Measurement of US Tobacco Liabilities: A Burning Issue or Just Smoke?

1. Measurement of US Tobacco Liabilities:A Burning Issue or Just Smoke? New Classes of Claims / Megatort Update CAS Annual Meeting Philip D. Miller

2. Background - Usage • Usage in America dates back to 1 BC • introduced in Europe during the 17th century • Usage grew despite early concerns about potential health risks • King James: “Smoking is a custom loathsome to the eye, hateful to the nose, harmful to the brain, dangerous to the lungs…” • Economic importance also grew – along with government tax revenues • Following the invention of the cigarette, usage increased rapidly and became more socially acceptable during the 19th century

3. Background - Usage • Fueled by 2 world wars, cigarette consumption grew from 2.5 billion/year in 1900 to 524 billion in 1963, or from 54 to 4,345 per year per capita

4. Tobacco-Related Diseases • 1964 Surgeon General’s report confirmed long term suspicions about cigarette smoking and its impact on health • Associated with a 70% increase in death rates of men • “Causally” related to lung cancer in men • Relationships exist with other diseases and illnesses • 1989 report summarized subsequent findings including • “Causes” lung cancer in women • It is a “cause” of stroke • It is a major “cause” of coronary heart disease • There is a dose-response relationship with # smoked per day, degree of inhalation, and age at initiation • Definition of Cause as used by the Surgeon General • “The notion of a significant, effectual relationship between agent and an associated disease in the host” • Does not exclude other agents as causes • Significant to litigation: no “signature disease”

5. Tobacco-Related Diseases • Association between lung cancer and smoking is one of the strongest: over 90% of men with lung cancer are smokers

6. Tobacco-Related Diseases • Despite statistical association between lung cancer and smoking, it is not easy to prove that an individual’s lung cancer was due solely to smoking • Certain types of cancer (e.g., large cell) are not associated with smoking as strongly as others (e.g., small cell) • Other factors can increase risk including • family history • other lung diseases • occupational exposure • air pollution • diet • Difficulty of making the case increases for other diseases due to • Lower degree of association • More potential intervening factors, e.g., lack of exercise

7. Litigation History - Issues • Key manufacturer defenses • Preemption under the Federal Cigarette Labeling and Advertising Act • Assumption of risks • Lack of proximate cause • Lack of defect • Statute of limitations • Manufacturers have generally mounted strong defenses, refusing to pay any settlements and pursued all possible appeals • Motions and court rulings litigated until satisfactory result or no further recourse • Frequently won the war of attrition • Early pattern established was that even when plaintiff successfully convinced jurors that smoking causes lung cancer, they could not get past the assumption of risk argument

8. Litigation History - Cases • First suit filed in 1954 • Began the first wave • Mostly standard product liability negligence, failure to warn, design defect • < 10 suits per year • As manufacturers win, suits filed trickles • Second wave triggered by 1964 SG report • 17 suits in ‘64, average of 10 per year • Ended by 1972 as manufacturers won all verdicts and key rulings • Third wave triggered in 1983 by adverse rulings in Cipollone case • Eighty five cases at the peak • Appealed • Eventually won by manufacturer • Score - 300 filed cases, no sustained verdicts or paid indemnity

9. Litigation History - Cases • Fourth wave began in 1994 • Plaintiff verdict in Kent filter case • Momentum grew in AG health care recovery suits • First settlements occurred • in the Broin case $349M for research • and with AGs for $246B • More than 1,500 suits were filed in the 1990s with 1,225 still pending as of 12/31/99 • Will the next wave be a tidal wave? • There have been several plaintiff verdicts, but most cases continue to be won by the defendants • No individual smoker case with a plaintiff verdict has been sustained on appeal – yet • AG cases somewhat unique, due to special legislation taking away assumption of risk and weakening causation defenses

10. Litigation History - Cases • Engle case • Florida smoker class action • Phase I concluded in July 1999 that cigarettes • cause 20 diseases • are addictive • manufacturers conduct rose to a level that would permit punitive damages • Phase II concluded in April 2000 with compensatory damages of $6.9M awarded to 2 of the 3 named plaintiffs (the 3rd was barred by statute of limitations) and determined that punitive damages for the entire class should be $144B • Phase III requires individual trials for each class member to determine liability. Punitive damages can’t be determined for any individual until all cases are tried • The manufacturers are appealing • Most other class actions won by manufacturers because of “diversity” • Main takeaway • It ain’t over until it’s over

11. Insurer Involvement • Limited to date • Prior to 1996 no reported lawsuits by manufacturers seeking coverage • 1/96 Imperial Tobacco filed in Quebec against 2 insurers • still pending • 3/97 Louisiana AG attempted to include more than 100 insurers • Only 3 states have direct action statutes • Included foreign insurers • Jurisdiction removed to London and dismissed prior to significant litigation • 3/98 individual smoker case in Louisiana • dismissed in August 1999 • A limited number of public reports of claims filed reported by AM Best • 1999 report by Schroder Securities on BAT stock • Identifies what they consider to be substantial evidence of coverage • Reviewed policies in La. AG suit CGL and explicit tobacco health liability • Claims exclusions are of dubious value, some have no exclusions, poor definitions and ambiguous terms

12. Insurer Involvement • 1999 report by Schroder Securities on BAT stock (continued) • Claims that senior policyholder attorneys are keen to litigate • Says that it is clearly in the best interest of shareholders for manufacturers to sue for coverage • Insurers identified in Schroder report vehemently deny coverage exists • Explicit health liability policies are claims made • allowable reporting period has lapsed without a claim • CGL policies have • explicit tobacco exclusions • numerous other provisions that bar such claims • February 2000 Liggett Group filed suit • Against 33 insurers • Seeking DJ of coverage for defense costs and payments from primary, excess and umbrella, and advertising liability policies 1970 - 1999

13. Insurer Involvement • Potential coverage issues identified by insurers or other observers include • Specific tobacco exclusions • started to include in late 1950s • prevalence of use and strength of wording increased over time • not likely to be in policies of potential secondary defendants such as suppliers, distributors, advertisers, and law firms • Pollution exclusions in ETS cases • introduced in early 1970s, strengthened in 1986 • is smoke discharged into enclosed interior spaces discharged into the atmosphere? Was it sudden and accidental? Is this exclusion applicable to product liability? • Occurrence definition • do the liabilities result from “an accident…which results in bodily injury…that was neither expected nor intended” • what did the manufacturers know and when • covered damages • is health care reimbursement bodily injury or equitable relief

14. Insurer Involvement • Potential coverage issues (continued) • Late notice • was notice provided “as soon as practicable” • if not, was failure to do so prejudicial • Coverage trigger • exposure • manifestation • continuous • Extensive issues must be resolved by the courts, most likely state-by-state • Potential future involvement • Except for Liggett no propensity to file claim notices or initiate DJ actions • May be affected by • shareholder pressure ala Schroder report • Liggett suit outcome • significant plaintiff verdicts sustained on appeal

15. Quantifying the Potential Liability • Categories of potential liability include • Individual smoker injuries • Class actions involving groups of individual smoker injuries • Addiction only suits, individual and class • Secondhand smoke suits, individual and class • Health care reimbursement – federal government, native american governments among other public and private providers • Other tobacco products (e.g., pipes, cigars, and smokeless) • Quantification techniques are described briefly in my paper published in the CAS Forum, Fall 2000. • The paper describes a seven step exposure-based simulation model and includes references to potential data sources for various parameter estimates • FAS 5 & 60 provide the principle accounting rules that govern whether disclosure, reserves or neither is required

16. Quantifying the Potential Liability • Issues of materiality, probability of incurral and reasonable estimability • May differ by component of reserve • DJ, defense,adjusting, indemnity, etc. • Status may change over time • Facts and circumstances of each insurer will govern • Liggett DJ action • Could trigger an accounting obligation for an involved insurer, if material litigation expenses are involved • But, prior to determining that there is a coverage obligation as a result of a DJ action there may not be a reserving obligation for indemnity amounts • Quantification at this time may simply be a useful tool for internal contingency planning purposes