants solely to avoid the further
expense, inconvenience, burden and uncertainty of litigation.
LIGGETT SETTLEMENT - Liggett Group, Inc. and its parent company, Brooke Group,
Ltd., Inc. ("Liggett"), and the Attorneys General for a total of 40 states, have
announced that they have reached agreements (the "Liggett Settlements") to
settle the reimbursement claims made by those states. The proposed settlements
reportedly will require Liggett: to make one-time payments to each of the
settling states in an amount of as much as $1.0 million; to pay to the settling
states an aggregate percentage of as much as 30% of its pre-tax profits annually
for the next 25 years; 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 Settlements also
purport to be on behalf of "all persons who, prior to or during the term of [the
Liggett Settlements], have smoked cigarettes or have used other tobacco products
and have suffered or claim to have suffered injury as a consequence thereof."
Pursuant to the Liggett Settlements described above, Liggett has submitted
numerous documents from its files to courts and defendants in several of the
Reimbursement 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.
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.
44
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.
Other Legal Proceedings: In September 1997, a purported class action was
commenced by private plaintiffs in Alabama state court alleging that the U.S.
tobacco companies and others conspired to fix cigarette prices in Alabama, that
agreements leading to price increases were reached during the negotiations
leading to the Proposed Resolution, and that prices were increased pursuant to
the alleged conspiracy in 1997 (Mosley, et al. v. Philip Morris Companies Inc.,
et al.). The parties are currently discussing settlement of this action for a
payment by defendants in an aggregate amount approximating $60,000 to cover
costs incurred by plaintiff's counsel.
Department of Justice Investigation - Early in 1994, the Energy and Commerce
Subcommittee on Health and the Environment of the U.S. House of Representatives
(the "Subcommittee") launched an oversight investigation into tobacco products,
including possible regulation of nicotine-containing cigarettes as drugs. During
the course of such investigation, the Subcommittee held hearings at which
executives of each of the major tobacco manufacturers testified. Following the
November 1994 elections, the incoming Chairman of the Energy and Commerce
Committee indicated that this investigation by the Subcommittee would not
continue, and on December 20, 1994, the outgoing majority staff of the
Subcommittee issued two final reports. One of these reports questioned the
scientific practices of what it characterized as the tobacco industry's "long-
running campaign" related to ETS, but reached no final conclusions. The second
report asserted that documents obtained from American Tobacco Company, a
competitor of Lorillard's, "reflect an intense research and commercial interest
in nicotine."
The U.S. Department of Justice is investigating allegations of perjury in
connection with the testimony provided by tobacco industry executives, including
Lorillard executives, to the Subcommittee in April 1994. Lorillard has not
received any request for documents or testimony. It is impossible at this time
to predict the outcome of this investigation.
In 1996 Lorillard responded to a grand jury subpoena for documents in
connection with a grand jury investigation commenced in 1992 by the United
States Attorney's Office for the Eastern District of New York regarding possible
fraud by Lorillard and other tobacco companies relating to smoking and health
research undertaken or administered by the Council for Tobacco Research - USA,
Inc. There have been no requests for any testimony by any Lorillard personnel.
At the present time, Lorillard is unable to predict whether the United States
Attorney's Office will ultimately determine to bring any proceeding against
Lorillard. An adverse outcome of this investigation could result in criminal,
administrative or other proceedings against Lorillard.
In March 1996, the Company and Lorillard each received a grand jury subpoena
duces tecum from the United States Attorney's Office for the Southern District
of New York seeking documents, advertisements or related materials distributed
by the Company and Lorillard to members of the general public relating to, among
other things, the health effects of cigarettes, nicotine or tobacco products,
the addictiveness of such products, and Congressional hearings relating to
cigarettes or the tobacco industry. The Company and Lorillard responded to the
subpoena. The Company and Lorillard were informed in the latter part of 1996
that responsibility for this investigation has been transferred from the United
States Attorney's Office for the Southern District of New York to the United
States Department of Justice in Washington, D.C. It is impossible at this time
to predict the ultimate outcome of this investigation.
45
Item 4. Submission of Matters to a Vote of Security Holders.
None.
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS OF THE REGISTRANT
First
Became
Name Position and Offices Held Age Officer
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Gary W. Garson .......... Vice President and 51 1988
Assistant Secretary
Barry Hirsch ............ Senior Vice President and 64 1971
Secretary
Herbert C. Hofmann ...... Senior Vice President 55 1979
Peter W. Keegan ......... Senior Vice President and 53 1997
Chief Financial Officer
John J. Kenny ........... Treasurer 60 1991
Guy A. Kwan ............. Controller 55 1987
John G. Malino .......... Vice President-Real Estate 58 1985
Alan Momeyer ............ Vice President-Human Resources 50 1996
Stuart B. Opotowsky ..... Vice President-Tax 63 1987
Richard E. Piluso ....... Vice President-Internal Audit 59 1990
Andrew H. Tisch ......... Chairman of the Management 48 1985
Committee
James S. Tisch .......... President and Chief Operating 45 1981
Officer
Jonathan M. Tisch ....... Vice President 44 1987
Laurence A. Tisch ....... Co-Chairman of the Board and 75 1959
Co-Chief Executive Officer
Preston R. Tisch ........ Co-Chairman of the Board and 71 1960
Co-Chief Executive Officer
</TABLE>
Laurence A. Tisch and Preston R. Tisch are brothers. Andrew H. Tisch and James
S. Tisch are sons of Laurence A. Tisch and Jonathan M. Tisch is a son of Preston
R. Tisch. None of the other officers or directors of Registrant is related to
any other.
All executive officers of Registrant, except Peter W. Keegan, have been
engaged actively and continuously in the business of Registrant for more than
the past five years. Peter W. Keegan was Senior Vice President of Finance at CBS
Inc. prior to joining Loews Corporation.
Officers are elected and hold office until their successors are elected and
qualified, and are subject to removal by the Board of Directors.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
Price Range of Common Stock
Loews Corporation's common stock is listed on the New York Stock Exchange. The
following table sets forth the reported consolidated tape high and low sales
prices in each calendar quarter of 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------------
High Low High Low
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
First Quarter ............ $112.88 $88.13 $88.25 $74.25
Second Quarter ........... 107.00 85.50 83.50 72.50
Third Quarter ............ 114.13 94.63 83.88 73.63
Fourth Quarter ........... 115.63 99.63 95.88 77.13
</TABLE>
46
Dividend Information
The Company has paid quarterly cash dividends on its common stock in each year
since 1967. Regular dividends of $.25 per share of common stock were paid in
each calendar quarter of 1997 and 1996.
Approximate Number of Equity Security Holders
The Company has approximately 3,200 holders of record of Common Stock.
Item 6. Selected Financial Data.
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------
(Amounts in millions, except per share data)
<S> <C> <C> <C> <C> <C>
Results of Operations:
Revenues ....................... $20,138.8 $20,442.4 $18,677.4 $13,515.2 $13,686.8
Income before taxes and
minority interest ............ $ 1,593.2 $ 2,407.8 $ 2,839.3 $ 266.1 $ 689.4
Net income excluding net
investment (losses)/gains
and tobacco litigation
settlements .................. $ 1,075.5 $ 1,020.3 $ 793.8 $ 522.0 $ 132.2
Tobacco litigation
settlements .................. (122.0)
- ------------------------------------------------------------------------------------------------
Net operating income ........... 953.5 1,020.3 793.8 522.0 132.2
Net investment (losses)/gains... (159.9) 363.6 971.9 (254.2) 461.9
- ------------------------------------------------------------------------------------------------
Net income ..................... $ 793.6 $ 1,383.9 $ 1,765.7 $ 267.8 $ 594.1
================================================================================================
Earnings Per Share:
Net income excluding net
investment (losses)/gains and
tobacco litigation settlements $ 9.35 $ 8.78 $ 6.73 $ 4.33 $ 1.03
Tobacco litigation settlements . (1.06)
- ------------------------------------------------------------------------------------------------
Net operating income ........... 8.29 8.78 6.73 4.33 1.03
Net investment (losses)/gains .. (1.39) 3.13 8.25 (2.11) 3.60
- ------------------------------------------------------------------------------------------------
Net income ..................... $ 6.90 $ 11.91 $ 14.98 $ 2.22 $ 4.63
================================================================================================
Financial Position:
Total assets ................... $69,577.1 $67,402.9 $65,516.9 $50,336.0 $45,849.8
Long-term debt ................. 5,752.6 4,370.7 4,248.2 2,144.4 2,195.7
Shareholders' equity ........... 9,665.1 8,731.2 8,238.7 5,405.3 6,127.2
Cash dividends per share ....... 1.00 1.00 .63 .50 .50
Book value per share ........... 84.04 75.92 69.92 45.84 49.79
Shares of common stock
outstanding ................... 115.0 115.0 117.8 117.9 123.0
</TABLE>
47
Item 7. 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 conducted through
subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 84% owned
subsidiary of the Company.
CNA is one of the largest commercial insurers in the United States and the
third largest property and casualty company and the twenty-second largest life
insurance company in the country, based on 1996 net written premiums.
CNA's property and casualty insurance subsidiaries' statutory surplus grew
from $3.4 billion in 1994 to $7.1 billion in 1997. Surplus rose in part ($1.7
billion) due to the acquisition of The Continental Corporation in 1995.
Dividends of $175.0, $545.0 and $325.0 million were paid to CNA by Continental
Casualty Company in 1997, 1996 and 1995, respectively.
Statutory surplus of CNA's life insurance subsidiaries grew from $1.1 billion
at December 31, 1994 to $1.2 billion at December 31, 1997.
The liquidity requirements of CNA have been met by funds generated from
operations and investing activities. 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.
For the year ended December 31, 1997, CNA's operating activities generated
negative cash flows of $193.0 million compared to positive cash flows of $620.2
million in 1996 and $875.0 million in 1995. CNA's negative cash flows were
primarily due to claim payments made resulting from the settlement of the
Fibreboard litigation. The impact on cash flow for these claim payments was
approximately $1.0 billion in 1997 (see Note 18 of the Notes to Consolidated
Financial Statements).
Net cash flows are primarily 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 securities.
In 1997, CNA filed a Registration Statement on Form S-3 with the Securities
and Exchange Commission relating to $1.0 billion of debt and preferred stock
that became effective on October 22, 1997. On January 8, 1998, CNA issued $150.0
million principal amount of 6.45% senior notes due January 15, 2008 and $150.0
million principal amount of 6.95% senior notes due January 15, 2018. The net
proceeds were used to pay down bank loans drawn under a revolving credit
facility. Concurrent with the reduction in bank debt, CNA terminated $300.0
million notional amount of interest rate swaps.
The following table reflects ratings issued by A.M. Best, Standard and Poor's,
Moody's and Duff & Phelps for CNA's Continental Casualty Company ("CCC")
Intercompany Pool, Continental Insurance Company ("CIC") Intercompany Pool and
Continental Assurance Company ("CAC") Intercompany Pool. Also, rated were the
senior debt of both CNA and The Continental Corporation (Continental) and CNA's
preferred stock.
48
<TABLE>
<CAPTION>
Insurance Ratings Debt and Stock Ratings
--------------------- ----------------------------------
CNA CIC CNA CIC
----------- --- --------------------------- ------
Senior Commercial Preferred Senior
CCC CAC Debt Paper Stock Debt
- --------------------------------------------------------------------------------
Financial Strength
---------------------
<S> <C> <C> <C> <C> <C> <C> <C>
A.M. Best A A A- - - - -
Moody's A1 A1* A2 A3 P2 a3 Baa1
Claims Paying Ability
---------------------
Standard & Poor's A+ AA- A- A- A2 A- BBB-
Duff & Phelps AA- AA - A- - A- -
- --------------------------------------------------------------------------------
*Applies to Continental Assurance Company only.
Cigarettes
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
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 18 of the Notes to Consolidated 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 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 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 18 of the Notes to Consolidated 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 include:
(i) Regulations making 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 limiting all cigarette advertising to
49
a black and white, text only format in most publications and outdoor
advertising such as billboards, regulations prohibiting billboards
advertising cigarettes within 1,000 feet of a school or playground,
banning the use of cigarette brand names, logos and trademarks on
premium items and prohibiting 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.
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. The Court granted, in part, and
denied, in part, plaintiffs' motion for summary judgment. The Court held 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, also held 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 relating to
advertising and promotion of tobacco products, but allowed the access
restrictions to take effect as of February 27, 1997. Both the plaintiffs and the
defendants have filed an appeal of the District Court's ruling to the Fourth
Circuit Court of Appeals.
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
"Proposed 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 Proposed 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 Proposed Resolution. The Proposed 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 Proposed 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 Proposed Resolution. Certain
members of Congress have offered or indicated that they may offer alternative
legislation. Currently, over thirty bills have been introduced in Congress
regarding the issues raised in the Proposed Resolution, including bills seeking
more stringent regulation of the tobacco industry by the FDA and bills to
increase the federal excise tax on tobacco products. Several of these bills seek
to increase the payments by the tobacco industry from the levels reflected in
the Proposed Resolution and deny the tobacco industry any form of relief from
civil litigation. No bill currently introduced would adopt the Proposed
Resolution as agreed to. There can be no assurance that federal legislation in
the form of the Proposed Resolution will be enacted or that it will be enacted
without modification that is materially
50
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 Proposed 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 Proposed Resolution could affect
other federal, state and local regulation of the United States tobacco industry.
Advertising and Marketing Restrictions
The Proposed Resolution would incorporate certain regulations previously
promulgated by the FDA and add additional restrictions to curtail tobacco
product advertising and marketing, including among other things, a prohibition
on the use of human images and cartoon characters in all tobacco product
advertising, a ban on all outdoor tobacco product advertising, limiting tobacco
product advertising to black text on a white background in most major
publications, a ban on sponsorships (including concerts and sporting events) in
the name, logo or selling message of a tobacco brand, a ban on all non-tobacco
merchandise (such as caps, jackets and bags) bearing the name, logo or selling
message of a tobacco brand, a ban on offers of non-tobacco items or gifts based
on proofs-of-purchase of tobacco products, and other restrictions.'
In addition, the Proposed 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 Proposed Resolution would mandate a new set of rotating warnings to be
placed on packages of tobacco products with greater prominence than previous
warnings. 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 Proposed Resolution would restrict access to tobacco products by minors.
Without preventing state and local governments from imposing stricter measures,
the Proposed 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 set a minimum age
of 18 to purchase tobacco products, require retailers to check photo
identification of anyone under 27 years of age, establish a requirement of
face-to-face transactions for all sales of tobacco products, and other access
restrictions intended to reduce access by youth to tobacco products.
Surcharge for Failure to Achieve Underage Smoking Reduction Goals
The Proposed Resolution would impose surcharges on the tobacco 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.
51
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. The annual surcharge would be $80 million for each percentage point by
which the reduction in underage smoking falls short of the required reductions.
The annual surcharge would be subject to a $2 billion 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. 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 Proposed Resolution, had taken all reasonably available
measures to reduce youth tobacco usage and had not acted to undermine the
achievement of the reduction goals.
Regulation
Under the Proposed 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 Proposed 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.
The Proposed Resolution would also require, effective three years from the
date of implementing legislation, 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, if certain findings are met, 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.
The Proposed Resolution would subject the tobacco industry to the FDA's "good
manufacturing practice" standards, including requirements regarding quality
control systems, FDA inspections and record-keeping and reporting.
Public Disclosure
The Proposed 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 Proposed Resolution would also require the industry to disclose
all such internal laboratory research generated in the future.
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
52
implement compliance programs setting compliance standards and procedures for
employees and agents that are reasonably capable of reducing violations.
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.
Public Smoking
The Proposed Resolution would mandate minimum federal standards governing
smoking in public places or at work, with states and localities retaining power
to impose stricter requirements.
Industry Payments
The Proposed 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 Proposed 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, if required. 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 25% of the increased
profit. At current levels of sales and prior to any adjustment for inflation,
the Proposed 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 Proposed 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 Proposed Resolution
would provide for the pass-through to consumers of the annual Industry Payments
in order to promote the maximum reduction in underage use.
Effects on Litigation
If enacted, the federal legislation provided for in the
53
Proposed Resolution would settle present state-wide claims seeking, among other
damages, reimbursement of health care costs allegedly incurred as a result of
smoking (or similar actions brought by or on behalf of any governmental entity)
("Reimbursement Cases"), 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 Proposed Resolution provides that no stay
applications will be made in pending governmental actions without the mutual
consent of the parties. In furtherance of the Proposed Resolution, Lorillard and
other companies in the United States tobacco industry have settled Reimbursement
Cases brought by the states of Florida, Mississippi and Texas on terms
consistent with the Proposed Resolution. The Mississippi action was settled in
July 1997, Florida was settled in September 1997 and Texas was settled in
January 1998 (see "Results of Operations"). 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 Proposed Resolution. No
assurance can be given whether a postponement or settlement will be achieved,
or, if achieved, as to the terms thereof. The Proposed 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 Proposed 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 Proposed
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 Proposed 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 Proposed 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; and (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 Proposed Resolution.
Proposed Excise Tax Increases
The United States federal excise tax on cigarettes is presently $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
54
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. Various states have proposed, and certain states have recently
passed, increases in their state tobacco excise taxes. Such actions may
adversely affect Lorillard's volume, operating revenues and operating income.
* * * *
Funds from operations continue to exceed operating requirements. Lorillard
generated net cash flow from operations of approximately $521.4 million for the
year ended December 31, 1997, compared to $418.3 million for the prior year.
Hotels
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Loews Hotels is constructing a new 800 room property in Miami Beach, Florida
which is scheduled to open in late 1998. Initial funding for this project has
been provided by Loews Hotels and the City of Miami Beach. The balance of the
funds necessary for construction are being provided by a first mortgage.
Loews Hotels has entered into an agreement with the owners of the Universal
Florida resort to develop hotels at the resort. Capital expenditures in relation
to the Universal Florida hotel project are expected to be funded by a
combination of equity contributions by the development partners and mortgages.
Funds from operations continue to exceed operating requirements. Funds for
other capital expenditures and working capital requirements are expected to be
provided from operations. Loews Hotels expects to obtain its share of the equity
contributions for the development and acquisition of hotels (anticipated to
amount to approximately $138.0 million during the next three years for existing
development projects) under arrangements with the Company.
Offshore Drilling
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore"). Diamond
Offshore Drilling, Inc. is a 50.3% owned subsidiary of the Company.
In April 1997, Diamond Offshore completed a public offering of 2.5 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. 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.
Diamond Offshore continues to benefit from increased demand and the recent
tight supply of major offshore drilling rigs worldwide. These conditions are
due, in part, to the increasing impact of technological advances, including 3-D
seismic, horizontal drilling, and subsea completion procedures, on oil and gas
exploration and development economics. To address the current tight supply
situation, customers continue to seek to contract rigs for longer terms (as
opposed to contracts for the drilling of a single well or a group of wells) and
often will pay for upgrades and modifications necessary for more challenging
drilling locations in order to assure rig availability. Diamond Offshore seeks
to have a foundation of long-term contracts with a reasonable balance of
short-term or well-to-well contracts to minimize risk while participating in the
benefit of increasing dayrates in a rising market.
Diamond Offshore continues to enhance its fleet to meet customer demand for
diverse drilling capabilities, including those required for deep water and harsh
55
environment operations. In March 1997, Diamond Offshore completed the major
upgrade of the Ocean Star to fourth-generation capabilities and the rig began a
three-year commitment in the deep water market of the Gulf of Mexico. In July
1997, the Ocean Clipper I began a four-year contract in the deep water market of
the Gulf of Mexico following its upgrade project. The Ocean Victory, previously
stacked in the North Sea, completed modifications in connection with its
three-year deep water drilling program which began in November 1997. In
addition, Diamond Offshore is scheduled to begin the conversion of the
Polyconfidence, a semisubmersible accommodation vessel, in early 1998 in
connection with a five-year commitment in the Gulf of Mexico anticipated to
begin in late 1999.
The ability to minimize costs and downtime is critical to Diamond Offshore's
results of operations. The improved opportunities for the offshore contract
drilling industry worldwide have resulted in increased demand for and a shortage
of experienced personnel and equipment, including drill pipe and riser,
necessary on offshore drilling rigs. Diamond Offshore does not consider the
shortage of such personnel and equipment currently to be a material factor in
its business. However, because of the increased demand for oil field services, a
significant increase in costs, including compensation and training, is likely to
occur if present trends continue for an extended period. In addition, because of
periodic inspections required by certain regulatory agencies, 15 of Diamond
Offshore's rigs will be in the shipyard for a portion of 1998. Diamond Offshore
intends to focus on returning these rigs to operations as soon as reasonably
possible, in order to minimize the downtime and associated loss of revenues.
In February 1998, a fire was detected in the engine room of the Ocean Victory,
which was operating in the Gulf of Mexico. Although the fire was contained and
extinguished, damage was done to the power and electrical systems aboard the
rig. It is possible that the repair period could remove the rig from service for
a significant portion of 1998. Diamond Offshore expects that its insurance will
cover the repairs, but the loss of revenue during the repair period is not
covered by insurance. As a result, the loss of such revenues will reduce Diamond
Offshore's results of operations for 1998.
The recent improvement in the current results of operations and prospects for
the offshore contract drilling industry as a whole has led to increased rig
construction and enhancement programs by Diamond Offshore's competitors. A
significant increase in the supply of technologically advanced rigs capable of
drilling in deep water may have an adverse effect on the average operating
dayrates for Diamond Offshore's rigs, particularly its more advanced
semisubmersible units, and on the overall utilization level of Diamond
Offshore's fleet. In such case, Diamond Offshore's results of operations would
be adversely affected.
In order to effectively compete in this market, Diamond Offshore is required
to incur significant capital expenditures to meet customer requirements as well
as fund its own rig enhancement program. Diamond Offshore expects to spend
approximately $108.5 million during 1998 for rig upgrades in connection with
contract requirements. In addition, it has budgeted $126.7 million for 1998
capital expenditures associated with its continuing rig enhancement program,
spare equipment and other corporate requirements.
Diamond Offshore generated net cash flow from operations of approximately
$396.4 million for the year ended December 31, 1997, compared to $210.2 million
for the prior year. It is anticipated that funds for capital expenditures and
working capital requirements will be provided by cash flow from operations. In
February 1997, Diamond Offshore sold $400.0 million principal amount of 3 3/4%
convertible subordinated notes due February 15, 2007.
Historically, the offshore contract drilling industry has been highly
competitive and cyclical, and Diamond Offshore cannot predict the extent to
which current conditions will continue.
56
Watches and Clocks
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
Funds from operations continue to exceed operating requirements. Funds for
other capital expenditures and working capital requirements are expected to be
provided from operations. No material capital expenditures are anticipated
during 1998.
Parent Company
On September 16, 1997, the Company sold $1.2 billion principal amount of 3 1/8%
Exchangeable Subordinated Notes due 2007. See Note 11 of the Notes to
Consolidated Financial Statements. In addition, on January 15, 1997, the Company
redeemed its $200.0 million principal amount of 8 1/4% debentures due 2007 at a
price of 103.6%
The Company continues to pursue conservative financial strategies while
seeking opportunities for responsible growth. These include the expansion of
existing businesses, full or partial acquisitions and dispositions, and
opportunities for efficiencies and economies of scale.
57
INVESTMENTS
Investment activities of non-insurance companies include investments in fixed
income securities, equity securities including short sales, derivative
instruments and short-term investments. Equity securities, which are considered
part of the Company's trading portfolio, short sales and derivative instruments
are marked to market and reported as investment gains or losses in the income
statement. The remaining securities are carried at fair value with a net
unrealized loss of $3.2 million at December 31, 1997, compared to $22.4 million
at December 31, 1996.
The Company enters into short sales and invests in certain derivative
instruments for a number of purposes, including: (i) for its asset and liability
management activities, (ii) for income enhancements for its portfolio management
strategy, and (iii) to benefit from anticipated future movements in the
underlying markets that Company management expects to occur. If such movements
do not occur or if the market moves in the opposite direction from what
management expects, significant losses may occur.
Monitoring procedures include senior management review of daily detailed
reports of existing positions and valuation fluctuations to ensure that open
positions are consistent with the Company's portfolio strategy.
The credit exposure associated with these instruments is generally limited to
the positive market value of the instruments and will vary based on changes in
market prices. The Company enters into these transactions with large financial
institutions and considers the risk of nonperformance to be remote.
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex 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," "Quantitative and Qualitative Disclosures
about Market Risk" and Note 4 of the Notes to Consolidated Financial Statements
for additional information with respect to derivative instruments, including
recognized gains and losses on these instruments.
Insurance
CNA's general account investment portfolio is managed to maximize after tax
investment return, while minimizing credit risks. Investments are concentrated
in high quality securities to support its insurance underwriting operations.
CNA has the capacity to hold its fixed income 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, the fixed
maturity securities are classified as available for sale.
The general account portfolio consists primarily of high quality (BBB or
higher) marketable fixed maturities, 95.0% and 94.2% of which are rated as
investment grade at December 31, 1997 and 1996, respectively.
The following table summarizes the ratings of CNA's general account fixed
maturity bond portfolio at fair value:
</TABLE>
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
(Amounts in millions of dollars)
<S> <C> <C> <C> <C>
U.S. government and affiliated securities $13,679.0 46.4% $11,623.0 42.0%
Other AAA rated 8,801.0 29.9 9,277.0 33.5
AA and A rated 3,796.0 12.9 3,786.0 13.7
BBB rated 1,695.0 5.8 1,387.0 5.0
Below investment grade 1,480.0 5.0 1,581.0 5.8
- --------------------------------------------------------------------------------
Total $29,451.0 100.0% $27,654.0 100.0%
================================================================================
</TABLE>
58
Approximately 73.8% of Separate Account investments are used to fund guaranteed
investments contracts for which CAC guarantees principal and a specified return
to the contract holders. The following table summarizes the ratings of CNA's
guaranteed investment contract Separate Account fixed maturity bond portfolio at
fair value:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
(Amounts in millions of dollars)
<S> <C> <C> <C> <C>
U.S. government and affiliated securities $ 148.0 3.9% $ 192.0 5.0%
Other AAA rated 2,401.0 62.6 2,279.0 59.0
AA and A rated 569.0 14.8 723.0 18.7
BBB rated 406.0 10.6 345.0 8.9
Below investment grade 310.0 8.1 324.0 8.4
- --------------------------------------------------------------------------------
Total $3,834.0 100.0% $3,863.0 100.0%
================================================================================
</TABLE>
The ratings in the two tables above are primarily from independent rating
agencies (89.8% and 89.0% of the general account portfolio, and 82.1% and 84.7%
of the guaranteed investment portfolio in 1997 and 1996, respectively, were
rated by major rating agencies). In addition, CNA's investments in mortgage
loans and real estate as a percentage of total assets are substantially below
industry average.
High yield securities are bonds rated below investment grade by bond rating
agencies and other unrated securities which, in the opinion of management, are
below investment grade (below BBB). High yield securities generally involve a
greater degree of risk than 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. CNA's
concentration in high yield bonds including Separate Account business was
approximately 3.2% of its total assets at December 31, 1997 and 1996.
Included in CNA's fixed maturity securities at December 31, 1997 (general and
guaranteed investment portfolios) are $7.2 billion of asset-backed securities,
consisting of approximately 11.2% in U.S. government agency issued pass-through
certificates, 40.0% in collateralized mortgage obligations ("CMO's"), 29.8% in
corporate asset-backed obligations and 19.0% in corporate mortgage-backed pass-
through securities.
CMO's are subject to prepayment risks that tend to vary with changes in
interest rates. During periods of declining interest rates, CMO's generally
prepay faster as the underlying mortgages are prepaid and refinanced by
borrowers in order to take advantage of the lower rates. Conversely, during
periods of rising interest rates, prepayments are generally slow which may
result in a decrease in yield or a loss as a result of the slower prepayments.
CNA limits the risks associated with interest rate fluctuations and prepayment
by concentrating its CMO investments in planned amortization classes with
relatively short principal repayment windows. CNA avoids investments in complex
mortgage derivatives without readily ascertainable market prices. At December
31, 1997, the fair value of asset-backed securities was greater than the
amortized cost by approximately $114.0 million, as compared to net unrealized
losses of approximately $5.0 million for the comparable period a year ago.
At December 31, 1997 and 1996, short-term investments consisted primarily of
U.S. treasury bills and commercial paper.
59
CNA invests from time to time in certain derivative financial instruments to
reduce its exposure to market risk (principally interest rate, equity price and
foreign currency risk). CNA also uses derivatives to mitigate the risk
associated with its indexed group annuity contract by purchasing S&P 500 futures
contracts in a notional amount equal to the original customer deposit.
CNA considers its derivatives as being held for purposes other than trading.
Derivative securities, except for interest rate swaps associated with corporate
borrowings, are recorded at fair value at the reporting date with changes in
market value reflected in investment gains and losses. The interest rate swaps
on corporate borrowings are accounted for on the accrual basis with the related
income or expense recorded as an adjustment to interest expense.
As of December 31, 1997 CNA's general account investments in bonds and
redeemable preferred stocks were carried at a fair value of $29.5 billion,
compared to $27.7 billion at December 31, 1996. At December 31, 1997 and 1996,
net unrealized gains on fixed maturity securities amounted to approximately
$528.0 and $181.0 million, respectively. The gross unrealized gains and losses
for the fixed maturity securities portfolio at December 31, 1997 were $644.0 and
$116.0 million, respectively, compared to $444.0 and $263.0 million,
respectively, at December 31, 1996.
Net unrealized gains on general account bonds at December 31, 1997 include net
unrealized losses on high yield securities of $2.0 million, compared to
unrealized gains of $34.0 million at December 31, 1996. Carrying and fair values
of high yield securities in the general account were $1.5 billion at December
31, 1997, compared to $1.6 billion at December 31, 1996.
At December 31, 1997, total Separate Account cash and investments amounted to
$5.7 billion with taxable fixed maturities representing approximately 83.4% of
the Separate Account portfolio. Approximately 73.8% of Separate Account
investments are used to fund guaranteed investments contracts for which CAC
guarantees principal and a specified return to the contract holders. The
duration of fixed maturity securities included in the guaranteed investment
contract portfolio are matched approximately with the corresponding payout
pattern of the liabilities of the guaranteed investment contracts. 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 per annum.
Deposits are taken for a three- year period with no payout until the end of the
period. CNA mitigates the risk associated with the contract liability by a
combination of purchasing S&P 500 futures contracts in a notional amount equal
to the original deposit and investing in high quality securities. The futures
contracts are adjusted regularly to approximate the future liability to the
contract holder. The gross notional amount of these futures totaled $860.0 and
$394.0 million at December 31, 1997 and 1996, respectively.
At December 31, 1997, fixed maturity securities in the guaranteed investment
contract portfolio are carried at fair value, and amounted to $4.0 billion. At
December 31, 1997, net unrealized gains on fixed maturity securities in these
Separate Accounts amounted to approximately $71.0 million. This compares to net
unrealized losses of $0.7 million at December 31, 1996. The gross unrealized
gains and losses for the fixed maturity securities portfolio at December 31,
1997 were $87.0 and $16.0 million, respectively, compared to $55.0 and $55.7
million, respectively, at December 31, 1996.
High yield securities in the guaranteed investment contract portfolio are
carried at fair value and amounted to $310.0 and $324.0 million at December 31,
1997 and 1996, respectively. Net unrealized losses on high yield securities held
in such Separate Account portfolio were $1.0 million at December 31, 1997,
compared to $8.0 million at December 31, 1996.
60
RESULTS OF OPERATIONS
Revenues in 1997 decreased by $303.6 million, or 1.5%, and increased by $1.5
billion, or 7.8%, in each case as compared to 1996 and 1995, respectively. Net
income declined by $590.3 and $972.1 million, or 42.7% and 55.1% as compared to
1996 and 1995, respectively. Revenues include $(113.6), $676.5 and $1,578.0
million and net income includes $(159.9), $363.6 and $971.9 million of
investment (losses) gains for the years 1997, 1996 and 1995, respectively.
Net investment losses in 1997 resulted primarily from losses on equity index
securities and short sales by non-insurance companies, partially offset by net
investment gains of insurance companies (see information concerning the
components of investment (losses) gains of non-insurance companies included in
"Results of Operations-Other," below). The Company enters into these investment
positions for a number of purposes: (i) for its asset and liability management
activities, (ii) for income enhancements for its portfolio management strategy;
and (iii) to benefit from anticipated future movements in the underlying markets
that Company management expects to occur. If such movements do not occur or if
the market moves in the opposite direction from what management expects,
significant losses may occur.
Exposure to market risk is managed and monitored by senior management. Senior
management approves the overall investment strategy employed by the Company and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to it. The Company may manage
risk by buying or selling instruments or entering into offsetting positions.
The Company continues to maintain its equity index and short sale positions in
1998 and has experienced additional significant losses from these positions.
Insurance
Property and casualty operations showed a modest improvement in 1997 as a
result of increased net investment gains.
Property and casualty revenues decreased by $47.3 million, or 0.4%, and
increased $1.9 billion, or 16.7%, as compared to 1996 and 1995, respectively.
Property and casualty premium revenues decreased by $200.0 million, or 2.0%,
and increased $1.2 billion, or 13.8%, as compared to 1996 and 1995,
respectively. Premium revenues declined, as compared to 1996, due primarily to
lower professional and specialty ($157.0 million), general liability and
commercial automobile ($72.0 million), and reinsurance and other premiums
($106.0 million). These declines were partially offset by increased accident and
health premiums ($163.0 million).
Professional and specialty earned premiums declined due primarily to lower
financial insurance premiums of approximately $90.0 million and agricultural
insurance of $85.0 million. General liability and commercial automobile earned
premiums declined as a result of a soft market which has made profitable growth
difficult to achieve. The reduced premiums from reinsurance are attributable to
a decline in CNA's London business.
Premium revenues increased, as compared to 1995, due primarily to higher
workers' compensation ($369.0 million), accident and health ($363.0 million),
and multiple peril ($188.0 million) premiums. The increase over 1995 is
primarily a result of an improvement in the involuntary market and CNA
voluntarily writing more of that business, and a full year of CIC's business
included in 1997, as compared to the period of May 10 to December 31, 1995.
Property and casualty investment income decreased by $91.0 million, or 4.8%,
and increased $91.0 million, or 5.4%, as compared to 1996 and 1995,
respectively. The decline, as compared to 1996, is principally due to overall
lower yields primarily in the bond market due to lower interest rates. The
increase, as compared to 1995, reflects a higher base of invested assets,
partially offset by lower bond yields. The bond segment of the investment
portfolio yielded 6.5% in 1997, compared with 6.8% and 6.9% in 1996 and 1995,
respectively.
61
Pre-tax investment gains amounted to $592.5, $473.6 and $320.6 million for the
years 1997, 1996 and 1995, respectively.
Net income excluding net investment gains of CNA's property and casualty
insurance subsidiaries was $386.2 million for 1997, compared to $444.8 and
$355.3 million in 1996 and 1995, respectively. Net investment gains for 1997
were $323.6 million, compared to $255.6 and $174.8 million in 1996 and 1995,
respectively.
Underwriting results, which include insurance and insurance-related
operations, deteriorated by 1.7%, primarily the result of an extremely
competitive commercial market place exerting pressure on pricing and increased
operating expenses. Operating expenses increased as a result of technology and
system upgrades and consulting costs. Property and casualty underwriting losses
were $1.2 billion in 1997, compared to $1.1 and $1.1 billion in 1996 and 1995,
respectively. Underwriting results in 1996 generally reflected improved loss
experience from workers' compensation business, partially offset by lower
results from personal lines.
Catastrophe losses for 1997 on a pre-tax basis were approximately $92.0
million, compared with $315.0 million in 1996 and $149.0 million in 1995. CNA's
1997 and 1996 catastrophe losses were primarily weather related losses,
including winter storms, tornadoes and flooding. CNA's 1995 catastrophe losses
related primarily to tropical storms and hail storms in Texas.
CNA's property and casualty results of operations are significantly impacted
by actuarial estimates of claim and claim expense reserves. These reserves
represent an accumulation of the amounts CNA feels are necessary to settle all
outstanding claims, including incurred but not reported claims.
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 become apparent.
The following favorable (adverse) reserve development reflects the effects of
management's ongoing evaluation of reserve levels and is comprised of the
following components:
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------
(Amount in millions)
<S> <C> <C> <C>
Asbestos $(105.0) $(50.5) $(273.7)
Environmental Pollution (64.7) (226.0)
Other 361.0 206.2 377.7
- --------------------------------------------------------------------------------
Total $ 256.0 $ 91.0 $(122.0)
================================================================================
</TABLE>
Management believes its reserves for environmental pollution and asbestos
claims are appropriately established based upon known facts and current case
law. However, due to the inconsistencies of court coverage decisions, the number
of waste sites subject to clean-up, the standards for clean-up and liability,
and other factors, the ultimate exposure to CNA for these claims may vary
materially from the amounts currently recorded, resulting in a potential
increase in the claim reserves recorded. In addition, issues related to, among
other things, specific policy provisions, allocation of liability among
insurers, consequences of conduct of the insured, missing policies and proof of
coverage make quantification of liabilities exceptionally difficult and subject
to adjustment based upon newly available data. Due to the uncertainties and
factors described above, the ultimate exposure to CNA for environmental
pollution claims may vary substantially from the amounts currently recorded.
Unfavorable 1997 asbestos reserve development of $105.0 million results from
CNA's ongoing
62
monitoring of current payment and settlement patterns, current pending cases and
potential future claims.
Other 1997 favorable loss reserve development of $361.0 million was
attributable to approximately $540.0 million in involuntary risk business, and
approximately $200.0 million in personal lines business, partially offset by
unfavorable loss and loss adjustment expense development of $379.0 million in
commercial lines. The 1997 favorable loss development was offset in part by
unfavorable premium development of approximately $340.0 million in involuntary
risk business and $170.0 million favorable premium development in commercial
lines.
Other 1996 and 1995 favorable reserve development, which aggregated $206.2 and
$377.7 million, respectively, was principally due to favorable claim frequency
(rate of claim occurrence) and severity (average cost per claim) experience in
the workers' compensation line of business. These trends reflect the positive
effects of changes in workers' compensation laws, more moderate increases in
medical costs, and a generally strong economy in which individuals return to the
workplace more quickly.
Life insurance revenues increased by $87.9 and $514.7 million, or 2.2% and
14.2%, as compared to 1996 and 1995, respectively. Life premium revenues
increased by $83.4 and $424.0 million, or 2.5% and 14.1%, as compared to 1996
and 1995, respectively. Life and annuity group premiums increased by $68.0
million, as compared to 1996. Group accident and health premiums increased by
$337.0 million and individual life and annuity premiums increased by $145.0
million, as compared to 1995. These increases reflect increased business for
CNA's Viaterm and single premium guaranteed annuities, partially offset by a
reduction in CNA's foreign operations. Life investment income increased by
approximately 4.8% due to a larger asset base generated from increased cash
flows resulting from premium growth. The bond segment of the life investment
portfolio yielded 6.4% in 1997, compared to 6.5% and 6.9% in 1996 and 1995,
respectively.
CNA's life insurance subsidiaries' net income excluding net investment gains
was $85.8 million for 1997, compared to $94.4 and $91.3 million for 1996 and
1995, respectively. The decline in net operating income is primarily due to poor
experience in certain group accident and health contracts and increased expenses
related to new business initiatives. Net investment gains for 1997 were $81.4
million, compared to $80.5 and $71.9 million for 1996 and 1995, respectively.
Cigarettes
Revenues increased by $177.7 and $335.7 million, or 7.9% and 16.1%, as
compared to 1996 and 1995, respectively. Net income decreased by $81.3 and $21.9
million, or 18.3% and 5.7%, as compared to 1996 and 1995, respectively.
Revenues increased, as compared to 1996, by approximately $70.2 million, or
3.2%, due to an increase in unit sales volume and by approximately $108.5
million, or 4.9%, due to increased unit prices. Compared to 1995, revenues
increased by approximately $180.3 million, or 8.8%, due to increased sales
volume and by approximately $158.9 million, or 7.7%, due to higher unit prices.
Lorillard's unit sales volume increased by 3.4% and 8.7% as compared to 1996
and 1995, respectively. Newport, a full price brand which accounts for
approximately 76% of Lorillard's unit sales, increased by 7.5% and 17.0% as
compared to 1996 and 1995, respectively.
Virtually all of Lorillard's sales are in the full price brand category.
Discount brand sales have decreased from an average of 31.4% of industry sales
during 1994 to an average of 27.0% during 1997. At December 31, 1997, they
represented 27.0% of industry sales.
Net income declined due primarily to the settlement of certain tobacco related
litigation. As discussed in Note 18 of the Notes to Consolidated Financial
Statements, Lorillard and other companies in the United States tobacco industry
have entered into agreements to settle health care cost recovery actions in
Florida, Mississippi and Texas,
63
and entered into an agreement to settle a class action lawsuit in Florida. Based
on the agreements, Lorillard recorded pre-tax and after tax settlement charges
of $198.8 and $122.0 million, respectively.
Without the charges for tobacco related litigation, net income would have
increased by $40.7 and $100.1 million as compared to 1996 and 1995,
respectively. These increases were due primarily to the increased revenues,
partially offset by higher legal expenses in 1997. The rise in legal expenses
reflects the increasing number of cases seeking damages against Lorillard for
cancer and other health effects claimed to have resulted from an individual's
use of cigarettes or exposure to tobacco smoke. At December 31, 1997, Lorillard
was named as a defendant in approximately 384 lawsuits, compared to 143 lawsuits
in the prior year. Lorillard continues to vigorously defend itself against these
actions.
Hotels
Revenues increased by $21.9 and $4.5 million, or 10.9% and 2.1%, as compared
to 1996 and 1995, respectively. Net income increased by $11.9 and $2.0 million,
as compared to 1996 and 1995, respectively.
Revenues in 1995 included gains of $14.5 and $4.0 million ($9.4 and $2.6
million after taxes) related to the transfer of the Monte Carlo casino
operations and the settlement of a management contract.
Exclusive of these transactions, revenues increased by $23.0 million, or
11.5%, and net income increased by $14.0 million, as compared to 1995.
The increases in 1997 are due primarily to higher average room rates and
higher occupancy rates, partially offset by costs of a legal settlement in 1997.
Offshore Drilling
Revenues increased by $329.4 and $638.0 million, as compared to 1996 and 1995,
respectively. Net income increased by $78.8 and $139.6 million, as compared to
1996 and 1995, respectively. Revenues increased by $106.6 and $223.4 million, as
compared to 1996 and 1995, respectively, due to the 11 rigs acquired in the
acquisition of Arethusa in April 1996.
In addition, revenues increased $189.4 and $313.5 million as a result of
higher dayrates, and $11.5 and $35.5 million from increased utilization rates as
compared to 1996 and 1995, respectively. The increased dayrates and utilization
rates reflect the overall improvement in the offshore drilling market as
previously discussed. Revenues also increased by $61.4 and $67.3 million, as
compared to 1996 and 1995, respectively, due to the completion of upgrade
projects on four drilling rigs. In addition, during 1996 Diamond Offshore
recognized gains totaling $34.8 million from the sale of all of its land
drilling rigs and related equipment, and three offshore drilling rigs. Diamond
Offshore's revenues also benefitted from higher interest income, partially
offset by the absence of revenues from the sale of its land drilling rigs.
Net income increased as a result of the higher revenues discussed above and
lower interest expense, partially offset by increased operating costs related to
the drilling rigs acquired from Arethusa, and higher depreciation expense
resulting from capital expenditures associated with drilling rig upgrades and
modifications.
In October 1995 Diamond Offshore sold shares of its common stock through an
initial public offering, the proceeds of which were used to retire intercompany
debt. Accordingly, operating results in 1997 and 1996 benefited from lower
interest expense as compared to 1995.
Watches and Clocks
Revenues increased by $8.1 and $19.4 million, or 6.7% and 17.7%, as compared
to 1996 and 1995, respectively. Net income increased by $2.9 and $6.9 million,
as compared to 1996 and 1995, respectively.
Revenues and net income increased due primarily to higher watch unit sales
volume of 6.6% and 21.9% as compared
64
to 1996 and 1995, respectively, and an overall increase in watch unit prices.
The increased net income was partially offset by higher brand support
advertising in 1997. In addition, revenues and net income in 1995 included
interest income of $4.2 million and a tax expense of $3.2 million resulting from
a tax audit adjustment.
Other
Revenues decreased by $881.3 and $1,901.9 million, as compared to 1996 and
1995, respectively. Net income decreased by $604.3 and $1,282.4 million as
compared to 1996 and 1995, respectively. Other operations consist primarily of
investment income of non-insurance companies, including investment (losses)
gains from the Company's investment portfolio.
The components of investment (losses) gains included in other operations are
as follows:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions)
<S> <C> <C> <C>
Derivative instruments (1) $(610.3) $(153.8) $ (40.1)
Short-term investments, primarily
U.S. government securities (.1) 28.0 36.1
Common stock of Diamond Offshore (2) 29.1 186.6 192.9
Common stock of CBS Inc. 579.2
Common stock of Champion
International Corporation 20.3 372.9
Equity securities, including
short positions (1) (299.2) (29.2) (38.7)
Other 10.8 (12.6) 15.9
- --------------------------------------------------------------------------------
(869.7) 39.3 1,118.2
Income tax benefit (expense) 304.4 (13.7) (392.8)
Minority interest .4 1.9 (.2)
- --------------------------------------------------------------------------------
Net (loss) income $(564.9) $ 27.5 $ 725.2
================================================================================
</TABLE>
(1) Includes losses on short sales, equity index futures and options
aggregating $936.6, $285.7 and $122.6 for the years ended December 31,
1997, 1996 and 1995, respectively. The Company continued to experience
significant losses from these short sales and its open contracts on equity
index positions in 1998.
(2) See Note 14 of the Notes to Consolidated Financial Statements.
65
Exclusive of securities transactions, other revenues increased by $27.7 and
$86.0 million, or 17.3% and 84.3%, as compared to 1996 and 1995, respectively.
Revenues increased due primarily to higher investment income reflecting
increased levels of invested assets. Net loss increased by $11.9 million and
decreased by $7.7 million, as compared to 1996 and 1995, respectively. Net loss
increased, as compared to 1996, due primarily to higher corporate interest
expense, partially offset by higher investment income. Net loss declined, as
compared to 1995, due primarily to the increased investment income, partially
offset by higher corporate interest and administrative expenses.
YEAR 2000 ISSUE
Most of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs contain time-sensitive software that recognize a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
The Company has completed an assessment of the scope of this problem and is
working to modify or replace the affected software so that its computer systems
will function properly with respect to dates in the year 2000 and thereafter.
The total Year 2000 project cost is estimated at approximately $61.0 million. To
date, the Company has incurred and expensed approximately $24.0 million.
The project is estimated to be completed not later than December 31, 1998,
which is prior to any anticipated impact on its operating systems. The Company
believes that with modifications to existing software and conversions to new
software, the Year 2000 issue will not pose significant operational problems for
its computer systems. However, if such modifications and conversions are not
made, or are not completed timely, the Year 2000 issue could have a material
impact on the operations of the Company. In addition, due to the interdependent
nature of computer systems, the Company may be adversely impacted depending upon
whether it or other entities not affiliated with the Company (vendors and
business partners) address this issue successfully. In addition, property and
casualty insurance subsidiaries may have an underwriting exposure related to the
Year 2000. Although CNA has not received any claims for coverage from its
policyholders based on losses resulting from Year 2000 issues, there can be no
assurance that policyholders will not suffer losses of this type and seek
compensation under CNA's insurance policies. If any claims are made, coverage,
if any, will depend on the facts and circumstances of the claim and the
provisions of the policy. At this time, CNA is unable to determine whether the
adverse impact, if any, in connection with the foregoing circumstances would be
material.
The cost of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ materially from those anticipated. Specific factors that
might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("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
66
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 the 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 fiscal years beginning
after December 15, 1997 and will require the Company to expand its segment
disclosure.
In December 1997, the AICPA's Accounting Standards Executive Committee issued
SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments," which provides guidance on accounting by all entries that are
subject to insurance-related assessments. The SOP requires entities to recognize
liabilities for insurance-related assessments when certain criteria are met.
This SOP is effective for fiscal years beginning after December 15, 1998. The
Company is currently evaluating the effects of this SOP on its accounting for
insurance-related assessments.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This Statement standardizes
disclosure requirements for pension and other postretirement benefits to the
extent practicable, requires additional information on changes in benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer useful to users
of financial statements. It also suggests combined formats for presentation of
pension and other postretirement benefit disclosures. The Statement supersedes
the disclosure requirements of a number of earlier opinions of the FASB and does
not address measurement or recognition. It is effective for fiscal years
beginning after December 15, 1997. The Company is currently evaluating the
effects of this Statement on its benefit plan disclosures.
FORWARD-LOOKING STATEMENTS
When included in this Report, the words "believes," "expects," "intends,"
"anticipates," "estimates," and analogous expressions are intended to identify
forward-looking statements. Such statements inherently are subject to a variety
of risks and uncertainties that could cause actual results to differ materially
from those projected. Such risks and uncertainties include, among others,
general economic and business conditions, competition, changes in financial
markets (interest rate, 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, the impact of bills introduced in Congress in relation to
tobacco operations, implementation of the Proposed Resolution, 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.
67
SUPPLEMENTAL FINANCIAL INFORMATION
The following supplemental condensed financial information reflects the
financial position, results of operations and cash flows of Loews Corporation
with its investments in CNA and Diamond Offshore accounted for on an equity
basis rather than as consolidated subsidiaries. It does not purport to present
the financial position, results of operations and cash flows of the Company in
accordance with generally accepted accounting principles because it does not
comply with SFAS No. 94, "Consolidation of All Majority-Owned Subsidiaries."
Management believes, however, that this disaggregated financial data enhances an
understanding of the consolidated financial statements by providing users with a
format that management uses in assessing the Company.
Condensed Balance Sheet Information
Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the
Equity Method)
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
(Amounts in millions)
Assets:
<S> <C> <C>
Current assets $ 563.3 $ 546.7
Investments in U.S. government securities and other 5,031.0 4,486.3
- --------------------------------------------------------------------------------
Total current assets and investments in securities 5,594.3 5,033.0
Investment in CNA 6,861.9 5,802.3
Investment in Diamond Offshore 772.4 584.7
Other assets 642.1 640.5
- --------------------------------------------------------------------------------
Total assets $13,870.7 $12,060.5
================================================================================
Liabilities and Shareholders' Equity:
Current liabilities $ 1,555.0 $ 1,204.0
Securities sold under agreements to repurchase 447.8
Long-term debt, less current maturities and
unamortized discount 2,340.1 1,315.4
Other liabilities 310.5 362.1
- --------------------------------------------------------------------------------
Total liabilities 4,205.6 3,329.3
Shareholders' equity 9,665.1 8,731.2
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $13,870.7 $12,060.5
================================================================================
</TABLE>
68
Condensed Statements of Income Information
Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the
Equity Method)
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions)
Revenues:
<S> <C> <C> <C>
Manufactured products and other $2,746.5 $2,552.6 $2,393.1
Investment income 215.7 202.2 137.2
Investment (losses) gains (866.2) 57.9 1,114.1
- --------------------------------------------------------------------------------
Total 2,096.0 2,812.7 3,644.4
- --------------------------------------------------------------------------------
Expenses:
Cost of manufactured products sold and other 1,986.7 1,857.3 1,765.0
Tobacco settlement charges 198.8
Interest 116.1 115.6 100.5
Income tax (benefit) expense (58.1) 316.7 657.2
- --------------------------------------------------------------------------------
Total 2,243.5 2,289.6 2,522.7
- --------------------------------------------------------------------------------
(Loss) income from operations (147.5) 523.1 1,121.7
Equity in income of:
CNA 810.2 808.7 635.2
Diamond Offshore 130.9 52.1 8.8
- --------------------------------------------------------------------------------
Net income $ 793.6 $1,383.9 $1,765.7
================================================================================
</TABLE>
69
Condensed Statements of Cash Flow Information
Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the
Equity Method)
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions)
Operating Activities:
<S> <C> <C> <C>
Net income $ 793.6 $1,383.9 $ 1,765.7
Adjustments to reconcile net
income to net cash provided by
operating activities:
Investment losses (gains) 866.2 (57.9) (1,114.1)
Other (1,037.3) (755.7) (495.3)
Changes in assets and liabilities-net (583.7) (453.1) 220.9
- --------------------------------------------------------------------------------
Total 38.8 117.2 377.2
- --------------------------------------------------------------------------------
Investing Activities:
Net (increase) decrease in short-term
investments, primarily U.S. government
securities (344.3) (447.1) 77.4
Securities sold under agreements to
repurchase (447.8) 447.8 (2,092.9)
Net decrease in securities 624.0
Proceeds from sale of CBS stock 901.7
Repayment of advances to subsidiary 331.2
Other (66.6) (74.8) (133.8)
- --------------------------------------------------------------------------------
Total (858.7) (74.1) (292.4)
- --------------------------------------------------------------------------------
Financing Activities:
Dividends paid to shareholders (115.0) (116.2) (73.8)
Increase (decrease) in long-term
debt-net 926.0 299.5 (5.5)
Purchases of treasury shares (215.7) (6.0)
- --------------------------------------------------------------------------------
Total 811.0 (32.4) (85.3)
- --------------------------------------------------------------------------------
Net change in cash (8.9) 10.7 (.5)
Cash, beginning of year 20.4 9.7 10.2
- --------------------------------------------------------------------------------
Cash, end of year $ 11.5 $ 20.4 $ 9.7
================================================================================
</TABLE>
70
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Loews Corporation is a large diversified financial services company. As such,
it has significant amounts of financial instruments that involve market risk.
The Company's measure of market risk exposure represents an estimate of the
change in fair value of its financial instruments. Changes in the trading
portfolio would be recognized as net losses in the income statement. Market risk
exposure is presented for each class of financial instrument held by the Company
at December 31, assuming immediate adverse market movements of the magnitude
described below. The Company believes that the various rates of adverse market
movements represent a measure of exposure to loss under hypothetically assumed
adverse conditions. The estimated market risk exposure represents the
hypothetical loss to future earnings and does not represent the maximum possible
loss nor any expected actual loss, even under adverse conditions, because actual
adverse fluctuations would likely differ. In addition, since the Company's
investment portfolio is subject to change based on its portfolio management
strategy as well as in response to changes in the market, these estimates are
not necessarily indicative of the actual results which may occur.
The following tables present the Company's market risk by category (equity
markets, interest rates, foreign currency exchange rates and commodity prices)
on the basis of those entered into for trading purposes and other than trading
purposes.
Trading portfolio:
<TABLE>
<CAPTION>
December 31, 1997
- --------------------------------------------------------------------------------
Fair Value Market
Category of risk exposure: Asset (Liability) Risk
- --------------------------------------------------------------------------------
(Amounts in millions)
<S> <C> <C>
Equity markets (1):
Equity securities $ 173.3 $ 43.3
Options purchased 176.3 (162.2)
Options written (18.8) 3.5
Futures (465.3)
Short sales (880.7) (220.2)
Commodities:
Oil (2):
Swaps (2.4) (12.2)
Energy purchase obligations (9.8) (6.8)
Gold (3):
Options purchased 27.9 (27.9)
Options written (4.2) 4.2
Other (4) 5.0 (4.8)
- --------------------------------------------------------------------------------
</TABLE>
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) an
increase in equity prices of 25%, (2) a decline in oil prices of 20%, (3)
an increase in gold prices of 20% and (4) a decrease of 10%. Adverse
changes on options which differ from those presented above would not
necessarily result in a proportionate change to the estimated market risk
exposure.
71
The most significant areas of market risk in the Company's trading portfolio
result from positions held in S&P futures contracts, short sales of certain
equity securities and put options purchased on the S&P 500 index. The Company
enters into these positions primarily to benefit from anticipated future
movements in the underlying markets that Company management expects to occur. If
such movements do not occur or if the market moves in the opposite direction
from what management expects, significant losses may occur. The Company
continues to maintain these positions in 1998 and has experienced additional
significant losses.
Exposure to market risk is managed and monitored by senior management. Senior
management approves the overall investment strategy employed by the Company and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to it. The Company may manage
risk by buying or selling instruments or entering into offsetting positions.
Other than trading portfolio:
<TABLE>
<CAPTION>
December 31, 1997
- --------------------------------------------------------------------------------
Fair Value Market
Category of risk exposure: Asset (Liability) Risk
- --------------------------------------------------------------------------------
(Amounts in millions)
<S> <C> <C>
Equity market (1):
Equity securities:
CNA Financial general accounts (a) $ 813.7 $ (81.0)
CNA Financial separate accounts 206.0 (21.0)
Equity index futures, separate accounts (b) (66.0)
Redeemable preferred stocks 97.0 (10.0)
Interest rate (2):
Fixed maturities (a) 30,626.2 (1,429.5)
Short-term investments (a) 8,754.2 (11.0)
Interest rate swaps (4.0) 20.0
Separate Accounts:
Fixed maturities 4,769.0 (190.0)
Short-term investments 629.0 (1.0)
Long-term debt (5,943.1)
- --------------------------------------------------------------------------------
</TABLE>
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) a
decrease in equity prices of 25% and (2) an increase in interest rates of
100 basis points.
(a) Certain securities are denominated in foreign currencies. Assuming a 20%
decline in the underlying exchange rates would result in an aggregate
foreign currency exchange rate risk of $(48.0).
(b) This market risk would be offset by decreases in liabilities to customers
under variable insurance contracts.
72
Equity Price Risk - The Company has exposure to equity price risk as a result
of its investment in equity securities and equity derivatives. Equity price risk
results from changes in the level or volatility of equity prices which affect
the value of equity securities or instruments which derive their value from such
securities or indexes. Equity price risk was measured assuming an instantaneous
25% change in the underlying reference price or index from its level at December
31, 1997, with all other variables held constant.
Interest Rate Risk - The Company has exposure to interest rate risk, arising
from changes in the level or volatility of interest rates or the shape and slope
of the yield curve. The Company attempts to mitigate its exposure to interest
rate risk by utilizing instruments such as interest rate swaps, interest rate
caps, commitments to purchase securities, options, futures and forwards. The
Company monitors its sensitivity to interest rate risk by evaluating the change
in its financial assets and liabilities relative to fluctuations in interest
rates. The evaluation is made using an instantaneous parallel yield curve shift
of varying magnitude on a static balance sheet to determine the effect such a
change in rates would have on the Company's market value at risk and the
resulting effect on shareholders' equity. The analysis presents the sensitivity
of the market value of the Company's financial instruments to selected changes
in market rates and prices which the Company believes are reasonably possible
over a one-year period.
The analysis assumes that the composition of the Company's interest sensitive
assets and liabilities existing at the beginning of the period remains constant
over the period being measured and also assumes that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
time to maturity. The interest rates on certain types of assets and liabilities
may fluctuate in advance of changes in market interest rates, while interest
rates on other types may lag behind changes in market rates. Accordingly the
analysis may not be indicative of, is not intended to, and does not provide a
precise forecast of the effect of changes of market interest rates on the
Company's earnings or shareholders' equity. Further, the computations do not
contemplate any actions the Company could undertake in response to changes in
interest rates.
The Company's long-term debt, including interest rate swap agreements, as of
December 31, 1997 is denominated in U.S. Dollars. The Company's debt has been
primarily issued at fixed rates, and as such, interest expense would not be
impacted by interest rate shifts.
The sensitivity analysis assumes an instantaneous shift in market rates
increasing 100 basis points from their levels at December 31, 1997, with all
other variables held constant.
Foreign Exchange Risk - Foreign exchange rate risk arises from the possibility
that changes in foreign currency exchange rates will impact the value of
financial instruments. The Company has foreign exchange exposure when it buys or
sells foreign currencies or financial instruments denominated in a foreign
currency. This exposure is mitigated by the Company's asset/liability matching
strategy and through the use of futures for those instruments which are not
matched. The Company's foreign transactions are primarily denominated in
Canadian Dollars, British Pounds, German Duetschmarks and Japanese Yen. The
sensitivity analysis also assumes an instantaneous 20% change in the foreign
currency exchange rates versus the U.S. Dollar from their levels at December 31,
1997, with all other variables held constant.
Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in oil swaps, energy purchase obligations, gold
options and other investments. Commodity price risk results from changes in the
level or volatility of commodity prices that impact instruments which derive
their value from such commodities. Commodity price risk was measured assuming an
instantaneous change of 20% and 10% in the value of the underlying commodities.
73
Item 8. Financial Statements and Supplementary Data.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Assets:
- --------------------------------------------------------------------------------
December 31 1997 1996
- --------------------------------------------------------------------------------
(Amounts in millions of dollars)
<S> <C> <C>
Investments (Notes 1, 2, 3 and 4):
Fixed maturities, amortized cost of $30,201.6
and $29,319.3 $30,723.2 $29,478.3
Equity securities, cost of $1,102.6 and $981.8 1,163.3 1,136.3
Other investments 978.4 997.9
Short-term investments 8,754.2 8,304.9
- --------------------------------------------------------------------------------
Total investments 41,619.1 39,917.4
Cash 497.8 305.7
Receivables-net (Notes 1 and 6) 13,325.9 13,427.1
Property, plant and equipment-net (Notes 1 and 8) 2,590.2 2,225.1
Deferred income taxes (Note 10) 944.3 1,138.0
Goodwill and other intangible assets-net (Note 1) 751.4 562.4
Other assets (Notes 1, 7, 13 and 17) 1,895.1 1,852.1
Deferred policy acquisition costs of insurance
subsidiaries (Note 1) 2,141.7 1,854.2
Separate Account business (Notes 1 and 3) 5,811.6 6,120.9
- --------------------------------------------------------------------------------
Total assets $69,577.1 $67,402.9
================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
74
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Liabilities and Shareholders' Equity:
- --------------------------------------------------------------------------------
December 31 1997 1996
- --------------------------------------------------------------------------------
(Amounts in millions of dollars)
<S> <C> <C>
Insurance reserves (Notes 1 and 9):
Claim and claim expense $29,226.8 $30,394.5
Future policy benefits 4,829.2 4,181.3
Unearned premiums 4,699.9 4,658.7
Policyholders' funds 741.5 745.6
- --------------------------------------------------------------------------------
Total insurance reserves 39,497.4 39,980.1
Payable for securities purchased (Note 4) 1,559.2 966.4
Securities sold under agreements to repurchase
(Notes 1 and 2) 152.7 548.3
Long-term debt, less unamortized discount
(Notes 3 and 11) 5,752.6 4,370.7
Other liabilities (Notes 1, 3 and 13) 4,749.1 4,804.4
Separate Account business (Notes 1 and 3) 5,811.6 6,120.9
- --------------------------------------------------------------------------------
Total liabilities 57,522.6 56,790.8
- --------------------------------------------------------------------------------
Minority interest 2,389.4 1,880.9
- --------------------------------------------------------------------------------
Commitments and contingent liabilities
(Notes 1, 2, 4, 9, 10, 11, 12, 13, 17 and 18)
Shareholders' equity (Notes 1, 2, 11 and 15):
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 8,895.4 8,216.8
Unrealized appreciation 488.9 233.6
- --------------------------------------------------------------------------------
Total shareholders' equity 9,665.1 8,731.2
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $69,577.1 $67,402.9
================================================================================
</TABLE>
75
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions, except per share data)
<S> <C> <C> <C>
Revenues (Note 1):
Insurance premiums (Note 17):
Property and casualty $ 9,927.1 $10,127.1 $ 8,723.8
Life 3,430.5 3,347.1 3,006.5
Investment income, net of expenses (Note 2) 2,442.0 2,477.7 2,213.5
Investment (losses) gains (Note 2) (237.9) 489.9 1,385.1
Gains on issuance of subsidiaries' stock
(Notes 2 and 14) 124.3 186.6 192.9
Manufactured products (including excise
taxes of $491.0, $477.6 and $455.0) 2,514.4 2,327.5 2,152.2
Other 1,938.4 1,486.5 1,003.4
- --------------------------------------------------------------------------------
Total 20,138.8 20,442.4 18,677.4
- --------------------------------------------------------------------------------
Expenses (Note 1):
Insurance claims and policyholders'
benefits (Notes 9 and 17) 11,268.5 11,370.5 9,951.7
Amortization of deferred policy
acquisition costs 2,383.2 2,192.1 1,843.5
Cost of manufactured products sold 1,024.5 992.1 964.1
Selling, operating, advertising and
administrative expenses 3,546.0 3,161.9 2,796.3
Interest 323.4 318.0 282.5
- --------------------------------------------------------------------------------
Total 18,545.6 18,034.6 15,838.1
- --------------------------------------------------------------------------------
1,593.2 2,407.8 2,839.3
- --------------------------------------------------------------------------------
Income taxes (Note 10) 495.3 791.4 945.3
Minority interest 304.3 232.5 128.3
- --------------------------------------------------------------------------------
Total 799.6 1,023.9 1,073.6
- --------------------------------------------------------------------------------
Net income $ 793.6 $ 1,383.9 $ 1,765.7
================================================================================
Net income per common share (Note 15) $ 6.90 $ 11.91 $ 14.98
================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
76
<TABLE>
<CAPTION>
Additional Earnings Pension Common
Common Paid-in Retained in Unrealized Liability Stock Held
Stock Capital the Business Appreciation Adjustment in Treasury
- -------------------------------------------------------------------------------------------------
(Amounts in millions)
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 $ 59.0 $219.1 $5,469.9 $ (322.7) $(20.0)
Net income 1,765.7
Two-for-one stock split 59.0 (59.0)
Dividends paid,
$.63 per share (73.8)
Purchases of common stock $ 4.3
Retirement of treasury
stock (.2) (.1) (4.0) (4.3)
Net unrealized
appreciation 1,115.8
Pension liability
adjustment 20.0
Equity in certain
transactions of
subsidiary companies 10.0
- -------------------------------------------------------------------------------------------------
Balance, December 31, 1995 117.8 170.0 7,157.8 793.1
Net income 1,383.9
Dividends paid,
$1.00 per share (116.2)
Purchases of common stock 215.7
Retirement of treasury
stock (2.8) (4.2) (208.7) (215.7)
Net unrealized
depreciation (559.5)
- -------------------------------------------------------------------------------------------------
Balance, December 31, 1996 115.0 165.8 8,216.8 233.6
Net income 793.6
Dividends paid,
$1.00 per share (115.0)
Net unrealized
appreciation 255.3
- -------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $115.0 $165.8 $8,895.4 $ 488.9
=================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
77
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions)
<S> <C> <C> <C>
Operating Activities:
Net income $ 793.6 $ 1,383.9 $ 1,765.7
Adjustments to reconcile net income to net
cash provided by operating activities:
Investment losses (gains) 113.6 (676.5) (1,578.0)
Provision for minority interest 304.3 232.5 128.3
Amortization of investments (115.2) (177.6) (141.4)
Depreciation and amortization 341.7 285.0 225.8
Provision for deferred income taxes 59.3 474.9 302.3
Changes in assets and liabilities-net:
Reinsurance receivables 804.0 204.1 (41.4)
Other receivables (111.8) (334.6) (164.5)
Deferred policy acquisition costs (287.5) (360.9) (162.6)
Insurance reserves and claims (464.5) (358.0) 431.0
Other liabilities (410.3) 885.9 415.6
Investments classified as trading
securities (682.4) (247.2)
Other-net (117.0) (367.8) 115.1
- --------------------------------------------------------------------------------
227.8 943.7 1,295.9
- --------------------------------------------------------------------------------
Investing Activities:
Purchases of fixed maturities (47,434.7) (41,004.7) (29,275.3)
Proceeds from sales of fixed maturities 43,997.0 41,895.6 24,093.6
Proceeds from maturities of fixed maturities 2,996.9 1,796.3 2,855.2
Purchases of equity securities (1,332.3) (971.6) (1,479.3)
Proceeds from sales of equity securities 1,405.9 1,077.4 2,317.9
Purchase of The Continental Corporation-net
of cash acquired (960.4)
Proceeds from sale of CBS stock 901.7
Proceeds from sale of Diamond Offshore stock 338.4
Purchases of property and equipment (702.4) (545.5) (257.9)
Proceeds from sales of property and equipment 9.9 54.4 16.5
Securities sold under agreements to repurchase (395.5) (225.8) (3,797.4)
Change in short-term investments (365.0) (2,809.6) 2,998.8
Change in other investments 538.2 171.3 (1.5)
- --------------------------------------------------------------------------------
(1,282.0) (562.2) (2,249.7)
- --------------------------------------------------------------------------------
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(Amounts in millions)
Financing Activities:
<S> <C> <C> <C>
Dividends paid to shareholders (115.0) (116.2) (73.8)
Purchases of treasury shares (215.7) (6.0)
Principal payments on long-term debt (271.4) (574.2) (8.8)
Issuance of long-term debt 1,661.0 615.9 1,337.0
Change in short-term debt (10.0) 2.3 (201.9)
Receipts credited to policyholders 6.6 11.0 22.6
Withdrawals of policyholder account balances (24.9) (40.6) (34.2)
- --------------------------------------------------------------------------------
1,246.3 (317.5) 1,034.9
- --------------------------------------------------------------------------------
Net change in cash 192.1 64.0 81.1
Cash, beginning of year 305.7 241.7 160.6
- --------------------------------------------------------------------------------
Cash, end of year $ 497.8 $ 305.7 $ 241.7
================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share data)
Note 1. Summary of Significant Accounting Policies -
Principles of consolidation - The consolidated financial statements include
all significant subsidiaries and all material intercompany accounts and
transactions have been eliminated. Unless the context otherwise requires, the
term "Company" means Loews Corporation and its consolidated subsidiaries. The
equity method of accounting is used for investments in associated companies in
which the Company generally has an interest of 20% to 50%.
Accounting estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and the related notes. Actual results could differ from
those estimates.
Investments - Investments in securities, which are held principally by
insurance subsidiaries of CNA Financial Corporation ("CNA"), an 84% owned
subsidiary, are carried as follows:
The Company classifies fixed maturity securities (bonds and redeemable
preferred stocks) and equity securities held by insurance subsidiaries as
available for sale and they are carried at fair value. The amortized cost of
fixed maturity securities is adjusted for amortization of premiums and accretion
of discounts to maturity. Such amortization and accretion are included in
investment income. Effective January 1, 1996, equity securities added to the
parent company's investment portfolio are classified as trading securities in
order to reflect the Company's investment philosophy. These investments are
carried at fair value with the net unrealized gain or loss included in the
income statement.
Derivative instruments are generally held for trading purposes and, as such,
are marked to market. Gains or losses are included in investment gains or
losses. Interest rate swaps which are used to manage the Company's exposure to
variable rate long-term debt are not considered held for trading purposes. Such
swaps are accounted for on an accrual basis and are included in the income
statement as an adjustment to interest expense.
Short-term investments include U.S. government securities, repurchase
agreements and commercial paper and are carried at fair value, which
approximates amortized cost.
All securities transactions are recorded on the trade date. The cost of
securities sold is determined by the identified certificate method. Unrealized
appreciation in shareholders' equity reflects the unrealized gain or loss on
investments which are available for sale and carried at fair value, net of
applicable deferred income taxes and participating policyholders' and minority
interests. Investments are written down to estimated fair values and losses are
charged to income when a decline in value is considered to be other than
temporary.
Other invested assets consist primarily of investments in joint ventures and
limited partnerships and other investments not classified elsewhere. The joint
ventures and limited partnerships are carried at equity value.
Securities sold under agreements to repurchase - The Company 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 these 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 U.S. government securities and commercial paper). The
Company continues to receive the interest on loaned debt securities, as
beneficial owner, and accordingly, loaned debt securities are included within
fixed maturity securities. The liabilities for securities sold under agreements
to repurchase are recorded at their contracted repurchase amounts.
Insurance Operations - Premium revenue - Insurance premiums on property and
casualty and health insurance contracts (included in life premiums) are earned
ratably over the terms of the policies after provision for estimated adjustments
on retrospectively rated policies and deductions for ceded insurance. Revenues
on universal life type contracts are comprised of contract charges and fees
which are recognized over the coverage period. Other life insurance premiums are
recognized as revenue when due after deductions for ceded insurance.
Claim and claim expense reserves - Claim and claim expense reserves, except
reserves for structured settlements, workers' compensation lifetime claims and
accident and disability claims, are not discounted and are based on (a) case
basis estimates for losses report-
79
ed on direct business, adjusted in the aggregate for ultimate loss expectations,
(b) estimates of unreported losses based upon past experience, (c) estimates of
losses on assumed insurance, and (d) estimates of future expenses to be incurred
in settlement of claims. In establishing these estimates, consideration is given
to current conditions and trends as well as past company and industry
experience. The effects of inflation, which can be significant, are implicitly
considered in the reserving process and are part of the recorded reserve
balance.
Claim and claim expense reserves represent management's estimates of ultimate
liabilities based on currently available facts and case law. CNA regularly
reviews its reserves, and any adjustments that are made to the reserves are
reflected in operating income in the period the need for such adjustments become
apparent. See Note 9 for a further discussion of claim and claim expense
reserves.
Structured settlements have been negotiated for claims on certain property and
casualty insurance policies. Structured settlements are agreements to provide
periodic payments to claimants, which are fixed and determinable as to the
amount and time of payment. Certain structured settlements are funded by
annuities purchased from CNA's life insurance subsidiary. Related annuity
obligations are recorded in future policy benefits reserves. Obligations for
structured settlements not funded by annuities are carried at the present value
of future benefits. At December 31, 1997 and 1996, such reserves, discounted at
interest rates ranging from 6.3% to 7.5%, totaled $913.0 and $924.0,
respectively (reflecting a discount of $1,527.0 and $1,556.0, respectively).
Workers' compensation lifetime claims and accident and health disability claim
reserves are discounted at interest rates allowed by insurance regulators
ranging from 3.5% to 6.0% with mortality and morbidity assumptions reflecting
CNA's and current industry experience. Such discounted reserves totaled $2,196.0
and $2,165.4 (reflecting a discount of $882.0 and $903.0, respectively) at
December 31, 1997 and 1996, respectively.
Future policy benefits reserves - Reserves for traditional life insurance
products are computed based upon the net level premium method using actuarial
assumptions as to interest rates, mortality, morbidity, withdrawals and
expenses. Actuarial assumptions include a margin for adverse deviation and
generally vary by plan, age at issue and policy duration. Interest rates range
from 3.0% to 11.0%, and mortality, morbidity and withdrawal assumptions reflect
CNA and industry experience prevailing at the time of issue. Expense assumptions
include the estimated effects of inflation and expenses beyond the premium
paying period.
Involuntary risks - CNA's share of involuntary risks is mandatory and
generally a function of its share of the voluntary market by line of insurance
in each state. CNA records the estimated effects of its mandatory participation
in residual markets on an accrual basis. CNA records assessments for
insolvencies as they are paid. Accrual for such assessments have not been
practical as the availability of information, in sufficient detail, regarding
related assessments has been limited.
Reinsurance - 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, provide greater
diversification of risk and 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. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability.
Deferred policy acquisition costs - Costs of acquiring property and casualty
insurance business, which vary with and are primarily related to the production
of such business, are deferred and amortized ratably over the period the related
premiums are recognized. Such costs include commissions, premium taxes, and
certain underwriting and policy issuance costs. Anticipated investment income is
considered in the determination of the recoverability of deferred policy
acquisition costs. Life acquisition costs are capitalized and amortized based on
assumptions consistent with those used for computing policy benefit reserves.
Acquisition costs on ordinary life business are amortized over the assumed
premium paying periods. Universal life and annuity acquisition costs are
amortized in proportion to the present value of estimated gross profits over the
80
products' assumed durations, which are regularly evaluated and adjusted, as
appropriate.
Restricted investments - On December 30, 1993, CNA deposited $986.8 in an
escrow account, pursuant to the Fibreboard Global Settlement Agreement, as
discussed in Note 18. The funds are included in short-term investments and are
invested in U.S. treasury securities. The escrow account amounted to $1,098.0
and $1,071.2 at December 31, 1997 and 1996, respectively.
Participating business - Participating business represented 0.7%, 0.5% and
0.6% of CNA's gross life insurance in force and 0.7%, 0.7% and 0.8% of life
insurance premium income for 1997, 1996 and 1995, respectively. Participating
policyholders' equity is determined by allocating 90% of related net income or
loss and unrealized investment gains or losses related to such business as
allowed by applicable laws, less dividends determined by CNA's Board of
Directors. In the accompanying Consolidated Statements of Income, revenues and
benefits and expenses include amounts related to participating policies; the net
income or loss allocated to participating policyholders' equity is a component
of insurance claims and policyholders' benefits.
Separate Account business - CNA's life insurance subsidiary, Continental
Assurance Company ("CAC"), issues certain investment and annuity contracts. The
supporting assets and liabilities of these contracts are legally segregated and
reflected in the accompanying Consolidated Balance Sheets as assets and
liabilities of Separate Account business. CAC guarantees principal and a
specified return to the contract holders on approximately 74% of the Separate
Account business. Substantially all assets of the Separate Account business are
carried at fair value. Separate Account liabilities are carried at contract
value.
Statutory capital and surplus - Statutory capital and surplus and net income,
determined in accordance with accounting practices prescribed by the regulations
and statutes of various insurance departments, for property and casualty and
life insurance subsidiaries, are as follows:
<TABLE>
<CAPTION>
Statutory Capital
and Surplus Statutory Net Income
-------------------- ------------------------------
December 31 Year Ended December 31
-------------------- ------------------------------
1997 1996 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Property and casualty $7,123.0 $6,348.8 $1,043.0 $1,208.0 $1,208.3
Life 1,224.0 1,163.4 43.0 57.6 30.2
- --------------------------------------------------------------------------------
</TABLE>
Statutory accounting practices - CNA's insurance affiliates are domiciled in
various jurisdictions. These affiliates prepare statutory financial statements
in accordance with accounting practices "prescribed" or otherwise "permitted" by
the respective jurisdiction's insurance regulator. Prescribed statutory
accounting practices are set forth in a variety of publications of the National
Association of Insurance Commissioners, as well as state laws, regulations and
general administrative rules. CNA has no material permitted accounting
practices.
81
Inventories -
Tobacco products - These inventories, aggregating $227.9 and $247.4 at
December 31, 1997 and 1996, respectively, are stated at the lower of cost or
market, using the last-in, first-out (LIFO) method.
Watches and clocks - These inventories, aggregating $35.7 and $37.1 at
December 31, 1997 and 1996, respectively, are stated at the lower of cost or
market, using the first-in, first-out (FIFO) method.
Goodwill and other intangible assets - Goodwill, representing the excess of
the purchase price over the fair value of the net assets of the acquired
entities, is generally amortized on a straight-line basis over the period of
expected benefit of twenty years. Other intangible assets are amortized on a
straight-line basis over their estimated economic lives. Accumulated
amortization at December 31, 1997 and 1996 was $283.0 and $243.4, respectively.
Amortization expense amounted to $39.6, $36.3 and $25.6 for the years ended
December 31, 1997, 1996 and 1995, respectively. Intangible assets are
periodically reviewed to determine whether an impairment in value has occurred.
Property, plant and equipment - Property, plant and equipment is carried at
cost less accumulated depreciation. Depreciation is computed principally by the
straight-line method over the estimated useful lives of the various classes of
properties. Leaseholds and leasehold improvements are depreciated or amortized
over the terms of the related leases (including optional renewal periods where
appropriate) or the estimated lives of improvements, if less than the lease
term.
The principal service lives used in computing provisions for depreciation are
as follows:
Years
-----
Buildings and building equipment 40
Building fixtures 10 to 20
Machinery and equipment 5 to 12
Hotel equipment 4 to 12
Offshore drilling equipment 10 to 25
Impairment of long-lived assets - The Company reviews its long-lived assets
for impairment when changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. Long-lived assets and certain intangibles,
under certain circumstances, are reported at the lower of carrying amount or
fair value. Assets to be disposed of and assets not expected to provide any
future service potential to the Company are recorded at the lower of carrying
amount or fair value less cost to sell.
Reclassification - Certain amounts applicable to prior periods have been
reclassified to conform to the classifications followed in 1997.
82
Note 2. Investments -
Investment income consisted of:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities:
Taxable $1,616.4 $1,820.9 $1,512.1
Tax exempt 289.2 273.4 264.3
Equity securities 37.6 46.4 55.5
Security repurchase transactions 84.4 89.2 215.5
Short-term investments 457.6 290.5 304.3
Other 100.9 80.5 80.7
- --------------------------------------------------------------------------------
Total investment income 2,586.1 2,600.9 2,432.4
Investment expenses (79.8) (43.2) (46.1)
Security repurchase transactions (64.3) (80.0) (172.8)
- --------------------------------------------------------------------------------
Investment income-net $2,442.0 $2,477.7 $2,213.5
================================================================================
<CAPTION>
Investment (losses) gains are as follows:
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Trading securities:
Derivative instruments (a) $(618.7) $(137.6) $ (31.4)
Equity securities, including short
positions (a) (299.0) (7.7)
- --------------------------------------------------------------------------------
(917.7) (145.3) (31.4)
Other than trading:
Fixed maturities 463.4 324.6 222.4
Equity securities (b) 102.7 216.3 1,075.5
Short-term investments 7.1 10.0 45.5
Other 106.6 84.3 73.1
- --------------------------------------------------------------------------------
Investment (losses) gains (237.9) 489.9 1,385.1
Gains on issuance of subsidiaries' stock 124.3 186.6 192.9
- --------------------------------------------------------------------------------
(113.6) 676.5 1,578.0
Income tax benefit (expense) 43.2 (237.5) (551.6)
Allocated to participating policyholders (14.6) (14.3) (7.8)
Minority interest (74.9) (61.1) (46.7)
- --------------------------------------------------------------------------------
Investment (losses) gains-net $(159.9) $ 363.6 $ 971.9
================================================================================
</TABLE>
(a) Includes losses on short sales, equity index futures and options
aggregating $936.6, $285.7 and $122.6 for the years ended December 31,
1997, 1996 and 1995 respectively. The Company continued to experience
significant losses from these short sales and its open contracts on equity
index positions in 1998.
(b) On November 24, 1995, Westinghouse Electric Corporation completed its
acquisition of CBS Inc. ("CBS") for cash consideration of $82.06 per share.
The Company received proceeds of $901.7 for its CBS shares and recorded a
pre-tax and after tax gain of $579.2 and $376.5, respectively.
83
The carrying value of investments (other than equity securities) that have not
produced income for the last twelve months is $35.0 at December 31, 1997.
Investment gains of $837.6, $716.0 and $1,131.8 and losses of $264.4, $165.1
and $367.6 were realized on securities available for sale for the years ended
December 31, 1997, 1996 and 1995, respectively. Investment gains in 1997 and
1996 also include $58.6 and $2.7 of net unrealized losses on equity securities
in the Company's trading portfolio.
The amortized cost and market values of securities are as follows:
<TABLE>
<CAPTION>
Unrealized
Amortized ---------------- Market
December 31, 1997 Cost Gains Losses Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government and obligations of
government agencies $14,034.9 $119.4 $ 25.3 $14,129.0
Asset-backed 4,716.1 97.8 9.6 4,804.3
States, municipalities and political
subdivisions-tax exempt 4,534.3 194.0 3.8 4,724.5
Corporate 5,282.7 142.2 53.1 5,371.8
Other debt 1,566.9 60.8 31.1 1,596.6
Redeemable preferred stocks 66.7 30.3 97.0
- --------------------------------------------------------------------------------
Total fixed maturities available for sale 30,201.6 644.5 122.9 30,723.2
Equity securities available for sale 694.4 190.1 70.8 813.7
Equity securities, trading portfolio 408.2 4.1 62.7 349.6
Short-term investments available for sale 8,754.5 .1 .4 8,754.2
- --------------------------------------------------------------------------------
$40,058.7 $838.8 $256.8 $40,640.7
================================================================================
<CAPTION>
December 31, 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government and obligations of
government agencies $11,619.5 $ 72.4 $114.1 $11,577.8
Asset-backed 6,297.9 53.3 58.9 6,292.3
States, municipalities and
political subdivisions-tax exempt 4,859.6 120.9 29.3 4,951.2
Corporate 4,745.1 122.1 64.1 4,803.1
Other debt 1,748.0 59.5 19.2 1,788.3
Redeemable preferred stocks 49.2 16.7 .3 65.6
- --------------------------------------------------------------------------------
Total fixed maturities available for sale 29,319.3 444.9 285.9 29,478.3
Equity securities available for sale 701.9 254.3 97.1 859.1
Equity securities, trading portfolio 279.9 24.9 27.6 277.2
Short-term investments available for sale 8,305.1 .4 .6 8,304.9
- --------------------------------------------------------------------------------
$38,606.2 $724.5 $411.2 $38,919.5
================================================================================
</TABLE>
84
The amortized cost and market value of fixed maturities at December 31, 1997
and 1996 are shown below by contractual maturity. Actual maturities may differ
from contractual maturities because securities may be called or prepaid with or
without call or prepayment penalties.
<TABLE>
<CAPTION>
1997 1996
--------------------- ----------------------
Amortized Market Amortized Market
December 31 Cost Value Cost Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 2,059.0 $ 2,076.7 $ 2,494.1 $ 2,506.4
Due after one year through
five years 12,675.9 12,674.0 10,145.7 10,041.8
Due after five years through
ten years 3,324.4 3,374.9 4,811.5 4,829.7
Due after ten years 7,426.2 7,793.3 5,570.1 5,808.1
Asset-backed securities not
due at a single maturity date 4,716.1 4,804.3 6,297.9 6,292.3
- --------------------------------------------------------------------------------
$30,201.6 $30,723.2 $29,319.3 $29,478.3
================================================================================
</TABLE>
Note 3. Fair Value of Financial Instruments -
<TABLE>
<CAPTION>
1997 1996
----------------------- ---------------------
Carrying Estimated Carrying Estimated
December 31 Amount Fair Value Amount Fair Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Other investments $ 973.9 $ 971.9 $ 987.0 $ 977.2
Separate Account business:
Fixed maturities 4,769.0 4,769.0 4,608.3 4,608.3
Equity securities 206.0 206.0 169.2 169.2
Short-term investments 629.0 629.0 906.1 906.1
Other 208.0 208.0 437.4 437.4
Financial liabilities:
Premium deposits and annuity
contracts 1,194.0 1,145.0 1,064.5 1,017.6
Long-term debt 5,697.2 5,943.1 4,313.9 4,322.8
Financial guarantee
liabilities 382.0 373.0 382.0 378.3
Separate Account business:
Guaranteed investment
contracts 3,414.0 3,448.0 3,989.5 4,011.5
Deferred annuities 73.0 90.0 73.0 84.1
Variable Separate Accounts 997.0 997.0 568.6 568.6
Other 614.0 614.0 895.6 895.6
- --------------------------------------------------------------------------------
</TABLE>
85
In cases where quoted market prices are not available, fair values may be
based on estimates using present value or other valuation techniques. These
techniques are significantly affected by the assumptions used, including the
discount rates and estimates of future cash flows. Accordingly, the estimates
presented herein are subjective in nature and are not necessarily indicative of
the amounts that the Company could realize in a current market exchange. The
amounts reported in the consolidated balance sheet for fixed maturities
securities, equity securities, derivative instruments, short-term investments
and securities sold under agreements to repurchase are at fair value. As such,
these financial instruments are not shown in the table above. See Note 4 for the
fair value of derivative instruments. Since the disclosure excludes certain
financial instruments and all nonfinancial instruments such as real estate and
insurance reserves, the aggregate fair value amounts cannot be summed to
determine the underlying economic value of the Company.
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Fixed maturity securities, equity securities and separate account securities
are based on quoted market prices, where available. For securities not actively
traded, fair values are estimated using values obtained from independent pricing
services or quoted market prices of comparable instruments adjusted for
differences between the quoted instruments and the instruments being valued.
Other investments consist of mortgage loans and notes receivable, policy
loans, investments in limited partnerships and various miscellaneous assets.
Valuation techniques to determine fair value of other investments and other
Separate Account assets consist of discounted cash flows and quoted market
prices of (a) the investments, (b) comparable instruments or (c) underlying
assets of the investments.
Premium deposits and annuity contracts are valued based on cash surrender
values and the outstanding fund balances.
The fair value of the liability for financial guarantee contracts is based on
discounted cash flows utilizing interest rates currently being offered for
similar contracts.
The fair value of guaranteed investment contracts and deferred annuities of
the Separate Accounts business are estimated using discounted cash flow
calculations, based on interest rates currently being offered for similar
contracts with similar maturities. The fair value of the liabilities for
variable Separate Accounts business are based on the quoted market values of the
underlying assets of each variable Separate Account. The fair value of other
Separate Account business liabilities approximates carrying value.
Fair value of long-term debt is based on quoted market prices when available.
The fair values for other long-term debt are based on quoted market prices of
comparable instruments adjusted for differences between the quoted instruments
and the instruments being valued or are estimated using discounted cash flow
analyses, based on current incremental borrowing rates for similar types of
borrowing arrangements.
86
Note 4. Off-Balance-Sheet and Derivative Financial Instruments -
The Company enters into various transactions involving off-balance-sheet
financial instruments through a variety of futures, swaps, options, forwards and
other contracts (the "Contracts") as part of its investing activities. These
Contracts are commonly referred to as derivative instruments since their
underlying values may be linked to, among other things, interest rates, exchange
rates, prices of securities and financial or commodity indexes. The Company uses
these Contracts for a number of purposes, including: (i) for its asset and
liability management activities; (ii) for income enhancements for its portfolio
management strategy; and (iii) to benefit from anticipated future movements in
the underlying markets that Company management expects to occur. If such
movements do not occur or if the market moves in the opposite direction from
what management expects, significant losses may occur. These Contracts also
involve the risk of dealing with counterparties and their ability to meet the
terms of the Contracts.
Exposure to market risk is managed and monitored by senior management. Senior
management approves the overall investment strategy employed by the Company and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to it. The Company may manage
risk by buying and selling instruments or entering into offsetting positions.
The notional amounts of derivatives shown in the following table do not
represent amounts exchanged in these transactions and, therefore, are not a
measure of the exposure the Company has through its use of derivative
instruments. In addition, notional amounts are presented gross and do not
reflect the net effect of offsetting positions. The amounts exchanged are
calculated on the basis of the notional amounts and the other terms of the
derivative instruments.
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 Contracts with large financial
institutions and considers the risk of nonperformance to be remote.
The Company's investments in derivative instruments held for trading are as
follows:
<TABLE>
<CAPTION>
Fair Value Asset (Liability)
Contractual/ ----------------------------
Notional Average for Recognized
December 31, 1997 Value Year-End the Year (Loss) Gain
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity markets:
Options purchased $2,272.0 $176.3 $1,072.3 $(336.2)
Options written 269.7 (18.8) (134.1) 42.9
S&P futures 1,881.0 (381.2)
Commodities:
Oil:
Swaps 63.3 (2.4) (3.2) (18.8)
Energy purchase
obligations 44.0 (9.8) (3.1) (10.1)
Gold:
Options purchased 488.3 27.9 27.5 44.3
Options written 84.6 (4.2) (2.0) 3.6
Other 67.5 5.0 9.6 21.4
Other 15.4
- --------------------------------------------------------------------------------
Total $5,170.4 $174.0 $ 967.0 $(618.7)
================================================================================
</TABLE>
87
<TABLE>
<CAPTION>
Fair Value Asset (Liability)
Contractual/ ----------------------------
Notional Average for Recognized
December 31, 1996 Value Year-End the Year (Loss) Gain
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity markets:
Options purchased $1,995.7 $100.7 $ 66.1 $(149.1)
Options written 1,223.5 (19.1) (25.5) 63.4
Futures 1,466.9 (138.2)
Interest rate risk:
Treasury bill calls 218.6 1.3 .6 3.3
Interest rate swaps 85.0 (.4) 2.3 29.0
Commitments to purchase
government and municipal
securities 406.5 (.9) (1.0)
Foreign exchange futures
and forwards 599.0 (2.0) (1.7) (3.5)
Commodities:
Oil:
Swaps 104.0 6.3 (13.5) 52.2
Energy purchase
obligations 79.1 2.3 (7.0) 17.1
Gold options purchased 209.0 2.1 2.2 (2.1)
Other 176.5 3.4 (1.5) (9.7)
- --------------------------------------------------------------------------------
Total $6,563.8 $ 93.7 $ 21.0 $(137.6)
================================================================================
<CAPTION>
December 31, 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity markets:
Options purchased $2,337.1 $ 65.0 $ 42.6 $(83.4)
Options written 1,118.0 (25.8) (23.2) 24.1
Futures 717.1 (44.0)
Interest rate risk:
Treasury bill calls 1,111.6 (12.1) (3.4) (1.8)
Interest rate swaps 93.0 10.0 1.1 9.1
Foreign exchange rates:
Options 434.7 37.8 10.4 72.5
Futures and forwards 508.6 (.5) .3 (3.9)
Commodities:
Oil:
Swaps 262.1 (31.4) (33.5) (3.4)
Energy purchase
obligations 88.0 (14.4) (19.6) 1.7
Gold options purchased 591.1 2.6 3.1 (2.7)
Other 13.3 (.1) .2 .4
- --------------------------------------------------------------------------------
Total $7,274.6 $ 31.1 $(22.0) $(31.4)
================================================================================
</TABLE>
88
CNA has entered into interest rate swap agreements to convert the variable
rate of the borrowing under the bank credit facility and the commercial paper
program to a fixed rate. Since these interest rate swaps are not held for
trading purposes, they are not included in the preceding tables. The outstanding
interest rate swap agreements had a total notional principal amount of $950.0,
and a fair value liability of $4.0 and fair value asset of $3.0 at December 31,
1997 and 1996, respectively. These agreements, which terminate from May to
December 2000, effectively fix the Company's interest rate exposure on $950.0 of
variable rate debt.
CNA also uses derivatives to mitigate the risk associated with its indexed
group annuity contracts by purchasing S&P 500 futures contracts in a notional
amount equal to the original customer deposit. CNA generally does not hold or
issue these instruments for trading purposes. The gross notional principal or
contractual amounts of these instruments in the Separate Accounts totaled $615.0
and $319.0 at December 31, 1997 and 1996, respectively.
The Company also enters into short sales as part of its portfolio management
strategy. Short sales are commitments to sell a financial instrument not owned
at the time of sale, usually done in anticipation of a price decline. These
sales resulted in proceeds of $602.3 and $543.5 with fair value liabilities of
$880.7 and $588.9 at December 31, 1997 and 1996, respectively. These positions
are marked to market and investment gains or losses are included in the income
statement.
Estimated fair values approximate carrying values and are based on quoted
market prices, where available. For securities not actively traded, fair values
are estimated using values obtained from independent pricing services, quoted
market prices of comparable instruments or present value models.
Through August 1, 1989, CNA's property and casualty operations wrote financial
guarantee insurance contracts. These contracts primarily represent industrial
development bond guarantees and equity guarantees typically extending from ten
to thirteen years. For these guarantees, CNA received an advance premium which
is recognized over the exposure period and in proportion to the underlying
exposure insured.
At December 31, 1997 and 1996, gross exposure of financial guarantee insurance
contracts amounted to $181.0 and $582.0, respectively. The degree of risk
attached to this exposure is substantially reduced through reinsurance,
diversification of exposures and collateral requirements. In addition, security
interests in real estate are also obtained. Approximately 54% and 47% of the
risks were ceded to reinsurers at December 31, 1997 and 1996, respectively.
Total exposure, net of reinsurance, amounted to $83.0 and $311.0 at December 31,
1997 and 1996, respectively. At December 31, 1997 and 1996, collateral
consisting of letters of credit and debt service reserves amounted to $22.0 and
$28.0, respectively. Gross unearned premium reserves for financial guarantee
contracts were $5.0 and $11.0 at December 31, 1997 and 1996, respectively. Gross
claim and claim expense reserves totaled $377.0 and $371.0 at December 31, 1997
and 1996, respectively.
89
Note 5. Purchase of Business -
On May 10, 1995, CNA acquired all the outstanding common shares of The
Continental Corporation ("CIC") for approximately $1,100.0, or $20 per CIC
share. To finance the acquisition, CNA entered into a five year $1,325.0
revolving credit facility (see Note 11). CIC is an insurance holding company
principally engaged through subsidiaries in the business of property and
casualty insurance.
The acquisition of CIC has been accounted for as a purchase, and CIC's
operations are included in the Consolidated Financial Statements as of May 10,
1995.
The pro forma consolidated condensed results of operations presented below
assume the above transaction had occurred at January 1, 1995.
<TABLE>
<CAPTION>
Year Ended December 31 1995
- --------------------------------------------------------------------------------
<S> <C>
Revenues $20,132.5
================================================================================
Investment gains included in revenue $ 1,699.0
================================================================================
Income before income taxes and minority interest $ 2,881.4
Income tax expense (975.8)
Minority interest (130.2)
- --------------------------------------------------------------------------------
Net income $ 1,775.4
================================================================================
Per share $ 15.07
================================================================================
</TABLE>
The pro forma consolidated condensed financial information is not necessarily
indicative either of the results of operations that would have occurred had this
transaction been consummated at January 1, 1995 or of future operations of the
combined companies.
Note 6. Receivables -
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Reinsurance $ 5,726.0 $ 6,530.0
Other insurance 6,333.9 5,942.5
Security sales 755.8 299.7
Accrued investment income 422.8 534.3
Other 405.4 412.0
- --------------------------------------------------------------------------------
Total 13,643.9 13,718.5
Less allowance for doubtful accounts
and cash discounts 318.0 291.4
- --------------------------------------------------------------------------------
Receivables-net $13,325.9 $13,427.1
================================================================================
</TABLE>
90
Note 7. Inventories -
Inventories, included in other assets, are as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Leaf tobacco $ 195.6 $ 210.8
Manufactured stock 62.4 69.4
Materials, supplies, etc. 40.4 35.7
- --------------------------------------------------------------------------------
Total $ 298.4 $ 315.9
================================================================================
</TABLE>
If the average cost method of accounting had been used for tobacco inventories
instead of the LIFO method, such inventories would have been $208.6 and $205.9
higher at December 31, 1997 and 1996, respectively.
Note 8. Property, Plant and Equipment -
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Land $ 123.4 $ 120.3
Buildings and building equipment 753.8 672.4
Offshore drilling rigs and equipment 1,781.1 1,333.0
Machinery and equipment 1,130.6 1,055.5
Leaseholds and leasehold improvements 67.7 70.4
- --------------------------------------------------------------------------------
Total, at cost 3,856.6 3,251.6
Less accumulated depreciation and amortization 1,266.4 1,026.5
- --------------------------------------------------------------------------------
Property, plant and equipment-net $2,590.2 $2,225.1
================================================================================
</TABLE>
Depreciation and amortization expense, including amortization of intangibles,
and capital expenditures, by business segment, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- -------------- --------------
Depr. Depr. Depr.
& Capital & Capital & Capital
Year Ended December 31 Amort. Expend. Amort. Expend. Amort. Expend.
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Property and casualty insurance $162.8 $238.3 $141.2 $180.2 $101.8 $ 99.7
Life insurance 24.6 42.0 22.5 25.1 18.9 26.5
Cigarettes 21.0 34.4 21.5 35.3 28.4 43.1
Hotels 17.7 15.7 18.7 16.7 18.5 21.1
Offshore drilling 108.3 362.6 75.8 267.2 52.9 66.7
Watches and clocks .8 .6 .8 .1 .6 .1
- --------------------------------------------------------------------------------
Total business segments 335.2 693.6 280.5 524.6 221.1 257.2
Corporate 6.5 8.8 4.5 20.9 4.7 .7
- --------------------------------------------------------------------------------
Total $341.7 $702.4 $285.0 $545.5 $225.8 $257.9
================================================================================
</TABLE>
91
Note 9. Liability for Unpaid Claims and Claim Adjustment Expenses -
CNA's property and casualty insurance claims and claims expense reserve
represents the estimated amounts necessary to settle all outstanding claims,
including claims which are incurred but not reported, as of the reporting date.
The Company's reserve projections are based primarily on detailed analysis of
the facts in each case, CNA's experience with similar cases, and various
historical development patterns. Consideration is given to such historical
patterns as field reserving trends, loss payments, pending levels of unpaid
claims and product mix, as well as court decisions, economic conditions and
public attitudes. All of these can affect the estimation of reserves.
Establishing loss reserves is an estimation process. Many factors can
ultimately affect the final settlement of a claim and, therefore, the reserve
that is needed. Changes in the law, results of litigation, medical costs, the
cost of repair materials and labor rates can all impact ultimate claim costs. In
addition, time can be a critical part of reserving determinations since the
longer the span between the incidence of a loss and the payment or settlement of
the claim, the more variable the ultimate settlement amount can be. Accordingly,
short-tail claims, such as property damage claims, tend to be more reasonably
predictable than long-tail claims, such as general liability and professional
liability claims.
The table below provides a reconciliation between beginning and ending claim
and claim expense reserve balances for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Reserves at beginning of year:
Gross $29,395.0 $31,044.0 $21,639.0
Ceded reinsurance 5,660.0 6,089.0 2,705.0
- --------------------------------------------------------------------------------
Net reserves at beginning of year 23,735.0 24,955.0 18,934.0
Reserves of acquired insurance companies 57.0 6,063.0
- --------------------------------------------------------------------------------
Net 23,792.0 24,955.0 24,997.0
- --------------------------------------------------------------------------------
Net incurred claim and claim expenses:
Provision for insured events of current year 7,942.0 7,922.0 6,787.0
(Decrease) increase in provision for insured
events of prior years (256.0) (91.0) 122.0
Amortization of discounts 143.0 149.0 106.0
- --------------------------------------------------------------------------------
Total net incurred 7,829.0 7,980.0 7,015.0
- --------------------------------------------------------------------------------
Net payments attributable to:
Current year events 2,514.0 2,676.0 2,000.0
Prior year events 5,862.0 6,524.0 5,057.0
- --------------------------------------------------------------------------------
Total net payments 8,376.0 9,200.0 7,057.0
- --------------------------------------------------------------------------------
Net reserves at end of year 23,245.0 23,735.0 24,955.0
Ceded reinsurance at end of year 4,995.0 5,660.0 6,089.0
- --------------------------------------------------------------------------------
Gross reserves at end of year (a) $28,240.0 $ 29,395.0 $31,044.0
================================================================================
</TABLE>
(a) Excludes life claim and claim expense reserves and intercompany
eliminations of $986.8, $999.5 and $988.0 as of December 31, 1997, 1996 and
1995, respectively, included in the Consolidated Balance Sheets.
92
Favorable (adverse) reserve development is comprised of the following
components:
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Asbestos $(105.0) $(50.5) $(273.7)
Environmental Pollution (64.7) (226.0)
Other 361.0 206.2 377.7
- --------------------------------------------------------------------------------
Total $ 256.0 $ 91.0 $(122.0)
================================================================================
</TABLE>
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.
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 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 ("NPL"). The addition of new clean-up sites to the NPL has slowed in recent
years. Many clean-up sites have been designated by state authorities as well.
Many policyholders have made claims against various CNA insurance subsidiaries
for defense costs and indemnification in connection with environmental pollution
matters. CNA and the insurance industry are disputing coverage for many such
claims. Key coverage issues include whether clean-up costs are considered
damages under the policies, trigger of coverage, applicability of pollution
exclusions, and owned property exclusions, the potential for joint and several
liability and definition of an occurrence. To date, courts have been
inconsistent in their rulings on these issues.
A number of proposals to reform Superfund have been made by various parties.
However, no reforms were enacted by Congress in 1997 and it is unclear as to
what positions Congress or the Administration will take and 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 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, CNA's ultimate liability for environmental
pollution claims may vary substantially from the amount currently recorded.
As of December 31, 1997 and 1996, CNA carried approximately $773.0 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.
CNA's insurance subsidiaries have exposure to asbestos-related claims,
including those attributable to CNA's litigation with Fibreboard Corporation
(see Note 18). Estimation of asbestos-related claim reserves involves many of
the same limitations discussed above for environmental pollution claims such as
inconsistency of court decisions, specific policy provisions, allocation of
liability among insurers, missing policies and proof of coverage. As of December
31, 1997 and 1996, CNA carried approximately $1,400.0 and $1,506.2,
respectively, of claim and claim expense reserves, net of reinsurance
recoverable, for reported and unreported asbestos-related claims.
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 these liabilities and make further
adjustments as warranted.
Other 1997 favorable loss reserve development of $361.0 was attributable to
approximately $540.0 in
93
involuntary risk business, and approximately $200.0 in personal lines business,
partially offset by unfavorable loss and loss adjustment expense development of
$379.0 in commercial lines. The 1997 favorable loss development was offset in
part by unfavorable premium development of approximately $340.0 in involuntary
risk business and $170.0 favorable premium development in commercial lines.
The other favorable development during 1996 and 1995, of $206.2 and $377.7
respectively, was principally due to favorable claim experience in the workers'
compensation line of business.
The following tables provide additional data related to CNA's environmental
pollution and asbestos-related claims activity.
<TABLE>
<CAPTION>
Reserve Summary
December 31 1997 1996
- --------------------------------------------------------------------------------
Environmental Environmental
Pollution Asbestos Pollution Asbestos
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported Claims:
Gross reserves $279.0 $1,384.0 $288.9 $1,551.4
Less reinsurance recoverable (36.0) (117.0) (95.1) (139.2)
- --------------------------------------------------------------------------------
Net reported claims 243.0 1,267.0 193.8 1,412.2
Net unreported claims 530.0 133.0 714.0 94.0
- --------------------------------------------------------------------------------
Net reserves $773.0 $1,400.0 $907.8 $1,506.2
================================================================================
</TABLE>
Changes in Environmental Pollution Reserves
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995*
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net reserves at beginning of year $ 907.8 $1,063.0 $ 948.8
Reserve strengthening 64.7 226.0
Less:
Gross payments (258.0) (304.2) (183.4)
Reinsurance recoveries 123.2 84.3 71.6
- --------------------------------------------------------------------------------
Net reserves at end of year $ 773.0 $ 907.8 $1,063.0
================================================================================
</TABLE>
*Includes CIC net reserves of $443.1 at May 10, 1995.
Changes in Asbestos Reserves
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995*
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net reserves at beginning of year $1,506.2 $2,191.1 $2,109.1
Reserve strengthening 105.0 50.5 273.7
Less:
Gross payments (268.2) (787.7) (267.8)
Reinsurance recoveries 57.0 52.3 76.1
- --------------------------------------------------------------------------------
Net reserves at end of year $1,400.0 $1,506.2 $2,191.1
================================================================================
</TABLE>
*Includes CIC net reserves of $170.4 at May 10, 1995.
94
Note 10. Income Taxes -
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Income taxes (benefits):
Federal:
Current $372.2 $276.4 $595.8
Deferred 59.3 474.9 302.3
State, city and other, principally current 63.8 40.1 47.2
- --------------------------------------------------------------------------------
Total $495.3 $791.4 $945.3
================================================================================
</TABLE>
Deferred tax assets (liabilities) are as follows:
<TABLE>
<CAPTION>
December 31 1997 1996 1995(a) 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Insurance reserves:
Property and casualty
claim reserves $1,101.3 $1,145.2 $1,328.0 $1,027.4
Unearned premium reserves 283.2 268.0 251.0 137.4
Life reserve differences 156.4 141.1 153.4 115.9
Others 22.2 31.4 22.8 10.3
Deferred policy acquisition costs (666.7) (570.1) (457.2) (312.6)
Employee benefits 219.6 219.0 202.9 157.1
Property, plant and equipment (109.8) (145.5) (56.5) (133.2)
Investments 49.0 (71.2) 74.8 111.7
Alternative minimum tax credit 239.6
Net operating loss carry forward 304.9 279.9 298.0
Other-net 204.7 318.3 273.8 60.7
Valuation allowance (258.0) (250.0) (250.0)
- -------------------------------------------------------------------------------
1,306.8 1,366.1 1,841.0 1,414.3
Unrealized (appreciation)
depreciation (290.7) (133.2) (579.9) 282.4
Other-net (71.8) (94.9) (55.9) (17.5)
- --------------------------------------------------------------------------------
Deferred tax assets-net $ 944.3 $1,138.0 $1,205.2 $1,679.2
================================================================================
(a) CIC deferred tax assets at May 10, 1995, amounted to $729.0.
</TABLE>
Gross deferred tax assets amounted to $2,891.8 and $2,826.5 and liabilities
amounted to $1,947.5 and $1,688.5 for the years ended December 31, 1997 and
1996, respectively.
At December 31, 1997, the Company had net operating loss carryforwards of
$870.0 for income tax purposes that expire in years 2000 through 2017. Of the
$870.0 in loss carryforwards approximately $800.0 of those carryforwards
resulted from CNA's acquisition of CIC.
95
The Company has a past history of profitability and anticipates sufficient
future taxable income to fully support recognition of its deferred tax balance
at December 31, 1997, including but not limited to the reversal of existing
temporary differences and the implementation of tax planning strategies, if
needed.
A valuation allowance is maintained due to the uncertainty regarding the
realizability of certain deferred tax assets.
Total income tax expense for the years ended December 31, 1997, 1996 and 1995
was different than the amounts of $557.6, $842.7 and $993.8, computed by
applying the statutory U.S. federal income tax rate of 35% to income before
income taxes and minority interest for each of the years.
A reconciliation between the statutory federal income tax rate and the
Company's effective income tax rate as a percentage of income before income
taxes and minority interest is as follows:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory rate 35% 35% 35%
(Decrease) increase in income tax rate resulting from:
Exempt interest and dividends received deduction (6) (3) (3)
State and city income taxes 2 1 1
- --------------------------------------------------------------------------------
Effective income tax rate 31% 33% 33%
================================================================================
</TABLE>
Federal, foreign, state and local income tax payments, net of refunds,
amounted to approximately $565.3, $407.8 and $386.5 for the years ended December
31, 1997, 1996 and 1995, respectively.
The Company has entered into separate tax allocation agreements with Bulova
and CNA, majority-owned subsidiaries in which its ownership exceeds 80% (the
"Subsidiaries"). Each agreement provides that the Company will (i) pay to the
Subsidiary the amount, if any, by which the Company's consolidated federal
income tax is reduced by virtue of inclusion of the Subsidiary in the Company's
return, or (ii) be paid by the Subsidiary an amount, if any, equal to the
federal income tax which would have been payable by the Subsidiary if it had
filed a separate consolidated return. Under these agreements, CNA will pay or
has paid the Company approximately $210.0 and $99.0 for 1997 and 1996,
respectively, and received from the Company approximately $78.0 for 1995. The
federal income tax to be received from Bulova amounted to approximately $2.6 and
$5.3 for 1997 and 1996, respectively, and Bulova has received approximately $2.1
for 1995. Each agreement may be cancelled by either of the parties upon thirty
days' written notice.
The Company's federal income tax returns have been settled through 1990 and
the years 1991 through 1994 are currently under examination. While tax
liabilities for subsequent years are subject to audit and final determination,
in the opinion of management the amount accrued in the consolidated balance
sheet is believed to be adequate to cover any additional assessments which may
be made by federal, state and local tax authorities and should not have a
material effect on the financial condition or results of operations of the
Company.
96
Note 11. Long-Term Debt -
<TABLE>
<CAPTION>
Unamortized Current
December 31, 1997 Principal Discount Net Maturities
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loews Corporation $2,442.8 $41.0 $2,401.8 $117.8
CNA 2,907.4 10.5 2,896.9 4.8
Diamond Offshore 400.0 4.6 395.4
Other 58.5 58.5 2.4
- --------------------------------------------------------------------------------
Total $5,808.7 $56.1 $5,752.6 $125.0
================================================================================
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Loews Corporation (Parent Company):
Senior:
8.5% notes due 1998 (effective interest rate of 8.6%)
(authorized, $125) (a) $ 117.8 $ 117.8
6.8% notes due 2006 (effective interest rate of 6.8%)
(authorized, $300) 300.0 300.0
8.9% debentures due 2011 (effective interest rate of
9.0%) (authorized, $175) 175.0 175.0
7.6% notes due 2023 (effective interest rate of 7.8%)
(authorized, $300) (b) 300.0 300.0
7.0% notes due 2023 (effective interest rate of 7.2%)
(authorized, $400) (c) 400.0 400.0
8.3% debentures due 2007 200.0
Subordinated:
3.1% exchangeable subordinated notes due 2007
(effective interest rate of 3.4%)
(authorized, $1,150) (d) 1,150.0
CNA Financial Corporation:
8.9% notes due 1998 (effective interest rate of 9.2%)
(authorized, $150) 150.0 150.0
8.3% notes due 1999 (effective interest rate of 7.3%)
(authorized, $100) 100.0 100.0
6.3% notes due 2003 (effective interest rate of 6.4%)
(authorized, $250) 250.0 250.0
7.3% notes due 2003 (effective interest rate of 7.8%)
(authorized, $150) 150.0 150.0
6.8% notes due 2006 (effective interest rate of 6.8%)
(authorized, $250) 250.0 250.0
8.4% notes due 2012 (effective interest rate of 8.6%)
(authorized, $100) 100.0 100.0
7.3% debentures due 2023 (effective interest rate of
7.3%) (authorized, $250) 250.0 250.0
Commercial Paper (weighted average yield 6.1% and 5.7%) 675.0 675.0
Bank revolving credit due 2001 (effective interest
rate of 6.2% and 5.7%) 400.0 400.0
Mortgage notes at 11%, due 2013 389.2 386.6
Revolving credit facility due 2002 (effective interest
rate 6.2%) 118.0
Other senior debt (effective interest rates approximate
8.2% and 8.4%) 75.2 64.4
Diamond Offshore Drilling, Inc.:
3.8% convertible subordinated notes due 2007 (effective
interest rate of 3.9%) (authorized, $400) (e) 400.0
Bank revolving credit 63.0
Other senior debt, principally mortgages (effective
interest rates approximate 9.4%) 58.5 71.2
- --------------------------------------------------------------------------------
5,808.7 4,403.0
Less unamortized discount 56.1 32.3
- --------------------------------------------------------------------------------
Long-term debt, less unamortized discount $5,752.6 $4,370.7
================================================================================
</TABLE>
97
(a) Net of $7.2 held by the Company.
(b) Redeemable in whole or in part at June 1, 2003 at 103.8%, and decreasing
percentages thereafter.
(c) Redeemable in whole or in part at October 15, 2003 at 102.4%, and
decreasing percentages thereafter.
(d) The notes are exchangeable into 15.376 shares of Diamond Offshore's common
stock per $1,000 principal amount of notes, at a price of $65.04 per share.
Redeemable in whole or in part at September 15, 2002 at 101.6%, and
decreasing percentages thereafter.
(e) The notes are convertible into 24.691 shares of Diamond Offshore's common
stock per $1,000 principal amount of notes, at a price of $40.50 per share.
Redeemable in whole or in part at February 22, 2001 at 102.1%, and
decreasing percentages thereafter.
In September 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 15.376
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.
In February 1997, Diamond Offshore issued $400.0 million principal amount of 3
3/4% convertible subordinated notes convertible into 24.691 shares of Diamond
Offshore's common stock per one thousand dollar principal amount of notes, at a
price of $40.50 per share. Redeemable in whole or in part at February 22, 2001
at 102.1%, and decreasing percentages thereafter.
To finance the 1995 acquisition of CIC, CNA entered into a five-year $1,325.0
revolving credit facility (the "Bank Facility"). In 1996, CNA renegotiated the
facility extending the maturity to May 2001. The interest rate is based on the
one, two, three or six month London Interbank Offered Rate ("LIBOR"), as
elected, plus 16 basis points. Additionally, there is a facility fee of 9 basis
points. Under the terms of the facility, CNA may prepay the debt without
penalty.
In 1995, CNA entered into interest rate swap agreements with a notional
principal amount of $1,200.0, which terminate from May to December 2000. These
agreements effectively convert variable rate debt into fixed rate debt and
provide that CNA pay interest at a fixed rate, averaging 6.2% at December 31,
1997, in exchange for the receipt of interest at the three month LIBOR rate.
Concurrent with the pay down of $250.0 on the Bank Facility, CNA terminated
interest rate swaps with a total notional amount of $250.0. As a result, the
borrowing capacity under the Bank Facility was reduced to $1,075.0. The effect
of these interest rate swaps was to increase interest expense by approximately
$4.0 and $7.0 for the years ended December 31, 1997 and 1996, respectively.
In 1995, to take advantage of favorable interest rate spreads, CNA established
a commercial paper program borrowing from investors to reduce a like amount of
the Bank Facility. These borrowings are classified as long-term debt, as the
Bank Facility supports the commercial paper program. At December 31, 1997, there
was no unused borrowing capacity under the Bank Facility after the effects of
the commercial paper program.
The weighted average interest rate (interest and facility fees) on the
acquisition debt, which includes the Bank Facility, commercial paper and the
effect of the interest rate swaps, was 6.4% and 6.3% at December 31, 1997 and
1996, respectively.
In conjunction with the merger with Capsure Holdings Corp. CNA's affiliate,
CNA Surety entered into a $130.0, 5 year revolving credit facility which closed
and was funded on September 30, 1997. The interest rate for the facility is
based on LIBOR plus 20 basis points. Additionally there is a facility fee of 10
basis points annually. At December 31, 1997 the interest rate was 6.2%.
The aggregate of long-term debt maturing in each of the next five years is
approximately as follows: $125.0 in 1998, $135.5 in 1999, $9.3 in 2000, $1,090.6
in 2001 and $144.6 in 2002. The Company paid interest expenses of approximately
$325.1, $315.3 and $276.0 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Payment of dividends by insurance subsidiaries of CNA without prior regulatory
approval is limited to certain formula-derived amounts. At December 31, 1997,
approximately $5,231.8 of retained earnings was not available for dividends.
98
Note 12. Leases -
The Company's hotels in some instances are constructed on leased land or are
leased. Other leases cover office facilities, computer and transportation
equipment. Rent expense amounted to $127.2, $128.6 and $118.9 for the years
ended December 31, 1997, 1996 and 1995, respectively. It is expected, in the
normal course of business, that leases which expire will be renewed or replaced
by leases on other properties; therefore, it is believed that future minimum
annual rental commitments will not be less than the amount of rental expense
incurred in 1997. At December 31, 1997 future aggregate minimum rental payments
approximated $635.9.
Note 13. Benefit Plans -
Pension Plans - The Company and its subsidiaries have several non-contributory
defined benefit plans for eligible employees. The benefits for certain plans
which cover salaried employees and certain union employees are based on formulas
which include among others, years of service and average pay. The benefits for
one plan which covers union workers under various union contracts and certain
salaried employees are based on years of service multiplied by a stated amount.
Effective January 1, 1998, one of the Company's retirement plans was converted
to a cash balance plan. A cash balance plan is a form of non-contributory,
defined benefit pension plan in which the value of each participant's benefit is
expressed as a nominal cash balance account established in the name of such
participant. The cash balance in each account is increased annually based on a
specified percentage of annual earnings (based on the participant's age) and a
specified interest rate (which is established annually for all participants).
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned $ 67.3 $ 69.3 $ 54.6
Interest cost 166.8 155.7 129.0
Return on plan assets-actual (162.6) (88.9) (240.2)
Net amortization and deferrals 44.1 (20.5) 149.8
- --------------------------------------------------------------------------------
Net pension cost $ 115.6 $115.6 $ 93.2
================================================================================
</TABLE>
99
The following table sets forth the funded status of the Company's pension
plans:
<TABLE>
<CAPTION>
1997 1996
Overfunded Underfunded Overfunded Underfunded
December 31 Plans Plans Plans Plans
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Actuarial present value of benefit
obligations:
Accumulated benefit obligation $ 332.8 $1,747.9 $ 858.5 $ 947.7
================================================================================
Accumulated vested benefit
obligation $ 313.0 $1,645.7 $ 799.7 $ 890.9
================================================================================
Projected benefit obligation $ 332.8 $2,170.5 $1,081.4 $1,139.2
Plan assets at fair value 343.4 1,609.7 1,035.7 770.2
- --------------------------------------------------------------------------------
Projected benefit obligation over
plan assets (10.6) 560.8 45.7 369.0
Unrecognized prior service cost (26.2) (87.5) (39.3) (78.9)
Unrecognized net obligation,
January 1 (16.6) 1.3 (15.0) (.8)
Unrecognized net loss (54.4) (279.6) (169.3) (37.0)
Minimum liability 2.5
- --------------------------------------------------------------------------------
Net pension (asset) liability
recognized in the balance sheet $(107.8) $ 197.5 $ (177.9) $ 252.3
================================================================================
</TABLE>
The rates used in the actuarial assumptions were:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.0% to 7.3% 7.5% 7.0% to 7.3%
Rate of compensation increase 2.8% to 5.5% 2.8% to 5.8% 2.8% to 5.5%
Expected long-term rate of
return on assets 7.5% 7.0% to 7.8% 7.5% to 8.8%
- --------------------------------------------------------------------------------
</TABLE>
The Company's funding policy is to make contributions in accordance with
applicable governmental regulatory requirements. The assets of the plans are
invested primarily in interest-bearing obligations and for one plan with an
insurance subsidiary of the Company, in its Separate Account business. In 1995,
the Company made contributions totaling approximately $186.0 to fund completely
certain plans which had been underfunded.
Other Postretirement Benefit Plans - The Company and its subsidiaries have
several postretirement benefit plans covering eligible employees and retirees.
Participants generally become eligible after reaching age 55 with required years
of service. Actual requirements for coverage vary by plan. Benefits for retirees
who were covered by bargaining units vary by each unit and contract. Benefits
for certain retirees are in the form of a Company health care account.
Benefits for retirees reaching age 65 are generally integrated with Medicare.
Other retirees, based on plan provisions, must use Medicare as their primary
coverage, with the Company reimbursing a portion of the unpaid amount; or are
reimbursed for the Medicare Part B premium or have no Company coverage. The
benefits provided by the Company are basically health and, for certain retirees,
life insurance type benefits.
The Company does not fund any of these benefit plans and accrues
postretirement benefits during the active service of those employees who would
become eligible for such benefits when they retire.
100
The rates used in the actuarial assumptions were:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Net periodic postretirement benefit cost 7.5% 7.0% to 7.3%
Accumulated postretirement benefit liability 7.0% to 7.3% 7.5%
- --------------------------------------------------------------------------------
</TABLE>
The following table sets forth the postretirement benefit plans' status:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $286.5 $269.2
Fully eligible active plan participants 91.8 109.8
Other active plan participants 127.6 146.0
- --------------------------------------------------------------------------------
505.9 525.0
Unrecognized prior service cost 7.7 (3.7)
Unrecognized net gain 88.9 62.9
- --------------------------------------------------------------------------------
Accrued postretirement benefit liability $602.5 $584.2
================================================================================
</TABLE>
Postretirement benefit cost includes the following components:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service costs $14.5 $16.9 $10.3
Interest costs 34.0 35.8 28.5
- --------------------------------------------------------------------------------
Net periodic postretirement benefit cost $48.5 $52.7 $38.8
================================================================================
</TABLE>
For measurement purposes, a trend rate for covered costs of 8.3% to 9.0%
pre-65 and 7.3% post-65, was used. These trend rates are expected to decrease
gradually to 5.0% at rates from .3% to .5% per annum. An increase of one
percentage point in assumed health care cost trend rates would increase the
accumulated postretirement benefit obligation by approximately $33.8 and the net
periodic postretirement benefit cost by approximately $4.1.
Savings Plans - The Company and its subsidiaries have several contributory
savings plans which allow employees to make regular contributions based upon a
percentage of their salary. Effective January 1, 1998, a savings plan was
changed where the Company will provide a matching contribution of two-thirds of
a participant's contribution, up to the first 6% of their pay. The Company's
contributions to these plans amounted to $29.1, $28.6 and $25.9 for the years
ended December 31, 1997, 1996 and 1995, respectively.
101
Note 14. Gains on Issuance of Subsidiaries' Stock -
In September 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 $95.2 ($52.2 after provision for deferred taxes
and minority interest) from issuance of its subsidiary's common stock.
In April 1997, Diamond Offshore Drilling Inc., (Diamond Offshore) completed a
public offering of 2.5 million shares of its common stock for net proceeds of
approximately $82.3. 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. 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 ($18.9 after
provision for deferred taxes).
On April 29, 1996, Diamond Offshore, then a 70% owned subsidiary, acquired
Arethusa (Off-Shore) Limited ("Arethusa"). Diamond Offshore issued 35.8 million
shares of its common stock and assumed Arethusa stock options as consideration
for the purchase price of approximately $550.7. Arethusa owned a fleet of 11
mobile offshore drilling rigs and operated two additional mobile offshore rigs
pursuant to bareboat charters. The acquisition of Arethusa has been accounted
for as a purchase, and Arethusa's operations are included in the Consolidated
Financial Statements as of April 29, 1996. Pro forma operating results for the
years ended December 31, 1996 and 1995, assuming the transaction had occurred at
the beginning of the respective periods, would not be materially different from
those reported in the Consolidated Financial Statements. The Company recognized
a gain of approximately $186.6 ($121.3 after provision for deferred income
taxes) and its interest in Diamond Offshore declined to approximately 51%.
In October 1995 the Company's then wholly owned subsidiary, Diamond Offshore,
sold 29.9 million shares of its common stock through an initial public offering
at $12 per share. Diamond Offshore used the net proceeds of approximately $338.4
to fund the repayment of its intercompany debt as well as a dividend to the
Company. As a result of the offering, the Company's ownership interest in
Diamond Offshore declined to approximately 70% and the Company recorded a gain
of approximately $192.9 ($125.4 after provision for deferred income taxes).
Note 15. Capital Stock and Earnings Per Share -
In addition to its common stock, the Company has authorized 100,000,000 shares
of preferred stock, $.10 par value.
Earnings per share are based on the weighted average number of shares
outstanding during each year (115,000,000, 116,161,000 and 117,835,000 for the
years ended December 31, 1997, 1996 and 1995, respectively).
Note 16. Quarterly Financial Data (Unaudited) -
<TABLE>
<CAPTION>
1997 Quarters Ended Dec. 31 Sept. 30 June 30 March 31
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $5,339.2 $5,111.4 $4,749.1 $4,939.1
Net income 292.9 197.6 63.8 239.3
Per share 2.55 1.72 .55 2.08
<CAPTION>
1996 Quarters Ended Dec. 31 Sept. 30 June 30 March 31
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $5,137.0 $5,216.3 $5,044.6 $5,044.5
Net income 247.8 388.6 378.7 368.8
Per share 2.15 3.37 3.25 3.13
- --------------------------------------------------------------------------------
</TABLE>
102
Note 17. Reinsurance -
The effects of reinsurance on earned premiums are as follows:
<TABLE>
<CAPTION>
%
Direct Assumed Ceded Net Assumed
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997:
Life $ 908.0 $ 128.0 $ 131.0 $ 905.0 14.1%
Accident and health 3,599.0 111.0 154.0 3,556.0 3.1
Property and casualty 8,408.0 1,101.0 612.0 8,897.0 12.4
- --------------------------------------------------------------------------------
Total $12,915.0 $1,340.0 $ 897.0 $13,358.0 10.0%
================================================================================
Year Ended December 31, 1996:
Life $ 736.0 $ 121.0 $ 55.0 $ 802.0 15.1%
Accident and health 3,570.0 187.0 176.0 3,581.0 5.2
Property and casualty 8,957.0 1,123.0 989.0 9,091.0 12.4
- --------------------------------------------------------------------------------
Total $13,263.0 $1,431.0 $1,220.0 $13,474.0 10.6%
================================================================================
Year Ended December 31, 1995:
Life $ 701.0 $ 109.0 $ 21.0 $ 789.0 13.8%
Accident and health 3,012.0 125.0 106.0 3,031.0 4.1
Property and casualty 7,868.0 1,335.0 1,293.0 7,910.0 16.9
- --------------------------------------------------------------------------------
Total $11,581.0 $1,569.0 $1,420.0 $11,730.0 13.4%
================================================================================
</TABLE>
Written premiums were $13,500.0, $13,892.0 and $12,952.0 at December 31, 1997,
1996 and 1995, respectively. 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 CNA's states of
domicile, CNA receives collateral, primarily in the form of bank letters of
credit. Such collateral totaled approximately $857.0 and $800.9 at December 31,
1997 and 1996, respectively. CNA's largest recoverable from a single reinsurer,
including prepaid reinsurance premiums, is with Lloyd's of London and
approximates $451.0 and $440.0 at December 31, 1997 and 1996, respectively.
Insurance claims and policyholders' benefits are net of reinsurance recoveries
of $1,309.0, $1,220.0 and $934.8 for the years ended December 31, 1997, 1996 and
1995, 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.
103
Note 18. 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
provide 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. On June 27, 1997, the Supreme Court granted two
petitions for certiorari vacating the Fifth Circuit's judgment as respects the
Global Settlement Agreement, and remanded the matter to the Fifth Circuit for
reconsideration in light of the Supreme Court's decision in Amchem Products Co.
v. Windsor.
On January 27, 1998, a panel of the United States Fifth Circuit Court of
Appeals again approved the Global Settlement Agreement by a 2 to 1 vote.
Objectors have ninety days after the judgment is entered by the Fifth Circuit to
file a Petition for Certiorari to the Supreme Court.
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,
although the Global Settlement has so far been approved on appeal, further
review may be sought. There is limited precedent for settlements which determine
the rights of future claimants to seek relief.
Through December 31, 1997, Casualty, Fibreboard and plaintiff attorneys had
reached settlements with respect to approximately 135,400 claims, for an
estimated settlement amount of approximately $1,600.0 plus any applicable
interest. Final court approval of the Trilateral Agreement obligates Casualty to
pay under these settlements. Approximately $1,600.0 including interest was paid
through December 31, 1997. Such payments are partially recoverable from Pacific
Indemnity. Casualty may negotiate other agreements with various classes of
claimants including groups who may have previously reached agreement with
Fibreboard.
Final court approval of the Trilateral Agreement and its implementation has
resolved Casualty's exposure with respect to Fibreboard asbestos claims.
Casualty does not anticipate 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
104
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.
NON-INSURANCE
Tobacco Litigation - Lawsuits continue to be 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 for damages
allegedly caused by smoking ("Class Actions"); 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 asbestos manufacturers ("Claims for Contribution"). 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
instance, 15 Class Actions that name Lorillard and/or the Company as defendants
were filed and served during 1996; at least 32 such suits have been filed during
1997. Nineteen Reimbursement Cases were filed by state or local governmental
entities during 1996; at least 29 Reimbursement Cases have been filed by
governmental entities during 1997 as well as suits by five Indian Tribes and 45
suits by unions. 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. In 1997, approximately 450
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. Some cases are scheduled
for trial during 1998.
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
105
"Proposed Resolution"). The Proposed 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. (See "Proposed
Resolution of Certain Regulatory and Litigation Issues" below.)
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 590 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 200 of these cases. The Company is a defendant in
eight 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 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 in which she smoked
them. Plaintiff has filed a motion for new trial, which is pending.
During 1997, juries returned verdicts in favor of the defendants in trials in
two smoking and health cases in which Lorillard was not a party, Connor v. R.J.
Reynolds Tobacco Company (verdict returned May 5, 1997) and Karbiwnyk v. R.J.
Reynolds Tobacco Company (verdict returned October 31, 1997) (both cases were
tried in the Circuit Court of Duval County, Florida). Appeals are not pending in
either case.
CLASS ACTIONS - 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 49 of the 53 cases seeking class certification. The Company is a
defendant in 20 of the purported class actions. Many of 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). On October 10, 1997, the parties to this class
action brought on behalf of flight attendants claiming injury as a result of
exposure to environmental tobacco smoke executed a settlement agreement which
was finally approved by the court on February 3, 1998. 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. 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, but
these individuals may not seek punitive damages for injuries that arose prior to
January 15, 1997 which enabled them to be members of the class. The defendants
that executed the settlement agreement agreed to pay a total of $49.0 as fees
and expenses of the attorneys who represented plaintiffs. Certain of the absent
class members objected to the settlement agreement and some have noticed an
appeal from the February 3, 1998 order.
106
REIMBURSEMENT CASES - Approximately 110 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 19 of them.
State or Local Governmental Reimbursement Cases - To date, suits filed by 40
states, the Commonwealth of Puerto Rico and the Republic of The Marshall Islands
are pending. In addition, cities, counties or other local governmental entities
have filed eight such suits. The Company is a defendant in 15 cases filed by
state or local governmental entities. Since January 1, 1997, cases brought by
Florida, Mississippi and Texas have been settled (see "Settlements of
Reimbursement Cases"). Trial for the case brought by the State of Minnesota
began on January 20, 1998 and is proceeding. Many of the pending Reimbursement
Cases are in the pre-trial, discovery stage.
The governmental entities pursuing the Reimbursement Cases 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.
Private Citizens Reimbursement Cases - There are five suits pending in which
plaintiffs are private citizens. Four of the suits have been filed by private
citizens on behalf of taxpayers of their respective states, although
governmental entities have filed reimbursement suits in two of the four states.
The Company is a defendant in four of the five pending private citizen
reimbursement cases. Lorillard is a defendant in each of the cases. Each of
these cases is in the pre-trial, discovery stage.
Reimbursement Cases by Indian Tribes - Indian Tribes have filed five
reimbursement suits in their tribal courts, one of which 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.
Reimbursement Cases by Labor Unions - Labor unions have filed approximately 45
reimbursement suits in various states in federal or state courts. 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.
CONTRIBUTION CLAIMS - In addition to the foregoing cases, five cases are
pending in which private companies seek recovery of funds expended by them to
individuals whose asbestos disease or illness was alleged to have been caused in
whole or in part by smoking-related illnesses. Lorillard is named as a defendant
in each action. The Company is named as a defendant in two of the cases. Each of
these cases is in the pre-trial, discovery stage.
FILTER CASES - A number of cases have been filed against Lorillard seeking
damages for cancer and other health effects claimed to have resulted from
exposure to asbestos fibers which were incorporated, for a limited period of
time, ending more than forty years ago, into the filter material used in one of
the brands of cigarettes manufactured by Lorillard. Sixteen such cases are
pending in federal and state courts. Allegations of liability 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, which
Lorillard has appealed, requires Lorillard to pay the amount of $.14, although
the award subsequently was reduced to $.07.
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
107
verdict in favor of plaintiffs, which was upheld on appeal. The Company has paid
the compensatory judgment award, trial costs and interest thereon in the amount
of $1.6 on December 30, 1997. The Company has filed a petition for writ of
certiorari to the United States Supreme Court as to the punitive damage award,
which is pending.
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 made by Lorillard and other companies in the tobacco
industry that certain documents sought by plaintiffs are protected from
disclosure by the attorney-client privilege and work product protection. These
challenges include, among other things, allegations that such documents do not
contain legal advice or were not prepared for litigation purposes and, thus, are
not privileged or protected as attorney work product. Certain plaintiffs in
these cases have also alleged that defendants' privileged documents should be
discoverable pursuant to the so-called crime/fraud exception which negates the
privilege as to documents found to have been related to and prepared in
furtherance of an alleged crime or fraud.
Various courts have addressed these issues and have arrived at differing
conclusions as to whether the privilege for some of defendants' documents should
be maintained. Some of these rulings are final and, as a result, certain
documents as to which defendants have claimed a privilege have been released to
plaintiffs.
In addition, on December 5, 1997, certain documents as to which defendants had
claimed privilege were provided to the Chairman of the House Commerce Committee
in response to a subpoena. These documents were subsequently made available on
the Internet. On February 19, 1998, the Committee subpoenaed an additional
approximately 39,000 documents which Lorillard and other companies in the
tobacco industry have asserted to be privileged. These documents are the subject
of a March 7, 1998 ruling in the Reimbursement Case brought by the State of
Minnesota, in which the judge ordered that the documents should be released on
the basis of the crime/fraud exception. Defendants have sought appellate review
of this ruling.
Under the Proposed Resolution discussed below, Lorillard and other companies
in the tobacco industry agreed to establish an industry-funded document
depository to allow public viewing of certain industry documents. In recent
Congressional testimony, representatives of the tobacco companies offered to
make tens of millions of pages of documents public prior to the enactment of any
comprehensive legislation to demonstrate their commitment to the principles set
forth in the Proposed Resolution. On February 27, 1998, Lorillard and other
companies in the tobacco industry posted on the Internet the first installment
of these documents for public access. In addition, the tobacco companies have
asked the court in the Reimbursement Case brought by the State of Minnesota to
grant public access to the Minnesota document depository established in that
case. The publicly available materials will not include documents containing
trade secret information, certain personnel and third party information, or
documents for which attorney-client privilege or work product doctrine claims
have been asserted.
Tobacco industry documents have generated extensive media coverage recently
and have become a focal point in the litigation. The Company cannot predict the
effect disclosure of these documents may have on pending litigation or
Congressional consideration of the Proposed Resolution.
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
108
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
The Proposed Resolution, which can be implemented only by federal legislation,
would resolve many of the issues relating to tobacco litigation.
The Proposed 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 Proposed Resolution. Certain
members of Congress have offered or indicated that they may offer alternative
legislation. Currently, over thirty bills have been introduced in Congress
regarding the issues raised in the Proposed Resolution, including bills seeking
more stringent regulation of the tobacco industry by the Food and Drug
Administration (the "FDA") and bills to increase the federal excise tax on
tobacco products. Several of these bills seek to increase the payments by the
tobacco industry from the levels reflected in the Proposed Resolution and deny
the industry any form of relief from civil litigation. No bill currently
introduced would adopt the Proposed Resolution as agreed to. There can be no
assurance that federal legislation in the form of the Proposed 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 Proposed 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 Proposed Resolution could affect
other federal, state and local regulation of the United States tobacco industry.
The Proposed 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, regulation of tobacco products by 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 Proposed Resolution, industry payments and
litigation.
Industry Payments
The Proposed 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 Proposed 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 (to be
adjusted downward for initial payments made to Florida, Mississippi and Texas
pursuant to settlements, see "Settlements of Reimbursement Cases," discussed
below). Thereafter,
109
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 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 Proposed 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 discussed below.
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 Proposed 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 Proposed 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 Proposed Resolution would require the FDA to impose annual surcharges on
the industry if targeted reductions in underage smoking are not achieved in
accordance with a legislative timetable. The surcharge would be based upon an
approximation of the present value of the profit the companies would earn over
the lives of all underage consumers in excess of the target and would be
allocated among participating manufacturers based on their market share of the
United States cigarette industry.
Effects on Litigation
If enacted, the federal legislation provided for in the Proposed 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. However, the
Proposed 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, and January 16, 1998, together with other companies in the
United States tobacco industry, Lorillard entered into Memoranda of
Understanding with the States of Florida, Mississippi and Texas, respectively,
with respect to those states' health care cost recovery actions. See
"Settlements of Reimbursement Cases" 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
Proposed Resolution. No assurance can be given whether a postponement or
settlement will be achieved, or, if achieved, as to the terms thereof. The
Proposed 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 Proposed 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
110
conduct would be resolved as part of the Proposed 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 Proposed 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 Proposed 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; and (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
Proposed Resolution.
SETTLEMENTS OF REIMBURSEMENT CASES - In furtherance of the Proposed
Resolution, Lorillard and other companies in the United States tobacco industry
(the "Settling Defendants") have settled reimbursement cases brought by the
States of Florida, Mississippi and Texas on terms consistent with the Proposed
Resolution. The Mississippi action was settled in July 1997, Florida was settled
in September 1997 and Texas was settled in January 1998, although final approval
of the Texas settlement has been deferred until March 25, 1998 to enable the
state and certain of its political subdivisions and hospital systems an
opportunity to litigate issues with respect to the scope of the agreement. These
settlements resulted in a pre-tax charge to earnings of $163.4 in 1997.
Under the Mississippi settlement agreement, the Settling Defendants paid $170
representing Mississippi's estimated share of the $10,000 initial payment under
the Proposed Resolution, and paid an additional $15 to reimburse Mississippi and
its private counsel for out-of-pocket costs. The Settling Defendants also paid
approximately $62 to support a pilot program aimed at reducing the use of
tobacco products by persons under the age of eighteen. Lorillard's share of all
the foregoing payments, approximately $19.5, was charged to expense in 1997.
Beginning December 31, 1998, the Settling Defendants will pay Mississippi
amounts based on its anticipated share of the annual industry payments under the
Proposed Resolution. These payments, which (except for the payment with respect
to 1998) will be adjusted as provided in the Proposed Resolution, are estimated
to be $68 with respect to 1998 and will increase annually thereafter to an
estimated $136 by 2003, continuing at that level thereafter, and will be
allocated among the Settling Defendants in accordance with their relative unit
volume of domestic tobacco product sales.
Under the Florida settlement agreement, the Settling Defendants paid $550,
representing Florida's estimated share of the $10,000 initial payment under the
Proposed Resolution, and also reimbursed Florida's expenses and those of its
private counsel. The Settling Defendants also paid $200 to support a pilot
program by Florida aimed at reducing the use of tobacco products by persons
under the age of eighteen. Lorillard's share of all the foregoing payments,
approximately $59.5, was charged to expense in 1997.
On September 15, 1998, and annually thereafter on December 31, the Settling
Defendants will make ongoing payments to Florida in the following estimated
amounts - 1998: $220; 1999: $247.5; 2000: $275; 2001: $357.5; 2002: $357.5; and
each year thereafter $440. These amounts are projected to approximate that
portion of the annual industry payments under the Proposed Resolution which is
contemplated to be paid to Florida. These payments (except for the payment with
respect to 1998) will be adjusted as provided in the Proposed Resolution and
will be allocated among the Settling Defendants in accordance with their
relative unit volume of domestic tobacco product sales.
Under the Texas settlement agreement, the Settling
111
Defendants agreed to pay Texas an up-front payment of $725 in 1998, representing
Texas's estimated share of the $10,000 initial payment under the Proposed
Resolution, and agreed to reimburse Texas and its private counsel for expenses
in the estimated amount of $45. The Settling Defendants also agreed to pay Texas
$264 to support a pilot program aimed at reducing the use of tobacco by persons
under the age of eighteen. Lorillard's share of all of the foregoing payments,
approximately $84.4, was charged to expense in 1997.
Beginning in November and December 1998, and on December 31 of each subsequent
year, the Settling Defendants will pay Texas 7.25% of the annual industry
payments contemplated to be paid to the states under the Proposed Resolution.
These payments, which (except for the payments with respect to 1998) will be
adjusted as provided in the Proposed Resolution, will be in the following
estimated amounts - 1998: $290; 1999: $326; 2000: $363; 2001: $471; 2002: $471;
and 2003 and each year thereafter: $580. These payments will be allocated among
the Settling Defendants in accordance with their relative unit volume of
domestic tobacco product sales.
The Settling Defendants have also agreed to pay reasonable attorneys' fees of
private contingency fee counsel of Florida, Mississippi and Texas as set by a
panel of independent arbitrators. Each of these payments would be allocated
among the Settling Defendants in accordance with their relative unit volume of
domestic tobacco product sales and will be subject to an aggregate national
annual cap of $500. Certain of Florida's private contingency fee counsel have
challenged the attorney's fees provision set forth in the Florida settlement
agreement, arguing that the settlement agreement has no effect on their rights
under their contingency fee agreement with Florida. In November 1997, the court
ordered all parties to comply with the provisions for obtaining attorneys' fees,
as set forth in the settlement agreement. Certain contingency fee counsel are
appealing this ruling. One of these contingency fee counsel has filed suit
against certain companies in the tobacco industry, although not Lorillard,
alleging, among other things, tortious interference with such counsel's
contingency fee agreement with the State.
If legislation implementing the Proposed Resolution or its substantial
equivalent is enacted, the settlements will remain in place, but the terms of
the federal legislation will supercede the settlement agreements (except for the
terms of the pilot programs and payments thereunder, the initial payments and
the annual payments with respect to 1998), and the other payments described
above will be adjusted so that Florida, Mississippi and Texas will receive the
same payments as they would receive under such legislation.
If the Settling Defendants enter into any future pre-verdict settlement
agreement with a non-federal governmental plaintiff on more favorable terms
(after due consideration of relevant differences in population or other
appropriate factors), Florida, Mississippi and Texas will obtain treatment at
least as relatively favorable as such governmental plaintiff.
If federal legislation implementing the Proposed Resolution or its substantial
equivalent is enacted, the parties contemplate that Florida, Mississippi and
Texas and any other state that has made an exceptional contribution to secure
resolution of these matters may apply to a panel of independent arbitrators for
reasonable compensation for its efforts in securing the Proposed Resolution. The
Settling Defendants have agreed not to oppose applications for $75 by
Mississippi, $250 by Florida and $329.5 by Texas, subject to a nationwide annual
cap for all such payments of $100.
Finally, the settlement agreements provide that they are not an admission or
concession or evidence of any liability or wrongdoing on the part of any party,
and were entered into by the Settling Defendants solely to avoid the further
expense, inconvenience, burden and uncertainty of litigation.
* * * *
While Lorillard intends to defend vigorously all smoking and health related
litigation which may be brought against it, it is not possible to predict the
outcome of any of this litigation. Litigation is subject to many uncertainties,
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 including the release of
documents by the industry. 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.
112
Except for the effect of the Proposed 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.
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.
Note 19. Business Segments -
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property, casualty and life insurance (CNA
Financial Corporation, an 84% owned subsidiary, "CNA"); the production and sale
of cigarettes (Lorillard, Inc., a wholly owned subsidiary, "Lorillard"); the
operation of hotels (Loews Hotels Holding Corporation, a wholly owned
subsidiary, "Loews Hotels"); the operation of offshore oil and gas drilling rigs
(Diamond Offshore Drilling, Inc., a 50.3% owned subsidiary, "Diamond Offshore");
and the distribution and sale of watches and clocks (Bulova Corporation, a 97%
owned subsidiary, "Bulova").
As multiple-line insurers, CNA's insurance operations underwrite property,
casualty, life, and accident and health coverages in the United States. Foreign
operations are not significant. Insurance products are marketed by CNA through
independent agents and brokers.
Lorillard's principal products are marketed under the brand names of Newport,
Kent and True with substantially all of its sales in the United States.
Loews Hotels owns and/or operates 14 hotels, 11 of which are in the United
States, two are in Canada and one is located in Monte Carlo.
Diamond Offshore's business primarily consists of operating 46 offshore
drilling rigs that are chartered on a contract basis for fixed terms by
companies engaged in exploration and production of hydrocarbons. Offshore rigs
are mobile units that can be relocated based on market demand. Currently 65% of
these rigs operate in the Gulf of Mexico, 11% operate in the North Sea and the
remaining 24% are located in various foreign markets.
Bulova distributes and sells watches and clocks under the brand names of
Bulova, Caravelle and Accutron with substantially all of its sales in the United
States and Canada. All watches and clocks are purchased from foreign suppliers.
The following table sets forth the major sources of the Company's consolidated
revenues, income and assets.
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues (a):
Property and casualty insurance $12,943.1 $12,990.4 $11,092.1
Life insurance (b) 4,131.7 4,043.8 3,617.0
Cigarettes 2,416.8 2,239.1 2,081.1
Hotels 222.5 200.6 218.0
Offshore drilling 977.5 648.1 339.5
Watches and clocks 128.9 120.8 109.5
Investment (loss) income-net (c) (681.8) 215.3 1,228.1
Other and eliminations-net .1 (15.7) (7.9)
- --------------------------------------------------------------------------------
Total $20,138.8 $20,442.4 $18,677.4
================================================================================
113
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Income contribution (a)(d):
Property and casualty insurance $ 1,287.5 $ 1,287.1 $ 953.6
Life insurance 313.5 327.7 330.8
Cigarettes (e) 578.4 744.0 662.3
Hotels 39.4 22.0 32.3
Offshore drilling 440.3 215.1 13.9
Watches and clocks 17.4 12.4 8.2
Investment income-net (c) (688.3) 209.6 1,224.9
Other 1.4 4.0 4.9
- --------------------------------------------------------------------------------
Total $ 1,989.6 $ 2,821.9 $ 3,230.9
================================================================================
Net income (a):
Property and casualty insurance $ 709.8 $ 700.4 $ 530.1
Life insurance 167.2 174.9 163.2
Cigarettes (e) 363.1 444.4 385.0
Hotels 18.8 6.9 16.8
Offshore drilling 130.9 52.1 (8.7)
Watches and clocks 9.7 6.8 2.8
Investment income-net (c) (447.7) 137.2 792.1
Corporate interest expense (71.8) (72.2) (64.5)
Corporate expense and other-net (86.4) (66.6) (51.1)
- --------------------------------------------------------------------------------
Total $ 793.6 $ 1,383.9 $ 1,765.7
================================================================================
Identifiable assets:
Property and casualty insurance $46,398.2 $46,719.6 $47,108.3
Life insurance 14,736.9 14,040.5 13,101.4
Cigarettes 1,312.1 899.6 882.3
Hotels 216.5 231.2 214.2
Offshore drilling 2,293.9 1,574.5 618.1
Watches and clocks 155.2 148.6 134.1
Investment income 4,584.3 4,408.7 3,551.8
Corporate 112.1 31.0 19.8
Other and eliminations-net (232.1) (650.8) (113.1)
- --------------------------------------------------------------------------------
Total $69,577.1 $67,402.9 $65,516.9
================================================================================
</TABLE>
114
(a) Investment (losses) gains included in Revenues, Income contribution and Net
income are as follows:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Property and casualty insurance $ 592.5 $473.6 $ 320.6
Life insurance 163.6 163.6 139.2
Investment income-net (869.7) 39.3 1,118.2
- --------------------------------------------------------------------------------
Total $(113.6) $676.5 $1,578.0
================================================================================
Income contribution:
Property and casualty insurance $ 592.5 $473.6 $ 320.6
Life insurance 149.0 149.3 131.4
Investment income-net (869.7) 39.3 1,118.2
- --------------------------------------------------------------------------------
Total $(128.2) $662.2 $1,570.2
================================================================================
Net income:
Property and casualty insurance $ 323.6 $255.6 $ 174.8
Life insurance 81.4 80.5 71.9
Investment income-net (564.9) 27.5 725.2
- --------------------------------------------------------------------------------
Total $(159.9) $363.6 $ 971.9
================================================================================
(b) Includes $2,100.0, $2,100.0 and $1,900.0 under contracts covering U.S.
government employees and their dependents for the respective periods.
(c) Consists of investment income of non-insurance operations. Investment
income of insurance operations is included in the Revenues, Income
contribution and Net income of the related insurance operations.
(d) Consists of income before minority interest and allocation for financial
reporting purposes of interest expense, corporate expense and income taxes.
(e) Includes pre-tax and after tax charges related to the settlements of
tobacco litigation of $198.8 and $122.0, respectively, for the year ended
December 31, 1997.
115
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Information called for by Part III has been omitted as Registrant intends to
file with the Securities and Exchange Commission not later than 120 days after
the close of its fiscal year a definitive Proxy Statement pursuant to regulation
14A.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial Statements:
The financial statements appear above under Item 8. The following additional
financial data should be read in conjunction with those financial statements.
Schedules not included with these additional financial data have been omitted
because they are not applicable or the required information is shown in the
consolidated financial statements or notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
Page
2. Financial Statement Schedules: Number
------
<S> <C>
Independent Auditors' Report ......................................... L-1
Loews Corporation and Subsidiaries:
Schedule I-Condensed financial information of Registrant for the
years ended December 31, 1997, 1996 and 1995 ...................... L-2
Schedule II-Valuation and qualifying accounts for the years ended
December 31, 1997, 1996 and 1995 .................................. L-6
Schedule V-Supplemental information concerning property/casualty
insurance operations for the years ended December 31, 1997, 1996
and 1995 .......................................................... L-7
3. Exhibits:
<CAPTION>
Exhibit
Description Number
----------- -------
<S> <C>
(2) Plan of acquisition, reorganization, arrangement, liquidation
or succession
Merger Agreement, dated as of December 6, 1994, by and among
CNA Financial Corporation, Chicago Acquisition Corp. and The
Continental Corporation is incorporated herein by reference to
Exhibit 2 to CNA Financial Corporation's (Commission File Number
1-5823) Report on Form 8-K filed December 9, 1994 ............... 2.01
(3) Articles of Incorporation and By-Laws
Restated Certificate of Incorporation of the Registrant,
incorporated herein by reference to Exhibit 3 to Registrant's
Report on Form 10-Q for the quarter ended June 30, 1996 ......... 3.01
By-Laws of the Registrant as amended to date, incorporated herein
by reference to Exhibit 3.01 to Registrant's Report on Form 10-Q
for the quarter ended June 30, 1997 ............................. 3.02
116
<CAPTION>
Exhibit
Description Number
----------- -------
<S> <C>
(4) Instruments Defining the Rights of Security Holders, Including
Indentures
The Registrant hereby agrees to furnish to the Commission upon
request copies of instruments with respect to long-term debt,
pursuant to Item 601(b)(4)(iii) of Regulation S-K.
(10) Material Contracts
Employment Agreement between Registrant and Laurence A. Tisch
dated March 1, 1971 as amended through February 20, 1996 is
incorporated herein by reference to Exhibit 10.01 to Registrant's
Reports on Form 10-K for the years ended December 31, 1981,
1983, 1984, 1985, 1986, 1988, 1989, 1992, 1994 and 1995 ......... 10.01
Employment Agreement dated as of March 1, 1988 between Registrant
and Preston R. Tisch as amended through February 20, 1996 is
incorporated herein by reference to Exhibit 10.05 to Registrant's
Report on Form 10-K for the years ended December 31, 1987,
1989 and 1992 and to Exhibit 10.02 to Registrant's Report on Form
10-K for the year ended December 31, 1994 and 1995 .............. 10.02
Continuing Service Agreement between a subsidiary of Registrant
and Edward J. Noha, dated February 27, 1991 incorporated herein
by reference to Exhibit 10.04 to Registrant's Report on Form 10-K
for the year ended December 31, 1990 ............................ 10.03
Loews Corporation Benefits Equalization Plan as amended and
restated as of December 31, 1996 is incorporated herein by
reference to Exhibit 10.04 to Registrant's Report on Form 10-K
for the year ended December 31, 1996 ............................ 10.04
Loews Corporation Deferred Compensation Plan as amended and
restated as of December 31, 1995 is incorporated herein by
reference to Exhibit 10.05 to Registrant's Report on Form 10-K
for the year ended December 31, 1996 ............................ 10.05
Agreement between Fibreboard Corporation and Continental Casualty
Company, dated April 9, 1993 is incorporated herein by reference
to Exhibit A to Registrant's Report on Form 8-K filed April 12,
1993 ............................................................ 10.06
Settlement Agreement entered into on October 12, 1993 by and
among Fibreboard Corporation, Continental Casualty Company, CNA
Casualty Company of California, Columbia Casualty Company and
Pacific Indemnity Company is incorporated herein by reference to
Exhibit 99.1 to Registrant's Report on Form 10-Q for the quarter
ended September 30, 1993 ........................................ 10.07
Continental-Pacific Agreement entered into on October 12, 1993
between Continental Casualty Company and Pacific Indemnity
Company is incorporated herein by reference to Exhibit 99.2 to
Registrant's Report on Form 10-Q for the quarter ended September
30, 1993 ........................................................ 10.08
Global Settlement Agreement among Fibreboard Corporation,
Continental Casualty Company, CNA Casualty Company of California,
Columbia Casualty Company, Pacific Indemnity Company and the
Settlement Class dated December 23, 1993 is incorporated herein
by reference to Exhibit 10.09 to Registrant's Report on Form 10-K
for the year ended December 31, 1993 ............................ 10.09
117
<CAPTION>
Exhibit
Description Number
----------- -------
<S> <C>
Glossary of Terms in Global Settlement Agreement, Trust
Agreement, Trust Distribution Process and Defendant Class
Settlement Agreement dated December 23, 1993 is incorporated
herein by reference to Exhibit 10.10 to Registrant's Report on
Form 10-K for the year ended December 31, 1993 .................. 10.10
Fibreboard Asbestos Corporation Trust Agreement dated December
23, 1993 is incorporated herein by reference to Exhibit 10.11 to
Registrant's Report on Form 10-K for the year ended December 31,
1993 ............................................................ 10.11
Trust Distribution Process - Annex A to the Trust Agreement dated
December 23, 1993 is incorporated herein by reference to Exhibit
10.12 to Registrant's Report on Form 10-K for the year ended
December 31, 1993 ............................................... 10.12
Defendant Class Settlement Agreement dated December 23, 1993 is
incorporated herein by reference to Exhibit 10.13 to Registrant's
Report on Form 10-K for the year ended December 31, 1993 ........ 10.13
Escrow Agreement among Continental Casualty Company, Pacific
Indemnity Company and the First National Bank of Chicago dated
December 23, 1993 is incorporated herein by reference to Exhibit
10.14 to Registrant's Report on Form 10-K for the year ended
December 31, 1993 ............................................... 10.14
Incentive Compensation Plan incorporated herein by reference to
Exhibit 10.15 to Registrant's Report on Form 10-K for the year
ended December 31, 1996 ......................................... 10.15
Memorandum of Understanding related to proposed resolution of
certain regulatory and litigation issues affecting the United
States tobacco industry incorporated herein by reference to
Exhibit 10 to Registrant's Report on Form 8-K filed June 24, 1997 10.16
(21) Subsidiaries of the Registrant
List of subsidiaries of Registrant .............................. 21.01*
(27) Financial Data Schedule ......................................... 27.01*
</TABLE>
* Filed herewith
(b) Reports on Form 8-K:
There were no reports filed for the three months ended December 31, 1997.
118
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Dated: March 30, 1998 By /s/ Peter W. Keegan
---------------------------------
(Peter W. Keegan, Senior Vice
President and Chief Financial
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: March 30, 1998 By /s/ Laurence A. Tisch
---------------------------------
(Laurence A. Tisch, Co-Chairman
of the Board and Principal
Executive Officer)
Dated: March 30, 1998 By /s/ Peter W. Keegan
---------------------------------
(Peter W. Keegan, Senior Vice
President and Chief Financial
Officer)
Dated: March 30, 1998 By /s/ Guy A. Kwan
---------------------------------
(Guy A. Kwan, Controller)
Dated: March 30, 1998 By /s/ Charles B. Benenson
---------------------------------
(Charles B. Benenson, Director)
Dated: March 30, 1998 By /s/ John Brademas
---------------------------------
(John Brademas, Director)
Dated: March 30, 1998 By /s/ Dennis H. Chookaszian
---------------------------------
(Dennis H. Chookaszian, Director)
Dated: March 30, 1998 By /s/ Paul Fribourg
---------------------------------
(Paul Fribourg, Director)
By
---------------------------------
(Bernard Myerson, Director)
119
Dated: March 30, 1998 By /s/ Edward J. Noha
---------------------------------
(Edward J. Noha, Director)
Dated: March 30, 1998 By /s/ Gloria R. Scott
---------------------------------
(Gloria R. Scott, Director)
Dated: March 30, 1998 By /s/ Andrew H. Tisch
---------------------------------
(Andrew H. Tisch, Director)
Dated: March 30, 1998 By /s/ James S. Tisch
---------------------------------
(James S. Tisch, Director)
Dated: March 30, 1998 By /s/ Jonathan M. Tisch
---------------------------------
(Jonathan M. Tisch, Director)
Dated: March 30, 1998 By /s/ Preston R. Tisch
---------------------------------
(Preston R. Tisch, Director)
120
INDEPENDENT AUDITORS' REPORT
The Board of Directors and
Shareholders of Loews Corporation:
We have audited the accompanying consolidated balance sheets of Loews
Corporation and its subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1997. Our audits
also included the financial statement schedules listed in the Index at Item
14(a)2. These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedules based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Loews Corporation and its
subsidiaries at December 31, 1997 and 1996 and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles. Also, in
our opinion, such financial statement schedules, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly in
all material respects the information set forth therein.
Deloitte & Touche LLP
New York, New York
February 18, 1998
L-1
SCHEDULE I
Condensed Financial Information of Registrant
LOEWS CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
(In millions)
<S> <C> <C>
Current assets, principally investment in U.S.
government securities ............................. $ 4,251.6 $ 4,140.8
Investments in securities .......................... 351.7 283.4
Investments in capital stocks of subsidiaries, at
equity ............................................ 8,441.1 6,908.1
Other assets ....................................... 161.0 73.2
- --------------------------------------------------------------------------------
Total assets .................................. $13,205.4 $11,405.5
================================================================================
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Accounts payable and accrued liabilities ........... $ 1,071.5 $ 618.4
Current maturities of long-term debt ............... 117.8 200.0
Securities sold under agreements to repurchase ..... 447.8
Long-term debt, less current maturities (a) ........ 2,284.0 1,271.6
Deferred income tax ................................ 67.0 136.5
- --------------------------------------------------------------------------------
Total liabilities ............................. 3,540.3 2,674.3
Shareholders' equity ............................... 9,665.1 8,731.2
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity .... $13,205.4 $11,405.5
================================================================================
</TABLE>
L-2
SCHEDULE I
(Continued)
Condensed Financial Information of Registrant
LOEWS CORPORATION
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(In millions)
<S> <C> <C> <C>
Revenues:
Equity in income of subsidiaries (c) . $1,329.9 $1,324.0 $1,442.4
Investment (losses) gains ............ (866.2) 57.9 535.9
Interest and other ................... 199.2 177.9 102.5
- --------------------------------------------------------------------------------
Total ............................. 662.9 1,559.8 2,080.8
- --------------------------------------------------------------------------------
Expenses:
Administrative ....................... 34.9 38.1 12.6
Interest ............................. 109.4 109.9 97.8
- --------------------------------------------------------------------------------
Total ............................. 144.3 148.0 110.4
- --------------------------------------------------------------------------------
518.6 1,411.8 1,970.4
Income tax benefit (expense) (b) ....... 275.0 (27.9) (204.7)
- --------------------------------------------------------------------------------
Net income ............................. $ 793.6 $1,383.9 $1,765.7
================================================================================
</TABLE>
L-3
SCHEDULE I
(Continued)
Condensed Financial Information of Registrant
LOEWS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(In millions)
<S> <C> <C> <C>
Operating Activities:
Net income ............................ $ 793.6 $ 1,383.9 $ 1,765.7
Adjustments to reconcile net income to
net cash provided by operating
activities:
Undistributed earnings of affiliates. (1,225.9) (879.9) (327.6)
Investment losses (gains) ........... 866.2 (57.9) (535.9)
Changes in assets and liabilities-net:
Receivables ......................... (7.0) (107.5) 174.3
Accounts payable and accrued
liabilities ........................ (12.2) 19.7 (37.8)
Federal income taxes ................ 37.7 (75.4) 226.8
Investments classified as trading
securities ......................... (682.4) (247.2)
Other-net ........................... (72.4) 70.7 86.3
- --------------------------------------------------------------------------------
(302.4) 106.4 1,351.8
- --------------------------------------------------------------------------------
Investing Activities:
Purchases of securities ............... (395.4)
Proceeds from sales of securities ..... 1,031.1
Investments in and advances to
subsidiaries-net ..................... (104.7) (30.8) 557.5
Net increase in short-term investments,
primarily U.S. government securities . 53.7 (482.5) (393.6)
Securities sold under agreements to
repurchase ........................... (447.8) 447.8 (2,092.9)
Change in other investments ........... (7.8) (1.0) (2.2)
- --------------------------------------------------------------------------------
(506.6) (66.5) (1,295.5)
- --------------------------------------------------------------------------------
Financing Activities:
Dividends paid to shareholders ........ (115.0) (116.2) (73.8)
Purchases of treasury shares .......... (215.7) (6.0)
Principal payments on long-term debt .. (200.0)
Issuance of long-term debt ............ 1,129.3 298.2
- --------------------------------------------------------------------------------
814.3 (33.7) (79.8)
- --------------------------------------------------------------------------------
Net change in cash ...................... 5.3 6.2 (23.5)
Cash, beginning of year ................. 7.8 1.6 25.1
- --------------------------------------------------------------------------------
Cash, end of year ....................... $ 13.1 $ 7.8 $ 1.6
================================================================================
</TABLE>
L-4
SCHEDULE I
(Continued)
Condensed Financial Information of Registrant
- --------------
Notes:
(a) Long-term debt consisted of:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
8.5% notes due 1998 (effective interest rate
of 8.6%) (authorized, $125) ................ $ 117.8 $ 117.8
6.8% notes due 2006 (effective interest rate
of 6.8%) (authorized, $300) ................ 300.0 300.0
3.1% exchangeable subordinated notes due 2007
(effective interest rate of 3.4%)
(authorized $1,150) (1) .................... 1,150.0
8.9% debentures due 2011 (effective interest
rate of 9.0%) (authorized, $175) ........... 175.0 175.0
7.6% notes due 2023 (effective interest rate
of 7.8%) (authorized, $300) (2) ............ 300.0 300.0
7% notes due 2023 (effective interest rate of
7.2%) (authorized, $400) (3) ............... 400.0 400.0
8.3% debentures due 2007 .................... 200.0
- --------------------------------------------------------------------------------
2,442.8 1,492.8
Less unamortized discount ................... 41.0 21.2
current maturities ..................... 117.8 200.0
- --------------------------------------------------------------------------------
$2,284.0 $1,271.6
================================================================================
(1) Redeemable in whole or in part at September 15, 2002 at 101.6%, and
decreasing percentages thereafter. The notes are exchangeable into
15.376 shares of Diamond Offshore's common stock per $1,000 principal
amount of notes, at a price of $65.04 per share.
(2) Redeemable in whole or in part at June 1, 2003 at 103.8%, and
decreasing percentages thereafter.
(3) Redeemable in whole or in part at October 15, 2003 at 102.4%, and
decreasing percentages thereafter.
</TABLE>
The aggregate of long-term debt maturing in the next five years is $117.8 for
the year ending December 31, 1998.
(b) The Company is included in a consolidated federal income tax return with
certain of its subsidiaries and, accordingly, participates in the allocation of
certain components of the consolidated provision for federal income taxes. Such
taxes are generally allocated on a separate return bases.
The Company has entered into separate tax allocation agreements with Bulova
and CNA, majority-owned subsidiaries in which its ownership exceeds 80% (the
"Subsidiaries"). Each agreement provides that the Company will (i) pay to the
Subsidiary the amount, if any, by which the Company's consolidated federal
income tax is reduced by virtue of inclusion of the Subsidiary in the Company's
return, or (ii) be paid by the Subsidiary an amount, if any, equal to the
federal income tax which would have been payable by the Subsidiary if it had
filed a separate consolidated return. Under these agreements, CNA will pay or
has paid Loews approximately $210.0 and $99.0 for 1997 and 1996, and received
from Loews approximately $78.0 for the year 1995. The federal income tax to be
received from Bulova amounted to approximately $2.6, $5.3 for 1997 and 1996 and
Bulova has received approximately $2.1 for the year 1995. Each agreement may be
canceled by either of the parties upon thirty days' written notice. See Note 10
of the Notes to Consolidated Financial Statements of Loews Corporation and
subsidiaries included in Item 8.
(c) Cash dividends paid to the Company by affiliates amounted to $113.2, $445.4
and $1,085.7 for the years ended December 31, 1997, 1996 and 1995, respectively.
L-5
SCHEDULE II
LOEWS CORPORATION AND SUBSIDIARIES
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
----------------------
Balance at Charged to Charged Balance at
Beginning Costs and to Other End of
Description of Period Expenses Accounts Deductions Period
- --------------------------------------------------------------------------------
(In millions)
<CAPTION>
For the Year Ended December 31, 1997
<S> <C> <C> <C> <C>
Deducted from assets:
Allowance for
discounts ......... $ 1.4 $ 93.0 $ 93.0 $ 1.4
Allowance for
doubtful accounts 290.0 30.6 4.0 316.6
------------------------------------------------------
Total .......... $ 291.4 $123.6 $ 97.0 $318.0
======================================================
<CAPTION>
For the Year Ended December 31, 1996
<S> <C> <C> <C> <C> <C>
Deducted from assets:
Allowance for
discounts ......... $ 2.0 $ 84.0 $ 84.6(1) $ 1.4
Allowance for
doubtful accounts 301.0 36.4 47.4 290.0
------------------------------------------------------
Total .......... $ 303.0 $120.4 $132.0 $291.4
======================================================
<CAPTION>
For the Year Ended December 31, 1995
<S> <C> <C> <C> <C> <C>
Deducted from assets:
Allowance for
discounts ......... $ 2.0 $ 78.0 $ 78.0(1) $ 2.0
Allowance for
doubtful accounts 138.0 41.0 $143.5(2) 21.5 301.0
------------------------------------------------------
Total .......... $ 140.0 $119.0 $143.5 $ 99.5 $303.0
======================================================
- -----------
Notes: (1) Discounts allowed.
(2) Includes CIC allowance at acquisition.
</TABLE>
L-6
SCHEDULE V
LOEWS CORPORATION AND SUBSIDIARIES
Supplemental Information Concerning Property/Casualty Insurance Operations
<TABLE>
<CAPTION>
Consolidated Property/Casualty Entities
- --------------------------------------------------------------------------------
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
(In millions)
<S> <C> <C> <C>
Deferred policy acquisition costs .... $ 1,162 $ 1,084 $ 969
Reserves for unpaid claim and claim
expenses ............................ 28,240 29,830 31,044
Discount deducted from claims and
claim expenses reserves above(based
on interest rates ranging from
3.5% to 7.5%) ....................... 2,409 2,459 2,449
Unearned premiums .................... 4,700 4,659 4,549
Earned premiums ...................... 9,927 10,127 8,725
Net investment income ................ 1,790 1,881 1,699
Claim and claim expenses related to
current year ........................ 7,942 7,922 6,787
Claim and claim expenses related to
prior years ......................... (256) (91) 122
Amortization of deferred policy
acquisition costs ................... 2,262 2,179 1,783
Paid claim and claim expenses ........ 8,376 9,200 7,057
Premiums written ..................... 10,186 10,611 9,126
L-7
</TABLE>
Exhibit 21.01
LOEWS CORPORATION
Subsidiaries of the Registrant
December 31, 1997
<TABLE>
<CAPTION>
Organized Under
Name of Subsidiary Laws of Business Names
------------------ --------------- ----------------
<S> <C> <C>
CNA Financial Corporation ............. Delaware )
Continental Casualty Company ......... Illinois )
Continental Assurance Company ....... Illinois )
National Fire Insurance Company of )
Hartford ........................... Connecticut )
American Casualty Company of )
Reading, Pennsylvania .............. Pennsylvania ) CNA Insurance
CNA Management Company Limited ...... Great Britain )
CNA Surety Corporation .............. Delaware )
The Continental Corporation .......... New York )
The Buckeye Union Insurance Company . Ohio )
Firemen's Insurance Company of )
Newark, New Jersey ................. New Jersey )
The Continental Insurance Company ... New Hampshire )
Lorillard, Inc. ....................... New York )
Lorillard Tobacco Company ............ Delaware ) Lorillard
Vegan Development Corp. .............. Nevada )
Diamond Offshore Drilling, Inc. ....... Delaware Diamond Offshore
</TABLE>
The names of certain subsidiaries which, if considered as a single subsidiary,
would not constitute a "significant subsidiary" as defined in Regulation S-X,
have been omitted.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 497,800
<SECURITIES> 40,640,700
<RECEIVABLES> 13,643,900
<ALLOWANCES> 318,000
<INVENTORY> 298,400
<CURRENT-ASSETS> 0
<PP&E> 3,856,600
<DEPRECIATION> 1,266,400
<TOTAL-ASSETS> 69,577,100
<CURRENT-LIABILITIES> 0
<BONDS> 5,752,600
0
0
<COMMON> 115,000
<OTHER-SE> 9,550,100
<TOTAL-LIABILITY-AND-EQUITY> 69,577,100
<SALES> 2,514,400
<TOTAL-REVENUES> 20,138,800
<CGS> 1,024,500
<TOTAL-COSTS> 14,676,200
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 323,400
<INCOME-PRETAX> 1,593,200
<INCOME-TAX> 495,300
<INCOME-CONTINUING> 793,600
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 793,600
<EPS-PRIMARY> 6.90
<EPS-DILUTED> 0
</TABLE>
