LOEWS CORP, 10-Q, 1998-08-14

LOEWS CORP
10-Q, 1998-08-14
FIRE, MARINE & CASUALTY INSURANCE

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===============================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 1998
-------------

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

For the transition period from to
------------- -------------

Commission file number 1-6541
------

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

Delaware 13-2646102
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)

667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087
----------------------------------------------------
(Address of principal executive offices) (Zip Code)

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

NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)

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

Yes X No
--------- ---------

Class Outstanding at August 7, 1998
- -------------------------- ------------------------------
Common stock, $1 par value 114,711,400 shares

===============================================================================

Page 1

INDEX

Part I. Financial Information Page No.
--------
Item 1. Financial Statements

Consolidated Condensed Balance Sheets--
June 30, 1998 and December 31, 1997 ........................... 3

Consolidated Condensed Statements of Income--
Three and six months ended June 30, 1998 and 1997 ............. 4

Consolidated Condensed Statements of Cash Flows--
Six months ended June 30, 1998 and 1997 ....................... 5

Notes to Consolidated Condensed Financial Statements ............ 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 37

Item 3. Quantitative and Qualitative Disclosures about Market Risk 53

Part II. Other Information

Item 1. Legal Proceedings ......................................... 57

Item 4. Submission of Matters to a Vote of Security Holders ....... 57

Item 6. Exhibits and Reports on Form 8-K .......................... 59

Page 2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.
--------------------

<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
- -------------------------------------------------------------------------------
(Amounts in millions) June 30, December 31,
1998 1997
-----------------------------
<S> <C> <C>
Assets:

Investments:
Fixed maturities, amortized cost of $30,467.5
and $30,201.6 ................................ $31,010.1 $30,723.2
Equity securities, cost of $1,480.7 and
$1,102.6 ..................................... 1,600.4 1,163.3
Other investments ............................. 1,206.9 978.4
Short-term investments ........................ 7,609.5 8,754.2
----------------------------
Total investments .......................... 41,426.9 41,619.1
Cash ............................................ 186.3 497.8
Receivables-net ................................. 15,686.5 13,325.9
Property, plant and equipment-net ............... 2,620.0 2,590.2
Deferred income taxes ........................... 882.6 944.3
Goodwill and other intangible assets-net ........ 756.7 751.4
Other assets .................................... 1,825.3 1,895.1
Deferred policy acquisition costs of insurance
subsidiaries ................................... 2,379.4 2,141.7
Separate Account business ....................... 5,582.0 5,811.6
----------------------------
Total assets ............................... $71,345.7 $69,577.1
============================

Liabilities and Shareholders' Equity:

Insurance reserves and claims ................... $40,621.1 $39,497.4
Payable to brokers .............................. 2,151.4 1,559.2
Securities sold under repurchase agreements ..... 302.7 152.7
Long-term debt, less unamortized discount ....... 5,696.3 5,752.6
Other liabilities ............................... 4,636.1 4,749.1
Separate Account business ....................... 5,582.0 5,811.6
----------------------------
Total liabilities .......................... 58,989.6 57,522.6
Minority interest ............................... 2,553.1 2,389.4
Shareholders' equity ............................ 9,803.0 9,665.1
----------------------------
Total liabilities and shareholders' equity . $71,345.7 $69,577.1
============================

See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>

Page 3

<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Income
- -------------------------------------------------------------------------------------------------
(Amounts in millions, except per share data) Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
---------------------------------------------------

<S> <C> <C> <C> <C>
Revenues:

Insurance premiums:
Property and casualty ................. $2,665.9 $2,529.4 $ 5,192.9 $4,999.9
Life .................................. 800.1 817.5 1,640.1 1,692.5
Investment income, net of expenses ...... 621.9 604.3 1,252.5 1,219.8
Investment gains (losses) ............... 25.6 (295.4) (325.0) (266.6)
Manufactured products (including excise
taxes of $127.7, $124.3, $236.7 and
$234.4) ................................ 724.3 625.5 1,321.0 1,166.6
Other ................................... 567.0 467.8 1,118.4 876.0
--------------------------------------------------
Total ................................ 5,404.8 4,749.1 10,199.9 9,688.2
--------------------------------------------------

Expenses:

Insurance claims and policyholders'
benefits ............................... 2,937.4 2,860.1 5,787.2 5,752.5
Amortization of deferred policy
acquisition costs ...................... 670.5 595.9 1,258.8 1,116.2
Cost of manufactured products sold ...... 262.0 260.9 496.6 498.1
Selling, operating, advertising and
administrative expenses ................ 917.8 750.8 1,973.8 1,542.1
Interest ................................ 99.2 76.3 193.0 151.1
--------------------------------------------------
Total ................................ 4,886.9 4,544.0 9,709.4 9,060.0
--------------------------------------------------
517.9 205.1 490.5 628.2
--------------------------------------------------
Income tax expense ...................... 168.8 69.7 147.1 196.1
Minority interest ....................... 101.9 71.6 179.9 129.0
--------------------------------------------------
Total ................................ 270.7 141.3 327.0 325.1
--------------------------------------------------
Net income ................................ $ 247.2 $ 63.8 $ 163.5 $ 303.1
==================================================

Net income per share ...................... $ 2.15 $ .55 $ 1.42 $ 2.63
==================================================

Cash dividends per share .................. $ .25 $ .25 $ .50 $ .50
==================================================

Weighted average number of shares
outstanding .............................. 115.0 115.0 115.0 115.0
==================================================

See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>

Page 4

<TABLE>
<CAPTION>
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
- -------------------------------------------------------------------------------
(Amounts in millions) Six Months Ended June 30,
1998 1997
----------------------------
<S> <C> <C>
Operating Activities:
Net income .................................... $ 163.5 $ 303.1
Adjustments to reconcile net income to net
cash used by operating activities-net ........ 610.8 518.4
Changes in assets and liabilities-net:
Reinsurance receivable ...................... (306.9) 366.2
Other receivables ........................... (1,438.0) (475.8)
Deferred policy acquisition costs ........... (237.7) (268.7)
Insurance reserves and claims ............... 1,133.3 563.7
Other liabilities ........................... 99.3 (1,099.9)
Trading securities .......................... (822.5) (364.5)
Other-net ................................... 108.2 (75.7)
--------------------------
(690.0) (533.2)
--------------------------
Investing Activities:
Purchases of fixed maturities ................. (26,622.9) (19,476.5)
Proceeds from sales of fixed maturities ....... 25,623.2 20,419.1
Proceeds from maturities of fixed maturities .. 1,042.8 1,105.4
Change in securities sold under repurchase
agreements ................................... 150.0 1,070.3
Purchases of equity securities ................ (457.5) (563.9)
Proceeds from sales of equity securities ...... 342.8 781.5
Change in short-term investments .............. 896.6 (2,330.2)
Purchases of property, plant and equipment .... (211.8) (399.8)
Change in other investments ................... (259.4) 46.3
--------------------------
503.8 652.2
--------------------------
Financing Activities:
Dividends paid to shareholders ................ (57.5) (57.5)
Issuance of long-term debt .................... 1,005.1 395.3
Principal payments on long-term debt .......... (1,063.3) (204.1)
Net change in revolving line of credit ........ (63.0)
Net change in short-term debt ................. (10.0)
Receipts credited to policyholders ............ 6.9 4.3
Withdrawals of policyholder account balances .. (16.5) (11.5)
---------------------------
(125.3) 53.5
---------------------------
Net change in cash .............................. (311.5) 172.5
Cash, beginning of period ....................... 497.8 305.7
---------------------------
Cash, end of period ............................. $ 186.3 $ 478.2
===========================

See accompanying Notes to Consolidated Condensed Financial Statements.
</TABLE>

Page 5

Loews Corporation and Subsidiaries
Notes to Consolidated Condensed Financial Statements
- -------------------------------------------------------------------------------
(Dollars in millions, except per share data)

1. General:

Reference is made to Notes to Consolidated Financial Statements in the 1997
Annual Report to Shareholders which should be read in conjunction with
these consolidated condensed financial statements.

Comprehensive income

Comprehensive income includes all changes to shareholders' equity,
including net income (loss), except those resulting from investments by,
and distributions to, owners. For the three and six months ended June 30,
1998 and 1997, comprehensive income totaled $302.3, $281.5, $195.4 and
$194.1 respectively. Comprehensive income includes net income, unrealized
appreciation (depreciation) and foreign currency translation gains or
losses.

Net income per share

The Company adopted SFAS No. 128, "Earnings Per Share," which requires
presentation of basic and diluted earnings per share for entities with
complex capital structures. Basic earnings per share excludes dilution and
is computed by dividing net income by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. The
Company does not have any dilutive instruments related to its common
shares. Accordingly, basic and diluted earnings per share are the same.

Reclassifications

Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 1998.

2. 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.

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, securing a large portion of the recoverables.

Page 6

The effects of reinsurance on earned premiums are as follows:

% %
Direct Assumed Ceded Net Assumed Direct Assumed Ceded Net Assumed
--------------------------------------------------------------------------------------

Six Months Ended June 30,
--------------------------------------------------------------------------------------
---------------- 1998 -------------------- ---------------- 1997 -------------------

<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Property and
casualty .. $3,938.0 $ 976.0 $262.0 $4,652.0 21.0% $4,304.0 $560.0 $459.0 $4,405.0 12.7%
Accident and
health .... 1,730.0 115.0 144.0 1,701.0 6.8% 1,856.0 57.0 65.0 1,848.0 3.1
Life ....... 526.0 72.0 118.0 480.0 15.0% 435.0 61.0 57.0 439.0 13.8
--------------------------------------------------------------------------------------
Total .... $6,194.0 $1,163.0 $524.0 $6,833.0 17.0% $6,595.0 $678.0 $581.0 $6,692.0 10.1%
======================================================================================
</TABLE>

In the above table, life premium revenue is principally 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.

Insurance claims and policyholders' benefits are net of reinsurance
recoveries of $501.0 and $394.0 for the six months ended June 30, 1998 and
1997, respectively.

3. The Company's receivables are comprised of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
--------------------------

<S> <C> <C>
Reinsurance .................................. $ 6,032.9 $ 5,726.0
Other insurance .............................. 7,548.8 6,333.9
Security sales ............................... 1,440.5 755.8
Accrued investment income .................... 414.1 422.8
Other ....................... ................ 571.8 405.4
--------------------------
Total ................................. 16,008.1 13,643.9
Less allowance for doubtful accounts and
cash discounts .............................. 321.6 318.0
--------------------------
Receivables-net ....................... $15,686.5 $13,325.9
===========================
</TABLE>

Page 7

4. Shareholders' equity:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---------------------------

<S> <C> <C>
Preferred stock, $.10 par value,
Authorized--100,000,000 shares
Common stock, $1 par value:
Authorized--400,000,000 shares
Issued and outstanding--115,000,000 shares . $ 115.0 $ 115.0
Additional paid-in capital ................... 165.8 165.8
Earnings retained in the business ............ 9,001.4 8,895.4
Accumulated other comprehensive income ....... 520.8 488.9
--------------------------
Total ................................. $9,803.0 $9,665.1
==========================
</TABLE>

5. 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") to resolve all future asbestos-related bodily injury
claims involving Fibreboard, which is subject to court approval.

Casualty, Fibreboard and Pacific Indemnity have also reached an agreement
(the "Trilateral Agreement") on a settlement to resolve the coverage
litigation 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 to both
of these decisions. On July 25, 1996, a panel of the United States Fifth
Circuit Court of Appeals in New Orleans affirmed the judgment approving the
Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment
approving the Trilateral Agreement by a 3 to 0 vote. Petitions for
rehearing by the panel and Suggestions for Rehearing by the entire Fifth
Circuit Court of Appeals as respects to the decision on the Global
Settlement Agreement were denied. Two petitions for certiorari were filed
in the Supreme Court as respects the Global Settlement Agreement. On June
27, 1997, the Supreme Court granted these petitions, vacated the Fifth
Circuit's judgment as respects to 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

Page 8

Appeals again approved the Global Settlement Agreement by a 2 to 1 vote.
Two sets of objectors filed petitions for certiorari which were docketed on
April 16 and 17, 1998, by the United States Supreme Court. On June 22,
1998, the Supreme Court granted the petition for certiorari filed by one of
the sets of objectors. The parties will file briefs on the merits during
the next several months. The Supreme Court will most likely set oral
argument for late 1998 or early 1999.

No further appeal was filed with respect to the Trilateral Agreement;
therefore, court approval of the Trilateral Agreement has become final.

Global Settlement Agreement - 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 $1,525.0 to a trust fund
for a class of all future asbestos claimants, defined generally as those
persons whose claims against Fibreboard were neither filed nor settled
before August 27, 1993. An additional $10.0 is to be contributed to the
fund by Fibreboard. As indicated above, the Global Settlement approval has
been approved by the Fifth Circuit a second time, but the Supreme Court has
granted a petition for certiorari filed by one of the sets of objectors to
the settlement.

Trilateral Agreement - On October 12, 1993, Casualty, Pacific Indemnity and
Fibreboard entered into an agreement to settle the coverage litigation to
operate in the event that the Global Settlement Agreement is disapproved.
The Trilateral Agreement calls for payment by Casualty and Pacific
Indemnity of an aggregate of $2,000.0, of which Casualty's portion is
approximately $1,460.0, to Fibreboard to resolve all claims by Fibreboard
and all future and unsettled present asbestos claimants arising under the
policy issued to Fibreboard by Casualty.

Under either the Global Settlement Agreement or the Trilateral Agreement,
Casualty is also obligated to pay under prior settlements of present
asbestos claims. As a result of the final approval of the Trilateral
Agreement, such obligation has become final as well. Through June 30, 1998,
Casualty, Fibreboard and plaintiff attorneys had reached settlements with
respect to approximately 135,500 present claims, for an estimated
settlement amount of approximately $1,630.0 plus any applicable interest.
Approximately $1,660.0 (including interest of $184.0) was paid through June
30, 1998. Such payments have been partially recovered from Pacific
Indemnity. Casualty may negotiate other agreements for unsettled claims.

Final court approval of the Trilateral Agreement and its implementation
resolved Casualty's exposure with respect to the Fibreboard asbestos
claims. Casualty's management does not anticipate further material
exposure with respect to the Fibreboard matter, and subsequent adverse
reserve adjustments, if any, are not expected to materially affect the
results of operations or equity of the Company.

Page 9

Tobacco Litigation
------------------

Several of CNA's property/casualty subsidiaries have been named as
defendants as part of a "direct action" lawsuit, Richard P. Ieyoub v. The
American Tobacco Company, et al., filed by the Attorney General for the
State of Louisiana, in state court, Calcasieu Parish, Louisiana. In that
suit, filed against certain tobacco manufacturers and distributors (the
"Tobacco Defendants") and over 100 insurance companies, the State of
Louisiana seeks to recover medical expenses allegedly incurred by the State
as a result of tobacco-related illnesses.

The original suit was filed on March 13, 1996, against the Tobacco
Defendants only. The insurance companies were added to the suit in March
1997 under a "direct action" procedure 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.

In June of 1997, 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 CNA.

Environmental Pollution and Asbestos
------------------------------------

The CNA property and casualty insurance companies have potential exposures
related to environmental pollution and asbestos claims.

Environmental pollution clean-up is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to clean-up. The insurance industry is involved in extensive
litigation regarding coverage issues. Judicial interpretations in many
cases have expanded the scope of coverage and liability beyond the original
intent of the policies.

The Comprehensive Environmental Response Compensation and Liability Act of
1980 ("Superfund") and comparable state statutes ("mini-Superfund") govern
the clean-up and restoration of abandoned toxic waste sites and formalize
the concept of legal liability for clean-up and restoration by potentially
responsible parties ("PRP's"). Superfund and the mini-Superfunds
(Environmental Clean-up Laws or "ECLs") establish mechanisms to pay for
clean-up of waste sites if PRPs fail to do so, and to assign liability to
PRPs. The extent of liability to be allocated to a PRP is dependent on a
variety of factors. Further, the number of waste sites subject to 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

Page 10

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 Clinton 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 significantly reduced in favor of state
action. Substantial changes in the federal statute or the activity of the
EPA may cause states to reconsider their environmental clean-up statutes
and regulations. There can be no meaningful prediction of the pattern of
regulation that would result.

Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
clean-up, and the standards for clean-up and liability, CNA's ultimate
liability for environmental pollution claims may vary substantially from
the amount currently recorded.

As of June 30, 1998 and December 31, 1997, CNA carried approximately $681.0
and $768.0, 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, after which CNA adopted the Simplified Commercial General Liability
coverage form which included an absolute pollution exclusion. There was no
environmental pollution reserve development for the six months ended June
30, 1998 and 1997.

CNA's property and casualty insurance subsidiaries have exposure to
asbestos claims, including those attributable to CNA's litigation with
Fibreboard Corporation (see above). Estimation of asbestos 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 June 30, 1998 and December 31, 1997, CNA carried
approximately $1,382.0 and $1,445.0, respectively, of claim and claim
expense reserves, net of reinsurance recoverables, for reported and
unreported asbestos-related claims. Unfavorable asbestos claim reserve
development for the six months ended June 30, 1998 and 1997 totaled $29.0
and $25.0, respectively.

Page 11

The following tables provide additional data related to CNA's environmental
pollution and asbestos-related claims activity.

<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
----------------------------------------------------
Environmental Environmental
Pollution Asbestos Pollution Asbestos
----------------------------------------------------

<S> <C> <C> <C> <C>
Reported Claims:
Gross reserves .................... $263.0 $1,439.0 $276.0 $1,430.0
Less reinsurance recoverable ...... (39.0) (91.0) (38.0) (118.0)
------------------------------------------------
Net reported claims ............... 224.0 1,348.0 238.0 1,312.0
Net unreported claims ............... 457.0 34.0 530.0 133.0
------------------------------------------------
Net reserves ........................ $681.0 $1,382.0 $768.0 $1,445.0
================================================
</TABLE>

The results of operations in future years may continue to be adversely
affected by environmental pollution and asbestos claims and claim expenses.
Management will continue to monitor these liabilities and make further
adjustments as warranted.

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 anti-trust laws and state 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

Page 12

enacted into law, the legislation implementing the Proposed Resolution
would resolve many of the regulatory and litigation issues affecting the
United States tobacco industry thereby reducing uncertainties facing the
industry. Certain legislation has been introduced in Congress that would
significantly modify the Proposed Resolution including provisions more
stringent than those included in the Proposed Resolution. On April 18,
1998, Lorillard and other companies announced a withdrawal from the
legislative process to enact a comprehensive tobacco settlement. (See Item
1 - Lorillard, Inc. - "Proposed Resolution of Certain Regulatory and
Litigation Issues" in the Company's annual report on Form 10-K for the year
ended December 31, 1997.)

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 300 of these cases.
The Company is a defendant in 17 of the cases, although four have not been
served.

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 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. The court denied plaintiffs'
motion for new trial. Plaintiffs did not notice an appeal.

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 1998, a jury in the Circuit Court of Duval County, Florida, returned
a verdict in favor of plaintiffs in a smoking and health case in which
Lorillard was not a party, Widdick v. Brown & Williamson Tobacco
Corporation (verdict returned June 10, 1998). The jury awarded plaintiffs
$1.0 in actual damages and punitive damages. The First District of the
Florida Court of Appeal reversed the trial court's order denying Brown &
Williamson Tobacco Corporation's motion to transfer venue. The Circuit
Court of Duval County, Florida, must decide whether to grant a new trial
due to the ruling.

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.

The Florida Court of Appeals issued a ruling in the case of Carter v. Brown
& Williamson Tobacco Corporation, filed in the Circuit Court of Duval
County, Florida, that reversed a 1996 verdict entered in favor of
plaintiffs in which they were awarded a total of seven hundred fifty
thousand dollars

Page 13

in actual damages. The Court of Appeals directed that judgment be entered
in favor of Brown & Williamson Tobacco Corporation by the trial court.
Plaintiffs have asked the Court of Appeals to reconsider its decision.
Lorillard was not a party to Carter v. Brown & Williamson Tobacco
Corporation.

CLASS ACTIONS - There are 70 purported class actions pending against
cigarette manufacturers and other defendants, including the Company. Two
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 two of the purported class actions seek class
certification on behalf of individuals who smoked cigarettes or were
exposed to environmental tobacco smoke. Two of the cases seek class
certification on behalf of individuals who have paid insurance premiums to
Blue Cross and Blue Shield organizations. Plaintiffs in a number of
Reimbursement cases also seek certification as class actions (see
Reimbursement Cases, below).

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 62 of the 70 cases seeking
class certification. The Company is a defendant in 27 of the purported
class actions, four of which have not been served. 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 approved by the trial 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. None
of these payments are to be made until all appeals have been exhausted and
judgment becomes final. 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
will 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 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 to reimburse the
costs and expenses of plaintiffs' counsel. This amount will be credited
against any

Page 14

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. Trial
is underway and jury selection is proceeding.

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.
Defendants have filed a petition for writ of mandamus or prohibition from
the class certification order with the Maryland Court of Special Appeals.

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 an 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 was granted. On appeal, the Appellate Division
of the New York Supreme Court reversed the trial court's class
certification order and directed the trial court to enter judgment in favor
of the defendants.

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.

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.

Holmes v. The American Tobacco Company, et al. (Circuit Court, Montgomery
County, Alabama, filed August 8, 1996). The Company is a defendant in the
case.

Page 15

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). The court has heard
argument on plaintiffs' motion for class certification.

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. (U.S. District Court, Western
District, Wisconsin, filed April 21, 1997).

Geiger v. The American Tobacco Company, et al. (Supreme Court, Queens
County, New York, filed April 30, 1997). The trial court granted on an
interim basis plaintiffs' motion for class certification on behalf of New
York residents who allege lung cancer or throat cancer as a result of

Page 16

smoking cigarettes. The Appellate Division of the New York Supreme Court
reversed the class certification order and directed the trial court to
allow the parties to conduct additional discovery on the class
certification motion.

Cole v. The Tobacco Institute, Inc., et al. (U.S. District Court, Eastern
District, Texas, Texarkana Division, filed May 5, 1997).

Clay v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Southern District, Illinois, Benton Division, filed May 22, 1997).

Anderson v. The American Tobacco Company, Inc., et al. (U.S. District
Court, Eastern District, Tennessee, filed May 23, 1997). The Company is a
defendant in the case.

Taylor v. The American Tobacco Company, Inc., et al. (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). The court has heard argument on
plaintiffs' motion for class certification.

Kirstein 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).

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). The court granted
defendants' motion to dismiss. Plaintiffs have attempted to notice appeals
to the United States Court of Appeals for the Third Circuit.

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.

Page 17

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.

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.

DiEnno v. Liggett Group, Inc., et al. (U.S. District Court, Nevada, filed
December 22, 1997).

McCauley v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Northern 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.

Basik v. Lorillard Tobacco Company, et al. (Circuit Court, Cook County,
Illinois, filed March 17, 1998).

Daniels v. Philip Morris Companies, Inc., et al. (U.S. District Court,
Southern District, California, filed April 2, 1998). The Company is a
defendant in the case. To date, none of the defendants have received
service of process.

Christensen v. Philip Morris Companies, Inc., et al. (U.S. District Court,
Nevada, filed April 3, 1998). The Company is a defendant in the case. To
date, none of the defendants have received service of process.

Avallone v. The American Tobacco Company, Inc., et al. (Superior Court,
Atlantic County, New Jersey, filed April 23, 1998). The Company is a
defendant in the case.

Landry v. Louisiana Health Service and Indemnity Co., Inc., et al. (U.S.
District Court, Middle District, Louisiana, filed May 18, 1998). The
Company is a defendant in the case.

Collier v. Philip Morris Incorporated, et al. (U.S. District Court,
Southern District, Mississippi, filed May 27, 1998).

Page 18

Cleary v. Philip Morris Incorporated, et al. (Circuit Court, Cook County,
Illinois, filed June 5, 1998).

REIMBURSEMENT CASES - Approximately 135 actions are pending in which
governmental entities, private citizens, or other organizations, including
labor unions, insurers 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 in a number of these actions seek certification as class
actions. 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 except
for one filed in a U.S. court by a nation in which Lorillard does not
conduct business (The Republic of Guatemala). The Company is named as a
defendant in 18 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 14 cases filed by state or local governmental entities. Since
January 1, 1997, cases brought by Florida, Minnesota, Mississippi, Texas
and Blue Cross and Blue Shield of Minnesota have been settled (see
"Settlements of Reimbursement Cases"). Many of the pending Reimbursement
Cases are in the pre-trial, discovery stage.

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. On
May 8, 1998, the parties reached an agreement to settle the matter. See
"Settlements of Reimbursement Cases" below.

McGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha
County, West Virginia, filed September 20, 1994 by the West Virginia
Attorney General and state agencies). The 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. The
remaining claims have now been dismissed.

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

Page 19

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).

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 21, 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 March 4, 1999.

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 January 25, 1999.

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.

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.

Page 20

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. The Supreme Court of Iowa has affirmed
the trial court's order dismissing plaintiff's claims of deception,
voluntary assumption of a special duty and indemnity. Plaintiff did not
attempt to appeal the dismissal of its claim of unjust
enrichment/restitution.

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). The court has granted
defendants' motion to dismiss all counts of the complaint. The time for
plaintiffs to notice an appeal has not expired.

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).

Page 21

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).

The Republic of Guatemala v. The Tobacco Institute, Inc., et al. (U.S.
District Court, District of Columbia, filed May 11, 1998). Neither
Lorillard nor the Company are named as defendants in the matter.

State of Vermont v. Philip Morris, Incorporated, et al. (Superior Court,
Chittenden County, Vermont, filed July 7, 1998). Plaintiff asserts
different claims in this suit than in the one filed on May 29, 1997, that
is listed above.

Page 22

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 two 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.

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).

Wynn v. Philip Morris, Inc., et al. (U.S. District Court, Northern
District, Alabama, filed May 27, 1998). The suit is on behalf of taxpayers
of Alabama.

Reimbursement Cases By Indian Tribes - Indian Tribes have filed seven
reimbursement suits in their tribal courts, two of which have been
dismissed. Lorillard is a defendant in each of the cases. The Company is
not named as a defendant in any of the seven 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).

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).

The Standing Rock Sioux Tribe v. The American Tobacco Company, et al.
(Tribal Court, Standing Rock Sioux Tribe, filed May 8, 1998).

The Sisseton-Wahpeton Sioux Tribe v. The American Tobacco Company, et al.
(Tribal Court, Sisseton-Wahpeton Sioux Tribe, filed May 12, 1998).

Reimbursement Cases By Labor Unions - Labor unions have filed approximately
65 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 a defendant in two of the pending suits. 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).

Page 23

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 United States Court of Appeals for
the Ninth Circuit has declined to review the ruling at this time.

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).

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 granted defendants' motion for judgment on the pleadings,
which dismissed the case. The time for plaintiffs to notice an appeal has
not expired.

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). The court has granted defendants' motion to dismiss
the case. The time for plaintiffs to notice an appeal has not expired.

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.

Page 24

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. (Supreme Court, New York County, New York, filed July 28, 1997).

Asbestos Workers Local 53 Health and Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Louisiana, filed
August 15, 1997). This action has been consolidated with the case of Ark-La-
Miss Laborers Welfare Fund.

Steamfitters Local Union No. 420 Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Pennsylvania, filed
August 21, 1997). The court granted defendants' motion to dismiss the case.
Plaintiffs have noticed an appeal to the United States Court of Appeals for
the Third Circuit.

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). The court granted defendants' motion to
dismiss the case. Plaintiff has noticed an appeal from the judgment to the
United States Court of Appeals for the Eleventh Circuit.

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. (Circuit Court, St. Joseph County, Indiana, filed
September 12, 1997).

Operating Engineers Local 12 Health and Welfare Trust v. American Tobacco
Company, et al. (Superior Court, Los Angeles County, California, filed
September 16, 1997).

Puerto Rican ILGWU Health & Welfare Fund v. Philip Morris Inc., et al.
(Supreme Court, New York County, New York, filed September 17, 1997).

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,

Page 25

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.
(Supreme Court, New York County, New York, filed November 25, 1997).

IBEW Local 363 Welfare Fund v. Philip Morris, Inc., et al. (Supreme Court,
New York County, New York, filed November 25, 1997).

Local 138, 138A and 138B International Union of Operating Engineers Welfare
Fund v. Philip Morris, Inc., et al. (Supreme Court, New York County, New
York, filed November 25, 1997).

Local 840, International Brotherhood of Teamsters Health and Insurance Fund
v. Philip Morris, Inc., et al. (Supreme Court, New York County, New York,
filed November 25, 1997).

Long Island Council of Regional Carpenters Welfare Fund v. Philip Morris,
Inc., et al. (Supreme Court, New York County, New York, filed November 25,
1997).

Day Care Council - Local 205 D.C. 1707 Welfare Fund v. Philip Morris, Inc.,
et al. (Supreme Court, New York County, New York, filed December 8, 1997).

Local 1199 Home Care Industry Benefit Fund v. Philip Morris, Inc., et al.
(Supreme Court, New York County, New York, filed December 8, 1997).

Local 1199 National Benefit Fund for Health and Human Services Employees v.
Philip Morris, Inc., et al. (Supreme Court, New York County, 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).

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. (U.S. District Court, Southern District,
Alabama, filed February 19, 1998). The court granted plaintiffs' motion to
dismiss the case without prejudice.

Page 26

National Asbestos Workers, et al. v. Philip Morris Incorporated, et al.
(U.S. District Court, Eastern District, New York, filed February 27, 1998).
The Company is a defendant in the case.

Milwaukee Carpenters, et al. v. Philip Morris, Incorporated, et al. (U.S.
District Court, Eastern District, Wisconsin, filed March 4, 1998). To
date, none of the defendants have received service of process.

Service Employees International Union Health & Welfare Fund, et al. v.
Philip Morris, Inc., et al. (U.S. District Court, District of Columbia,
filed March 19, 1998).

Milwaukee Carpenters, et al. v. Philip Morris, Incorporated, et al. (U.S.
District Court, Eastern District, Wisconsin, filed March 30, 1998).

United Association of Plumbing and Pipefitters Industry Local 467, et al.
v. Philip Morris Incorporated, et al. (Superior Court, San Mateo County,
California, filed March 31, 1998).

Newspaper Periodical Drivers Local 921 San Francisco Newspaper Agency
Health & Welfare Fund v. Philip Morris, Inc., et al. (Superior Court, San
Mateo County, California, filed April 15, 1998).

Teamsters Benefit Trust v. Philip Morris, Inc., et al. (Superior Court,
Alameda County, California, filed April 15, 1998).

United Association Local 159 Health and Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, Alameda County, California, filed
April 15, 1998).

Bay Area Automotive Group Welfare Fund v. Philip Morris, Inc., et al.
(Superior Court, San Francisco County, California, filed April 16, 1998).

Bay Area Delivery Drivers Security Fund v. Philip Morris, Inc., et al.
(Superior Court, Alameda County, California, filed April 16, 1998).

Pipe Trades District Council No. 36 Health & Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, Alameda County, California, filed
April 16, 1998).

Sign, Pictorial and Display Industry Welfare Fund v. Philip Morris, Inc.,
et al. (Superior Court, San Francisco County, California, filed April 16,
1998).

United Association Local No. 343 Health and Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, Alameda County, California, filed
April 16, 1998).

San Francisco Newspaper Publishers and Northern California Newspaper Guild
Health & Welfare Trust v. Philip Morris, Inc., et al. (Superior Court, San
Francisco County, California, filed April 17, 1998).

North Coast Trust Fund v. Philip Morris, Inc., et al. (Superior Court, San
Francisco County, California, filed April 24, 1998).

Northern California Bakery Drivers Security Fund v. Philip Morris, Inc., et
al. (Superior Court, Alameda County, California, filed April 24, 1998).

Northern California Plasterers Health & Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, San Francisco County, California,
filed May 21, 1998).

Page 27

U.A. Local No. 393 Health and Welfare Trust Fund v. Philip Morris, Inc., et
al. (Superior Court, Alameda County, California, filed May 21, 1998).

Northern California General Teamsters Security Fund v. Philip Morris, Inc.,
et al. (Superior Court, Alameda County, California, filed May 22, 1998).

Utah Laborers Health & Welfare Trust Fund, et al. v. Philip Morris
Incorporated, et al. (U.S. District Court, Utah, Central Division, filed
June 4, 1998). The Company is a defendant in the case.

Joint Benefit Trust v. Philip Morris, Inc., et al. (Superior Court, Alameda
County, California, filed June 15, 1998).

Northern California Pipe Trades Health and Welfare Trust v. Philip Morris,
Inc., et al. (Superior Court, Alameda County, California, filed June 18,
1998).

S.E.I.U. v. Philip Morris, Inc., et al. (U.S. District Court, District of
Columbia, filed June 22, 1998). To date, none of the defendants have
received service of process.

Holland, et al., Trustees of United Mine Workers v. Philip Morris
Incorporated, et al. (U.S. District Court, District of Columbia, filed July
9, 1998).

Reimbursement Cases By Private Companies - Private companies have filed six
Reimbursement Cases to date. Lorillard is named as a defendant in each of
the cases filed by private companies. The Company is not a defendant in the
cases filed by private companies.

Group Health Plan, Inc., et al. v. Philip Morris Incorporated, et al. (U.S.
District Court, Minnesota, filed March 11, 1998).

Williams and Drake Company v. The American Tobacco Company, et al. (U.S.
District Court, Western District, Pennsylvania, filed March 23, 1998).

Conwed Corporation, et al. v. R.J. Reynolds Tobacco Company, et al.
(District Court, Second Judicial District, Ramsey County, Minnesota, filed
April 10, 1998).

Arkansas Blue Cross and Blue Shield, et al. v. Philip Morris, Incorporated,
et al. (U.S. District Court, Northern District, Illinois, filed April 29,
1998).

Blue Cross and Blue Shield of New Jersey, Inc., et al. v. Philip Morris,
Incorporated, et al. (U.S. District Court, Eastern District, New York,
filed April 29, 1998).

Regence Blueshield, et al. v. Philip Morris, Incorporated, et al. (U.S.
District Court, Western District, Washington, filed April 29, 1998).

CONTRIBUTION CLAIMS - In addition to the foregoing cases, eight 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. One of the cases
has not been served. Lorillard is named as a defendant in each action. The
Company is named as a defendant in three of the cases but has not received
service of process in one of them. Each of these cases is in the pre-trial,
discovery stage.

Raymark Industries v. R.J. Reynolds Tobacco Company, et al. (Circuit Court,

Page 28

Duval County, Florida, filed September 15, 1997). The Company is a
defendant in the case but has not received service of process to date.

Raymark Industries v. Brown & Williamson Tobacco Corporation, et al. (U.S.
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, 1997). 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).

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.

Raymark Industries v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, New York, filed January 30, 1998).

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. Eighteen such
cases, including one that also includes allegations that plaintiff also was
injured as a result of smoking cigarettes, 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 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 one hundred forty thousand dollars, although the award
subsequently was reduced to seventy thousand dollars.

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 on December 30, 1997. The
United States Supreme Court denied the Company's petition for writ of
certiorari as to the punitive damages award.

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

Page 29

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.

In addition, two California cities, Los Angeles and San Jose, suing on
behalf of The People of the State of California, have filed suits alleging
cigarette manufacturers, including Lorillard, have violated a California
statute, commonly known as "Proposition 65," that requires California
residents to be informed if they are exposed to substances that are alleged
to cause cancer or birth defects. Plaintiffs in both suits allege that non-
smokers have not been warned by cigarette manufacturers that exposure to
environmental tobacco smoke may cause illness. Plaintiffs in both suits
further allege defendants violated certain provisions of the California
Business and Professions Code (The People of the State of California, and
American Environmental Safety Institute v. Philip Morris Incorporated, et
al. (Superior Court, Los Angeles County, California, filed July 14, 1998)
and The People of the State of California, the City of San Jose and Paul
Dowhall v. Brown & Williamson Tobacco Corporation, et al. (Superior Court,
San Francisco County, California, filed July 28, 1998)).

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, joint defense
privilege and work product doctrine. 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. In addition, several plaintiffs have argued,
and certain courts have found, that defendants have "waived" their
privilege as to a number of documents. Such arguments by plaintiffs
generally pertain to certain industry documents which were subpoenaed by
the House Commerce Committee (see discussion below).

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.

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. As of June 30, 1998, Lorillard had posted more than 250,000
documents on the Internet.

On February 19, 1998, the Committee subpoenaed approximately 39,000
additional documents which Lorillard and other companies in the tobacco
industry have asserted to be privileged. These documents were 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 exhausted their
remedies through the state's judicial system as well as the U.S. Supreme

Page 30

Court. On April 6, 1998, the U.S. Supreme Court denied defendants'
application for a Stay and, in accordance with the March 7, 1998 ruling of
the district court, such documents were released to plaintiffs in
Minnesota. Also on April 6, 1998 and pursuant to the February 19, 1998
subpoena, documents were submitted to the Committee. The Committee
subsequently made available on the Internet the vast majority, and perhaps
all, of those documents.

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 - During 1997 and 1998, Lorillard and
other companies in the United States tobacco industry (the "settling
defendants") settled health care cost recovery actions brought by the
States of Mississippi, Florida, Texas and Minnesota. Claims of Blue Cross
and Blue Shield of Minnesota asserted against the settling defendants
together with Minnesota's claims were separately settled as well. These
settlements are described in Note 5 of the Notes to Consolidated Condensed
Financial Statements of the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998. Recently, as detailed below, the Mississippi
and Texas settlement agreements have been amended pursuant to their "most
favored nation" clauses to reflect terms of the Minnesota settlement. The
Florida, Texas and Minnesota health care cost recovery settlements and
certain ancillary agreements are filed as Exhibits to various reports of
the Company filed with the Securities and Exchange Commission, and the
amendments to the Mississippi and Texas settlements and certain ancillary
agreements are filed as Exhibits to this Form 10-Q, and the discussion
herein is qualified by reference thereto. These settlements resulted in
pre-tax charges to earnings of $163.4 in the third and fourth quarter of
1997, and $42.7 and $185.1 in the quarter and six months ended June 30,
1998.

Following the settlement with Minnesota, Lorillard was contacted by
counsel for the States of Texas, Florida and Mississippi seeking to discuss
the issue of what effect, if any, the settlement of the Minnesota action
has upon the terms of the prior settlements with those states pursuant to
the "most favored nation" ("MFN") provision of those prior state
settlements. That provision provides that, in the event the settling
defendants enter into a subsequent pre-verdict settlement with a non-
federal governmental entity on terms more favorable to such entity than the
terms of the prior state settlements (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
prior state settlements will be revised to provide treatment at least as
relatively favorable. As discussed below, the Mississippi and Texas
settlement

Page 31

agreements were recently amended pursuant to this provision. Lorillard
cannot presently determine what the result of any discussions with Florida
regarding the MFN issue may be, nor can it determine what the result of any
litigation with Florida concerning that issue may be. A determination of
this issue adverse to Lorillard could result in an obligation to make
substantial additional payments to Florida.

On July 6 and July 24, 1998 respectively, Lorillard and the other settling
defendants reached agreements with the States of Mississippi and Texas to
amend those States' settlements pursuant to the MFN provision. The
Mississippi and Texas MFN amendments call for the settling defendants to
make additional settlement payments to Mississippi and Texas aggregating
$550.0 and $2,275.0, respectively. These amounts are payable in January of
the year indicated:
<TABLE>
<CAPTION>

1999 2000 2001 2002 2003 Total
---------------------------------------------------------

<S> <C> <C> <C> <C> <C> <C>
Mississippi $ 41.7 $145.2 $145.2 $145.2 $ 72.7 $ 550.0
Texas 156.5 605.1 605.1 605.1 303.2 2,275.0
---------------------------------------------------------
$198.2 $750.3 $750.3 $750.3 $375.9 $2,825.0
=========================================================
</TABLE>

These payments, which in the case of payments after 1999 will be adjusted
for inflation, changes in domestic sales volume, and, under specified
circumstances, increases in net operating profits from domestic sales, will
be allocated among the settling defendants in accordance with their
relative unit volume of domestic cigarette sales.

In the event a settling defendant defaults on its obligation to make timely
payment of the above amounts, the remaining settling defendants may, in
their absolute discretion, pay the missing payment. If they elect not to
make up the missing payment, each settling defendant can be required by the
state to pay its share of the remaining payments scheduled above within 30
days of the default, subject to inflation and volume adjustments. The
obligations of the settling defendants under the amended settlement
agreements are several and not joint; the amended settlement agreements do
not obligate any settling defendant to pay the share of another settling
defendant.

The nominal amounts of the ongoing annual payments, (the "Ongoing Annual
Payments") contemplated by the original Mississippi and Texas settlement
agreements are unchanged by the MFN amendments.

The MFN amendments modify the provisions of the original settlement
agreements that address the impact enactment of federal tobacco legislation
before November 30, 2000 would have on such settlements. Under the MFN
amendments, the settling defendants will be entitled to receive a dollar-
for-dollar offset against their Ongoing Annual Payments for amounts that
Mississippi or Texas, as the case may be, could elect to receive pursuant
to such federal tobacco legislation ("Federal Settlement Funds"), except to
the extent that: (i) such Federal Settlement Funds are required to be used
for purposes other than health care or tobacco-related purposes; (ii) such
federal tobacco legislation does not provide for the abrogation, settlement
or relinquishment of state tobacco-related claims; or (iii) state receipt
of such Federal Settlement Funds is conditioned upon (A) the relinquishment
of

Page 32

rights or benefits under that respective state's settlement (excepting any
Ongoing Annual Payment amounts subject to the offset); or (B) actions or
expenditures by such state unrelated to health care or tobacco (including
but not limited to tobacco education, cessation, control or enforcement).

The MFN amendments also supersede the MFN provisions contained in the
original settlement agreements. Under the revised MFN provision if the
settling defendants enter into any future pre-verdict settlement agreement
of similar health care cost recovery litigation on terms more favorable to
a non-federal governmental plaintiff, the Mississippi and Texas settlements
will not otherwise be revised except to the extent such future settlement
provides for: (i) joint and several liability for monetary payments, (ii) a
parent company guaranty or other credit assurance, (iii) the implementation
of different non-economic tobacco-related public health measures, or (iv)
monetary offsets in the event of federal tobacco legislation that are more
favorable to such plaintiff than those described above.

The settling defendants agreed as part of the MFN amendments to disclose
specified future payments for lobbying or related purposes in Mississippi
and Texas, to support enumerated legislative and regulatory proposals and
to not support legislation, rules or policies that would diminish
Mississippi's and Texas' rights under the amended settlement agreements.

The settling defendants also submitted to a Consent Judgment enjoining the
settling defendants from (i) offering or selling non-tobacco services or
merchandise (e.g., caps, jackets or bags) in Mississippi and Texas bearing
the name or logo of a tobacco brand other than tobacco products or items
with the sole function of advertising; (ii) making any material
misrepresentation of fact regarding the health consequences of using
tobacco products; (iii) entering into any contract, combination or
conspiracy to limit health information or research into smoking and health
or product development; and (iv) taking any action to target children in
Mississippi and Texas in the advertising, promotion or marketing of
cigarettes.

In connection with the MFN amendments, the parties executed new agreements
governing settling defendants' payment of attorneys fees to counsel for
Mississippi and Texas. (Copies of these agreements are filed as Exhibits to
this Form 10-Q, and the discussion herein is qualified by reference
thereto.) The agreements provide that beginning in November 1998, a three-
member arbitration panel will consider and determine the amount of
attorneys' fees to be awarded. These awards will be allocated among the
settling defendants in accordance with their relative unit volume of
domestic cigarette shipments. Under the agreements, there is an annual cap
of $500.0 on aggregate attorneys' fees to be paid pursuant to arbitration
awards, including those to be paid for counsel for Mississippi and Texas. A
one-time $250.0 payment may be paid for cases that were settled in 1997.
This aggregate annual cap includes; (i) all attorneys' fees paid pursuant
to an award by the panel in connection with settlements of any smoking and
health cases (other than individual cases), (ii) all attorneys' fees paid
pursuant to an award by the panel for activities in connection with smoking
and health cases resolved by operation of federal legislation provided such
legislation imposes an obligation on the settling defendants to pay
attorneys' fees, and (iii) all attorneys' and professional fees paid
pursuant to an award by the panel for contributions made toward the
enactment of federal tobacco legislation.

The settling defendants have made payments to counsel for Mississippi and
Texas totaling $200.0 as advances against awards of attorneys' fees by the
arbitration panel, such advances to be credited against the annual cap over

Page 33
several years commencing in 1999.

Included in the charges stated above for settlements of reimbursement cases
are charges recorded by Lorillard of $30.7 ($18.4 after taxes) in the
second quarter of 1998 to accrue for its share of all fixed and
determinable portions of the MFN amendments with Mississippi and Texas as
described above.

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; 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.

Lorillard believes that it has a number of defenses to pending cases, in
addition to defenses based on preemption described above, and Lorillard
will

Page 34

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 have settled this action
for a payment by defendants in an aggregate amount approximating sixty
thousand dollars 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

Page 35

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.

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.

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.

6. In the opinion of Management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as
of June 30, 1998 and December 31, 1997 and the results of operations for
the three and six months and changes in cash flows for the six months ended
June 30, 1998 and 1997, respectively.

Results of operations for the second quarter and the first six months of
each of the years is not necessarily indicative of results of operations
for that entire year.

Page 36

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
----------------------------------------------------------------------

Liquidity and Capital Resources:
- -------------------------------

Insurance
- ---------

CNA Financial Corporation and subsidiaries ("CNA"). CNA is an 84% owned
subsidiary of the Company.

Statutory surplus of the property and casualty insurance subsidiaries was
approximately $7.0 billion at June 30, 1998, compared to approximately $7.1
billion on December 31, 1997. The major component of this change was a decline
of $369.0 million of other items, primarily dividends paid to CNA, partially
offset by statutory net income of $147.0 million and an increase in net
unrealized investment gains of $181.0 million. The statutory surplus of the
life insurance subsidiaries was approximately $1.3 billion at June 30, 1998,
compared to $1.2 billion at year end 1997.

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 first six months of 1998, CNA's operating cash flows were a negative
$579.6 million, compared to a negative $669.7 million for the six months ended
June 30, 1997. Negative cash flows for 1998 and 1997 are substantially the
result of claim payments resulting primarily from the settlement of the
Fibreboard litigation.

Net cash flows from operations are invested in marketable securities.
Investment strategies employed by CNA's insurance subsidiaries consider the
cash flow requirements of the insurance products sold and the tax attributes of
the various types of marketable investments.

On August 5, 1998, CNA announced a reassessment of its businesses which would
involve reorganization of a number of its businesses and corporate support
areas. The organizational changes include the closing of a number of facilities
and consolidating certain processing locations, reducing workforce and
enhancing computer systems.

Within its commercial insurance business, CNA will consolidate four regional
offices into two zone offices and streamline decision-making processes in
support of branch offices and agents. The plan also calls for a reduction of
its claim processing offices from 24 to 8 and system upgrades to enable CNA to
centralize its policy processing into one center located in Orlando, Florida.
These changes are expected to reduce paperwork and allow branch employees to
spend more time with customers.

Within its risk management business, CNA will form a new holding company with
a simplified cost structure. Two separate claim organizations will be united to
form a new claims service company for risk management clients. The new company
will employ one of the largest claims technical staff in the insurance industry
as well as achieve cost savings through economies of scale.

CNA's remaining businesses anticipate finalizing their reorganization plans
by the end of the third quarter of 1998.

Page 37

With finalization of the plan expected to occur by the end of third quarter,
CNA estimates that it will record a pre-tax charge of $100.0 to $140.0 million
for restructuring costs. CNA expects additional pre-tax transition costs of
$200.0 to $260.0 million related to the restructuring, which will be incurred
over the next 12 to 18 months. The pre-tax impact on third-quarter earnings
from these reorganization charges is estimated to be $175.0 to $260.0 million.
CNA anticipates that its current workforce of approximately 24,000 employees
will be reduced by approximately 10%.

While CNA has not yet completed its analysis of anticipated cost savings, it
estimates that its reorganization, which includes the restructuring plan as
well as revenue enhancements and operating efficiencies, will result in
anticipated reductions of approximately 2 points in CNA's expense ratio and
savings of approximately $300.0 to $350.0 million on an annualized basis. CNA
expects a portion of the anticipated savings will be realized beginning in the
latter part of 1998 and to achieve the full expense ratio reduction within 18
months.

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.

On April 15, 1998, CNA issued $500.0 million principal amount of 6.50% senior
notes due April 15, 2005. The net proceeds were used to pay down existing bank
debt, provide refinancing of certain senior notes and provide funds for
acquisitions.

On August 5, 1998, CNA's board of directors approved a plan to purchase, in
open market or privately negotiated transactions, its outstanding common stock
from time to time as market conditions warrant.

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 through
1997 and in 1998. See Note 5 of the Notes to Consolidated Condensed Financial
Statements. In a number of cases, the Company is named as a defendant. Tobacco
litigation includes claims brought by individual plaintiffs and claims brought
as class actions on behalf of a large number of individuals for damages
allegedly caused by smoking; and claims brought on behalf of governmental
entities, private citizens, or other organizations seeking reimbursement of
health care costs allegedly 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.

Page 38

It has also been reported that the Executive branch of the government has
urged the U.S. Justice Department to commence an action against the tobacco
industry seeking reimbursement of Medicare expenditures resulting from injuries
or other health effects allegedly caused by use of tobacco products.

In 1997 and 1998, 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 5 of the Notes to Consolidated Condensed
Financial Statements.

FDA Regulations

The Food and Drug Administration ("FDA") has published regulations (the "FDA
Regulations") severely restricting cigarette advertising and promotion and
limiting the manner in which tobacco products can be sold. The FDA premised its
regulations on the need to reduce smoking by underage youth and young adults.
The FDA Regulations 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 a black and white,
text only format in most publications and outdoor advertising such as
billboards, 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, and oral arguments were heard by that Court on
June 8, 1998. To date, the Court has not rendered its decision.

Proposed Resolution of Certain Regulatory and Litigation Issues

On June 20, 1997, Lorillard, together with other companies in the United
States tobacco industry, 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 would permit extensive regulation of the industry by the FDA and

Page 39

would impose large monetary obligations on the industry to be paid to the
federal government and to the states. The Proposed Resolution would require the
manufacturers to sign private contracts, or Protocols, which embody significant
restrictions on the industry's commercial free speech advertising. In return,
the Proposed Resolution would resolve much of the industry's litigation and
establish a rational litigation system for future lawsuits. The Proposed
Resolution, by the nature of its terms, could be implemented only by federal
legislation. Incorporated by reference into this filing is the discussion of
the Proposed Resolution in the Company's annual report on Form 10-K for the
year ended December 31, 1997.

Since the Proposed Resolution was announced, it has been the subject of
intense review and criticism by the White House, the public health community,
and other interested parties. Certain members of Congress have offered, or
indicated that they intend to offer, alternative legislation. No bill
introduced would adopt the Proposed Resolution as agreed to. Over 50 bills have
been introduced in Congress regarding the issues raised in the Proposed
Resolution, including bills seeking more stringent regulation of tobacco
products by the Food and Drug Administration and more punitive monetary
payments by the companies. One particular bill initially introduced by Senator
John McCain from Arizona, was approved by the Senate Commerce Committee. The
McCain bill included, among other things, provisions more stringent than those
in the Proposed Resolution regarding FDA regulation, licensing of tobacco
manufacturers and retailers, surcharges against the industry for failure to
achieve underage smoking reduction goals, advertising restrictions and labeling
requirements, industry payments, smoking restrictions, civil liability
limitations, a method for determining the amount and payment of attorneys'
fees, and public disclosure of industry documents. On June 17, 1998, the United
States Senate voted to return the McCain bill to the Senate Commerce Committee
after several weeks of debate. It is unlikely that the McCain bill will be
reconsidered by that Committee or by the Senate during this Congressional term.

On April 18, 1998, Lorillard, along with the other signatory companies to the
Proposed Resolution, announced a withdrawal from the legislative process to
enact a comprehensive tobacco settlement. Lorillard remains committed to the
Proposed Resolution, but does not believe that the current political process in
Washington can produce legislation that is fair to the industry.

For information with respect to these matters, as well as with respect to
discussions regarding an attempt to achieve a comprehensive legislative
resolution to litigation and regulatory issues affecting the United States
tobacco industry, see Note 5 of the Notes to Consolidated Condensed Financial
Statements.

Cigarette Excise Taxes

The United States federal excise tax on cigarettes is presently $12.00 per
1,000 cigarettes ($0.24 per pack of 20 cigarettes). In early August of 1997,
the United States Congress approved and the President signed into law an
increase in the federal excise tax on cigarettes of $7.50 per 1,000 cigarettes
($0.15 per pack of 20 cigarettes). This increase is phased in at a rate of
$5.00 per 1,000 cigarettes in the year 2000 and an additional $2.50 per 1,000
cigarettes in the year 2002. 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.

Page 40

Hotels
- ------

Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.

Funds from operations continue to exceed operating requirements. 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 will be funded by a combination of equity
contributions by the development partners and mortgages. Loews Hotels will
obtain its share of the equity contributions for the development of these
hotels 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.

For the first six months of 1998, Diamond Offshore's cash provided by
operating activities amounted to $224.1 million, compared to $159.7 million in
the 1997 period. This increase in operating cash flow was primarily
attributable to a $70.9 million increase in net income for the first half of
1998, an $11.7 million increase in depreciation and amortization expense, and
various changes in operating assets and liabilities.

Diamond Offshore continues to enhance its fleet to meet customer demand for
diverse drilling capabilities, including those required for deep water and
harsh environment operations. Diamond Offshore has revised its 1998 budgeted
capital expenditures for rig upgrades to $125.2 million from $108.5 million.
Diamond Offshore expended $35.3 million, including capitalized interest
expenses, for significant rig upgrades during the six months ended June 30,
1998. The rig upgrade projects include the conversion of an accommodation
vessel to a semisubmersible drilling unit capable of operating in harsh
environments and ultra-deep water. Diamond Offshore has revised the estimated
cost of conversion to approximately $210.0 million from $190.0 million due to
additional steel requirements and mechanical and electrical system costs. Upon
completion of the conversion, the rig will begin a five year drilling program
in the Gulf of Mexico, which is anticipated to commence in late 1999. Other
upgrade projects included the cantilever conversion project on the Ocean
Warwick, a jack-up drilling rig located in the Gulf of Mexico, which was
completed in March 1998. In addition, leg strengthening and other modifications
for another jack-up rig operating in the Gulf of Mexico were completed in May
1998. The rig returned to the shipyard for repairs shortly after its return to
work due to leg damage sustained on location. The repairs were completed in
June 1998 and the rig is currently idle in the Gulf of Mexico. Diamond Offshore
has also budgeted $126.7 million for 1998 capital expenditures associated with
its continuing rig enhancement program, spare equipment and other corporate
requirements. These expenditures include purchases of anchor chain, drill pipe,
riser, and other drilling equipment. During the first six months of 1998, $38.0
million was expended on this program.

Diamond Offshore believes it has the financial resources needed to meet its
business requirements in the foreseeable future, including capital expenditures
for major upgrades, continuing rig enhancements and working capital
requirements.

The ability to minimize costs and downtime is critical to Diamond Offshore's
results of operations. However, the company's plan to retain qualified rig
personnel includes periodic compensation enhancements. As of July 1, 1998,

Page 41

Diamond Offshore has adjusted the compensation levels for most offshore
positions. Although Diamond Offshore does not expect such adjustments to have a
material effect on its current results of operations, significant increases in
costs, including compensation and training, may occur in the future. 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. At June 30, 1998, eight of these 15 inspections were completed.
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.

Also, increased rig construction and enhancement programs are ongoing 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.

As a result of the recent decline in product prices, the contract drilling
market has begun to experience declining dayrates and decreased utilization
primarily in the shallow waters of the Gulf of Mexico. The impact of these
changing market conditions could have an adverse affect on Diamond Offshore's
future results of operations, although the extent of such change cannot be
accurately predicted.

Since June 30, 1998 and through August 13, 1998, Diamond Offshore purchased
1,700,000 shares of its outstanding Common Stock at an aggregate cost of
approximately $47.4 million. Depending on market conditions, Diamond Offshore
from time to time may purchase additional shares in the open market or
otherwise.

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. Bulova's
cash and cash equivalents, and investments amounted to $41.3 million at June
30, 1998, as compared to $29.1 million at December 31, 1997. Funds for other
capital expenditures and working capital requirements are expected to be
provided from operations.

Parent Company
- --------------

Since June 30, 1998 and through August 13, 1998, the Company purchased
288,600 shares of its outstanding Common Stock at an aggregate cost of
approximately $24.2 million. Depending on market conditions, the Company from
time to time may purchase additional shares in the open market or otherwise.

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

Page 42

unrealized loss of $2.1 and $3.2 million at June 30, 1998 and December 31,
1997, respectively.

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" and "Quantitative and Qualitative Disclosures
about Market Risk" for additional information with respect to derivative
instruments, including recognized gains and losses on these instruments. See
also Note 4 of the Notes to Consolidated Financial Statements in the 1997
Annual Report on Form 10-K.

Page 43

Insurance
- ---------

A summary of CNA's general account fixed maturity securities portfolio and
short-term investments, at carrying value, are as follows:

Change in
Unrealized
June 30, December 31, Gains
1998 1997 (Losses)
------------------------------------
(In millions)
<S> <C> <C> <C>
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies . $11,043.0 $12,980.0 $ 18.0
Asset-backed securities ............. 5,697.0 4,804.0 8.0
Tax exempt securities ............... 5,996.0 4,724.0 (28.0)
Taxable ............................. 6,823.0 7,040.0 18.0
---------------------------------
Total fixed maturity securities. 29,559.0 29,548.0 16.0
Stocks ................................ 1,054.0 814.0 107.0
Short-term and other investments....... 5,498.0 5,829.0 (54.0)
Derivative security investments ....... 64.0 12.0
---------------------------------
Total .......................... $36,175.0 $36,203.0 $ 69.0
=================================
Short-term investments:
Commercial paper .................... $ 1,598.0 $ 1,850.0
Security repurchase collateral ...... 251.0 154.0
Escrow .............................. 969.0 1,065.0
U.S. Treasuries ..................... 536.0 558.0
Money markets ....................... 446.0 624.0
Others .............................. 588.0 633.0
Other investments ..................... 1,110.0 945.0
-----------------------
Total short-term and other
investments ................... $ 5,498.0 $ 5,829.0
=======================
</TABLE>

CNA's general account investment portfolio is managed to maximize after tax
investment return, while minimizing credit risks with investments concentrated
in high quality securities to support its insurance underwriting operations.

CNA has the capacity to hold its fixed maturity portfolio to maturity.
However, securities may be sold as part of CNA's asset/liability strategies or
to take advantage of investment opportunities generated by changing interest
rates, tax and credit considerations, or other similar factors. Accordingly,
fixed maturity securities are classified as available for sale.

CNA invests from time to time in certain derivative financial instruments
primarily 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.

Page 44

CNA considers its derivatives as being held for purposes other than trading.
Derivative securities, except for interest rate swaps associated with certain
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;
the changes in fair value are not recorded.

The general account portfolio consists primarily of high quality (BBB or
higher) marketable fixed maturity securities, approximately 94.3% of which are
rated as investment grade. At June 30, 1998, tax exempt securities and short-
term investments excluding collateral for securities sold under repurchase
agreements, comprised approximately 16.6% and 11.4%, respectively, of the
general account's total investment portfolio compared to 13.1% and 13.1%,
respectively, at December 31, 1997. Historically, CNA has maintained short-term
assets at a level that provided for liquidity to meet its short-term
obligations, as well as reasonable contingencies and anticipated claim payout
patterns. Short-term investments at both June 30, 1998 and December 31, 1997
are substantially higher than historical levels in anticipation of Fibreboard-
related claim payments. At June 30, 1998, the major components of the short-
term investment portfolio consist primarily of high grade commercial paper and
U.S. Treasury bills.

As of June 30, 1998, the market value of CNA's general account investments in
fixed maturities was $29.6 billion and was greater than amortized cost by
approximately $545.0 million. This compares to a market value of $29.5 billion
and approximately $528.0 million of net unrealized investment gains at December
31, 1997. The gross unrealized investment gains and losses for the fixed
maturity securities portfolio at June 30, 1998 were $653.0 and $108.0 million,
respectively, compared to $644.0 and $116.0 million, respectively, at December
31, 1997.

Net unrealized investment gains on general account fixed maturities at June
30, 1998 include net unrealized investment gains on high yield securities of
$4.0 million, compared to net unrealized investment losses of $2.0 million at
December 31, 1997. High yield securities are bonds rated as below investment
grade by bond rating agencies, plus private placements and other unrated
securities which, in the opinion of management, are below investment grade
(below BBB). Fair values of high yield securities in the general account
decreased $203.0 million to approximately $1.7 billion at June 30, 1998 when
compared to December 31, 1997.

At June 30, 1998, total Separate Account cash and investments amounted to
approximately $5.5 billion with taxable fixed maturity securities representing
approximately 82.5% of the Separate Accounts' portfolios. Approximately 68.7%
of Separate Account investments are used to fund guaranteed investments for
which CNA's life insurance affiliate guarantees principal and a specified
return to the contract holders. The duration of fixed maturity securities
included in the guaranteed investment portfolio are generally matched with the
corresponding payout pattern of the liabilities of the guaranteed investment
contracts. The fair value of all fixed maturity securities in the guaranteed
investment portfolio was $3.5 billion at June 30, 1998 compared to $3.8 billion
at December 31, 1997. At June 30, 1998, fair value exceeded amortized cost by
approximately $79.0 million, as compared to an unrealized gain of approximately
$71.0 million at December 31, 1997. The gross unrealized investment gains and
losses for the guaranteed investment fixed maturity securities portfolio at
June 30, 1998 were $93.0 and $14.0 million, respectively, as compared to a gain
of $87.0 million and loss of $16.0 million at December 31, 1997.

Carrying values of high yield securities in the guaranteed investment
portfolio were $272.0 and $310.0 million at June 30, 1998 and December 31,

Page 45

1997, respectively. Net unrealized investment losses on high yield securities
held in such Separate Accounts were $4.0 million at June 30, 1998, compared to
$1.0 million at December 31, 1997.

High yield securities generally involve a greater degree of risk than that of
investment grade securities. Expected returns should, however, compensate for
the added risk. The risk is also considered in the interest rate assumptions in
the underlying insurance products. At June 30, 1998, CNA's investment in high
yield bonds, including Separate Accounts, was approximately 3.4% of its total
assets. In addition, CNA's investment in mortgage loans and investment real
estate are substantially below the industry average, representing less than one
quarter of one percent of its total assets.

Included in CNA's fixed maturity securities at June 30, 1998 (general and
guaranteed investment portfolios) are $8.0 billion of asset-backed securities,
consisting of approximately 51.3% in collateralized mortgage obligations
("CMO's"), 16.1% in corporate asset-backed obligations, 23.5% in corporate
mortgage backed security pass-through obligations and 9.1% in U.S. government
agency issued pass-through certificates. The majority of CMO's held are
corporate mortgaged backed securities, which are actively traded in liquid
markets and are priced monthly by broker-dealers. At June 30, 1998, the fair
value of asset-backed securities exceeded the amortized cost by approximately
$139.0 million compared to net unrealized investment gains of $114.0 million at
December 31, 1997. CNA limits the risks associated with interest rate
fluctuations and prepayment by concentrating its CMO investments in early
planned amortization classes with relatively short principal repayment windows.

At June 30, 1998, 38.8% of the general account's fixed maturity securities
portfolio was invested in U.S. government securities, 36.2% in other AAA rated
securities and 13.9% in AA and A rated securities. CNA's guaranteed investment
fixed maturity securities portfolio is comprised of 3.8% U.S. government
securities, 62.9% in other AAA rated securities and 14.2% in AA and A rated
securities. These ratings are primarily from Standard and Poor's.

Results of Operations:
- ----------------------

Revenues increased by $655.7 and $511.7 million, or 13.8% and 5.3%,
respectively, and net income increased by $183.4 million and decreased by
$139.6 million, respectively, for the quarter and six months ended June 30,
1998 as compared to the corresponding periods of the prior year. The following
table sets forth the major sources of the Company's consolidated revenues and
net income.

Page 46

Three Months Ended Six Months Ended
June 30, June 30,
-----------------------------------------------------
1998 1997 1998 1997
-----------------------------------------------------
(In millions)

<S> <C> <C> <C> <C>
Revenues (a):
Property and casualty insurance ....... $3,454.4 $3,256.7 $ 6,754.0 $6,332.0
Life insurance ........................ 978.6 988.2 2,008.4 2,029.6
Cigarettes ............................ 709.6 604.3 1,285.3 1,120.8
Hotels ................................ 64.9 61.1 113.4 107.0
Offshore drilling ..................... 331.3 234.0 623.9 441.6
Watches and clocks .................... 28.5 27.9 60.8 57.9
Investment (loss) income-net (non-
insurance companies) ................. (162.1) (420.7) (643.2) (394.2)
Other and eliminations-net ............ (.4) (2.4) (2.7) (6.5)
----------------------------------------------------
$5,404.8 $4,749.1 $10,199.9 $9,688.2
====================================================

Net income (a):
Property and casualty insurance ....... $ 153.5 $ 163.7 $ 321.8 $ 284.4
Life insurance ........................ 37.5 42.4 79.0 77.1
Cigarettes ............................ 138.6 123.5 160.7 203.0
Hotels ................................ 10.0 8.9 11.5 9.1
Offshore drilling ..................... 52.2 30.6 90.0 57.4
Watches and clocks .................... 1.8 1.2 4.1 2.7
Investment (loss) income-net (non-
insurance companies) ................. (106.3) (275.1) (421.4) (260.6)
Corporate interest expense ............ (21.7) (16.6) (44.0) (32.4)
Unallocated corporate expense and
other-net ............................ (18.4) (14.8) (38.2) (37.6)
----------------------------------------------------
$ 247.2 $ 63.8 $ 163.5 $ 303.1
====================================================

(a) Includes investment gains (losses) as follows:
<CAPTION>

Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------------------
1998 1997 1998 1997
---------------------------------------------------

<S> <C> <C> <C> <C>
Revenues:
Property and casualty insurance ....... $ 191.3 $ 127.7 $ 325.9 $ 146.0
Life insurance ........................ 42.3 43.4 90.5 72.5
Investment income-net ................. (208.0) (466.5) (741.4) (485.1)
---------------------------------------------------
$ 25.6 $(295.4) $(325.0) $(266.6)
===================================================

Net income:
Property and casualty insurance ....... $ 103.1 $ 69.4 $ 175.4 $ 79.5
Life insurance ........................ 20.6 22.0 46.3 36.9
Investment income-net ................. (135.0) (303.4) (481.7) (317.3)
---------------------------------------------------
$ (11.3) $(212.0) $(260.0) $(200.9)
===================================================
</TABLE>

Page 47

Insurance
- ---------

Property and casualty revenues, excluding investment gains, increased by
$134.1 and $242.1 million, or 4.3% and 3.9%, for the quarter and six months
ended June 30, 1998, as compared to the same periods a year ago.

Property and casualty premium revenues increased by $136.5 and $193.0
million, or 5.4% and 3.9%, for the quarter and six months ended June 30, 1998,
from the prior year's comparable periods. The increase is attributable to
higher involuntary risk earned premium of approximately $206.0 million and an
increase in personal lines premiums of approximately $41.0 million, partially
offset by lower commercial lines premiums of approximately $54.0 million.
Involuntary premium for 1997 reflected reductions in estimates of premium for
1996 and prior periods, primarily in the workers' compensation line of
business, and a greater willingness on the part of the involuntary market,
including CNA, to write these types of risks. The 1998 estimated premiums
reflect a return to historical levels. The increase in personal lines premium
continues the trend seen in 1997 and the first quarter of 1998 and is
attributable to growth in private passenger automobile business and individual
long-term care. The decrease in commercial lines is primarily due to a decrease
in accident and health business. Net investment income decreased by $2.0 and
$10.0 million, or 0.4% and 1.1%, for the quarter and six months ended June 30,
1998, compared with the same period in the prior year, due to lower yielding
investments. The bond segment of the investment portfolio yielded 6.2% in the
first half of 1998 compared with 6.4% for the same period a year ago.

Life insurance revenues, excluding investment gains, decreased by $8.5 and
$39.2 million, or 0.9% and 2.0%, for the quarter and six months ended June 30,
1998 as compared to the same periods a year ago. Life premium revenues
decreased by $17.4 and $52.4 million, or 2.1% and 3.1%, for the quarter and six
months ended June 30, 1998. The decrease is primarily due to lower premiums for
the Federal Employees Health Benefit Plan ("FEHBP") and a reduction in
individual annuities. The decrease in FEHBP premiums is due to improved claim
experience upon which premiums are based and continues the trend from the first
quarter of this year. The decrease in individual annuity premium is
attributable to a shift in CNA's marketing efforts towards more profitable
products. Life net investment income increased by $14.0 and $20.0 million, or
14.1% and 9.8%, for the quarter and six months ended June 30, 1998, compared to
the same periods a year ago. The bond segment of the life investment portfolio
yielded approximately 6.4% in the first half of 1998 and 1997.

Property and casualty underwriting losses for the quarter and six months
ended June 30, 1998 were $373.0 and $661.0 million, compared to $277.2 and
$570.4 million for the same periods in 1997. The increase in underwriting
losses is primarily due to an increase in catastrophe losses for the first six
months of 1998. Pre-tax catastrophe losses were approximately $126.0 and $151.0
million for the quarter and six months ended June 30, 1998 as compared to $45.0
and $76.0 million in 1997. The increase in catastrophe losses is mainly due to
spring storms throughout the United States.

Page 48

The components of CNA's investment gains are as follows:

Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------
1998 1997 1998 1997
-------------------------------------------------
(In millions)

<S> <C> <C> <C> <C>
Bonds:
U.S. Government ....................... $ 46.0 $ 43.1 $ 96.0 $ 49.0
Tax exempt ............................ 16.0 1.7 32.0 2.2
Asset-backed .......................... 14.0 2.4 27.0 9.2
Taxable ............................... 40.0 73.6 69.0 84.0
-------------------------------------------------
Total bonds ........................ 116.0 120.8 224.0 144.4
Stocks .................................. 17.0 9.6 13.0 39.3
Derivative instruments .................. 41.0 (4.0) 34.0 (.7)
Separate Accounts and other ............. 58.0 45.6 144.0 55.0
-------------------------------------------------
Total investment gains ............. $232.0 $172.0 $415.0 $238.0
=================================================
</TABLE>

CNA's primary property and casualty subsidiary, Continental Casualty Company,
is party to litigation with Fibreboard Corporation involving coverage for
certain asbestos-related claims and defense costs (see Note 5 of the Notes to
Consolidated Condensed Financial Statements).

Cigarettes
- ----------

Revenues increased by $105.3 and $164.5 million, or 17.4% and 14.7%,
respectively, and net income increased by $15.1 million, or 12.2%, and
decreased by $42.3 million, or 20.8%, respectively, for the quarter and six
months ended June 30, 1998 as compared to the corresponding periods of the
prior year.

The increase in revenues is composed primarily of an increase of
approximately $76.3 and $134.9 million, or 12.7% and 12.1%, respectively, due
to higher average unit prices and an increase of approximately $22.4 and $16.9
million, or 3.7% and 1.5%, reflecting higher unit sales volume for the quarter
and six months ended June 30, 1998, as compared to the corresponding periods of
the prior year.

Net income for the quarter and six months ended June 30, 1998 includes a pre-
tax charge of $45.1 and $187.5 million ($27.0 and $112.1 million after taxes)
to reflect the settlement of tobacco litigation in Texas, Mississippi, Florida
and Minnesota. Included in the tobacco litigation charges was $30.7 million
($18.4 million after taxes) for the three months ended June 30, 1998 for the
amended settlements with the states of Mississippi and Texas (see Note 5 of the
Notes to Consolidated Condensed Financial Statements). Excluding these charges,
net income would have increased by $42.1 and $69.8 million, or 34.1% and 34.4%,
as a result of the improved revenues, partially offset by higher legal
expenses.

Lorillard's unit sales volume increased by 3.8% and 0.9%, while Newport's
sales volume increased by 8.4% and 5.5% for the quarter and six months ended
June 30, 1998, as compared to the corresponding periods of the prior year.
Newport, a full price brand, accounted for 78.3% of Lorillard's unit sales.
Discount brand sales have decreased from an average of 31.4% of industry sales

Page 49

during 1994 to an average of 27.0% during 1997. At June 30, 1998, they
represented 26.6% of industry sales.

Hotels
- ------

Revenues increased by $3.8 and $6.4 million, or 6.2% and 6.0%, respectively,
and net income increased by $1.1 and $2.4 million, or 12.4% and 26.4%,
respectively, for the quarter and six months ended June 30, 1998, as compared
to the prior year, due primarily to higher overall average room rates and
increased occupancy rates at the New York properties. Revenues also increased
for the quarter due to the collection of a $2.2 million pre-opening advance
which had been fully reserved. These increases were partially offset by lower
results from the Loews Monte Carlo.

Offshore drilling
- -----------------

Revenues increased by $97.3 and $182.3 million, or 41.6% and 41.3%, and net
income increased by $21.6 and $32.6 million, or 70.6% and 56.8%, respectively,
for the quarter and six months ended June 30, 1998, as compared to the prior
year.

Revenues from semisubmersible rigs increased by $79.3 and $144.0 million, or
33.9% and 32.6%, for the quarter and six months ended June 30, 1998. The
revenue increase is due to higher dayrates ($69.2 and $126.4 million),
recognized by semisubmersible rigs located in the North Sea and the Gulf of
Mexico. These increases were partially offset by revenues foregone ($14.7 and
$47.8 million) during mandatory inspections. Revenues from jackup rigs
increased by $16.4 and $32.9 million, or 7.0% and 7.5%, due to improvements in
dayrates, primarily in the Gulf of Mexico ($17.9 and $38.6 million).

Net income for the quarter and six months ended June 30, 1998 increased due
primarily to the higher revenues discussed above, partially offset by increased
contract drilling expenses due to higher utilization of rigs and increased
depreciation and administrative expenses.

Watches and Clocks
- ------------------

Revenues increased by $0.6 and $2.9 million, or 2.2% and 5.0%, respectively,
and net income increased by $0.6 and $1.4 million, or 50.0% and 51.9%,
respectively, for the quarter and six months ended June 30, 1998 as compared to
the corresponding periods of the prior year.

Revenues increased for the quarter and six months ended June 30, 1998 due
primarily to increased watch unit prices and, for the six months ended June 30,
1998, increased sales volume.

Net income increased for the quarter and six months ended June 30, 1998 due
primarily to the increased revenue discussed above and lower cost of sales.

Other
- -----

Revenues increased by $260.6 million, or 61.6%, and decreased $245.2 million,
or 61.2%, respectively, and net loss decreased by $160.1 million, or 52.2%, and
increased by $173.0, or 52.3%, respectively, for the quarter and six months
ended June 30, 1998 as compared to the corresponding periods of the prior year.

Page 50

The components of investment (losses) gains included in Investment (loss)
income-net are as follows:

Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
--------------------------------------
(In millions)

<S> <C> <C> <C> <C>
Revenues:
Derivative instruments (1) ............ $(121.6) $(357.4) $(500.2) $(380.7)
Equity securities, including short
positions (1) ........................ (82.7) (135.3) (229.3) (149.3)
Fixed maturities ...................... (3.7) (3.3) (12.0) 14.9
Short-term investments, primarily U.S.
government securities ................ .5 (.3) .6 (.4)
Gain on issuance of subsidiary's stock 29.1 29.1
Other ................................. (.5) .7 (.5) 1.3
------------------------------------
(208.0) (466.5) (741.4) (485.1)
Income tax benefit ...................... 72.9 163.2 259.6 169.7
Minority interest ....................... .1 (.1) .1 (1.9)
------------------------------------

Net (loss) income .................. $(135.0) $(303.4) $(481.7) $(317.3)
====================================
</TABLE>

(1) Includes losses on short sales, equity index futures and options
aggregating $171.1, $475.9, $713.4 and $522.1 for the quarter and six
months ended June 30, 1998 and 1997, respectively. The Company continues
to maintain these positions.

Exclusive of securities transactions, revenues increased $2.1 and $11.1
million, or 4.8% and 13.2%, for the quarter and six months ended June 30, 1998
due primarily to increased investment interest income. Net loss increased by
$8.3 and $8.6 million for the quarter and six months ended June 30, 1998 due to
higher corporate interest expenses, partially offset by the increased interest
income.

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 $70.0 to $80.0
million.

Page 51

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 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 entities that are
subject to insurance-related assessments. It requires that entities recognize
liabilities for insurance-related assessments when all of the following
criteria have been met: an assessment has been imposed or a probable assessment
will be imposed; the event obligating an entity to pay an imposed or probable
assessment has occurred on or before the date of the financial statements; and
the amount of the assessment can be reasonably estimated. 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.

In March 1998, the AICPA's Accounting Standards Executive Committee issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained

Page 52

for Internal Use," which provides guidance on accounting for costs of computer
software developed or obtained for internal use and for determining whether
computer software is for internal use. For purposes of this SOP, internal-use
software is software acquired, internally developed or modified solely to meet
the entity's internal needs for which no substantive plan exists or is being
developed to market the software externally during the software's development
or modification. Accounting treatment for costs associated with software
developed or obtained for internal use, as defined by this SOP, is based upon a
number of factors, including the point in time during the project that costs
are incurred as well as the types of costs incurred. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company is currently evaluating the effects of this SOP.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for the
accounting and reporting for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment,
(b) a hedge of the exposure to variable cash flows of a forecasted transaction,
or (c) a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. The
accounting for changes in the fair value of a derivative depends on the
intended use of the derivative and the resulting designation. This Statement is
effective for all fiscal quarters of fiscal years beginning after June 15,
1999. The Company is currently evaluating the effects of this Statement on its
accounting and reporting for derivatives and hedges.

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.

Item 3. 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

Page 53

portfolio would be recognized as investment gains (losses) in the income
statement. Market risk exposure is presented for each class of financial
instrument held by the Company at June 30, 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:

June 30, 1998
- -------------------------------------------------------------------------------
Fair Value Market
Category of risk exposure: Asset (Liability) Risk
- -------------------------------------------------------------------------------
(In millions)

<S> <C> <C>
Equity markets (1):
Equity securities $ 218.1 $ 54.5
Options purchased 328.3 (230.1)
Options written (49.8) (2.3)
Futures (249.9)
Short sales (763.5) (190.9)
Commodities:
Oil (2):
Swaps (1.5) 3.2
Energy purchase obligations (14.1) (6.0)
Gold (3):
Options purchased 13.6 (13.6)
Options written (3.4) 3.4
Other (4) .3 (.9)
- -------------------------------------------------------------------------------
</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.

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

Page 54

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.

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:

<S> <C> <C>
Equity market (1):
Equity securities:
CNA Financial general accounts (a) $ 1,054.0 $ (264.0)
CNA Financial separate accounts 208.0 (52.0)
Equity index futures, separate accounts (b) (209.0)
Interest rate (2):
Fixed maturities (a) 31,010.1 (1,633.0)
Short-term investments (a) 7,609.5 (9.0)
Interest rate swaps (3.0) 9.0
Separate Accounts:
Fixed maturities (a) 4,496.0 (219.0)
Short-term investments (a) 605.0 (1.0)
Long-term debt (5,713.4)
- -------------------------------------------------------------------------------
</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 $(392.0).
(b) This market risk would be offset by decreases in liabilities to
customers under variable insurance contracts.

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 June 30, 1998, with all other variables held constant.

Page 55

Interest Rate Risk - The Company has exposure to interest rate risk arising
from changes in the level or volatility of interest rates. The Company attempts
to mitigate its exposure to interest rate risk by utilizing instruments such as
interest rate swaps, interest rate caps, commitments to purchase securities,
options, futures and forwards. The Company monitors its sensitivity to interest
rate risk by evaluating the change in its financial assets and liabilities
relative to fluctuations in interest rates. The evaluation is made using an
instantaneous parallel change in interest rates by varying magnitudes on a
static balance sheet to determine the effect such a change in rates would have
on the 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. Also the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Accordingly the analysis may not be indicative of, is not intended to provide,
and does not provide a precise forecast of the effect of changes of market
interest rates on the Company's earnings or shareholders' equity. Further, the
computations do not contemplate any actions the Company would undertake in
response to changes in interest rates.

The Company's long-term debt, including interest rate swap agreements, as of
June 30, 1998 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 interest
rates increasing 100 basis points from their levels at June 30, 1998, 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 Deutschmarks 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 June 30,
1998, with all other variables held constant.

Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in 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.

Page 56

PART II. OTHER INFORMATION

Item 1. 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 Note 5 of the Notes to Consolidated
Condensed Financial Statements in Part I.

2. Lorillard is involved in various lawsuits involving tobacco products
seeking damages for cancer and other health effects claimed to have resulted
from the use of cigarettes or from exposure to tobacco smoke. Information
involving such lawsuits is incorporated by reference to Note 5 of the Notes to
Consolidated Condensed Financial Statements in Part I.

Item 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------

Set forth below is information relating to the 1998 Annual Meeting of
Shareholders of the Registrant:

The annual meeting was called to order at 11:00 A.M., May 12, 1998.
Represented at the meeting, in person or by proxy, were 103,646,155 shares,
approximately 90.1% of the issued and outstanding shares entitled to vote.

The following business was transacted:

Election of Directors
- -------------------------------------------------------------------------------
Over 98% of the votes cast for directors were voted for the election of the
following directors. The number of votes for and withheld with respect to each
director was as follows:

Votes For Votes Withheld
--------- --------------

Charles B. Benenson 101,643,862 2,002,293
John Brademas 101,644,315 2,001,840
Dennis H. Chookaszian 101,647,016 1,999,139
Paul J. Fribourg 101,647,139 1,999,016
Bernard Myerson 101,600,908 2,045,247
Edward J. Noha 101,579,010 2,067,145
Gloria R. Scott 101,631,308 2,014,847
Andrew H. Tisch 101,540,162 2,105,993
James S. Tisch 101,574,417 2,017,738
Jonathan M. Tisch 101,583,843 2,062,312
Laurence A. Tisch 101,556,813 2,089,342
Preston R. Tisch 101,568,411 2,077,744

Ratification of the appointment of Independent Certified Public Accountants
- -------------------------------------------------------------------------------
Approved-- 103,353,698 shares, approximately 99.7% of the shares voting,
voted to ratify the appointment of Deloitte & Touche, LLP as independent
certified public accountants for the Company. 140,438 shares, approximately
0.1% of the shares voting, voted against, and 152,019 shares, approximately
0.2% of the shares voting, abstained.

Page 57

Shareholder proposal relating to reporting of executive compensation
- -------------------------------------------------------------------------------
Rejected-- 85,477,678 shares, approximately 89.6% of the shares voting, voted
against this shareholder proposal. 3,567,145 shares, approximately 3.8% of the
shares voting, were cast for, and 6,323,417 shares, approximately 6.6% of the
shares voting, abstained. In addition, there were 8,277,917 shares as to which
brokers indicated that they did not have authority to vote ("broker non-votes").

Shareholder proposal relating to pregnant women
- -------------------------------------------------------------------------------
Rejected-- 84,264,878 shares, approximately 88.4% of the shares voting, voted
against this shareholder proposal. 3,262,605 shares, approximately 3.4% of the
shares voting, were cast for, and 7,838,358 shares, approximately 8.2% of the
shares voting, abstained. In addition, there were 8,280,314 broker non-votes.

Shareholder proposal relating to teen smoking
- -------------------------------------------------------------------------------
Rejected-- 84,794,827 shares, approximately 88.9% of the shares voting, voted
against this shareholder proposal. 2,668,432 shares, approximately 2.8% of the
shares voting, were cast for, and 7,904,982 shares, approximately 8.3% of the
shares voting, abstained. In addition, there were 8,277,914 broker non-votes.

Shareholder proposal relating to independent directors
- -------------------------------------------------------------------------------
Rejected-- 69,131,815 shares, approximately 72.5% of the shares voting, voted
against this shareholder proposal. 25,680,990 shares, approximately 27.0% of
the shares voting, were cast for, and 555,434 shares, approximately 0.5% of the
shares voting, abstained. In addition, there were 8,277,916 broker non-votes.

Shareholder proposal relating to confidential voting
- -------------------------------------------------------------------------------
Rejected-- 54,025,770 shares, approximately 56.6% of the shares voting, voted
against this shareholder proposal. 40,908,196 shares, approximately 42.9% of
the shares voting, were cast for; and 431,875 shares, approximately 0.5% of the
shares voting, abstained. In addition, there were 8,280,314 broker non-votes.

Shareholder proposal relating to nominating committee
- -------------------------------------------------------------------------------
Rejected-- 72,493,202 shares, approximately 76.0% of the shares voting, voted
against this shareholder proposal. 22,301,002 shares, approximately 23.4% of
the shares voting, were cast for, and 571,635 shares, approximately 0.6% of the
shares voting, abstained. In addition, there were 8,280,316 broker non-votes.

Shareholder proposal relating to cigarette filters
- -------------------------------------------------------------------------------
Rejected-- 83,881,349 shares, approximately 88.0% of the shares voting, voted
against this shareholder proposal. 3,786,727 shares, approximately 4.0% of the
shares voting, were cast for, and 7,700,166 shares, approximately 8.0% of the
shares voting, abstained. In addition, there were 8,277,913 broker non-votes.

Page 58

Item 6. Exhibits and Reports on Form 8-K.
--------------------------------

(a) Exhibits--

(10.1) Stipulation of Amendment to Settlement Agreement and For Entry
of Agreed Order, dated July 2, 1998, regarding the settlement
of the Mississippi health care cost recovery action.

(10.2) Mississippi Fee Payment Agreement, dated July 2, 1998,
regarding the payment of attorneys' fees.

(10.3) Mississippi MFN Escrow Agreement, dated July 2, 1998.

(10.4) Stipulation of Amendment to Settlement Agreement and For Entry
of Consent Decree, dated July 24, 1998, regarding the
settlement of the Texas health care recovery action.

(10.5) Texas Fee Payment Agreement, dated July 24, 1998, regarding the
payment of attorneys' fees.

(27.1) Financial Data Schedule for the six months ended June 30, 1998.

(b) Current reports on Form 8-K--There were no reports on Form 8-K filed for
three months ended June 30, 1998.

Page 59

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

LOEWS CORPORATION
-----------------
(Registrant)

Dated: August 14, 1998 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
(Duly authorized officer
and principal financial
officer)

Page 60

Exhibit 10.1

IN THE CHANCERY COURT OF JACKSON COUNTY,
STATE OF MISSISSIPPI

)
IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429
STATE OF MISSISSIPPI TOBACCO LITIGATION )
)

STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT
AND FOR ENTRY OF AGREED ORDER

THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF
AGREED ORDER (the "Stipulation of Amendment") is made as of the date hereof, by
and among the parties hereto, as indicated by their signatures below, to amend
the Comprehensive Settlement Agreement and Release entered into by the parties
hereto with respect to this Action on October 17, 1997 (the "Settlement
Agreement").

WHEREAS, on July 2, 1997, the State of Mississippi and certain defendants
(the "Settling Defendants") entered into a Memorandum of Understanding (the
"MOU"), setting forth the terms of an agreement in principle to settle all
present and future claims relating to the subject matter of this Action, which
MOU contemplated that the parties would draft and execute a comprehensive
settlement agreement incorporating the terms of the MOU as well as other
customary terms and conditions, including releases;

WHEREAS, on October 17, 1997, the State of Mississippi and Settling
Defendants entered into the Settlement Agreement to settle and resolve with
finality all present and future civil claims against all parties to this
litigation relating to the subject matter of this litigation which have been or
could have been asserted by any of the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated December 29, 1997;

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of this Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Mississippi will
obtain treatment at least as relatively favorable as any such non-federal
governmental entity;

WHEREAS, on May 8, 1998, Settling Defendants entered into a pre-verdict
settlement agreement with the State of Minnesota to settle the lawsuit State of
Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed
Aug. 17, 1994) (the "Minnesota Settlement");

WHEREAS, the State of Mississippi and Settling Defendants agree that,
pursuant to the Most Favored Nation clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Mississippi and Settling Defendants have agreed on
the terms of revisions to the Settlement Agreement in light of the Minnesota
Settlement, as set forth in this Stipulation of Amendment and the Agreed Order
attached as Exhibit 1 hereto; and

WHEREAS, the parties hereto have further agreed jointly to petition the
Court for approval of the Agreed Order:

NOW, THEREFORE, BE IT KNOWN THAT, pursuant to the Most Favored Nation
clause of the Settlement Agreement and in consideration of their mutual
agreement to the terms of this Stipulation of Amendment (including, inter alia,
waiver of any further claim to revise the Settlement Agreement pursuant to the
Most Favored Nation clause, except as expressly provided herein), and such other
consideration as described herein, the sufficiency of which is hereby
acknowledged, the parties hereto, acting by and through their authorized agents,
memorialize and agree as follows:

1. Amendment of Settlement Agreement. The provisions of this Stipulation
of Amendment supplement the terms of the Settlement Agreement,

which shall remain in full force and effect except insofar as they are expressly
revised by the provisions of this Stipulation of Amendment.

2. Voluntary Agreement of the Parties. The Court may, upon the State's
application, enter the Agreed Order attached hereto as Exhibit A. The State and
Settling Defendants understand that Congress may enact legislation dealing with
some of the issues addressed in the Settlement Agreement, this Stipulation of
Amendment or the Agreed Order. Settling Defendants and their assigns,
affiliates, agents and successors hereby voluntarily waive any right to
challenge the Settlement Agreement, this Stipulation of Amendment or the Agreed
Order, directly or through third parties, on the ground that any term thereof or
hereof is unconstitutional, outside the power or jurisdiction of the Court or
preempted by or in conflict with any current or future federal legislation
(except insofar as any terms of the Settlement Agreement (as revised hereby) or
the Agreed Order that relate to matters other than payments are irreconcilable
with any such future federal legislation).

3. Definitions. For the purposes of the Settlement Agreement, this
Stipulation of Amendment and the Agreed Order, the following terms shall have
the meanings set forth below:

(a) "Consumer Price Index" means the Consumer Price Index for All
Urban Consumers for the most recent twelve-month period for which

such percentage information is available, as published by the Bureau of
Labor Statistics of the U.S. Department of Labor;

(b) "Market Share" means a Settling Defendant's respective share of
sales of cigarettes, by number of individual cigarettes shipped for
consumption in the United States, during (i) with respect to payments made
pursuant to paragraph 7 of this Stipulation of Amendment, the calendar
year ending on the date on which the payment at issue is due, regardless
of when such payment is made, and (ii) with respect to all other payments
made pursuant to this Stipulation of Amendment and the Settlement
Agreement, the calendar year immediately preceding the year in which the
payment at issue is due, regardless of when such payment is made;

(c) "Cigarettes" means any product which contains nicotine, is
intended to be burned or heated under ordinary conditions of use, and
consists of or contains (i) any roll of tobacco wrapped in paper or in any
substance not containing tobacco; or (ii) tobacco, in any form, that is
functional in the product, which, because of its appearance, the type of
tobacco used in the filler, or its packaging and labeling, is likely to be
offered to, or purchased by, consumers as a cigarette; or (iii) any roll
of tobacco wrapped in any substance containing tobacco which, because of
its appearance, the type of tobacco used in the filler, or its packaging
and

labeling, is likely to be offered to, or purchased by, consumers as a
cigarette described in subparagraph (i) of this paragraph;

(d) "Smokeless Tobacco" means any powder that consists of cut,
ground, powdered or leaf tobacco that contains nicotine and that is
intended to be placed in the oral cavity;

(e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and

(f) "Children" means persons under the age of 18;

The above definitions supplement the definitions provided in the Settlement
Agreement and, insofar as they differ, supersede them.

4. Settlement Receipts. The payments to be made by Settling Defendants
under the Settlement Agreement and this Stipulation of Amendment constitute
reimbursement for public health expenditures of the State of Mississippi and the
political subdivisions and agencies of the State of Mississippi, including but
not limited to the Mississippi State Employees Health Insurance Plan, University
Medical Center and charity hospitals, as well as for Medicaid expenditures of
the State of Mississippi. Any payments made by Settling Defendants in a given
year are in settlement of claims for damages by the State in the year of payment
or earlier years related to the subject matter of this Action, including,
without limitation, claims for equitable and injunctive relief, claims for
health care

expenditures and claims for punitive damages, except that no part of any payment
under the Settlement Agreement or this Stipulation of Amendment is made in
settlement of an actual or potential liability for a fine, penalty (civil or
criminal) or enhanced damages or as the cost of a tangible or intangible asset
or other future benefit. In consonance with the relief sought by this Action and
the Proposed Resolution, the parties hereto anticipate that the funds provided
hereunder and under the Settlement Agreement, other than funds provided pursuant
to the Settlement Agreement that are dedicated for the Mississippi Pilot Program
and legal expense reimbursement, will be used for health-related expenditures of
the State of Mississippi. This paragraph 4 supersedes paragraph 11 of the
Settlement Agreement, which is hereby rendered null, void and of no further
effect.

5. Supplemental Initial Payment. Each Settling Defendant severally shall
cause to be paid, pro rata in proportion to its Market Share and in accordance
with and subject to paragraph 17 of this Stipulation of Amendment, to an account
designated in writing by the State of Mississippi, its share of $41,738,000, to
be paid on or before January 4, 1999; its share of $145,173,000, to be paid on
or before January 3, 2000; its share of $145,173,000, to be paid on or before
January 2, 2001; its share of $145,173,000, to be paid on or before January 2,
2002; and its share of $72,743,000, to be paid on or before January 2, 2003. The
payments made by Settling Defendants pursuant to this paragraph shall be
adjusted upward

by the greater of 3% or the actual total percent change in the Consumer Price
Index applied each year on the previous year, beginning with the payment due to
be made on or before January 3, 2000. The payments due to be made by Settling
Defendants pursuant to this paragraph on or before January 3, 2000, on or before
January 2, 2001, on or before January 2, 2002, and on or before January 2, 2003,
will also be decreased or increased, as the case may be, in accordance with the
formula for adjustment of payments set forth in Appendix A hereto. The payment
due to be made by Settling Defendants pursuant to this paragraph 5 on or before
January 4, 1999, shall not be subject to adjustment for inflation or in
accordance with the formula for adjustment of payments set forth in Appendix A
hereto.

6. Acceleration of Supplemental Initial Payment. In the event that any
Settling Defendant fails to make any payment required of it pursuant to
paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the
applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of
Mississippi shall provide notice to each of the Settling Defendants of such
non-payment. The Defaulting Defendant shall have 15 days after receipt of such
notice to pay the Missed Payment, together with interest accrued from the
original applicable due date at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the date of default plus 3%.
If the Defaulting Defendant does not make such payment within such 15-day
period, the State of

Mississippi shall have the option of providing notice to each of the Settling
Defendants of such continued non-payment. In the event that the State of
Mississippi elects to provide such notice, any or all of the Settling Defendants
(other than the Defaulting Defendant) shall have 15 days after receipt of such
notice to elect (in such Settling Defendant's or such Settling Defendants' sole
and absolute discretion) to pay the Missed Payment, together with interest
accrued from the original applicable due date at the prime rate as published in
the Wall Street Journal on the latest publication date on or before the date of
default plus 3%. In the event that the State of Mississippi does not receive the
Missed Payment, together with such accrued interest, within such additional
15-day period, all payments required to be made by each of the respective
Settling Defendants pursuant to paragraph 5 of this Stipulation of Amendment
that have yet to come due prior to the conclusion of such additional 15-day
period shall be accelerated and immediately become due and owing to the State of
Mississippi from each Settling Defendant, pro rata in proportion to its Market
Share; provided, however, that such accelerated payments (a) shall all be
adjusted upward by the greater of (i) the rate of 3% per annum or (ii) the
actual total percent change in the Consumer Price Index, in either instance for
the period between January 1 of the year in which the acceleration of payments
pursuant to this paragraph occurs and the date on which such accelerated
payments are made pursuant to this paragraph 6, and (b)

shall all immediately be adjusted in accordance with the formula for adjustment
of payments set forth in Appendix A hereto.

Nothing in this paragraph 6 shall be deemed under any circumstance to
create any obligation on the part of any Settling Defendant to pay any amount
owed or payable to the State of Mississippi by any other Settling Defendant. All
obligations of the Settling Defendants pursuant to this paragraph 6 are intended
to be and shall remain several, and not joint.

7. Annual Payments. Each of the Settling Defendants agrees that, beginning
on December 31, 1998 (subject to adjustment for appropriate allocation among
Settling Defendants by January 30, 1999), and annually thereafter on December
31st of each year after 1998 (subject to final adjustment within 30 days), it
shall severally cause to be paid to an account designated in writing by the
State of Mississippi, in accordance with and subject to paragraph 17 of this
Stipulation of Amendment, pro rata in proportion to its respective Market Share,
its share of 1.7% of the following amounts (in billions):

Year 1998 1999 2000 2001 2002 2003 thereafter

1 2 3 4 5 6

Amount $4B $4.5B $5B $6.5B $6.5B $8B $8B

annual payment due on December 31, 1999. Such payments will also be decreased or
increased, as the case may be, beginning with the annual payment due on December
31, 1999, in accordance with the formula for adjustments of payments set forth
in Appendix A. This paragraph 7 supersedes paragraph 9 of the Settlement
Agreement (and, insofar as not already superseded thereby, paragraph 3 of the
MOU), which is hereby rendered null, void and of no further effect.

8. Determination of Market Share. In the event of a disagreement between
or among any Settling Defendants as to their respective shares of any payment
due to be paid on a Market Share basis pursuant to the Settlement Agreement and
this Stipulation of Amendment, each Settling Defendant shall pay its undisputed
share of such payment promptly on or before the date on which such payment is
due, and shall, within 21 days of such date, submit copies of its federal excise
tax reports for the year in question to a third party to be selected by
agreement of Settling Defendants (the "Third Party"), who shall determine the
Market Share of each Settling Defendant within 3 business days of receipt of
such federal excise tax reports. The decision of the Third Party shall be final
and non-appealable, and shall be communicated by facsimile to each person
designated to receive notice under paragraph 23 of the Settlement Agreement.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay the State or such other Settling Defendant, as
appropriate, the difference, if any, between (1)

the amount that such Settling Defendant has already paid with respect to the
payment in question and (2) the amount of the payment in question that
corresponds to such Settling Defendant's Market Share as determined by the Third
Party, together with interest accrued from the original date on which the
payment in question was due, at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the original date on which
the payment in question was due, plus 3%.

9. Adjustments in Event of Federal Legislation. In the event that federal
tobacco legislation is enacted before November 30, 2000 that provides for
payments by tobacco companies (whether in the form of settlement payment, tax or
otherwise) ("Tobacco Legislation"):

(a) Settling Defendants shall be entitled to receive a dollar for
dollar offset against the annual payments required under paragraph 7 of
this Stipulation of Amendment of any amounts that the State of Mississippi
could elect to receive pursuant to such Tobacco Legislation ("Federal
Settlement Funds"), up to the full amount of such annual payments, except
to the extent that:

(i) such Federal Settlement Funds are required to be used for
purposes other than health care or tobacco-related purposes;

(ii) such Tobacco Legislation does not provide for the
abrogation, settlement or relinquishment of state tobacco-related
claims; or

(iii) state receipt of such Federal Settlement Funds is
conditioned upon (A) the relinquishment of rights or benefits under
the Settlement Agreement (including this Stipulation of Amendment
and the Agreed Order) (excepting any annual payment amounts subject
to the offset); or (B) actions or expenditures by the state
unrelated to health care or tobacco (including but not limited to
tobacco education, cessation, control or enforcement).

(b) Nothing in this paragraph 9 shall reduce (i) the payments made
to the State of Mississippi pursuant to paragraphs 7 and 8 of the
Settlement Agreement and paragraphs 5 and 6 of this Stipulation of
Amendment (by offset, credit, recoupment, refund or otherwise); or (ii)
the percentage figure (1.7%) used to determine the State of Mississippi's
annual payments pursuant to paragraph 7 of this Stipulation of Amendment.
Nothing in this paragraph 9 is intended to or shall reduce the total
amounts payable by Settling Defendants to the State of Mississippi under
the Settlement Agreement (as revised hereby) by an amount greater than the
amount of

Federal Settlement Funds that the State of Mississippi could elect to
receive.

This paragraph 9 supersedes paragraph 10 of the Settlement Agreement (and,
insofar as not already superseded thereby, paragraph 5 of the MOU), which is
hereby rendered null, void and of no further effect.

10. Clarification of Scope of State's Release. The release of claims
provided in paragraph 13 of the Settlement Agreement shall, with respect to the
Claims identified in subparagraph (2) thereof, apply only to monetary Claims
and, further, shall not operate as a release of any person, party or entity
(whether or not a signatory to the Settlement Agreement or this Stipulation of
Amendment) as to any of the obligations undertaken in the Settlement Agreement
(as revised hereby) in connection with a monetary breach or default thereof.
This paragraph 10 does not supersede but rather supplements and clarifies the
scope of the release provided in paragraph 13 of the Settlement Agreement.

11. Limited Most-Favored Nation Provision. In partial consideration for
the monetary payments to be made by Settling Defendants pursuant to this
Stipulation of Amendment, the State of Mississippi agrees that, if Settling
Defendants enter into any future pre-verdict settlement agreement of other
similar litigation brought by a non-federal governmental plaintiff, or any
amendment to any such existing settlement agreement, on terms more favorable to
such non-

federal governmental plaintiff than the terms of the Settlement Agreement
(including this Stipulation of Amendment and the Agreed Order) (after due
consideration of relevant differences in population or other appropriate
factors), the terms of the Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall not be revised except as follows: to the
extent, if any, such other pre-verdict settlement agreement includes terms that
provide:

(a) for joint and several liability among Settling Defendants with
respect to monetary payments to be made pursuant to such agreement;

(b) a guarantee by the parent company of any of Settling Defendants
or other assurances of payment or creditors' remedies with respect to
monetary payments to be made pursuant to such agreement;

(c) for the implementation of non-economic tobacco-related public
health measures different from those contained in the Settlement Agreement
(including this Stipulation of Amendment and the Agreed Order);

(d) for no offset of Federal Settlement Funds against annual
settlement payments pursuant to such settlement agreement; or

(e) for an offset term more favorable to the plaintiff than the
offset provisions of paragraph 9 of this Stipulation of Amendment,

then the Settlement Agreement shall, at the option of the Office of the Attorney
General of the State of Mississippi, be revised to include terms comparable to
such terms.

This paragraph 11 supersedes paragraph 15 of the Settlement Agreement
(and, insofar as not already superseded thereby, paragraph 7 of the MOU), which
is hereby rendered null, void and of no further effect. The State of Mississippi
hereby acknowledges that, pursuant to the terms of this paragraph 11, it has
irrevocably waived any future claim to revise the terms of the Settlement
Agreement or this Stipulation of Amendment pursuant to paragraph 15 of the
Settlement Agreement (or paragraph 7 of the MOU) (except as provided in
paragraph 23 of this Stipulation of Amendment), and it hereby further covenants
and agrees that, in consideration for Settling Defendants' agreement to the
terms of this Stipulation of Amendment, it shall not hereafter seek to revise
the Settlement Agreement or this Stipulation of Amendment, except as expressly
provided in this paragraph 11 (or pursuant to mutually agreeable amendment by
the parties hereto as provided in paragraph 22 of the Settlement Agreement and
paragraph 19 hereof).

12. Settling Defendants' Assurances. Settling Defendants agree:

(a) to support the legislative initiatives to enact new laws and
administrative initiatives to promulgate new rules described in paragraph
6 of the Settlement Agreement; and

(b) not to support in Congress or any other forum legislation, rules
or policies which would preempt, override, abrogate or diminish the
State's rights or recoveries under the Settlement Agreement (as amended
hereby). Except as specifically provided in the foregoing sentence,
nothing in this Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall be deemed to restrain the parties
from advocating terms of any national settlement or taking any other
positions on issues relating to tobacco.

13. Disclosure of Payments. Each Settling Defendant shall disclose to the
Office of the Attorney General and the Office of the Governor, at the times and
in the manner provided below, information about the following payments:

(a) Any payment to a "lobbyist" within the meaning of Miss. Code
Ann. ss.ss. 5-8-3, 5-8-7 (Supp. 1997)), if the Settling Defendant knows or
has reason to know that the payment will be used, directly or indirectly,
to influence legislative or administrative action or the official action
of state or local government in Mississippi in any way relating to Tobacco
Products or their use;

(b) Any payment to a third party, if the Settling Defendant knows
the payment is partly in consideration for the third party attending,
offering testimony at, or participating before a state or local government
hearing in Mississippi in any way relating to Tobacco Products or their
use; and

(c) Any payment (other than a "campaign contribution" under Miss.
Code Ann. ss.ss. 23-15-801 et. seq. (1972 & Supp. 1997) to, or for the
benefit of, a state or local official in Mississippi, whether made
directly by the Settling Defendant or indirectly through an employee of
the Settling Defendant acting within the scope of his employment, or
through an affiliate, lobbyist or other agent acting under the substantial
control of the Settling Defendant.

Disclosures required under this paragraph 13 shall be filed with the Office of
the Attorney General and the Office of the Governor on the first day of
February, May, August and November of each year for any and all payments made
through the first day of the previous month, and shall be transmitted in
electronic format or such format as the Attorney General may require, with the
following information:

o The name, address, telephone number and e-mail address of the
recipient;
o The amount of each payment described in this paragraph 13; and
o The aggregate amount of all payments described in this paragraph 13
to the recipient in the calendar year.

Information disclosed pursuant to this paragraph 13 is a "public record" within
the meaning of the Mississippi Public Records Act of 1983, Miss. Code Ann.
ss.ss. 25-61-1 et seq. (1972 & Supp. 1997).

14. Prohibition of Certain Payments for Product Placement. Settling
Defendants shall not make or cause to be made, in connection with any motion
picture made in the United States, any payment, direct or indirect, to any
person to use, display, make reference to or use as a prop any cigarette,
cigarette package, advertisement for cigarettes, or any other item bearing the
brand name, logo, symbol, motto, selling message, recognizable color or pattern
of colors, or any other indicia of product identification identical or similar
to, or identifiable with, those used for any brand of domestic Tobacco Products.

15. Prohibition on Promotional Merchandise. On and after December 31,
1998, Settling Defendants shall permanently cease marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Mississippi, any service or item
(other than Tobacco Products or any item of which the sole function is to
advertise Tobacco Products) which bears the brand name (alone or in conjunction
with any other word), logo, symbol, motto, selling message, recognizable color
or pattern of colors, or any other indicia of product identification identical
or similar to, or identifiable with, those used for any brand of domestic
Tobacco Products.

16. Document Production. Settling Defendants shall provide to the State of
Mississippi a copy of any CD-ROMs of documents that Settling Defendants have
agreed to produce, pursuant to the Minnesota Settlement, to the document
depository established in connection with the lawsuit State of Minnesota v.
Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17,
1994), with a copy of the accompanying transmittal letter provided to each
person designated to receive notice under paragraph 23 of the Settlement
Agreement.

17. Court Approval. The parties hereto agree to submit this Stipulation of
Amendment promptly to the Court for its review and approval. If the Court
refuses to approve this Stipulation of Amendment or any material provision
hereof, or if such approval is modified in any material respect or set aside on
appeal, then this Stipulation of Amendment shall be canceled and terminated and
it and all orders issued pursuant hereto (including the Agreed Order) shall
become null and void and of no further effect. Any such cancellation or
termination of this Stipulation of Amendment shall not result in the
cancellation or termination of the Settlement Agreement as approved by the Court
on December 29, 1997. All payments described in this Stipulation of Amendment
shall be paid into a special escrow account, pursuant to the terms of a mutually
acceptable escrow agreement (the "MFN Escrow Agreement"), and if so paid shall
remain in said escrow account, until such time as (1) the time for appeal or to
seek review of the Court's order

approving this Stipulation of Amendment has expired without the filing of any
notice of appeal or petition for review; or (2) in the event of any such appeal
or petition, the appeal or the petition has been dismissed or the Court's order
has been affirmed in all material respects by the court of last resort to which
such appeal or petition has been taken and such dismissal or affirmance has
become no longer subject to further appeal or review. Any payments made into
escrow shall be disbursed from escrow only in strict accordance with the terms
of the MFN Escrow Agreement.

18. Obligations Several, Not Joint. All obligations of the Settling
Defendants pursuant to the Settlement Agreement and this Stipulation of
Amendment are intended to be and shall remain several, and not joint.

19. Applicable Provisions of Settlement Agreement. The provisions of
paragraphs 17 (Representations of Parties); 19 (Headings), 20 (No Determination
or Admission), 21 (Non-Admissibility), 22 (Amendment), 23 (Notices), 24
(Cooperation), 26 (Construction), 27 (Severability), 28 (Intended Beneficiaries)
and 29 (Counterparts) of the Settlement Agreement shall be equally applicable to
this Stipulation of Amendment as though fully set forth herein, and all
references to the Settlement Agreement in the paragraphs thereof specifically
listed in this paragraph 19 shall be construed to include this Stipulation of
Amendment.

20. Release of Right to Additional Compensation. In consideration for the
terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the
State of Mississippi hereby irrevocably releases Settling Defendants from any
claim for additional compensation pursuant to paragraph 16 of the Settlement
Agreement (and, insofar as not already superseded thereby, paragraph 8 of the
MOU), the provisions of which regarding the State's rights to additional
compensation are hereby rendered null, void and of no further effect.

21. Governing Law. The Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall be governed by the laws of the State of
Mississippi without regard to the conflict of law rules of such State. This
paragraph supersedes paragraph 25 of the Settlement Agreement, which is hereby
rendered null, void and of no further effect.

22. Attorneys' Fees. The parties hereto acknowledge that the entire
obligation of Settling Defendants regarding payment of private counsel's fees
pursuant to paragraph 16 of the Settlement Agreement (and, insofar as not
already superseded thereby, paragraph 8 of the MOU) is set forth in the
Mississippi Fee Payment Agreement dated July 2, 1998. The Attorney General
represents that all of the State's outside counsel that have represented the
State in connection with this action are, by and through their authorized
representatives, signatories to the Mississippi Fee Payment Agreement. Under no
circumstances shall Settling

Defendants' entry into this Stipulation of Amendment or the Mississippi Fee
Payment Agreement be construed as, or deemed to be, evidence of or an admission
or concession that the Settlement Agreement can be revised pursuant to the Most
Favored Nations clause without incorporation of all terms of any settlement
agreement that provides the occasion for any such revision, including all terms
with respect to attorneys' fees.

23. Conditioned on Minnesota Settlement. In the event that a court order
or other judicial determination is issued on or before January 2, 2003 that
overturns, voids or invalidates the Minnesota Settlement or otherwise declares
it to be unenforceable (such that Settling Defendants are relieved from making
payments required under the Minnesota Settlement) (the "Minnesota Order"),
Settling Defendants shall have the option to elect not to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due
on or after the date of such Minnesota Order. In the event that Settling
Defendants make such an election:

(a) Settling Defendants shall not be obligated to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that
becomes due on or after the date of the Minnesota Order; provided,
however, that if the Minnesota Order is reversed on appeal or otherwise
set aside, Settling Defendants shall be obligated to make any payments

pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were
not made when initially due as result of the Minnesota Order;

(b) the provisions of paragraph 11 of this Stipulation of Amendment
shall not apply to preclude the application of paragraph 15 of the
Settlement Agreement with respect to any pre-verdict settlement agreement
described therein entered into after the date of the Minnesota Order; and

(c) Settling Defendants shall be entitled to a credit, in the amount
of any payments made pursuant to paragraphs 5 and 6 of this Stipulation of
Amendment, against any payments due to the State of Mississippi as a
result of application of paragraph 15 of the Settlement Agreement in
connection with any pre-verdict settlement agreement entered into after
the date of the Minnesota Order, pursuant to subparagraph (b) of this
paragraph 23.

No other provision of the Settlement Agreement, this Stipulation of Amendment or
the Consent Decree shall be affected by the Minnesota Order. Settling Defendants
will provide the State of Mississippi with notice of any filing seeking to
obtain a Minnesota Order.

24. Entire Agreement of Parties. The Settlement Agreement (including for
purposes of this paragraph 24 this Stipulation of Amendment, the Mississippi Fee
Payment Agreement and the Agreed Order) contains an entire, complete and

integrated statement of each and every term and provision agreed to by and among
the parties hereto relating in any way to the settlement of the tobacco
litigation brought by the State of Mississippi, and is not subject to any
condition not provided for herein.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Stipulation of Amendment as of this 2nd day
of July, 1998.

STATE OF MISSISSIPPI, acting by and
through Michael C. Moore, its duly
elected and authorized Attorney General

By: /s/ Michael C. Moore
-------------------------------
Michael C. Moore
Attorney General

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
--------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
--------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO
COMPANY

By: /s/ Arthur F. Golden
--------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt by AFG
--------------------------------
Charles A. Blixt
General Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President and
General Counsel

APPENDIX A

FORMULA FOR CALCULATING VOLUME ADJUSTMENTS

Any payment that by the terms of the Stipulation of Amendment is to be
adjusted pursuant to this Appendix (the "Applicable Base Payment") shall be
adjusted pursuant to this Appendix in the following manner:

(A) in the event the aggregate number of cigarettes shipped for domestic
consumption by Settling Defendants in the Applicable Year (as defined
hereinbelow) (the "Actual Volume") is greater than the aggregate number of
cigarettes shipped for domestic consumption by Settling Defendants in 1997
(the "Base Volume"), the Applicable Base Payment shall be multiplied by
the ratio of the Actual Volume to the Base Volume;

(B) in the event the Actual Volume is less than the Base Volume,

(i) the Applicable Base Payment shall be multiplied by the ratio of
the Actual Volume to the Base Volume, and the resulting product
shall be divided by 0.98; and

(ii) if a reduction of the Applicable Base Payment results from the
application of subparagraph (B)(i) of this Appendix, but the
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes for the Applicable Year (the "Actual Net
Operating Profit") is greater than the Settling Defendants'
aggregate net operating profits from domestic sales of cigarettes in
1997 (the "Base Net Operating Profit") (such Base Net Operating
Profit being adjusted upward by the greater of the rate of 3% per
annum or the actual total percent change in the Consumer Price
Index, in either instance for the period between January 1, 1998 and
the date on which the payment at issue is made), then the amount by
which the Applicable Base Payment is reduced by the application of
subparagraph (B)(i) shall be reduced (but not below zero) by 1.7% of
25% of such increase in such profits. For purposes of this Appendix,
"net operating profits from domestic sales of cigarettes" shall mean
net operating profits from domestic sales of cigarettes as reported
to the United States Securities and Exchange Commission ("SEC") for
the Applicable Year or, in the

case of a Settling Defendant that does not report profits to the
SEC, as reported in financial statements prepared in accordance with
generally accepted accounting principles and audited by a nationally
recognized accounting firm. The determination of Settling
Defendants' aggregate net operating profits from domestic sales of
cigarettes shall be derived using the same methodology as was
employed in deriving such Settling Defendants' aggregate net
operating profits from domestic sales of cigarettes in 1997. Any
increase in an Applicable Base Payment pursuant to this subparagraph
B(ii) shall be payable within 120 days after the date that the
payment at issue was required to be made.

(C) "Applicable Year" means (i) with respect to the payments made pursuant
to paragraph 7 of the Stipulation of Amendment, the calendar year ending
on the date on which the payment at issue is due, regardless of when such
payment is made; and (ii) with respect to all other payments made pursuant
to the Stipulation of Amendment, the calendar year immediately preceding
the year in which the payment at issue is due, regardless of when such
payment is made.

EXHIBIT 1

IN THE CHANCERY COURT OF JACKSON COUNTY,
STATE OF MISSISSIPPI

)
IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429
STATE OF MISSISSIPPI TOBACCO LITIGATION )
)

AGREED ORDER APPROVING STIPULATION OF
AMENDMENT TO SETTLEMENT AGREEMENT
PURSUANT TO COURT ORDER OF DECEMBER 29, 1997

WHEREAS, on October 17, 1997, the State of Mississippi and certain
Defendants entered into a Comprehensive Settlement Agreement and Release (the
"Settlement Agreement") to settle and resolve with finality all present and
future claims against all parties to this litigation relating to the subject
matter of this litigation which have been or could have been asserted by any of
the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated December 29, 1997;

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement

EXHIBIT 1

Agreement shall be revised so that the State of Mississippi will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, the State of Mississippi and Settling Defendants agree that,
pursuant to the Most Favored Nations clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Mississippi and Settling Defendants have agreed on
the terms of the revisions to the Settlement Agreement as set forth in a
Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order
executed on July 2, 1998 (the "Stipulation of Amendment");

WHEREAS, the Stipulation of Amendment provides for entry of this Agreed
Order and, further, provides that the Settling Defendants have waived as
specified therein their right to challenge the terms of this Agreed Order as
being superseded or preempted by future congressional enactments; and

WHEREAS, the Attorney General believes the entry of this Agreed Order is
appropriate and in the public interest;

EXHIBIT 1

NOW, THEREFORE, the State of Mississippi and Settling Defendants having
come before the Court on their joint motion Ore Tenus for approval of a
Stipulation of Amendment to the Settlement Agreement pursuant to the Most
Favored Nations clause of the Settlement Agreement and this Court's December 29,
1997 Judgment of Dismissal and Order Approving Settlement Agreement (the
"December 29, 1997 Order"), and the Court having reviewed and considered the
Stipulation of Amendment and otherwise being fully advised in the premises, it
is hereby ORDERED, ADJUDGED and DECREED as follows:

1. Approval. Pursuant to the Settlement Agreement and this Court's
December 29, 1997 Order, this Court has continuing jurisdiction to enforce and
implement the terms of the Settlement Agreement, including the Most Favored
Nations clause of the Settlement Agreement. The Court finds that the terms of
the Stipulation of Amendment are just and in the best interests of the State of
Mississippi and Settling Defendants, and the same is hereby approved. The
parties are directed to comply with the terms of the Stipulation of Amendment.

2. Jurisdiction and Venue. In keeping with the Settlement Agreement and
this Court's December 29, 1997 Order, the Court retains jurisdiction for the
purpose of enforcement of the Settlement Agreement (as amended by the
Stipulation of Amendment) and this Agreed Order. Any party to this Agreed Order
may apply to this Court at any time for such further orders and directions as

EXHIBIT 1

may be necessary or appropriate for the construction and enforcement of the
Settlement Agreement, the Stipulation of Amendment and this Agreed Order.

3. Definitions. The definitions set forth in the Settlement Agreement (as
supplemented or superseded by the Stipulation of Amendment) are incorporated by
reference herein.

4. Applicability. This Agreed Order applies only to Settling Defendants in
their corporate capacity acting through their respective successors and assigns,
directors, officers, employees, agents, subsidiaries, divisions or other
internal organizational units of any kind or any other entity acting in concert
or participating with them. The remedies and penalties for a violation of this
Agreed Order shall apply only to Settling Defendants, and shall not be imposed
or assessed against any employee, officer or director of Settling Defendants or
other person or entity as a consequence of such a violation, and there shall be
no jurisdiction under this Agreed Order to impose or assess a penalty against
any employee, officer or director of Settling Defendants or other person or
entity as a consequence of a violation of this Agreed Order.

5. Effect on Third Parties. This Agreed Order is not intended to and does
not vest standing in any third party with respect to the terms hereof, or create
for any person other than the parties hereto a right to enforce the terms
hereof.

6. Injunctive Relief. Settling Defendants are permanently enjoined from:

EXHIBIT 1

(a) On and after December 31, 1998, marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Mississippi, any service or item
(other than Tobacco Products or any item the sole function of which is to
advertise Tobacco Products) which bears the brand name (alone or in
conjunction with any other word), logo, symbol, motto, selling message,
recognizable color or pattern of colors, or any other indicia or product
identification identical or similar to, or identifiable with, those used
for any domestic brand of Tobacco Products.

(b) Making any material misrepresentation of fact regarding the
health consequence of using any Tobacco Product, including any tobacco
additives, filters, paper or other ingredients; provided, however, that
nothing in this paragraph shall limit the exercise of any First Amendment
right or any defense or position which persons bound by this Agreed Order
may assert in any judicial, legislative or regulatory forum.

(c) Entering into any contract, combination or conspiracy between or
among themselves which has the purpose or effect of: (1) limiting
competition in the production or distribution of information about the
health hazards or other consequences of the use of Tobacco Products;

EXHIBIT 1

(2) limiting or suppressing research into smoking and health; or (3)
limiting or suppressing research into, marketing, or development of new
products.

(d) Taking any action, directly or indirectly, to target children in
Mississippi in the advertising, promotion, or marketing of cigarettes, or
taking any action the primary purpose of which is to initiate, maintain or
increase the incidence of underage smoking in Mississippi.

7. No Determination or Admission. The Settlement Agreement having been
executed prior to the taking of any testimony, no final determination of any
violation of any provision of law has been made in this Action. This Agreed
Order is not intended to be and shall not in any event be construed as, or
deemed to be, an admission or concession or evidence of any liability or any
wrongdoing whatsoever on the part of any person covered by the releases provided
in paragraphs 12, 13 and 14 of the Settlement Agreement; nor shall this Agreed
Order be construed as, or deemed to be, an admission or concession or evidence
of personal jurisdiction by any person not a party to this Agreed Order.
Defendants specifically disclaim any liability or wrongdoing whatsoever with
respect to the claims and allegations asserted against them in this Action and
Settling Defendants have entered into the Settlement Agreement and the
Stipulation of Amendment, and have stipulated to entry of this Agreed Order,
solely to avoid the further expense, inconvenience, burden and risk of
litigation.

EXHIBIT 1

8. Modification. This Agreed Order shall not be modified unless the party
seeking modification demonstrates, by clear and convincing evidence, that it
will suffer irreparable harm from new and unforeseen conditions; provided,
however, that the provisions of paragraph 4 of this Agreed Order shall in no
event be subject to modification. Changes in the economic conditions of the
parties shall not be grounds for modification. It is intended that Settling
Defendants will comply with this Agreed Order as originally entered, even if
Settling Defendants' obligations hereunder are greater than those imposed under
current or future law. Therefore, a change in law that results, directly or
indirectly, in more favorable or beneficial treatment of any one or more of the
Settling Defendants shall not support modification of this Agreed Order. The
provisions of this paragraph shall not be construed to limit or affect any
future modification of the Settlement Agreement (as amended by the Stipulation
of Amendment) in the manner provided in paragraphs 11 and 23 of the Stipulation
of Amendment.

9. Enforcement and Attorneys' Fees. In any proceeding which results in a
finding that a Settling Defendant violated this Agreed Order, the responsible
Settling Defendant or Settling Defendants shall pay the State's costs and
attorneys' fees incurred in such proceeding.

10. Non-Exclusivity of Remedy. The remedies in this Agreed Order are
cumulative and in addition to any other remedies the State may have at law or

EXHIBIT 1

equity. Nothing herein shall be construed to prevent the State from bringing any
action simply because the conduct that is the basis for such action may also
violate this Agreed Order.

SO ORDERED AND ADJUDGED, this the 11th day of July, 1998.

/s/ William H. Myers
-----------------------------
WILLIAM H. MYERS,
CHANCELLOR

APPROVED:

/s/ Michael C. Moore
- ------------------------------------
MICHAEL C. MOORE, Attorney General,
for the State of Mississippi

/s/ Joe R. Colingo
- ------------------------------------
JOE R. COLINGO, for Settling Defendants

Exhibit 10.2

MISSISSIPPI FEE PAYMENT AGREEMENT

This Mississippi Fee Payment Agreement (the "Agreement") is entered into
as of July 2, 1998, by and among Philip Morris Incorporated, R.J. Reynolds
Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco
Company (collectively and severally "Settling Defendants" and each individually
a "Settling Defendant"), the State of Mississippi and private counsel retained
by the State of Mississippi in connection with the lawsuit In re Mike Moore,
Attorney General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429
(Miss. Ch. Ct., Jackson County) (the "Action").

WITNESSETH:

WHEREAS, on October 17, 1997, the State of Mississippi and Settling
Defendants entered into a comprehensive settlement agreement to settle and
resolve with finality all present and future civil claims relating to the
subject matter of the Action (the "Settlement Agreement"), which Settlement
Agreement was approved by the Chancery Court for the Jackson County (the
"Court") and adopted as an enforceable order of the Court pursuant to Court
Order dated December 29, 1997;

WHEREAS, paragraph 16 of the Settlement Agreement provides that Settling
Defendants shall pay reasonable attorneys' fees to private counsel for the State
of Mississippi, in an amount set by arbitration, subject to an appropriate
annual cap on all such payments of attorneys' fees by Settling Defendants, as
well as other conditions;

WHEREAS, paragraph 16 of the Settlement Agreement did not and was not
intended to reflect the entire agreement of Settling Defendants and the State of
Mississippi as to the procedures and conditions that would govern Settling
Defendants' payment of fees to private counsel retained by the State of
Mississippi in connection with the Action ("Mississippi Counsel"), including an
agreed specific annual aggregate national cap on all payments of attorneys' fees
and certain other professional fees by Settling Defendants, as well as other
essential terms;

WHEREAS, Settling Defendants and Mississippi Counsel have entered into a
letter agreement dated October 10, 1997 (the "October 10th Letter") which

describes the essential terms of Settling Defendants' agreement to pay fees to
Mississippi Counsel pursuant to paragraph 16 of the Settlement Agreement;

WHEREAS, paragraph 15 of the Settlement Agreement contains a "Most Favored
Nation" clause which provides that, in the event that Settling Defendants enter
into a future pre-verdict settlement agreement of other litigation brought by a
non-federal governmental plaintiff on terms more favorable to such governmental
plaintiff than the terms of the Settlement Agreement (after due consideration of
relevant differences in population or other appropriate factors), the terms of
the Settlement Agreement shall be revised so that the State of Mississippi will
obtain treatment at least as relatively favorable as any such non-federal
governmental entity;

WHEREAS, on January 16, 1998, Settling Defendants entered into a
pre-verdict settlement agreement with the State of Texas, which sets forth the
terms of Settling Defendants' agreement to pay attorneys' fees to private
counsel for the State of Texas and includes provisions for advances on such
attorneys' fees by Settling Defendants and the State of Texas;

WHEREAS, on May 8, 1998, certain Settling Defendants entered into a
pre-verdict settlement agreement with the State of Minnesota (the "Minnesota
Settlement"), which includes provisions for payment of attorneys' fees to
private counsel for the State of Minnesota;

WHEREAS, on July 2, 1998, Settling Defendants and the State of Mississippi
entered into a Stipulation of Amendment to Settlement Agreement and for Entry of
Agreed Order (the "Stipulation of Amendment") to resolve any disputes with
respect to the Most Favored Nation clause of the Settlement Agreement, including
any disputes regarding payment of attorneys' fees, in light of the Texas and
Minnesota Settlements; and

WHEREAS, Settling Defendants, the State of Mississippi and Mississippi
Counsel, in order to resolve any disputes with respect to paragraphs 15 and 16
of the Settlement Agreement, and to describe more fully the procedures that will
govern Settling Defendants' payment of fees to Mississippi Counsel, have agreed
to the terms of this Agreement:

NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual
agreement to the terms of this Agreement, the State of Mississippi's and
Settling Defendants' mutual agreement to the terms of the Stipulation of

Amendment, and such other consideration described herein, including the release
of certain claims against Settling Defendants, the sufficiency of which is
hereby acknowledged, the parties hereto, acting by and through their authorized
agents, memorialize and agree as follows:

SECTION 1. Agreement to Pay Fees.

Settling Defendants will pay reasonable attorneys' fees to Mississippi
Counsel for their representation of the State of Mississippi in connection with
the Action. The amount of such fees will be set by a panel of three independent
arbitrators (the "Panel") whose decision as to the amount of fees for
Mississippi Counsel arbitrated in connection with this Agreement (the
"Mississippi Fee Award") shall be final and not appealable. The procedures
governing Settling Defendants' obligation to pay the Mississippi Fee Award,
including the procedures for making, and the timing of payments in satisfaction
of, the Mississippi Fee Award, shall be as provided herein.

SECTION 2. Aggregate National Caps on Payment of Certain Fees.

Settling Defendants' payment of the Mississippi Fee Award pursuant to this
Agreement shall be subject to the payment schedule and the annual and quarterly
aggregate national caps specified in sections 11, 12, 13, 14 and 15 hereof,
which shall apply to:

(a) all payments of attorneys' fees pursuant to an award arbitrated by the
Panel ("Fee Award") in connection with the settlement of any tobacco and health
cases (other than non-class action personal injury cases brought directly by or
on behalf of a single natural person or the survivor of such person or for
wrongful death, or any non-class action consolidation of two or more such cases)
("Tobacco Cases") on terms that provide for payment by Settling Defendants or
other defendants acting in agreement with Settling Defendants (collectively,
"Participating Defendants") of fees with respect to private counsel retained by
the plaintiff in connection with any such case ("Private Counsel"), subject to
an annual cap on payment of all such fees;

enforceable obligation on Participating Defendants to pay attorneys' fees with
respect to Private Counsel (any such legislation hereinafter referred to as
"Federal Legislation"); and

(c) all payments of attorneys' fees and certain other professional fees
(other than fees for attorneys or agents of Participating Defendants) pursuant
to a Fee Award for contributions made toward enacted Federal Legislation. In the
event that Federal Legislation is enacted, the terms "Private Counsel" and
"Eligible Counsel" shall apply not only to persons otherwise falling within the
definitions of such terms herein but also to all persons granted Fee Awards for
such contributions (such persons being Eligible Counsel with respect to each
month beginning with the month the Federal Legislation was enacted).

Nothing in this Agreement shall be construed to require any Settling
Defendant to pay Fee Awards in connection with any litigation other than the
Action.

SECTION 3. Exclusive Obligation of Settling Defendants; Release.

The provisions set forth herein constitute the entire obligation of
Settling Defendants with respect to payment of attorneys' fees in connection
with the Action and the exclusive means by which Mississippi Counsel may seek
payment of fees by Settling Defendants in connection with the Action. The
parties hereto acknowledge that the provisions for payment set forth herein are
the entirety of Settling Defendants' obligations with respect to payment of
attorneys' fees pursuant to paragraph 16 of the Settlement Agreement and the
October 10th Letter. The State of Mississippi agrees that Settling Defendants
shall have no other obligation to pay fees or otherwise compensate Mississippi
Counsel, any other counsel or representative of the State of Mississippi or the
State of Mississippi itself with respect to attorneys' fees in connection with
the Action. Each Mississippi Counsel hereby irrevocably releases Settling
Defendants and their respective present and former parents, subsidiaries,
divisions, affiliates, officers, directors, employees, representatives,
insurers, agents and attorneys (as well as the predecessors, heirs, executors,
administrators, successors and assigns of each of the foregoing) from any and
all claims that such counsel ever had, now has or hereafter can, shall or may
have in any way related to the Action (including but not limited to any
negotiations related to the settlement of the Action). The foregoing shall not
be construed as a release of any person or entity as to any of the obligations
undertaken in this Agreement in connection with a breach thereof.

SECTION 4. Composition of the Panel.

(a) The first and the second members of the Panel shall both be permanent
members of the Panel and, as such, will participate in the determination of all
Fee Awards. The third Panel member shall not be a permanent Panel member, but
instead shall be a state-specific member selected to determine Fee Awards on
behalf of Private Counsel retained in connection with litigation within a single
state. Accordingly, the third, state-specific member of the Panel for purposes
of determining Fee Awards with respect to litigation in the State of Mississippi
shall not participate in any determination as to any Fee Award with respect to
litigation in any other state (unless selected to participate in such
determinations by such persons as may be authorized to make such selections
under other agreements).

(b) The members of the Panel shall be selected as follows:

(i) The first member shall be a natural person selected by
Participating Defendants, who shall advise Mississippi Counsel of the name
of the person selected by October 8, 1998.

(ii) The second member shall be a natural person selected by
agreement of Participating Defendants and a majority of the members of a
committee composed of the following members: Joseph F. Rice, Richard F.
Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the
Castano Plaintiffs' Legal Committee and, at the option of Participating
Defendants, one additional representative to serve on behalf of counsel
for any one or more states that, subsequent to the date hereof, enter into
settlement agreements with Participating Defendants that provide for
payment of such states' Private Counsel pursuant to an arbitrated award of
fees; such second member shall be selected by October 1, 1998.

(iii) The third, state-specific member for purposes of determining
Fee Awards with respect to litigation in the State of Mississippi shall be
a natural person selected by Mississippi Counsel, who shall notify
Settling Defendants of the name of the person selected by October 15,
1998.

SECTION 5. Commencement of Panel Proceedings.

No application for a Fee Award shall be presented to the Panel or any
Panel member until November 3, 1998. The Panel shall consider and render

decisions on applications for Fee Awards in the order in which they are
submitted or pursuant to notice by counsel having priority that they have ceded
their place to others. In the event that more than one application for a Fee
Award is submitted on the same date, the Panel shall consider and render
decisions on such applications in the order in which their respective cases were
settled. Counsel may seek permission from the Panel to make combined
presentations of aspects of their respective applications. Settling Defendants
shall not oppose any request to combine presentations of applications for Fee
Awards in connection with the Action, the lawsuit State of Florida v. American
Tobacco Co., No. 95-1466AH (15th Jud. Circuit, Palm Beach County), or the
lawsuit State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed
Mar. 28, 1996).

SECTION 6. Costs of Arbitration.

All costs and expenses of the arbitration proceedings held by the Panel,
including compensation of Panel members (but not including any costs, expenses
or compensation of counsel making applications to the Panel), shall be borne by
Settling Defendants in proportion to their respective Market Shares.

SECTION 7. Panel Procedures Regarding Application of Mississippi Counsel.

Mississippi Counsel shall make a collective written application to the
Panel for a Fee Award on behalf of all Mississippi Counsel not later than
November 3, 1998. All interested persons, including persons not parties hereto,
may submit to the Panel any information that they wish; but interested persons
not parties hereto may submit only written materials. The Panel shall consider
all such submissions by any party hereto and may consider any such materials
submitted by other interested persons. All written submissions relating to
applications for a Fee Award in connection with the Action shall be served on
all parties hereto by November 13, 1998. Presentations to the Panel shall, to
the extent possible, be based on affidavit rather than live testimony. The Panel
shall preserve the confidentiality of any attorney work-product materials or
other similar confidential information that may be submitted. Settling
Defendants will not take any position adverse to the amount of the Fee Award
requested by Mississippi Counsel, nor will they or their representatives express
any opinion (even upon request) as to the appropriateness or inappropriateness
of the amount of any proposed Mississippi Fee Award. The undersigned outside
counsel for Settling Defendants Philip Morris Incorporated and R.J. Reynolds
Tobacco Company will appear, if requested, to provide information as to the
nature and efficacy of the

work of Mississippi Counsel and to advise the Panel that they support a
Mississippi Fee Award of full reasonable compensation under the circumstances.

SECTION 8. Award of Fees to Mississippi Counsel.

The members of the Panel will consider all relevant information submitted
to them in reaching a decision as to a Fee Award that fairly provides for full
reasonable compensation of Mississippi Counsel for their representation of the
State of Mississippi in connection with the Action. The Panel shall determine
the amount of fees for all Mississippi Counsel collectively no later than
December 10, 1998. Given the significance and uniqueness of the Action, the
Panel shall not be limited to an hourly-rate or lodestar analysis in determining
the amount of the Mississippi Fee Award, but shall take into account the
totality of the circumstances. In considering the amount of the Mississippi Fee
Award, the Panel shall not consider Fee Awards that already have been or yet may
be awarded to others. The Panel's decisions as to Fee Awards shall be in writing
and shall report the amount of the fee awarded (with or without explanation or
opinion, at the Panel's discretion).

SECTION 9. Allocation of Payments among Mississippi Counsel.

All payments (including advances) made by Settling Defendants in
satisfaction of the Mississippi Fee Award pursuant to this Agreement shall be
paid in the first instance to an account designated in writing by Joseph F.
Rice, Esq. Each Mississippi Counsel shall be entitled to receive a percentage of
each such payment equal to the percentage such counsel would receive of any fee
recovery in the Action, under the terms of the fee-sharing agreement among
Mississippi Counsel (such percentage being such counsel's "Fee Percentage" of
the payment in question).

SECTION 10. Advances on Payment of Fees.

Settling Defendants shall severally make two payments as an advance
against later payments of the Mississippi Fee Award pursuant to this Agreement,
to be credited as provided in section 15 hereof, as follows:

(a) On or before July 6, 1998, each Settling Defendant shall pay to
Mississippi Counsel, pro rata in proportion to its Market Share indicated on
Schedule A hereto, its respective share of $50 million.

(b) On or before July 31, 1998, each Settling Defendant shall pay to
Mississippi Counsel, pro rata in proportion to its Market Share indicated on
Schedule A hereto, its respective share of $50 million.

SECTION 11. Annual Amount for 1997; Allocation.

(a) For 1997, Settling Defendants shall pay, in the manner described in
section 13 hereof, the unsatisfied amount of the Fee Award (the "Unpaid Fees")
of Mississippi Counsel, and those Participating Defendants so obligated shall
make payments with respect to the Unpaid Fees of Private Counsel retained in
connection with the lawsuits State of Florida v. American Tobacco Co., No.
95-1466 AH (15th Jud. Circuit, Palm Beach County), and Mangini v. R.J. Reynolds
Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County), in an amount
not to exceed $250 million for all payments described in this subsection.

(b) In the event that the sum of the Unpaid Fees of those Private Counsel
identified in subsection (a) of this section exceeds $250 million, such amount
shall be allocated among the payments to be made with respect to such Private
Counsel in proportion to the amount of their respective Unpaid Fees (the amount
so allocated with respect to the Unpaid Fees of each such Private Counsel being
such counsel's "Allocable Share" for 1997).

SECTION 12. Annual Amount for 1998; Allocation.

(a) For 1998, Settling Defendants shall pay, in the manner described in
section 13 hereof, the Unpaid Fees of Mississippi Counsel, and those
Participating Defendants so obligated shall make payments with respect to the
Unpaid Fees of all other Private Counsel, in an amount not to exceed $500
million for all such payments described in this subsection.

(b) The amount payable to Mississippi Counsel by Settling Defendants for
1998 shall be determined as follows: The $500 million annual cap for 1998 shall
be allocated equally among each month of the year. Except as provided in section
13(b) hereof, each monthly amount shall be allocated to those Private Counsel
retained in connection with Tobacco Cases settled by Participating Defendants or
resolved by Federal Legislation before or during such month, up to the amounts
of their respective Unpaid Fees (such counsel being "Eligible Counsel" with
respect to such monthly amount). In the event that the monthly amount is less
than the sum of Eligible Counsel's Unpaid Fees, the monthly amount shall be
allocated to Eligible Counsel in proportion to the amounts of their

respective Unpaid Fees (the amount so allocated to each Eligible Counsel for a
given month being such counsel's Allocable Share for such month, and the sum of
each Private Counsel's Allocable Shares for each month being such counsel's
Allocable Share for 1998).

SECTION 13. Payments with Respect to Annual Amounts for 1997 and 1998.

(a) On the earlier of December 15, 1998 or 15 days after the date of the
Panel's decision with respect to the Mississippi Fee Award (the "Initial
Mississippi Fee Payment Date"), each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of an initial fee payment with
respect to the Mississippi Fee Award (the "Initial Mississippi Fee Payment"),
which shall include:

(i) Mississippi Counsel's Allocable Share for 1997 as provided in
section 11 hereof or, in the event that the Panel has not rendered Fee
Awards with respect to all Private Counsel described in section 11(a)
hereof as of five business days prior to the Initial Mississippi Fee
Payment Date, Settling Defendants' reasonable estimation of Mississippi
Counsel's Allocable Share for 1997; and

(ii) Mississippi Counsel's Allocable Share for 1998 as provided in
section 12 hereof for each month of 1998 except those with respect to
which Mississippi Counsel's Allocable Share could not be determined as of
five days prior to the Initial Mississippi Fee Payment Date, as a result
of there being other Eligible Counsel that, as of such date, had not yet
been granted or denied a Fee Award by the Panel (either because such
counsel's application for a Fee Award was still under consideration by the
Panel or for any other reason).

(b) On January 15, 1999, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of Mississippi Counsel's
Allocable Share for those months of 1998 not included in the Initial Mississippi
Fee Payment. Mississippi Counsel's Allocable Share for any such month shall be
based on an allocation of the monthly amount among Eligible Counsel having Fee
Awards as of December 31, 1998, without regard to whether there may be other
Eligible Counsel that have not been granted or denied a Fee Award by the Panel
as of such date.

(c) In the event that Settling Defendants pay an estimation of Mississippi
Counsel's Allocable Share for 1997, as provided in subsection (a)(i) of this
section, subsequent payments pursuant to this Agreement shall be adjusted to
ensure that Mississippi Counsel receive their actual Allocable Share for 1997.

(d) Notwithstanding any provision of this Agreement, Mississippi Counsel
agree to defer payment of $62 million of the payment due from Settling Defendant
R.J. Reynolds Tobacco Company ("Reynolds") on the Initial Mississippi Fee
Payment Date. In the event that (i) Reynolds' share of the Initial Mississippi
Fee Payment is less than $62 million or (ii) the Mississippi Fee Award has not
been determined as of the date of any other payment by Reynolds in 1998 with
respect to Fee Awards, individual Mississippi Counsel Scruggs, Millette, Bozeman
& Dent, P.A. ("Scruggs, Millette") and Ness, Motley, Loadholt, Richardson &
Poole ("Ness, Motley") shall also defer the amounts of their respective Fee
Percentages of such other 1998 payments, until the sum of all deferred amounts
equals $62 million. Under no circumstances shall this subsection require any
increase in any payment to be made by any other Settling Defendant. On January
5, 1999, Reynolds shall pay to the appropriate persons the amounts of its 1998
payments deferred pursuant to this section.

SECTION 14. Quarterly Amounts for 1999 and Subsequent Years; Allocation.

Within 10 business days after the end of each calendar quarter beginning
with the first calendar quarter of 1999, Settling Defendants shall pay, in the
manner provided in subsection (d) of this section, the Unpaid Fees of
Mississippi Counsel, and those Participating Defendants so obligated shall make
payments with respect to the Unpaid Fees of all other Private Counsel, in an
amount not to exceed $125 million for all such payments, as follows:

(a) In the event that Federal Legislation has been enacted by the end of
the calendar quarter with respect to which such quarterly payment is being made
(the "Applicable Quarter"):

(i) the quarterly amount shall be allocated among Private Counsel,
up to the amount of their respective Unpaid Fees. Each Private Counsel
shall be allocated an amount of each quarterly payment for the calendar
year up to (or, in the event that the sum of such Private Counsel's Unpaid
Fees exceeds the quarterly amount, in proportion to) the amount of such
Private Counsel's Unpaid Fees. Each quarterly payment shall be allocated
among Private Counsel having Unpaid Fees, without regard to whether there
are other Private Counsel that have not yet been granted or denied a Fee
Award by the Panel as of the end of the Applicable Quarter. Subsequent
quarterly payments shall be adjusted, if necessary, to account for Private
Counsel that are granted Fee Awards in a subsequent quarter of the
calendar year, as provided in paragraph (ii)(B) of this subsection.

(ii) In the event that a quarterly payment for the calendar year is
less than the sum of all Private Counsel's Unpaid Fees:

(A) in the case of the first such quarterly payment, the
quarterly amount shall be allocated among Private Counsel in
proportion to the amounts of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment that is less than the sum of all such Unpaid Fees,
the quarterly amount shall be allocated only to those Private
Counsel, if any, that were not paid a proportionate share of all
prior quarterly payments for the calendar year (either because such
Private Counsel's applications for Fee Awards were still under
consideration as of the end of the calendar quarters with respect to
which such quarterly payments were made or for any other reason),
until each such Private Counsel has been allocated a proportionate
share of all prior quarterly payments. In the event that the sum of
all such shares exceeds the amount of the quarterly payment, such
payment shall be allocated among such Private Counsel in proportion
to the amounts of their respective Unpaid Fees (without regard to
whether there are other Private Counsel that have not yet been
granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

(b) In the event that Federal Legislation has not been enacted by the end
of the Applicable Quarter:

(i) the quarterly amount shall be allocated equally among each of
the three months of the calendar quarter. The amount for each such month
shall be allocated among those Private Counsel retained in connection with
Tobacco Cases settled before or during such month (such Private Counsel
being "Eligible Counsel" with respect to such monthly amount), each of
whom shall be allocated a portion of each such monthly amount up to (or,
in the event that the sum of Eligible Counsel's respective Unpaid Fees
exceeds such monthly amount, in proportion to) the amount of such Eligible
Counsel's Unpaid Fees. The monthly amount for each month of the calendar
quarter shall be allocated among Eligible Counsel having Unpaid Fees,
without regard to whether there may be Eligible Counsel that have not yet
been granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter. Subsequent quarterly payments shall be adjusted, as
necessary, to account for Eligible Counsel that are granted Fee Awards in
a subsequent quarter of the calendar year, as provided in paragraph
(ii)(B) of this subsection.

(ii) In the event that the amount for a given month is less than the
sum of all Eligible Counsel's Unpaid Fees:

(A) in the case of a first quarterly payment, such monthly
amount shall be allocated among Eligible Counsel for such month in
proportion to the amount of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment, the quarterly amount shall be allocated among
only those Private Counsel, if any, that were Eligible Counsel with
respect to any monthly amount paid in a prior quarter of the
calendar year but were not allocated a proportionate share of such
monthly amount (either because such counsel's applications for Fee
Awards were still under consideration as of the end of the calendar
quarter containing the month in question or for any other reason),
until each such Eligible Counsel has been allocated a proportionate
share of all such prior monthly payments for the calendar year. In
the event that the sum of all such shares exceeds the amount of the
quarterly payment, the quarterly payment shall

be allocated among Eligible Counsel in proportion to the amounts of
their respective Unpaid Fees (without regard to whether there may be
other Eligible Counsel with respect to such prior monthly amounts
that have not yet been granted or denied a Fee Award by the Panel as
of the end of the Applicable Quarter).

(c) Adjustments pursuant to paragraphs (a)(ii)(B) and (b)(ii)(B) of this
section shall be made separately for each calendar year. No amounts paid in any
calendar year shall be subject to refund, nor shall any payment in any given
calendar year affect the allocation of payments to be made in any subsequent
calendar year.

(d) Each Settling Defendant shall severally pay, pro rata in proportion to
its respective Market Share, its share of the amounts, if any, allocated to
Mississippi Counsel pursuant to this section.

SECTION 15. Credits and Limitations.

Notwithstanding any other provision of this Agreement, all payments by
Settling Defendants with respect to Fee Awards shall be subject to the
following:

(a) Notwithstanding any other provision of this Agreement, the advances
against future payments to Mississippi Counsel made pursuant to section 10
hereof shall be credited against and shall reduce the payments due to
Mississippi Counsel hereunder, beginning with the first quarterly payment for
1999 pursuant to section 14 hereof, in an amount equal to 50% of the payment in
question, until the advances paid by Settling Defendants are fully credited;
provided, however, that the sum of all such credits applied in any calendar year
with respect to the advances made to Mississippi Counsel pursuant to section 10
hereof shall not exceed $50 million. The amount of any credit made against any
such payment to Mississippi Counsel shall be counted in computing the annual and
quarterly aggregate national caps on all payments made with respect to Private
Counsel, in the amount of the credit applied to any such payment to Mississippi
Counsel in any quarterly or annual period.

(b) Under no circumstances shall Settling Defendants be required to make
payments that would result in aggregate national payments by Participating
Defendants with respect to Fee Awards:

(i) for 1997, totaling more than $250 million;

(ii) during 1998, totaling more than $500 million, except insofar as
payments under the separate $250 million cap for 1997 are made in 1998
pursuant to section 13 hereof, and except insofar as advances are made in
1998 against payments due in years after 1998;

(iii) during any year beginning with 1999, totaling more than $500
million, excluding payments with respect to any Private Counsel's
Allocable Shares for 1998 that are paid in 1999; and

(iv) during any calendar quarter beginning with the first calendar
quarter of 1999, totaling more than $125 million, excluding payments with
respect to any Private Counsel's Allocable Shares for 1998 that are paid
in 1999 and except to the extent that payments with respect to any prior
quarter of the calendar year did not total $125 million.

SECTION 16. Contribution to National Legislation.

If Federal Legislation is enacted that implements the Proposed Resolution,
a three-member national panel including the two permanent members of the Panel
shall consider any application for Fee Awards on behalf of Private Counsel for
contributions made toward the enactment of such Federal Legislation, along with
all applications for Fee Awards for professional fees by any other persons who
claim to have made similar contributions (other than attorneys or agents of
Participating Defendants). No person shall make more than one application for a
Fee Award in connection with any such contributions toward enactment of such
Federal Legislation. All payments with respect to such Fee Awards, if any, shall
be paid on the payment schedule and subject to, and counted in computing, the
annual and quarterly national caps described in sections 12, 13, 14 and 15
hereof.

SECTION 17. Payments on Market Share Basis.

All payments to Mississippi Counsel pursuant to this Agreement shall be
paid by Settling Defendants pro rata in proportion to their respective Market
Shares. Each Settling Defendant shall be severally liable for its share of all
such payments. Under no circumstances shall any such payment or portion thereof
become the joint obligation of Settling Defendants or the obligation of any
party other than the Settling Defendant from which such payment is originally
due, nor shall any Settling Defendant be required to pay a portion of any such
payment greater than its respective Market Share. With respect to payment of the
advances

described in section 10 hereof and the payment for 1997 described in section 11
hereof, the Market Share of each Settling Defendant shall be as provided in
Schedule A hereto. With respect to the payment for 1998 described in section 12
hereof, the Market Share of each Settling Defendant shall be its respective
share of sales of cigarettes, by number of individual cigarettes shipped for
consumption in the United States, for 1998. With respect to all other payments
pursuant to this Agreement, each Settling Defendant's Market Share shall be its
respective share of sales of cigarettes, by number of individual cigarettes
shipped for consumption in the United States, for the 12 month period preceding
the end of the calendar quarter with respect to which such payment is made.

SECTION 18. Determination of Market Share.

In the event of a disagreement between or among any Settling Defendants as
to their respective shares of any payment pursuant to this Agreement (except
payments for which each Settling Defendant's Market Share is expressly provided
herein), each Settling Defendant shall pay its undisputed share of such payment
promptly, on or before the date on which such payment is due, and shall within
21 days submit copies of its federal excise tax reports for the period in
question to a third party to be selected by agreement of Settling Defendants
(the "Third Party"), who shall within three days determine the Market Share of
each Settling Defendant. The decision of the Third Party shall be final and
non-appealable, and shall be communicated by facsimile to each party hereto.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay Mississippi Counsel or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate, as published in the Wall Street Journal on the latest publication date on
or before the original date on which the payment in question was due, plus 3%.

SECTION 19. Limited Waiver as to Other Terms.

In consideration of Settling Defendants' agreement to the terms hereof,
each Mississippi Counsel hereby covenants and agrees that it will not argue in
any forum (other than in proceedings before the Panel relating to Mississippi
Counsel's application) that the arrangements made in connection with the Texas
Settlement or the Minnesota Settlement for payment of fees to private counsel
for

the States of Texas or Minnesota give rise to any claim or entitlement on the
part of Mississippi Counsel (or any other person) in connection with this
Action.

SECTION 20. State's Identification of Mississippi Counsel.

The Attorney General represents and warrants that Schedule B hereto
contains the names of all Mississippi Counsel.

SECTION 21. Intended Beneficiaries.

No part of this Agreement creates any rights on the part of, or is
enforceable by, any person or entity that is not a party hereto or a person
covered by the release described in section 3 hereof. Nor shall any part of this
Agreement bind any non-party or determine, limit or prejudice the rights of any
such person or entity.

SECTION 22. Definitions.

Terms used herein that are defined in the Settlement Agreement or the
Stipulation of Amendment are, unless otherwise defined herein, used in this
Agreement as defined in the Settlement Agreement or the Stipulation of
Amendment, as applicable.

SECTION 23. Representations of Parties.

The parties hereto hereby represent that this Agreement has been duly
authorized and, upon execution, will constitute a valid and binding contractual
obligation, enforceable in accordance with its terms, of each of the parties
hereto.

SECTION 24. No Admission.

This Agreement is not intended to be and shall not in any event be
construed as, or deemed to be, an admission or concession or evidence of any
liability or wrongdoing whatsoever on the part of any party hereto or any person
covered by the release provided under section 3 hereof. Settling Defendants
specifically disclaim and deny any liability or wrongdoing whatsoever with
respect to the claims released under section 3 hereof and enter into this
Agreement for the sole purposes of memorializing Settling Defendants' rights and
obligations with respect to payment of attorneys' fees pursuant to the
Settlement Agreement

and avoiding the further expense, inconvenience, burden and uncertainty of
potential litigation.

SECTION 25. Non-admissibility.

This Agreement having been undertaken by the parties hereto in good faith
and for settlement purposes only, neither this Agreement nor any evidence of
negotiations relating hereto shall be offered or received in evidence in any
action or proceeding other than an action or proceeding arising under this
Agreement.

SECTION 26. Amendment and Waiver.

This Agreement may be amended only by a written instrument executed by the
Attorney General, Mississippi Counsel and Settling Defendants. The waiver of any
rights conferred hereunder shall be effective only if made by written instrument
executed by the waiving party. The waiver by any party of any breach of this
Agreement shall not be deemed to be or construed as a waiver of any other
breach, whether prior, subsequent or contemporaneous, of this Agreement.

SECTION 27. Notices.

All notices or other communications to any party hereto shall be in
writing (including but not limited to telex, telecopy or similar writing) and
shall be given to the respective parties listed on Schedule C hereto at the
addresses therein indicated. Any party hereto may change the name and address of
the person designated to receive notice on behalf of such party by notice given
as provided in this section including an updated list conformed to Schedule C
hereto.

SECTION 28. Governing Law.

This Settlement Agreement shall be governed by the laws of the State of
Mississippi, without regard to the conflict of law rules of such State.

SECTION 29. Construction.

None of the parties hereto shall be considered to be the drafter of this
Agreement or any provision hereof for the purpose of any statute, case law or
rule of interpretation or construction that would or might cause any provision
to be construed against the drafter hereof.

SECTION 30. Captions.

The captions of the sections of this Agreement are included for
convenience of reference only and shall be ignored in the construction and
interpretation hereof.

SECTION 31. Counterparts.

This Agreement may be executed in counterparts. Facsimile or photocopied
signatures shall be considered as valid signatures as of the date hereof,
although the original signature pages shall thereafter be appended to this
Settlement Agreement.

SECTION 32. Entire Agreement of Parties.

This Agreement contains an entire, complete and integrated statement of
each and every term and provision agreed to by and among the parties hereto with
respect to payment of attorneys' fees by Settling Defendants in connection with
the Action and is not subject to any condition not provided for herein.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Mississippi Fee Payment Agreement as of
this 2nd day of July, 1998.

STATE OF MISSISSIPPI acting by and through
Michael C. Moore, its duly elected and authorized
Attorney General

By: /s/ Michael C. Moore
---------------------------------
Michael C. Moore
Attorney General

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
------------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
------------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
------------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt by A.F.G.
------------------------------------
Charles A. Blixt
General Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President & General
Counsel

MISSISSIPPI COUNSEL

By: /s/ Joseph F. Rice
------------------------------------
Joseph F. Rice
Ness, Motley, Loadholt, Richardson
& Poole

By: /s/ Richard F. Scruggs by W.S. Bozeman
--------------------------------------
Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent,
P.A

By: /s/ Don Barrett
--------------------------------------
Don Barrett
Barrett Law Offices

By: /s/ Paul T. Benton
--------------------------------------
Paul T. Benton

By: /s/ Frederick B. Clark
--------------------------------------
Frederick B. Clark

By: /s/ Michael T. Lewis
--------------------------------------
Michael T. Lewis
Lewis & Lewis

By: /s/ David O. McCormick
------------------------------------
David O. McCormick

By: /s/ Charles Victor McTeer
------------------------------------
Charles Victor McTeer
McTeer & Associates

By: /s/ Robert H. Oswald
------------------------------------
Robert H. Oswald
Oswald & Reed

By: /s/ Crymes G. Pittman
------------------------------------
Crymes G. Pittman
Pittman, Germany, Roberts & Welsh

By: /s/ Thomas H. Rhoden
------------------------------------
Thomas H. Rhoden
Rhoden, Lacy, Downey & Colbert

By: /s/ Paul S. Minor
------------------------------------
Paul S. Minor

SCHEDULE A

MARKET SHARE PERCENTAGES

Settling Defendant Percentage
- ------------------ ----------

Philip Morris Incorporated ............................................ 49.9

R.J. Reynolds Tobacco Company.......................................... 24.8

Brown & Williamson Tobacco Corp........................................ 16.4

Lorillard Tobacco Company.............................................. 8.9

----------

TOTAL 100

SCHEDULE B

DESIGNATION of MISSISSIPPI COUNSEL
by the Attorney General

Ness, Motley, Loadholt, Richardson & Poole (Ronald L. Motley, Joseph F. Rice,
Charles W. Patrick, Jr., Edward J. Westbrook, Ann K. Ritter, J. Anderson Berly,
III, John J. McConnell, Jr., Susan Nial, Robert J. McConnell, Richard L. Akel,
Nancy Worth Davis, Alexandra M. Wagner, Kimberly S. Vroon, Jodi W. Flowers,
Frederick C. Baker, R. Brian Johnson, Cindi Anne Solomon, Jerry Hudson Evans,
Gregory S. Lofstead, William Michael Gruenloh)

Scruggs, Millette, Bozeman & Dent, P.A. (Richard F. Scruggs, W. Steve Bozeman,
Charles J. Mikhail, Lee E. Young, Jennifer A. Coley, Ashley Hutchings Hendren)

Barrett Law Offices (Don Barrett)

Paul T. Benton

Frederick B. Clark

Lewis & Lewis (Michael T. Lewis, Pauline Shular Lewis)

David O. McCormick

McTeer & Associates (Charles Victor McTeer)

Oswald & Reed (Robert H. Oswald, William T. Reed)

Pittman, Germany, Roberts & Welsh (Crymes G. Pittman, Robert G. Germany, Joseph
E. Roberts, Jr., C. Victor Welsh)

Rhoden, Lacy, Downey & Colbert (Thomas H. Rhoden)

Paul S. Minor

SCHEDULE C

NOTICES

State of Mississippi

Hon. Michael C. Moore
Attorney General's Office
450 High Street
Post Office Box 220
Jackson, MS 39205
Fax: (601) 359-3441

With copies to:

Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent, P.A.
743 Delmas Avenue
Pascagoula, MS 39568-1425
Fax: (228) 762-1207

and:

Joseph F. Rice, Esq.
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (843) 720-9290

and:

David O. McCormick
707 Watts Avenue
P.O. Box 865
Pascagoula, MS 39568-0865
Fax: (228) 762-4864

(continued)

Settling Defendants

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

Martin J. Barrington, Esq. Charles A. Blixt, Esq.
Philip Morris Incorporated R.J. Reynolds Tobacco Company
120 Park Avenue 401 North Main Street
New York, NY 10017-5592 Winston-Salem, NC 27102
Fax: (212) 907-5399 Fax: (336) 741-2998

With a copy to: With a copy to:

Meyer G. Koplow, Esq. Arthur F. Golden, Esq.
Wachtell, Lipton, Rosen & Katz Davis Polk & Wardwell
51 West 52nd Street 450 Lexington Avenue
New York, NY 10019 New York, NY 10017
Fax: (212) 403-2000 Fax: (212) 450-4800

Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company:

F. Anthony Burke, Esq. Arthur J. Stevens, Esq.
Brown & Williamson Tobacco Corp. Lorillard Tobacco Company
200 Brown & Williamson Tower 714 Green Valley Road
401 South Fourth Avenue Greensboro, NC 27408
Louisville, KY 40202 Fax: (336) 335-7707
Fax: (502) 568-7297

With a copy to:

Stephen R. Patton, Esq.
Kirkland & Ellis
200 East Randolph Dr.
Chicago, IL 60601
Fax: (312) 861-2200

(continued)

Mississippi Counsel

Joseph F. Rice, Esq. Richard F. Scruggs
Ness, Motley, Loadholt, Scruggs, Millette, Bozeman & Dent, P.A.
Richardson & Poole 743 Delmas Avenue
151 Meeting Street, Suite 600 Pascagoula, MS 39568-1425
Charleston, SC 29402 Fax: (228) 762-1207
Fax: (843) 720-9290

Don Barrett, Esq. Paul T. Benton, Esq.
Barrett Law Offices Attorney At Law
P.O. Box 987 P.O. Box 1341
Lexington, Mississippi 39095 Biloxi, MS 39533-1341
Fax 1: (850) 654-4072 Fax: (228) 432-0336
Fax 2: (601) 948-6187

Frederick B. Clark, Esq. Michael T. Lewis
Attorney At Law Lewis & Lewis
P.O. Box 1806 P.O. Box 1600
Greenwood, MS 38930 Clarksdale, MS 38614
Fax: (601) 455-1282 Fax: (601) 627-2267

David O. McCormick, Esq. Charles Victor McTeer, Esq.
707 Watts Avenue McTeer & Associates
P.O. Box 865 P.O. Box 1835
Pascagoula, MS 39568-0865 Greenville, MS 38702
Fax: (228) 762-4864 Fax: (601) 334-6847

Robert H. Oswald, Esq. Crymes Pittman, Esq.
Oswald & Reed Pittman, Germany, Roberts & Welsh
3106 Canty Street 401 S. President Street
Pascagoula, MS 39567 Jackson, MS 39201
Fax: (228) 769-9019 Fax: (601) 948-6187

(continued)

Thomas H. Rhoden, Esq. Paul S. Minor, Esq.
Rhoden, Lacy, Downey & Colbert Minor & Associates
111 Park Circle Drive 400 Main Street
Flowood, MS 39208 Biloxi, MS 39530
Fax: (601) 936-2515 Fax: (228) 374-6630

Exhibit 10.3

MFN ESCROW AGREEMENT

This escrow agreement (the "MFN Escrow Agreement") is entered into as of
July 2, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company
(collectively and severally, "Settling Defendants" and each individually a
"Settling Defendant"), the State of Mississippi and SouthTrust Bank, N.A., as
escrow agent (the "MFN Escrow Agent").

WITNESSETH:

WHEREAS, the State of Mississippi and Settling Defendants entered into a
comprehensive settlement agreement and release as of October 17, 1997 (the
"Settlement Agreement"), setting forth the terms and conditions of an agreement
to settle and resolve with finality all present and future claims relating to
the subject matter of the litigation entitled In re Mike Moore, Attorney
General, ex rel. State of Mississippi Tobacco Litig., Cause No. 94-1429 (Miss.
Ch. Ct., Jackson County) (the "Action"), in the Chancery Court of Jackson
County, Mississippi (the "Court");

WHEREAS, the State of Mississippi and Settling Defendants entered into a
Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order
(the "Stipulation of Amendment") on July 2, 1998, paragraph 17 of which provides
for Court approval of the Stipulation of Amendment;

WHEREAS, paragraph 5 of the Stipulation of Amendment provides that, on the
dates specified therein, each Settling Defendant shall severally pay to the
State of Mississippi, pro rata in proportion to its Market Share, its respective
share of the amounts indicated for each date;

WHEREAS, paragraph 17 of the Stipulation of Amendment further provides
that all payments described in the Stipulation of Amendment shall be paid into a
special escrow account (and if so paid shall remain in said escrow account)
until such time as (1) the time for appeal or to seek review of the Court's
order approving this Stipulation of Amendment has expired without the filing of
any notice of appeal or petition for review; or (2) in the event of any such
appeal or petition, the appeal or the petition has been dismissed or the Court's
order has been affirmed in all material respects by the court of last resort to
which such appeal or petition has been taken and such dismissal or affirmance
has become no longer subject to further appeal or review (the "Availability
Date"); and

WHEREAS, the parties hereto believe that at least one of the payments
described in the preceding paragraphs may be made prior to the Availability
Date:

NOW, THEREFORE, the parties hereto agree as follows:

SECTION 1. Appointment of MFN Escrow Agent.

Settling Defendants and the State of Mississippi hereby appoint the MFN
Escrow Agent to act as escrow agent on the terms and conditions set forth
herein, and the MFN Escrow Agent hereby accepts such appointment on such terms
and conditions.

SECTION 2. Deposit.

In the event that any payment pursuant to paragraph 5 of the Stipulation
of Amendment becomes due on a date prior to the Availability Date, each Settling
Defendant shall severally deliver to the MFN Escrow Agent in immediately
available funds such Settling Defendant's respective share of the payment in
question (the sum of such shares being the "Initial Deposit"). Upon receipt, the
MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow
account established for such purpose and governed by the terms of this MFN
Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to
the Stipulation of Amendment that becomes due prior to the Availability Date
shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the
Initial Deposit and any subsequent payments deposited into the MFN Escrow
Account, including any payments of interest or other income on investment of the
MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and
shall be governed by the terms of this MFN Escrow Agreement. All such deliveries
of funds are subject to the right of Settling Defendants to obtain, pursuant to
section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN
Escrow Amount (less appropriate deductions for administrative fees and expenses,
including taxes and other related costs) in the event that the Stipulation of
Amendment is cancelled and terminated pursuant to paragraph 17 of the
Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested
and disbursed by the MFN Escrow Agent strictly in accordance with this MFN
Escrow Agreement.

SECTION 3. Investment of MFN Escrow Amount.

repurchase agreements fully collateralized by securities of the kind specified
in clause (i) above; (iii) money market accounts maturing within 30 days of the
acquisition thereof and issued by a bank or trust company organized under the
laws of the United States of America or a State thereof (a "United States Bank")
and having a combined capital surplus in excess of $250,000,000; or (iv) demand
deposits with any United States Bank or any federal savings and loan institution
having a combined capital surplus in excess of $250,000,000. Any loss on any
such investment, including, without limitation, any penalty for any liquidation
required to fund a disbursement, shall be borne pro rata by the parties in
proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN
Escrow Agent's fees and all expenses, including taxes and other related costs,
shall, to the extent possible, be paid out of income earned. Whenever the MFN
Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as
provided herein, the MFN Escrow Agent shall also pay to such party all interest
and profits earned to the date of payment on such amount, less deductions for
fees and all expenses, including taxes and other related fees.

SECTION 4. Release of the MFN Escrow Amount.

After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as
set forth below:

(a) Following receipt of written notice signed by counsel for the
Settling Defendants certifying that such notice has been delivered by
counsel for the Settling Defendants to all parties hereto and stating that
the Stipulation of Amendment has not received court approval or has been
canceled, terminated or has otherwise become null and void for any reason,
the MFN Escrow Agent shall upon the expiration of ten (10) business days
following the MFN Escrow Agent's receipt of notice, and without an order
of the Court, disburse the entire MFN Escrow Amount (including any
interest thereon, as provided in Section 3) to the Settling Defendants on
the same pro rata basis as such funds were contributed to the MFN Escrow
Account.

(b) Upon receipt of written notice signed by counsel for the
Settling Defendants and counsel for the State of Mississippi stating that
the Availability Date has occurred, the MFN Escrow Agent shall proceed to
distribute the MFN Escrow Amount.

Escrow Amount for any such charge until it shall have presented its
statement to and received approval by counsel for the Settling Defendants
and counsel for the State of Mississippi, which approval shall not be
unreasonably withheld. Such approval shall be deemed given if the MFN
Escrow Agent has not received written objections from either counsel for
Settling Defendants or counsel for the State of Mississippi within 14 days
after presentment of its statement. Such fees and all expenses charged
against the MFN Escrow Amount shall, to the extent possible, be paid out
of interest earned. In the event that counsel for the Settling Defendants
or counsel for the State of Mississippi objects in writing to such fees,
the MFN Escrow Agent shall not debit the MFN Escrow Amount except upon a
court order approving such fees.

SECTION 5. Substitute Form W-9; Qualified Settlement Fund.

Each of the signatories to this MFN Escrow Agreement shall provide the MFN
Escrow Agent with a correct taxpayer identification number on a substitute Form
W-9 within 90 days of the date hereof and indicate thereon that it is not
subject to backup withholding. It is anticipated that the MFN Escrow Account
established pursuant to this MFN Escrow Agreement shall be treated as a
Qualified Settlement Fund for federal tax purposes pursuant to Treas. Reg. ss.
1.468B-1.

SECTION 6. Termination of MFN Escrow Account.

This MFN Escrow Agreement (other than the MFN Escrow Agent's right to
indemnification set forth in Section 7) shall terminate when the MFN Escrow
Agent shall have released from the MFN Escrow Account all amounts pursuant to
Section 4 hereof.

SECTION 7. MFN Escrow Agent.

(a) The MFN Escrow Agent shall have no duty or obligation hereunder
other than to take such specific actions as are required of it from time
to time under the provisions hereof, and it shall incur no liability
hereunder or in connection herewith for anything whatsoever other than as
a result of its own negligence or willful misconduct. The MFN Escrow Agent
shall be fully protected if it acts in accordance with the written advice
of its counsel. In the event the MFN Escrow Agent fails to receive the
instructions contemplated by Section 4 hereof or receives conflicting
instructions, the MFN Escrow Agent shall be fully protected in refraining
from acting until such instructions are received or such conflict is
resolved by written agreement or court order.

(b) Settling Defendants, on the same pro rata basis as the funds
constituting the MFN Escrow Amount were contributed to the MFN Escrow
Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent
from and against any and all losses, claims, liabilities and reasonable
expenses, including the reasonable fees of its counsel, which it may
suffer or incur hereunder or in connection herewith prior to the
Availability Date, except such as shall result solely and directly from
its own negligence or willful misconduct. The MFN Escrow Agent shall not
be bound in any way by any agreement or contract between Settling
Defendants and the State of Mississippi (whether or not the MFN Escrow
Agent has knowledge thereof) and the only duties and responsibilities of
the MFN Escrow Agent shall be to hold and invest the MFN Escrow Amount
received hereunder and to release such MFN Escrow Amount in accordance
with the terms of this MFN Escrow Agreement.

(c) The MFN Escrow Agent may resign at any time by giving written
notice thereof to the other parties hereto, but such resignation shall not
become effective until a successor MFN Escrow Agent, selected by the
Settling Defendants and agreeable to the State of Mississippi, shall have
been appointed and shall have accepted such appointment in writing. If an
instrument of acceptance by a successor MFN Escrow Agent shall not have
been delivered to the MFN Escrow Agent within 30 days after the giving of
such notice of resignation, the resigning MFN Escrow Agent may, at the
expense of the Settling Defendants and the State of Mississippi (to be
shared equally between the State of Mississippi and the Settling
Defendants), petition the Court for the appointment of a successor MFN
Escrow Agent.

(d) Upon the Availability Date having occurred, provided that
Settling Defendants have performed all of their obligations required to be
performed prior to the Availability Date, all duties and obligations of
Settling Defendants hereunder shall cease, with the exception of any
indemnification obligation of Settling Defendants incurred prior to the
Availability Date.

SECTION 8. Miscellaneous.

(a) Notices. All notices or other communications to any party or
other person hereunder shall be in writing (which shall include telex,
telecopy or similar writing) and shall be given to the respective parties
or persons at the following addresses. Any party or person may change the
name and address of the person designated to receive notice on behalf of
such party or person by notice given as provided in this paragraph.

State of Mississippi:

Hon. Michael C. Moore
Attorney General's Office
450 High Street
Post Office Box 220
Jackson, MS 39205
Fax: (601) 359-3441

With copies to:

Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent, P.A.
P.O. Drawer 1425
743 Delmas Avenue
Pascagoula, MS 39568-1425
Fax: (228) 762-1207

and:

Joseph F. Rice, Esq.
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (843) 720-9290

and:

David O. McCormick
707 Watts Avenue
P.O. Box 865
Pascagoula, MS 39568-0865
Fax: (228) 762-4864

Settling Defendants:

For Philip Morris Incorporated:
Martin J. Barrington
Philip Morris Incorporated
120 Park Avenue
New York, NY 10017-5592
Fax: (212) 907-5399

With a copy to:

Meyer G. Koplow
Wachtell, Lipton, Rosen & Katz
51 West 52nd Street
New York, NY 10019
Fax: (212) 403-2000

For R.J. Reynolds Tobacco Company:

Charles A. Blixt
R.J. Reynolds Tobacco Company
401 North Main Street
Winston-Salem, NC 27102
Fax: (336) 741-2998

With a copy to:

Arthur F. Golden
Davis Polk & Wardwell
450 Lexington Avenue
New York, NY 10017
Fax: (212) 450-4800

For Brown & Williamson Tobacco Corporation:

Michael Walter
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7187

With a copy to:

F. Anthony Burke
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7297

For Lorillard Tobacco Company:
Arthur J. Stevens
Lorillard Tobacco Company
714 Green Valley Road
Greensboro, NC 27408
Fax: (336) 335-7707

MFN Escrow Agent:

SouthTrust Bank, N.A.
854 Howard Avenue
Post Office Box 1419
Biloxi, MS 39530
Phone: (228) 436-8656
Fax: (228) 436-8689

Wire Transfer Instructions:
ABA #: 062000080
Account #: 62-780173
Account Name: Mississippi MFN Escrow Account

(b) Successors and Assigns. The provisions of this MFN Escrow
Agreement shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and assigns.

(c) Governing Law. This MFN Escrow Agreement shall be construed in
accordance with and governed by the laws of the State of Mississippi,
without regard to the conflicts of law rules of such state.

(d) Jurisdiction and Venue. The parties hereto irrevocably and
unconditionally submit to the jurisdiction of the Court for purposes of
any suit, action or proceeding seeking to enforce any provision of, or
based on any right arising out of, this MFN Escrow Agreement, and the
parties hereto agree not to commence any such suit, action or proceeding
except in such Court. The parties hereto hereby irrevocably and
unconditionally waive any objection to the laying of venue of any such
suit, action or proceeding in the Court and hereby further irrevocably
waive and agree not to plead or claim in such Court that any such suit,
action or proceeding has been brought in an inconvenient forum.

(e) Definitions. Terms used herein that are defined in the
Settlement Agreement or the Stipulation of Amendment are, unless otherwise
defined herein, used in this MFN Escrow Agreement as defined

in the Settlement Agreement or the Stipulation of Amendment, as
appropriate.

(f) Amendments. This MFN Escrow Agreement may be amended only by
written instrument executed by all parties hereto. The waiver of any
rights conferred hereunder shall be effective only if made by written
instrument executed by the waiving party. The waiver by any party of any
breach of this MFN Escrow Agreement shall not be deemed to be or construed
as a waiver of any other breach, whether prior, subsequent or
contemporaneous, of this MFN Escrow Agreement.

(g) Counterparts; Effectiveness. This MFN Escrow Agreement may be
signed in any number of counterparts, each of which shall be an original,
with the same effect as if the signatures thereto and hereto were upon the
same instrument. This MFN Escrow Agreement shall become effective when
each party hereto shall have signed a counterpart hereof. Delivery by
facsimile of a signed agreement shall be deemed delivery for purposes of
acknowledging acceptance hereof; however, an original executed signature
page must promptly thereafter be appended to this MFN Escrow Agreement,
and an original executed agreement shall promptly thereafter be delivered
to each party hereto.

(h) Captions. The captions herein are included for convenience of
reference only and shall be ignored in the construction and interpretation
hereof.

IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as
of the day and year first hereinabove written.

STATE OF MISSISSIPPI

By: /s/ Michael C. Moore
-------------------------------
Michael C. Moore
Attorney General

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
---------------------------------------
Meyer G. Koplow
Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
---------------------------------------
Arthur F. Golden
Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
---------------------------------------
Stephen R. Patton
Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
---------------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

SOUTHTRUST BANK, N.A.
as MFN Escrow Agent

By: /s/ Walter H. Stuart, III
-------------------------------
Name: Walter H. Stuart, III
Title: President & CEO

Exhibit 10.4

IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

____________________________________
)
STATE OF TEXAS, )
)
Plaintiff, )
)
vs. ) No. 5-96CV-91
)
AMERICAN TOBACCO )
COMPANY, et al., )
)
Defendants. )
____________________________________)

STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT
AND FOR ENTRY OF CONSENT DECREE

THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF
CONSENT DECREE (the "Stipulation of Amendment") is made as of the date hereof,
by and among the parties hereto, as indicated by their signatures below, to
amend the Comprehensive Settlement Agreement and Release entered into by the
parties hereto with respect to this Action on January 16, 1998 (the "Settlement
Agreement").

WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants
entered into the Settlement Agreement to settle and resolve with finality all
present and future civil claims against all parties to this litigation

relating to the subject matter of this litigation which have been or could have
been asserted by any of the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated January 22, 1998.

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, on May 8, 1998, Settling Defendants Philip Morris Incorporated,
R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and
Lorillard Tobacco Company (the "MFN Settling Defendants") entered into a
pre-verdict settlement agreement with the State of Minnesota (the "Minnesota
Settlement") to resolve the lawsuit State of Minnesota v. Philip Morris Inc.,
No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994);

WHEREAS, the State of Texas and MFN Settling Defendants agree that,
pursuant to the Most Favored Nation clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Texas and Settling Defendants have agreed on the
terms of revisions to the Settlement Agreement, including revisions in light of
the Minnesota Settlement, as set forth in this Stipulation of Amendment and the
attached Consent Decree; and

WHEREAS, the parties hereto have further agreed jointly to petition the
Court for approval of the Consent Decree:

1. Amendment of Settlement Agreement. The provisions of this Stipulation
of Amendment supplement the terms of the Settlement Agreement, which shall
remain in full force and effect except insofar as they are expressly

revised by the provisions of this Stipulation of Amendment. Nothing in this
Stipulation of Amendment shall be construed to release Settling Defendants from
any of the obligations assumed in paragraphs 6 (Elimination of Billboards and
Transit Advertisements), 8 (Initial Payments) and 9 (Pilot Program Payments) of
the Settlement Agreement.

2. Voluntary Agreement of the Parties. This Stipulation of Amendment is
entered into voluntarily by the parties hereto. The State and Settling
Defendants understand that Congress may enact legislation dealing with some of
the issues addressed in the Settlement Agreement, this Stipulation of Amendment
or the Consent Decree. The MFN Settling Defendants and their assigns,
affiliates, agents and successors hereby voluntarily waive any right to
challenge the Settlement Agreement, this Stipulation of Amendment or the Consent
Decree, directly or through third parties, on the ground that any term thereof
or hereof is unconstitutional, outside the power or jurisdiction of the Court or
preempted by or in conflict with any current or future federal legislation
(except insofar as the non-economic terms of the Settlement Agreement (as
revised hereby) or the Consent Decree are irreconcilable with any such future
federal legislation). The Court may, upon the State's application, enter a
Consent Decree in the form attached as Exhibit 1 hereto.

3. Definitions. For the purposes of the Settlement Agreement, this
Stipulation of Amendment and the Consent Decree, the following terms shall have
the meanings set forth below:

(a) "Consumer Price Index" means the Consumer Price Index for All
Urban Consumers for the most recent twelve-month period for which such
percentage information is available, as published by the Bureau of Labor
Statistics of the U.S. Department of Labor;

(b) "Market Share" means a Settling Defendant's respective share of
sales of Cigarettes, by number of individual Cigarettes shipped in the
United States for domestic consumption, as measured by such Settling
Defendant's audited reports of shipments of Tobacco Products provided to
the U.S. Securities and Exchange Commission ("SEC") (or, in the case of
any Settling Defendant that does not provide such reports to the SEC,
audited reports of shipments containing the same shipment information as
contained in the reports provided to the SEC) ("Shipment Reports"), during
(i) with respect to payments made pursuant to paragraph 7 of this
Stipulation of Amendment, the calendar year ending on the date on which
the payment at issue is due (or, in the case of the payment due on
November 1, 1998, the calendar year ending December 31, 1998), regardless
of when such payment is made, and (ii) with respect to all other

payments made pursuant to this Stipulation of Amendment and the Settlement
Agreement, the calendar year immediately preceding the year in which the
payment at issue is due, regardless of when such payment is made;

(d) "Smokeless Tobacco" means any product that consists of cut,
ground, powdered or leaf tobacco that contains nicotine and that is
intended to be placed in the oral cavity;

(e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and

(f) "Children" means persons under the age of 18.

The above definitions supplement the definitions provided in the Settlement
Agreement and, insofar as they differ, supersede them.

4. Settlement Receipts. The payments to be made by Settling Defendants
under this Stipulation of Amendment during the year 1998 are in settlement of
the State's claims for reimbursement for public health expenditures of the State
of Texas incurred in the year of payment or earlier years related to the subject
matter of this Action, including without limitation expenditures made by the
State's Employees' Health Insurance Program and Charity Care programs. All other
payments made by Settling Defendants pursuant to this Stipulation of Amendment
are in settlement of all of the State of Texas's claims for damages incurred by
the State in the year of payment or earlier years related to the subject matter
of this Action, including claims for reimbursement of Medicaid expenditures and
punitive damages, except that no part of any payment under the Settlement
Agreement or this Stipulation of Amendment is made in settlement of an actual or
potential liability for a fine, penalty (civil or criminal) or enhanced damages
or as the cost of a tangible or intangible asset or other future benefit.

5. Supplemental Initial Payment. Each MFN Settling Defendant severally
shall cause to be paid into the registry of the court and in accordance with and
subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion
to

its Market Share, its share of $156,530,000, to be paid on or before January 4,
1999; its share of $605,090,000, to be paid on or before January 3, 2000; its
share of $605,090,000, to be paid on or before January 2, 2001; its share of
$605,090,000, to be paid on or before January 2, 2002; and its share of
$303,200,000, to be paid on or before January 2, 2003. The payments made by MFN
Settling Defendants pursuant to this paragraph shall be adjusted upward by the
greater of 3% or the actual total percent change in the Consumer Price Index
applied each year on the previous year, beginning with the payment due to be
made on or before January 3, 2000. The payments due to be made by MFN Settling
Defendants pursuant to this paragraph 5 on or before January 3, 2000, on or
before January 2, 2001, on or before January 2, 2002, and on or before January
2, 2003, will also be decreased or increased, as the case may be, in accordance
with the formula for adjustment of payments set forth in Appendix A hereto. The
payment due to be made by MFN Settling Defendants pursuant to this paragraph 5
on or before January 4, 1999, shall not be subject to adjustment for inflation
or in accordance with the formula for adjustment of payments set forth in
Appendix A hereto.

6. Acceleration of Supplemental Initial Payment. In the event that any MFN
Settling Defendant fails to make any payment required of it pursuant to
paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the

applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of
Texas shall provide notice to each of the MFN Settling Defendants of such
non-payment. The Defaulting Defendant shall have 15 days after receipt of such
notice to pay the Missed Payment, together with interest accrued from the
original applicable due date at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the date of default plus 3%.
If the Defaulting Defendant does not make such payment within such 15-day
period, the State of Texas shall have the option of providing notice to each of
the MFN Settling Defendants of such continued non-payment. In the event that the
State of Texas elects to provide such notice, any or all of the MFN Settling
Defendants (other than the Defaulting Defendant) shall have 15 days after
receipt of such notice to elect (in such MFN Settling Defendant's or such MFN
Settling Defendants' sole and absolute discretion) to pay the Missed Payment,
together with interest accrued from the original applicable due date at the
prime rate as published in the Wall Street Journal on the latest publication
date on or before the date of default plus 3%. In the event that the State of
Texas does not receive the Missed Payment, together with such accrued interest,
within such additional 15-day period, all future payments required to be made by
each of the respective MFN Settling Defendants pursuant to paragraph 5 of this
Stipulation of Amendment shall at the end of such additional 15-day period be
accelerated and immediately become due and owing to

the State of Texas from each MFN Settling Defendant, pro rata in proportion to
its Market Share; provided, however, that such accelerated payments (a) shall
all be adjusted upward by the greater of (i) the rate of 3% per annum or (ii)
the actual total percent change in the Consumer Price Index, in either instance
for the period between January 1 of the year in which the acceleration of
payments pursuant to this paragraph occurs and the date on which such
accelerated payments are made pursuant to this paragraph 6, and (b) shall all
immediately be adjusted in accordance with the formula for adjustment of
payments set forth in Appendix A hereto.

Nothing in this paragraph 6 shall be deemed under any circumstance to
create any obligation on the part of any MFN Settling Defendant to pay any
amount owed or payable to the State of Texas by any other MFN Settling
Defendant. All obligations of the MFN Settling Defendants pursuant to this
paragraph 6 are intended to be and shall remain several, and not joint.

7. Annual Payments. Each of the Settling Defendants agrees that it shall
severally cause to be paid into the registry of the Court, in accordance with
and subject to paragraph 17 of this Stipulation of Amendment, pro rata in
proportion to its Market Share, its share of the following payments (subject to
adjustment for appropriate allocation among Settling Defendants by January 30,
1999): $89

million to be paid on or before November 1, 1998; and $201 million to be paid on
or before December 31, 1998.

Each of the Settling Defendants further agrees that, on December 31, 1999
and annually thereafter on December 31st of each year after 1999 (subject to
final adjustment within 30 days), it shall severally cause to be paid into the
registry of the Court and in accordance with and subject to paragraph 17 of this
Stipulation of Amendment, pro rata in proportion to its Market Share, its share
of 7.25% of the following amounts (in billions):

Year 1999 2000 2001 2002 2003 thereafter
----
2 3 4 5 6

Amount $4.5B $5B $6.5B $6.5B $8B $8B
------

The payments made by Settling Defendants pursuant to this paragraph 7
shall be adjusted upward by the greater of 3% or the actual total percent change
in the Consumer Price Index applied each year on the previous year, beginning
with the annual payment due on December 31, 1999. Such payments will also be
decreased or increased, as the case may be, beginning with the annual payment
due on December 31, 1999, in accordance with the formula for adjustment of
payments set forth in Appendix A hereto. Settling Defendants shall pay the
payments due pursuant to this paragraph 7 on November 1, 1998 and December 31,
1998 without adjustment for inflation or in accordance with the formula for
adjustments of payments set forth in Appendix A hereto. This paragraph 7
supersedes paragraph

10 of the Settlement Agreement, which is hereby rendered null, void and of no
further effect.

8. Determination of Market Share. In the event of a disagreement between
or among any Settling Defendants as to their respective shares of any payment
due to be paid on a Market Share basis pursuant to the Settlement Agreement and
this Stipulation of Amendment, each Settling Defendant shall pay its undisputed
share of such payment promptly on or before the date on which such payment is
due, and shall, within 21 days of such date, submit its Shipment Reports for the
year in question to a third party to be selected by agreement of Settling
Defendants (the "Third Party"), who shall determine the Market Share of each
Settling Defendant within three business days of receipt of such Shipment
Reports. The decision of the Third Party shall be final and non-appealable, and
shall be communicated by facsimile to each person designated to receive notice
hereunder. Each Settling Defendant shall, within two business days of receipt of
the Third Party's decision, pay the State or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate as published in the Wall Street

Journal on the latest publication date on or before the original date on which
the payment in question was due plus 3%.

(a) MFN Settling Defendants shall be entitled to receive a dollar
for dollar offset against the annual payments required under paragraph 7
of this Stipulation of Amendment of any amounts that the State of Texas
could elect to receive pursuant to such Tobacco Legislation ("Federal
Settlement Funds"), up to the full amount of such annual payments, except
to the extent that:

(i) such Federal Settlement Funds are required to be used for
purposes other than health care or tobacco-related purposes;

(ii) such Tobacco Legislation provides the opportunity for
other states to elect to receive Federal Settlement Funds but does
not provide for the abrogation, settlement or relinquishment of any
tobacco-related claims of such states that have not previously been
resolved; or

(iii) state receipt of such Federal Settlement Funds is
conditioned upon (A) the relinquishment of rights or benefits under
the Settlement Agreement (including this Stipulation of Amendment
and the Consent Decree) (excepting any annual payment amounts
subject to the offset); or (B) actions or expenditures by the state
unrelated to health care or tobacco (including but not limited to
tobacco education, cessation, control or enforcement).

(b) Nothing in this paragraph 9 shall reduce (i) the payments made
to the State of Texas pursuant to paragraphs 8 and 9 of the Settlement
Agreement and paragraphs 5 and 6 of this Stipulation of Amendment (by
offset, credit, recoupment, refund or otherwise); or (ii) the percentage
figure (7.25%) used to determine the State of Texas's annual payments
pursuant to paragraph 7 of this Stipulation of Amendment. Nothing in this
paragraph 9 is intended to or shall reduce the total amounts payable by
MFN Settling Defendants to the State of Texas under the Settlement
Agreement (as revised hereby) by an amount greater than the amount of
Federal Settlement Funds that the State of Texas could elect to receive.

This paragraph 9 supersedes paragraph 12 of the Settlement Agreement,
which is hereby rendered null, void and of no further effect.

10. Clarification of Scope of State's Release. The release of claims
provided in paragraph 14 of the Settlement Agreement shall, with respect to the
Claims identified in subparagraph (2) thereof, apply only to monetary Claims.
This paragraph 10 does not supersede but rather supplements and clarifies the
scope of the release provided in paragraph 14 of the Settlement Agreement.

11. Limited Most-Favored Nation Provision. In partial consideration for
the monetary payments to be made by MFN Settling Defendants pursuant to this
Stipulation of Amendment, the State of Texas agrees that, if MFN Settling
Defendants enter into any future pre-verdict settlement agreement of other
similar litigation brought by a non-federal governmental plaintiff, or any
amendment to any such existing settlement agreement, on terms more favorable to
such non-federal governmental plaintiff than the terms of the Settlement
Agreement (including this Stipulation of Amendment and the Consent Decree)
(after due consideration of relevant differences in population or other
appropriate factors), the terms of the Settlement Agreement (including this
Stipulation of Amendment and the Consent Decree) shall not be revised except as
follows: to the extent, if any, such other pre-verdict settlement agreement
includes terms that provide:

(a) for joint and several liability among MFN Settling Defendants
with respect to monetary payments to be made pursuant to such agreement;

(b) a guarantee by the parent company of any of MFN Settling
Defendants or other assurances of payment or creditors' remedies with
respect to monetary payments to be made pursuant to such agreement;

(d) for no offset of Federal Settlement Funds against annual
settlement payments pursuant to such settlement agreement; or

(e) for an offset term more favorable to the plaintiff than the
offset provisions of paragraph 9 of this Stipulation of Amendment,

then the Settlement Agreement shall, at the option of the Office of the Attorney
General of the State of Texas, be revised to include terms comparable to such
terms.

This paragraph 11 supersedes paragraph 16 of the Settlement Agreement,
which is hereby rendered null, void and of no further effect as to any MFN
Settling Defendant. The State of Texas hereby acknowledges that, pursuant to the
terms of this paragraph 11, it has irrevocably waived any future claim against
MFN Settling Defendants to revise the terms of the Settlement Agreement or this
Stipulation of Amendment pursuant to paragraph 16 of the Settlement Agreement
(except as

provided in paragraph 23 of this Stipulation of Amendment), and it hereby
further covenants and agrees that, in consideration for MFN Settling Defendants'
agreement to the terms of this Stipulation of Amendment, it shall not hereafter
seek to revise the Settlement Agreement or this Stipulation of Amendment as to
MFN Settling Defendants, except as expressly provided in this paragraph 11 (or
pursuant to mutually agreeable amendment by the parties hereto as provided in
paragraph 23 of the Settlement Agreement and paragraph 19 hereof).

12. MFN Settling Defendants' Assurances. MFN Settling Defendants agree:

(a) to support the legislative initiatives to enact new laws and
administrative initiatives to promulgate new rules described in paragraph
7 of the Settlement Agreement; and

(b) not to support in Congress or any other forum legislation, rules
or policies which would preempt, override, abrogate or diminish the
State's rights or recoveries under the Settlement Agreement (as amended
hereby). Except as specifically provided in the foregoing sentence,
nothing in the Settlement Agreement (including this Stipulation of
Amendment and the Consent Decree) shall be deemed to restrain the parties
from advocating terms of any national settlement or taking any other
positions on issues relating to tobacco.

13. Disclosure of Payments. Each MFN Settling Defendant shall disclose to
the Office of the Attorney General and the Texas Ethics Commission, at the times
and in the manner provided below, information about the following payments:

(a) Any payment to a person required to register under Tex. Gov't
Code Ann. ss.305.005 (West 1998), if the MFN Settling Defendant knows or
has reason to know that the payment will be used, directly or indirectly,
to influence legislative or administrative action or the official action
of state or local government in Texas in any way relating to Tobacco
Products or their use;

(b) Any payment to a third party, if the MFN Settling Defendant
knows the payment is partly in consideration for the third party
attending, offering testimony at, or participating before a state or local
government hearing in Texas in any way relating to Tobacco Products or
their use; and

(c) Any payment (other than a "political contribution" under 2
U.S.C. ss.431(8)(A)) to, or for the benefit of, a state or local official
in Texas, whether made directly by the MFN Settling Defendant or
indirectly through an employee of the MFN Settling Defendant acting within
the scope of his employment, or through an affiliate, lobbyist or other
agent acting under the substantial control of the MFN Settling Defendant.

Disclosures required under this paragraph 13 shall be filed with the Office of
the Attorney General and the Texas Ethics Commission on the first day of
February, May, August and November of each year (beginning November 1, 1998) for
any and all payments made through the first day of the previous month, and shall
be transmitted in electronic format or such format as the Attorney General may
require, with the following information:

o The name, address, telephone number and e-mail address of the
recipient;

o The amount of each payment described in this paragraph 13; and

o The aggregate amount of all payments described in this paragraph 13
to the recipient in the calendar year.

Information disclosed pursuant to this paragraph is "public information" within
the meaning of Tex. Gov't Code Ann. ss. 552.002 (West 1998).

14. Prohibition of Certain Payments for Product Placement. MFN Settling
Defendants shall not make or cause to be made, in connection with any motion
picture made in the United States, any payment, direct or indirect, to any
person to use, display, make reference to or use as a prop any cigarette,
cigarette package, advertisement for cigarettes, or any other item bearing the
brand name, logo, symbol, motto, selling message, recognizable color or pattern
of colors, or any other indicia of product identification identical or similar
to, or identifiable with, those used for any brand of domestic Tobacco Products.

15. Prohibition on Promotional Merchandise. On and after December 31,
1998, MFN Settling Defendants shall permanently cease marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Texas, any item (other than Tobacco
Products or any item of which the sole function is to advertise Tobacco
Products) which bears the brand name (alone or in conjunction with any other
word), logo, symbol, motto, selling message, recognizable color or pattern of
colors, or any other indicia of product identification identical or similar to,
or identifiable with, those used for any brand of domestic Tobacco Products,
except that nothing in this paragraph shall (i) require any MFN Settling
Defendant to terminate, breach or violate any licensing agreement or contract in
existence as of July 1, 1998 for the remaining term of such contract; (ii)
prohibit the distribution to any employee (18 years of age or older) of an MFN
Settling Defendant of any item described above that is intended for the personal
use of such employee by such MFN Settling Defendant; or (iii) prohibit items
necessarily incidental to or ordinarily distributed in connection with any
sponsorship described in paragraph 4(e)(2) of the Settlement Agreement.

16. Document Production. MFN Settling Defendants shall, upon request,
provide to the State of Texas a copy of any CD-ROMs of documents that MFN
Settling Defendants have agreed to produce, pursuant to the Minnesota
Settlement,

to the document depository established in connection with the lawsuit State of
Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed
Aug. 17, 1994), with a copy of the accompanying transmittal letter provided to
each person designated to receive notice hereunder.

17. Court Approval. The parties hereto agree to submit this Stipulation of
Amendment promptly to the Court for its review and approval. If the Court
refuses to approve this Stipulation of Amendment and the Consent Decree in any
respect unacceptable to either of the parties hereto or to enter the Order
Granting Joint Motion for Approval of Agreement Regarding Disposition of
Settlement Proceeds and to Withdraw with Predjudice All Political Subdivisions'
Motions to Intervene (the "Political Subdivisions Order," in the form attached
as Exhibit 2 hereto), or if such approval or the Political Subdivisions Order is
modified in any respect unacceptable to either of the parties hereto or set
aside on appeal, then this Stipulation of Amendment shall be canceled and
terminated and it and all orders issued pursuant hereto (including the Consent
Decree) shall become null and void and of no further effect. Any such
cancellation or termination of this Stipulation of Amendment shall not of itself
result in the cancellation or termination of, or otherwise affect, the
Settlement Agreement as approved by the Court on January 22, 1998. All payments
described in this Stipulation of Amendment shall be paid into a special escrow
account, pursuant to the terms of a mutually acceptable

escrow agreement (the "MFN Escrow Agreement" in the form attached as Exhibit 3
hereto), and if so paid shall remain in said escrow account, until such time as
(1) the 30-day time periods to seek review of the Court's order approving this
Stipulation of Amendment and the Political Subdivisions Order have expired
without the filing of any notice of appeal or petition for review; or (2) in the
event of a timely appeal or petition, the appeal or the petition has been
dismissed or the Court order in question has been affirmed in all material
respects by the court of last resort to which such appeal or petition has been
taken and such dismissal or affirmance has become no longer subject to further
appeal or review. Any payments made into escrow shall be disbursed from escrow
only in strict accordance with the terms of the MFN Escrow Agreement and upon
disbursement shall be transferred into the registry of the Court. All payments
described in this Stipulation of Amendment that are not required to be paid into
the MFN Escrow Account pursuant to this paragraph 17 shall be paid into the
registry of the Court.

18. Payment Responsibility. All obligations of the Settling Defendants
pursuant to the Settlement Agreement and this Stipulation of Amendment are
intended to be and shall remain several, and not joint. Due to the particular
corporate structures of Settling Defendants R.J. Reynolds Tobacco Company
("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown & Williamson")
with respect to their non-domestic tobacco operations, Settling

Defendants Reynolds and Brown & Williamson shall be severally liable for their
respective shares of each payment due pursuant to the Settlement Agreement and
this Stipulation of Amendment up to (and their liability hereunder shall not
exceed) the full extent of their assets used in, and earnings derived from, the
manufacture and sale in the United States of Tobacco Products intended for
domestic consumption, and no recourse shall be had against any of their other
assets or earnings to satisfy such obligations.

19. Applicable Provisions of Settlement Agreement. The provisions of
paragraphs 18 (Representations of Parties), 20 (Headings), 21 (No Admission), 22
(Non-Admissibility), 23 (Amendment), 25 (Cooperation), 26 (Governing Law), 27
(Construction), 28 (Severability), 29 (Intended Beneficiaries) and 30
(Counterparts) of the Settlement Agreement shall be equally applicable to this
Stipulation of Amendment as though fully set forth herein, and all references to
the Settlement Agreement in the sections thereof specifically listed in this
paragraph 19 shall be construed to include this Stipulation of Amendment.

20. Release of Right to Additional Compensation. In consideration for the
terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the
State of Texas hereby irrevocably releases MFN Settling Defendants from any
claim for additional compensation pursuant to paragraphs 17(a) and (d) of the
Settlement Agreement, and the provisions of paragraphs 17(a) and (d) regarding
the State's

rights to additional compensation are hereby rendered null, void and of no
further effect.

21. Discovery Materials. Paragraph 22 of the Settlement Agreement is
hereby modified to permit the Attorney General of the State of Texas to seek the
dissolution of any protective order in this Action governing treatment of
discovery materials during the pendency of this Action (as well as existing
confidentiality designations), but only with regard to materials that have been
made public in other litigation pursuant to a final court order, subject to any
defenses or objections as may be made by Settling Defendants. Except as
expressly provided above, the provisions of paragraph 22 of the Settlement
Agreement with respect to discovery materials shall remain in effect for the
period of time specified therein.

22. Attorneys' Fees. Settling Defendants, the State of Texas, Private
Counsel and the Law Offices of Marc D. Murr, P.C. have entered into a separate
agreement on July 24, 1998 (the "Texas Fee Payment Agreement") that sets forth
the entire obligation of Settling Defendants with respect to payment of
attorneys' fees pursuant to paragraph 17 of the Settlement Agreement. The
parties hereto agree that the Texas Fee Payment Agreement supersedes Exhibit 1
to the Settlement Agreement, which is hereby rendered null, void and of no
further effect. The parties further agree that Settling Defendants shall not be
required to perform any obligation pursuant to this Stipulation of Amendment
(excepting Settling

Defendants' obligations with respect to the advance to be paid pursuant to
section 12 of the Texas Fee Payment Agreement) until such time as (1) the Court
issues an order confirming that amounts payable with respect to attorneys' fees
of Texas Counsel pursuant to the Texas Fee Payment Agreement are not funds of
the State of Texas and that Settling Defendants are under no obligation to pay
such amounts to the State of Texas; (2) the 30-day period to seek review of such
order has expired without the filing of any notice of appeal or petition for
review; and (3) in the event of a timely appeal or petition, such appeal or
petition has been dismissed or the order has been affirmed in all material
respects by the court of last resort to which such appeal or petition has been
taken and such dismissal or affirmance has become no longer subject to further
appeal or review. Under no circumstances shall Settling Defendants' entry into
this Stipulation of Amendment or the Texas Fee Payment Agreement be construed
as, or deemed to be, evidence of or an admission or concession that the
Settlement Agreement can be revised pursuant to the Most Favored Nation clause
without incorporation of all terms of any settlement agreement that provides the
occasion for any such revision, including all terms thereof with respect to
attorneys' fees.

be unenforceable (such that MFN Settling Defendants are relieved from making
payments required under the Minnesota Settlement) (the "Minnesota Order"), MFN
Settling Defendants shall have the option to elect not to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due
on or after the date of such Minnesota Order. In the event that MFN Settling
Defendants make such an election:

(a) MFN Settling Defendants shall not be obligated to make any
payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment
that becomes due on or after the date of the Minnesota Order; provided,
however, that if the Minnesota Order is reversed on appeal or otherwise
set aside, MFN Settling Defendants shall be obligated to make any payments
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were
not made when initially due as result of the Minnesota Order;

(b) the provisions of paragraph 11 of this Stipulation of Amendment
shall not apply to preclude the application of paragraph 16 of the
Settlement Agreement with respect to any pre-verdict settlement agreement
described therein entered into after the date of the Minnesota Order; and

(c) MFN Settling Defendants shall be entitled to a credit, in the
amount of any payments made pursuant to paragraphs 5 and 6 of this

Stipulation of Amendment, against any payments due to the State of Texas
as a result of application of paragraph 16 of the Settlement Agreement in
connection with any pre-verdict settlement agreement entered into after
the date of the Minnesota Order, pursuant to subparagraph (b) of this
paragraph 23.

No other provision of the Settlement Agreement, this Stipulation of Amendment or
the Consent Decree shall be affected by the Minnesota Order. MFN Settling
Defendants will provide the State of Texas with notice of any filing seeking to
obtain a Minnesota Order.

24. Entire Agreement of Parties. The Settlement Agreement (including this
Stipulation of Amendment, the Texas Fee Payment Agreement and the Consent Decree
but excluding Exhibit 1 to the Settlement Agreement, which is hereby rendered
null, void and of no further effect) contains an entire, complete and integrated
statement of each and every term and provision agreed to by and among the
parties hereto relating in any way to the settlement of the tobacco litigation
brought by the State of Texas, and is not subject to any condition not provided
for herein.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Stipulation of Amendment as of this 24th
day of July, 1998.

STATE OF TEXAS, acting by and through
Dan Morales, its duly elected and
authorized Attorney General

By: /s/ Dan Morales
----------------------------------
Dan Morales
Attorney General

COUNSEL TO THE STATE OF TEXAS

By: /s/ Walter Umphrey
----------------------------------
Walter Umphrey
Provost & Umphrey

By: /s/ John M. O'Quinn
----------------------------------
John M. O'Quinn

By: /s/ John Eddie Williams, Jr.
----------------------------------
John Eddie Williams, Jr.

By: /s/ Wayne A. Reaud
----------------------------------
Wayne A. Reaud
Reaud, Morgan & Quinn, Inc.

By: /s/ Harold W. Nix
----------------------------------
Harold W. Nix
The Nix Law Firm

By: /s/ Cary Patterson
----------------------------------
Cary Patterson
The Nix Law Firm

By: /s/ Marc D. Murr
----------------------------------
Marc D. Murr
Law Offices of Marc D. Murr, P.C.

By: /s/ Grant Kaiser
----------------------------------
Grant Kaiser
Kaiser & Morrison

By: /s/ T. Richardson, Jr.
----------------------------------
For Joseph F. Rice
Ness, Motley, Loadholt,
Richardson & Poole

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
----------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
----------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
----------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt
----------------------------------
Charles A. Blixt
General Counsel

BROWN & WILLIAMSON TOBACCO CORPORATION

By: /s/ Stephen R. Patton
----------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
----------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
----------------------------------
Arthur J. Stevens
Senior Vice President & General
Counsel

UNITED STATES TOBACCO COMPANY

By: /s/ Richard H. Verheij
----------------------------------
Richard H. Verheij
Executive Vice President &
General Counsel

APPENDIX A

FORMULA FOR CALCULATING VOLUME ADJUSTMENTS

(B) in the event the Actual Volume is less than the Base Volume,

(i) the Applicable Base Payment shall be multiplied by the ratio of
the Actual Volume to the Base Volume, and the resulting product
shall be divided by 0.98; and

(ii) if a reduction of the Applicable Base Payment results from the
application of subparagraph (B)(i) of this Appendix, but the
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes for the Applicable Year (the "Actual Net
Operating Profit") is greater than the Settling Defendants'
aggregate net operating profits from domestic sales of cigarettes in
1997 (the "Base Net Operating Profit") (such Base Net Operating
Profit being adjusted upward by the greater of the rate of 3% per
annum or the actual total percent change in the Consumer Price
Index, in either instance for the period between January 1, 1998 and
the date on which the payment at issue is made), then the amount by
which the Applicable Base Payment is reduced by the application of
subparagraph (B)(i) shall be reduced (but not below zero) by 7.25%
of 25% of such increase in such profits. For purposes of this
Appendix, "net operating profits from domestic sales of cigarettes"
shall mean net operating profits from domestic sales of cigarettes
as reported to the United States Securities and Exchange Commission
("SEC") for the Applicable Year or, in the case of a Settling
Defendant that does not report profits to the SEC, as reported in

financial statements prepared in accordance with generally accepted
accounting principles and audited by a nationally recognized
accounting firm. The determination of Settling Defendants' aggregate
net operating profits from domestic sales of cigarettes shall be
derived using the same methodology as was employed in deriving such
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes in 1997. Any increase in an Applicable Base
Payment pursuant to this subparagraph B(ii) shall be payable within
120 days after the date that the payment at issue was required to be
made.

EXHIBIT 1

IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

____________________________________
)
STATE OF TEXAS, )
)
Plaintiff, )
)
vs. ) No. 5-96CV-91
)
AMERICAN TOBACCO )
COMPANY, et al., )
)
Defendants. )
____________________________________)

CONSENT DECREE

WHEREAS, on January 16, 1998, the State of Texas and certain defendants
entered into a Comprehensive Settlement Agreement and Release (the "Settlement
Agreement") to settle and resolve with finality all present and future claims
against all parties to this litigation relating to the subject matter of this
litigation which have been or could have been asserted by any of the parties
hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated January 22, 1998,
in which the Court expressly retained continuing jurisdiction to enforce and
implement the terms of the Settlement Agreement, including the Most Favored
Nation clause of the Settlement Agreement;

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, the State of Texas and Settling Defendants have agreed on the
terms of the revisions to the Settlement Agreement as set forth in a Stipulation

of Amendment to Settlement Agreement and for Entry of Consent Decree executed on
July 24, 1998 (the "Stipulation of Amendment");

WHEREAS, the Stipulation of Amendment provides for entry of this Consent
Decree, which sets forth certain terms of injunctive relief, and further,
provides that the MFN Settling Defendants have waived as specified therein their
right to challenge the terms of this Consent Decree as being superseded or
preempted by future congressional enactments; and

WHEREAS, the Attorney General believes the entry of this Consent Decree is
appropriate and in the public interest;

NOW, THEREFORE, the State of Texas and MFN Settling Defendants having come
before the Court on their joint motion for approval of a Stipulation of
Amendment to the Settlement Agreement, and the Court having reviewed and
considered the Stipulation of Amendment and otherwise being fully advised in the
premises, it is hereby ORDERED, ADJUDGED and DECREED as follows:

1. Approval. The Court finds that the terms of the Stipulation of
Amendment are just and in the best interests of the State of Texas and Settling
Defendants, and the same is hereby approved. The Court further finds that the
Texas Fee Payment Agreement referred to in paragraph 22 of the Stipulation of
Amendment sets forth the entire obligation of Settling Defendants with respect
to payment of attorneys' fees pursuant to paragraph 17 of the Settlement
Agreement and supersedes Exhibit 1 to the Settlement Agreement, which is hereby
declared

to be null, void and of no further effect, that amounts payable with respect to
attorneys' fees of Texas Counsel pursuant to the Texas Fee Payment Agreement are
not funds of the State of Texas and that Settling Defendants are under no
obligation to pay such amounts to the State of Texas.

2. Jurisdiction and Venue. In keeping with the Settlement Agreement and
this Court's January 22, 1998 Order, the Court expressly retains jurisdiction
for the purpose of enforcement of the Settlement Agreement (as amended by the
Stipulation of Amendment) and this Consent Decree, as well as other issues
relating to the settlement of this Action that are currently pending before the
Court. Any party to this Consent Decree may apply to this Court at any time for
such further orders and directions as may be necessary or appropriate for the
construction and enforcement of the Settlement Agreement, the Stipulation of
Amendment and this Consent Decree.

3. Definitions. The definitions set forth in the Settlement Agreement (as
supplemented or superseded by the Stipulation of Amendment) are incorporated by
reference herein.

4. Applicability. This Consent Decree applies only to MFN Settling
Defendants in their corporate capacity acting through their respective
successors and assigns, directors, officers, employees, agents, subsidiaries,
divisions or other internal organizational units of any kind or any other entity
acting in concert or participating with them, and only with respect to
activities in connection with the

manufacture and sale in the United States of Tobacco Products intended for
domestic consumption. The remedies and penalties for a violation of this Consent
Decree shall apply only to MFN Settling Defendants, and shall not be imposed or
assessed against any employee, officer or director of MFN Settling Defendants or
other person or entity as a consequence of such a violation, and there shall be
no jurisdiction under this Consent Decree to impose or assess a penalty against
any employee, officer or director of MFN Settling Defendants or other person or
entity as a consequence of a violation of this Consent Decree.

5. Effect on Third Parties. This Consent Decree is not intended to and
does not vest standing in any third party with respect to the terms hereof, or
create for any person other than the parties hereto a right to enforce the terms
hereof.

6. Injunctive Relief. MFN Settling Defendants are permanently enjoined
from:

(a) On and after December 31, 1998, marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Texas, any item (other than
Tobacco Products or any item the sole function of which is to advertise
Tobacco Products) which bears the brand name (alone or in conjunction with
any other word), logo, symbol, motto, selling message, recognizable color
or pattern of colors, or any other indicia or product identification
identical or similar to, or identifiable with, those used for any domestic

brand of Tobacco Products, except that nothing in this paragraph shall (i)
require any MFN Settling Defendant to terminate, breach or violate any
licensing agreement or contract in existence as of July 1, 1998 for the
remaining term of such contract; (ii) prohibit the distribution to any
employee (18 years of age or older) of an MFN Settling Defendant of any
item described above that is intended for the personal use of such
employee by such MFN Settling Defendant; or (iii) prohibit items
necessarily incidental to or ordinarily distributed in connection with any
sponsorship described in paragraph 4(e)(2) of the Settlement Agreement.

(b) Making any material misrepresentation of fact regarding the
health consequence of using any Tobacco Product, including any tobacco
additives, filters, paper or other ingredients; provided, however, that
nothing in this paragraph shall limit the exercise of any First Amendment
right or any defense or position which persons bound by this Consent
Decree may assert in any judicial, legislative or regulatory forum.

(3) limiting or suppressing research into, marketing, or development of
new products.

(d) Taking any action, directly or indirectly, to target children in
Texas in the advertising, promotion, or marketing of cigarettes, or taking
any action the primary purpose of which is to initiate, maintain or
increase the incidence of underage smoking in Texas.

7. No Determination or Admission. The Settlement Agreement having been
executed prior to the taking of any testimony, no final determination of any
violation of any provision of law has been made in this Action. This Consent
Decree is not intended to be and shall not in any event be construed as, or
deemed to be, an admission or concession or evidence of any liability or any
wrongdoing whatsoever on the part of any person covered by the releases provided
in paragraphs 14 and 15 of the Settlement Agreement; nor shall this Consent
Decree be construed as, or deemed to be, an admission or concession or evidence
of personal jurisdiction by any person not a party to this Consent Decree.
Defendants specifically disclaim any liability or wrongdoing whatsoever with
respect to the claims and allegations asserted against them in this Action and
MFN Settling Defendants have entered into the Settlement Agreement and the
Stipulation of Amendment, and have stipulated to entry of this Consent Decree,
solely to avoid the further expense, inconvenience, burden and risk of
litigation.

8. Modification. This Consent Decree shall not be modified unless the
party seeking modification demonstrates, by clear and convincing evidence, that
it will suffer irreparable harm from new and unforeseen conditions; provided,
however, that the provisions of paragraph 4 of this Consent Decree shall in no
event be subject to modification. Changes in the economic conditions of the
parties shall not be grounds for modification. It is intended that MFN Settling
Defendants will comply with this Consent Decree as originally entered, even if
MFN Settling Defendants' obligations hereunder are greater than those imposed
under current or future law. Therefore, a change in law that results, directly
or indirectly, in more favorable or beneficial treatment of any one or more of
the MFN Settling Defendants shall not support modification of this Consent
Decree. The provisions of this paragraph shall not be construed to limit or
affect any future modification of the Settlement Agreement (as amended by the
Stipulation of Amendment) in the manner provided in paragraphs 11 and 23 of the
Stipulation of Amendment.

9. Enforcement and Attorneys' Fees. In any proceeding which results in a
finding that a MFN Settling Defendant violated this Consent Decree, the
responsible MFN Settling Defendant or MFN Settling Defendants shall pay the
State's costs and attorneys' fees incurred in such proceeding.

10. Non-Exclusivity of Remedy. The remedies in this Consent Decree are
cumulative and in addition to any other remedies the State may have at law or

equity. Nothing herein shall be construed to prevent the State from bringing any
action simply because the conduct that is the basis for such action may also
violate this Consent Decree.

DONE AND ORDERED at Texarkana, Texas, this the 24th day of July, 1998.

/s/ David Folsom
--------------------------------------
DAVID FOLSOM
JUDGE, UNITED STATES DISTRICT COURT

APPROVED:

/s/ Dan Morales
- -----------------------------------
Dan Morales, Attorney General,
For the State of Texas

Howard Waldrop

By: /s/ Josh R. Morriss, III
- -----------------------------------
Howard Waldrop
For MFN Settling Defendants

EXHIBIT 2

IN THE UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

THE STATE OF TEXAS, ) CIVIL NO.: 5:96-CV-0091
PLAINTIFF, )
)
VS. ) JUDGE: DAVID FOLSOM
)
THE AMERICAN TOBACCO ) MAGISTRATE JUDGE:
COMPANY, ET AL, ) WENDELL C. RADFORD
DEFENDANTS. )

ORDER GRANTING JOINT MOTION FOR
APPROVAL OF SETTLEMENT AGREEMENT REGARDING DISPOSITION OF
SETTLEMENT PROCEEDS AND TO WITHDRAW WITH PREJUDICE
POLITICAL SUBDIVISIONS' MOTIONS TO INTERVENE

Before the Court is a Joint Motion for Approval of Settlement Agreement
Regarding Disposition of Settlement Proceeds and to Withdraw with Prejudice
Political Subdivisions(1) Motions to Intervene. After considering the filings
related to this motion, the evidence, and the applicable law, the Court is of
the opinion the Motion should be granted. The Court therefore makes the
following findings of fact and conclusions of law.

1. The Court finds that the Agreement Regarding Disposition of Settlement
Proceeds ("Disposition Agreement") is in the public interest and
should be approved. The benefits of this agreement include certainty
for the parties and movants as well as judicial economy.

2. Therefore, the Court approves and adopts the Disposition Agreement,
attached hereto and incorporated herein, as an enforceable judgment of
this Court. The parties and movants are ordered to comply with all
terms and conditions contained in the Disposition Agreement.

- --------------
(1)Dallas County, Dallas County Hospital District, El Paso County, El Paso
County Hospital District, Harris County, Harris County Hospital District,
Montgomery County Hospital District, Nueces County, Nueces County Hospital
District, and Tarrant County Hospital District.

3. The Court further finds, as it has previously found, that the Attorney
General brought this suit on behalf of the State in its
quasi-sovereign capacity. SEE MEMORANDUM OPINION AND ORDER RE:
DEFENDANTS' MOTION TO DISMISS COUNTS 1-3 AND COUNTS 4-17 OF THE
STATE'S SECOND AMENDED COMPLAINT at 5 (Sept. 8, 1997).

4. The January 16, 1998, Comprehensive Settlement Agreement and
Release (the "CSA") negotiated by the parties and approved by the
Court defines the "State of Texas" to include "all of its officers
acting in their official capacities and any department, subdivision
or agency of the State, regardless of whether a named plaintiff".
Paragraph 14 of the CSA further provides that the Waiver and Release
given pursuant to paragraph 14 of the CSA constitutes a release of
claims of "the State of Texas (including any of its past, present or
future agents, officials acting in their official capacities, legal
representatives, agencies, departments, commissions, divisions,
subdivisions (political and otherwise), public entities,
corporations, instrumentalities and educational institutions, and
whether or not any such person or entity participates in the
settlement)".

5. The Court further finds and declares that during the litigation of
this action and the negotiation of the CSA, the Attorney General,
acting on behalf of the State in its quasi-sovereign capacity, had the
authority to and did adequately represent the State of Texas and the
persons and entities enumerated in paragraph 14 of the CSA (as quoted
in the preceding paragraph of this Order) (the "Releasing Parties"),
including, without limitation, all political subdivisions and hospital
districts of the State of Texas. Accordingly, the Court further finds
and declares that all Releasing Parties are encompassed within and
bound by the release provided pursuant to the CSA, that all Releasing
Parties are further encompassed within and bound by the Court's
January 22, 1998 Final Judgment approving and incorporating the CSA,
and that all Released Claims (as defined in paragraph 14 of the CSA)
of the Releasing Parties were fully and finally compromised, settled
and released by the CSA.

6. The Court also grants the Movants' request that the Political
Subdivisions withdraw their motions to intervene and all other motions
with prejudice to refiling. All motions filed by the Political
Subdivisions are hereby dismissed with prejudice.

7. It is further ordered that this Court shall have exclusive
jurisdiction over the provisions of this Order and the Final Judgment
in this case. All persons in privity with the parties, including all
persons represented by the parties, who seek to raise any objections
or challenges in any forum to any provision of this Judgment are
hereby enjoined from proceeding in any other state or federal court.
SEE, E.G., IN RE CORRUGATED CONTAINER ANTITRUST LITIGATION, 659 F.2d
1332, 1334-35 (5th Cir. 1981), CERT. DENIED, 456 U.S. 936 (1982);
SOUTHWEST AIRLINES CO. V. TEXAS INTERNATIONAL AIRLINES, INC., 546 F.2d
84, 91 (5th Cir.), CERT. DENIED, 434 U.S. 832 (1977)

8. The Political Subdivisions' withdrawal of all their motions with
prejudice leaves undisturbed the entirety of the merits of the January
22, 1998, Final Judgment in this cause. The Court's January 22, 1998,
Final Judgment disposed of all claims in the underlying suit. It is
therefore is a "final decision" as a matter of federal law under 28
U.S.C. Section 1291.

SIGNED JULY 24, 1998.

/s/ David Folsom
------------------------------
DAVID FOLSOM
UNITED STATES DISTRICT JUDGE

EXHIBIT 3

MFN ESCROW AGREEMENT

This escrow agreement (the "MFN Escrow Agreement") is entered into as of
July __, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company
(collectively and severally, "MFN Settling Defendants" and each individually a
"MFN Settling Defendant"), the State of Texas and __________ Bank, N.A., as
escrow agent (the "MFN Escrow Agent").

WITNESSETH:

WHEREAS, the State of Texas and Settling Defendants entered into a
comprehensive settlement agreement and release as of January 16, 1998 (the
"Settlement Agreement"), setting forth the terms and conditions of an agreement
to settle and resolve with finality all present and future claims relating to
the subject matter of the litigation entitled State of Texas v. American Tobacco
Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action"), in the United
States District Court for the Eastern District of Texas (the "Court");

WHEREAS, the State of Texas and Settling Defendants entered into a
Stipulation of Amendment to Settlement Agreement and for Entry of Consent Decree
(the "Stipulation of Amendment") on July 24, 1998, paragraph 17 of which
provides for Court approval of the Stipulation of Amendment and the entry by the
Court of the Political Subdivisions Order attached to the Stipulation of
Amendment as Exhibit 2 thereto;

WHEREAS, the Stipulation of Amendment provides that, on the dates
specified therein, each MFN Settling Defendant shall severally pay to the State
of Texas, pro rata in proportion to its Market Share, its respective share of
the amounts indicated for each date;

WHEREAS, paragraph 17 of the Stipulation of Amendment further provides
that all payments described in the Stipulation of Amendment shall be paid into a
special escrow account (and if so paid shall remain in said escrow account)
until such time as (1) the 30 day periods for appeal or to seek review of the
Court's order approving this Stipulation of Amendment and the Court's entry of
the Political Subdivisions Order have expired without the filing of any notice
of appeal or petition for review; or (2) in the event of any such appeal or
petition, the appeal or the petition has been dismissed or the order in question
has been affirmed in all material respects by the court of last resort to which
such appeal or

EXHIBIT 3

petition has been taken and such dismissal or affirmance has become no longer
subject to further appeal or review (the "Availability Date"); and

WHEREAS, the parties hereto believe that at least one of the payments
described in the preceding paragraphs may be made prior to the Availability
Date:

NOW, THEREFORE, the parties hereto agree as follows:

SECTION 1. Appointment of MFN Escrow Agent.

MFN Settling Defendants and the State of Texas hereby appoint the MFN
Escrow Agent to act as escrow agent on the terms and conditions set forth
herein, and the MFN Escrow Agent hereby accepts such appointment on such terms
and conditions.

SECTION 2. Deposit.

In the event that any payment pursuant to the Stipulation of Amendment
becomes due on a date prior to the Availability Date, each MFN Settling
Defendant shall severally deliver to the MFN Escrow Agent in immediately
available funds such MFN Settling Defendant's respective share of the payment in
question (the sum of such shares being the "Initial Deposit"). Upon receipt, the
MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow
account established for such purpose and governed by the terms of this MFN
Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to
the Stipulation of Amendment that becomes due prior to the Availability Date
shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the
Initial Deposit and any subsequent payments deposited into the MFN Escrow
Account, including any payments of interest or other income on investment of the
MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and
shall be governed by the terms of this MFN Escrow Agreement. All such deliveries
of funds are subject to the right of MFN Settling Defendants to obtain, pursuant
to section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN
Escrow Amount (less appropriate deductions for administrative fees and expenses,
including taxes and other related costs) in the event that the Stipulation of
Amendment is cancelled and terminated pursuant to paragraph 17 of the
Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested
and disbursed by the MFN Escrow Agent strictly in accordance with this MFN
Escrow Agreement.

EXHIBIT 3

SECTION 3. Investment of MFN Escrow Amount.

The MFN Escrow Agent shall invest and reinvest the MFN Escrow Amount in
either (i) direct obligations of, or obligations the principal and interest on
which are unconditionally guaranteed by, the United States of America (including
government-sponsored agencies) or the State of Texas; (ii) repurchase agreements
fully collateralized by securities of the kind specified in clause (i) above;
(iii) money market accounts maturing within 30 days of the acquisition thereof
and issued by a bank or trust company organized under the laws of the United
States of America or a State thereof (a "United States Bank") and having a
combined capital surplus in excess of $250,000,000; or (iv) demand deposits with
any United States Bank or any federal savings and loan institution having a
combined capital surplus in excess of $250,000,000. Any loss on any such
investment, including, without limitation, any penalty for any liquidation
required to fund a disbursement, shall be borne pro rata by the parties in
proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN
Escrow Agent's fees and all expenses, including taxes and other related costs,
shall, to the extent possible, be paid out of income earned. Whenever the MFN
Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as
provided herein, the MFN Escrow Agent shall also pay to such party all interest
and profits earned to the date of payment on such amount, less deductions for
fees and all expenses, including taxes and other related fees.

SECTION 4. Release of the MFN Escrow Amount.

After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as
set forth below:

(a) Following receipt of written notice signed by counsel for the
MFN Settling Defendants certifying that such notice has been delivered by
counsel for the MFN Settling Defendants to all parties hereto and stating
that the Stipulation of Amendment has not received court approval or has
been canceled, terminated or has otherwise become null and void for any
reason, the MFN Escrow Agent shall upon the expiration of ten (10)
business days following the MFN Escrow Agent's receipt of notice, and
without an order of the Court, disburse the entire MFN Escrow Amount
(including any interest thereon, as provided in Section 3) to the MFN
Settling Defendants on the same pro rata basis as such funds were
contributed to the MFN Escrow Account.

EXHIBIT 3

(b) Upon receipt of (i) written notice signed by counsel for the MFN
Settling Defendants and counsel for the State of Texas stating that the
Availability Date has occurred and (ii) an order of the Court so
directing, the MFN Escrow Agent shall proceed to distribute the MFN Escrow
Amount in accordance with such Court order.

(c) For its services, the MFN Escrow Agent shall receive fees in
accordance with the MFN Escrow Agent's customary fees in similar matters.
All such fees shall constitute a direct charge against the MFN Escrow
Amount, but the MFN Escrow Agent shall not debit the MFN Escrow Amount for
any such charge until it shall have presented its statement to and
received approval by counsel for the MFN Settling Defendants and counsel
for the State of Texas, which approval shall not be unreasonably withheld.
Such approval shall be deemed given if the MFN Escrow Agent has not
received written objections from either counsel for MFN Settling
Defendants or counsel for the State of Texas within 30 days after
presentment of its statement. Such fees and all expenses charged against
the MFN Escrow Amount shall, to the extent possible, be paid out of
interest earned. In the event that counsel for MFN Settling Defendants or
counsel for the State of Texas objects in writing to such fees, the MFN
Escrow Agent shall not debit the MFN Escrow Amount except upon a court
order approving such fees.

SECTION 5. Substitute Form W-9; Qualified Settlement Fund.

SECTION 6. Termination of MFN Escrow Account.

EXHIBIT 3

SECTION 7. MFN Escrow Agent.

(a) The MFN Escrow Agent shall have no duty or obligation hereunder
other than to take such specific actions as are required of it from time
to time under the provisions hereof, and it shall incur no liability
hereunder or in connection herewith for anything whatsoever other than as
a result of its own negligence or willful misconduct. In the event the MFN
Escrow Agent fails to receive the instructions contemplated by Section 4
hereof or receives conflicting instructions, the MFN Escrow Agent shall be
fully protected in refraining from acting until such instructions are
received or such conflict is resolved by written agreement or court order.

(b) MFN Settling Defendants, on the same pro rata basis as the funds
constituting the MFN Escrow Amount were contributed to the MFN Escrow
Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent
from and against any and all losses, claims, liabilities and reasonable
expenses, including the reasonable fees of its counsel, which it may
suffer or incur hereunder or in connection herewith prior to the
Availability Date, except such as shall result solely and directly from
its own negligence or willful misconduct. The MFN Escrow Agent shall not
be bound in any way by any agreement or contract between MFN Settling
Defendants and the State of Texas (whether or not the MFN Escrow Agent has
knowledge thereof) and the only duties and responsibilities of the MFN
Escrow Agent shall be to hold and invest the MFN Escrow Amount received
hereunder and to release such MFN Escrow Amount in accordance with the
terms of this MFN Escrow Agreement.

(c) The MFN Escrow Agent may resign at any time by giving written
notice thereof to the other parties hereto, but such resignation shall not
become effective until a successor MFN Escrow Agent, selected by the MFN
Settling Defendants and agreeable to the State of Texas, shall have been
appointed and shall have accepted such appointment in writing. If an
instrument of acceptance by a successor MFN Escrow Agent shall not have
been delivered to the MFN Escrow Agent within 30 days after the giving of
such notice of resignation, the resigning MFN Escrow Agent may, at the
expense of MFN Settling Defendants and the State of Texas (to be shared
equally between the State of Texas and the MFN Settling Defendants),
petition the Court for the appointment of a successor MFN Escrow Agent.

EXHIBIT 3

(d) Upon the Availability Date having occurred, provided that MFN
Settling Defendants have performed all of their obligations required to be
performed prior to the Availability Date, all duties and obligations of
MFN Settling Defendants hereunder shall cease, with the exception of any
indemnification obligation of MFN Settling Defendants incurred prior to
the Availability Date.

SECTION 8. Miscellaneous.

State of Texas:

Hon. Dan Morales
Office of the Attorney General

P.O. Box 12548
Capitol Station
Austin, TX 78711
(512) 463-2063

With a copy to:

Walter Umphrey
Provost & Umphrey
490 Park Street
P.O. Box 4905
Beaumont, TX 77704
Fax: (409) 838-8888

EXHIBIT 3

Settling Defendants:

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

With a copy to: With a copy to:

For Brown & Williamson Tobacco Lorillard Tobacco Company:
Corporation:

Michael Walter Arthur J. Stevens, Esq.
Brown & Williamson Tobacco Corp. Lorillard Tobacco Company
200 Brown & Williamson Tower 714 Green Valley Road
401 South Fourth Avenue Greensboro, NC 27408
Louisville, KY 40202 Fax: (336) 335-7707
Fax: (502) 568-7187

With a copy to:

F. Anthony Burke
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7187

MFN Escrow Agent:

_________________ Bank, N.A.
Phone:
Fax:
Wire Transfer Instructions:
ABA #:
Account #:
Account Name:

EXHIBIT 3

(b) Successors and Assigns. The provisions of this MFN Escrow
Agreement shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and assigns.

(c) Governing Law. This MFN Escrow Agreement shall be construed in
accordance with and governed by the laws of the State of Texas, without
regard to the conflicts of law rules of such state.

(d) Jurisdiction and Venue. The parties hereto irrevocably and
unconditionally submit to the jurisdiction of the United States District
Court for the Eastern District of Texas for purposes of any suit, action
or proceeding seeking to enforce any provision of, or based on any right
arising out of, this MFN Escrow Agreement, and the parties hereto agree
not to commence any such suit, action or proceeding except in such Court.
The parties hereto hereby irrevocably and unconditionally waive any
objection to the laying of venue of any such suit, action or proceeding in
the Court and hereby further irrevocably waive and agree not to plead or
claim in such Court that any such suit, action or proceeding has been
brought in an inconvenient forum.

(e) Definitions. Terms used herein that are defined in the
Settlement Agreement or the Stipulation of Amendment are, unless otherwise
defined herein, used in this MFN Escrow Agreement as defined in the
Settlement Agreement or the Stipulation of Amendment, as appropriate.

EXHIBIT 3

purposes of acknowledging acceptance hereof; however, an original executed
signature page must promptly thereafter be appended to this MFN Escrow
Agreement, and an original executed agreement shall promptly thereafter be
delivered to each party hereto.

(h) Captions. The captions herein are included for convenience of
reference only and shall be ignored in the construction and interpretation
hereof.

IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as
of the day and year first hereinabove written.

STATE OF TEXAS

By:
-------------------------------
Dan Morales
Attorney General

PHILIP MORRIS INCORPORATED

By:
-------------------------------
Meyer G. Koplow
Counsel

EXHIBIT 3

R.J. REYNOLDS TOBACCO COMPANY

By:
-------------------------------
Arthur F. Golden
Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By:
-------------------------------
Stephen R. Patton
Counsel

LORILLARD TOBACCO COMPANY

By:
-------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

EXHIBIT 3

_____________________ BANK, N.A.
as MFN Escrow Agent

By:
-------------------------------
Name:
Title:

Exhibit 10.5

TEXAS FEE PAYMENT AGREEMENT

This Texas Fee Payment Agreement (the "Agreement") is entered into as of
July 24, 1998, by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation, Lorillard Tobacco Company and
United States Tobacco Company (collectively and severally "Settling Defendants"
and each individually a "Settling Defendant"), Walter Umphrey, John M. O'Quinn,
P.C., John Eddie Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm
and Ness, Motley, Loadholt, Richardson & Poole (collectively, "Private
Counsel"), the Law Offices of Marc D. Murr, P.C. ("Other Texas Counsel") and the
State of Texas, in connection with the lawsuit State of Texas v. American
Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action").

WITNESSETH:

WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants
entered into a comprehensive settlement agreement to settle and resolve with
finality all present and future civil claims relating to the subject matter of
the Action (the "Settlement Agreement"), which Settlement Agreement was approved
by the United States District Court for the Eastern District of Texas (the
"Court") and adopted as an enforceable order of the Court pursuant to Court
Order dated January 22, 1998.

WHEREAS, paragraph 17 of the Settlement Agreement and Exhibit 1 thereto
provide that Settling Defendants shall pay reasonable attorneys' fees to Private
Counsel and Other Texas Counsel (collectively "Texas Counsel"), in an amount set
by arbitration, subject to an appropriate annual cap on all such payments of
attorneys' fees by Settling Defendants, as well as other conditions set forth
therein;

WHEREAS, paragraph 16 of the Settlement Agreement contains a "Most Favored
Nation" clause which provides that, in the event that Settling Defendants enter
into a future pre-verdict settlement agreement of other litigation brought by a
non-federal governmental plaintiff on terms more favorable to such governmental
plaintiff than the terms of the Settlement Agreement (after due consideration of
relevant differences in population or other appropriate factors), the terms of
the Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, on July 24, 1998, Settling Defendants and the State of Texas
entered into a Stipulation of Amendment to Settlement Agreement and for Entry of
Consent Decree (the "Stipulation of Amendment") to resolve any disputes with
respect to the Most Favored Nation clause of the Settlement Agreement, including
any disputes regarding payment of attorneys' fees, in light of the Minnesota
Settlement; and

WHEREAS, Settling Defendants, the State of Texas and Texas Counsel, in
order to resolve any disputes with respect to paragraphs 16 and 17 of the
Settlement Agreement, and to describe more fully the procedures that will govern
Settling Defendants' payment of fees to Texas Counsel, have agreed to the terms
of this Agreement:

NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual
agreement to the terms of this Agreement, the State of Texas's and Settling
Defendants' mutual agreement to the terms of the Stipulation of Amendment, and
such other consideration described herein, including the release of certain
claims against Settling Defendants, the sufficiency of which is hereby
acknowledged, the parties hereto, acting by and through their authorized agents,
memorialize and agree as follows:

SECTION 1. Agreement to Pay Fees.

Settling Defendants will pay reasonable attorneys' fees to Texas Counsel
(as identified by the Attorney General pursuant to section 21 hereof) for their
representation of the State of Texas in connection with the Action. The amount
of such fees will be set by a panel of three independent arbitrators (the
"Panel") whose decisions as to the amount of fees to be paid in connection with
this Agreement ("Fee Award(s)") shall be final and not appealable. The
procedures governing Settling Defendants' obligation to pay any such Fee Awards,
including the procedures for making, and the timing of payments in satisfaction
of, such Fee Awards shall be as provided herein.

SECTION 2. Aggregate National Caps on Payment of Certain Fees.

Settling Defendants' payment of any Fee Award pursuant to this Agreement
shall be subject to the payment schedule and the annual and quarterly aggregate
national caps specified in sections 13, 14, 15 and 16 hereof, which shall apply
to:

(a) all payments of attorneys' fees pursuant to an award arbitrated by the
Panel ("Fee Award") in connection with the settlement of any tobacco and health
cases (other than non-class action personal injury cases brought directly by or
on behalf of a single natural person or the survivor of such person or for
wrongful death, or any non-class action consolidation of two or more such cases)
("Tobacco Cases") on terms that provide for payment by Settling Defendants or
other defendants acting in agreement with Settling Defendants (collectively,
"Participating Defendants") of fees with respect to private counsel retained by
the plaintiff in connection with any such case ("Outside Counsel"), subject to
an annual cap on payment of all such fees;

(b) all payments of attorneys' fees (other than fees for attorneys of
Participating Defendants) pursuant to a Fee Award for activities in connection
with Tobacco Cases resolved by operation of federal legislation that either (i)
implements the terms of the June 20, 1997 Proposed Resolution (or a
substantially equivalent federal program) (the "Proposed Resolution") or (ii)
imposes an enforceable obligation on Participating Defendants to pay attorneys'
fees with respect to Outside Counsel (any such legislation hereinafter referred
to as "Federal Legislation"); and

(c) all payments of attorneys' fees and certain other professional fees
(other than fees for attorneys or agents of Participating Defendants) pursuant
to a Fee Award for contributions made toward enacted Federal Legislation. In the
event that Federal Legislation is enacted, the terms "Outside Counsel" and
"Eligible Counsel" shall apply not only to persons otherwise falling within the
definitions of such terms herein but also to all persons granted Fee Awards for
such contributions (such persons being Eligible Counsel with respect to each
month beginning with the month the Federal Legislation was enacted).

Nothing in this Agreement shall be construed to require any Settling
Defendant to pay Fee Awards in connection with any litigation other than the
Action.

SECTION 3. Exclusive Obligation of Settling Defendants; Release.

The provisions set forth herein constitute the entire obligation of
Settling Defendants with respect to payment of attorneys' fees in connection
with the Action and the exclusive means by which Texas Counsel may seek payment
of fees by Settling Defendants in connection with the Action. The parties hereto
acknowledge that the provisions for payment set forth herein are the entirety of
Settling Defendants' obligations with respect to payment of attorneys' fees
pursuant to paragraph 17 of the Settlement Agreement. The State of Texas agrees
that Settling Defendants have no obligation to pay attorneys' fees pursuant to
paragraph 17 of the Settlement Agreement with respect to any counsel other than
Texas Counsel (as identified by the Attorney General pursuant to section 21
hereof), and that Settling Defendants have no other obligation to pay fees or
otherwise compensate Texas Counsel, any other counsel or representative of the
State of Texas or the State of Texas itself with respect to attorneys' fees in
connection with the Action. Each Texas Counsel hereby irrevocably releases
Settling Defendants and their respective present and former parents,
subsidiaries, divisions, affiliates, officers, directors, employees,
representatives, insurers, agents and attorneys (as well as the predecessors,
heirs, executors, administrators, successors and assigns of each of the
foregoing) from any and all claims that such counsel ever had, now has or
hereafter can, shall or may have in any way related to the Action (including but
not limited to any negotiations related to the settlement of the Action). The
foregoing shall not be construed as a release of any person or entity as to any
of the obligations undertaken in this Agreement in connection with a breach
thereof.

SECTION 4. No Effect on Texas Counsel's Fee Contracts.

The State of Texas has entered into a contingent-fee contract with certain
Private Counsel ("Private Counsel's Contract") and has entered into a fee
contract with Other Texas Counsel ("Other Texas Counsel's Contract"). The rights
and obligations, if any, of the parties to Private Counsel's Contract and Other
Texas Counsel's Contract shall be unaffected by this Agreement. Those Private
Counsel that are parties to Private Counsel's Contract shall not be deemed to
have waived any rights under Private Counsel's Contract, nor shall Other Texas
Counsel be deemed to have waived any rights under Other Texas Counsel's
Contract, as a result of their acceptance of payments made pursuant to this
Agreement. However, any Private Counsel Payments made in connection with this
Action shall be credited against any amounts that may be due to Private Counsel
that are parties to Private Counsel's Contract from the State of Texas under
Private

Counsel's Contract, and any payments received pursuant to this Agreement by
Other Texas Counsel shall be credited against any amounts that may be due to
Other Texas Counsel from the State of Texas under Other Texas Counsel's
Contract.

SECTION 5. Composition of the Panel.

(a) The first and the second members of the Panel shall both be permanent
members of the Panel and, as such, will participate in the determination of all
Fee Awards. The third Panel member shall not be a permanent Panel member, but
instead shall be a state-specific member selected to determine Fee Awards on
behalf of Outside Counsel retained in connection with litigation within a single
state. Accordingly, the third, state-specific member of the Panel for purposes
of determining Fee Awards with respect to litigation in the State of Texas shall
not participate in any determination as to any Fee Award with respect to
litigation in any other state (unless selected to participate in such
determinations by such persons as may be authorized to make such selections
under other agreements).

(b) The members of the Panel shall be selected as follows:

(i) The first member shall be a natural person selected by
Participating Defendants, who shall advise Texas Counsel of the name of
the person selected by October 8, 1998.

(ii) The second member shall be a natural person selected by
agreement of Participating Defendants and a majority of the members of a
committee composed of the following members: Joseph F. Rice, Richard F.
Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the
Castano Plaintiffs' Legal Committee and, at the option of Participating
Defendants, one additional representative to serve on behalf of counsel
for any one or more states that, subsequent to the date hereof, enter into
settlement agreements with Participating Defendants that provide for
payment of such states' Outside Counsel pursuant to an arbitrated award of
fees. Such second member shall be selected by October 1, 1998.

(iii) The third, state-specific member for purposes of determining
Fee Awards with respect to litigation in the State of Texas shall be a
natural person selected by Private Counsel, who shall notify Settling

Defendants and Other Texas Counsel of the name of the person selected by
October 15, 1998.

SECTION 6. Commencement of Panel Proceedings.

No application for a Fee Award shall be presented to the Panel or any
Panel member until November 3, 1998. The Panel shall consider and render
decisions on applications for Fee Awards in the order in which they are
submitted or pursuant to notice by counsel having priority that they have ceded
their place to others. In the event that more than one application for a Fee
Award is submitted on the same date, the Panel shall consider and render
decisions on such applications in the order in which their respective cases were
settled. Private Counsel may seek permission from the Panel to make combined
presentations of aspects of their respective applications. Settling Defendants
shall not oppose any request to combine presentations of applications for Fee
Awards in connection with the Action, the lawsuit In re Mike Moore, Attorney
General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429 (Miss. Ch.
Ct., Jackson County), or the lawsuit State of Florida v. American Tobacco Co.,
No. 95-1466 AH (15th Jud. Circuit, Palm Beach County).

SECTION 7. Costs of Arbitration.

SECTION 8. Application of Private Counsel.

Private Counsel shall make a collective written application to the Panel
for a single Fee Award (the "Private Counsel Fee Award") on November 3, 1998.
All interested persons, including persons not parties hereto, may submit to the
Panel any information that they wish; but interested persons not parties hereto
may submit only written materials. The Panel shall consider all such submissions
by any party hereto and may consider any such materials submitted by other
interested persons. All written submissions relating to applications for a Fee
Award in connection with the Action shall be served on all parties hereto by
November 13, 1998. Presentations to the Panel shall, to the extent possible, be
based on affidavit or video presentation rather than live testimony. The Panel
shall preserve the confidentiality of any attorney work-product materials or
other

similar confidential information that may be submitted. Settling Defendants will
not take any position adverse to the amount of the Fee Award requested by
Private Counsel, nor will they or their representatives express any opinion
(even upon request) as to the appropriateness or inappropriateness of the amount
of any proposed Private Counsel Fee Award. The undersigned outside counsel for
Settling Defendants Philip Morris Incorporated and R.J. Reynolds Tobacco Company
will appear, if requested, to provide information as to the nature and efficacy
of the work of Private Counsel and to advise the Panel that they support a
Private Counsel Fee Award of full reasonable compensation under the
circumstances.

SECTION 9. Award of Fees to Private Counsel.

The members of the Panel will consider all relevant information submitted
to them in reaching a decision as to a Fee Award that fairly provides for full
reasonable compensation of Private Counsel for their representation of the State
of Texas in connection with the Action. The Panel shall determine the amount of
the Private Counsel Fee Award for all Private Counsel collectively no later than
December 10, 1998. Given the significance and uniqueness of the Action, the
Panel shall not be limited to an hourly-rate or lodestar analysis in determining
the amount of the Private Counsel Fee Award, but shall take into account the
totality of the circumstances. In considering the amount of the Private Counsel
Fee Award, the Panel shall not consider Fee Awards that already have been or yet
may be awarded in connection with any other Tobacco Case. The Panel's decisions
as to Fee Awards shall be in writing and shall report the amount of the fee
awarded (with or without explanation or opinion, at the Panel's discretion).

SECTION 10. Application of Other Texas Counsel.

Other Texas Counsel may submit an application for a Fee Award separate
from Private Counsel. The procedures, schedule and process with respect to such
application on behalf of Other Texas Counsel shall be the same as the
procedures, schedule and process set forth in sections 6, 7, 8 and 9 hereof with
respect to the fee application on behalf of Private Counsel, except that
Settling Defendants shall be in no way constrained from contesting Other Texas
Counsel's entitlement to receive a Fee Award or the amount of the Fee Award
requested by Other Texas Counsel.

SECTION 11. Allocation of Payments among Private Counsel.

All payments (including advances) made by Settling Defendants with respect
to the Private Counsel Fee Award pursuant to this Agreement ("Private Counsel
Payments") shall be paid in the first instance to Walter Umphrey, Esq. (or such
other person designated in writing by Private Counsel), on behalf of Private
Counsel. Each Private Counsel shall be entitled to receive a percentage of such
payment equal to the percentage of any fee recovery allocated to such Private
Counsel under the terms of the fee-sharing agreement among Private Counsel (or
any written amendment thereto). Settling Defendants shall have no obligation,
responsibility or liability with respect to the allocation among Private
Counsel, or with respect to any claim of misallocation, of any amounts of any
Private Counsel Payment.

SECTION 12. Advances on Payment of Fees.

Each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of
Private Counsel, its respective share of $50 million, as listed in Rider B to
Exhibit 1 to the Settlement Agreement, as an advance against later Private
Counsel Payments. On or before the later of July 31, 1998 or the fifth business
day following entry by the Court of an order approving the Stipulation of
Amendment, each Settling Defendant shall severally pay to Private Counsel, pro
rata in proportion to its Market Share indicated on Schedule A hereto, its
respective share of $50 million, as a further advance against later Private
Counsel Payments. Each of the advances described in this section shall be
credited as provided in section 16 hereof.

SECTION 13. Annual Amount for 1998; Allocation.

(a) For 1998, Settling Defendants shall pay, in the manner described in
section 14 hereof, the unsatisfied amount of the Fee Awards (the "Unpaid Fees")
of Texas Counsel, and those Participating Defendants so obligated shall make
payments with respect to the Unpaid Fees of all other Outside Counsel, in an
amount not to exceed $500 million for all such payments described in this
subsection.

(b) The amount payable by Settling Defendants with respect to each Fee
Award for 1998 shall be determined as follows: The $500 million annual cap for
1998 shall be allocated equally among each month of the year. Except as provided
in section 14(b) hereof, each monthly amount shall be allocated to those

Outside Counsel retained in connection with Tobacco Cases settled by
Participating Defendants or resolved by Federal Legislation before or during
such month, up to the amounts of their respective Unpaid Fees (such counsel
being "Eligible Counsel" with respect to such monthly amount). In the event that
the monthly amount is less than the sum of Eligible Counsel's Unpaid Fees, the
monthly amount shall be allocated to Eligible Counsel in proportion to the
amounts of their respective Unpaid Fees (the amount so allocated to each
Eligible Counsel for a given month being such counsel's Allocable Share for such
month, and the sum of each Outside Counsel's Allocable Shares for each month
being such counsel's Allocable Share for 1998).

(c) Settling Defendants represent that, as of the date of this Agreement,
the only Tobacco Cases (other than the Action) that have been settled by
Participating Defendants on terms that allow for Outside Counsel retained in
connection with such cases to seek a Fee Award from the Panel are In re Mike
Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., No.
94-1429 (Miss. Ch. Ct., Jackson County), State of Florida v. American Tobacco
Co., No. 95-1466 AH (15th Jud. Cir., Palm Beach County), and Mangini v. R.J.
Reynolds Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County). In
addition, Outside Counsel retained in connection with Mangini v. Brown &
Williamson Tobacco Corp., No. 993893 (Cal. Super. Ct., San Francisco County),
may under the terms of the settlement in that action "apply to participate in
any national, reasonable, 'public benefit' fee award or arbitration process
created by a 'national settlement' or 'Congressional Resolution.'"

SECTION 14. Payments with Respect to Annual Amount for 1998.

(a) On December 15, 1998, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of an initial fee payment with
respect to the Private Counsel Award and the Fee Award, if any, on behalf of
Other Texas Counsel (the "Initial Texas Fee Payment"), which shall include Texas
Counsel's Allocable Share for 1998 as provided in section 13 hereof for each
month of 1998 except those with respect to which Texas Counsel's Allocable Share
could not be determined as of December 8, 1998, as a result of there being other
Eligible Counsel that, as of such date, had not yet been granted or denied a Fee
Award by the Panel (either because such counsel's application for a Fee Award
was still under consideration by the Panel or for any other reason).

(b) On January 15, 1999, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of Texas Counsel's Allocable

Share for those months of 1998 not included in the Initial Texas Fee Payment.
Texas Counsel's Allocable Share for any such month shall be based on an
allocation of the monthly amount among Eligible Counsel having Fee Awards as of
December 31, 1998, without regard to whether there may be other Eligible Counsel
that have not been granted or denied a Fee Award by the Panel as of such date.

(c) Notwithstanding any provision of this Agreement, Private Counsel shall
defer payment of the Private Counsel Payment due from Settling Defendant R.J.
Reynolds Tobacco Company ("Reynolds") on December 15, 1998, insofar as necessary
for the sum of all deferred amounts of any payments by Reynolds in 1998 with
respect to Fee Awards to equal $62 million. Under no circumstances shall this
subsection require any increase in any payment to be made by any other Settling
Defendant. On January 5, 1999, Reynolds shall pay to Private Counsel the amount,
if any, of the Initial Texas Fee Payment deferred pursuant to this subsection.

SECTION 15. Quarterly Amounts for 1999 and Subsequent Years; Allocation.

Within 10 business days after the end of each calendar quarter beginning
with the first calendar quarter of 1999, Settling Defendants shall pay, in the
manner provided in subsection (d) of this section, the Unpaid Fees of Texas
Counsel, and those Participating Defendants so obligated shall make payments
with respect to the Unpaid Fees of all other Outside Counsel, in an amount not
to exceed $125 million for all such payments, as follows:

(a) In the event that Federal Legislation has been enacted by the end of
the calendar quarter with respect to which such quarterly payment is being made
(the "Applicable Quarter"):

(i) the quarterly amount shall be allocated among Outside Counsel,
up to the amount of their respective Unpaid Fees. Each Outside Counsel
shall be allocated an amount of each quarterly payment for the calendar
year up to (or, in the event that the sum of such Outside Counsel's Unpaid
Fees exceeds the quarterly amount, in proportion to) the amount of such
Outside Counsel's Unpaid Fees. Each quarterly payment shall be allocated
among Outside Counsel having Unpaid Fees, without regard to whether there
are other Outside Counsel that have not yet been granted or denied a Fee
Award by the Panel as of the end of the Applicable Quarter. Subsequent
quarterly payments shall be adjusted, if

necessary, to account for Outside Counsel that are granted Fee Awards in a
subsequent quarter of the calendar year, as provided in paragraph (ii)(B)
of this subsection.

(ii) In the event that a quarterly payment for the calendar year is
less than the sum of all Outside Counsel's Unpaid Fees:

(A) in the case of the first such quarterly payment, the
quarterly amount shall be allocated among Outside Counsel in
proportion to the amounts of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment that is less than the sum of all such Unpaid Fees,
the quarterly amount shall be allocated only to those Outside
Counsel, if any, that were not paid a proportionate share of all
prior quarterly payments for the calendar year (either because such
Outside Counsel's applications for Fee Awards were still under
consideration as of the end of the calendar quarters with respect to
which such quarterly payments were made or for any other reason),
until each such Outside Counsel has been allocated a proportionate
share of all prior quarterly payments. In the event that the sum of
all such shares exceeds the amount of the quarterly payment, such
payment shall be allocated among such Outside Counsel in proportion
to the amounts of their respective Unpaid Fees (without regard to
whether there are other Outside Counsel that have not yet been
granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

(b) In the event that Federal Legislation has not been enacted by the end
of the Applicable Quarter:

(i) the quarterly amount shall be allocated equally among each of
the three months of the calendar quarter. The amount for each such month
shall be allocated among those Outside Counsel retained in connection with
Tobacco Cases settled before or during such month (such Outside Counsel
being "Eligible Counsel" with respect to such monthly amount), each of
whom shall be allocated a portion of each such monthly amount up to (or,
in the event that the sum of Eligible Counsel's respective Unpaid Fees
exceeds such monthly amount, in proportion to) the amount of such Eligible
Counsel's Unpaid Fees. The monthly amount

for each month of the calendar quarter shall be allocated among Eligible
Counsel having Unpaid Fees, without regard to whether there may be
Eligible Counsel that have not yet been granted or denied a Fee Award by
the Panel as of the end of the Applicable Quarter. Subsequent quarterly
payments shall be adjusted, as necessary, to account for Eligible Counsel
that are granted Fee Awards in a subsequent quarter of the calendar year,
as provided in paragraph (ii)(B) of this subsection.

(ii) In the event that the amount for a given month is less than the
sum of all Eligible Counsel's Unpaid Fees:

(A) in the case of a first quarterly payment, such monthly
amount shall be allocated among Eligible Counsel for such month in
proportion to the amount of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment, the quarterly amount shall be allocated among
only those Outside Counsel, if any, that were Eligible Counsel with
respect to any monthly amount paid in a prior quarter of the
calendar year but were not allocated a proportionate share of such
monthly amount (either because such counsel's applications for Fee
Awards were still under consideration as of the end of the calendar
quarter containing the month in question or for any other reason),
until each such Eligible Counsel has been allocated a proportionate
share of all such prior monthly payments for the calendar year. In
the event that the sum of all such shares exceeds the amount of the
quarterly payment, the quarterly payment shall be allocated among
Eligible Counsel in proportion to the amounts of their respective
Unpaid Fees (without regard to whether there may be other Eligible
Counsel with respect to such prior monthly amounts that have not yet
been granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

(d) Each Settling Defendant shall severally pay, pro rata in proportion to
its respective Market Share, its share of the amounts, if any, allocated to
Texas Counsel pursuant to this section.

SECTION 16. Credits and Limitations.

Notwithstanding any other provision of this Agreement, all payments by
Settling Defendants with respect to Fee Awards shall be subject to the
following:

(a) The advances against future Private Counsel Payments described in
section 12 hereof shall be credited against and shall reduce subsequent Private
Counsel Payments, beginning with the first quarterly payment for 1999 pursuant
to section 15 hereof, in an amount equal to 50% of the Private Counsel Payment
in question, until the advances paid by Settling Defendants are fully credited;
provided, however, that the sum of all such credits applied in any calendar year
with respect to the advances made to Private Counsel described in section 12
hereof shall not exceed $50 million. The amount of any credit made against any
such Private Counsel Payment shall be counted toward the annual and quarterly
aggregate national caps on all payments made with respect to Outside Counsel, in
the amount of the credit applied to any such Private Counsel Payment in any
quarterly or annual period. All credits against Private Counsel Payments
pursuant to this section shall be allocated among Settling Defendants in
proportion to their respective contributions toward the amounts of the advances
described in section 12 hereof.

(b) Under no circumstances shall Settling Defendants be required to make
payments that would result in aggregate national payments and credits by
Participating Defendants with respect to Fee Awards:

(i) during 1998, totaling more than $500 million, except insofar as
payments to certain Outside Counsel with respect to 1997 are made in 1998,
and except insofar as advances are made in 1998 against payments due in
years after 1998;

(ii) during any year beginning with 1999, totaling more than $500
million, excluding payments with respect to any Outside Counsel's
Allocable Shares for 1998 that are paid in 1999; and

(iii) during any calendar quarter beginning with the first calendar
quarter of 1999, totaling more than $125 million, excluding payments with

respect to any Outside Counsel's Allocable Shares for 1998 that are paid
in 1999 and except to the extent that payments and credits with respect to
any prior quarter of the calendar year did not total $125 million.

SECTION 17. Contribution to National Legislation.

If Federal Legislation is enacted that implements the Proposed Resolution,
a three-member national panel including the two permanent members of the Panel
shall consider any application for Fee Awards on behalf of Outside Counsel for
contributions made toward the enactment of such Federal Legislation, along with
all applications for Fee Awards for professional fees by any other persons who
claim to have made similar contributions (other than attorneys or agents of
Participating Defendants). No person shall make more than one application for a
Fee Award in connection with any such contributions toward enactment of such
Federal Legislation. All payments with respect to such Fee Awards, if any, shall
be paid on the payment schedule and subject to, and counted in computing, the
annual and quarterly national caps described in sections 13, 14, 15 and 16
hereof.

SECTION 18. Payments on Market Share Basis.

All payments due hereunder shall be paid by Settling Defendants pro rata
in proportion to their respective Market Shares as provided herein, and each
Settling Defendant shall be severally liable for its share of all such payments.
Due to the particular corporate structures of Settling Defendants R.J. Reynolds
Tobacco Company ("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown
& Williamson") with respect to their non-domestic tobacco operations, Settling
Defendants Reynolds and Brown & Williamson shall be severally liable for their
repsective shares of each payment due pursuant to this Agreement up to (and
their liability hereunder shall not exceed) the full extent of their assets used
in, and earnings and revenues derived from, their manufacture and sale in the
United States of Tobacco Products intended for domestic consumption, and no
recourse shall be had against any of their other assets or earnings to satisfy
such obligations. Under no circumstances shall any payment due hereunder or any
portion thereof become the joint obligation of Settling Defendants or the
obligation of any party other than the Settling Defendant from which such
payment is originally due, nor shall any Settling Defendant be required to pay a
portion of any such payment greater than its respective Market Share. With
respect to the advance to be paid pursuant to section 12 hereof, the Market
Share of each Settling Defendant shall be as provided in Schedule A hereto. With
respect to the amount for 1998 described in section 13 hereof, the Market Share
of

each Settling Defendant shall be its respective share pursuant to Appendix A
hereto for 1998. With respect to all other payments pursuant to this Agreement,
each Settling Defendant's Market Share shall be its respective share pursuant to
Appendix A hereto for the 12 month period ending on the last day of the calendar
quarter immediately preceding the calendar quarter with respect to which such
payment is made.

SECTION 19. Determination of Market Share.

In the event of a disagreement between or among any Settling Defendants as
to their respective shares of any payment pursuant to this Agreement (except
payments for which each Settling Defendant's Market Share is expressly provided
herein), each Settling Defendant shall pay its undisputed share of such payment
promptly, on or before the date on which such payment is due, and shall within
21 days submit copies of its audited reports of shipments of Tobacco Products
provided to the U.S. Securities and Exchange Commission ("SEC") for the period
in question (or, in the case of any Settling Defendant that does not provide
such reports to the SEC, audited reports of shipments containing the same
shipment information as contained in the reports provided to the SEC) ("Shipment
Reports") to a third party to be selected by agreement of Settling Defendants
(the "Third Party"), who shall within three business days determine the Market
Share of each Settling Defendant. The decision of the Third Party shall be final
and non-appealable, and shall be communicated by facsimile to each party hereto.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay Texas Counsel or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate as published in the Wall Street Journal on the latest publication date on
or before the original date on which the payment in question was due plus 3%.

SECTION 20. Limited Waiver as to Other Terms.

In consideration of Settling Defendants' agreement to the terms hereof,
each Texas Counsel hereby covenants and agrees that it will not argue in any
forum (other than in proceedings before the Panel relating to their Fee Award
application) that the arrangements made in connection with the Florida
Settlement, the Mississippi Settlement or the Minnesota Settlement for payment

of fees to Outside Counsel for the States of Florida, Mississippi or Minnesota
give rise to any claim or entitlement on the part of Texas Counsel (or any other
person) in connection with this Action.

SECTION 21. State's Identification of Texas Counsel.

The Attorney General represents and warrants that Schedule B hereto
identifies all Texas Counsel.

SECTION 22. Private Counsel's Costs.

Settling Defendants have agreed to reimburse Private Counsel for
reasonable costs and expenses incurred in connection with the Action, provided
that such costs and expenses are of the same nature as costs and expenses for
which Settling Defendants would reimburse their own counsel or agents. To this
end, each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of
Private Counsel, the respective amount listed for such Settling Defendant in
Rider A to Exhibit 1 to the Settlement Agreement, the sum of such payments being
$40 million, which equals Private Counsel's best estimate as of the date of the
Settlement Agreement of such costs and expenses. Private Counsel shall provide
Settling Defendants with an appropriately documented statement of their costs
and expenses consistent with the criteria set forth above. Settling Defendants
shall promptly pay the amounts of such costs and expenses in excess of $40
million, or shall receive a refund if the total of such costs and expenses is
less than $40 million. Any dispute as to the nature or amount of reimbursable
costs and expenses shall be decided with finality by the Panel.

SECTION 23. Intended Beneficiaries.

SECTION 24. Definitions.

SECTION 25. Representations of Parties.

SECTION 26. No Admission.

SECTION 27. Non-admissibility.

SECTION 28. Amendment and Waiver.

This Agreement may be amended only by a written instrument executed by the
Attorney General, Texas Counsel and Settling Defendants. The waiver of any
rights conferred hereunder shall be effective only if made by written instrument
executed by the waiving party. The waiver by any party of any breach of this
Agreement shall not be deemed to be or construed as a waiver of any other
breach, whether prior, subsequent or contemporaneous, of this Agreement.

SECTION 29. Notices.

indicated. Any party hereto may change the name and address of the person
designated to receive notice on behalf of such party by notice given as provided
in this section including an updated list conformed to Schedule C hereto.

SECTION 30. Governing Law.

This Settlement Agreement shall be governed by the laws of the State of
Texas, without regard to the conflict of law rules of such State.

SECTION 31. Construction.

SECTION 32. Captions.

The captions of the sections of this Agreement are included for
convenience of reference only and shall be ignored in the construction and
interpretation hereof.

SECTION 33. Execution of Agreement.

This Agreement may be executed in counterparts. Facsimile or photocopied
signatures shall be considered valid signatures as of the date hereof, although
the original signature pages shall thereafter be appended to this Agreement.

SECTION 34. Certain Court Orders Conditions Precedent.

The terms of this Agreement shall supersede the terms of Exhibit 1 to the
Settlement Agreement, and the parties hereto will promptly file a joint motion
requesting that the Court approve this Agreement. The parties further agree that
Settling Defendants shall not be required to perform any obligation hereunder
(excepting Settling Defendants' obligations with respect to the advance to be
paid pursuant to section 12 hereof) until such time as (1) the Court issues an
order declaring Exhibit 1 to the Settlement Agreement to be null, void and of no
further effect; (2) the Court issues an order approving the Stipulation of
Amendment; (3) the Court issues the Political Subdivisions Order in the form
attached to the

Stipulation of Amendment as Exhibit 2 thereto; (4) the Court issues an order
confirming that amounts payable to Texas Counsel pursuant to this Agreement are
not funds of the State of Texas and are not subject to appropriation by the
State of Texas and that Settling Defendants are under no obligation to pay such
amounts to the State of Texas; (5) the 30-day periods to seek review of such
orders have expired without the filing of any notice of appeal or petition for
review; and (6) in the event of a timely appeal or petition, such appeal or
petition has been dismissed or the order in question has been affirmed in all
material respects by the court of last resort to which such appeal or petition
has been taken and such dismissal or affirmance has become no longer subject to
further appeal or review.

SECTION 35. Entire Agreement of Parties.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Texas Fee Payment Agreement as of this 24th
day of July, 1998.

STATE OF TEXAS, acting by and through Dan
Morales, its duly elected and authorized Attorney
General

By: /s/ Dan Morales
-----------------------------------------
Dan Morales
Attorney General

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
--------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
--------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
--------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt
--------------------------------
Charles A. Blixt
General Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

UNITED STATES TOBACCO COMPANY

By: /s/ Richard H. Verheij
-----------------------------------
Richard H. Verheij
Executive Vice President & General Counsel

TEXAS COUNSEL

By: /s/ Walter Umphrey
------------------------------------
Walter Umphrey
Provost & Umphrey

By: /s/ John M. O'Quinn, P.C.
------------------------------------
John M. O'Quinn, P.C.

By: /s/ John Eddie Williams, Jr.
------------------------------------
John Eddie Williams, Jr.

By: /s/ Wayne A. Reaud
------------------------------------
Wayne A. Reaud
Reaud, Morgan & Quinn, Inc.

By: /s/ Harold W. Nix
------------------------------------
Harold W. Nix
The Nix Law Firm

By: /s/ Cary Patterson
------------------------------------
Cary Patterson
The Nix Law Firm

By: /s/ Marc D. Murr by Roy Q. Minton with permission
------------------------------------
Marc D. Murr
Law Offices of Marc D. Murr, P.C.

By: /s/ T. Richardson, Jr.
------------------------------------
For Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole

APPENDIX A

MARKET SHARE CALCULATION

The Market Share of each Settling Defendant for purposes of any payment
required hereunder shall be equal to the proportion of (1) such Settling
Defendant's Aggregate Sales Volume for the period in question to (2) the sum of
all Settling Defendants' Aggregate Sales Volumes for the period in question. For
purposes of the foregoing:

(a) Each Settling Defendant's Aggregate Sales Volume shall be the sum of
such Settling Defendant's Sales Volumes with respect to each type of Tobacco
Product.

(b) Each Settling Defendant's Sales Volume with respect to each type of
Tobacco Product shall be the number of Units of such type of Tobacco Product
sold within the United States by such Settling Defendant during the period in
question, as measured by such Settling Defendant's applicable Shipment Reports.

(1) one Cigarette;

(2) .12 ounces of Moist Snuff;

(3) .3 ounces of Loose Leaf, Plug, Twist, Roll or other form of
chewing tobacco;

(4) .25 ounces of Dry Snuff; and

(5) .16 ounces of Loose Leaf tobacco suitable for user preparation
of cigarettes.

SCHEDULE A

MARKET SHARE PERCENTAGES

Settling Defendant Percentage
- ------------------ --------------

Philip Morris Incorporated .................................49.26

R.J. Reynolds Tobacco Company...............................24.49

Brown & Williamson Tobacco Corp.............................16.20

Lorillard Tobacco Company....................................8.77

United States Tobacco Company................................1.28

----------
TOTAL 100.00

SCHEDULE B

DESIGNATION OF TEXAS COUNSEL
by the Attorney General

Pursuant to section 21 of the Texas Fee Payment Agreement, I hereby
identify as Texas Counsel: (1) Walter Umphrey, John M. O'Quinn, P.C., John Eddie
Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm and Ness, Motley,
Loadholt, Richardson & Poole ("Private Counsel") and (2) the Law Offices of Marc
D. Murr, P.C. ("Other Texas Counsel").

There are no other Texas Counsel entitled to seek any payment of
attorneys' fees by Settling Defendants under the Settlement Agreement or the
Texas Fee Payment Agreement.

/s/ Dan Morales
-----------------------------
Dan Morales
Attorney General

SCHEDULE C

NOTICES

State of Texas

Hon. Dan Morales
Attorney General
P.O. Box 12548
Capitol Station
Austin, TX 78711
Fax: (512) 463-2063

With copies to:
Harold W. Nix
Walter Umphrey Cary Patterson
Provost & Umphrey The Nix Law Firm
490 Park Street 205 Linda Drive
P.O. Box 4905 P.O. Box 679
Beaumont, TX 77704 Daingerfield, TX 75638
Fax: (409) 838-8888 Fax: (903) 645-5389

John M. O'Quinn John Eddie Williams, Jr.
440 Louisiana Street, Suite 2300 8441 Gulf Freeway, Suite 600
Houston, TX 77002 Houston, TX 77017
Fax: (713) 222-6903 Fax: (713) 649-0126

Wayne A. Reaud Marc D. Murr
Reaud, Morgan & Quinn, Inc. Law Offices of Marc D. Murr, P.C
801 Laurel 1001 Texas Avenue, Suite 1250
Beaumont, TX 77701 Houston, TX 77002-3131
Fax: (409) 833-8236 Fax: (713) 229-8003

Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (803) 720-9290 (continued)

Settling Defendants

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

With a copy to: With a copy to:

Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company:

With a copy to: United States Tobacco Company:

Stephen R. Patton, Esq. Richard H. Verheij
Kirkland & Ellis UST Inc.
200 East Randolph Dr. 100 West Putnam Avenue
Chicago, IL 60601 Greenwich, CT 06830
Fax: (312) 861-2200 Fax: (203) 863-7233

(continued)

Texas Counsel

Walter Umphrey Wayne A. Reaud
Provost & Umphrey Reaud, Morgan & Quinn, Inc.
490 Park Street 801 Laurel
P.O. Box 4905 Beaumont, TX 77701
Beaumont, TX 77704 Fax: (409) 833-8236
Fax: (409) 838-8888

John Eddie Williams, Jr. John M. O'Quinn
8441 Gulf Freeway, Suite 600 440 Louisiana Street, Suite 2300
Houston, TX 77017 Houston, TX 77002
Fax: (713) 649-0126 Fax: (713) 222-6903

Harold W. Nix Marc D. Murr
Cary Patterson Law Offices of Marc D. Murr, P.C.
The Nix Law Firm 1001 Texas Avenue, Suite 1250
205 Linda Drive Houston, TX 77002-3131
P.O. Box 679 Fax: (713) 229-8003
Daingerfield, TX 75638
Fax: (903) 645-5389

Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (803) 720-9290

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 186,300
<SECURITIES> 40,220,000
<RECEIVABLES> 16,008,100
<ALLOWANCES> 321,600
<INVENTORY> 276,900
<CURRENT-ASSETS> 0
<PP&E> 4,052,500
<DEPRECIATION> 1,432,500
<TOTAL-ASSETS> 71,345,700
<CURRENT-LIABILITIES> 0
<BONDS> 5,696,300
0
0
<COMMON> 115,000
<OTHER-SE> 9,688,000
<TOTAL-LIABILITY-AND-EQUITY> 71,345,700
<SALES> 1,321,000
<TOTAL-REVENUES> 10,199,900
<CGS> 496,600
<TOTAL-COSTS> 7,542,600
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<INCOME-PRETAX> 490,500
<INCOME-TAX> 147,100
<INCOME-CONTINUING> 163,500
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 163,500
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<EPS-DILUTED> 1.42

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