================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------- ------------- Commission file number 1-6541 ------ LOEWS CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 13-2646102 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087 ---------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 545-2000 ---------------------------------------------------- (Registrant's telephone number, including area code) NOT APPLICABLE ---------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------- --------- Class Outstanding at November 1, 1996 - -------------------------- ------------------------------- Common stock, $1 par value 115,000,000 shares ================================================================================ Page 1 INDEX Part I. Financial Information Page No. -------- Item 1. Financial Statements Consolidated Condensed Balance Sheets-- September 30, 1996 and December 31, 1995 ...................... 3 Consolidated Condensed Statements of Income-- Three and nine months ended September 30, 1996 and 1995 ....... 4 Consolidated Condensed Statements of Cash Flows-- Nine months ended September 30, 1996 and 1995 ................. 5 Notes to Consolidated Condensed Financial Statements ............ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........................................ 23 Part II. Other Information Item 1. Legal Proceedings ......................................... 33 Item 6. Exhibits and Reports on Form 8-K .......................... 33 Page 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements. -------------------- <TABLE> <CAPTION> Loews Corporation and Subsidiaries Consolidated Condensed Balance Sheets - -------------------------------------------------------------------------------- (Amounts in millions of dollars) September 30, December 31, 1996 1995 ----------------------------- <S> <C> <C> Assets: Investments: Fixed maturities, amortized cost of $27,075.9 and $29,403.5 ................................ $27,058.8 $30,467.7 Equity securities, cost of $1,028.1 and $990.9 1,199.1 1,213.6 Mortgage loans and notes receivable ........... 124.4 132.3 Policy loans .................................. 175.9 177.2 Other investments ............................. 413.0 503.1 Short-term investments ........................ 9,547.4 7,137.0 ----------------------------- Total investments .......................... 38,518.6 39,630.9 Cash ............................................ 306.9 241.7 Receivables-net ................................. 14,579.3 13,128.6 Property, plant and equipment-net ............... 2,080.1 1,437.5 Deferred income taxes ........................... 1,513.8 1,205.2 Prepaid reinsurance premiums .................... 373.3 495.4 Goodwill and other intangible assets-net ........ 531.4 481.8 Other assets .................................... 1,382.0 1,075.7 Deferred policy acquisition costs of insurance subsidiaries ................................... 1,777.8 1,493.3 Separate Account business ....................... 5,711.5 5,868.1 ----------------------------- Total assets ............................... $66,774.7 $65,058.2 ============================= Liabilities and Shareholders' Equity: Insurance reserves and claims ................... $41,073.3 $40,802.8 Accounts payable and accrued liabilities ........ 2,439.7 1,941.8 Payable for securities purchased ................ 1,156.5 435.3 Securities sold under repurchase agreements ..... 602.6 774.1 Long-term debt, less unamortized discount ....... 4,057.5 4,248.2 Deferred credits and participating policyholders' equity ......................................... 1,597.6 1,409.9 Separate Account business ....................... 5,711.5 5,868.1 ----------------------------- Total liabilities .......................... 56,638.7 55,480.2 Minority interest ............................... 1,759.1 1,339.3 Shareholders' equity ............................ 8,376.9 8,238.7 ----------------------------- Total liabilities and shareholders' equity . $66,774.7 $65,058.2 ============================= See accompanying Notes to Consolidated Condensed Financial Statements. </TABLE> Page 3 <TABLE> <CAPTION> Loews Corporation and Subsidiaries Consolidated Condensed Statements of Income - ------------------------------------------------------------------------------------------------- (Amounts in millions, except per share data) Three Months Ended Nine Months Ended September 30, September 30, 1996 1995 1996 1995 ------------------------------------------------- <S> <C> <C> <C> <C> Revenues: Insurance premiums: Property and casualty ................. $2,592.8 $2,427.9 $ 7,579.2 $ 6,375.0 Life .................................. 841.3 766.7 2,466.3 2,201.3 Investment income, net of expenses ...... 591.2 586.1 1,826.9 1,591.8 Realized investment gains ............... 166.5 294.7 656.5 701.1 Manufactured products (including excise taxes of $125.5, $118.4, $356.8 and $338.8) ................................ 620.9 565.6 1,730.1 1,592.5 Other ................................... 403.6 318.6 1,046.4 720.4 ------------------------------------------------- Total ................................ 5,216.3 4,959.6 15,305.4 13,182.1 ------------------------------------------------- Expenses: Insurance claims and policyholders' benefits ............................... 3,087.2 2,959.0 9,249.6 7,988.9 Amortization of deferred policy acquisition costs ...................... 601.5 480.1 1,568.5 1,262.3 Cost of manufactured products sold ...... 260.7 251.8 742.6 720.4 Selling, operating, advertising and administrative expenses ................ 545.2 542.2 1,557.5 1,346.8 Interest ................................ 79.7 89.6 240.3 195.4 ------------------------------------------------- Total ................................ 4,574.3 4,322.7 13,358.5 11,513.8 ------------------------------------------------- 642.0 636.9 1,946.9 1,668.3 ------------------------------------------------- Income taxes ............................ 194.6 223.1 639.7 551.6 Minority interest ....................... 58.8 27.4 171.1 96.1 ------------------------------------------------- Total ................................ 253.4 250.5 810.8 647.7 ------------------------------------------------- Net income ................................ $ 388.6 $ 386.4 $ 1,136.1 $ 1,020.6 ================================================= Net income per share ...................... $ 3.37 $ 3.28 $ 9.75 $ 8.66 ================================================= Cash dividends per share .................. $ .25 $ .13 $ .75 $ .38 ================================================= Weighted average number of shares outstanding .............................. 115.2 117.8 116.5 117.8 ================================================= See accompanying Notes to Consolidated Condensed Financial Statements. </TABLE> Page 4 <TABLE> <CAPTION> Loews Corporation and Subsidiaries Consolidated Condensed Statements of Cash Flows - -------------------------------------------------------------------------------- (Amounts in millions) Nine Months Ended September 30, 1996 1995 ------------------------------- <S> <C> <C> Operating Activities: Net income ................................. $ 1,136.1 $ 1,020.6 Adjustments to reconcile net income to net cash provided by operating activities-net . (126.3) (338.4) Changes in assets and liabilities-net: Reinsurance receivables .................. (104.2) (406.9) Other receivables ........................ (859.7) (655.9) Prepaid reinsurance premiums ............. 122.1 57.9 Deferred policy acquisition costs ........ (284.5) (147.6) Insurance reserves and claims ............ 292.6 756.9 Accounts payable and accrued liabilities . 597.4 105.7 Investments classified as trading securities .............................. (53.5) Other-net ................................ (449.7) 315.2 ------------------------------ 270.3 707.5 ------------------------------ Investing Activities: Purchases of fixed maturities .............. (24,783.0) (25,325.6) Proceeds from sales of fixed maturities .... 25,758.4 23,346.6 Proceeds from maturities of fixed maturities 1,657.9 2,306.3 Change in securities sold under repurchase agreements ................................ (171.6) (2,066.7) Purchases of equity securities ............. (513.1) (805.7) Proceeds from sales of equity securities ... 649.9 1,847.9 Purchase of The Continental Corporation, net of cash acquired .......................... (960.4) Change in short-term investments ........... (2,158.8) 240.3 Purchases of property, plant and equipment . (351.2) (141.9) Change in other investments ................ 297.8 (112.0) ------------------------------ 386.3 (1,671.2) ------------------------------ Financing Activities: Dividends paid to shareholders ............. (87.4) (44.2) Purchases of treasury shares ............... (215.7) (4.3) Issuance of long-term debt ................. 9.5 1,831.1 Principal payments on long-term debt ....... (323.0) (509.1) Net borrowings on revolving line of credit.. 55.0 Net decrease in short-term debt ............ (7.7) (205.0) Receipts credited to policyholders ......... 11.6 19.4 Withdrawals of policyholder account balances (33.7) (25.9) ------------------------------ (591.4) 1,062.0 ------------------------------ Net change in cash ........................... 65.2 98.3 Cash, beginning of period .................... 241.7 160.6 ------------------------------ Cash, end of period .......................... $ 306.9 $ 258.9 ============================== See accompanying Notes to Consolidated Condensed Financial Statements. </TABLE> Page 5 Loews Corporation and Subsidiaries Notes to Consolidated Condensed Financial Statements - -------------------------------------------------------------------------------- (Dollars in millions, except per share data) 1. Reference is made to Notes to Consolidated Financial Statements in the 1995 Annual Report to Shareholders which should be read in conjunction with these consolidated condensed financial statements. Certain amounts applicable to prior periods have been reclassified to conform to the classifications followed in 1996. 2. On May 10, 1995, CNA Financial Corporation, an 84% owned Subsidiary ("CNA"), acquired all the outstanding shares of The Continental Corporation ("CIC") for approximately $1,100, or $20 per CIC share. To finance the acquisition, CNA entered into a five year $1,325 revolving credit facility (see Note 13 of the Notes to Consolidated Financial Statements in the 1995 Annual Report on Form 10-K, included in Item 8). CIC is an insurance holding company principally engaged through subsidiaries in the business of property and casualty insurance. The acquisition of CIC has been accounted for as a purchase, and CIC's operations are included in the Consolidated Condensed Financial Statements as of May 10, 1995. The pro forma consolidated condensed results of operations presented below assumes the above transaction occurred at January 1, 1995. <TABLE> <CAPTION> Nine Months Ended September 30, 1995 ------------------- <S> <C> Revenues $14,669.7 ============================================================================================= Realized investment gains included in revenues $ 821.2 ============================================================================================= Income before taxes and minority interest $ 1,696.9 Income tax expense (575.0) Minority interest (97.0) --------------------------------------------------------------------------------------------- Net income $ 1,024.9 ============================================================================================= Net income per share $ 8.70 ============================================================================================= </TABLE> The pro forma consolidated condensed financial information is not necessarily indicative either of the results of operations that would have occurred had the transaction been consummated at January 1, 1995 or of future operations of the combined companies. 3. CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. Page 6 The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in its states of domiciles, CNA receives collateral primarily in the form of bank letters of credit, securing a large portion of the recoverables. At September 30, 1996, such collateral totaled approximately $1,100. CNA's largest recoverable from a single reinsurer, including prepaid reinsurance premiums, at September 30, 1996 was approximately $435 with Lloyd's of London. The effects of reinsurance on earned premiums, are as follows: <TABLE> <CAPTION> % % Direct Assumed Ceded Net Assumed Direct Assumed Ceded Net Assumed ------------------------------------------------------------------------------------ Nine Months Ended September 30, ------------------------------------------------------------------------------------ --------------- 1996 -------------------- ---------------------- 1995 -------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Life ................ $ 515.9 $ 87.3 $ 33.1 $ 570.1 15.3% $ 463.0 $ 81.4 $ 16.1 $ 528.3 15.4% Accident and health . 2,580.3 183.0 112.4 2,650.9 6.9 2,289.1 95.9 59.6 2,325.4 4.1 Property and casualty 6,702.2 1,177.5 1,055.2 6,824.5 17.3 5,764.0 925.5 966.9 5,722.6 16.2 ----------------------------------------------------------------------------------- Total ............ $9,798.4 $1,447.8 $1,200.7 $10,045.5 14.4% $8,516.1 $1,102.8 $1,042.6 $8,576.3 12.9% =================================================================================== <CAPTION> Three Months Ended September 30, ----------------------------------------------------------------------------------- --------------- 1996 -------------------- ---------------------- 1995 ------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Life ................ $ 164.3 $ 30.1 $ 17.9 $ 176.5 17.1% $ 167.3 $ 26.5 $ 6.7 $ 187.1 14.2% Accident and health . 919.6 93.5 79.2 933.9 10.0 847.9 27.7 21.4 854.2 3.2 Property and casualty 2,453.2 174.7 304.2 2,323.7 7.5 2,316.5 352.2 515.4 2,153.3 16.4 ----------------------------------------------------------------------------------- Total ............ $3,537.1 $ 298.3 $ 401.3 $ 3,434.1 8.7% $3,331.7 $ 406.4 $ 543.5 $3,194.6 12.7% =================================================================================== </TABLE> In the above table, life premium income is primarily from long duration contracts and the property and casualty earned premium is from short duration contracts, and accident and health earned premiums are primarily from short duration contracts. Insurance claims and policyholders' benefits are net of reinsurance of $108.5, $782.8, $1,010.3 and $1,112.8 for the three and nine months ended September 30, 1996 and 1995, respectively. Page 7 4. Shareholders' equity: <TABLE> <CAPTION> September 30, December 31, 1996 1995 --------------------------- <S> <C> <C> Preferred stock, $.10 par value, Authorized--100,000,000 shares Common stock, $1 par value: Authorized--400,000,000 shares Issued--117,832,800 shares ................. $ 117.8 $ 117.8 Additional paid-in capital ................... 170.0 170.0 Earnings retained in the business ............ 8,206.5 7,157.8 Unrealized appreciation ...................... 98.3 793.1 --------------------------- Total ................................. 8,592.6 8,238.7 Less common stock (2,832,800 shares) held in treasury at cost ............................ 215.7 --------------------------- Total ................................. $8,376.9 $8,238.7 =========================== </TABLE> 5. The Company's receivables are comprised of the following: <TABLE> <CAPTION> September 30, December 31, 1996 1995 --------------------------- <S> <C> <C> Reinsurance .................................. $ 7,273.2 $ 7,169.1 Other insurance .............................. 6,086.2 5,302.4 Security sales ............................... 694.2 187.7 Accrued investment income .................... 519.0 578.8 Other ........................................ 301.0 193.2 --------------------------- Total ................................. 14,873.6 13,431.2 Less allowance for doubtful accounts and cash discounts .............................. 294.3 302.6 --------------------------- Receivables-net ....................... $14,579.3 $13,128.6 =========================== </TABLE> 6. On April 29, 1996 Diamond Offshore Drilling, Inc., a 70% owned subsidiary ("Diamond Offshore"), acquired Arethusa (Off-Shore) Limited ("Arethusa"). Holders of Arethusa stock received 17.9 million shares of common stock issued by Diamond Offshore based on a ratio of .88 shares for each share of Arethusa common stock. The Company recognized a gain of approximately $186.6 during the second quarter of 1996 and its interest in Diamond Offshore declined to approximately 51%. Page 8 7. Legal Proceedings and Contingent Liabilities- Fibreboard Litigation --------------------- CNA's primary property and casualty subsidiary, Continental Casualty Company ("Casualty"), is 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 or is subsequently successfully attacked. The implementation of the Global Settlement or the Trilateral Agreement would have the effect of settling Casualty's litigation with Fibreboard. On July 27, 1995, the United States District Court for the Eastern District of Texas entered judgment approving the Global Settlement Agreement and the Trilateral Agreement. As expected, appeals were filed as respects both of these decisions. On July 25, 1996, a panel of the United States Fifth Circuit Court of Appeals in New Orleans affirmed the judgment approving the Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment approving the Trilateral Agreement by a 3 to 0 vote. A petition has been filed for re-hearing by the entire Fifth Circuit Court of Appeals as respects the decision on the Global Settlement Agreement. No further appeal has been filed with respect to the Trilateral Agreement and CNA believes that the time to file any such further appeal has expired, and accordingly, CNA believes that court approval of the Trilateral Agreement has become final. CNA currently expects that Casualty's litigation with Fibreboard will be dismissed during the first quarter of 1997. Global Settlement - On April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants. On August 27, 1993, the Settling Parties reached an agreement in principle for an omnibus settlement to resolve all future asbestos-related bodily injury claims involving Fibreboard. The Global Settlement Agreement was executed on December 23, 1993. The agreement calls for contribution by Casualty and Pacific Indemnity of an aggregate of $1,525 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 is to be contributed to the fund by Fibreboard. As indicated above, the Global Settlement approval has been affirmed on appeal, however, further review is being sought, and there is limited precedent with settlements which determine the rights of future claimants to seek relief. Subsequent to the announcement of the agreement in principle, Casualty, Fibreboard and Pacific Indemnity entered into the Trilateral Agreement which among other things, settles the coverage case in the event the Global Settlement approval is not ultimately upheld. In such case, Casualty and Pacific Indemnity will contribute to a settlement fund an aggregate of Page 9 $2,000, less certain adjustments. Such fund would be devoted to the payment of Fibreboard's asbestos liabilities other than liabilities for claims settled before August 23, 1993. Casualty's share of such fund would be $1,440 reduced by a portion of an additional payment of $635 which Pacific Indemnity has agreed to pay for claims either filed or settled before August 27, 1993. Based upon receipt of the final approval of the Trilateral Agreement, Casualty will assume responsibility for the claims that were settled before August 27, 1993. A portion of the additional $635 to be contributed by Pacific Indemnity will be applied to the payment of such claims as well. As a part of the Global Settlement and the Trilateral Agreement, Casualty is to be released by Fibreboard from any further liability under the comprehensive general liability policy written for Fibreboard by Casualty, including but not limited to liability for asbestos- related claims against Fibreboard. As indicated above, CNA believes that court approval of the Trilateral Agreement has become final and non- appealable. Casualty and Fibreboard have entered into a supplemental agreement (the "Supplemental Agreement") which governs the interim arrangements and obligations between the parties until such time as the coverage case is finally resolved, either through final court approval of the Global Settlement Agreement, or final court disapproval of the Global Settlement Agreement and final court approval of the Trilateral Agreement, or through a final decision in the California courts. It also governs certain obligations between the parties upon the Global Settlement being upheld on appeal including the payment of claims which are not included in the Global Settlement. In addition, Casualty and Pacific Indemnity have entered into an agreement (the "Casualty-Pacific Agreement") which sets forth the parties' agreement with respect to the means for allocating among themselves responsibility for payments arising out of the Fibreboard insurance policies. Under the Casualty-Pacific Agreement, Casualty and Pacific Indemnity have agreed to pay 64.71% and 35.29%, respectively, of the $1,525 to be used to satisfy the claims of future claimants, plus certain expenses. The $1,525 has already been deposited into an escrow for such purpose. Based upon the final approval of the Trilateral Agreement, Pacific Indemnity's share for unsettled present claims and presently settled claims will be $635. Through September 30, 1996, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 133,700 claims, subject to resolution of the coverage issues, for an estimated settlement amount of approximately $1,620 plus any applicable interest. Final court approval of the Trilateral Agreement obligates Casualty to pay under these settlements. Approximately $705 was paid through September 30, 1996. As described above, such payments are partially recoverable from Pacific Indemnity. Casualty may negotiate other agreements with various classes of claimants including groups who may have previously reached agreement with Fibreboard. Reserves - In the fourth quarter of 1992, Casualty increased its reserve with respect to potential exposure to asbestos-related bodily injury cases by $1,500. In connection with the agreement in principle announced on August 27, 1993, Casualty added $500 to such claim reserve in the third quarter of 1993. The Fibreboard litigation represents the major portion of Casualty's asbestos-related claim exposure. Casualty believes that final court approval of the Trilateral Agreement and its implementation will eliminate any further material exposure with respect to the Fibreboard matter. Under various reinsurance agreements, Casualty has asserted a right to Page 10 reimbursement for a portion of its potential exposure to Fibreboard. Casualty's principal reinsurers have disputed Casualty's right to reimbursement and have taken the position that any claim by Casualty is subject to arbitration under provisions in the reinsurance agreement. A federal court has ruled that the dispute must be resolved by arbitration. There can be no assurance that Casualty will be successful in obtaining a significant recovery under its reinsurance agreements. Environmental Pollution and Asbestos ------------------------------------ The CNA property/casualty insurance companies have potential exposures related to environmental pollution and asbestos-related claims. Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. 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") establishes a mechanism to pay for clean-up of waste sites if PRP's fail to do so, and to assign liability to PRP's. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency on its National Priorities List. On the other hand, the Congressional Budget Office is estimating that there will be 4,500 National Priority List sites, and other estimates project as many as 30,000 sites that will require clean-up under ECLs. Very few sites have been subject to clean-up to date. The extent of clean-up necessary and the assignment of liability has not been established. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether Superfund response costs are considered damages under the policies, trigger of coverage, applicability of pollution exclusions, the potential for joint and several liability and definition of an occurrence. Similar coverage issues exist for clean-up of waste sites not covered under Superfund. To date, courts have been inconsistent in their rulings on these issues. A number of proposals to reform Superfund have been made by various parties. Despite Superfund taxing authority expiring at the end of 1995, no reforms have been enacted by Congress. While the next Congress may address this issue, no predictions can be made as to what positions the Congress or the Administration will take and what legislation, if any, will result. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean-up may be materially reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental clean-up statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate Page 11 exposure to CNA for environmental pollution claims cannot be meaningfully quantified. Claim and claim expense reserves represent management's estimates of ultimate liabilities based on currently available facts and case law. However, in addition to the uncertainties previously discussed, additional issues related to, among other things, specific policy provisions, multiple insurers and allocation of liability among insurers, consequences of conduct by the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult and subject to adjustment based on new data. As of September 30, 1996 and December 31, 1995, CNA carried approximately $802 and $1,030, respectively, of claim and claim expense reserves, net of reinsurance recoverable, for reported and unreported environmental pollution claims. There was no environmental reserve development for the quarter and nine months ended September 30, 1996. Adverse environmental reserve development of $241 for the year ended December 31, 1995 includes $60 related to CIC and results from CNA's on-going monitoring of settlement patterns, current pending cases and potential future claims. The foregoing reserve information relates to claims for accident years 1988 and prior, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form which included an absolute pollution exclusion. CNA has exposure to asbestos-related claims, including those attributable to CNA's on-going litigation with Fibreboard Corporation (see discussion above). Estimation of asbestos-related claim reserves encounter many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, multiple insurers and allocation of liability among insurers, missing policies and proof of coverage. As of September 30, 1996 and December 31, 1995, CNA carried approximately $2,051 and $2,224, respectively, of claim and claim expense reserves, net of reinsurance recoverable, for reported and unreported asbestos-related claims. Unfavorable reserve development for the nine months ended September 30, 1996 and year ended December 31, 1995 totaled $38 and $258, respectively. CNA, consistent with sound reserving practices, regularly adjusts its reserve estimates in subsequent reporting periods as new facts and circumstances emerge that indicate the previous estimates need to be modified. Beginning the latter part of 1995 and through 1996 to date, CNA has been actively settling many of its larger environmental pollution and asbestos-related claim exposures. This strategy has resulted in a large volume of claim payments during 1996, and corresponding reductions in reserves. In addition, Fibreboard claim payments escalated in 1996 as some scheduled payments came due. Management does not believe that these recent activities have changed facts or circumstances evident at December 31, 1995, therefore, no material modifications to previous reserve estimates have been made in 1996. The following table provides additional data related to CNA's environmental pollution and asbestos-related claims reserves. <TABLE> <CAPTION> September 30, 1996 December 31, 1995 ---------------------------------------------------- Environmental Asbestos Environmental Asbestos ---------------------------------------------------- <S> <C> <C> <C> <C> Gross reserves: Reported claims ................... $ 328 $1,877 $ 337 $1,963 Unreported claims ................. 594 275 840 358 ------------------------------------------------ 922 2,152 1,177 2,321 Less reinsurance recoverable ........ (120) (101) (147) (97) ------------------------------------------------ Net reserves ...................... $ 802 $2,051 $1,030 $2,224 ================================================ </TABLE> Page 12 The results of operations in future years may continue to be adversely affected by environmental pollution and asbestos claim and claim expenses. Management will continue to monitor potential liabilities and make further adjustments as warranted. Tobacco Litigation ------------------ Lawsuits are being filed with increasing frequency against Lorillard and other manufacturers of tobacco products seeking damages for cancer and other health effects claimed to have resulted from an individual's use of cigarettes or exposure to tobacco smoke. Plaintiffs have asserted claims based on, among other things, theories of negligence, fraud, misrepresentation, strict liability, breach of warranty, enterprise liability, civil conspiracy, intentional infliction of harm, and failure to warn of the allegedly harmful and/or addictive nature of tobacco products. 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 $100 in compensatory damages and $600 in punitive damages. Conventional smoking and health cases - There are 317 cases filed by individual plaintiffs against manufacturers of tobacco products pending in the United States federal and state courts. Lorillard is a named defendant in 92 of these cases. The Company is a defendant in four of these cases. On August 23, 1996 the jury in Rogers v. R.J. Reynolds Tobacco Company, et al. (District Court, Marion County, Indiana), returned a verdict in favor of the defendants. Neither Lorillard nor the Company was a party in Rogers. On August 9, 1996 the jury in Carter v. Brown & Williamson Tobacco Corporation (District Court, Duval County, Florida), returned a verdict in favor of the plaintiffs and awarded them $0.8 in actual damages. The Company understands that Brown & Williamson Tobacco Corporation, the only defendant in the case, has filed post-trial motions for judgment notwithstanding the verdict or for new trial, and that if such motions are unsuccessful, Brown & Williamson intends to notice an appeal. Class Actions - In addition to the foregoing cases, there are 19 purported class actions pending against cigarette manufacturers. Lorillard is a defendant in 17 of these cases and the Company is a defendant in 11 of these cases. Fourteen of the purported class actions against Lorillard seek damages for alleged nicotine addiction and health effects claimed to have resulted from the use of cigarettes; two allege health effects from exposure to tobacco smoke; and one seeks disclosure of additives used in cigarettes. Theories of liability include a broad range of product liability theories, theories based upon consumer protection statutes and fraud and misrepresentation. These purported class actions are described below. Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County, Florida, filed October 31, 1991). The class consists of flight attendants claiming injury as a result of exposure to environmental tobacco smoke in the cabins of aircraft. Plaintiffs seek an unspecified amount in compensatory damages and $5,000 in punitive damages. The trial court granted plaintiffs' motion for class certification on December 12, 1994. Defendants' appeal of this ruling to the Florida Court of Appeal has been denied. Defendants' motion to reconsider the ruling or to certify it to the Florida Supreme Court has been denied. Defendants' attempts to appeal to the Florida Supreme Court have been denied. Castano v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed March 29, 1994). The purported class Page 13 consists of individuals in the United States who are allegedly nicotine- dependent and their estates and heirs. Plaintiffs are represented by a well- funded and coordinated consortium of over 60 law firms from around the United States. Plaintiffs seek unspecified amounts in actual damages and punitive damages. The court issued an order on February 17, 1995 that granted in part plaintiffs' motion for class certification. On appeal, the United States Court of Appeals for the Fifth Circuit issued an order decertifying the class. The Court of Appeals ordered the trial court to enter an order dismissing the class action allegations in plaintiffs' complaint. A dismissal order has not been entered to date. Granier v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed September 26, 1994). Plaintiffs seek certification of a class comprised of all residents of the United States who are addicted to nicotine, and of survivors who claim their decedents were addicted to nicotine. Plaintiffs seek unspecified actual damages and punitive damages and the creation of a medical monitoring fund to monitor the health of individuals allegedly injured by their addiction to nicotine. Plaintiffs' motion to consolidate this action with Castano, above, has not been decided by the court. Engle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida, filed May 5, 1994). The purported class consists of citizens and residents of the United States, and their survivors, who have or who have died from, diseases and medical conditions allegedly caused by smoking cigarettes containing nicotine. Plaintiffs in this case seek actual and punitive damages in excess of $200,000, and the creation of a medical fund to compensate individuals for future health care costs. Plaintiffs' motion for class certification was granted by the court on October 31, 1994. Defendants' appeal of this ruling to the Florida Court of Appeal was denied, although the court has modified the class certification order and has limited plaintiffs' class to citizens or residents of Florida. Defendants' motion to reconsider this ruling has been denied. Defendants have appealed the orders to the Florida Supreme Court. The Florida Supreme Court has denied defendants' petition to invoke the discretionary jurisdiction of the court to review the class certification rulings. Lacey v. Lorillard Tobacco Company, et al. (U.S. District Court, Northern District, Alabama, filed March 15, 1994). Plaintiff alleges that the defendants, Lorillard and two other cigarette manufacturers, did not disclose to the plaintiff or other cigarette smokers in the State of Alabama the nature, type, extent and identity of additives that the defendants allegedly caused or allowed to be made a part of cigarettes or cigarette components. Plaintiff requests injunctive relief requiring defendants to list the additives that defendants have caused or allowed to be placed in cigarettes sold in Alabama. Plaintiff seeks monetary damages not to exceed forty-eight thousand five hundred dollars for any individual. The U.S. District Court has advised the parties that it has granted defendants' motion for summary judgment but an order reflecting the ruling has not been entered. Norton v. RJR Nabisco Holdings Corporation, et al. (U.S. District Court, Southern District, Indiana, filed May 3, 1996). Plaintiffs seek certification of a class comprised of all allegedly nicotine-dependent persons in the state of Indiana who have purchased and smoked cigarettes manufactured by the defendant tobacco companies since January 1, 1940; the estates, representatives and administrators of allegedly nicotine-dependent smokers; and the spouses, children and dependent relatives of allegedly nicotine-dependent smokers. Plaintiffs seek unspecified amounts in actual damages and punitive damages; applicable damages for violation of Indiana's deceptive business practices statute; and creation of a medical monitoring fund. Page 14 Richardson v. Philip Morris Incorporated, et al. (U.S. District Court, Maryland, filed May 24, 1996). Plaintiffs seek certification of a class comprised of citizens or residents of Maryland who allege they or their decedents who have or died from diseases or medical conditions caused by addiction to smoking cigarettes or using other tobacco products containing nicotine. Plaintiffs seek unspecified amounts in actual damages and punitive damages and the creation of a medical monitoring fund, smoking cessation programs, and a corrective public education campaign. Scott v. The American Tobacco Company, et al. (District Court, Orleans Parish, Louisiana, filed May 24, 1996). Plaintiffs seek certification of a class of residents of Louisiana and the estates, representatives, administrators, spouses, children or significant others of Louisiana residents who allegedly are or were nicotine-dependent. Plaintiffs seek an unspecified amount of actual damages and the creation of a medical monitoring fund. This case was remanded to the state court. Reed v. Philip Morris Incorporated, et al. (Superior Court, District of Columbia, filed June 21, 1996). Plaintiff seeks certification of a class of residents of Washington, D.C., who allege they or their decedents are or were addicted to cigarettes. Plaintiff seeks actual damages in an amount specified to be in excess of $0.5 for each class member; punitive damages in an amount specified to be in excess of $1.0 for each class member; an unspecified amount in treble damages; and the funding of a medical monitoring fund and of smoking cessation programs. Mroczowski v. Lorillard, et al.; Hoskins v. R.J. Reynolds, et al,; Frosina v. Philip Morris, et al.; Stewart-Lomanitz v. Brown & Williamson, et al. and Zito v. American Tobacco, et al. (Supreme Court, New York County, New York, each filed on June 19, 1996). Plaintiffs in each of these cases seek certification of classes to be comprised of residents of the state of New York who allege they are nicotine-dependent, and the estates, representatives or administrators of the alleged nicotine-dependent smokers. Each of these cases names a cigarette manufacturer, the parent or holding company of the manufacturer, The Tobacco Institute and the Council for Tobacco Research as defendants. In Mroczowski, the only one of these cases to name Lorillard or the Company as defendants, plaintiffs seek unspecified amounts in actual damages and punitive damages. Arch v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Pennsylvania, filed August 8, 1996). Plaintiffs seek class certification on behalf of residents of Pennsylvania who allegedly are or were nicotine-dependent, or the estates, representatives, administrators, spouses, children or relatives of the allegedly nicotine-dependent smokers. Plaintiffs seek unspecified amounts in actual damages and punitive damages and the creation of a medical monitoring fund and of smoking cessation programs. Defendants named in the complaint are Lorillard, the Company, the other major U.S. cigarette manufacturers, their parent or holding companies, The Tobacco Institute, the Council for Tobacco Research, wholesalers, and a trade association. Harris v. The American Tobacco Company, et al. (U.S. District Court, Middle District, Pennsylvania, filed March 1, 1996; service not effected on any defendants until October 1996). Plaintiffs, who are incarcerated in federal correctional facility, are appearing pro se and in forma pauperis and seek certification of the case as a class action on behalf of all residents of the United States who allege they or their decedents are or were nicotine dependent. Plaintiffs seek unspecified amounts in actual damages, punitive damages and the creation of a medical monitoring fund. The defendants named in the complaint are Lorillard, the Company, the other major U.S. cigarette Page 15 manufacturers, their parent or holding companies and The Tobacco Institute. Lyons v. The American Tobacco Company, et al. (U.S. District Court, Southern District, Alabama, filed August 8, 1996). Plaintiffs seek class certification on behalf of residents of the states of Alabama and North Carolina who allegedly are addicted to cigarette smoking and on behalf of individuals whose claims are derivative of the claims of the allegedly addicted smokers. Plaintiffs seek unspecified amounts in actual damages, punitive damages and a medical monitoring fund. Lorillard, the other major U.S. cigarette manufacturers, The Tobacco Institute, the Council for Tobacco Research, a non-U.S. tobacco company and wholesalers are named as defendants in the complaint. Chamberlain v. The American Tobacco Company, et al. (U.S. District Court, Northern District, Ohio, filed August 14, 1996). Plaintiff seeks class certification on behalf of all residents of Ohio who allege they or their decedents are or were nicotine dependent. Plaintiffs seek unspecified amounts in actual damages and punitive damages and the creation of a medical monitoring fund. The defendants named in the complaint are Lorillard Tobacco Company, Lorillard, Inc., the Company, the other major U.S. cigarette manufacturers, their parent or holding companies, companies affiliated with one non-U.S. cigarette manufacturer, the Council for Tobacco Research, The Tobacco Institute, and wholesalers and retailers of tobacco products. Masepohl v. American Tobacco Company, Inc., et al. (U.S. District Court, Minnesota, filed September 3, 1996). Plaintiff seeks class certification on behalf of all residents of Minnesota who allege they or their decedents are or were nicotine dependent. Plaintiff seeks an unspecified amount in actual damages and the creation of a medical monitoring fund. Lorillard, the Company, the other major U.S. cigarette manufacturers, their parent or holding companies, two non-U.S. tobacco companies, The Tobacco Institute and the Council for Tobacco Research are named as defendants in the complaint. Perry v. The American Tobacco Company, et al. (Circuit Court, Coffee County, Tennessee, filed September 30, 1996). Plaintiffs seek certification of the case as a class action on behalf of individuals who have paid medical insurance premiums to a Blue Cross and Blue Shield organization. Plaintiffs seek recovery of the funds expended by members of the purported class for premiums paid to Blue Cross and Blue Shield entities. The defendants named in the complaint are Lorillard, the other major U.S. cigarette manufacturers, one non-U.S. tobacco company, Hill & Knowlton, The Tobacco Institute and the Council for Tobacco Research. McGinty v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Arkansas, filed November 4, 1996). Plaintiffs seek class certification on behalf of all residents of Arkansas who allege they or their decedents are or were nicotine dependent. Plaintiffs seek restitution and refunds of the sums paid by class members to purchase cigarettes; disgorgement of the profits from the sale of cigarettes; a medical monitoring fund; an unspecified amount in actual damages; and an unspecified amount in punitive damages. The complaint names Lorillard, the Company, the other major U.S. cigarette manufacturers, their parent or holding companies, The Tobacco Institute and the Council for Tobacco Research as defendants. Reimbursement Cases - In addition to the foregoing cases, there are 23 actions (one of which is unserved) initiated in which governmental entities seek recovery of funds expended by them, and in one case health insurers, 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 Page 16 based on antitrust laws and state consumer protection acts. Lorillard is named as a defendant in all 23 such actions. The Company is named as a defendant in six of them (one of which is unserved). These cases are described below. Moore v. The American Tobacco Company, et al. (Chancery Court, Jackson County, Mississippi, filed May 23, 1994), filed by the Attorney General of Mississippi. In February 1996, the Governor of Mississippi petitioned the Supreme Court of Mississippi for a writ of mandamus, claiming the Attorney General had no authority to bring a lawsuit against Lorillard and the other manufacturers of tobacco products without approval by the Governor. The Mississippi Supreme Court has heard argument in the petitions filed by the defendants in the action and separately by the Governor of Mississippi on September 4, 1996. McGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha County, West Virginia, filed September 20, 1994), filed by the Attorney General of West Virginia. In this case the court entered an order during June 1995 that granted defendants' motion to dismiss eight of the ten counts of the complaint. The motion to dismiss was not directed to plaintiff's two remaining claims of antitrust and consumer fraud. State of Minnesota v. Philip Morris Incorporated, et al. (District Court, Ramsey County, Minnesota, filed August 17, 1994), filed by the Attorney General of Minnesota and Blue Cross and Blue Shield of Minnesota. Commonwealth of Massachusetts v. Philip Morris Inc., et al. (Superior Court, Middlesex County, Massachusetts, filed December 19, 1995), filed by the Attorney General of Massachusetts. The action was remanded from U.S. District Court, Massachusetts. Ieyoub v. The American Tobacco Company, et al. (District Court, Calcasieu Parish, Louisiana, filed March 13, 1996), filed by the Attorney General of Louisiana. The action was remanded from U.S. District Court, Western District, Louisiana. The State of Texas v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Texas, filed March 28, 1996), filed by the Attorney General of Texas. State of Maryland v. Philip Morris Incorporated, et al. (Circuit Court, Baltimore City, Maryland, filed May 1, 1996), filed by the Attorney General of Maryland. The case was remanded from U.S. District Court, Maryland. State of Washington v. The American Tobacco Company, et al. (Superior Court, King County, Washington, filed June 5, 1996), filed by the Attorney General of the state of Washington. 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), filed by the City and County of San Francisco on behalf of the citizens of the state of California. State of Connecticut v. Philip Morris Incorporated, et al. (Superior Court, Stamford/Norwalk District, Connecticut, filed July 18, 1996), filed by the Attorney General of Connecticut. The State of Florida, et al. v. The American Tobacco Company, et al. (Circuit Court, Palm Beach County, Florida, filed February 22, 1995), filed by the State of Florida, the Governor of Florida, and two state agencies. This case has been brought under a Florida statute that permits the state to Page 17 sue a manufacturer to recover Medicaid costs incurred by the state that are claimed to result from the use of the manufacturer's product. The statute permits causation and damages to be proven by statistical analysis, abrogates all affirmative defenses, adopts a "market share" liability theory, applies joint and several liability and eliminates the statute of repose. An action for declaratory judgment has been commenced in Florida state court by companies and trade associations in several potentially affected industries challenging this statute. In June 1995, a ruling was issued by a Florida state court that granted in part this motion for declaratory judgment. The ruling declared that certain portions of this statute on which the lawsuit against cigarette companies was based violates the constitution of the State of Florida. Both parties appealed the ruling to the Florida Court of Appeal. The appeal subsequently was transferred to the Florida Supreme Court. On June 27, 1996, the Florida Supreme Court affirmed in part and reversed in part the trial court's judgment. A plurality of the court held that the 1994 amendments are constitutional on their face, but that cigarette manufacturers are not precluded from asserting an action in the future challenging the application of the amendments. The court further directed that the state must identify the individual Medicaid recipients for whom it is seeking recovery; that the cigarette manufacturers will be permitted to assert certain defenses to claims that appear to be time-barred; that the state will be prohibited from combining theories of market-share liability and joint and several liability (although the state may assert either claim individually); and that recovery of payments made prior to July 1, 1994, the effective date of the amendments, may be sought only under traditional methods such as subrogation, assignment or lien. Lorillard understands that several other states, and the Congress, have considered or are considering legislation similar to that passed in Florida. On September 16, 1996, the trial court granted defendants' motion to dismiss 15 of the 18 counts of the complaint, granted the motions to dismiss filed by certain parent company defendants, including Loews Corporation, and required the state to identify the Medicaid recipients for which it seeks to recover damages. Plaintiffs have noticed an appeal to the Florida Court of Appeal from that portion of the September 16, 1996 order dismissing the parent company defendants. The County of Los Angeles, et al. v. R.J. Reynolds Tobacco Company, et al. (Superior Court, Los Angeles County, California, filed August 5, 1996), filed by public attorneys for the County of Los Angeles. The State of Arizona, et al. v. The American Tobacco Company, et al. (Superior Court, Maricopa County, Arizona, filed August 20, 1996), filed by the Attorney General of Arizona on behalf of the state and the Arizona Health Care Cost Containment System. The State of Kansas v. R.J. Reynolds Tobacco Company, et al. (District Court, Shawnee County, Kansas, filed August 20, 1996), filed by the Attorney General of Kansas. Kelley v. Philip Morris Incorporated, et al. (Circuit Court, Ingham County, Michigan, filed August 21, 1996), filed by the Attorney General of Michigan. People of the State of California v. Philip Morris Incorporated, et al. (Superior Court, San Francisco County, California, filed September 5, 1996), filed by 12 California counties, the cities of San Francisco and San Jose, the California Division of the American Cancer Society, the California chapter of the American Heart Association, the California Medical Association, and the California District of the American Academy of Pediatrics. Page 18 State of New Jersey v. R.J. Reynolds Tobacco Company, et al. (Superior Court, Middlesex County, New Jersey, filed September 10, 1996), filed by the Attorney General of New Jersey. State of Oklahoma, et al. v. R.J. Reynolds Tobacco Company, et al. (filed in the District Court of Cleveland County, Oklahoma, filed September 11, 1996), filed by the Attorney General of Oklahoma on behalf of the state, the Oklahoma Health Care Authority, and the Oklahoma Departments of Human Services, Veterans Affairs, and Health. State of Utah v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court, Central Division, Utah, filed September 30, 1996), filed by the Attorney General of Utah. City of New York, et al. v. The Tobacco Institute, et al. (Supreme Court, New York County, New York, filed October 17, 1996), filed by the Corporation Counsel of the City of New York on behalf of the city and the New York City Health and Hospitals Corporation. The states pursuing the foregoing efforts are doing so at the urging and with the assistance of well known members of the plaintiffs bar and these lawyers have been meeting with attorneys general in other states to encourage them to file similar suits. In addition to the above, a private citizen has filed suit in the Circuit Court of Wayne County, Michigan, that seeks a writ of mandamus compelling the Governor of the State of Michigan to direct the Attorney General of the State of Michigan to file a reimbursement suit against the cigarette manufacturers and their holding companies named as defendants in the complaint, including the Company and Lorillard (Bleakley, et al. v. Engler, et al., filed March 21, 1996). In the alternative, the complaint seeks certification as a class action with the named plaintiffs representing a class defined as the taxpayers of the State of Michigan. Neither the Company nor Lorillard have received service of process of this suit. Defendants have removed the case to U.S. District Court for the District of Michigan. Private citizens filed suit in the Circuit Court of Montgomery County, Alabama seeking class certification on behalf of the taxpayers of Alabama. Plaintiffs seek recovery of funds expended by the state in providing health care to individuals allegedly injured by cigarette smoking (Crozier v. The American Tobacco Company, et al., filed August 8, 1996). Plaintiffs seek unspecified amounts in actual damages and punitive damages. Plaintiffs are represented by private counsel. Defendants have removed this case to the U.S. District Court, Middle District, Alabama. Private citizens have filed suit in Ohio seeking class certification on behalf of the taxpayers of the state. Plaintiffs seek recovery of funds expended by the state in providing health care through its Medicaid, State Teachers Retirement System and State Public Employment Retirement System programs to individuals allegedly injured by cigarette smoking (Coyne v. The American Tobacco Company, et al., U.S. District Court, Northern District, Ohio, filed September 17, 1996). Plaintiffs seek unspecified amounts in restitution and punitive damages, disgorgement of profits, and the funding of smoking cessation and corrective public education campaigns. Plaintiffs are represented by private counsel. The complaint names as defendants Lorillard, Inc., Lorillard Tobacco Company, Loews Corporation, the other major U.S. cigarette manufacturers, their parent or holding companies, companies affiliated with one non-U.S. cigarette manufacturer, the Council for Tobacco Research, the Tobacco Institute and wholesalers or retailers of tobacco products. Page 19 Lorillard, other cigarette manufacturers and others have commenced suits in seven states that seek declaratory judgment or injunctive relief as to the authority of the states or state agencies to commence actions seeking recovery of funds expended to provide health care for citizens with injuries allegedly caused by cigarette smoking, or to retain private counsel under a contingent fee contract to pursue such actions. The case of Philip Morris Incorporated, et al. v. Harshbarger was filed on November 28, 1995 in the U.S. District Court of Massachusetts. The case of Philip Morris Incorporated, et al. v. Morales, et al., was filed on November 28, 1995 in the District Court of Travis County, Texas. This action has been abated by the trial court pending resolution of State of Texas v. The American Tobacco Company, et al. The case of Philip Morris Incorporated, et al. v. Glendening, et al. was filed on January 22, 1996 in the Circuit Court of Talbot County, Maryland. The court has entered an order denying plaintiffs' motion for summary judgment and granting defendants' motion for summary judgment. The tobacco companies have noticed an appeal to the Maryland Court of Appeals. The case of Philip Morris Incorporated, et al. v. Blumenthal was filed on June 28, 1996 in U.S. District Court for the District of Connecticut. The case of Philip Morris Incorporated, et al. v. Graham, et al. was filed on July 15, 1996 in the District Court of Salt Lake County, Utah. The case of Philip Morris Incorporated, et al. v. Verniero, et al., was filed on August 20, 1996, in the Superior Court of Mercer County, New Jersey. The case of Philip Morris Incorporated, et al. v. Bronster, was filed on August 28, 1996, in the United States District Court for the District of Hawaii. Filter Cases - In addition to the foregoing cases, several 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 forty years ago, into the filter material used in one of the brands of cigarettes manufactured by Lorillard. Twelve such cases are pending in federal and state courts against Lorillard. Allegations of liability against Lorillard include negligence, strict liability, fraud, misrepresentation and breach of warranty. Plaintiffs seek unspecified amounts in compensatory and punitive damages in many cases, and in other cases damages are stated to amount to as much as $10 in compensatory damages and $100 in punitive damages. Trials were held in three cases of this type during 1995. In two of the cases, the juries returned verdicts in favor of Lorillard. In the third case, the jury returned a verdict in favor of plaintiffs. The verdict requires Lorillard to pay an amount between $1.8 and $2.0 in actual and punitive damages. The precise amount to be paid by Lorillard will be determined at a later date if the verdict withstands review by appellate courts. Lorillard has noticed an appeal from the judgment in plaintiffs' favor. Trials have been held in three cases of this type during 1996. In two of the cases, the juries returned verdicts in favor of Lorillard. In the third case, the jury returned a verdict in favor of plaintiffs. The verdict requires Lorillard to pay the amount of one hundred forty thousand dollars. The trial court has denied Lorillard's post-trial motion. Lorillard has noticed an appeal to the California Court of Appeals. In addition to the foregoing litigation, one pending case, Cordova v. Liggett Group, Inc., et al. (Superior Court, San Diego County, California, filed May 12, 1992), alleges that Lorillard and other named defendants, including other manufacturers of tobacco products, engaged in unfair and fraudulent business practices in connection with activities relating to the Council for Tobacco Research-USA, Inc., of which Lorillard is a sponsor, in violation of a California state consumer protection law by misrepresenting to or concealing from the public information concerning the health aspects of smoking. Plaintiff seeks an injunction ordering defendants to undertake a "corrective advertising campaign" in California to warn consumers of the Page 20 health hazards associated with smoking, to provide restitution to the public for funds "unlawfully, unfairly, or fraudulently" obtained by defendants, and to "disgorge" all revenues and profits acquired as a result of defendants' "unlawful, unfair and/or fraudulent business practices." Another case, Ellis v. R.J. Reynolds Tobacco Company, et al. (Superior Court, Orange County, California, filed July 24, 1996), alleges that the defendants denied and concealed that the nicotine contained within their tobacco products is addictive, and that the defendants controlled and manipulated the nicotine content of their cigarettes in order to create and sustain addiction. Plaintiff seeks declarations that defendants violated provisions of the California Business and Professions Code; injunctions prohibiting the defendants from engaging in conduct that violates the California Business and Professions Code; orders requiring the defendants to fund a public education campaign, smoking cessation programs and corrective advertising campaigns; and orders requiring defendants to disgorge profits and to pay restitution to the general public of California. 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. In addition to the defenses based on preemption under the Supreme Court decision referred to above, Lorillard believes that it has a number of other valid defenses to pending cases. 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, and has been so advised by counsel, that some or all of these defenses may, in any of the pending or anticipated cases, be found by a jury or court to bar recovery by a plaintiff. Application of valid defenses, including those of preemption, are likely to be the subject of further legal proceedings in the class action cases and in the actions brought by states or state agencies. Smoking and health related litigation has been brought by plaintiffs against Lorillard and other manufacturers of tobacco products for many years. While Lorillard intends to defend vigorously all such actions which may be brought against it, it is not possible to predict the outcome of any of this litigation. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the Page 21 commencement of additional similar litigation. 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 ultimate unfavorable outcome of certain pending litigation. Management believes, however, that the ultimate outcome of pending litigation should not have a material adverse effect on the Company's financial position. 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. 8. In the opinion of Management, the accompanying consolidated condensed financial statements reflect all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 1996 and December 31, 1995 and the results of operations for the three and nine months and changes in cash flows for the nine months ended September 30, 1996 and 1995, respectively. Results of operations for the third quarter and first nine months of each of the years is not necessarily indicative of results of operations for that entire year. Page 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. ----------------------------------------------------------------------- Liquidity and Capital Resources: - ------------------------------- Insurance - --------- Property and casualty and life insurance operations are wholly owned subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 84% owned subsidiary of the Company-- CNA has financed its acquisition of The Continental Corporation ("CIC") (including the refinancing of $205 million of CIC debt), through a five-year $1.3 billion revolving credit facility. The interest rate is based on the 1,2,3 or 6 month London Interbank Offered Rate ("LIBOR") plus 25 basis points. Additionally, there is a facility fee of 10 basis points annually. The average interest rate was 5.7% at September 30, 1996. In 1996, CNA renegotiated the credit facility extending the maturity by one year. Under the terms of the facility, CNA may prepay the debt without penalty, giving CNA flexibility to arrange longer-term financing on more favorable terms. In 1995, to take advantage of favorable interest rate spreads, CNA established a Commercial Paper Program, borrowing $500 million from investors to reduce a like amount of bank financing. In the first nine months of 1996, CNA increased commercial paper borrowings by $175 million replacing a like amount of bank financing. The weighted average yield on commercial paper at September 30, 1996 was 5.7%. The commercial paper borrowings are classified as long-term debt as $675 million of the committed credit facility supports the commercial paper program. CNA entered into interest rate swap agreements with several banks which terminate from May to December 2000. These agreements convert variable rate debt into fixed rate debt resulting in fixed rates on notional amounts of $1.2 billion. The effect of these interest rate swaps was to increase interest expense by $1.9 and $5.6 million for the quarter and nine months ended September 30, 1996. The weighted average interest rate (interest and facility fees) on the acquisition debt, which includes the revolving credit facility, commercial paper, and the effect of the interest rate swaps, was 6.4% at September 30, 1996. On March 1, 1996, CNA repaid $250 million of 8 5/8% senior notes, which had matured. For the first nine months of 1996, statutory surplus of the property and casualty insurance subsidiaries increased 3.1% to approximately $5.9 billion. The statutory surplus of the life insurance subsidiaries remained at approximately $1.1 billion. The principal cash flow sources of CNA's property and casualty and life insurance subsidiaries are premiums and investment income. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses. For the first nine months of 1996, CNA's operating activities reflect net negative cash flows of approximately $65 million, compared to positive cash flows of $409 million in 1995. The decrease is primarily the result of cash Page 23 flows used by underwriting activities including higher payments for catastrophe related losses and, as discussed in Note 7 of the Notes to Consolidated Condensed Financial Statements, increased settlement of environmental pollution and asbestos-related claim exposures resulting in a large volume of claim payments in 1996. Also contributing to the decreased operating cash flow is increased interest payments on acquisition debt for the full nine month period in 1996 compared to approximately five months in 1995. Net cash flows are generally invested in marketable securities. Investment strategies employed by CNA's insurance subsidiaries consider the cash flow requirements of the insurance products sold and the tax attributes of the various types of marketable investments. CNA and the insurance industry are exposed to an unknown amount of liability for environmental pollution, primarily related to toxic waste site clean-up. See Note 7 of the Notes to Consolidated Condensed Financial Statements for further discussion of environmental pollution exposures. Cigarettes - ---------- Lorillard, Inc. and subsidiaries ("Lorillard")-- Virtually all of Lorillard's sales are in the full price brand category. With the industry-wide list price reduction of full price brands, effective August 9, 1993, the market share of discount brands has declined and Lorillard's product line has benefited in terms of unit sales. Discount brand sales have decreased from an average of 37% of industry sales during 1993 to an average of 30% during 1995. At September 30, 1996, they represented 28.7% of industry sales. Lawsuits are being filed with increasing frequency against Lorillard and other manufacturers of tobacco products seeking damages for cancer and other health effects claimed to have resulted from the use of cigarettes or exposure to tobacco smoke. See Note 7 of the Notes to Consolidated Condensed Financial Statements. In a number of these cases the Company is named as a defendant. Pending litigation includes conventional smoking and health cases, purported class actions, governmental entities/medicaid reimbursement actions, and filter cases, most of which claim very substantial damages. Corporate - --------- During the nine months ended September 30, 1996 the Company purchased 2,832,800 shares of its outstanding Common Stock at an aggregate cost of approximately $215.7 million. The funds required for such purchases were provided from working capital. Depending on market conditions, the Company, from time to time, may purchase shares in the open market or otherwise. Page 24 Investments: - ----------- Insurance - --------- A summary of CNA's general account fixed maturity securities portfolio and short-term investments are as follows: <TABLE> <CAPTION> Change in September 30, December 31, Unrealized 1996 1995 Gains (Losses) ---------------------------------------- (In millions) <S> <C> <C> <C> Fixed income securities: U.S. Treasury securities and obligations of government agencies . $ 9,948 $13,542 $ (564) Asset-backed securities ............. 6,045 6,086 (218) Tax exempt securities ............... 4,147 3,603 (90) Taxable ............................. 6,898 7,214 (207) -------------------------------- Total fixed income securities .. 27,038 30,445 (1,079) Stocks ................................ 975 918 15 Short-term and other investments....... 6,855 4,482 Derivative security investments ....... 1 41 -------------------------------- Total .......................... $34,869 $35,886 $(1,064) ================================ Short-term investments: Security repurchase collateral ...... $ 603 $ 776 Escrow .............................. 1,066 1,045 Others .............................. 943 291 Commercial paper .................... 3,550 1,613 Other investments ..................... 693 757 --------------------- Total short-term and other investments ................... $ 6,855 $ 4,482 ===================== </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, prepayments, tax and credit considerations, or other similar factors. Accordingly, fixed maturity securities are classified as available for sale. CNA holds a relatively small amount of derivative financial instruments for purposes of enhancing income and total return. The derivative securities are marked-to-market with valuation changes reported as realized investment gains and losses. CNA's investment in, and risk in relation to, derivative securities is not significant. The general account portfolio consists primarily of high quality marketable Page 25 debt securities, approximately 96% of which are rated as investment grade. At September 30, 1996, tax exempt securities and short-term investments excluding collateral for securities sold under repurchase agreements, comprised approximately 12% and 16%, respectively, of the general account's total investment portfolio compared to 10% and 8%, respectively, at December 31, 1995. 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. The current level of short- term investments is anticipated to cover an increased volume of Fibreboard claim payments (see Note 7 of the Notes to Consolidated Condensed Financial Statements) resulting from the final approval of the Trilateral Agreement, as well as settlement of security transactions. At September 30, 1996, the major components of the short-term investment portfolio consist primarily of high grade commercial paper and U.S. Treasury bills. Collateral for securities sold under repurchase agreements decreased $173 million to $603 million at September 30, 1996 from $776 million at December 31, 1995. As of September 30, 1996, the market value of CNA's general account investments in fixed maturities was $27.0 billion and was less than amortized cost by approximately $20 million. This compares to a market value of $30.4 billion and $1,059 million of net unrealized investment gains at December 31, 1995. The gross unrealized investment gains and losses for the fixed maturity securities portfolio at September 30, 1996, were $352 and $372 million, respectively, compared to $1,136 and $77 million, respectively, at December 31, 1995. The change in unrealized investment gains on the fixed maturity portfolio of $1,079 million for the nine months ended September 30, 1996 is attributable, in large part, to increases in interest rates which have an adverse effect on bond prices. Net unrealized investment losses on general account fixed maturities at September 30, 1996 include net unrealized investment losses on high yield securities of $1 million, compared to net unrealized investment gains of $67 million at December 31, 1995. The change in unrealized investment gains on high yield securities is attributable to increases in interest rates which have an adverse effect on bond prices. 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. Fair values of high yield securities in the general account were $1.2 billion at September 30, 1996, compared to $1.9 billion at December 31, 1995. CNA's general account also maintains an equity securities portfolio, the fair value of which was $975 million compared to cost of $778 million reflecting unrealized gains of $197 million at September 30, 1996. The fair value of the equity securities portfolio in the general account was $918 million compared to a cost of $736 million, reflecting unrealized gains of approximately $182 million at December 31, 1995. At September 30, 1996, total Separate Account cash and investments amounted to $5.7 billion with taxable fixed maturity securities representing approximately 83% of the Separate Accounts' portfolio. Approximately 80% of Separate Account investments are used to fund guaranteed investments for which CNA's life insurance affiliate guarantees principal and a specified return to the contract holders. The duration of fixed maturity securities included in the guaranteed investment portfolio are matched approximately with the corresponding payout pattern of the liabilities of the guaranteed investment contracts. The fair value of all fixed maturity securities in the guaranteed investment portfolio was $4.0 billion compared to $4.8 billion at December 31, 1995. At September 30, 1996, amortized cost was greater than fair value by approximately $26 million. This compares to an unrealized gain of $53 million at December 31, 1995. The gross unrealized investment gains and losses for the fixed maturity securities portfolio at September 30, 1996 were $56 and $82 million, respectively. Page 26 Carrying values of high yield securities in the guaranteed investment portfolio were $603 and $944 million, respectively, at September 30, 1996 and December 31, 1995. Net unrealized investment losses on such high yield securities held were $34 million at September 30, 1996, compared to $14 million at December 31, 1995. 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 September 30, 1996, CNA's concentration in high yield bonds, including Separate Accounts, was approximately 3% 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 half of one percent of its total assets. Included in CNA's fixed maturity securities at September 30, 1996 (general and guaranteed investment portfolios) are $8.3 billion of asset-backed securities, consisting of approximately 36% in collateralized mortgage obligations ("CMO's"), 12% in corporate asset-backed obligations, and 42% in U.S. government agency issued pass-through certificates. The majority of CMO's held are U.S. government agency issues, which are actively traded in liquid markets and are priced monthly by broker-dealers. At September 30, 1996, the fair value of asset-backed securities was more than amortized cost by approximately $69 million compared to unrealized investment gains of $200 million at December 31, 1995. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in early planned amortization classes with relatively short principal repayment windows. Over the last few years, much concern has been raised regarding the quality of insurance company invested assets. At September 30, 1996, 56% of the general account's fixed maturity securities portfolio was invested in U.S. government securities, 25% in other AAA rated securities and 11% in AA and A rated securities. CNA's guaranteed investment fixed maturity securities portfolio is comprised of 38% U.S. government securities, 18% in other AAA rated securities and 15% in AA and A rated securities. These ratings are primarily from nationally recognized rating agencies. Other - ----- Investment activities of non-insurance companies include investments in fixed maturities securities, equity securities, derivative instruments and short-term investments. Derivative instruments are marked-to-market with valuation changes reported as realized investment gains or losses in the income statement. The remaining securities are carried at fair value with a net unrealized gain of $51.1 million at December 31, 1995. Effective January 1, 1996, equity securities added to the parent company's investment portfolio are classified as trading securities in order to reflect the Company's investment philosophy. These investments are carried at fair value with the net unrealized gain or loss included in the income statement. The Company invests in certain derivative instruments for income enhancements as part of its portfolio management strategy. These instruments include various swaps, forwards and futures contracts as well as both purchased and written options. These investments subject the Company to market risk for positions where the Company does not hold an offsetting security. The Company controls this risk through monitoring procedures which include daily detailed reports of existing positions and valuation fluctuations. These reports are reviewed by members of senior management to ensure that open positions are consistent with the Page 27 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. In addition, the amounts subject to credit risk are substantially mitigated by collateral requirements in many of these transactions. The Company does not believe that any of the derivative instruments utilized by it are unusually complex or volatile, or expose the Company to a higher degree of risk. See "Results of Operations -- Other". See Note 4 of the Notes to Consolidated Financial Statements in the 1995 Annual Report on Form 10-K, included in Item 8 for additional information with respect to derivative instruments. Results of Operations: - ---------------------- Revenues increased by $256.7 and $2,123.3 million, or 5.2% and 16.1%, and net income increased by $2.2 and $115.5 million, or .6% and 11.3%, respectively, for the quarter and nine months ended September 30, 1996 as compared to the prior year. The following table sets forth the major sources of the Company's consolidated revenues and net income. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------------------------- 1996 1995 1996 1995 ----------------------------------------------------- (In millions) <S> <C> <C> <C> <C> Revenues (a): Property and casualty insurance ....... $3,246.0 $3,104.7 $ 9,693.0 $ 8,069.2 Life insurance ........................ 1,012.5 890.2 2,993.1 2,634.7 Cigarettes ............................ 589.3 539.8 1,654.3 1,524.6 Hotels ................................ 52.7 65.9 148.4 169.3 Drilling .............................. 178.0 92.0 435.8 240.1 Watches and clocks .................... 34.7 27.1 84.2 77.2 Investment income-net (non-insurance companies) ........................... 111.1 237.1 317.5 460.7 Other and eliminations-net ............ (8.0) 2.8 (20.9) 6.3 --------------------------------------------------- $5,216.3 $4,959.6 $15,305.4 $13,182.1 =================================================== Net income (a): Property and casualty insurance ....... $ 172.7 $ 126.3 $ 554.4 $ 400.4 Life insurance ........................ 38.3 29.2 133.2 126.0 Cigarettes ............................ 121.2 96.4 304.8 271.7 Hotels ................................ 3.4 12.0 5.1 16.4 Drilling .............................. 12.9 .2 33.4 (12.7) Watches and clocks .................... 3.8 .9 5.1 2.1 Investment income-net (non-insurance companies) ........................... 71.0 151.1 203.9 296.9 Corporate interest expense ............ (18.2) (15.4) (53.0) (46.2) Unallocated corporate expense and other-net ............................ (16.5) (14.3) (50.8) (34.0) --------------------------------------------------- $ 388.6 $ 386.4 $ 1,136.1 $ 1,020.6 =================================================== Page 28 (a) Includes realized investment gains as follows: <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------------------------- 1996 1995 1996 1995 ----------------------------------------------------- (In millions) <S> <C> <C> <C> <C> Revenues: Property and casualty insurance ....... $ 71.6 $ 80.8 $351.4 $215.5 Life insurance ........................ 32.6 14.6 134.6 119.8 Investment income-net ................. 62.3 199.3 170.5 365.8 --------------------------------------------------- $166.5 $294.7 $656.5 $701.1 =================================================== Net income: Property and casualty insurance ....... $ 44.0 $ 44.3 $195.7 $116.5 Life insurance ........................ 18.6 7.6 66.5 61.4 Investment income-net ................. 40.1 129.2 110.9 237.2 --------------------------------------------------- $102.7 $181.1 $373.1 $415.1 =================================================== </TABLE> Insurance - --------- Property and casualty revenues, excluding realized investment gains, increased by $150.5 and $1,487.9 million, or 5.0% and 18.9%, respectively for the quarter and nine months ended September 30, 1996, as compared to the same periods a year ago. Property and casualty premium revenues increased by $164.9 and $1,204.2 million, or 6.8% and 18.9%, respectively, for the quarter and nine months ended September 30, 1996, from the prior year's comparable period. The increase in earned premium is primarily due to an increase in personal lines premium resulting from cancellation of a quota share agreement under which CIC was ceding premium, and also an increase in mass marketing business. Additionally, earned premium increased with the inclusion of CIC business for the full nine months of 1996, partially offset by a decline in workers' compensation premiums. Net investment income decreased by $15.8 million or 3.4% and increased by $157.5 million, or 12.8%, for the quarter and nine months compared with the same periods in the prior year. Investment income increased for the nine months of 1996 due primarily to the inclusion of the CIC portfolio for the full nine months of 1996, partially offset by a lower asset base resulting from operating cash outflows in 1996 and the repayment of $250 million in long-term debt. The decrease for the quarter in investment income was due primarily to the cash outflows noted above. The bond segment of the investment portfolio yielded 6.6% in the first nine months of 1996 compared with 7.0% for the same period a year ago. Life insurance revenues, excluding realized investment gains, increased by $104.3 and $343.6 million, or 11.9% and 13.7% as compared to the same periods a year ago. Life premium revenues increased by $74.6 and $265.0 million, or 9.7% and 12.0%, for the quarter and nine months ended September 30, 1996 with the primary growth in both group business and individual life business, which markets term, universal life and annuities. Life net investment income increased by $9.8 and $29.1 million, or 11.0% and 10.9%, for the quarter and nine months ended September 30, 1996, compared to the same period a year ago due to a larger asset base generated from increased cash flows from premium growth. The bond segment of the life investment portfolio, which is the primary investment Page 29 segment, yielded 6.7% in the first nine months of 1996 compared with 7.0% for the same period a year ago. Property and casualty underwriting losses for the quarter and nine months ended September 30, 1996 were $249.0 and $783.0 million, compared to $285.1 and $749.1 million for the same period in 1995. Operating results reflect continued favorable loss trends particularly in workers' compensation business, partially offset by increased weather related catastrophe costs. Pre-tax catastrophe losses for the quarter and nine months ended September 30, 1996 were $72.2 and $280.2 million, compared with $37.9 and $115.9 million in 1995. In addition, underwriting expenses reflect expected economies of scale from merging the operations of CIC with CNA. The components of CNA's realized investment gains are as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------------------------- 1996 1995 1996 1995 ----------------------------------------------------- (In millions) <S> <C> <C> <C> <C> Bonds: U.S. Government ....................... $(10.4) $ 1.3 $102.0 $ 99.2 Taxable ............................... 64.2 (12.9) 109.0 (17.6) Asset-backed .......................... 1.8 1.8 23.1 35.7 Tax exempt ............................ 4.0 5.7 13.5 23.6 --------------------------------------------------- Total bonds ........................ 59.6 (4.1) 247.6 140.9 Stocks .................................. 19.0 74.6 148.2 126.3 Derivative instruments .................. (.7) 8.0 11.3 .8 Separate Accounts and other ............. 31.4 19.2 80.0 71.3 --------------------------------------------------- Total realized investment gains .... $109.3 $ 97.7 $487.1 $ 339.3 =================================================== </TABLE> CNA's primary property and casualty subsidiary, Continental Casualty Company ("Casualty"), is party to litigation with Fibreboard Corporation ("Fibreboard") involving coverage for certain asbestos-related claims and defense costs (see Note 7 of the Notes to Consolidated Condensed Financial Statements). On July 27, 1995, the United States District Court for the Eastern District of Texas entered judgment approving the Global Settlement Agreement (see Note 7 of the Notes to Consolidated Condensed Financial Statements for a discussion on the Global Settlement) and the Trilateral Agreement. As expected, appeals were filed as respects both of these decisions. On July 25, 1996, a panel of the United States Fifth Circuit Court of Appeals in New Orleans affirmed the judgment approving the Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment approving the Trilateral Agreement by a 3 to 0 vote. A petition has been filed for re-hearing by the entire Fifth Circuit Court of Appeals as respects the decision on the Global Settlement Agreement. No further appeal has been filed with respect to the Trilateral Agreement and CNA believes that the time to file any such further appeal has expired, and accordingly, CNA believes that court approval of the Trilateral Agreement has become final. The implementation of the Trilateral Agreement has the effect of settling Casualty's litigation with Fibreboard. CNA currently expects that Casualty's litigation with Fibreboard will be dismissed during the first quarter of 1997. Page 30 Cigarettes - ---------- Revenues increased by $49.5 and $129.7 million, or 9.2% and 8.5%, and net income increased by $24.8 and $33.1 million, or 25.7% and 12.2%, respectively, for the quarter and nine months ended September 30, 1996 as compared to the corresponding periods of the prior year. The increase in revenues is primarily composed of an increase of approximately $32.7 and $82.1 million, or 6.1% and 5.4%, due to higher unit sales volume and an increase of approximately $15.5 and $44.4 million, or 2.9% and 2.9%, reflecting higher average unit prices for the quarter and nine months ended September 30, 1996, respectively, as compared to the prior year. Net income increased as a result of the improved revenues, partially offset by higher advertising, sales promotion and legal expenses. Hotels - ------ Revenues decreased by $13.2 and $20.9 million, or 20.0% and 12.3%, and net income decreased by $8.6 and $11.3 million, or 71.7% and 68.9%, for the quarter and nine months ended September 30, 1996, as compared to the prior year. Revenues and net income decreased for the quarter and nine months ended September 30, 1996, as compared to the prior year, due primarily to a pre-tax and after tax gain of $14.5 and $9.5 million, respectively, related to the division's cessation of casino operations at its Monte Carlo hotel in 1995. In addition, the 1995 nine month period included receipt of a $3.9 million payment related to termination of a management contract as well as revenues from casino operations. Exclusive of these 1995 events, revenues and net income for the quarter and nine months ended September 30, 1996 increased due primarily to higher overall average room rates. Drilling - -------- Revenues increased by $86.0 and $195.7 million and net income increased by $12.7 and $46.1 million, respectively, for the quarter and nine months ended September 30, 1996, as compared to the prior year. Revenues from semisubmersible rigs increased by $63.2 and $145.6 million, or 68.7% and 60.6%, for the quarter and nine months ended September 30, 1996, respectively. These increases reflect additional revenues ($32.9 and $57.1) from eight semisubmersible rigs acquired through Arethusa and higher dayrates recognized by semisubmersible rigs located in the North Sea and the Gulf of Mexico. Revenues from jackup rigs increased by $17.4 and $33.3 million, or 18.9% and 13.9%, due to additional rigs acquired through Arethusa and improvements in dayrates in the Gulf of Mexico. Net income for the quarter and nine months ended September 30, 1996 increased due primarily to the higher revenues discussed above and lower interest expense, partially offset by increased provision for minority interest as a result of the dilutive effect of Diamond Offshore's initial public offering in October 1995 and its subsequent acquisition of Arethusa in April 1996. Watches and Clocks - ------------------ Revenues increased by $7.6 and $7.0 million, or 28.0% and 9.1%, and net income increased by $2.9 and $3.0 million, respectively, for the quarter and nine months ended September 30, 1996 as compared to the prior year. Page 31 Revenues increased for the quarter and nine months ended September 30, 1996 due primarily to increased watch unit sales, partially offset by interest income of $4.2 million recorded in the 1995 nine month period related to a prior year tax audit adjustment. Net income increased for the quarter and nine months ended September 30, 1996 due primarily to the increased revenues discussed above, partially offset by a benefit of $1.0 million related to the prior year tax audit adjustment. Other - ----- Revenues decreased by $136.8 and $170.4 million, or 57.0% and 36.5%, and net income decreased by $85.1 and $116.6 million, or 70.1% and 53.8%, respectively, for the quarter and nine months ended September 30, 1996 as compared to the prior year. The components of realized investment gains (losses) included in Investment income-net are as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, 1996 1995 1996 1995 -------------------------------------- (In millions) <S> <C> <C> <C> <C> Revenues: Derivative instruments (1) ............ $ 39.7 $(15.1) $(63.2) $ (20.8) Short-term investments ................ 16.8 (.4) 24.5 38.2 Arethusa acquisition (2) .............. 186.6 Sale of Champion International common stock ................................ 227.5 20.3 372.9 Other ................................. 5.8 (12.7) 2.3 (24.5) ----------------------------------- 62.3 199.3 170.5 365.8 Income tax expense ...................... (21.6) (69.8) (59.4) (128.1) Minority interest ....................... (.6) (.3) (.2) (.5) ----------------------------------- Net income ......................... $ 40.1 $129.2 $110.9 $ 237.2 =================================== </TABLE> (1) Consists primarily of common stock index futures. (2) See Note 6 of the Notes to Consolidated Condensed Financial Statements. Exclusive of securities transactions, revenues increased $.2 and $24.9 million, or .5% and 24.6%, respectively, for the quarter and nine months ended September 30, 1996 due primarily to increased investment income reflecting increased levels of invested assets, partially offset by the absence of intercompany interest income of $8.9 and $26.1 million, and equity income from CBS of $4.0 and $13.0 million. Net income increased by $4.0 and $9.7 million, or 51.3% and 47.3%, respectively, for the quarter and nine months ended September 30, 1996 due to increased revenues, partially offset by higher interest expense. Page 32 Accounting Standards - -------------------- In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." This Statement establishes accounting standards based on consistent application of a financial- components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognized the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. The statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996, and is to be applied prospectively. This Statement will not have a significant impact on the Company. 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 7 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 7 of the Notes to Consolidated Condensed Financial Statements in Part I. In addition, on May 8, 1996, Lorillard received a grand jury subpoena duces tecum from the United States Attorney's Office for the Eastern District of New York. This subpoena relates to an investigation commenced in 1992 by that office regarding possible fraud by Lorillard and other tobacco companies relating to research undertaken or administered by the Council for Tobacco Research - USA, Inc., as reported in Item 1 of the Company's annual report on Form 10-K for the year ended December 31, 1995. It is impossible at this time to predict the ultimate outcome of this investigation. An adverse outcome of this investigation could result in criminal, administrative or other proceedings against Lorillard. Item 6. Exhibits and Reports on Form 8-K. -------------------------------- (a) Exhibits-- (3.01) By-Laws (27) Financial Data Schedule for the nine months ended September 30, 1996. (b) Current reports on Form 8-K--There were no reports on Form 8-K filed for the nine months ended September 30, 1996. Page 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LOEWS CORPORATION ----------------- (Registrant) Dated: November 14, 1996 By /s/ Roy E. Posner ------------------------- ROY E. POSNER Senior Vice President and Chief Financial Officer (Duly authorized officer and principal financial officer) Page 34