Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

 

x

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

For the Fiscal Year Ended December 31, 2009

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

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

667 Madison Avenue, New York, N.Y. 10065-8087

(Address of principal executive offices) (Zip Code)

(212) 521-2000

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Loews Common Stock, par value $0.01 per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

x

  

Accelerated filer

 

¨

Non-accelerated filer

 

¨

  

Smaller reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of voting and non-voting common equity held by non-affiliates as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $8,943,000,000.

As of February 12, 2010, there were 422,433,635 shares of Loews common stock outstanding.

Documents Incorporated by Reference:

Portions of the Registrant’s definitive proxy statement intended to be filed by Registrant with the Commission prior to April 30, 2010 are incorporated by reference into Part III of this Report.

 

 

 

 

1


Table of Contents

LOEWS CORPORATION

INDEX TO ANNUAL REPORT ON

FORM 10-K FILED WITH THE

SECURITIES AND EXCHANGE COMMISSION

For the Year Ended December 31, 2009

 

Item
No.

  

PART I

   Page
No.

1

  

Business

   3
  

CNA Financial Corporation

   3
  

Diamond Offshore Drilling, Inc.

   8
  

HighMount Exploration & Production LLC

   11
  

Boardwalk Pipeline Partners, LP

   16
  

Loews Hotels Holding Corporation

   19
  

Available Information

   21

1A

  

Risk Factors

   21

1B

  

Unresolved Staff Comments

   49

2

  

Properties

   49

3

  

Legal Proceedings

   49

4

  

Submission of Matters to a Vote of Security Holders

   50
  

Executive Officers of the Registrant

   50
PART II

5

  

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities

   50
  

Management’s Report on Internal Control Over Financial Reporting

   53
  

Reports of Independent Registered Public Accounting Firm

   54

6

  

Selected Financial Data

   56

7

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   57

7A

  

Quantitative and Qualitative Disclosures about Market Risk

   106

8

  

Financial Statements and Supplementary Data

   111

9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   197

9A

  

Controls and Procedures

   197

9B

  

Other Information

   197
PART III
  

Certain information called for by Part III (Items 10, 11, 12, 13 and 14) has been omitted as Registrant intends to file with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year a definitive Proxy Statement pursuant to Regulation 14A.

  
PART IV

15

  

Exhibits and Financial Statement Schedules

   198

 

2


Table of Contents

PART I

Unless the context otherwise requires, references in this Report to “Loews Corporation,” “we,” “our,” “us” or like terms refer to the business of Loews Corporation excluding its subsidiaries.

Item 1. Business.

We are a holding company. Our subsidiaries are engaged in the following lines of business:

 

   

commercial property and casualty insurance (CNA Financial Corporation, a 90% owned subsidiary);

 

   

operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 50.4% owned subsidiary);

 

   

exploration, production and marketing of natural gas and natural gas liquids (HighMount Exploration & Production LLC, a wholly owned subsidiary);

 

   

operation of interstate natural gas transmission pipeline systems (Boardwalk Pipeline Partners, LP, a 67% owned subsidiary); and

 

   

operation of hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary).

Please read information relating to our major business segments from which we derive revenue and income contained in Note 22 of the Notes to Consolidated Financial Statements, included under Item 8.

CNA FINANCIAL CORPORATION

CNA Financial Corporation (together with its subsidiaries, “CNA”) was incorporated in 1967 and is an insurance holding company. CNA’s property and casualty insurance operations are conducted by Continental Casualty Company (“CCC”), incorporated in 1897, and The Continental Insurance Company (“CIC”), organized in 1853, and its affiliates. CIC became a subsidiary of CNA in 1995 as a result of the acquisition of The Continental Corporation (“Continental”). CNA accounted for 60.0%, 58.9% and 69.1% of our consolidated total revenue for the years ended December 31, 2009, 2008 and 2007.

CNA’s core businesses serves a wide variety of customers, including small, medium and large businesses, associations, professionals and groups with a broad range of insurance and risk management products and services.

CNA’s insurance products primarily include commercial property and casualty coverages. CNA’s services include risk management, information services, warranty and claims administration. CNA’s products and services are marketed through independent agents, brokers and managing general agents.

CNA’s core business, commercial property and casualty insurance operations, is reported in two business segments: CNA Specialty and CNA Commercial. CNA’s non-core operations are managed in two business segments: Life & Group Non-Core and Other Insurance. Each segment is managed separately due to differences in their product lines and markets.

CNA’s property and casualty field structure consists of 41 branch locations across the country organized into 6 zones. The centralized processing operation for small and middle-market customers, located in Maitland, Florida, handles policy processing, billing and collection activities, and also acts as a call center to optimize customer service. The claims structure consists of a centralized claim center designed to efficiently handle the high volume of low severity claims including property damage, liability, and workers’ compensation medical only claims, and 14 principal claim office locations around the country handling the more complex claims.

CNA Specialty

CNA Specialty provides professional liability and other coverages through property and casualty products and services, both domestically and abroad, through a network of brokers, managing general underwriters and independent

 

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Table of Contents

Item 1. Business

CNA Financial Corporation – (Continued)

agencies. CNA Specialty provides solutions for managing the risks of its clients, including architects, lawyers, accountants, healthcare professionals, financial intermediaries and public and private companies. Product offerings also include surety and fidelity bonds and vehicle warranty services.

CNA Specialty includes the following business groups:

Professional & Management Liability:  Professional & Management liability provides management and professional liability insurance and risk management services and other specialized property and casualty coverages, primarily in the United States. This group provides professional liability coverages to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. Professional & Management Liability also provides Directors and Officers (“D&O”), employment practices, fiduciary and fidelity coverages. Specific areas of focus include small and mid-size firms as well as privately held firms and not-for-profit organizations, where tailored products for this client segment are offered. Products within Professional & Management Liability are distributed through brokers, agents and managing general underwriters.

Professional & Management Liability, through CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products include professional liability and associated standard property and casualty coverages, and are distributed on a national basis through brokers, agents and managing general underwriters. Key customer segments include long term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size and large healthcare facilities.

International:  International provides similar management and professional liability insurance and other specialized property and casualty coverages in Canada and Europe.

Surety:  Surety consists primarily of CNA Surety Corporation (“CNA Surety”) and its insurance subsidiaries and offers small, medium and large contract and commercial surety bonds. CNA Surety provides surety and fidelity bonds in all 50 states through a combined network of independent agencies. CNA owns approximately 62% of CNA Surety.

Warranty and Alternative Risks:  Warranty and Alternative Risks provides extended service contracts and related products that protect individuals from the financial burden associated with mechanical breakdown and other related losses, primarily for vehicles and portable electronic communication devices. These products are distributed through and administered by CNA’s wholly owned subsidiary, CNA National Warranty Corporation, or through a third party administrator.

CNA Commercial

CNA Commercial works with an independent agency distribution system and a network of brokers to market a broad range of property and casualty insurance products and services to small, middle-market and large businesses and organizations. Property products include standard and excess property coverages, as well as marine coverage, and boiler and machinery. Casualty products include standard casualty insurance products such as workers’ compensation, general and product liability, commercial auto and umbrella coverages. Most insurance programs are provided on a guaranteed cost basis; however, CNA also offers specialized loss-sensitive insurance programs to those customers viewed as higher risk and less predictable in exposure.

These property and casualty products are offered as part of CNA’s Commercial, Business and International insurance groups. CNA’s Business insurance group serves its smaller commercial accounts and the Commercial insurance group serves CNA’s middle markets and its larger risks. In addition, CNA Commercial provides total risk management services relating to claim and information services to the large commercial insurance marketplace, through a wholly owned subsidiary, CNA ClaimPlus, Inc., a third party administrator. The International insurance group primarily consists of the commercial product lines of CNA’s operations in Europe, Canada, Latin America and Hawaii.

Also included in CNA Commercial is CNA Select Risk (“Select Risk”), which includes CNA’s excess and surplus lines coverages. Select Risk provides specialized insurance for selected commercial risks on both an individual customer and program basis. Customers insured by Select Risk are generally viewed as higher risk and less predictable in exposure than those covered by standard insurance markets. Select Risk’s products are distributed throughout the United States through specialist producers, program agents and brokers.

 

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Table of Contents

Item 1. Business

CNA Financial Corporation – (Continued)

Life & Group Non-Core

The Life & Group Non-Core segment primarily includes the results of the life and group lines of business that are in run-off. CNA continues to service its existing individual long term care commitments, its payout annuity business and its pension deposit business. CNA also retains a block of group reinsurance and life settlement contracts. These businesses are being managed as a run-off operation. CNA’s group long term care business, while considered non-core, continues to be actively marketed. During 2008, CNA exited the indexed group annuity portion of its pension deposit business.

Other Insurance

Other Insurance includes certain CNA corporate expenses, including interest on CNA corporate debt, and the results of certain property and casualty business primarily in run-off, including CNA Re. This segment also includes the results related to the centralized adjusting and settlement of asbestos and environmental pollution (“A&E”) claims.

Please read Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations by Business Segment – CNA Financial” for information with respect to each segment.

The following table displays the distribution of CNA’s direct written premiums by geographic concentration.

 

Year Ended December 31    2009     2008     2007      
 

California

   9.1   9.2   9.5  

New York

   6.8      6.9      7.0     

Texas

   6.6      6.2      6.1     

Florida

   6.2      6.5      7.5     

Illinois

   3.8      3.8      3.8     

New Jersey

   3.7      3.8      3.7     

Missouri

   3.6      3.1      2.9     

Pennsylvania

   3.2      3.3      3.4     

All other states, countries or political subdivisions (a)

   57.0      57.2      56.1     
 
   100.0   100.0   100.0  
 

 

(a)

No other individual state, country or political subdivision accounts for more than 3.0% of direct written premiums.

Approximately 7.0%, 7.4% and 6.9% of CNA’s direct written premiums were derived from outside of the United States for the years ended December 31, 2009, 2008 and 2007. Premiums from any individual foreign country were not significant.

Property and Casualty Claim and Claim Adjustment Expenses

The following loss reserve development table illustrates the change over time of reserves established for property and casualty claim and claim adjustment expenses at the end of the preceding ten calendar years for CNA’s property and casualty insurance companies. The table excludes CNA’s life subsidiaries, and as such, the carried reserves will not agree to the Consolidated Financial Statements included under Item 8. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to the originally reported reserve liability. The third section, reading down, shows re-estimates of the originally recorded reserves as of the end of each successive year, which is the result of CNA’s property and casualty insurance subsidiaries’ expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest re-estimated reserves to the reserves originally established, and indicates whether the original reserves were adequate or inadequate to cover the estimated costs of unsettled claims.

 

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Table of Contents

Item 1. Business

CNA Financial Corporation – (Continued)

The loss reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. The development amounts in the table below include the impact of commutations, but exclude the impact of the provision for uncollectible reinsurance.

 

      Schedule of Loss Reserve Development
Year Ended December 31    1999(a)     2000     2001(b)     2002(c)     2003     2004     2005     2006     2007     2008     2009
(In millions of dollars)                                                                 

Originally reported gross reserves for unpaid claim and claim adjustment expenses

     26,850        26,510        29,649        25,719        31,284        31,204        30,694        29,459        28,415        27,475      26,712

Originally reported ceded recoverable

     6,091        7,333        11,703        10,490        13,847        13,682        10,438        8,078        6,945        6,213      5,524
 

Originally reported net reserves for unpaid claim and claim adjustment expenses

     20,759        19,177        17,946        15,229        17,437        17,522        20,256        21,381        21,470        21,262      21,188
 

Cumulative net paid as of:

                      

One year later

     6,547        7,686        5,981        5,373        4,382        2,651        3,442        4,436        4,308        3,930      -

Two years later

     11,937        11,992        10,355        8,768        6,104        4,963        7,022        7,676        7,127        -      -

Three years later

     15,256        15,291        12,954        9,747        7,780        7,825        9,620        9,822        -        -      -

Four years later

     18,151        17,333        13,244        10,870        10,085        9,914        11,289        -        -        -      -

Five years later

     19,686        17,775        13,922        12,814        11,834        11,261        -        -        -        -      -

Six years later

     20,206        18,970        15,493        14,320        12,988        -        -        -        -        -      -

Seven years later

     21,231        20,297        16,769        15,291        -        -        -        -        -        -      -

Eight years later

     22,373        21,382        17,668        -        -        -        -        -        -        -      -

Nine years later

     23,276        22,187        -        -        -        -        -        -        -        -      -

Ten years later

     23,992        -        -        -        -        -        -        -        -        -      -

Net reserves re-estimated as of:

                      

End of initial year

     20,759        19,177        17,946        15,229        17,437        17,522        20,256        21,381        21,470        21,262      21,188

One year later

     21,163        21,502        17,980        17,650        17,671        18,513        20,588        21,601        21,463        21,021      -

Two years later

     23,217        21,555        20,533        18,248        19,120        19,044        20,975        21,706        21,259        -      -

Three years later

     23,081        24,058        21,109        19,814        19,760        19,631        21,408        21,609        -        -      -

Four years later

     25,590        24,587        22,547        20,384        20,425        20,212        21,432        -        -        -      -

Five years later

     26,000        25,594        22,983        21,076        21,060        20,301        -        -        -        -      -

Six years later

     26,625        26,023        23,603        21,769        21,217        -        -        -        -        -      -

Seven years later

     27,009        26,585        24,267        21,974        -        -        -        -        -        -      -

Eight years later

     27,541        27,207        24,548        -        -        -        -        -        -        -      -

Nine years later

     28,035        27,510        -        -        -        -        -        -        -        -      -

Ten years later

     28,352        -        -        -        -        -        -        -        -        -      -
 

Total net (deficiency) redundancy

     (7,593     (8,333     (6,602     (6,745     (3,780     (2,779     (1,176     (228     211        241      -
 

Reconciliation to gross re-estimated reserves:

                      

Net reserves re-estimated

     28,352        27,510        24,548        21,974        21,217        20,301        21,432        21,609        21,259        21,021      -

Re-estimated ceded recoverable

     10,511        11,277        16,756        16,107        14,468        13,349        10,727        8,444        7,113        6,101      -
 

Total gross re-estimated reserves

     38,863        38,787        41,304        38,081        35,685        33,650        32,159        30,053        28,372        27,122      -
 

Total gross (deficiency) redundancy

   $ (12,013   $ (12,277   $ (11,655   $ (12,362   $ (4,401   $ (2,446   $ (1,465   $ (594   $ 43      $ 353      -
 

Net (deficiency) redundancy related to:

                      

Asbestos claims

     (1,655     (1,590     (818     (827     (177     (123     (113     (112     (107     (79   -

Environmental claims

     (691     (635     (288     (282     (209     (209     (159     (159     (159     (76   -
 

Total asbestos and environmental

     (2,346     (2,225     (1,106     (1,109     (386     (332     (272     (271     (266     (155   -

Other claims

     (5,247     (6,108     (5,496     (5,636     (3,394     (2,447     (904     43       477       396     -
 

Total net (deficiency) redundancy

     (7,593     (8,333     (6,602     (6,745     (3,780     (2,779     (1,176     (228     211       241     -
 

 

(a)

Ceded recoverable includes reserves transferred under retroactive reinsurance agreements of $784 as of December 31, 1999.

(b)

Effective January 1, 2001, CNA established a new life insurance company, CNA Group Life Assurance Company (“CNAGLA”). Further, on January 1, 2001 $1,055 of reserves were transferred from CCC to CNAGLA.

(c)

Effective October 31, 2002, CNA sold CNA Reinsurance Company Limited. As a result of the sale, net reserves were reduced by $1,316.

 

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Table of Contents

Item 1. Business

CNA Financial Corporation – (Continued)

Please read information relating to CNA’s property and casualty claim and claim adjustment expense reserves and reserve development set forth under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), and in Notes 1 and 9 of the Notes to Consolidated Financial Statements, included under Item 8.

Investments

Please read Item 7, MD&A – Investments and Notes 1, 3, 4 and 5 of the Notes to Consolidated Financial Statements, included under Item 8.

Other

Competition:  The property and casualty insurance industry is highly competitive both as to rate and service. CNA competes with stock and mutual insurance companies, reinsurance companies and other entities for both producers and customers. CNA must continuously allocate resources to refine and improve its insurance products and services.

Rates among insurers vary according to the types of insurers and methods of operation. CNA competes for business not only on the basis of rate, but also on the basis of availability of coverage desired by customers, ratings and quality of service, including claim adjustment services.

There are approximately 2,400 individual companies that sell property and casualty insurance in the United States. Based on 2008 statutory net written premiums, CNA is the seventh largest commercial insurance writer and the thirteenth largest property and casualty insurance organization in the United States.

Regulation:  The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative powers relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, prescribing the form and content of statutory financial reports, and regulating capital adequacy and the type, quality and amount of investments permitted. Such regulatory powers also extend to premium rate regulations, which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries, intercompany transfers of assets may be subject to prior notice or approval by the state insurance regulators, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer or payment.

Insurers are also required by the states to provide coverage to insureds who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. CNA’s share of these involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state.

Further, insurance companies are subject to state guaranty fund and other insurance-related assessments. Guaranty fund assessments are levied by the state departments of insurance to cover claims of insolvent insurers. Other insurance-related assessments are generally levied by state agencies to fund various organizations including disaster relief funds, rating bureaus, insurance departments, and workers’ compensation second injury funds, or by industry organizations that assist in the statistical analysis and ratemaking process.

Reform of the U.S. tort liability system is another issue facing the insurance industry. Over the last decade, many states have passed some type of tort reform. Even though there has been some tort reform success, new causes of action and theories of damages continue to be proposed in state court actions or by federal or state legislatures that continue to expand liability for insurers and their policyholders. For example, some state legislatures are considering legislation addressing direct actions against insurers related to bad faith claims. As a result of this unpredictability in the law, insurance underwriting and rating are expected to continue to be difficult in commercial lines, professional liability and some specialty coverages.

        Although the federal government and its regulatory agencies do not directly regulate the business of insurance, federal legislative and regulatory initiatives can impact the insurance industry in a variety of ways. These initiatives and legislation include tort reform proposals; proposals addressing natural catastrophe exposures; terrorism risk mechanisms; federal financial services reform; federal regulation of insurance; various tax proposals affecting insurance companies;

 

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Table of Contents

Item 1. Business

CNA Financial Corporation – (Continued)

and possible regulatory limitations, impositions and restrictions arising from the Emergency Economic Stabilization Act of 2008.

Properties:  The 333 S. Wabash Avenue building, located in Chicago, Illinois and owned by CCC, a wholly owned subsidiary of CNA, serves as the home office for CNA and its insurance subsidiaries. CNA owns or leases office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to the principal office buildings owned or leased by CNA:

 

Location   

Size

(square feet)

  Principal Usage

333 S. Wabash Avenue
Chicago, Illinois

   803,728  

Principal executive offices of CNA

401 Penn Street
Reading, Pennsylvania

   171,318  

Property and casualty insurance offices

2405 Lucien Way
Maitland, Florida

   121,959  

Property and casualty insurance offices

40 Wall Street
New York, New York

   107,927  

Property and casualty insurance offices

1100 Ward Avenue
Honolulu, Hawaii

   104,478  

Property and casualty insurance offices

101 S. Phillips Avenue
Sioux Falls, South Dakota

   83,616  

Property and casualty insurance offices

600 N. Pearl Street
Dallas, Texas

   70,790  

Property and casualty insurance offices

675 Placentia Avenue
Brea, California

   63,538  

Property and casualty insurance offices

1249 S. River Road
Cranbury, New Jersey

   56,100  

Property and casualty insurance offices

4267 Meridian Parkway
Aurora, Illinois

   46,903  

Data center

CNA leases its office space described above except for the Chicago, Illinois building, the Reading, Pennsylvania building, and the Aurora, Illinois building, which are owned.

DIAMOND OFFSHORE DRILLING, INC.

Diamond Offshore Drilling, Inc. (“Diamond Offshore”), is engaged, through its subsidiaries, in the business of owning and operating drilling rigs that are used in the drilling of offshore oil and gas wells on a contract basis for companies engaged in exploration and production of hydrocarbons. Diamond Offshore owns 47 offshore rigs. Diamond Offshore accounted for 25.9%, 26.3% and 18.3% of our consolidated total revenue for the years ended December 31, 2009, 2008 and 2007.

Diamond Offshore owns and operates 32 semisubmersible rigs, consisting of 13 high specification and 19 intermediate rigs. Semisubmersible rigs consist of an upper working and living deck resting on vertical columns connected to lower hull members. Such rigs operate in a “semi-submerged” position, remaining afloat, off bottom, in a position in which the lower hull is approximately 55 feet to 90 feet below the water line and the upper deck protrudes well above the surface. Semisubmersible rigs are typically anchored in position and remain stable for drilling in the semi-submerged floating position due in part to their wave transparency characteristics at the water line. Semisubmersible rigs can also be held in position through the use of a computer controlled thruster (“dynamic-positioning”) system to maintain the rig’s position over a drillsite. Five semisubmersible rigs in Diamond Offshore’s fleet have this capability.

        Diamond Offshore’s high specification semisubmersible rigs are generally capable of working in water depths of 4,000 feet or greater or in harsh environments and have other advanced features, as compared to intermediate semisubmersible rigs. As of January 25, 2010, seven of the 13 high specification semisubmersible rigs, including the recently acquired Ocean Courage, were located in the U.S. Gulf of Mexico (“GOM”). At that date Diamond Offshore had two high specification semisubmersible rigs operating offshore Brazil, while a third was en route to Brazil from the GOM. Of

 

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Diamond Offshore’s remaining high specification semisubmersible rigs, one was located offshore each of Malaysia and Angola, while the final rig, the Ocean Valor, was completing its commissioning in Singapore.

Diamond Offshore’s intermediate semisubmersible rigs generally work in maximum water depths up to 4,000 feet. As of January 25, 2010, Diamond Offshore had 19 intermediate semisubmersible rigs in various locations around the world. Seven of these semisubmersible rigs were operating offshore Brazil and an eighth unit was en route to Brazil; three were located in the North Sea; two each were located offshore Australia and offshore Mexico; one was located in the GOM and one offshore Vietnam. One unit was en route to the Falkland Islands, and the final intermediate semisubmersible rig, the Ocean Bounty, was in the process of being cold stacked in Malaysia.

Diamond Offshore has one high specification drillship, the Ocean Clipper, which was located offshore Brazil as of January 25, 2010. Drillships, which are typically self-propelled, are positioned over a drillsite through the use of either an anchoring system or a dynamic-positioning system similar to those used on certain semisubmersible rigs. Deepwater drillships compete in many of the same markets as do high specification semisubmersible rigs.

Diamond Offshore has 14 jack-up drilling rigs. Jack-up rigs are mobile, self-elevating drilling platforms equipped with legs that are lowered to the ocean floor until a foundation is established to support the drilling platform. The rig hull includes the drilling rig, jacking system, crew quarters, loading and unloading facilities, storage areas for bulk and liquid materials, heliport and other related equipment. Diamond Offshore’s jack-up rigs are used for drilling in water depths from 20 feet to 350 feet. The water depth limit of a particular rig is principally determined by the length of the rig’s legs. A jack-up rig is towed to the drillsite with its hull riding in the sea, as a vessel, with its legs retracted. Once over a drillsite, the legs are lowered until they rest on the seabed and jacking continues with the legs penetrating the seabed until resistance is sufficient to elevate the hull above the surface of the water. After completion of drilling operations, the hull is lowered until it rests in the water and then the legs are retracted for relocation to another drillsite.

As of January 25, 2010, six of Diamond Offshore’s 14 jack-up rigs were located in the GOM and a seventh rig, the Ocean Scepter, was en route from Uruguay for a six-well drilling program in the GOM. Four of those rigs are independent-leg cantilevered units, two are mat-supported cantilevered units, and one is a mat-supported slot unit. Diamond Offshore cold-stacked the three mat-supported jack-up rigs located in the GOM during the second quarter of 2009 and is no longer actively marketing these drilling units. Of Diamond Offshore’s seven remaining jack-up rigs, all of which are independent-leg cantilevered units, two each were located offshore Egypt and Mexico, and one was located offshore each of Indonesia, Croatia and the Joint Petroleum Development Area between Australia and Timor Leste.

Diamond Offshore’s long-term strategy has been to economically upgrade its fleet to meet customer demand for advanced, efficient, high-tech rigs, particularly deepwater semisubmersible rigs, in order to maximize the utilization of, and dayrates earned by, the rigs in its fleet. In addition, excluding Diamond Offshore’s two new deepwater floaters acquired in 2009, it has, since 1995, increased the number of its rigs capable of operating in 3,500 feet or more of water from three rigs to 14 (11 of which are high specification units), primarily by upgrading its existing fleet. Seven of these upgrades were to Diamond Offshore’s Victory-class semisubmersible rigs, the design of which is well-suited for significant upgrade projects. Diamond Offshore has two additional Victory-class intermediate semisubmersible rigs that could potentially be upgraded at some time in the future. During 2009, Diamond Offshore acquired two newbuild deepwater, semisubmersible, dynamically positioned drilling rigs, the Ocean Courage (June 2009) and the Ocean Valor (September 2009). The Ocean Courage is completing its commissioning and preparing for its first contract in the GOM, which is expected to begin in the first quarter of 2010. Commissioning of the Ocean Valor is expected to be completed in Singapore in the first quarter of 2010.

 

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Markets:  The principal markets for Diamond Offshore’s contract drilling services are the following:

 

   

the Gulf of Mexico, including the U.S. and Mexico;

 

   

South America, principally in Brazil;

 

   

Europe, principally in the United Kingdom, or U.K., and Norway;

 

   

the Mediterranean Basin, including Egypt;

 

   

Africa, currently in Angola;

 

   

Australia and Asia, including Malaysia, Indonesia and Vietnam; and

 

   

the Middle East, including Kuwait, Qatar and Saudi Arabia.

Diamond Offshore actively markets its rigs worldwide. From time to time Diamond Offshore’s fleet operates in various other markets throughout the world as the market demands.

Diamond Offshore believes its presence in multiple markets is valuable in many respects. For example, Diamond Offshore believes that its experience with safety and other regulatory matters in the U.K. has been beneficial in Australia and other international areas in which Diamond Offshore operates, while production experience it has gained through Brazilian and North Sea operations has potential application worldwide. Additionally, Diamond Offshore believes its performance for a customer in one market segment or area enables it to better understand that customer’s needs and better serve that customer in different market segments or other geographic locations.

Diamond Offshore’s contracts to provide offshore drilling services vary in their terms and provisions. Diamond Offshore typically obtains its contracts through competitive bidding, although it is not unusual for Diamond Offshore to be awarded drilling contracts without competitive bidding. Drilling contracts generally provide for a basic drilling rate on a fixed dayrate basis regardless of whether or not such drilling results in a productive well. Drilling contracts may also provide for lower rates during periods when the rig is being moved or when drilling operations are interrupted or restricted by equipment breakdowns, adverse weather conditions or other conditions beyond the control of Diamond Offshore. Under dayrate contracts, Diamond Offshore generally pays operating expenses of the rig, including wages and the cost of incidental supplies. Historically, dayrate contracts have accounted for the majority of Diamond Offshore’s revenues. In addition, from time to time, Diamond Offshore’s dayrate contracts may also provide for the ability to earn an incentive bonus from its customer based upon performance.

A dayrate drilling contract generally extends over a period of time covering either the drilling of a single well or a group of wells, which Diamond Offshore refers to as a well-to-well contract, or a fixed term, which Diamond Offshore refers to as a term contract, and may be terminated by the customer in the event the drilling unit is destroyed or lost or if drilling operations are suspended for an extended period of time as a result of a breakdown of equipment or, in some cases, due to other events beyond the control of either party to the contract. In addition, certain of Diamond Offshore’s contracts permit the customer to terminate the contract early by giving notice, and in most circumstances may require the payment of an early termination fee by the customer. The contract term in many instances may also be extended by the customer exercising options for the drilling of additional wells or for an additional length of time, generally at competitive market rates and mutually agreeable terms at the time of the extension.

Customers:  Diamond Offshore provides offshore drilling services to a customer base that includes major and independent oil and gas companies and government-owned oil companies. During 2009, Diamond Offshore performed services for 47 different customers and for 49 different customers each during 2008 and 2007. During 2009, 2008 and 2007, one of Diamond Offshore’s two customers in Brazil, Petróleo Brasileiro S.A., or Petrobras, (a Brazilian multinational energy company that is majority-owned by the Brazilian government) accounted for 15%, 13% and 9% of Diamond Offshore’s annual total consolidated revenues. No other customer accounted for 10% or more of Diamond Offshore’s annual total consolidated revenues during 2009 and 2008, nor did any single customer account for 10% or more of Diamond Offshore’s annual total consolidated revenues during 2007.

 

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Brazil is the most active floater market in the world today. The greatest concentration of Diamond Offshore’s operating assets outside the United States is offshore Brazil, where 12 rigs in its fleet are either currently working or contracted to work during 2010. Diamond Offshore’s contract backlog attributable to its expected operations offshore Brazil is $1.1 billion, $1.1 billion and $867.0 million for the years 2010, 2011 and 2012, and $1.2 billion in the aggregate for the years 2013 to 2016. Please see MD&A under Item 7 for additional information.

Competition:  The offshore contract drilling industry is highly competitive with numerous industry participants, none of which at the present time has a dominant market share. The drilling industry has experienced consolidation in recent years and may experience additional consolidation, which could create additional large competitors. Some of Diamond Offshore’s competitors may have greater financial or other resources than Diamond Offshore. Diamond Offshore competes with offshore drilling contractors that together have more than 600 mobile rigs available worldwide.

The offshore contract drilling industry is influenced by a number of factors, including global economies and demand for oil and natural gas, current and anticipated prices of oil and natural gas, expenditures by oil and gas companies for exploration and development of oil and natural gas and the availability of drilling rigs.

Drilling contracts are traditionally awarded on a competitive bid basis. Intense price competition is often the primary factor in determining which qualified contractor is awarded a job. Customers may also consider rig availability and location, a drilling contractor’s operational and safety performance record, and condition and suitability of equipment. Diamond Offshore believes it competes favorably with respect to these factors.

Governmental Regulation:  Diamond Offshore’s operations are subject to numerous international, U.S., state and local laws and regulations that relate directly or indirectly to its operations, including regulations controlling the discharge of materials into the environment, requiring removal and clean-up under some circumstances, or otherwise relating to the protection of the environment, and may include laws or regulations pertaining to climate change, carbon emissions or energy use.

Operations Outside the United States:  Diamond Offshore’s operations outside the U.S. accounted for approximately 66%, 59% and 50% of its total consolidated revenues for the years ended December 31, 2009, 2008 and 2007.

Properties: Diamond Offshore owns an eight-story office building containing approximately 182,000-net rentable square feet on approximately 6.2 acres of land located in Houston, Texas, where its corporate headquarters is located, two buildings totaling 39,000 square feet and 20 acres of land in New Iberia, Louisiana, for its offshore drilling warehouse and storage facility, a 13,000-square foot building and five acres of land in Aberdeen, Scotland, for its North Sea operations and two buildings totaling 65,000 square feet and 11 acres of land in Macae, Brazil, for its South American operations. Additionally, Diamond Offshore currently leases various office, warehouse and storage facilities in Louisiana, Australia, Brazil, Indonesia, Norway, the Netherlands, Malaysia, Singapore, Egypt, Angola, Vietnam and Mexico to support its offshore drilling operations.

HIGHMOUNT EXPLORATION & PRODUCTION LLC

HighMount is engaged in the exploration, production and marketing of natural gas, NGLs (predominantly ethane and propane) and, to a small extent, oil, primarily in the Permian Basin in Texas, the Antrim Shale in Michigan and the Black Warrior Basin in Alabama. HighMount holds interests in developed and undeveloped acreage, wellbores and well facilities, which generally take the form of working interests in leases that have varying terms. HighMount’s interests in these properties are, in many cases, held jointly with third parties and may be subject to royalty, overriding royalty, carried, net profits, working and other similar interests and contractual arrangements with other parties as is customary in the oil and gas industry. HighMount also owns or has interests in gathering systems which transport natural gas and NGLs, principally from its producing wells, to processing plants and pipelines owned by third parties. HighMount accounted for 4.4%, 5.8% and 2.1% of our consolidated total revenue for the years ended December 31, 2009, 2008 and 2007.

 

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We use the following terms throughout this discussion of HighMount’s business, with “equivalent” volumes computed with oil and natural gas liquid (“NGL”) quantities converted to Mcf, on an energy equivalent ratio of one barrel to six Mcf:

 

Average price

   -  

Average price during the twelve-month period, prior to the date of the estimate, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements with customers, excluding escalations based upon future conditions

Bbl

   -  

Barrel (of oil or NGLs)

Bcf

   -  

Billion cubic feet (of natural gas)

Bcfe

   -  

Billion cubic feet of natural gas equivalent

Developed acreage

   -  

Acreage assignable to productive wells

Mcf

   -  

Thousand cubic feet (of natural gas)

Mcfe

   -  

Thousand cubic feet of natural gas equivalent

MMBbl

   -  

Million barrels (of oil or NGLs)

MMBtu

   -  

Million British thermal units

MMcf

   -  

Million cubic feet (of natural gas)

MMcfe

   -  

Million cubic feet of natural gas equivalent

Productive wells

   -  

Producing wells and wells mechanically capable of production

Proved reserves

   -  

Quantities of natural gas, NGLs and oil which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be recoverable in the future from known reservoirs under existing economic conditions, operating methods and government regulations

Proved developed reserves

   -  

Proved reserves which can be expected to be recovered through existing wells with existing equipment, infrastructure and operating methods

Proved undeveloped reserves

   -  

Proved reserves which are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required

Tcf

   -  

Trillion cubic feet (of natural gas)

Tcfe

   -  

Trillion cubic feet of natural gas equivalent

Undeveloped acreage

   -  

Leased acres on which wells have not been drilled or completed to a point that would permit the production of economic quantities of oil or gas

In addition, as used in this discussion of HighMount’s business, “gross wells” refers to the total number of wells in which HighMount owns a working interest and “net wells” refers to the sum of each of the gross wells multiplied by the percentage working interest owned by HighMount in such well. “Gross acres” refers to the total number of acres with respect to which HighMount owns or leases an interest and “net acres” is the sum of each unit of gross acres covered by a lease or other arrangement multiplied by HighMount’s percentage mineral interest in such gross acreage.

As of December 31, 2009, HighMount owned 2.0 Tcfe of net proved reserves, of which 80.5% were classified as proved developed reserves. HighMount’s estimated total proved reserves consist of 1.5 Tcf of natural gas, 70.1 MMBbls of NGLs, and 3.7 MMBbls of oil and condensate. HighMount produced approximately 271 MMcfe per day of natural gas, NGLs and oil during 2009. HighMount holds leasehold or drilling rights in 1.0 million net acres, of which 0.6 million is developed acreage and the balance is held for future exploration and development drilling opportunities. HighMount participated in the drilling of 159 wells during 2009, of which 154 (or 96.9%) are productive wells.

Reserves:  HighMount’s reserves disclosed in this Report represent its share of reserves based on its net revenue interest in each property. Estimated reserves as of December 31, 2009 are based upon studies for each of HighMount’s properties prepared by HighMount staff engineers. Calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with Securities and Exchange Commission (“SEC”) guidelines.

HighMount implements various internal controls to assure objectivity of the reserve estimation process. The main internal controls include (a) detailed reviews of reserve-related information at various levels of the organization – Asset Management, Division Management, Corporate Engineering and Executive Management, (b) reserve audit performed by an independent third party reserve auditor, (c) segregation of duties and (d) system reconciliation or automated interface between various systems used in the reserve estimation process.

 

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HighMount employs a team of reservoir engineers that specialize in each of HighMount’s three basins. HighMount’s lead evaluator has over thirty years of oil and gas engineering experience, twelve of those in the reservoir discipline and has a registered professional engineering license from the State of Oklahoma.

Ryder Scott Company, L.P., an independent third party petroleum engineering consulting firm, has audited HighMount’s reserve estimates in accordance with the “Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information” promulgated by the Society of Petroleum Engineers. Ryder Scott’s lead reservoir engineer responsible for the reserve audit has more than thirty years of experience in the field of estimation and evaluation of petroleum reserves and resources. He has the professional qualifications of a Reserve Estimator and a Reserve Auditor set forth in Article III of the “Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information” promulgated by the Society of Petroleum Engineers. He earned a Bachelor of Science degree in Chemical Engineering at the University of Notre Dame in 1975 and a Masters of Business Administration at the University of Texas at Austin in 1998. He is a registered Professional Engineer in the State of Texas. He is also a member of the Society of Petroleum Engineers, the Texas Independent Producers and Royalty Owners Association, and the Houston’s Producers Forum.

The following table sets forth HighMount’s proved reserves at December 31, 2009, based on average 2009 prices of $3.87 per MMBtu for natural gas, $31.73 per Bbl for NGLs and $61.18 per Bbl for oil.

 

      Natural Gas
(MMcf)
  

NGLs

(Bbls)

  

Oil

(Bbls)

  

Natural Gas

Equivalents

(MMcfe)

    

Proved developed

             

Permian Basin

   942,639    55,198,202    2,706,258    1,290,066  

Antrim Shale

   188,327       226,598    189,686  

Black Warrior Basin

   100,164       96,138    100,741  

Proved undeveloped

             

Permian Basin

   242,046    14,905,936    704,698    335,710  

Antrim Shale

   39,422          39,422  

Black Warrior Basin

   8,710          8,710  
 

Total proved

   1,521,308    70,104,138    3,733,692    1,964,335  
 

During 2009, natural gas prices decreased significantly from their 2008 levels due largely to increased onshore natural gas production, plentiful levels of working gas in storage and reduced demand. At the same time, drilling costs remained relatively high during the first and second quarter of 2009. The impact of these developments was a reduction of HighMount’s proved reserves by 181.1 Bcfe, that included a reduction of proved undeveloped reserves of 115.4 Bcfe. During 2009, HighMount converted 20.8 Bcfe from proved undeveloped reserves to proved developed reserves by drilling 63 gross proved undeveloped wells. HighMount spent $27 million to drill and complete these wells. During 2009, HighMount added 8.9 Bcfe to its proved undeveloped reserves as a result of its development drilling.

Estimated net quantities of proved natural gas and oil (including condensate and NGLs) reserves at December 31, 2009, 2008 and 2007 and changes in the reserves during 2009, 2008 and 2007 are shown in Note 15 of the Notes to Consolidated Financial Statements included under Item 8.

HighMount’s properties typically have relatively long reserve lives, high well completion success rates and predictable production profiles. Based on December 31, 2009 proved reserves and HighMount’s average production from these properties during 2009, the average reserve-to-production index of HighMount’s proved reserves is 20 years.

In order to replenish reserves as they are depleted by production, and to increase reserves, HighMount further develops its existing acreage by drilling new wells and, where available, employing new technologies and drilling strategies designed to enhance production from existing wells. HighMount seeks to opportunistically acquire additional acreage in its core areas of operation, as well as other locations where its management has identified an opportunity.

 

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During the years ended December 31, 2009, 2008 and 2007, HighMount engaged in the drilling activity presented in the following table. All wells drilled during 2009, 2008 and 2007 disclosed in the table below were development wells.

 

Year Ended December 31      2009      2008      2007 (a)
        Gross      Net      Gross      Net      Gross      Net     

Productive Wells

                               

Permian Basin

     100      98.5      369      363.5      196      191.5  

Antrim Shale

     35      15.1      59      22.7      5      3.7  

Black Warrior Basin

     19      17.1      61      42.9      35      24.5  
 

Total Productive Wells

     154      130.7      489      429.1      236      219.7  
 

Dry Wells

                               

Permian Basin

     5      5.0      9      9.0      6      6.0  
 

Total Dry Wells

     5      5.0      9      9.0      6      6.0  
 

Total Completed Wells

     159      135.7      498      438.1      242      225.7  
 

Wells in Progress

                               

Permian Basin

     67      66.9      32      31.9      12      12.0  

Antrim Shale

     4      2.8      2      0.2            

Black Warrior Basin

     9      7.2      1      1.0      7      4.9  
 

Total Wells in Progress

     80      76.9      35      33.1      19      16.9  
 

 

(a)

HighMount commenced operations on July 31, 2007.

In addition, in 2009, HighMount drilled one successful exploratory well.

Acreage:  As of December 31, 2009, HighMount owned interests in developed and undeveloped acreage in the locations set forth in the table below:

 

     Developed Acreage   Undeveloped Acreage    Total Acreage
      Gross    Net   Gross   Net    Gross    Net      

Permian Basin

   588,973    450,746   202,258   64,828    791,231    515,574   

Antrim Shale

   246,611    115,345   18,102   6,536    264,713    121,881   

Black Warrior Basin

   112,764    80,331   394,031   254,158    506,795    334,489   
 

Total

      948,348       646,422      614,391      325,522    1,562,739       971,944   
 

Production and Sales:  Please see the Production and Sales statistics table for additional information included under MD&A in Item 7.

HighMount utilizes its own marketing and sales personnel to market the natural gas and NGLs that it produces to large energy companies and intrastate pipelines and gathering companies. Production is typically sold and delivered directly to a pipeline at liquid pooling points or at the tailgates of various processing plants, where it then enters a pipeline system. Permian Basin sales prices are primarily at a Houston Ship Channel Index, Antrim sales are at a MichCon Index and Black Warrior sales are at a Southern Natural Gas Pipeline Index.

To manage the risk of fluctuations in prevailing commodity prices, HighMount enters into commodity and basis swaps and other derivative instruments.

 

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Wells:  As of December 31, 2009, HighMount had an interest in the following natural gas producing wells:

 

      Gross    Net     

Permian Basin

   5,823    5,568  

Antrim Shale

   2,258    1,004  

Black Warrior Basin

   1,437    1,127  
 

Total producing wells

   9,518    7,699  
 

Wells located in the Permian Basin have a typical well depth in the range of 6,000 to 9,000 feet, while wells located in the Antrim Shale and the Black Warrior Basin have typical well depths of 1,200 feet and 2,000 feet.

Competition:  HighMount competes with other oil and gas companies in all aspects of its business, including acquisition of producing properties and leases and obtaining goods, services and labor, including drilling rigs and well completion services. HighMount also competes in the marketing of produced natural gas and NGLs. Some of HighMount’s competitors have substantially larger financial and other resources than HighMount. Factors that affect HighMount’s ability to acquire producing properties include available funds, available information about the property and standards established by HighMount for minimum projected return on investment. Competition for sales of natural gas and NGLs is also presented by alternative fuel sources, including heating oil, imported liquefied natural gas and other fossil fuels.

Governmental Regulation:  All of HighMount’s operations are conducted onshore in the United States. The U.S. oil and gas industry, and HighMount’s operations, are subject to regulation at the federal, state and local level. Such regulation includes requirements with respect to, among other things: permits to drill and to conduct other operations; provision of financial assurances (such as bonds) covering drilling and well operations; the location of wells; the method of drilling and completing wells; the surface use and restoration of properties upon which wells are drilled; the plugging and abandoning of wells; the marketing, transportation and reporting of production; and the valuation and payment of royalties; the size of drilling and spacing units (regarding the density of wells which may be drilled in a particular area); the unitization or pooling of properties; maximum rates of production from wells; venting or flaring of natural gas and the ratability of production.

The Federal Energy Policy Act of 2005 amended the Natural Gas Act (“NGA”) to prohibit natural gas market manipulation by any entity, directed the Federal Energy Regulatory Commission (“FERC”) to facilitate market transparency in the sale or transportation of physical natural gas and significantly increased the penalties for violations of the NGA of 1938, the NGA of 1978, or FERC regulations or orders thereunder. In addition, HighMount owns and operates gas gathering lines and related facilities which are regulated by the U.S. Department of Transportation (“DOT”) and state agencies with respect to safety and operating conditions.

HighMount’s operations are also subject to federal, state and local laws and regulations concerning the discharge of contaminants into the environment, the generation, storage, transportation and disposal of contaminants, and the protection of public health, natural resources, wildlife and the environment. In most instances, the regulatory requirements relate to the handling and disposal of drilling and production waste products, water and air pollution control procedures, and the remediation of petroleum-product contamination. In addition, HighMount’s operations may require it to obtain permits for, among other things, air emissions, discharges into surface waters, and the construction and operation of underground injection wells or surface pits to dispose of produced saltwater and other non-hazardous oilfield wastes. HighMount could be required, without regard to fault or the legality of the original disposal, to remove or remediate previously disposed wastes, to suspend or cease operations in contaminated areas or to perform remedial well plugging operations or cleanups to prevent future contamination.

In September 2009, the United States Environmental Protection Agency (“EPA”) adopted regulations under the Clean Air Act requiring the monitoring and reporting of annual greenhouse gas (“GHG”) emissions by certain large U.S. GHG emitters. Affected companies were required to monitor their GHG emissions starting January 1, 2010 and will be required to report to the EPA beginning in March 2011. Oil and gas exploration and production companies that emit less than 25,000 metric tons of GHG per year from any facility (as defined in the regulations), including HighMount, are not required to monitor or report emissions at this time. However, the EPA has indicated it will issue a proposed rule for

 

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comment as it pertains to Oil and Gas Systems and HighMount anticipates that it will be required to begin data collection in 2011 for subsequent reporting to the EPA.

Properties:  In addition to its interests in oil and gas producing properties, HighMount leases an aggregate of approximately 120,000 square feet of office space in three locations in Houston, Texas, which includes its corporate headquarters, and approximately 102,000 square feet of office space in Oklahoma City, Oklahoma and Traverse City, Michigan which is used in its operations. HighMount also leases other surface rights and office, warehouse and storage facilities necessary to operate its business.

BOARDWALK PIPELINE PARTNERS, LP

Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”) is engaged in the interstate transportation and storage of natural gas. Boardwalk Pipeline accounted for 6.4%, 6.4% and 4.7% of our consolidated total revenue for the years ended December 31, 2009, 2008 and 2007.

As of February 19, 2010, we owned approximately 67% of Boardwalk Pipeline comprised of 104,219,466 common units, 22,866,667 class B units and a 2% general partner interest. A wholly owned subsidiary of ours (“BPHC”) is the general partner and holds all of Boardwalk Pipeline’s incentive distribution rights which entitle the general partner to an increasing percentage of the cash that is distributed by Boardwalk Pipeline in excess of $0.4025 per unit per quarter.

Boardwalk Pipeline owns and operates three interstate natural gas pipelines, with approximately 14,200 miles of interconnected pipelines, directly serving customers in 12 states and indirectly serving customers throughout the northeastern and southeastern United States through numerous interconnections with unaffiliated pipelines. In 2009, its pipeline systems transported approximately 2.1 trillion cubic feet (“Tcf”) of gas. Average daily throughput on Boardwalk Pipeline’s pipeline systems during 2009 was approximately 5.7 billion cubic feet (“Bcf”). Boardwalk Pipeline’s natural gas storage facilities are comprised of 11 underground storage fields located in four states with aggregate working gas capacity of approximately 163.0 Bcf.

Boardwalk Pipeline conducts all of its operations through its three operating subsidiaries:

Gulf Crossing Pipeline Company LLC (“Gulf Crossing”):  The Gulf Crossing pipeline system, located in Texas and Louisiana, operates approximately 360 miles of natural gas pipeline. The pipeline system has a peak-day delivery capacity of 1.4 Bcf per day and average daily throughput for the year ended December 31, 2009 was 0.7 Bcf per day. The designated peak-day transmission capacity is expected to increase to 1.7 Bcf per day from the addition of compression which is expected to be placed into service in the first quarter of 2010.

Gulf South Pipeline Company, L.P. (“Gulf South”):  The Gulf South pipeline system runs approximately 7,700 miles along the Gulf Coast in the states of Texas, Louisiana, Mississippi, Alabama and Florida. Gulf South has two natural gas storage facilities with 83.0 Bcf of working gas storage capacity. The pipeline system has a peak-day delivery capacity of 6.2 Bcf per day and average daily throughput for the year ended December 31, 2009 was 3.1 Bcf per day.

Texas Gas Transmission, LLC (“Texas Gas”):  The Texas Gas pipeline system originates in Louisiana, East Texas and Arkansas and runs for approximately 6,110 miles north and east through Louisiana, Arkansas, Mississippi, Tennessee, Kentucky, Indiana, and into Ohio, with smaller diameter lines extending into Illinois. The pipeline system has a peak-day delivery capacity of 4.3 Bcf per day and average daily throughput for the year ended December 31, 2009 was 2.8 Bcf per day. Texas Gas owns nine natural gas storage fields, of which it owns the majority of the working and base gas, with 80.0 Bcf of working gas storage capacity.

In 2008 and 2009, Boardwalk Pipeline completed its East Texas Pipeline, Southeast Expansion and Gulf Crossing Project (“42-inch pipeline expansion projects”), which collectively consist of approximately 700 miles of 42-inch pipeline and certain related compression facilities. Boardwalk Pipeline also completed and placed in service its Fayetteville and Greenville Laterals, which together consist of approximately 260 miles of 36-inch pipeline and certain related compression facilities. Additional compression was placed into service on the Fayetteville and Greenville Laterals in January of 2010 and Boardwalk Pipeline expects to place into service additional compression on the Gulf Crossing Project in the first quarter of 2010. With the exception of the Greenville Lateral, these projects were designed to operate at higher than normal operating pressures. While completing the requirements to operate Boardwalk Pipeline’s

 

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42-inch expansion project pipelines and the Fayetteville Lateral at higher than normal operating pressures in 2009, Boardwalk Pipeline discovered anomalies in certain pipeline segments on each of the projects, which resulted in reductions of operating pressures on these pipelines below normal operating pressures and the shut down of segments of the pipelines for periods of time to remediate the anomalies, adversely impacting average daily throughput. Please see MD&A under Item 7 for additional information. Boardwalk Pipeline is currently engaged in the Haynesville Project and Clarence Compression Project.

Boardwalk Pipeline serves a broad mix of customers, including marketers, local distribution companies, producers, electric power generators, intrastate and interstate pipelines and direct industrial users located throughout the Gulf Coast, Midwest and Northeast regions of the U.S.

Competition:  Boardwalk Pipeline competes with other pipelines to maintain current business levels and to serve new demand and markets. Boardwalk Pipeline also competes with other pipelines for contracts with producers that would support new growth opportunities. The principal elements of competition among pipelines are available capacity, rates, terms of service, access to supply and flexibility and reliability of service. Competition is particularly strong in the Midwest and Gulf Coast states where Boardwalk Pipeline competes with numerous existing pipelines, including the Rockies Express Pipeline that transports natural gas from northern Colorado to eastern Ohio and the Mid-Continent Express Pipeline that transports natural gas from Oklahoma and Texas to Alabama. Boardwalk Pipeline will also directly compete with several new pipeline projects that are proposed or under development, including projects originating in the Haynesville Shale area – more specifically, the Tiger Pipeline that will transport gas to Perryville, Louisiana and the Haynesville Extension Pipeline that will transport gas to the industrial complex in southeastern Louisiana - and the Fayetteville Express Pipeline which will originate in the Fayetteville Shale area and continue eastward to Mississippi. In addition, regulators’ continuing efforts to increase competition in the natural gas industry have increased the natural gas transportation options of Boardwalk Pipeline’s traditional customers. As a result of the regulators’ policies, segmentation and capacity release have created an active secondary market which increasingly competes with Boardwalk Pipeline’s pipeline services. Additionally, natural gas competes with other forms of energy available to Boardwalk Pipeline’s customers, including electricity, coal and fuel oils.

The natural gas industry has built, or is in the process of completing, significant new pipeline infrastructure that will support the development of unconventional natural gas supply basins across the U.S. Additional pipeline infrastructure projects are being proposed. These new pipeline developments have increased competition in certain pipeline markets, resulting in lower price differentials between physical locations (basis spreads). Basis spreads can impact the rates Boardwalk Pipeline will be able to negotiate with its customers when contracts come up for renewal. Despite these competitive conditions, assuming that customers use all of their reserved capacity, substantially all of the operating capacity on Boardwalk Pipeline’s pipeline systems is contracted for with a weighted-average contract life of approximately 5.9 years, although each year a portion of Boardwalk Pipeline’s capacity becomes subject to re-contracting risk. For example, approximately 14.0% of Boardwalk Pipeline’s contracts are due to expire in 2010.

Seasonality:  Boardwalk Pipeline’s revenues can be affected by weather and natural gas price levels and volatility. Weather impacts natural gas demand for heating needs and power generation, which in turn influences the short-term value of transportation and storage across its pipeline systems. Colder than normal winters can result in an increase in the demand for natural gas for heating needs and warmer than normal summers can impact cooling needs, both of which typically result in increased pipeline transportation revenues and throughput. While traditionally peak demand for natural gas occurred during the winter months driven by heating needs, the increased use of natural gas for cooling needs during the summer months has reduced the seasonality of Boardwalk Pipeline’s revenues over time. During 2009, approximately 55.0% of Boardwalk Pipeline’s revenues were recognized in the first and fourth quarters of the year.

Governmental Regulation:  FERC regulates Boardwalk Pipeline’s operating subsidiaries under the NGA of 1938 and the NGA of 1978. FERC regulates, among other things, the rates and charges for the transportation and storage of natural gas in interstate commerce and the extension, enlargement or abandonment of facilities under its jurisdiction. Where required, Boardwalk Pipeline’s operating subsidiaries hold certificates of public convenience and necessity issued by FERC covering certain of its facilities, activities and services. The maximum rates that may be charged by Boardwalk Pipeline for gas transportation are established through FERC’s cost-of-service rate-making process. The maximum rates that may be charged by Boardwalk Pipeline for storage services on Texas Gas, with the exception of approximately 8.3 Bcf of working gas capacity on that system, are also established through FERC’s cost-of-service rate-making process. Key determinants in FERC’s cost-of-service rate-making process are the costs of providing service, the allowed rate of

 

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return, throughput assumptions, the allocation of costs, the capital structure and the rate design. FERC has authorized Gulf South to charge market-based rates for its firm and interruptible storage. Texas Gas is authorized to charge market-based rates for the firm and ISS services associated with approximately 8.3 Bcf of its storage capacity. Texas Gas is prohibited from placing new rates into effect prior to November 1, 2010, and neither Gulf South nor Texas Gas has an obligation to file a new rate case. Gulf Crossing will have to either file a rate case or justify its initial firm transportation rates by the end of the first quarter of 2012.

Boardwalk Pipeline is also regulated by the DOT under the Natural Gas Pipeline Safety Act of 1968, as amended by Title I of the Pipeline Safety Act of 1979, which regulates safety requirements in the design, construction, operation and maintenance of interstate natural gas pipelines. Boardwalk Pipeline has received authority from the Pipeline and Hazardous Materials Safety Administration (“PHMSA”), an agency of the DOT, to operate its recently completed 42-inch pipeline expansion projects under special permits that will allow it to operate the pipelines at higher than normal operating pressures of up to 0.80 of the pipe’s Specified Minimum Yield Strength (SMYS). Boardwalk Pipeline is seeking authority from PHMSA to operate its Fayetteville Lateral at higher than normal operating pressures. Boardwalk Pipeline will need to operate each of these pipelines at higher than normal operating pressures in order to transport all of the volumes it has contracted for with its customers. PHMSA retains discretion whether to grant or maintain authority for Boardwalk Pipeline to operate these pipelines at higher pressures.

Boardwalk Pipeline’s operations are also subject to extensive federal, state, and local laws and regulations relating to protection of the environment. Such regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and waste and in connection with spills, releases and emissions of various substances into the environment. Environmental regulations also require that Boardwalk Pipeline’s facilities, sites and other properties be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities.

Under the EPA’s regulations adopted in September of 2009, Boardwalk Pipeline was required, beginning in January of 2010, to monitor the GHG emissions from certain of its facilities, particularly compression stations, that emit more than 25,000 metric tons of GHG per year and must report on such emissions to the EPA beginning in March of 2011.

Properties:  Boardwalk Pipeline is headquartered in approximately 103,000 square feet of leased office space located in Houston, Texas. Boardwalk Pipeline also has approximately 108,000 square feet of office space in Owensboro, Kentucky in a building that it owns. Boardwalk Pipeline’s operating subsidiaries own their respective pipeline systems in fee. However, substantial portions of these systems are constructed and maintained on property owned by others pursuant to rights-of-way, easements, permits, licenses or consents.

 

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LOEWS HOTELS HOLDING CORPORATION

The subsidiaries of Loews Hotels Holding Corporation (“Loews Hotels”), our wholly owned subsidiary, presently operate the following 18 hotels. Loews Hotels accounted for 2.0%, 2.9% and 2.7% of our consolidated total revenue for the years ended December 31, 2009, 2008 and 2007.

 

Name and Location    Number of
Rooms
   Owned, Leased or Managed

Loews Annapolis Hotel
Annapolis, Maryland

   220   

Owned

Loews Coronado Bay
San Diego, California

   440   

Land lease expiring 2034

Loews Denver Hotel
Denver, Colorado

   185   

Owned

The Don CeSar, a Loews Hotel
St. Pete Beach, Florida

   347   

Management contract (a)(b)

Hard Rock Hotel,
at Universal Orlando
Orlando, Florida

   650   

Management contract (c)

Loews Lake Las Vegas
Henderson, Nevada

   493   

Management contract (a)

Loews Le Concorde Hotel
Quebec City, Canada

   405   

Land lease expiring 2069

The Madison, a Loews Hotel
Washington, D.C.

   353   

Management contract expiring 2021 (a)

Loews Miami Beach Hotel
Miami Beach, Florida

   790   

Owned

Loews New Orleans Hotel
New Orleans, Louisiana

   285   

Management contract expiring 2018 (a)

Loews Philadelphia Hotel
Philadelphia, Pennsylvania

   585   

Owned

Loews Portofino Bay Hotel,
at Universal Orlando
Orlando, Florida

   750   

Management contract (c)

Loews Regency Hotel
New York, New York

   350   

Land lease expiring 2013, with renewal option for 47 years

Loews Royal Pacific Resort
at Universal Orlando
Orlando, Florida

   1,000   

Management contract (c)

Loews Santa Monica Beach Hotel
Santa Monica, California

   340   

Management contract expiring 2018, with renewal option for

    5 years (a)

Loews Vanderbilt Hotel
Nashville, Tennessee

   340   

Owned

Loews Ventana Canyon
Tucson, Arizona

   400   

Management contract expiring 2019 (a)

Loews Hotel Vogue
Montreal, Canada

   140   

Owned

 

(a) These management contracts are subject to termination rights.
(b) A Loews Hotels subsidiary is a 20% owner of the hotel, which is being operated by Loews Hotels pursuant to a management contract.
(c) A Loews Hotels subsidiary is a 50% owner of these hotels located at the Universal Orlando theme park, through a joint venture with Universal Studios and the Rank Group. The hotels are on land leased by the joint venture and are operated by Loews Hotels pursuant to a management contract.

 

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Loews Hotels Holding Corporation – (Continued)

The hotels owned by Loews Hotels are subject to mortgage indebtedness totaling approximately $224 million at December 31, 2009 with interest rates ranging from 2.5% to 6.3%, and maturing between 2010 and 2028. In addition, certain hotels are held under leases which are subject to formula derived rental increases, with rentals aggregating approximately $6 million for the year ended December 31, 2009.

Competition from other hotels and lodging facilities is vigorous in all areas in which Loews Hotels operates. The demand for hotel rooms in many areas is seasonal and dependent on general and local economic conditions. Loews Hotels properties also compete with facilities offering similar services in locations other than those in which its hotels are located. Competition among luxury hotels is based primarily on location and service. Competition among resort and commercial hotels is based on price as well as location and service. Because of the competitive nature of the industry, hotels must continually make expenditures for updating, refurnishing and repairs and maintenance, in order to prevent competitive obsolescence.

SEPARATION OF LORILLARD

In June of 2008, we disposed of our entire ownership interest in our wholly owned subsidiary, Lorillard, Inc. (“Lorillard”), through the following two integrated transactions, collectively referred to as the “Separation”:

 

   

On June 10, 2008, we distributed 108,478,429 shares, or approximately 62%, of the outstanding common stock of Lorillard in exchange for and in redemption of all of the 108,478,429 outstanding shares of our former Carolina Group stock, in accordance with our Restated Certificate of Incorporation (the “Redemption”); and

 

   

On June 16, 2008, we distributed the remaining 65,445,000 shares, or approximately 38%, of the outstanding common stock of Lorillard in exchange for 93,492,857 shares of Loews common stock, reflecting an exchange ratio of 0.70 (the “Exchange Offer”).

As a result of the Separation, Lorillard is no longer a subsidiary of ours and we no longer own any interest in the outstanding stock of Lorillard. As of the completion of the Redemption, the former Carolina Group and former Carolina Group stock have been eliminated. In addition, at that time all outstanding stock options and stock appreciation rights (“SARs”) awarded under our former Carolina Group 2002 Stock Option Plan were assumed by Lorillard and converted into stock options and SARs which are exercisable for shares of Lorillard common stock.

The Loews common stock acquired by us in the Exchange Offer was recorded as a decrease in our Shareholders’ equity, reflecting Loews common stock at market value of the shares of Loews common stock delivered in the Exchange Offer. This decline was offset by a $4.3 billion gain to us from the Exchange Offer, which was reported as a gain on disposal of the discontinued business.

Our Consolidated Financial Statements have been reclassified to reflect Lorillard as a discontinued operation. Accordingly, the assets and liabilities, revenues and expenses and cash flows have been excluded from the respective captions in the Consolidated Balance Sheets, Consolidated Statements of Income, and Consolidated Statements of Cash Flows and have been included in Assets and Liabilities of discontinued operations, Discontinued operations, net and Net cash flows - discontinued operations.

Prior to the Redemption, we had a two class common stock structure: Loews common stock and former Carolina Group stock. Former Carolina Group stock, commonly called a tracking stock, was intended to reflect the performance of a defined group of Loews’s assets and liabilities referred to as the former Carolina Group. The principal assets and liabilities attributable to the former Carolina Group were our 100% ownership of Lorillard, including all dividends paid by Lorillard to us, and any and all liabilities, costs and expenses arising out of or relating to tobacco or tobacco-related businesses. Immediately prior to the Separation, outstanding former Carolina Group stock represented an approximately 62% economic interest in the performance of the former Carolina Group. The Loews Group consisted of all of Loews’s assets and liabilities other than those allocated to the former Carolina Group, including an approximately 38% economic interest in the former Carolina Group.

 

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EMPLOYEE RELATIONS

Including our operating subsidiaries as described below, we employed approximately 18,500 persons at December 31, 2009. We, and our subsidiaries, have experienced satisfactory labor relations.

CNA employed approximately 8,900 persons.

Diamond Offshore employed approximately 5,500 persons, including international crew personnel furnished through independent labor contractors.

HighMount employed approximately 600 persons.

Boardwalk Pipeline employed approximately 1,110 persons, approximately 115 of whom are included in collective bargaining units.

Loews Hotels employed approximately 2,070 persons, approximately 800 of whom are union members covered under collective bargaining agreements.

AVAILABLE INFORMATION

Our website address is www.loews.com. We make available, free of charge, through the website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after these reports are electronically filed with or furnished to the SEC. Copies of our Code of Business Conduct and Ethics, Corporate Governance Guidelines, Audit Committee charter, Compensation Committee charter and Nominating and Governance Committee charter have also been posted and are available on our website.

Item 1A. RISK FACTORS.

Our business faces many risks. We have described below some of the more significant risks which we and our subsidiaries face. There may be additional risks that we do not yet know of or that we do not currently perceive to be significant that may also impact our business or the business of our subsidiaries.

Each of the risks and uncertainties described below could lead to events or circumstances that have a material adverse effect on our business, results of operations, cash flows, financial condition or equity and/or the business, results of operations, financial condition or equity of one or more of our subsidiaries.

You should carefully consider and evaluate all of the information included in this Report and any subsequent reports we may file with the SEC or make available to the public before investing in any securities issued by us. Our subsidiaries, CNA Financial Corporation, Diamond Offshore Drilling, Inc. and Boardwalk Pipeline Partners, LP, are public companies and file reports with the SEC. You are also cautioned to carefully review and consider the information contained in the reports filed by those subsidiaries before investing in any of their securities.

We are a holding company and derive substantially all of our income and cash flow from our subsidiaries.

We rely upon our invested cash balances and distributions from our subsidiaries to generate the funds necessary to meet our obligations and to declare and pay any dividends to holders of our common stock. Our subsidiaries are separate and independent legal entities and have no obligation, contingent or otherwise, to make funds available to us, whether in the form of loans, dividends or otherwise. The ability of our subsidiaries to pay dividends to us is also subject to, among other things, the availability of sufficient earnings and funds in such subsidiaries, applicable state laws, including in the case of the insurance subsidiaries of CNA, laws and rules governing the payment of dividends by regulated insurance companies, and their compliance with covenants in their respective loan agreements. Claims of creditors of our subsidiaries will generally have priority as to the assets of such subsidiaries over our claims and our creditors and shareholders.

 

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Deterioration in the public debt and equity markets could lead to investment losses and lower cash balances at the parent company, which could impair our ability to fund acquisitions, share buybacks, dividends or other investments or to fund capital needed by our subsidiaries.

The U.S. and global capital and credit markets experienced severe volatility, illiquidity, uncertainty and disruption in recent years, including among other things, large bankruptcies, government intervention in a number of large financial institutions, growing levels of defaults on indebtedness, recessionary economic conditions and widening of credit spreads. These conditions resulted in significant realized and unrealized losses and substantially reduced investment income, including a significant decline in income from limited partnership investments, at CNA and the parent company during 2008. Should these or similar conditions recur, we could experience additional losses and further reduced investment income, which would among other things reduce the cash balances available at the parent company. Please see MD&A under Item 7 of this Report for additional information on our Investments.

Certain of our operating subsidiaries require substantial amounts of capital or other financial support from time to time to fund expansions, enhance capital, refinance indebtedness, satisfy rating agency or regulatory requirements or for other reasons. Sufficient capital to satisfy these needs may not be available to our subsidiaries when needed on acceptable terms from the credit or capital markets or other third parties. In such cases, we have in the past, and may in the future, provide substantial amounts of debt or equity capital to our subsidiaries, which may not be on market terms. Any such investments further reduce the amount of cash available at the parent company which might otherwise be used to fund acquisitions, share buybacks, dividends or other investments or to fund other capital requirements of our subsidiaries. In addition, significantly reduced levels of cash at the parent company could make us unable or unwilling to fund future capital needs of our subsidiaries and result in a downgrade of our ratings by the major credit rating agencies.

We could have liability in the future for tobacco-related lawsuits.

As a result of our ownership of Lorillard, Inc. (“Lorillard”) prior to the separation (the “Separation”), which was consummated in June 2008, from time to time we have been named as a defendant in tobacco-related lawsuits. We are currently a defendant in three such lawsuits and could be named as a defendant in additional tobacco-related suits, notwithstanding the completion of the Separation. In the Separation Agreement entered into between us and Lorillard and its subsidiaries in connection with the Separation, Lorillard and each of its subsidiaries has agreed to indemnify us for liabilities related to Lorillard’s tobacco business, including liabilities that we may incur for current and future tobacco-related litigation against us. An adverse decision in a tobacco-related lawsuit against us could, if the indemnification is deemed for any reason to be unenforceable or any amounts owed to us thereunder are not collectible, in whole or in part, have a material adverse effect on our financial condition, results of operations and equity. We do not expect that the Separation will alter the legal exposure of either entity with respect to tobacco-related claims. We do not believe that we had or have any liability for tobacco-related claims, and we have never been held liable for any such claims.

Risks Related to Us and Our Subsidiary, CNA Financial Corporation

CNA has incurred and may continue to incur significant realized and unrealized investment losses and volatility in net investment income arising from the severe disruption in the capital and credit markets.

Investment returns are an important part of CNA’s overall profitability. General economic conditions, changes in financial markets such as fluctuations in interest rates, long term periods of low interest rates, credit conditions and currency, commodity and stock prices, including the short and long-term effects of losses in relation to asset-backed securities, and many other factors beyond CNA’s control can adversely affect the value of CNA’s investments and the realization of investment income. Further, CNA invests a portion of its assets in equity securities and limited partnerships which are subject to greater volatility than CNA’s fixed income investments. Limited partnership investments generally present greater volatility, higher illiquidity, and greater risk than fixed income investments. As a result of all of these factors, CNA may not realize an adequate return on CNA’s investments, may incur losses on sales of its investments, and may be required to write down the value of its investments. Therefore, the Company’s results of operations, equity and CNA’s business, insurer financial strength and debt ratings could be materially adversely impacted.

 

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CNA’s underwriting results may continue to suffer as a result of the unfavorable global economic conditions.

Overall global economic conditions may continue to be recessionary and highly unfavorable. Although many lines of CNA’s business have both direct and indirect exposure to these economic conditions, the exposure is especially high for the lines of business that provide management and professional liability insurance, as well as surety bonds, to businesses engaged in real estate, financial services and professional services. As a result, CNA has experienced and may continue to experience unanticipated underwriting losses with respect to these lines of business. Additionally, global recessionary conditions have led to decreased insured exposures causing CNA to experience declines in premium volume. Consequently, the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings could be adversely impacted.

CNA’s valuation of investments and impairment of securities requires significant judgment.

CNA’s investment portfolio is exposed to various risks, such as interest rate, credit, and currency risks, many of which are unpredictable. CNA exercises significant judgment in analyzing these risks and in validating fair values provided by third parties for securities in its investment portfolio that are not regularly traded. CNA also exercises significant judgment in determining whether the impairment of particular investments is temporary or other-than-temporary. Securities with exposure to residential and commercial mortgage and other loan collateral can be particularly sensitive to fairly small changes in actual collateral performance and assumptions as to future collateral performance.

During 2008, CNA incurred significant unrealized losses in its investment portfolio. During 2009, financial markets were volatile and CNA experienced improvement in its unrealized position. In addition, during 2009 and 2008 CNA recorded significant other-than-temporary impairment (“OTTI”) losses primarily in the corporate and other taxable bonds, asset-backed securities and non-redeemable preferred equity securities sectors.

Due to the inherent uncertainties involved with these types of risks and the resulting judgments, CNA may incur further unrealized losses and conclude that further other-than-temporary write downs of CNA’s investments are required. As a result, the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings could be materially adversely impacted. Additional information on CNA’s investment portfolio is included in the MD&A under Item 7 and Notes 3, 4, and 5 of the Notes to Consolidated Financial Statements included under Item 8.

CNA is unable to predict the impact on itself of governmental efforts and policy changes taken and proposed to be taken in response to the unfavorable economic conditions.

The federal government has implemented various measures, including the establishment of the Troubled Assets Relief Program pursuant to the Emergency Economic Stabilization Act of 2008, in an effort to deal with the ongoing economic conditions. In addition, there are numerous proposals for further legislative and regulatory actions at both the federal and state levels, particularly with respect to the financial services industry. Since these new laws and regulations, or other policy changes, could involve critical matters affecting CNA’s operations, they may have an impact on CNA’s business and its overall financial condition. Due to this significant uncertainty, CNA is unable to determine whether its actions in response to these governmental efforts will be effective or to predict with any certainty the overall impact these governmental efforts will have on it. As a result, the Company’s results of operations and equity and CNA’s business, insurer financial strength and debt ratings could be materially adversely impacted.

CNA is subject to extensive federal, state and local governmental regulations that restrict its ability to do business and generate revenues.

The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Most insurance regulations are designed to protect the interests of CNA’s policyholders rather than its investors. Each state in which CNA does business has established supervisory agencies that regulate the manner in which it does business. Their regulations relate to, among other things, the following:

 

   

standards of solvency including risk-based capital measurements;

 

   

restrictions on the nature, quality and concentration of investments;

 

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restrictions on CNA’s ability to withdraw from unprofitable lines of insurance or unprofitable market areas;

 

   

the required use of certain methods of accounting and reporting;

 

   

the establishment of reserves for unearned premiums, losses and other purposes;

 

   

potential assessments for funds necessary to settle covered claims against impaired, insolvent or failed private or quasi-governmental insurers;

 

   

licensing of insurers and agents;

 

   

approval of policy forms;

 

   

limitations on the ability of CNA’s insurance subsidiaries to pay dividends to CNA; and

 

   

limitations on the ability to non-renew, cancel or change terms and conditions in policies.

Regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. The states in which CNA does business also require CNA to provide coverage to persons whom CNA would not otherwise consider eligible. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. CNA’s share of these involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state.

Any of these regulations could materially adversely affect the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings.

CNA is subject to capital adequacy requirements and, if it is unable to maintain or raise sufficient capital to meet these requirements, regulatory agencies may restrict or prohibit CNA from operating its business.

Insurance companies such as CNA are subject to risk-based capital standards set by state regulators to help identify companies that merit further regulatory attention. These standards apply specified risk factors to various asset, premium and reserve components of CNA’s statutory capital and surplus reported in CNA’s statutory basis of accounting financial statements. Current rules require companies to maintain statutory capital and surplus at a specified minimum level determined using the risk-based capital formula. If CNA does not meet these minimum requirements, state regulators may restrict or prohibit it from operating its business. If CNA is required to record a material charge against earnings in connection with a change in estimates or circumstances or if it incurs significant unrealized losses related to its investment portfolio, CNA may violate these minimum capital adequacy requirements unless it is able to raise sufficient additional capital. Examples of events leading CNA to record a material charge against its earnings include impairment of CNA’s investments or unexpectedly poor claims experience.

Loews has provided CNA with substantial amounts of capital in prior years. Loews may be restricted in its ability or willingness to provide additional capital support to CNA. As a result, if CNA is in need of additional capital, CNA may be required to secure this funding from sources other than Loews. CNA may be limited in its ability to raise significant amounts of capital on favorable terms or at all.

Rating agencies may downgrade their ratings of CNA and thereby adversely affect its ability to write insurance at competitive rates or at all.

Ratings are an important factor in establishing the competitive position of insurance companies. CNA’s insurance company subsidiaries, as well as CNA’s public debt, are rated by rating agencies, namely, A.M. Best Company, Moody’s Investors Service, Inc. and Standard & Poor’s. Ratings reflect the rating agency’s opinions of an insurance company’s or insurance holding company’s financial strength, capital adequacy, operating performance, strategic position and ability to meet its obligations to policyholders and debt holders.

Due to the intense competitive environment in which CNA operates, the disruption in the capital and credit markets, the uncertainty in determining reserves and the potential for CNA to take material unfavorable development in the future,

 

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and possible changes in the methodology or criteria applied by the rating agencies, the rating agencies may take action to lower CNA’s ratings in the future. If CNA’s property and casualty insurance financial strength ratings are downgraded below current levels, CNA’s business and results of operations could be materially adversely affected. The severity of the impact on CNA’s business is dependent on the level of downgrade and, for certain products, which rating agency takes the rating action. Among the adverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain major insurance brokers, the inability to sell a material volume of CNA’s insurance products to certain markets, and the required collateralization of certain future payment obligations or reserves.

In addition, it is possible that a lowering of the debt ratings of Loews by certain of the rating agencies could result in an adverse impact on CNA’s ratings, independent of any change in CNA’s circumstances. CNA has entered into several settlement agreements and assumed reinsurance contracts that require collateralization of future payment obligations and assumed reserves if its ratings or other specific criteria fall below certain thresholds. The ratings triggers are generally more than one level below CNA’s current ratings. Additional information on CNA’s ratings and ratings triggers is included in the MD&A under Item 7.

CNA’s insurance subsidiaries, upon whom CNA depends for dividends in order to fund its working capital needs, are limited by state regulators in their ability to pay dividends.

CNA is a holding company and is dependent upon dividends, loans and other sources of cash from its subsidiaries in order to meet its obligations. Ordinary dividend payments, or dividends that do not require prior approval by subsidiaries’ domiciliary state departments of insurance and are generally limited to amounts determined by formula which varies by state. The formula for the majority of the states is the greater of 10% of the prior year statutory surplus or the prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to the date of payment. Some states, however, have an additional stipulation that dividends cannot exceed the prior year’s earned surplus. If CNA is restricted, by regulatory rule or otherwise, from paying or receiving inter-company dividends, CNA may not be able to fund its working capital needs and debt service requirements from available cash. As a result, CNA would need to look to other sources of capital which may be more expensive or may not be available at all.

If CNA determines that its recorded loss reserves are insufficient to cover its estimated ultimate unpaid liability for claims, CNA may need to increase its loss reserves.

CNA maintains loss reserves to cover its estimated ultimate unpaid liability for claims and claim adjustment expenses for reported and unreported claims and for future policy benefits. Reserves represent CNA’s best estimate at a given point in time. Insurance reserves are not an exact calculation of liability but instead are complex estimates derived by CNA, generally utilizing a variety of reserve estimation techniques from numerous assumptions and expectations about future events, many of which are highly uncertain, such as estimates of claims severity, frequency of claims, mortality, morbidity, expected interest rates, inflation, claims handling, case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time of its ultimate settlement. Many of these uncertainties are not precisely quantifiable and require significant judgment on CNA’s part. As trends in underlying claims develop, particularly in so-called “long tail” or long duration coverages, CNA is sometimes required to add to its reserves. This is called unfavorable net prior year development and results in a charge to CNA’s earnings in the amount of the added reserves, recorded in the period the change in estimate is made. These charges can be substantial. Additional information on CNA’s reserves is included in the MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

CNA is subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on CNA’s business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims, resulting in further increases in CNA’s reserves which can have a material adverse effect on its results of operations and equity. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict. Examples of emerging or potential claim and coverage issues include:

 

   

increases in the number and size of claims relating to injuries from various medical products including pharmaceuticals;

 

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the effects of recessionary economic conditions and financial reporting scandals, which have resulted in an increase in the number and size of claims, due to corporate failures; these claims include both directors and officers (“D&O”) and errors and omissions (“E&O”) insurance claims;

 

   

class action litigation relating to claims handling and other practices;

 

   

construction defect claims, including claims for a broad range of additional insured endorsements on policies;

 

   

clergy abuse claims, including passage of legislation to reopen or extend various statutes of limitations; and

 

   

mass tort claims, including bodily injury claims related to welding rods, benzene, lead, noise induced hearing loss and various other chemical and radiation exposure claims.

In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, CNA reviews and change its reserve estimates in a regular and ongoing process as experience develops and further claims are reported and settled. In addition, CNA periodically undergoes state regulatory financial examinations, including review and analysis of CNA’s reserves. If estimated reserves are insufficient for any reason, the required increase in reserves would be recorded as a charge against CNA’s earnings for the period in which reserves are determined to be insufficient. These charges could be substantial and could materially adversely affect the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings.

Loss reserves for asbestos and environmental pollution are especially difficult to estimate and may result in more frequent and larger additions to these reserves.

CNA’s experience has been that establishing reserves for casualty coverages relating to asbestos and environmental pollution (which CNA refers to as A&E) claim and claim adjustment expenses are subject to uncertainties that are greater than those presented by other claims. Estimating the ultimate cost of both reported and unreported claims are subject to a higher degree of variability due to a number of additional factors including, among others, the following:

 

   

coverage issues including whether certain costs are covered under the policies and whether policy limits apply;

 

   

inconsistent court decisions and developing legal theories;

 

   

continuing aggressive tactics of plaintiffs’ lawyers;

 

   

the risks and lack of predictability inherent in major litigation;

 

   

changes in the frequency of asbestos and environmental pollution claims;

 

   

changes in the severity of claims including bodily injury claims for malignancies arising out of exposure to asbestos;

 

   

the impact of the exhaustion of primary limits and the resulting increase in claims on any umbrella or excess policies CNA has issued;

 

   

CNA’s ability to recover reinsurance for these claims; and

 

   

changes in the legal and legislative environment in which CNA operates.

As a result of this higher degree of variability, CNA has necessarily supplemented traditional actuarial methods and techniques with additional estimating techniques and methodologies, many of which involve significant judgment on its part. Consequently, CNA may periodically need to record changes in its claim and claim adjustment expense reserves in the future in these areas in amounts that could materially adversely affect the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings. Additional information on A&E claims is included in the MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

 

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Asbestos claims.  The estimation of reserves for asbestos claims is particularly difficult in light of the factors noted above. In addition, CNA’s ability to estimate the ultimate cost of asbestos claims is further complicated by the following:

 

   

inconsistency of court decisions and jury attitudes, as well as future court decisions;

 

   

interpretation of specific policy provisions;

 

   

allocation of liability among insurers and insureds;

 

   

missing policies and proof of coverage;

 

   

the proliferation of bankruptcy proceedings and attendant uncertainties;

 

   

novel theories asserted by policyholders and their legal counsel;

 

   

the targeting of a broader range of businesses and entities as defendants;

 

   

uncertainties in predicting the number of future claims and which other insureds may be targeted in the future;

 

   

volatility in frequency of claims and severity of settlement demands;

 

   

increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims;

 

   

the efforts by insureds to obtain coverage that is not subject to aggregate limits;

 

   

the long latency period between asbestos exposure and disease manifestation, as well as the resulting potential for involvement of multiple policy periods for individual claims;

 

   

medical inflation trends;

 

   

the mix of asbestos-related diseases presented; and

 

   

the ability to recover reinsurance.

In addition, a number of CNA’s insureds have asserted that their claims for insurance are not subject to aggregate limits on coverage. If these insureds are successful in this regard, CNA’s potential liability for their claims would be unlimited. Some of these insureds contend that their asbestos claims fall within the so-called “non-products” liability coverage within their policies, rather than the products liability coverage, and that this “non-products” liability coverage is not subject to any aggregate limit. It is difficult to predict the extent to which these claims will succeed and, as a result, the ultimate size of these claims.

Environmental pollution claims.  The estimation of reserves for environmental pollution claims is complicated by liability and coverage issues arising from these claims. CNA and others in the insurance industry are disputing coverage for many such claims. In addition to the coverage issues noted in the asbestos claims section above, key coverage issues in environmental pollution claims include the following:

 

   

whether cleanup costs are considered damages under the policies (and accordingly whether CNA would be liable for these costs);

 

   

the trigger of coverage and the allocation of liability among triggered policies;

 

   

the applicability of pollution exclusions and owned property exclusions;

 

   

the potential for joint and several liability; and

 

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the definition of an occurrence.

To date, courts have been inconsistent in their rulings on these issues, thus adding to the uncertainty of the outcome of many of these claims.

Further, the scope of federal and state statutes and regulations determining liability and insurance coverage for environmental pollution liabilities have been the subject of extensive litigation. In many cases, courts have expanded the scope of coverage and liability for cleanup costs beyond the original intent of CNA’s insurance policies. Additionally, the standards for cleanup in environmental pollution matters are unclear, the number of sites potentially subject to cleanup under applicable laws is unknown, and the impact of various proposals to reform existing statutes and regulations is difficult to predict.

Catastrophe losses are unpredictable.

Catastrophe losses are an inevitable part of CNA’s business. Various events can cause catastrophe losses, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather, and fires, and their frequency and severity are inherently unpredictable. In addition, longer-term natural catastrophe trends may be changing and new types of catastrophe losses may be developing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain, and snow. The extent of CNA’s losses from catastrophes is a function of both the total amount of CNA’s insured exposures in the affected areas and the severity of the events themselves. In addition, as in the case of catastrophe losses generally, it can take a long time for the ultimate cost to CNA to be finally determined. As CNA’s claim experience develops on a particular catastrophe, CNA may be required to adjust its reserves, or take unfavorable development, to reflect its revised estimates of the total cost of claims. CNA believes it could incur significant catastrophe losses in the future. Therefore, the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings could be materially adversely impacted. Additional information on catastrophe losses is included in the MD&A under Item 7 and Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

CNA’s key assumptions used to determine reserves and deferred acquisition costs for CNA’s long term care product offerings could vary significantly from actual experience.

CNA’s reserves and deferred acquisition costs for its long term care product offerings are based on certain key assumptions including morbidity, which is the frequency and severity of illness, sickness and diseases contracted, policy persistency, which is the percentage of policies remaining in force, interest rates and future health care cost trends. If actual experience differs from these assumptions, the deferred acquisition asset may not be fully realized and the reserves may not be adequate, requiring CNA to add to reserves, or take unfavorable development. Therefore, the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings could be materially adversely impacted.

CNA is unable to predict the impact of federal health care reform legislation.

The federal government may be implementing landmark health care reform legislation that could involve critical matters affecting CNA’s operations, particularly CNA’s workers’ compensation and long term care products. Until the legislation is enacted, CNA is unable to predict with any certainty the overall impact it will have. As a result, the Company’s results of operations and equity, and CNA business, insurer financial strength and debt ratings could be materially adversely impacted.

CNA’s premium writings and profitability are affected by the availability and cost of reinsurance.

CNA purchases reinsurance to help manage its exposure to risk. Under CNA’s reinsurance arrangements, another insurer assumes a specified portion of its claim and claim adjustment expenses in exchange for a specified portion of policy premiums. Market conditions determine the availability and cost of the reinsurance protection CNA purchases, which affects the level of CNA’s business and profitability, as well as the level and types of risk CNA retains. If CNA is unable to obtain sufficient reinsurance at a cost it deems acceptable, CNA may be unwilling to bear the increased risk

 

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and would reduce the level of its underwriting commitments. Therefore, the Company’s financial results of operations could be materially adversely impacted. Additional information on reinsurance is included in Note 17 of the Notes to Consolidated Financial Statements included under Item 8.

CNA may not be able to collect amounts owed to it by reinsurers.

CNA has significant amounts recoverable from reinsurers which are reported as receivables in its balance sheets and are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves. The ceding of insurance does not, however, discharge CNA’s primary liability for claims. As a result, CNA is subject to credit risk relating to its ability to recover amounts due from reinsurers. Certain of CNA’s reinsurance carriers have experienced deteriorating financial conditions or have been downgraded by rating agencies. A continuation or worsening of the current unfavorable global economic conditions could similarly impact all of CNA’s reinsurers. In addition, reinsurers could dispute amounts which CNA believes are due to it. If CNA is not able to collect the amounts due to it from reinsurers, CNA’s claims expenses will be higher which could materially adversely affect the Company’s results of operations and equity, and CNA’s business, insurer financial strength and debt ratings. Additional information on reinsurance is included in Note 17 of the Notes to Consolidated Financial Statements included under Item 8.

Risks Related to Us and Our Subsidiary, Diamond Offshore Drilling, Inc.

Diamond Offshore’s business depends on the level of activity in the oil and gas industry, which is significantly affected by volatile oil and gas prices.

Diamond Offshore’s business depends on the level of activity in offshore oil and gas exploration, development and production in markets worldwide. Worldwide demand for oil and gas, oil and gas prices, market expectations of potential changes in these prices and a variety of political and economic factors significantly affect this level of activity. However, higher or lower commodity demand and prices do not necessarily translate into increased or decreased drilling activity since Diamond Offshore’s customers’ project development time, reserve replacement needs, as well as expectations of future commodity demand and prices all combine to affect demand for Diamond Offshore’s rigs. Oil and gas prices have been, and are expected to continue to be, extremely volatile and are affected by numerous factors beyond Diamond Offshore’s control, including:

 

   

worldwide demand for oil and gas;

 

   

the level of economic activity in energy-consuming markets;

 

   

the worldwide economic environment or economic trends, such as recessions;

 

   

the ability of the Organization of Petroleum Exporting Countries, commonly called OPEC, to set and maintain production levels and pricing;

 

   

the level of production in non-OPEC countries;

 

   

the worldwide political and military environment, including uncertainty or instability resulting from an escalation or additional outbreak of armed hostilities in the Middle East, other oil-producing regions or other geographic areas or further acts of terrorism in the United States or elsewhere;

 

   

the cost of exploring for, producing and delivering oil and gas;

 

   

the discovery rate of new oil and gas reserves;

 

   

the rate of decline of existing and new oil and gas reserves;

 

   

available pipeline and other oil and gas transportation capacity;

 

   

the ability of oil and gas companies to raise capital;

 

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weather conditions in the United States and elsewhere;

 

   

the policies of various governments regarding exploration and development of their oil and gas reserves;

 

   

development and exploitation of alternative fuels;

 

   

competition for customers’ drilling budgets from land-based energy markets around the world;

 

   

domestic and foreign tax policy; and

 

   

advances in exploration and development technology.

The continuing global financial crisis and worldwide economic downturn has had, and may continue to have, a negative impact on Diamond Offshore’s business and financial condition.

The continuing worldwide financial crisis has reduced the availability of liquidity and in some cases has reduced the availability of and/or increased the cost of credit to fund the continuation and expansion of industrial business operations worldwide, and has led to a worldwide economic recession. This deterioration of the worldwide economy has resulted in reduced demand for crude oil and natural gas, exploration and production activity and offshore drilling services that has had a negative impact on our business and financial condition, including declines in dayrates earned by Diamond Offshore’s drilling rigs and a decrease in new contract activity, which may continue and may worsen.

In addition, the worldwide economic recession has had, and could continue to have, a negative impact on Diamond Offshore’s customers and/or its suppliers including, among other things, causing them to fail to meet their obligations to Diamond Offshore. Additionally, if a potential customer is unable to obtain an adequate level of credit, it may preclude Diamond Offshore from doing business with that potential customer. Similarly, the restricted credit market could affect lenders participating in Diamond Offshore’s credit facility, making them unable to fulfill their commitments and obligations to Diamond Offshore. Any such reductions in drilling activity or failure by Diamond Offshore’s customers, suppliers or lenders to meet their contractual obligations to Diamond Offshore, or Diamond Offshore’s inability to secure additional financing, could adversely affect the Company’s financial position, results of operations and cash flows.

Diamond Offshore’s industry is cyclical.

Diamond Offshore’s industry has historically been cyclical. There have been periods of high demand, short rig supply and high dayrates, followed by periods of lower demand, excess rig supply and low dayrates. Diamond Offshore cannot predict the timing or duration of such business cycles. Periods of excess rig supply intensify the competition in the industry and often result in rigs being idle for long periods of time. In response to a contraction in demand for its services, Diamond Offshore has cold stacked three of its rigs and is in the process of cold stacking a fourth unit. Diamond Offshore may be required to idle additional rigs or to enter into lower rate contracts. Prolonged periods of low utilization and dayrates could also result in the recognition of impairment charges on certain of Diamond Offshore’s drilling rigs if future cash flow estimates, based upon information available to management at the time, indicate that the carrying value of these rigs may not be recoverable.

Diamond Offshore can provide no assurance that its current backlog of contract drilling revenue will be ultimately realized.

As of February 1, 2010, Diamond Offshore’s contract drilling backlog was approximately $8.5 billion for contracted future work extending, in some cases, until 2016. Generally, contract backlog only includes future revenue under firm commitments; however, from time to time, Diamond Offshore may report anticipated commitments for which definitive agreements have not yet been executed. Diamond Offshore can provide no assurance that it will be able to perform under these contracts due to events beyond its control or that Diamond Offshore will be able to ultimately execute a definitive agreement where one does not currently exist. In addition, Diamond Offshore can provide no assurance that its customers will be able to or willing to fulfill their contractual commitments. Diamond Offshore’s inability to perform under its contractual obligations or to execute definitive agreements or its customers’ inability to fulfill their contractual commitments may have a material adverse effect on Diamond Offshore’s business.

 

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Diamond Offshore relies heavily on a relatively small number of customers and the loss of a significant customer and/or a dispute that leads to the loss of a customer could have a material adverse impact on its financial results.

Diamond Offshore provides offshore drilling services to a customer base that includes major and independent oil and gas companies and government-owned oil companies. However, the number of potential customers has decreased in recent years as a result of mergers among the major international oil companies and large independent oil companies. In 2009, Diamond Offshore’s five largest customers in the aggregate accounted for approximately 41.0% of its consolidated revenues. Diamond Offshore expects Petrobras, which accounted for approximately 15.0% of Diamond Offshore’s consolidated revenues in 2009 to continue to be a significant customer in 2010. While it is normal for Diamond Offshore’s customer base to change over time as work programs are completed, the loss of any major customer may have a material adverse effect on Diamond Offshore’s business.

The terms of Diamond Offshore’s dayrate drilling contracts may limit its ability to attain profitability in a declining market or to benefit from increasing dayrates in an improving market.

The duration of offshore drilling contracts is generally determined by customer requirements and, to a lesser extent, the respective management strategies of the offshore drilling contractors. In periods of decreasing demand for offshore rigs, drilling contractors generally prefer longer term contracts, but often at flat or slightly lower dayrates, to preserve dayrates at existing levels and ensure utilization, while customers prefer shorter contracts that allow them to more quickly obtain the benefit of lower dayrates. Conversely, in periods of rising demand for offshore rigs, contractors typically prefer shorter contracts that allow them to more quickly profit from increasing dayrates. In contrast, during these periods customers with reasonably definite drilling programs typically prefer longer term contracts to maintain dayrate prices at a consistent level. An inability to obtain longer term contracts in a declining market or to fully benefit from increasing dayrates in an improving market through shorter term contracts may limit Diamond Offshore’s profitability.

Contracts for Diamond Offshore’s drilling units are generally fixed dayrate contracts, and increases in Diamond Offshore’s operating costs could adversely affect the profitability of those contracts.

Diamond Offshore’s contracts for its drilling units provide for the payment of a fixed dayrate per rig operating day, although some contracts do provide for a limited escalation in dayrate due to increased operating costs incurred. Many of Diamond Offshore’s operating costs, such as labor costs, are unpredictable and fluctuate based on events beyond Diamond Offshore’s control. The gross margin that Diamond Offshore realizes on these fixed dayrate contracts will fluctuate based on variations in Diamond Offshore’s operating costs over the terms of the contracts. In addition, for contracts with dayrate escalation clauses, Diamond Offshore may be unable to recover increased or unforeseen costs from its customers which could adversely affect the Company’s financial position, results of operations, or cash flows.

Diamond Offshore’s drilling contracts may be terminated due to events beyond its control.

Diamond Offshore’s customers may terminate some of their drilling contracts if the drilling unit is destroyed or lost or if drilling operations are suspended for a specified period of time as a result of a breakdown of major equipment or, in some cases, due to other events beyond the control of either party. In addition, some of Diamond Offshore’s drilling contracts permit the customer to terminate the contract after specified notice periods by tendering contractually specified termination amounts. These termination payments may not fully compensate Diamond Offshore for the loss of a contract. In addition, the early termination of a contract may result in a rig being idle for an extended period of time. During periods of depressed market conditions, Diamond Offshore may be subject to an increased risk of its customers seeking to repudiate their contracts. Diamond Offshore’s customers’ ability to perform their obligations under drilling contracts may also be adversely affected by restricted credit markets and the economic downturn. If Diamond Offshore’s customers cancel some of their contracts, and Diamond Offshore is unable to secure new contracts on a timely basis and on substantially similar terms, or if contracts are suspended for an extended period of time or if a number of Diamond Offshore’s contracts are renegotiated, it could adversely affect the Company’s financial position, results of operations or cash flows.

 

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Diamond Offshore’s business involves numerous operating hazards and Diamond Offshore is not fully insured against all of them.

Diamond Offshore’s operations are subject to the usual hazards inherent in drilling for oil and gas offshore, such as blowouts, reservoir damage, loss of production, loss of well control, punchthroughs, craterings and natural disasters such as hurricanes or fires. The occurrence of these events could result in the suspension of drilling operations, damage to or destruction of the equipment involved and injury or death to rig personnel, damage to producing or potentially productive oil and gas formations and environmental damage. Operations also may be suspended because of machinery breakdowns, abnormal drilling conditions, failure of subcontractors to perform or supply goods or services or personnel shortages. In addition, offshore drilling operators are subject to perils peculiar to marine operations, including capsizing, grounding, collision and loss or damage from severe weather, and Diamond Offshore does not typically retain loss-of-hire insurance policies to cover its rigs. Damage to the environment could also result from Diamond Offshore’s operations, particularly through oil spillage or extensive uncontrolled fires. Diamond Offshore may also be subject to damage claims by oil and gas companies or other parties.

Pollution and environmental risks generally are not fully insurable. Diamond Offshore’s insurance policies and contractual rights to indemnity may not adequately cover its losses, or may have exclusions of coverage for some losses. Diamond Offshore does not have insurance coverage or rights to indemnity for all risks, including, among other things, liability risk for certain amounts of excess coverage and certain physical damage risk. If a significant accident or other event occurs and is not fully covered by insurance or contractual indemnity, it could adversely affect Diamond Offshore’s financial position, results of operations and cash flows. There can be no assurance that Diamond Offshore will continue to carry the insurance it currently maintains or that those parties with contractual obligations to indemnify Diamond Offshore will necessarily be financially able to indemnify it against all these risks. In addition, no assurance can be made that Diamond Offshore will be able to maintain adequate insurance in the future at rates it considers to be reasonable or that it will be able to obtain insurance against some risks.

Diamond Offshore is self-insured for physical damage to rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico.

Because the amount of insurance coverage available has been limited, and the cost for such coverage has increased substantially, Diamond Offshore has elected to self-insure for physical damage to rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico. This results in a higher risk of losses, which could be material, that are not covered by third party insurance contracts. If one or more named windstorms in the U.S. Gulf of Mexico cause significant damage to Diamond Offshore’s rigs or equipment, it could have a material adverse effect on the Company’s financial position, results of operations or cash flows.

A significant portion of Diamond Offshore’s operations are conducted outside the United States and involve additional risks not associated with domestic operations.

Diamond Offshore operates in various regions throughout the world that may expose it to political and other uncertainties, including risks of:

 

   

terrorist acts, war and civil disturbances;

 

   

piracy or assaults on property or personnel;

 

   

kidnapping of personnel;

 

   

expropriation of property or equipment;

 

   

renegotiation or nullification of existing contracts;

 

   

changing political conditions;

 

   

foreign and domestic monetary policies;

 

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the inability to repatriate income or capital;

 

   

difficulties in collecting accounts receivable and longer collection periods;

 

   

fluctuations in currency exchange rates;

 

   

regulatory or financial requirements to comply with foreign bureaucratic actions;

 

   

travel limitations or operational problems caused by public health threats; and

 

   

changing taxation policies.

Diamond Offshore is subject to the U.S. Treasury Department’s Office of Foreign Assets Control and other U.S. laws and regulations governing its international operations. In addition, international contract drilling operations are subject to various laws and regulations in countries in which Diamond Offshore operates, including laws and regulations relating to:

 

   

the equipping and operation of drilling units;

 

   

repatriation of foreign earnings;

 

   

import - export quotas or other trade barriers;

 

   

oil and gas exploration and development;

 

   

taxation of offshore earnings and earnings of expatriate personnel; and

 

   

use and compensation of local employees and suppliers by foreign contractors.

Some foreign governments favor or effectively require the awarding of drilling contracts to local contractors, require use of a local agent or require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. These practices may adversely affect Diamond Offshore’s ability to compete in those regions. It is difficult to predict what governmental regulations may be enacted in the future that could adversely affect the international drilling industry. The actions of foreign governments may adversely affect Diamond Offshore’s ability to compete.

The greatest concentration of Diamond Offshore’s operating assets outside the United States is Brazil, where it has 12 rigs in its fleet either currently working or contracted to work during 2010 offshore Brazil.

Diamond Offshore’s drilling contracts offshore Mexico expose it to greater risks than they normally assume.

Diamond Offshore currently operates and expects to continue to operate rigs drilling offshore Mexico for PEMEX - Exploracion Y Produccion (“PEMEX”), the national oil company of Mexico. The terms of these contracts expose Diamond Offshore to greater risks than they normally assume, such as exposure to greater environmental liability. In addition, each contract can be terminated by PEMEX on 30 days notice, contractually or by statute, subject to certain conditions. While Diamond Offshore believes that the financial terms of these contracts and its operating safeguards in place mitigate these risks, Diamond Offshore can provide no assurance that the increased risk exposure will not have a negative impact on its future operations or financial results.

 

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Fluctuations in exchange rates and nonconvertibility of currencies could result in losses.

Due to Diamond Offshore’s international operations, Diamond Offshore may experience currency exchange losses where revenues are received and expenses are paid in nonconvertible currencies or where it does not effectively hedge an exposure to a foreign currency. Diamond Offshore may also incur losses as a result of an inability to collect revenues because of a shortage of convertible currency available to the country of operation, controls over currency exchange or controls over the repatriation of income or capital. Diamond Offshore can provide no assurance that financial hedging arrangements will effectively hedge any foreign currency fluctuation losses that may arise.

Diamond Offshore may be required to accrue additional tax liability on certain of its foreign earnings.

Certain of Diamond Offshore’s international rigs are owned and operated, directly or indirectly, by Diamond Offshore International Limited (“DOIL”), a wholly owned Cayman Islands subsidiary. Since forming this subsidiary it has been Diamond Offshore’s intention to indefinitely reinvest the earnings of this subsidiary to finance foreign operations. During 2007, DOIL made a non-recurring distribution to its U.S. parent company, and Diamond Offshore recognized U.S. federal income tax expense on the portion of the distribution that consisted of earnings of the subsidiary that had not previously been subjected to U.S. federal income tax. Notwithstanding the non-recurring distribution made in December of 2007, it remains Diamond Offshore’s intention to indefinitely reinvest the future earnings of DOIL to finance foreign activities, except for the earnings of Diamond East Asia Limited, a wholly owned subsidiary of DOIL formed in December of 2008. It is Diamond Offshore’s intention to repatriate the earnings of Diamond East Asia Limited, and U.S. income taxes will be provided on such earnings. Diamond Offshore does not expect to provide for U.S. taxes on any future earnings generated by DOIL, except to the extent that these earnings are immediately subjected to U.S. federal income tax or as they relate to Diamond East Asia Limited. Should a future distribution be made from any unremitted earnings of this subsidiary, Diamond Offshore may be required to record additional U.S. income taxes.

Public health threats could have a material adverse effect on Diamond Offshore’s operations and financial results.

Public health threats such as outbreaks of highly communicable diseases, which periodically occur in various parts of the world in which Diamond Offshore operates, could adversely impact its operations, the operations of its customers and the global economy, including the worldwide demand for oil and natural gas and the level of demand for Diamond Offshore’s services. Any quarantine of personnel or inability to access Diamond Offshore’s offices or rigs could adversely affect its operations. Travel restrictions or operational problems in any part of the world in which Diamond Offshore operates, or any reduction in the demand for drilling services caused by public health threats in the future, may have a material adverse effect on the Company’s financial position, results of operations and cash flows.

Rig conversions, upgrades or new builds may be subject to delays and cost overruns.

From time to time, Diamond Offshore may undertake to add new capacity through conversions or upgrades to rigs or through new construction. Projects of this type are subject to risks of delay or cost overruns inherent in any large construction project resulting from numerous factors, including the following:

 

   

shortages of equipment, materials or skilled labor;

 

   

work stoppages;

 

   

unscheduled delays in the delivery of ordered materials and equipment;

 

   

unanticipated cost increases;

 

   

weather interferences;

 

   

difficulties in obtaining necessary permits or in meeting permit conditions;

 

   

design and engineering problems;

 

   

customer acceptance delays;

 

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shipyard failures or unavailability; and

 

   

failure or delay of third party service providers and labor disputes.

Failure to complete a rig upgrade or new construction on time, or failure to complete a rig conversion or new construction in accordance with its design specifications may, in some circumstances, result in the delay, renegotiation or cancellation of a drilling contract, resulting in a loss of revenue to Diamond Offshore. If a drilling contract is terminated under these circumstances, Diamond Offshore may not be able to secure a replacement contract with equally favorable terms.

Risks Related to Us and Our Subsidiary, HighMount Exploration & Production LLC

HighMount may not be able to replace reserves and sustain production at current levels. Replacing reserves is risky and uncertain and requires significant capital expenditures.

HighMount’s future success depends largely upon its ability to find, develop or acquire additional reserves that are economically recoverable. Unless HighMount replaces the reserves produced through successful development, exploration or acquisition, its proved reserves will decline over time. HighMount may not be able to successfully find and produce reserves economically in the future or to acquire proved reserves at acceptable costs.

HighMount makes a substantial amount of capital expenditures for the acquisition, exploration and development of reserves. HighMount expects to fund its capital expenditures with cash from its operating activities. If HighMount’s cash flow from operations is not sufficient to fund its capital expenditure budget, there can be no assurance that additional debt or equity financing will be available or available at favorable terms to meet those requirements.

Estimates of natural gas and NGL reserves are uncertain and inherently imprecise.

Estimating the volume of proved natural gas and NGL reserves is a complex process and is not an exact science because of numerous uncertainties inherent in the process. The process relies on interpretations of available geological, geophysical, engineering and production data. The extent, quality and reliability of this technical data can vary. The process also requires certain economic assumptions, some of which are mandated by the SEC, such as oil and gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Therefore, these estimates are inherently imprecise. The accuracy of reserve estimates is a function of:

 

   

the quality and quantity of available data;

 

   

the interpretation of that data;

 

   

the accuracy of various mandated economic assumptions; and

 

   

the judgment of the persons preparing the estimate.

Actual future production, commodity prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable reserves most likely will vary from HighMount’s estimates. Any significant variance could materially affect the quantities and present value of HighMount’s reserves. In addition, HighMount may adjust estimates of proved reserves upward or downward to reflect production history, results of exploration and development drilling, prevailing commodity prices and prevailing development expenses.

The timing of both the production and the expenses from the development and production of natural gas and NGL properties will affect both the timing of actual future net cash flows from proved reserves and their present value. In addition, the 10.0% discount factor, which is required by the SEC to be used in calculating discounted future net cash flows for reporting purposes, is not necessarily the most accurate representation of their value. The effective interest rate at various times, and the risks associated with our business, or the oil and gas industry in general, will affect their value relative to the 10.0% discount factor.

 

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If commodity prices decrease, HighMount may be required to take additional write-downs of the carrying values of its properties.

HighMount may be required, under full cost accounting rules, to write down the carrying value of its natural gas and NGL properties if commodity prices decline significantly, or if it makes substantial downward adjustments to its estimated proved reserves, or increases its estimates of development costs or experiences deterioration in its exploration results. HighMount utilizes the full cost method of accounting for its exploration and development activities. Under full cost accounting, HighMount is required to perform a ceiling test each quarter. The ceiling test is an impairment test and generally establishes a maximum, or “ceiling,” of the book value of HighMount’s natural gas properties that is equal to the expected after tax present value (discounted at the required rate of 10.0%) of the future net cash flows from proved reserves, including the effect of cash flow hedges, calculated using the average first day of the month price for the preceding 12-month period.

If the net book value of HighMount’s exploration and production (“E&P”) properties (reduced by any related net deferred income tax liability) exceeds its ceiling limitation, SEC regulations require HighMount to impair or “write down” the book value of its E&P properties. HighMount recorded after tax ceiling test impairment charges of $660 million and $440 million in the first quarter of 2009 and the fourth quarter of 2008. A write down may not be reversed in future periods, even though higher natural gas and NGL prices may subsequently increase the ceiling. Depending on the magnitude of any future impairment, a ceiling test write down could significantly reduce HighMount’s income, or produce a loss. As ceiling test computations involve the average first day of the month price for the preceding 12-month period, it is impossible to predict the timing and magnitude of any future impairment. Additional information on the ceiling test is included in Critical Accounting Estimates included in MD&A under Item 7 and Note 8 of the Notes to Consolidated Financial Statements included under Item 8.

HighMount may incur additional goodwill impairment charges if market conditions deteriorate.

HighMount evaluates goodwill for impairment annually, or when events or circumstances change, such as an adverse change in business climate, that would indicate an impairment may have occurred. Goodwill is deemed to be impaired when the carrying value exceeds its estimated fair value. HighMount’s annual impairment test, which is performed as of April 30th each year, is based on several factors requiring judgment. A significant decrease in expected cash flows or changes in market conditions may represent an impairment indicator requiring an assessment for the potential impairment of recorded goodwill. Also, a ceiling test impairment may represent a triggering event requiring HighMount to perform an interim period goodwill impairment test. Should market conditions continue to significantly deteriorate, including further declining commodity prices, HighMount could be required to record additional goodwill impairments that may be significant. HighMount recorded an after tax goodwill impairment charge of $314 million in the fourth quarter of 2008. Please read Critical Accounting Estimates included in MD&A under Item 7 and Note 1 of the Notes to Consolidated Financial Statements included under Item 8.

Natural gas, NGL and other commodity prices are volatile.

The commodity price HighMount receives for its production heavily influences its revenue, profitability, access to capital and future rate of growth. HighMount is subject to risks due to frequent and often substantial fluctuations in commodity prices. NGL prices generally fluctuate on a basis that correlates to fluctuations in crude oil prices. In the past, the prices of natural gas and crude oil have been extremely volatile, and HighMount expects this volatility to continue. The markets and prices for natural gas and NGLs depend upon factors beyond HighMount’s control. These factors include demand, which fluctuates with changes in market and economic conditions and other factors, including:

 

   

the impact of market and basis differentials - market price spreads between two points across HighMount’s natural gas system;

 

   

the impact of weather on the demand for these commodities;

 

   

the level of domestic production and imports of these commodities;

 

   

the impact of changes in technologies on the level of supply;

 

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natural gas storage levels;

 

   

actions taken by foreign producing nations;

 

   

the availability of local, intrastate and interstate transportation systems;

 

   

the availability and marketing of competitive fuels;

 

   

the impact of energy conservation efforts; and

 

   

the extent of governmental regulation and taxation.

Lower commodity prices may decrease HighMount’s revenues and may reduce the amount of natural gas and NGLs that HighMount can produce economically.

HighMount engages in commodity price hedging activities.

HighMount is exposed to risks associated with fluctuations in commodity prices. The extent of HighMount’s commodity price risk is related to the effectiveness and scope of HighMount’s hedging activities. To the extent HighMount hedges its commodity price risk, HighMount will forego the benefits it would otherwise experience if commodity prices or interest rates were to change in its favor. Furthermore, because HighMount has entered into derivative transactions related to only a portion of the volume of its expected natural gas supply and production of NGLs, HighMount will continue to have direct commodity price risk on the unhedged portion. HighMount’s actual future supply and production may be significantly higher or lower than HighMount estimates at the time it enters into derivative transactions for that period.

As a result, HighMount’s hedging activities may not be as effective as HighMount intends in reducing the volatility of its cash flows, and in certain circumstances may actually increase the volatility of cash flows. In addition, even though HighMount’s management monitors its hedging activities, these activities can result in substantial losses. Such losses could occur under various circumstances, including if a counterparty does not perform its obligations under the applicable hedging arrangement, the hedging arrangement is imperfect or ineffective.

Drilling for and producing natural gas and NGLs is a high risk activity with many uncertainties.

HighMount’s future success will depend in part on the success of its exploitation, exploration, development and production activities. HighMount’s E&P activities are subject to numerous risks beyond its control, including the risk that drilling will not result in oil and natural gas production volumes that are commercially viable. HighMount’s decisions to purchase, explore, develop or otherwise exploit prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations. HighMount’s cost of drilling, completing and operating wells is often uncertain before drilling commences. Overruns in budgeted expenditures are common risks that can make a particular project uneconomical. Further, many factors may curtail, delay or cancel drilling, including the following:

 

   

lack of acceptable prospective acreage;

 

   

inadequate capital resources;

 

   

unexpected drilling conditions; pressure or irregularities in formations; equipment failures or accidents;

 

   

adverse weather conditions;

 

   

unavailability or high cost of drilling rigs, equipment, labor or services;

 

   

reductions in commodity prices;

 

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the impact of changes in technologies on commodity prices;

 

   

limitations in the market for natural gas and NGLs;

 

   

title problems;

 

   

compliance with and the impact of changes in governmental regulations; and

 

   

mechanical difficulties.

HighMount’s business involves many hazards and operational risks, some of which may not be fully covered by insurance.

HighMount is not insured against all risks. Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect HighMount’s business, financial condition or results of operations. HighMount’s E&P activities are subject to all of the operating risks associated with drilling for and producing natural gas and NGLs, including the possibility of:

 

   

environmental hazards, such as uncontrollable flows of natural gas, brine, well fluids, toxic gas or other pollution into the environment, including groundwater contamination;

 

   

abnormally pressured formations;

 

   

mechanical difficulties, such as stuck drilling and service tools and casing collapse;

 

   

fires and explosions;

 

   

personal injuries and death; and

 

   

natural disasters.

If any of these events occur, HighMount could incur substantial losses as a result of injury or loss of life, damage to and destruction of property, natural resources and equipment, pollution and other environmental damage, clean-up responsibilities, regulatory investigation and penalties, suspension of HighMount’s operations and repairs to resume operations, any of which could adversely affect its ability to conduct operations or result in substantial losses. HighMount may elect not to obtain insurance if the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable.

Risks Related to Us and Our Subsidiary, Boardwalk Pipeline Partners, LP

Boardwalk Pipeline needs to obtain and maintain authority from PHMSA to operate at higher than normal operating pressures.

Boardwalk Pipeline has entered into firm transportation contracts with shippers which would utilize the maximum design capacity of its recently completed 42-inch pipeline expansion projects and the Fayetteville Lateral assuming that Boardwalk Pipeline operates those pipelines at higher than normal operating pressures (up to 0.80 SMYS), which increases the pipeline’s peak-day transmission capacity from that available at normal operating pressures (up to 0.72 SMYS).

In December of 2009, Boardwalk Pipeline received authority from PHMSA to operate its 42-inch pipeline expansion projects at higher than normal operating pressures. If PHMSA were to withdraw such authority, Boardwalk Pipeline would not be able to transport all of its contracted quantities of natural gas on these pipelines, beginning in mid-2010, or Boardwalk Pipeline could incur additional costs to re-obtain such authority or seek alternate ways to meet its contractual obligations, any of which could have a material adverse affect on Boardwalk Pipeline’s business, financial condition, results of operations and cash flows.

 

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Boardwalk Pipeline is seeking authority from PHMSA to operate its Fayetteville Lateral at higher than normal operating pressures. Unless Boardwalk Pipeline obtains such authority from PHMSA, Boardwalk Pipeline will not be able to operate the Fayetteville Lateral at its anticipated peak-day transmission capacity, and beginning in mid-2011, will not be able to transport all of the contracted for volumes on that pipeline. In addition, Boardwalk Pipeline has incurred and may continue to incur significant costs to inspect, test and remediate pipe segments on the Fayetteville Lateral in order to obtain, or maintain if granted, authority to operate at higher than normal operating pressures or to develop alternative ways to meet Boardwalk Pipeline’s contractual obligations, any of which could have a material adverse affect on Boardwalk Pipeline’s business, financial condition, results of operations and cash flows. PHMSA retains discretion as to whether to grant, or to maintain in force, authority to operate a pipeline at higher than normal operating pressures.

Boardwalk Pipeline may not be able to maintain or replace expiring gas transportation and storage contracts at favorable rates.

Boardwalk Pipeline’s primary exposure to market risk occurs at the time existing transportation contracts expire and are subject to renegotiation. As of December 31, 2009, approximately 14.0% of the contracts for firm transportation capacity on Boardwalk Pipeline’s pipeline systems will expire during 2010. Upon expiration, Boardwalk Pipeline may not be able to extend contracts with existing customers or obtain replacement contracts at favorable rates or on a long-term basis. Key drivers that influence the rates that Boardwalk Pipeline’s customers are willing to pay for transportation is the price differential of natural gas between physical locations, which can be affected by, among other things, the availability and supply of natural gas, available capacity, storage inventories, weather and general market demand in the respective areas.

The extension or replacement of existing contracts depends on a number of factors beyond Boardwalk Pipeline’s control, including:

 

   

existing and new competition to deliver natural gas to Boardwalk Pipeline’s markets;

 

   

development of new supplies located near key markets;

 

   

the growth in demand for natural gas in Boardwalk Pipeline’s markets;

 

   

whether the market will continue to support long-term contracts;

 

   

the current price differentials, or market price spreads between various pipeline receipt and delivery points; and

 

   

the effects of state regulation on customer contracting practices.

Increased competition could result in lower contracted pipeline capacity, decreased rates for Boardwalk Pipeline’s services and reduced revenues.

Boardwalk Pipeline competes primarily with other interstate and intrastate pipelines in the transportation and storage of natural gas. Competition is particularly strong in the Midwest and Gulf Coast states where Boardwalk Pipeline competes with numerous existing pipelines, such as the Rockies Express Pipeline and the Mid-Continent Express Pipeline. Boardwalk Pipeline will also compete with several new pipeline projects that are proposed or under development, including projects originating in the Haynesville Shale area – more specifically, the Tiger Pipeline that will transport gas to Perryville, Louisiana and the Haynesville Extension Pipeline that will transport gas to the industrial complex in southeastern Louisiana - and the Fayetteville Express Pipeline which will originate in the Fayetteville Shale area and continue eastward to Mississippi. For new growth and expansion projects, Boardwalk Pipeline competes with other pipelines for contracts mainly with producers that would support such projects in order to transport their gas to market areas. At an industry level, the various natural gas supply areas compete against one another to reach optimal market areas, and natural gas, as a commodity, competes with other forms of energy available to Boardwalk Pipeline’s customers, including electricity, coal and fuel oils, and other alternative fuel resources.

Boardwalk Pipeline’s ability to renew or replace existing contracts at rates sufficient to maintain current revenues and cash flows could be adversely affected by competition or changing market conditions. The principal elements of competition among pipelines are availability of capacity, rates, terms of service, access to gas supplies, flexibility and reliability. FERC’s policies promote competition in gas markets by increasing the number of gas transportation options available to Boardwalk Pipeline’s customer base. Increased competition could reduce the volumes of gas transported by Boardwalk Pipeline’s pipeline systems or, in instances where Boardwalk Pipeline does not have long-term contracts with

 

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fixed rates, could force Boardwalk Pipeline to decrease transportation or storage rates charged to its customers. Competition could intensify the negative impact of factors that could significantly decrease demand for natural gas in the markets served by Boardwalk Pipeline’s operating subsidiaries, such as a recession or adverse economic conditions, weather, higher fuel costs and taxes or other governmental or regulatory actions that directly or indirectly increase the cost or limit the use of natural gas.

The regulatory program that applies to interstate pipelines is different than the regulatory program that applies to many of Boardwalk Pipeline’s competitors that are not regulated interstate pipelines. This difference in regulatory oversight can result in longer lead times to develop and complete a project when it is regulated at the federal level. Boardwalk Pipeline competes against a number of intrastate pipelines which have significant regulatory advantages because of the absence of FERC regulation. In view of potential rate advantages and construction and service flexibility available to intrastate pipelines, Boardwalk Pipeline may lose customers and throughput to intrastate competitors.

Continued development of new supply sources could impact demand.

The discovery of non-traditional natural gas production areas nearer to key market areas Boardwalk Pipeline accesses directly, or indirectly through third-party pipeline interconnects, may compete with gas originating in production areas connected to Boardwalk Pipeline’s system. For example, the Marcellus Shale in Pennsylvania, New York, West Virginia and Ohio, may cause gas in supply areas connected to Boardwalk Pipeline’s system to be diverted to markets other than Boardwalk Pipeline’s traditional market areas and may adversely affect capacity utilization on Boardwalk Pipeline’s systems and its ability to renew or replace existing contracts at rates sufficient to maintain current revenues and cash flows. In addition to supply volumes from the Marcellus Shale, gas from the Rocky Mountains, Canada and LNG import terminals may compete with and displace volumes from the Gulf Coast and Mid-Continent supply sources in order to serve the Midwest and East Coast markets. The displacement of gas originating in supply areas connected to Boardwalk Pipeline’s pipeline systems by these new supply sources that are closer to the end-use markets could result in lower transportation revenues, which could have a material adverse impact on Boardwalk Pipeline’s business, financial condition, results of operations and cash flows.

Boardwalk Pipeline is undertaking and may continue to pursue complex pipeline or storage projects which involve significant risks that may adversely affect its business.

Boardwalk Pipeline has recently completed several pipeline expansion projects and may also undertake additional pipeline or storage projects in the future. In pursuing previous projects, Boardwalk Pipeline has experienced significant cost overruns and may experience cost increases in the future. Boardwalk Pipeline has also experienced delays in constructing and commissioning previous projects and may experience additional delays or cost increases in the future resulting from a variety of factors, including but not limited to the following:

 

   

delays in obtaining regulatory approvals, including delays in receiving authorization from PHMSA to operate at higher than normal operating pressures under special permits;

 

   

difficult construction conditions, including adverse weather conditions;

 

   

delays in obtaining, or high demand for, key materials; and

 

   

shortages of qualified labor and escalating costs of labor and materials resulting from the high level of construction activity in the pipeline industry.

In pursuing current or future projects, Boardwalk Pipeline could experience delays or cost increases for the reasons described above or as a result of other factors. Boardwalk Pipeline may not be able to complete its current or future projects on the expected terms, cost or schedule, or at all. In addition, Boardwalk Pipeline cannot be certain that, if completed, it will be able to operate these projects, or that they will perform, in accordance with expectations. Other areas of Boardwalk Pipeline’s business may suffer as a result of the diversion of management’s attention and other resources from its other business concerns to Boardwalk Pipeline’s projects. Any of these factors could impair Boardwalk Pipeline’s ability to realize revenues from its current or future projects sufficient to cover the costs associated with owning and operating these pipelines and to provide the benefits it had anticipated from the projects, which could

 

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have a material adverse effect on Boardwalk Pipeline’s business, financial condition, results of operations and cash flows, including its ability to make distributions to its unitholders.

Boardwalk Pipeline is exposed to credit risk relating to nonperformance by its customers.

Credit risk relates to the risk of loss resulting from the nonperformance by a customer of its contractual obligations. Boardwalk Pipeline’s exposure generally relates to receivables for services provided, future performance under firm agreements and volumes of gas owed by customers for imbalances or gas loaned by Boardwalk Pipeline to them under certain no-notice services and parking and lending (“PAL”) services. FERC gas tariffs only allow Boardwalk Pipeline to require limited credit support in the event that transportation customers are unable to pay for its services. If any of Boardwalk Pipeline’s significant customers have credit or financial problems which result in a delay or failure to pay for services provided by Boardwalk Pipeline or contracted for with Boardwalk Pipeline, or to repay the gas they owe Boardwalk Pipeline, it could have a material adverse effect on Boardwalk Pipeline’s business. In addition, as contracts expire, the failure of any of Boardwalk Pipeline’s customers could also result in the non-renewal of contracted capacity, which could have a material adverse effect on Boardwalk Pipeline’s business. See Item 7A for more information on credit risk arising from gas loaned to customers.

Boardwalk Pipeline depends on certain key customers for a significant portion of its revenues. The loss of any of these key customers could result in a decline in Boardwalk Pipeline’s revenues.

Boardwalk Pipeline relies on a limited number of customers for a significant portion of revenues. For example, Devon Energy Production Company, LP represented over 11.0% of Boardwalk Pipeline’s 2009 revenues and Boardwalk Pipeline expects this customer to continue to account for more than 10.0% of Boardwalk Pipeline’s 2010 revenues. Additionally, Boardwalk Pipeline may be unable to negotiate extensions or replacements of contracts and key customers on favorable terms. The loss of all or even a portion of the contracted volumes of these customers, as a result of competition, creditworthiness or otherwise, could have a material adverse effect on Boardwalk Pipeline’s business, financial condition, operating revenues and cash flows.

Significant changes in energy prices could affect natural gas market supply and demand, or potentially reduce the competitiveness of natural gas compared with other forms of energy available to Boardwalk Pipeline’s customers, which could reduce system throughput and adversely affect Boardwalk Pipeline’s revenues and available cash.

Due to the natural decline in traditional gas production connected to Boardwalk Pipeline’s system, Boardwalk Pipeline’s success depends on its ability to obtain access to new sources of natural gas, which is dependent on factors beyond its control including the price level of natural gas. In general terms, the price of natural gas fluctuates in response to changes in supply and demand, market uncertainty and a variety of additional factors that are beyond Boardwalk Pipeline’s control. These factors include:

 

   

worldwide economic conditions;

 

   

weather conditions, seasonal trends and hurricane disruptions;

 

   

the relationship between the available supplies and the demand for natural gas;

 

   

the availability of LNG;

 

   

the availability of adequate transportation capacity;

 

   

storage inventory levels;

 

   

the price and availability of other forms of energy;

 

   

the effect of energy conservation measures;

 

   

the nature and extent of, and changes in, governmental regulation, for example greenhouse gas legislation and taxation; and

 

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the anticipated future prices of natural gas, LNG and other commodities.

It is difficult to predict future changes in gas prices, however the abundance of natural gas supply discoveries over the last few years and global economic slowdown would generally indicate a bias toward downward pressure on prices. Downward movement in gas prices could negatively impact producers in nontraditional supply areas such as the Barnett Shale, the Bossier Sands, the Caney Woodford Shale, the Fayetteville Shale and the Haynesville Shale, including producers who have contracted for capacity with Boardwalk Pipeline. Significant financial difficulties experienced by Boardwalk Pipeline’s producer customers could impact their ability to pay for services rendered or otherwise reduce their demand for Boardwalk Pipeline’s services.

High natural gas prices may result in a reduction in the demand for natural gas. A reduced level of demand for natural gas could reduce the utilization of capacity on Boardwalk Pipeline’s systems, reduce the demand for Boardwalk Pipeline’s services and could result in the non-renewal of contracted capacity as contracts expire.

Boardwalk Pipeline’s natural gas transportation and storage operations are subject to FERC’s rate-making policies which could limit Boardwalk Pipeline’s ability to recover the full cost of operating its pipelines, including earning a reasonable return.

Boardwalk Pipeline is subject to extensive regulations relating to the rates it can charge for its transportation and storage operations. For cost-based services, FERC establishes both the maximum and minimum rates Boardwalk Pipeline can charge. The basic elements that FERC considers are the cost of providing the service, the volumes of gas being transported, how costs are allocated between services, the capital structure and the rate of return a pipeline is permitted to earn. While neither Gulf South nor Texas Gas has an obligation to file a rate case, Boardwalk Pipeline’s Gulf Crossing pipeline has an obligation to file either a rate case or a cost-and-revenue study by the end of the first quarter of 2012 to justify its rates. Customers of Boardwalk Pipeline’s subsidiaries or FERC can challenge the existing rates on any of its pipelines. FERC recently challenged the rates of three non-affiliated pipelines. Such a challenge against Boardwalk Pipeline could adversely affect its ability to establish reasonable transportation rates, to charge rates that would cover future increases in Boardwalk Pipeline’s costs or even to continue to collect rates to maintain its current revenue levels that are designed to permit a reasonable opportunity to recover current costs and depreciation and earn a reasonable return. Additionally, FERC can propose changes or modifications to any of its existing rate-related policies.

If Boardwalk Pipeline’s subsidiaries were to file a rate case, or if Boardwalk Pipeline has to defend its rates in a proceeding commenced by a customer or FERC, Boardwalk Pipeline would be required, among other things, to establish that the inclusion of an income tax allowance in Boardwalk Pipeline’s cost of service is just and reasonable. Under current FERC policy, since Boardwalk Pipeline is a limited partnership and does not pay U.S. federal income taxes, this would require Boardwalk Pipeline to show that its unitholders (or their ultimate owners) are subject to federal income taxation. To support such a showing, Boardwalk Pipeline’s general partner may elect to require owners of Boardwalk Pipeline’s units to re-certify their status as being subject to U.S. federal income taxation on the income generated by Boardwalk Pipeline’s subsidiaries or Boardwalk Pipeline may attempt to provide other evidence. Boardwalk Pipeline can provide no assurance that the evidence it might provide to FERC will be sufficient to establish that its unitholders (or their ultimate owners) are subject to U.S. federal income tax liability on the income generated by Boardwalk Pipeline’s jurisdictional pipelines. If Boardwalk Pipeline is unable to make such a showing, FERC could disallow a substantial portion of the income tax allowance included in the determination of the maximum rates that may be charged by Boardwalk Pipeline’s subsidiaries, which could result in a reduction of such maximum rates from current levels.

Boardwalk Pipeline may not be able to recover all of its costs through existing or future rates. An adverse determination in any future rate proceeding brought by or against any of Boardwalk Pipeline’s subsidiaries could have a material adverse effect on its business.

Boardwalk Pipeline’s operations are subject to catastrophic losses, operational hazards and unforeseen interruptions for which it may not be adequately insured.

There are a variety of operating risks inherent in Boardwalk Pipeline’s natural gas transportation and storage operations such as leaks, explosions and mechanical problems. Additionally, the nature and location of Boardwalk Pipeline’s business may make Boardwalk Pipeline susceptible to catastrophic losses from hurricanes or other named

 

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storms, particularly with regard to its assets in the Gulf Coast region, windstorms, earthquakes, hail, explosions, severe winter weather and fires. Any of these or other similar occurrences could result in the disruption of Boardwalk Pipeline’s operations, substantial repair costs, personal injury or loss of human life, significant damage to property, environmental pollution, impairment of Boardwalk Pipeline’s operations and substantial financial losses. The location of pipelines near populated areas, including residential areas, commercial business centers and industrial sites, could significantly increase the level of damages resulting from some of these risks.

Boardwalk Pipeline currently possesses property, business interruption and general liability insurance, but proceeds from such insurance coverage may not be adequate for all liabilities or expenses incurred or revenues lost. Moreover, such insurance may not be available in the future at commercially reasonable costs and terms. The insurance coverage Boardwalk Pipeline does obtain may contain large deductibles or fail to cover certain hazards or all potential losses.

Risks Related to Us and Our Subsidiaries Generally

In addition to the specific risks and uncertainties faced by our subsidiaries, as discussed above, we and all of our subsidiaries face risks and uncertainties related to, among other things, terrorism, hurricanes and other natural disasters, competition, government regulation, dependence on key executives and employees, litigation, dependence on information technology and compliance with environmental laws.

Future acts of terrorism could harm us and our subsidiaries.

Future terrorist attacks and the continued threat of terrorism in this country or abroad, as well as possible retaliatory military and other action by the United States and its allies, could have a significant impact on the businesses of certain of our subsidiaries, including the following:

CNA.  CNA continues to face exposure to losses arising from terrorist acts, despite the passage of the Terrorism Risk Insurance Program Reauthorization Act of 2007. The Terrorism Risk Insurance Program Reauthorization Act of 2007 extended, until December 31, 2014, the program established within the U.S. Department of Treasury by the Terrorism Risk Insurance Act of 2002. This program requires insurers to offer terrorism coverage and the federal government to share in insured losses arising from acts of terrorism. Given the unpredictability of the nature, targets, severity and frequency of potential terrorist acts, this program does not provide complete protection for future losses derived from acts of terrorism. Further, the laws of certain states restrict CNA’s ability to mitigate this residual exposure. For example, some states mandate property insurance coverage of damage from fire following a loss, thereby prohibiting CNA from excluding terrorism exposure. In addition, some states generally prohibit CNA from excluding terrorism exposure from its primary workers’ compensation policies. Consequently, there is substantial uncertainty as to CNA’s ability to contain its terrorism exposure effectively since CNA continues to issue forms of coverage, in particular, workers’ compensation, that are exposed to risk of loss from a terrorism act.

Diamond Offshore, Boardwalk Pipeline and HighMount.  The continued threat of terrorism and the impact of retaliatory military and other action by the United States and its allies might lead to increased political, economic and financial market instability and volatility in prices for oil and gas, which could affect the market for Diamond Offshore’s oil and gas offshore drilling services, Boardwalk Pipeline’s natural gas transportation, gathering and storage services and HighMount’s natural gas exploration and production activities. In addition, it has been reported that terrorists might target domestic energy facilities. While our subsidiaries take steps that they believe are appropriate to increase the security of their energy assets, there is no assurance that they can completely secure their assets, completely protect them against a terrorist attack or obtain adequate insurance coverage for terrorist acts at reasonable rates.

Loews Hotels.  The travel and tourism industry went into a steep decline in the periods following the 2001 World Trade Center event which had a negative impact on the occupancy levels and average room rates at Loews Hotels. Future terrorist attacks could similarly lead to reductions in business travel and tourism which could harm Loews Hotels.

 

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Certain of our subsidiaries face significant risks related to the impact of hurricanes and other natural disasters.

In addition to CNA’s exposure to catastrophe losses discussed above, the businesses operated by several of our other subsidiaries are exposed to significant harm from the effects of natural disasters, particularly hurricanes and related flooding and other damage. While much of the damage caused by natural disasters is covered by insurance, we cannot be sure that such coverage will be available or be adequate in all cases. These risks include the following:

Diamond Offshore.  Diamond Offshore operates its offshore rig fleet in waters that can be severely impacted by hurricanes and other natural disasters, including the U.S. Gulf of Mexico. In September of 2008, one of Diamond Offshore’s jack-up drilling rigs, the Ocean Tower, was damaged in Hurricane Ike, losing its derrick, drill floor and drill floor equipment. In late August 2005, one of Diamond Offshore’s jack-up drilling rigs, the Ocean Warwick, was seriously damaged during Hurricane Katrina and other rigs in Diamond’s fleet and its warehouse in New Iberia, Louisiana sustained lesser damage in Hurricanes Katrina or Rita, or in some cases both storms. In addition to damaging or destroying rig equipment, some or all of which may be covered by insurance, catastrophes of this kind result in additional operating expenses for Diamond Offshore, including the cost of reconnaissance aircraft, rig crew over-time and employee assistance, hurricane relief supplies, temporary housing and office space and the rental of mooring equipment and others which may not be covered by insurance.

Boardwalk Pipeline.  The nature and location of Boardwalk Pipeline’s business, particularly with regard to its assets in the Gulf Coast region, may make Boardwalk Pipeline susceptible to catastrophic losses especially from hurricanes or named storms. Various other events can cause catastrophic losses, including windstorms, earthquakes, hail, explosions, and severe winter weather and fires. The frequency and severity of these events are inherently unpredictable. The extent of losses from catastrophes is a function of both the total amount of insured exposures in the affected areas and the severity of the events themselves. Although Boardwalk Pipeline carries insurance, in the event of a loss the coverage could be insufficient or there could be a material delay in the receipt of the insurance proceeds.

Loews Hotels.  Hotels operated by Loews Hotels are exposed to damage, business interruption and reductions in travel and tourism in markets affected by significant natural disasters such as hurricanes. For example, Loews Hotels’ properties located in Florida and New Orleans suffered significant damage from hurricanes and related flooding during the past five years.

Certain of our subsidiaries are subject to extensive federal, state and local governmental regulations.

The businesses operated by certain of our subsidiaries are impacted by current and potential federal, state and local governmental regulations which imposes or might impose a variety of restrictions and compliance obligations on those companies. Governmental regulations can also change materially in ways that could adversely affect those companies. Risks faced by our subsidiaries related to governmental regulation include the following:

CNA.  The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Most insurance regulations are designed to protect the interests of CNA’s policyholders rather than its investors. Each state in which CNA does business has established supervisory agencies that regulate the manner in which CNA does business. Their regulations relate to, among other things:

 

   

standards of solvency, including risk-based capital measurements;

 

   

restrictions on the nature, quality and concentration of investments;

 

   

restrictions on CNA’s ability to withdraw from unprofitable lines of insurance or unprofitable market areas;

 

   

the required use of certain methods of accounting and reporting;

 

   

the establishment of reserves for unearned premiums, losses and other purposes;

 

   

potential assessments for funds necessary to settle covered claims against impaired, insolvent or failed private or quasi-governmental insurers;

 

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licensing of insurers and agents;

 

   

approval of policy forms;

 

   

limitations on the ability of CNA’s insurance subsidiaries to pay dividends to us; and

 

   

limitations on the ability to non-renew, cancel or change terms and conditions in policies.

Regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. CNA also is required by the states to provide coverage to persons who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. CNA’s share of these involuntary risks is mandatory and is generally a function of its respective share of the voluntary market by line of insurance in each state.

Diamond Offshore.  The drilling industry is dependent on demand for services from the oil and gas exploration industry and, accordingly, is affected by changing tax and other laws relating to the energy business generally. Diamond Offshore may be required to make significant capital expenditures to comply with governmental laws and regulations. It is also possible that these laws and regulations may in the future add significantly to Diamond Offshore’s operating costs or may significantly limit drilling activity.

Governments in some foreign countries are increasingly active in regulating and controlling the ownership of concessions, the exploration for oil and gas and other aspects of the oil and gas industries. The modification of existing laws or regulations or the adoption of new laws or regulations curtailing exploratory or developmental drilling for oil and gas for economic, environmental or other reasons could materially and adversely affect Diamond Offshore’s operations by limiting drilling opportunities.

The Minerals Management Service of the U.S. Department of the Interior, or MMS, has established guidelines for drilling operations in the GOM. Diamond Offshore believes that it is currently in compliance with the existing regulations set forth by the MMS with respect to its operations in the GOM; however, these regulations are continually under review. Implementation of additional MMS regulations may subject Diamond Offshore to increased costs of operating, or a reduction in the area and/or periods of operation, in the GOM.

HighMount.  All of HighMount’s operations are conducted onshore in the United States. The U.S. oil and gas industry, and HighMount’s operations, are subject to regulation at the federal, state and local level. Such regulation includes requirements with respect to, among other things: permits to drill and to conduct other operations; provision of financial assurances (such as bonds) covering drilling and well operations; the location of wells; the method of drilling and completing wells; the surface use and restoration of properties upon which wells are drilled; the plugging and abandoning of wells; the marketing, transportation and reporting of production; and the valuation and payment of royalties; the size of drilling and spacing units (regarding the density of wells which may be drilled in a particular area); the unitization or pooling of natural gas and oil properties; maximum rates of production from natural gas and oil wells; venting or flaring of natural gas and the ratability of production.

The conference committee report for The Department of the Interior, Environment, and Related Agencies Appropriations Act for Fiscal Year 2010 requested the EPA to conduct a study of hydraulic fracturing, particularly the relationship between hydraulic fracturing and drinking water. Hydraulic fracturing is a technique commonly used by oil and gas exploration companies, including HighMount, to stimulate the production of oil and natural gas by injecting fluids and sand into underground wells at high pressures, causing fractures or fissures in the geological formation which allow oil and gas to flow more freely. In recent years, concerns have been raised that the fracturing process may contaminate underground sources of drinking water. Several bills have been introduced in Congress seeking federal regulation of hydraulic fracturing, which has historically been regulated at the state level, though none of the proposed legislation has moved out of committee. If hydraulic fracturing is banned or significantly restricted by federal regulation or otherwise, it would have a material adverse effect on HighMount’s ability to economically drill new natural gas wells, which would materially reduce its production, revenues and profitability.

HighMount’s operations are also subject to federal, state and local laws and regulations concerning the discharge of contaminants into the environment, the generation, storage, transportation and disposal of contaminants, and the

 

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protection of public health, natural resources, wildlife and the environment. In most instances, the regulatory requirements relate to the handling and disposal of drilling and production waste products, water and air pollution control procedures, and the remediation of petroleum-product contamination. In addition, HighMount’s operations may require it to obtain permits for, among other things, air emissions, discharges into surface waters, and the construction and operation of underground injection wells or surface pits to dispose of produced saltwater and other non-hazardous oilfield wastes.

Boardwalk Pipeline.  Boardwalk Pipeline’s natural gas transportation and storage operations are subject to extensive regulation by FERC and the DOT among other federal and state authorities. In addition to FERC rules and regulations related to the rates Boardwalk Pipeline can charge for its services, FERC’s regulatory authority extends to:

 

   

operating terms and conditions of service;

 

   

the types of services Boardwalk Pipeline may offer to its customers;

 

   

construction of new facilities;

 

   

creation, extension or abandonment of services or facilities;

 

   

accounts and records; and

 

   

relationships with certain types of affiliated companies involved in the natural gas business.

FERC’s action in any of these areas or modifications of its current regulations can adversely impact Boardwalk Pipeline’s ability to compete for business, to construct new facilities, offer new services or to recover the full cost of operating its pipelines. This regulatory oversight can result in longer lead times to develop and complete any future project. The federal regulatory approval and compliance process could raise the costs of such projects to the point where they are no longer sufficiently timely or cost competitive when compared to competing projects that are not subject to the federal regulatory regime.

The businesses operated by our subsidiaries face intense competition.

Each of the businesses operated by our subsidiaries faces intense competition in its industry and will be harmed materially if it is unable to compete effectively. Certain of the competitive risks faced by those companies include:

CNA.  All aspects of the insurance industry are highly competitive and CNA must continuously allocate resources to refine and improve its insurance products and services. CNA competes with a large number of stock and mutual insurance companies and other entities for both distributors and customers. Insurers compete on the basis of factors including products, price, services, ratings and financial strength. CNA may lose business to competitors offering competitive insurance products at lower prices.

Diamond Offshore.  The offshore contract drilling industry is highly competitive with numerous industry participants, none of which at the present time has a dominant market share. Some of Diamond Offshore’s competitors may have greater financial or other resources than Diamond Offshore. The drilling industry has experienced consolidation in recent years and may experience additional consolidation, which could create additional large competitors. Drilling contracts are traditionally awarded on a competitive bid basis. Intense price competition is often the primary factor in determining which qualified contractor is awarded a job, although rig availability and location, a drilling contractor’s safety record and the quality and technical capability of service and equipment may also be considered. Mergers among oil and gas exploration and production companies have reduced the number of available customers as well as the contraction of the global economy, increasing competition. Significant new rig construction and upgrades of existing drilling units could also intensify price competition. Diamond Offshore believes there are approximately 50 jack-up rigs and 70 floaters on order and scheduled for delivery between 2010 and 2012. The resulting increase in rig supply could result in depressed rig utilization and greater price competition.

HighMount.  HighMount competes with other oil and gas companies in all aspects of its business, including acquisition of producing properties and leases and obtaining goods, services and labor, including drilling rigs and well

 

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completion services. HighMount also competes in the marketing of produced natural gas and NGLs. Some of HighMount’s competitors have substantially larger financial and other resources than HighMount. Factors that affect HighMount’s ability to acquire producing properties include available funds, available information about the property and standards established by HighMount for minimum projected return on investment. Competition for sales of natural gas and NGLs is also presented by alternative fuel sources, including heating oil, imported LNG and other fossil fuels.

Boardwalk Pipeline.  Boardwalk Pipeline competes with other pipelines to maintain current business levels and to serve new demand and markets. Boardwalk Pipeline also competes with other pipelines for contracts with producers that would support new growth opportunities. The principal elements of competition among pipelines are available capacity, rates, terms of service, access to supply and flexibility and reliability of service. Competition is particularly strong in the Midwest and Gulf Coast states where Boardwalk Pipeline competes with numerous existing pipelines, including the Rockies Express Pipeline that transports natural gas from northern Colorado to eastern Ohio and the Mid-Continent Express Pipeline that transports natural gas from Oklahoma and Texas to Alabama. Boardwalk Pipeline will also directly compete with several new pipeline projects that are proposed or under development, including projects originating in the Haynesville Shale area – more specifically, the Tiger Pipeline that will transport gas to Perryville, Louisiana and the Haynesville Extension Pipeline that will transport gas to the industrial complex in southeastern Louisiana - and the Fayetteville Express Pipeline which will originate in the Fayetteville Shale area and continue eastward to Mississippi. In addition, regulators’ continuing efforts to increase competition in the natural gas industry have increased the natural gas transportation options of Boardwalk Pipeline’s traditional customers. As a result of the regulators’ policies, segmentation and capacity release have created an active secondary market which increasingly competes with Boardwalk Pipeline’s pipeline services. Additionally, natural gas competes with other forms of energy available to Boardwalk Pipeline’s customers, including electricity, coal and fuel oils. The natural gas industry has built, or is in the process of completing, significant new pipeline infrastructure that will support the development of unconventional natural gas supply basins across the U.S. Additional pipeline infrastructure projects are being proposed. These new pipeline developments have increased competition in certain pipeline markets, resulting in lower price differentials between physical locations (basis spreads). Basis spreads can impact the rates Boardwalk Pipeline will be able to negotiate with its customers when contracts come up for renewal. Each year a portion of Boardwalk Pipeline’s capacity becomes subject to re-contracting risk. For example, approximately 14.0% of Boardwalk Pipeline’s contracts are due to expire in 2010. Increased competition could reduce the volumes of gas transported by Boardwalk Pipeline’s systems or, in instances where Boardwalk Pipeline does not have long term contracts with fixed rates, could force Boardwalk Pipeline to decrease its transportation or storage rates.

The regulatory program that applies to interstate pipelines is different than the regulatory program that applies to many of Boardwalk Pipeline’s competitors that are not regulated interstate pipelines. This difference in regulatory oversight can result in longer lead times to develop and complete a project when it is regulated at the federal level. Boardwalk Pipeline competes against a number of intrastate pipelines which have significant regulatory advantages over Boardwalk Pipeline because of the absence of FERC regulation. In view of potential rate advantages and construction and service flexibility available to intrastate pipelines, Boardwalk Pipeline may lose customers and throughput to intrastate competitors.

We and our subsidiaries are subject to litigation.

We and our subsidiaries are subject to litigation in the normal course of business. Litigation is costly and time consuming to defend and could result in a material expense. Please read information on litigation included in the MD&A under Item 7 and Notes 9 and 19 of the Notes to Consolidated Financial Statements included under Item 8. Certain of the litigation risks faced by us and our subsidiaries are as follows:

CNA.  CNA faces substantial risks of litigation and arbitration beyond ordinary course claims and A&E matters, which may contain assertions in excess of amounts covered by reserves that it has established. These matters may be difficult to assess or quantify and may seek recovery of very large or indeterminate amounts that include punitive or treble damages.

We and our subsidiaries are each dependent on a small number of key executives and other key personnel to operate our businesses successfully.

Our success and the success of our operating subsidiaries substantially depends upon each company’s ability to attract and retain high quality executives and other qualified employees. In many instances, there may be only a limited number

 

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of available qualified executives in the business lines in which we and our subsidiaries compete and the loss of one or more key employees or the inability to attract and retain other talented personnel could impede the successful implementation of our and our subsidiaries’ business strategies. Diamond Offshore has experienced upward pressure on salaries and wages and increased competition for skilled workers as a result of the strong drilling market in recent years and has lost experienced personnel to competitors and customers. As a result, Diamond Offshore has implemented retention programs, including increases in compensation.

Certain of our subsidiaries face significant risks related to compliance with environmental laws.

Certain of our subsidiaries have extensive obligations and/or financial exposure related to compliance with federal, state and local environmental laws. Laws and regulations protecting the environment have become increasingly stringent in recent years, and may in some cases impose “strict liability,” rendering a person liable for environmental damage without regard to negligence or fault on the part of that person. These laws and regulations may expose us and our subsidiaries to liability for the conduct of or conditions caused by others or for acts that were in compliance with all applicable laws at the time they were performed. For example:

 

   

as discussed in more detail above, many of CNA’s policyholders have made claims for defense costs and indemnification in connection with environmental pollution matters;

 

   

as an operator of mobile offshore drilling units in navigable U.S. waters and some offshore areas, Diamond Offshore may be liable for, among other things, damages and costs incurred in connection with oil spills related to those operations, including for conduct of or conditions caused by others or for acts that were in compliance with all applicable laws at the time they were performed;

 

   

the risk of substantial environmental costs and liabilities is inherent in natural gas transportation, gathering and storage, including with respect to, among other things, the handling and discharge of solid and hazardous waste from Boardwalk Pipeline’s facilities, compliance with clean air standards and the abandonment and reclamation of Boardwalk Pipeline’s facilities, sites and other properties; and

 

   

development, production and sale of natural gas and NGLs in the United States are subject to extensive environmental laws and regulations, including those related to discharge of materials into the environment and environmental protection, permits for drilling operations, bonds for ownership, development and production of oil and gas properties and reports concerning operations, which could result in liabilities for personal injuries, property damage, spills, discharge of hazardous materials, remediation and clean-up costs and other environmental damages, suspension or termination of HighMount’s operations and administrative, civil and criminal penalties.

Certain of our subsidiaries are subject to physical and financial risks associated with climate change.

As awareness of climate change issues increases, governments around the world are beginning to address the matter. This may result in new environmental regulations that may unfavorably impact us, our subsidiaries and their suppliers and customers. We and our subsidiaries may be exposed to risks related to new laws or regulations pertaining to climate change, carbon emissions or energy use that could decrease the use of oil or natural gas, thus reducing demand for hydrocarbon-based fuel and related services or imposing significant new costs. Governments also may pass laws or regulations encouraging or mandating the use of alternative energy sources, such as wind power and solar energy, which may reduce demand for oil and natural gas. In addition, changing global weather patterns have been associated with extreme weather events and could change longer-term natural catastrophe trends, including increasing the frequency and severity of hurricanes and other natural disasters which could increase future catastrophe losses at CNA and damage to property, disruption of business and higher operating costs at Diamond Offshore, Boardwalk Pipeline, HighMount and Loews Hotels.

There is currently no federal regulation that limits or imposes additional costs with respect to greenhouse gas (“GHG”) emissions in the U.S. However, several bills were introduced in Congress during 2009 that would regulate U.S. GHG emissions under a cap and trade system and some regulation of that type may be enacted in the U.S. in the near future. In addition, in September 2009, the EPA adopted regulations under the Clean Air Act requiring the monitoring and reporting of annual GHG emissions by operators of facilities that emit more than 25,000 metric tons of GHG per year,

 

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which includes Boardwalk Pipeline beginning in 2010 and may include HighMount beginning in 2011. Numerous states and several regional multi-state climate initiatives have announced or adopted plans to regulate GHG emissions, though the state programs vary widely. The establishment of a GHG reporting system and registry may be a first step toward broader regulation of GHG emissions. Compliance with future laws and regulations could impose significant costs on affected companies or adversely affect the demand for and the cost to produce and transport natural gas and oil, which would adversely affect the businesses of our energy subsidiaries.

The economic recession and ongoing financial and credit markets crisis have had and may continue to have a negative impact on the business and financial condition of us and our subsidiaries.

The recent financial and credit crisis has substantially reduced the availability of liquidity and credit available to businesses and consumers worldwide. The continued shortage of liquidity and credit, combined with substantial losses in equity and fixed income markets, has led to an economic recession in the United States and abroad. Such deterioration of the worldwide economy and credit and capital markets has and may continue to adversely affect the customers of our subsidiaries, including the ability of such customers to perform under contracts. The recession has also resulted in, and may result in further, reduced demand for certain of the products and services provided by our subsidiaries, including property casualty insurance, natural gas and gas transportation services, offshore drilling services and hotel rooms and related services. Such decline in demand could lead to lower revenues and earnings by our subsidiaries. We cannot predict if the actions being taken by the United States and other governments around the world to address this situation will be successful in reducing the severity or duration of this recession.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our corporate headquarters is located in approximately 113,000 square feet of leased office space in New York City. Information relating to our subsidiaries’ properties is contained under Item 1.

Item 3. Legal Proceedings.

Information with respect to legal proceedings is incorporated by reference to Note 19 of the Notes to Consolidated Financial Statements included under Item 8.

 

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

None.

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Name    Position and Offices Held    Age    First
Became
Officer

David B. Edelson

  

Senior Vice President

   50    2005

Gary W. Garson

  

Senior Vice President, General Counsel and Secretary

   63    1988

Herbert C. Hofmann

  

Senior Vice President

   67    1979

Peter W. Keegan

  

Senior Vice President and Chief Financial Officer

   65    1997

Richard W. Scott

  

Senior Vice President and Chief Investment Officer

   56    2010

Kenneth I. Siegel

  

Senior Vice President

   52    2009

Andrew H. Tisch

  

Office of the President, Co-Chairman of the Board and Chairman of the Executive Committee

   60    1985

James S. Tisch

  

Office of the President, President and Chief Executive Officer

   57    1981

Jonathan M. Tisch

  

Office of the President and Co-Chairman of the Board

   56    1987

Andrew H. Tisch and James S. Tisch are brothers and are cousins of Jonathan M. Tisch. None of the other officers or directors of Registrant is related to any other.

All of our executive officers except for Kenneth I. Siegel and Richard W. Scott have been engaged actively and continuously in our business for more than the past five years. Prior to joining us, Mr. Siegel was employed as a Managing Director in the Mergers & Acquisitions Department at Lehman Brothers Holdings Inc. and in 2009 at Barclays Capital Inc. in a similar capacity. Prior to joining us, Mr. Scott was employed at American International Group, Inc. for more than five years, serving in various senior investment positions, including Chief Investment Officer–Insurance Portfolio Management.

Officers are elected and hold office until their successors are elected and qualified, and are subject to removal by the Board of Directors.

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Price Range of Common Stock

Our common stock is listed on the New York Stock Exchange under the symbol “L.” The following table sets forth the reported high and low sales prices in each calendar quarter:

 

     2009    2008    
      
     High    Low    High    Low    
 

First Quarter

   $ 30.60    $ 17.40    $ 51.33    $ 37.65  

Second Quarter

     29.17      21.49      51.51      39.89  

Third Quarter

     35.49      25.27      49.32      35.00  

Fourth Quarter

     36.84      32.77      39.17      19.39  

 

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Item 5.

  Market for the Registrant’s Common Equity, Related Stockholder Matters
    and Issuer Purchases of Equity Securities

The following graph compares annual total return of our Common Stock, the Standard & Poor’s 500 Composite Stock Index (“S&P 500 Index”) and our Peer Group (“Loews Peer Group”) for the five years ended December 31, 2009. The graph assumes that the value of the investment in our Common Stock, the S&P 500 Index and the Loews Peer Group was $100 on December 31, 2004 and that all dividends were reinvested.

LOGO

 

      2004    2005    2006    2007    2008    2009

Loews Common Stock

   100.00    135.92    179.47    219.01    123.70    160.62

S&P 500 Index

   100.00    104.91    121.48    128.16      80.74    102.11

Loews Peer Group (a)

   100.00    133.59    152.24    174.46    106.30    136.35

 

(a)

The Loews Peer Group consists of the following companies that are industry competitors of our principal operating subsidiaries: Ace Limited, W.R. Berkley Corporation, Cabot Oil & Gas Corporation, The Chubb Corporation, Energy Transfer Partners L.P., ENSCO International Incorporated, The Hartford Financial Services Group, Inc., Kinder Morgan Energy Partners, L.P., Noble Corporation, Range Resources Corporation, Spectra Energy Corporation (included from December 14, 2006 when it began trading), Transocean, Ltd. and The Travelers Companies, Inc.

Dividend Information

We have paid quarterly cash dividends on Loews common stock in each year since 1967. Regular dividends of $0.0625 per share of Loews common stock were paid in each calendar quarter of 2009 and 2008.

We paid quarterly cash dividends on the former Carolina Group stock until the Separation. Regular dividends of $0.455 per share of the former Carolina Group stock were paid in the first and second quarters of 2008.

 

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Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters

 

and Issuer Purchases of Equity Securities

 

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides certain information as of December 31, 2009 with respect to our equity compensation plans under which our equity securities are authorized for issuance.

 

Plan category    Number of
securities to be
issued upon exercise
of outstanding
options, warrants
and rights
   Weighted average
exercise price of
outstanding options,
warrants and rights
  

Number of

securities remaining
available for future
issuance under
equity compensation
plans (excluding
securities reflected
in the first column)

   
 

Equity compensation plans approved by
security holders (a)

   5,657,996    $ 31.24    3,447,947  

Equity compensation plans not approved by security holders (b)

   N/A      N/A    N/A  

 

(a) Reflects stock options and stock appreciation rights awarded under the Loews Corporation 2000 Stock Option Plan.
(b) We do not have equity compensation plans that have not been approved by our shareholders.

Approximate Number of Equity Security Holders

We have approximately 1,440 holders of record of Loews common stock.

Common Stock Repurchases

We repurchased Loews common stock in 2009 as follows:

 

Period    Total number of
shares purchased
   Average price
paid per share
   
 

January 1, 2009 – March 31, 2009

   0      N/A  

April 1, 2009 – June 30, 2009

   1,195,900    $ 26.79  

July 1, 2009 – September 30, 2009

   3,516,200      31.52  

October 1, 2009 – December 31, 2009

   5,811,700      35.26  

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for us. Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements.

There are inherent limitations to the effectiveness of any control system, however well designed, including the possibility of human error and the possible circumvention or overriding of controls. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Management must make judgments with respect to the relative cost and expected benefits of any specific control measure. The design of a control system also is based in part upon assumptions and judgments made by management about the likelihood of future events, and there can be no assurance that a control will be effective under all potential future conditions. As a result, even an effective system of internal control over financial reporting can provide no more than reasonable assurance with respect to the fair presentation of financial statements and the processes under which they were prepared.

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework. Based on this assessment, our management believes that, as of December 31, 2009, our internal control over financial reporting was effective.

Our independent registered public accounting firm, Deloitte & Touche LLP, has issued an audit report on the Company’s internal control over financial reporting. The report of Deloitte & Touche LLP follows this Report.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Loews Corporation

New York, NY

We have audited the internal control over financial reporting of Loews Corporation and subsidiaries (the “Company”) as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2009 and our report dated February 24, 2010 expressed an unqualified opinion on those consolidated financial statements and financial statement schedules and included an explanatory paragraph regarding the change in methods of accounting for noncontrolling interests in consolidated financial statements, accounting for oil and gas reserves, and accounting for other-than-temporary impairments.

DELOITTE & TOUCHE LLP

New York, NY

February 24, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Loews Corporation

New York, NY

We have audited the accompanying consolidated balance sheets of Loews Corporation and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2009 listed in the Index at Item 8. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Loews Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, the Company changed its methods of accounting related to noncontrolling interests in consolidated financial statements, accounting for oil and gas reserves, and accounting for other-than-temporary impairments.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

New York, NY

February 24, 2010

 

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Item 6. Selected Financial Data.

The following table presents selected financial data. The table should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data of this Form 10-K.

 

Year Ended December 31    2009     2008     2007    2006    2005    
 
(In millions, except per share data)    

Results of Operations:

              

Revenues

   $ 14,117      $ 13,247      $ 14,302    $ 13,844    $ 12,197  

Income before income tax

   $ 1,730      $ 587      $ 3,194    $ 3,096    $ 659  

Income from continuing operations

   $ 1,385      $ 580      $ 2,199    $ 2,172    $ 621  

Discontinued operations, net

     (2     4,713        901      818      739  
 

Net income

     1,383        5,293        3,100      2,990      1,360  

Amounts attributable to noncontrolling interests

     819        763        612      503      157  
 

Net income attributable to Loews Corporation

   $ 564      $ 4,530      $ 2,488    $ 2,487    $ 1,203  
 

Income (loss) attributable to:

              

Loews common stock:

              

Income (loss) from continuing operations

   $ 566      $ (182   $ 1,586    $ 1,672    $ 466  

Discontinued operations, net

     (2     4,501        369      399      486  
 

Loews common stock

     564        4,319        1,955      2,071      952  

Former Carolina Group stock:

              

Discontinued operations, net

       211        533      416      251  
 

Net income

   $ 564      $ 4,530      $ 2,488    $ 2,487    $ 1,203  
 

Diluted Net Income (Loss) Per Share:

              

Loews common stock:

              

Income (loss) from continuing operations

   $ 1.31      $ (0.38   $ 2.96    $ 3.02    $ 0.84  

Discontinued operations, net

     (0.01     9.43        0.69      0.72      0.87  
 

Net income

   $ 1.30      $ 9.05      $ 3.65    $ 3.74    $ 1.71  
 

Former Carolina Group stock:

              

Discontinued operations, net

   $ -      $ 1.95      $ 4.91    $ 4.46    $ 3.62  
 

Financial Position:

              

Investments

   $ 46,034      $ 38,450      $ 46,669    $ 52,102    $ 43,612  

Total assets

     74,070        69,870        76,128      76,898      70,917  

Debt

     9,485        8,258        7,258      5,540      5,157  

Shareholders’ equity

     16,899        13,133        17,599      16,511      13,113  

Cash dividends per share:

              

Loews common stock

     0.25        0.25        0.25      0.24      0.20  

Former Carolina Group stock

     -        0.91        1.82      1.82      1.82  

Book value per share of Loews common stock

     39.76        30.18        32.42      30.17      23.68  

Shares outstanding:

              

Loews common stock

     425.07        435.09        529.68      544.20      557.54  

Former Carolina Group stock

     -        -        108.46      108.33      78.19  

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management’s discussion and analysis of financial condition and results of operations is comprised of the following sections:

 

      Page
    No.    

Overview

  

Consolidated Financial Results

   58

Parent Company Structure

   59

Critical Accounting Estimates

   59

Results of Operations by Business Segment

   62

CNA Financial

   62

Reserves – Estimates and Uncertainties

   63

CNA Specialty

   69

CNA Commercial

   71

Life & Group Non-Core

   73

Other Insurance

   74

A&E Reserves

   75

Diamond Offshore

   76

HighMount

   80

Boardwalk Pipeline

   84

Loews Hotels

   89

Corporate and Other

   90

Liquidity and Capital Resources

   91

CNA Financial

   91

Diamond Offshore

   93

HighMount

   94

Boardwalk Pipeline

   95

Loews Hotels

   96

Corporate and Other

   96

Contractual Obligations

   97

Investments

   97

Accounting Standards Update

   103

Forward-Looking Statements

   104

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

We are a holding company. Our subsidiaries are engaged in the following lines of business:

 

   

commercial property and casualty insurance (CNA Financial Corporation (“CNA”), a 90% owned subsidiary);

 

   

operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc. (“Diamond Offshore”), a 50.4% owned subsidiary);

 

   

exploration, production and marketing of natural gas, natural gas liquids and, to a lesser extent, oil (HighMount Exploration & Production LLC (“HighMount”), a wholly owned subsidiary);

 

   

operation of interstate natural gas transmission pipeline systems (Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”), a 67% owned subsidiary); and

 

   

operation of hotels (Loews Hotels Holding Corporation (“Loews Hotels”), a wholly owned subsidiary).

Unless the context otherwise requires, references in this Report to “the Company,” “we,” “our,” “us” or like terms refer to the business of Loews Corporation excluding its subsidiaries.

The following discussion should be read in conjunction with Item 1A, Risk Factors, and Item 8, Financial Statements and Supplementary Data of this Form 10-K.

Consolidated Financial Results

Consolidated income from continuing operations for the year ended December 31, 2009 was $566 million, or $1.31 per share, compared to a loss of $182 million, or $0.38 per share, in 2008. Income from continuing operations for the 2009 fourth quarter was $403 million, or $0.94 per share compared to a loss of $958 million, or $2.20 per share in the 2008 fourth quarter.

Net income for 2009 amounted to $564 million compared to $4.5 billion in 2008. Net income in 2008 included a tax-free non-cash gain of $4.3 billion related to the Separation of Lorillard and an after tax gain of $75 million from the sale of Bulova, both reported as discontinued operations.

Net income and earnings (loss) per share information attributable to Loews common stock and our former Carolina Group stock is summarized in the table below.

 

Year Ended December 31    2009     2008       
(In millions, except per share data)      

Net income (loss) attributable to Loews common stock:

      

Income (loss) from continuing operations

   $ 566      $ (182  

Discontinued operations, net

     (2     4,501     
 

Net income attributable to Loews common stock

     564        4,319     

Net income attributable to former Carolina Group stock –

      

Discontinued operations, net (a)

       211     
 

Net income (loss) attributable to Loews Corporation

   $ 564      $ 4,530     
 

Net income (loss) per share:

      

Loews common stock

      

Income (loss) from continuing operations

   $ 1.31      $ (0.38  

Discontinued operations, net

     (0.01     9.43     
 

Loews common stock

   $ 1.30      $ 9.05     
 

Former Carolina Group stock – Discontinued operations, net (a)

     $ 1.95     
 

 

(a) The Carolina Group and Carolina Group stock were eliminated as part of the Separation of Lorillard.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated Financial Results – (Continued)

Income from continuing operations primarily reflects improved net investment income and net investment gains at CNA, compared to a loss from continuing operations in the prior year. Net investment income benefited from higher limited partnership results, partially offset by the impact of lower short-term interest rates. In addition, higher investment income from the holding company trading portfolio contributed to the improved results.

Net investment losses were $503 million (after tax and noncontrolling interests) in 2009, compared to losses of $754 million in the prior year. The improvement was driven by a $217 million (after tax and noncontrolling interest) realized investment gain from the sale of CNA’s common stock holdings in Verisk Analytics, Inc. and decreased OTTI losses recognized in CNA’s available-for-sale portfolio. The OTTI losses in 2009 were primarily driven by the impact of difficult economic conditions on residential and commercial mortgage-backed securities and by credit issues in the financial sector.

These improvements were partially offset by a non-cash impairment charge of $660 million (after tax) in 2009 related to the carrying value of HighMount’s natural gas and oil properties, reflecting declines in commodity prices. Excluding impairment charges, HighMount’s results declined over the prior year due to decreased production volumes and lower natural gas prices. Results at Boardwalk Pipeline were lower primarily due to loss of revenues while remediating pipeline anomalies, and favorable one time transactions in 2008.

The prior year loss from continuing operations reflects a $440 million (after tax) non-cash impairment charge related to the carrying value of HighMount Exploration & Production LLC’s natural gas and oil properties, reflecting negative revisions in proved reserve quantities as a result of declines in commodity prices; a $314 million (after tax) non-cash goodwill impairment charge related to HighMount; and other-than-temporary impairment (OTTI) losses related to CNA’s investment portfolio.

Parent Company Structure

We are a holding company and derive substantially all of our cash flow from our subsidiaries. We rely upon our invested cash balances and distributions from our subsidiaries to generate the funds necessary to meet our obligations and to declare and pay any dividends to our shareholders. The ability of our subsidiaries to pay dividends is subject to, among other things, the availability of sufficient earnings and funds in such subsidiaries, applicable state laws, including in the case of the insurance subsidiaries of CNA, laws and rules governing the payment of dividends by regulated insurance companies (see Liquidity and Capital Resources – CNA Financial, below) and compliance with covenants in their respective loan agreements. Claims of creditors of our subsidiaries will generally have priority as to the assets of such subsidiaries over our claims and those of our creditors and shareholders.

Book value per common share increased to $39.76 at December 31, 2009 as compared to $30.18 at December 31, 2008.

CRITICAL ACCOUNTING ESTIMATES

The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and the related notes. Actual results could differ from those estimates.

The Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP, applied on a consistent basis. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that we believe are reasonable under the known facts and circumstances.

We consider the accounting policies discussed below to be critical to an understanding of our Consolidated Financial Statements as their application places the most significant demands on our judgment. Due to the inherent uncertainties involved with this type of judgment, actual results could differ significantly from estimates and may have a material adverse impact on our results of operations and/or equity.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Estimates – (Continued)

Insurance Reserves

Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty insurance policies where the reserving process is based on actuarial estimates of the amount of loss, including amounts for known and unknown claims. Long-duration contracts typically include traditional life insurance, payout annuities and long term care products and are estimated using actuarial estimates about mortality, morbidity and persistency as well as assumptions about expected investment returns. The reserve for unearned premiums on property and casualty and accident and health contracts represents the portion of premiums written related to the unexpired terms of coverage. The inherent risks associated with the reserving process are discussed in the Reserves – Estimates and Uncertainties section below.

Reinsurance

Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported as receivables in the Consolidated Balance Sheets. The ceding of insurance does not discharge CNA of its primary liability under insurance contracts written by CNA. An exposure exists with respect to property and casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities assumed under reinsurance agreements. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, CNA’s past experience and current economic conditions. Further information on CNA’s reinsurance program is included in Note 17 of the Notes to Consolidated Financial Statements included under Item 8.

Litigation

We and our subsidiaries are involved in various legal proceedings that have arisen during the ordinary course of business. We evaluate the facts and circumstances of each situation, and when management determines it necessary, a liability is estimated and recorded. Please read Note 19 of the Notes to Consolidated Financial Statements included under Item 8.

Valuation of Investments and Impairment of Securities

The Company classifies its fixed maturity securities and equity securities as either available-for-sale or trading which are both carried at fair value. The determination of fair value requires management to make a significant number of assumptions, particularly with respect to asset-backed securities. Due to the level of uncertainty related to changes in the fair value of these assets, it is possible that changes in the near term could have a material adverse impact on our results of operations and/or equity.

CNA’s investment portfolio is subject to market declines below amortized cost that may be other-than-temporary. A significant judgment in the valuation of investments is the determination of whether a credit loss exists on impaired securities, which results in the recognition of impairment losses in earnings. CNA has an Impairment Committee which reviews the investment portfolio on at least a quarterly basis, with ongoing analysis as new information becomes available. Further information on CNA’s process for evaluating impairments is included in Note 3 of the Notes to Consolidated Financial Statements included under Item 8.

Long Term Care Products

Reserves and deferred acquisition costs for CNA’s long term care products are based on certain assumptions including morbidity, policy persistency and interest rates. The recoverability of deferred acquisition costs and the adequacy of the reserves are contingent on actual experience related to these key assumptions and other factors such as future health care cost trends. If actual experience differs from these assumptions, the deferred acquisition costs may not be fully realized and the reserves may not be adequate, requiring CNA to add to reserves, or take unfavorable development. Therefore, our financial results could be adversely impacted.

Payout Annuity Contracts

Reserves for CNA’s payout annuity products are based on certain assumptions including mortality and interest rates. The adequacy of the reserves is contingent on actual experience related to these key assumptions. If actual experience

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Estimates – (Continued)

differs from these assumptions, reserves may not be adequate, requiring CNA to add to its reserves, or take unfavorable development. Therefore, our results of operations and/or equity could be adversely impacted.

Pension and Postretirement Benefit Obligations

We are required to make a significant number of assumptions in order to estimate the liabilities and costs related to our pension and postretirement benefit obligations to employees under our benefit plans. The assumptions that have the most impact on pension costs are the discount rate, the expected return on plan assets and the rate of compensation increases. These assumptions are evaluated relative to current market factors such as inflation, interest rates and fiscal and monetary policies. Changes in these assumptions can have a material impact on pension obligations and pension expense.

In determining the discount rate assumption, we utilized current market information and liability information, including a discounted cash flow analysis of our pension and postretirement obligations. In particular, the basis for our discount rate selection was the yield on indices of highly rated fixed income debt securities with durations comparable to that of our plan liabilities. The yield curve was applied to expected future retirement plan payments to adjust the discount rate to reflect the cash flow characteristics of the plans. The yield curves and indices evaluated in the selection of the discount rate are comprised of high quality corporate bonds that are rated AA by an accepted rating agency.

In 2009, the Company recorded an expense of $65 million for pension and other postretirement benefit plans. Based on current assumptions, the expected expense for the 2010 pension and other postretirement benefit plans is approximately $50 million.

Further information on our pension and postretirement benefit obligations is included in Note 16 of the Notes to Consolidated Financial Statements included under Item 8.

Valuation of HighMount’s Proved Reserves

HighMount follows the full cost method of accounting for natural gas and oil exploration and production (“E&P”) activities prescribed by the Securities and Exchange Commission (“SEC”). Under the full cost method, all direct costs of property acquisition, exploration and development activities are capitalized and subsequently depleted using the units-of-production method. The depletable base of costs includes estimated future costs to be incurred in developing proved natural gas and natural gas liquids (“NGLs”) reserves, as well as capitalized asset retirement costs, net of projected salvage values. Capitalized costs in the depletable base are subject to a ceiling test prescribed by the SEC. The test limits capitalized amounts to a ceiling the present value of estimated future net revenues to be derived from the production of proved natural gas and NGL reserves, using calculated average prices adjusted for any cash flow hedges in place. If net capitalized costs exceed the ceiling test at the end of any quarterly period, then a permanent write-down of the assets must be recognized in that period. A write-down may not be reversed in future periods, even though higher natural gas and NGL prices may subsequently increase the ceiling. HighMount performs the ceiling test quarterly. At March 31, 2009 and December 31, 2008, total capitalized costs exceeded the ceiling and HighMount recognized non-cash impairment charges of $1,036 million ($660 million after tax) and $691 million ($440 million after tax), related to the carrying value of natural gas and oil properties, as discussed further in Note 8 of the Notes to Consolidated Financial Statements included under Item 8. In addition, gains or losses on the sale or other disposition of natural gas and NGL properties are not recognized unless the gain or loss would significantly alter the relationship between capitalized costs and proved reserves.

HighMount’s estimate of proved reserves requires a high degree of judgment and is dependent on factors such as historical data, engineering estimates of proved reserve quantities, estimates of the amount and timing of future expenditures to develop the proved reserves, and estimates of future production from the proved reserves. HighMount’s estimated proved reserves as of December 31, 2009 and 2008 are based upon studies for each of HighMount’s properties prepared by HighMount staff engineers. Calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with SEC guidelines.

Ryder Scott Company, L.P., an independent third party petroleum engineering consulting firm, has audited HighMount’s reserve estimates in accordance with the “Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information” promulgated by the Society of Petroleum Engineers. Given the volatility of natural gas and

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Estimates – (Continued)

NGL prices, it is possible that HighMount’s estimate of discounted future net cash flows from proved natural gas and NGL reserves that is used to calculate the ceiling could materially change in the near term.

The process to estimate reserves is imprecise, and estimates are subject to revision. If there is a significant variance in any of HighMount’s estimates or assumptions in the future and revisions to the value of HighMount’s proved reserves are necessary, related depletion expense and the calculation of the ceiling test would be affected and recognition of natural gas and NGL property impairments could occur.

Impairment of Long-Lived Assets

The Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets and intangibles with finite lives are reported at the lower of the carrying amount or fair value. The Company uses a probability-weighted cash flow analysis to test property and equipment for impairment based on relevant market data. Management’s cash flow assumptions are an inherent part of our asset impairment evaluation and the use of different assumptions could produce results that differ from the reported amounts.

Goodwill

Management must apply judgment in determining the estimated fair value of its reporting units’ goodwill for purposes of performing impairment tests. Management uses all available information to make these fair value determinations, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets and observed market multiples. Goodwill is required to be evaluated on an annual basis and whenever, in management’s judgment, there is a significant change in circumstances that would be considered a triggering event.

Income Taxes

We account for taxes under the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities. Any resulting future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized. The assessment of the need for a valuation allowance requires management to make estimates and assumptions about future earnings, reversal of existing temporary differences and available tax planning strategies. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized resulting in an increase to income tax expense in our results of operations. In addition, the ability to record deferred tax assets in the future could be limited resulting in a higher effective tax rate in that future period.

The Company has not established deferred tax liabilities for certain of its foreign earnings as it intends to indefinitely reinvest those earnings to finance foreign activities. However, if these earnings become subject to U.S. federal tax, any required provision could have a material impact on our financial results.

RESULTS OF OPERATIONS BY BUSINESS SEGMENT

CNA Financial

As a result of CNA’s realignment of management responsibilities, CNA revised its property and casualty segments in the fourth quarter of 2009. There was no change in CNA’s Life & Group Non-Core and Other Insurance segments. Prior period segment disclosures have been conformed to the current year presentation. The new segment structure reflects the way CNA management currently reviews results and makes business decisions.

CNA’s core property and casualty commercial insurance operations are reported in two business segments: CNA Specialty and CNA Commercial. CNA Specialty provides a broad array of professional, financial and specialty property and casualty products and services, primarily through insurance brokers and managing general underwriters. CNA Commercial includes property and casualty coverages sold to small businesses and middle market entities and organizations primarily through an independent agency distribution system. CNA Commercial also includes commercial insurance and risk management products sold to large corporations primarily through insurance brokers. Previously,

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations – CNA Financial – (Continued)

CNA’s international operations were treated as a separate business unit within CNA Specialty. The products sold through CNA’s international operations are now reflected within CNA Specialty and CNA Commercial in a manner that aligns with the products within each segment. Additionally, CNA’s excess and surplus lines, which were previously included in CNA Specialty, are now included in CNA Commercial, as part of CNA Select Risk.

CNA’s non-core operations are managed in two segments: Life & Group Non-Core and Other Insurance. Life & Group Non-Core primarily includes the results of the life and group lines of business that have been placed in run-off. Other Insurance primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business primarily in run-off, including CNA Re. This segment also includes the results related to the centralized adjusting and settlement of asbestos and environmental pollution (“A&E”).

Reserves – Estimates and Uncertainties

CNA maintains reserves to cover its estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled (case reserves) and claims that have been incurred but not reported (“IBNR”). Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading “Insurance Reserves.” Adjustments to prior year reserve estimates, if necessary, are reflected in results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves as of each balance sheet date are provided in the Segment Results section of this MD&A and in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

The level of reserves CNA maintains represents its best estimate, as of a particular point in time, of what the ultimate settlement and administration of claims will cost based on CNA’s assessment of facts and circumstances known at that time. Reserves are not an exact calculation of liability but instead are complex estimates that CNA derives, generally utilizing a variety of actuarial reserve estimation techniques, from numerous assumptions and expectations about future events, both internal and external, many of which are highly uncertain.

CNA is subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on CNA’s business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Examples of emerging or potential claims and coverage issues include:

 

   

increases in the number and size of claims relating to injuries from various medical products including pharmaceuticals;

 

   

the effects of recessionary economic conditions and financial reporting scandals, which have resulted in an increase in the number and size of claims, due to corporate failures; these claims include both directors and officers (“D&O”) and errors and omissions (“E&O”) insurance claims;

 

   

class action litigation relating to claims handling and other practices;

 

   

construction defect claims, including claims for a broad range of additional insured endorsements on policies;

 

   

clergy abuse claims, including passage of legislation to reopen or extend various statutes of limitations; and

 

   

mass tort claims, including bodily injury claims related to welding rods, benzene, lead, noise induced hearing loss and various other chemical and radiation exposure claims.

CNA’s experience has been that establishing reserves for casualty coverages relating to A&E claims and claim adjustment expenses are subject to uncertainties that are greater than those presented by other claims. Estimating the ultimate cost of both reported and unreported A&E claims are subject to a higher degree of variability due to a number of additional factors, including among others:

 

   

coverage issues, including whether certain costs are covered under the policies and whether policy limits apply;

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations – CNA Financial – (Continued)

 

   

inconsistent court decisions and developing legal theories;

 

   

continuing aggressive tactics of plaintiffs’ lawyers;

 

   

the risks and lack of predictability inherent in major litigation;

 

   

changes in the frequency of A&E claims;

 

   

changes in the severity of claims, including bodily injury claims for malignancies arising out of exposure to asbestos;

 

   

the impact of the exhaustion of primary limits and the resulting increase in claims on any umbrella or excess policies CNA has issued;

 

   

CNA’s ability to recover reinsurance for A&E claims; and

 

   

Changes in the legal and legislative environment in which CNA operates.

It is also difficult to forecast changes in the legal and legislative environment and the impact on the future development of A&E claims. This development will be affected by future court decisions and interpretations, as well as changes in applicable legislation. It is difficult to predict the ultimate outcome of large coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective.

Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment reserves for A&E, particularly in an environment of emerging or potential claims and coverage issues that arise from industry practices and legal, judicial and social conditions. Therefore, these traditional actuarial methods and techniques are necessarily supplemented with additional estimation techniques and methodologies, many of which involve significant judgments that are required of management. For A&E, CNA regularly monitors its exposures, including reviews of loss activity, regulatory developments and court rulings. In addition, CNA performs a ground up analysis on its exposures. CNA’s actuaries, in conjunction with its specialized claim unit, use various modeling techniques to estimate its overall exposure to known accounts. CNA uses this information and additional modeling techniques to develop loss distributions and claim reporting patterns to determine reserves for accounts that will report A&E exposure in the future. Estimating the average claim size requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of legal fees, judicial decisions, legislative changes, and other factors. Due to the inherent uncertainties in estimating reserves for A&E claim and claim adjustment expenses and the degree of variability due to, among other things, the factors described above, CNA may be required to record material changes in CNA’s claim and claim adjustment expense reserves in the future, should new information become available or other developments emerge. See the A&E Reserves section of this MD&A and Note 9 of the Notes to Consolidated Financial Statements included under Item 8 for additional information relating to A&E claims and reserves.

The impact of these and other unforeseen emerging or potential claims and coverage issues is difficult to predict and could materially adversely affect the adequacy of CNA’s claim and claim adjustment expense reserves and could lead to future reserve additions. See the Segment Results sections of this MD&A and Note 9 of the Notes to Consolidated Financial Statements included under Item 8 for a discussion of changes in reserve estimates and the impact on our results of operations.

Establishing Reserve Estimates

In developing claim and claim adjustment expense (“loss” or “losses”) reserve estimates, CNA’s actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a “product” level. A product can be a line of business covering a subset of insureds such as commercial automobile liability for small and middle market customers, it can encompass several lines of business provided to a specific set of customers such as dentists, or it can be a particular type of claim such as construction defect. Every product is analyzed at least once during the year, and many

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations – CNA Financial – (Continued)

products are analyzed multiple times. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, CNA reviews actual loss emergence for all products each quarter.

The detailed analyses use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. CNA’s actuaries determine a point estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the product being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).

Most of CNA’s business can be characterized as long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. CNA’s long-tail exposures include commercial automobile liability, workers’ compensation, general liability, medical malpractice, other professional liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine and warranty. CNA Specialty and CNA Commercial contain both long-tail and short-tail exposures. Other Insurance contains long-tail exposures.

Various methods are used to project ultimate loss for both long-tail and short-tail exposures including, but not limited to, the following:

 

   

Paid Development,

 

   

Incurred Development,

 

   

Loss Ratio,

 

   

Bornhuetter-Ferguson Using Premiums and Paid Loss,

 

   

Bornhuetter-Ferguson Using Premiums and Incurred Loss,

 

   

Frequency times Severity, and

 

   

Stochastic modeling.

The paid development method estimates ultimate losses by reviewing paid loss patterns and applying them to accident years with further expected changes in paid loss. Selection of the paid loss pattern requires analysis of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves.

For many products, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers’ compensation.

        The incurred development method is similar to the paid development method, but it uses case incurred losses instead of paid losses. Since the method uses more data (case reserves in addition to paid losses) than the paid development method, the incurred development patterns may be less variable than paid patterns. However, selection of the incurred loss pattern requires analysis of all of the factors above. In addition, the inclusion of case reserves can lead to distortions

 

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if changes in case reserving practices have taken place, and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available.

The loss ratio method multiplies premiums by an expected loss ratio to produce ultimate loss estimates for each accident year. This method may be useful for immature accident periods or if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios from earlier accident years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes, and other applicable factors.

The Bornhuetter-Ferguson using premiums and paid loss method is a combination of the paid development approach and the loss ratio approach. This method normally determines expected loss ratios similar to the approach used to estimate the expected loss ratio for the loss ratio method and requires analysis of the same factors described above. This method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the paid development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the paid development method requires consideration of all factors listed in the description of the paid development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.

The Bornhuetter-Ferguson using premiums and incurred loss method is similar to the Bornhuetter-Ferguson using premiums and paid loss method except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method requires analysis of all the factors that need to be reviewed for the loss ratio and incurred development methods.

The Frequency times Severity method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for products where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that impact the number and size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims requires analysis of several factors including the rate at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.

Stochastic modeling produces a range of possible outcomes based on varying assumptions related to the particular product being modeled. For some products, CNA uses models which rely on historical development patterns at an aggregate level, while other products are modeled using individual claim variability assumptions supplied by the claims department. In either case, multiple simulations are run and the results are analyzed to produce a range of potential outcomes. The results will typically include a mean and percentiles of the possible reserve distribution which aid in the selection of a point estimate.

For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, CNA’s actuaries typically assign more weight to the incurred development method than to the paid development method. As claims continue to settle and the volume of paid loss increases, the actuaries may assign additional weight to the paid development method. For most of CNA’s products, even the incurred losses for accident years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, CNA will not assign any weight to the paid and incurred development methods. CNA will use loss ratio, Bornhuetter-Ferguson and average loss methods. For short-tail exposures, the paid and incurred development methods can often be relied on sooner primarily because CNA’s history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, CNA may also use loss ratio, Bornhuetter-Ferguson and average loss methods for short-tail exposures.

 

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For other more complex products where the above methods may not produce reliable indications, CNA uses additional methods tailored to the characteristics of the specific situation. Such products include construction defect losses and A&E.

For construction defect losses, CNA’s actuaries organize losses by report year. Report year groups claims by the year in which they were reported. To estimate losses from claims that have not been reported, various extrapolation techniques are applied to the pattern of claims that have been reported to estimate the number of claims yet to be reported. This process requires analysis of several factors including the rate at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. An average claim size is determined from past experience and applied to the number of unreported claims to estimate reserves for these claims.

Periodic Reserve Reviews

The reserve analyses performed by CNA’s actuaries result in point estimates. Each quarter, the results of the detailed reserve reviews are summarized and discussed with CNA’s senior management to determine the best estimate of reserves. This group considers many factors in making this decision. The factors include, but are not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in CNA’s pricing and underwriting, pricing and underwriting trends in the insurance market, and legal, judicial, social and economic trends.

CNA’s recorded reserves reflect its best estimate as of a particular point in time based upon known facts, consideration of the factors cited above, and its judgment. The carried reserve may differ from the actuarial point estimate as the result of CNA’s consideration of the factors noted above as well as the potential volatility of the projections associated with the specific product being analyzed and other factors impacting claims costs that may not be quantifiable through traditional actuarial analysis. This process results in management’s best estimate which is then recorded as the loss reserve.

Currently, CNA’s recorded reserves are modestly higher than the actuarial point estimate. For both CNA Commercial and CNA Specialty, the difference between CNA’s reserves and the actuarial point estimate is primarily driven by uncertainty with respect to immature accident years, claim cost inflation, changes in claims handling, tort reform roll-backs which may adversely impact claim costs, and the effects of the recessionary economy. For Other Insurance, the carried reserve is relatively consistent with the actuarial point estimate.

The key assumptions fundamental to the reserving process are often different for various products and accident years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the paid development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims. As a result, the effect on reserve estimates of a particular change in assumptions usually cannot be specifically quantified, and changes in these assumptions cannot be tracked over time.

CNA’s recorded reserves are management’s best estimate. In order to provide an indication of the variability associated with CNA’s net reserves, the following discussion provides a sensitivity analysis that shows the approximate estimated impact of variations in the most significant factor affecting CNA’s reserve estimates for particular types of business. These significant factors are the ones that could most likely materially impact the reserves. This discussion covers the major types of business for which CNA believes a material deviation to its reserves is reasonably possible. There can be no assurance that actual experience will be consistent with the current assumptions or with the variation indicated by the discussion. In addition, there can be no assurance that other factors and assumptions will not have a material impact on CNA’s reserves.

Within CNA Specialty, CNA believes a material deviation to its net reserves is reasonably possible for professional liability and related business. This business includes professional liability coverages provided to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. This business also includes D&O, employment practices, fiduciary and fidelity coverages as well as insurance products serving the healthcare delivery system. The most significant factor affecting reserve estimates for this business is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions,

 

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legislation and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim severity. If the estimated claim severity increases by 9.0%, CNA estimates that the net reserves would increase by approximately $450 million. If the estimated claim severity decreases by 3.0%, CNA estimates that net reserves would decrease by approximately $150 million. CNA’s net reserves for this business were approximately $4.9 billion at December 31, 2009.

Within CNA Commercial, the two types of business for which CNA believes a material deviation to its net reserves is reasonably possible are workers’ compensation and general liability.

For CNA Commercial workers’ compensation, since many years will pass from the time the business is written until all claim payments have been made, claim cost inflation on claim payments is the most significant factor affecting workers’ compensation reserve estimates. Workers’ compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers’ compensation claim cost inflation increases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would increase by approximately $450 million. If estimated workers’ compensation claim cost inflation decreases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would decrease by approximately $400 million. CNA’s net reserves for CNA Commercial workers’ compensation were approximately $4.8 billion at December 31, 2009.

For CNA Commercial general liability, the most significant factor affecting reserve estimates is severity. Claim severity is driven by changes in the cost to repair or replace property, the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other factors. If the estimated claim severity for general liability increases by 6.0%, CNA estimates that its net reserves would increase by approximately $200 million. If the estimated claim severity for general liability decreases by 3.0%, CNA estimates that its net reserves would decrease by approximately $100 million. CNA’s net reserves for CNA Commercial general liability were approximately $3.3 billion at December 31, 2009.

Within Other Insurance, the two types of business for which CNA believes a material deviation to its net reserves is reasonably possible are CNA Re and A&E.

For CNA Re, the predominant method used for estimating reserves is the incurred development method. Changes in the cost to repair or replace property, the cost of medical care, the cost of wage replacement, the rate at which ceding companies report claims, judicial decisions, legislation and other factors all impact the incurred development pattern for CNA Re. The pattern selected results in the incurred development factor that estimates future changes in case incurred loss. If the estimated incurred development factor for CNA Re increases by 40.0%, CNA estimates that its net reserves for CNA Re would increase by approximately $100 million. If the estimated incurred development factor for CNA Re decreases by 30.0%, CNA estimates that its net reserves would decrease by approximately $75 million. CNA’s net reserves for CNA Re were approximately $0.7 billion at December 31, 2009.

For A&E, the most significant factor affecting reserve estimates is overall account severity. Overall account severity for A&E reflects the combined impact of economic trends (inflation), changes in the types of defendants involved, the expected mix of asbestos disease types, judicial decisions, legislation and other factors. If the estimated overall account severity for A&E increases approximately 20.0%, CNA estimates that its A&E net reserves would increase by approximately $300 million. If the estimated overall account severity for A&E decreases by approximately 10.0%, CNA estimates that its A&E net reserves would decrease by approximately $150 million. CNA’s net reserves for A&E were approximately $1.4 billion at December 31, 2009.

Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, CNA regularly reviews the adequacy of its reserves and reassesses its reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods.

In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, CNA reviews its reserve estimates on a regular basis and make adjustments in the period that the need for such adjustments is determined. These reviews have resulted in CNA’s identification of information and trends

 

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that have caused CNA to change its reserves in prior periods and could lead to the identification of a need for additional material increases or decreases in claim and claim adjustment expense reserves, which could materially affect our results of operations and equity and CNA’s business, insurer financial strength and debt ratings positively or negatively. See the Ratings section of this MD&A for further information regarding CNA’s financial strength and debt ratings.

Segment Results

CNA utilizes the net operating income financial measure to monitor its operations. Net operating income is calculated by excluding from net income the after tax effects of (i) net realized investment gains or losses, (ii) income or loss from discontinued operations and (iii) any cumulative effects of changes in accounting guidance. In evaluating the results of the CNA Specialty and CNA Commercial segments, CNA utilizes the loss ratio, the expense ratio, the dividend ratio, and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders’ dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios.

Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals, net of reinsurance, for prior years are defined as net prior year development within this MD&A. These changes can be favorable or unfavorable. Net prior year development does not include the impact of related acquisition expenses. Further information on CNA’s reserves is provided in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

The following discusses the results of continuing operations for CNA’s operating segments.

CNA Specialty

The following table summarizes the results of operations for CNA Specialty:

 

Year Ended December 31    2009     2008     2007       
(In millions, except %)      

Net written premiums

   $ 2,684      $ 2,719      $ 2,766     

Net earned premiums

     2,697        2,755        2,759     

Net investment income

     526        354        493     

Net operating income

     532        372        467     

Net realized investment losses

     (110     (150     (41  

Net income

     422        222        426     

Ratios:

        

Loss and loss adjustment expense

     56.9     61.7     62.5  

Expense

     29.3        27.3        25.8     

Dividend

     0.3        0.5        0.2     
 

Combined

     86.5     89.5     88.5  
 

2009 Compared with 2008

Net written premiums for CNA Specialty decreased $35 million in 2009 as compared with 2008. The decrease in net written premiums was driven by CNA’s architects and engineers and surety bond lines of business, as current economic conditions have led to decreased insured exposures. This, along with the competitive market conditions, may continue to put ongoing pressure on premium and income levels and the expense ratio. Net written premiums were also unfavorably impacted by foreign exchange. Net earned premiums decreased $58 million as compared with the same period in 2008, consistent with the trend of lower net written premiums.

 

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CNA Specialty’s average rate decreased 2.0% for 2009 as compared to a decrease of 4.0% for 2008 for policies that renewed in each period. Retention rates of 85.0% were achieved for those policies that were available for renewal in each period.

Net income improved $200 million in 2009 as compared with 2008. This increase was due to improved net operating income and lower net realized investment losses. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.

Net operating income improved $160 million in 2009 as compared with 2008, primarily due to higher net investment income and increased favorable net prior year development.

The combined ratio improved 3.0 points in 2009 as compared with 2008. The loss ratio improved 4.8 points primarily due to increased favorable net prior year development. The expense ratio increased 2.0 points in 2009 as compared with 2008, primarily due to higher underwriting expenses and the lower net earned premium base. Underwriting expenses increased primarily due to higher employee-related costs.

Favorable net prior year development of $224 million was recorded in 2009 compared to $106 million in 2008. Further information on CNA Specialty net prior year development for 2009 and 2008 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

The following table summarizes the gross and net carried reserves for CNA Specialty:

 

December 31    2009    2008     
(In millions)    

Gross Case Reserves

   $ 2,208    $ 2,105  

Gross IBNR Reserves

     4,714      4,616  
 

Total Gross Carried Claim and Claim Adjustment Expense Reserves

     6,922    $ 6,721  
 

Net Case Reserves

   $ 1,781    $ 1,639  

Net IBNR Reserves

     4,085      3,896  
 

Total Net Carried Claim and Claim Adjustment Expense Reserves

   $ 5,866    $ 5,535  
 

2008 Compared with 2007

Net written premiums for CNA Specialty decreased $47 million in 2008 as compared with 2007. Premiums written in 2008 were unfavorably impacted by competitive market conditions resulting in decreased production, as compared with 2007, primarily in professional management and liability lines. The unfavorable impact in premiums written was partially offset by decreased ceded premiums primarily due to decreased use of reinsurance. Net earned premiums decreased $4 million as compared with the same period in 2007, consistent with the decrease in net written premiums.

CNA Specialty’s rate on average decreased 4.0% for 2008, as compared to a decrease of 5.0% for 2007 for policies that renewed in each period. Retention rates of 85.0% and 83.0% were achieved for those policies that were up for renewal in each period.

Net income decreased $204 million in 2008 as compared with 2007. This decrease was primarily attributable to higher net realized investment losses and lower net operating income. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.

Net operating income decreased $95 million in 2008 as compared with 2007. This decrease was primarily driven by significantly lower net investment income and decreased current accident year underwriting results. These unfavorable results were partially offset by the impact of favorable net prior year development in 2008 as compared to unfavorable net prior year development in 2007.

 

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The combined ratio increased 1.0 point in 2008 as compared with 2007. The loss ratio improved 0.8 points, primarily due to the impact of development. This was partially offset by higher current accident year loss ratios recorded primarily in CNA’s E&O and D&O coverages for financial institutions due to the financial markets credit crisis in 2008.

The expense ratio increased 1.5 points in 2008 as compared with 2007. The increase primarily related to increased underwriting expenses and reduced ceding commissions.

Favorable net prior year development of $106 million was recorded in 2008 compared to unfavorable net prior year development of $24 million in 2007. Further information on CNA Specialty net prior year development for 2008 and 2007 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

CNA Commercial

The following table summarizes the results of operations for CNA Commercial:

 

Year Ended December 31    2009     2008     2007      
 
(In millions, except %)      

Net written premiums

   $ 3,448      $ 3,770      $ 4,007     

Net earned premiums

     3,432        3,787        4,104     

Net investment income

     922        603        1,006     

Net operating income

     456        261        619     

Net realized investment losses

     (209     (302     (93  

Net income (loss)

     247        (41     526     

Ratios:

        

Loss and loss adjustment expense

     69.6     73.0     66.8  

Expense

     35.2        31.2        32.1     

Dividend

     0.3          0.2     
 

Combined

     105.1     104.2     99.1  
 

2009 Compared with 2008

Net written premiums for CNA Commercial decreased $322 million in 2009 as compared to 2008. Written premiums declined in most lines primarily due to general economic conditions. Current economic conditions have led to decreased insured exposures, such as in small businesses and in the construction industry due to smaller payrolls and reduced project volume. This, along with competitive market conditions, may continue to put ongoing pressure on premium and income levels and the expense ratio. Net earned premiums decreased $355 million in 2009 as compared with 2008, consistent with the trend of lower net written premiums. Premiums were also impacted by unfavorable premium development recorded in 2009 and unfavorable foreign exchange.

CNA Commercial’s average rate was flat, as compared to a decrease of 4.0% for 2008 for policies that renewed in each period. Retention rates of 81.0% were achieved for those policies that were available for renewal in both periods.

Net results improved $288 million in 2009 as compared with 2008. This improvement was due to increased net operating income and decreased net realized investment losses. See the Investments section of this MD&A for further discussion of net realized investment results and net investment income.

Net operating income improved $195 million in 2009 compared with 2008. This improvement was primarily driven by higher net investment income and lower catastrophe losses. Partially offsetting these favorable items was an unfavorable change in current accident year underwriting results excluding catastrophes.

The combined ratio increased 0.9 points in 2009 as compared with 2008. The loss ratio improved 3.4 points primarily due to decreased catastrophe losses, partially offset by the impact of higher current accident year non-catastrophe loss ratios. Catastrophe losses were $82 million, or 2.4 points of the loss ratio, for 2009 as compared to $343 million, or 9.0 points of the loss ratio, for 2008. The current accident year loss ratio, excluding catastrophe losses, was unfavorably

 

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impacted by loss experience in several lines of business, including workers’ compensation and renewable energy, as well as several significant property losses.

The expense ratio increased 4.0 points in 2009 as compared with 2008, primarily related to higher underwriting expenses, unfavorable changes in estimates for insurance-related assessments and the lower net earned premium base. Underwriting expenses increased primarily due to higher employee-related costs.

In 2008, the amount due from policyholders related to losses under deductible policies within CNA Commercial was reduced by $90 million for insolvent insureds. The reduction of this amount, which was reflected as unfavorable net prior year reserve development in 2008, had no effect on 2008 results of operations as CNA had previously recognized provisions in prior years. These impacts were reported in Insurance claims and policyholders’ benefits in the 2008 Consolidated Statements of Income.

Favorable net prior year development of $168 million was recorded in 2009, compared to favorable net prior year development of $96 million in 2008. Excluding the impact of the $90 million of unfavorable net prior year reserve development discussed above, which had no net impact on the 2008 results of operations, favorable net prior year development was $186 million. Further information on CNA Commercial net prior year development for 2009 and 2008 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

The following table summarizes the gross and net carried reserves for CNA Commercial:

 

December 31    2009    2008    
 
(In millions)    

Gross Case Reserves

   $ 6,510    $ 6,772  

Gross IBNR Reserves

     6,495      6,837  
 

Total Gross Carried Claim and Claim Adjustment Expense Reserves

   $ 13,005    $ 13,609  
 

Net Case Reserves

   $ 5,269    $ 5,505  

Net IBNR Reserves

     5,580      5,673  
 

Total Net Carried Claim and Claim Adjustment Expense Reserves

   $ 10,849    $ 11,178  
 

2008 Compared with 2007

Net written premiums for CNA Commercial decreased $237 million in 2008 as compared with 2007. Premiums written in 2008 were unfavorably impacted by competitive market conditions resulting in decreased production, as compared with 2007, across most lines of business. This unfavorable impact was partially offset by decreased ceded premiums. Net earned premiums decreased $317 million in 2008 as compared with 2007, consistent with the decreased net written premiums.

CNA Commercial’s average rate decreased 4.0% for 2008, as compared to a decrease of 3.0% for 2007 for policies that renewed in each period. Retention rates of 81.0% and 79.0% were achieved for those policies that were available for renewal in each period.

Net results decreased $567 million in 2008 as compared with 2007. This decrease was attributable to decreased net operating income and higher net realized investment losses. See the Investments section of this MD&A for further discussion of the net realized investment results and net investment income.

Net operating income decreased $358 million in 2008 as compared with 2007. This decrease was primarily driven by significantly lower net investment income and higher catastrophe impacts. The catastrophe impacts were $207 million after tax and noncontrolling interest in 2008, which included a $6 million after tax and noncontrolling interest catastrophe-related insurance assessment, as compared to catastrophe losses of $44 million after tax and noncontrolling interest in 2007.

 

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The combined ratio increased 5.1 points in 2008 as compared with 2007. The loss ratio increased 6.2 points primarily due to increased catastrophe losses. Catastrophes losses related to 2008 events had an adverse impact of 9.0 points on the loss ratio in 2008 compared with an adverse impact of 1.8 points in 2007.

The expense ratio decreased 0.9 points in 2008 as compared with 2007 primarily related to changes in the assessment rates imposed by certain states for insurance-related assessments. The dividend ratio decreased 0.2 points in 2008 as compared with 2007 due to increased favorable dividend development in the workers’ compensation line of business.

Favorable net prior year development of $96 million was recorded in 2008. Excluding the impact of the $90 million of unfavorable net prior year reserve development discussed above, which had no net impact on the 2008 results of operations, favorable net prior year development was $186 million. Favorable net prior year development of $183 million was recorded in 2007. Further information on CNA Commercial net prior year development for 2008 and 2007 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

Life & Group Non-Core

The following table summarizes the results of operations for Life & Group Non-Core.

 

Year Ended December 31    2009     2008     2007      
 
(In millions)      

Net earned premiums

   $ 595      $ 612      $ 618     

Net investment income

     664        484        622     

Net operating loss

     (14     (97     (141  

Net realized investment losses

     (138     (212     (33  

Net loss

     (152     (309     (174  
 

2009 Compared with 2008

Net earned premiums for Life & Group Non-Core decreased $17 million in 2009 as compared with 2008. Net earned premiums relate primarily to the individual and group long term care businesses.

Net loss decreased $157 million in 2009 as compared with 2008. The decrease in net loss was primarily due to improved net realized investment results, favorable performance on CNA’s remaining pension deposit business as further discussed below, and a settlement reached with Willis Limited that resolved litigation related to the placement of personal accident reinsurance. Under the settlement agreement, Willis Limited agreed to pay CNA a total of $130 million, which resulted in an after tax and noncontrolling interest gain of $55 million, net of reinsurance. This litigation was brought by CNA in response to its settlement of the IGI contingency in 2007, as discussed below.

Certain of the separate account investment contracts related to CNA’s pension deposit business guarantee principal and an annual minimum rate of interest, for which CNA recorded an additional pretax liability in Policyholders’ funds in 2008. Based on the increase in value of the investments supporting this business, CNA decreased this pretax liability by $42 million during 2009. During 2008, CNA increased this liability by $68 million.

These favorable impacts were partially offset by unfavorable results in CNA’s long term care business and a $25 million after tax and noncontrolling interest legal accrual recorded in the second quarter of 2009 related to a previously held limited partnership investment. The limited partnership investment supported the indexed group annuity portion of CNA’s pension deposit business.

Net investment income for the year ended December 31, 2008 included trading portfolio losses of $146 million, which were substantially offset by a corresponding decrease in the policyholders’ funds reserves supported by the trading portfolio. This trading portfolio supported the indexed group annuity portion of CNA’s pension deposit business. During 2008, CNA settled these liabilities with policyholders with no material impact to results of operations. That business had a net loss of $20 million for the year ended December 31, 2008.

 

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2008 Compared with 2007

Net earned premiums for Life & Group Non-Core decreased $6 million in 2008 as compared with 2007.

Net loss increased $135 million in 2008 as compared with 2007. The increase in net loss was primarily due to increased net realized investment losses and adverse investment performance on a portion of CNA’s pension deposit business. As discussed above, during 2008, CNA recorded a pretax liability of $68 million in Policyholders’ funds due to the performance of the related assets supporting the pension deposit business in 2008. There was no liability recorded in 2007 related to this business.

The net loss in 2007 included an after tax and noncontrolling interest loss of $96 million related to the settlement of the IGI contingency. The IGI contingency related to reinsurance arrangements with respect to personal accident insurance coverages provided between 1997 and 1999 which were the subject of arbitration proceedings.

The decreased net investment income included a decline of trading portfolio results, which was substantially offset by a corresponding decrease in the policyholders’ fund reserves supported by the indexed group annuity trading portfolio. The trading portfolio supported the indexed group annuity portion of CNA’s pension deposit business. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.

Other Insurance

The following table summarizes the results of operations for the Other Insurance segment, including A&E and intrasegment eliminations.

 

Year Ended December 31    2009     2008     2007      
 
(In millions)

Net investment income

   $ 208      $ 178      $ 312     

Net operating income (loss)

     (70     (48     5     

Net realized investment losses

     (48     (92     (13  

Net loss

     (118     (140     (8  
 

2009 Compared with 2008

Net loss decreased $22 million in 2009 as compared with 2008, primarily due to improved net realized investment results and higher net investment income. Partially offsetting these favorable items was increased unfavorable net prior year development primarily related to A&E.

Unfavorable net prior year development of $184 million was recorded in 2009, including $79 million for asbestos exposures and $76 million for environmental pollution exposures. In CNA’s most recent actuarial ground up review CNA noted adverse development in various asbestos accounts due to increases in average claim severity and defense expense arising from increased trial activity. Additionally, CNA has not seen a decline in the overall emergence of new accounts during the last few years. CNA noted adverse development in various pollution accounts due to changes in the liabilities attributed to its policyholders and adverse changes in case law impacting insurers’ coverage obligations. These changes in turn increased CNA’s account estimates on certain accounts. In addition, the frequency of environmental pollution claims did not decline at the rate previously anticipated. Unfavorable net prior year development of $122 million was recorded in 2008. Further information on Other Insurance net prior year development for 2009 and 2008 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

 

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The following table summarizes the gross and net carried reserves for the Other Insurance segment:

 

December 31    2009    2008    
 
(In millions)

Gross Case Reserves

   $ 1,548    $ 1,823  

Gross IBNR Reserves

     2,458      2,578  
 

Total Gross Carried Claim and Claim Adjustment Expense Reserves

   $ 4,006    $ 4,401  
 

Net Case Reserves

   $ 972    $ 1,126  

Net IBNR Reserves

     1,515      1,561  
 

Total Net Carried Claim and Claim Adjustment Expense Reserves

   $ 2,487    $ 2,687  
 

2008 Compared with 2007

Net results decreased $132 million in 2008 as compared with 2007. This decrease was primarily due to lower net investment income, higher net realized investment losses and expenses associated with a legal contingency. These unfavorable impacts were partially offset by a $27 million release from the allowance for uncollectible reinsurance receivables arising from a change in estimate. In addition, the 2007 results included current accident year losses related to certain mass torts.

Unfavorable net prior year development of $122 million was recorded during 2008. Unfavorable net prior year development of $86 million was recorded in 2007. Further information on Other Insurance’s net prior year development for 2008 and 2007 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

A&E Reserves

CNA’s property and casualty insurance subsidiaries have actual and potential exposures related to A&E claims.

Establishing reserves for A&E claim and claim adjustment expenses is subject to a higher degree of variability due to a number of factors, as further discussed in the Reserve Estimates & Uncertainties section of this MD&A. Due to the inherent uncertainties in estimating claim and claim adjustment expense reserves for A&E and due to the significant uncertainties described related to A&E claims, CNA’s ultimate liability for these cases, both individually and in aggregate, may exceed the recorded reserves. Any such potential additional liability, or any range of potential additional amounts, cannot be reasonably estimated currently, but could be material to our results of operations and equity, and CNA’s business, insurer financial strength and debt ratings.

Asbestos

In the past several years, CNA experienced, at certain points in time, significant increases in claim counts for asbestos-related claims. The factors that led to these increases included, among other things, intensive advertising campaigns by lawyers for asbestos claimants, mass medical screening programs sponsored by plaintiff lawyers and the addition of new defendants such as the distributors and installers of products containing asbestos. In recent years, the rate of new filings has decreased. Various challenges to mass screening claimants have been successful. Historically, the majority of asbestos bodily injury claims have been filed by persons exhibiting few, if any, disease symptoms. Studies have concluded that the percentage of unimpaired claimants to total claimants ranges between 66.0% and up to 90.0%. Some courts and some state statutes mandate that so-called “unimpaired” claimants may not recover unless at some point the claimant’s condition worsens to the point of impairment. Some plaintiffs classified as “unimpaired” continue to challenge those orders and statutes. Therefore, the ultimate impact of the orders and statutes on future asbestos claims remains uncertain.

Despite the decrease in new claim filings in recent years, there are several factors, in CNA’s view, negatively impacting asbestos claim trends. Plaintiff attorneys who previously sued entities that are now bankrupt continue to seek other viable targets. As plaintiff attorneys named additional defendants to new and existing asbestos bodily injury lawsuits, CNA experienced an increase in the total number of policyholders with current asbestos claims. Companies with few or no previous asbestos claims are becoming targets in asbestos litigation and, although they may have little or

 

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no liability, nevertheless must be defended. Additionally, plaintiff attorneys and trustees for future claimants are demanding that policy limits be paid lump-sum into the bankruptcy asbestos trusts prior to presentation of valid claims and medical proof of these claims. Various challenges to these practices have succeeded in litigation, and are continuing to be litigated. Plaintiff attorneys and trustees for future claimants are also attempting to devise claims payment procedures for bankruptcy trusts that would allow asbestos claims to be paid under lax standards for injury, exposure and causation. This also presents the potential for exhausting policy limits in an accelerated fashion. Challenges to these practices are being mounted, though the ultimate impact or success of these tactics remains uncertain.

CNA is involved in significant asbestos-related claim litigation, which is described in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

Environmental Pollution

Environmental pollution cleanup is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to cleanup. The insurance industry has been 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-Superfunds”) govern the cleanup and restoration of toxic waste sites and formalize the concept of legal liability for cleanup and restoration by “Potentially Responsible Parties” (“PRP”s). Superfund and the mini-Superfunds establish mechanisms to pay for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs. The extent of liability to be allocated to a PRP is dependent upon a variety of factors. Further, the number of waste sites subject to cleanup is unknown. To date, approximately 1,500 cleanup sites have been identified by the Environmental Protection Agency (“EPA”) and included on its National Priorities List (“NPL”). State authorities have designated many cleanup sites as well.

Many policyholders have made claims against CNA for defense costs and indemnification in connection with environmental pollution matters. The vast majority of these claims relate to accident years 1989 and prior, which coincides with CNA’s adoption of the Simplified Commercial General Liability coverage form, which includes what is referred to in the industry as absolute pollution exclusion. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether cleanup costs are considered damages under the policies, trigger of coverage, allocation of liability among triggered policies, applicability of pollution exclusions and owned property exclusions, the potential for joint and several liability and the definition of an occurrence. To date, courts have been inconsistent in their rulings on these issues.

Further information on A&E claim and claim adjustment expense reserves and net prior year development is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.

Diamond Offshore

The two most significant variables affecting revenues are dayrates for rigs and rig utilization rates, each of which is a function of rig supply and demand in the marketplace. Demand for drilling services is dependent upon the level of expenditures set by oil and gas companies for offshore exploration and development, as well as a variety of political and economic factors. The availability of rigs in a particular geographical region also affects both dayrates and utilization rates. These factors are not within Diamond Offshore’s control and are difficult to predict.

Demand affects the number of days the fleet is utilized and the dayrates earned. When a rig is idle, no dayrate is earned and revenues will decrease as a result. Revenues can also be affected as a result of the acquisition or disposal of rigs, required surveys and shipyard upgrades. In order to improve utilization or realize higher dayrates, Diamond Offshore may mobilize its rigs from one market to another. However, during periods of mobilization, revenues may be adversely affected. As a response to changes in demand, Diamond Offshore may withdraw a rig from the market by stacking it or may reactivate a rig stacked previously, which may decrease or increase revenues.

Diamond Offshore’s operating income is primarily affected by revenue factors, but is also a function of varying levels of operating expenses. Diamond Offshore’s contract drilling expenses represent all direct and indirect costs associated with the operation and maintenance of its drilling equipment. The principal components of Diamond Offshore’s contract drilling costs are, among other things, direct and indirect costs of labor and benefits, repairs and maintenance, freight,

 

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regulatory inspections, boat and helicopter rentals and insurance. Labor and repair and maintenance costs represent the most significant components of contract drilling expenses. In periods of high, sustained utilization, maintenance and repair costs may increase in order to maintain Diamond Offshore’s equipment in proper, working order. Costs to repair and maintain equipment fluctuate depending upon the type of activity the drilling unit is performing, as well as the age and condition of the equipment and the regions in which the rigs are working. In general, Diamond Offshore’s labor costs increase primarily due to higher salary levels, rig staffing requirements and costs associated with labor regulations in the geographic regions in which Diamond Offshore’s rigs operate.

Contract drilling expenses generally are not affected by changes in dayrates, and short term reductions in utilization do not necessarily result in lower operating expenses. For instance, if a rig is to be idle for a short period of time, few decreases in contract drilling expenses may actually occur since the rig is typically maintained in a prepared or “ready stacked” state with a full crew. In addition, when a rig is idle, Diamond Offshore is responsible for certain contract drilling expenses such as rig fuel and supply boat costs, which are typically costs of the operator when a rig is under contract. However, if the rig is to be idle for an extended period of time, Diamond Offshore may reduce the size of a rig’s crew and take steps to “cold stack” the rig, which lowers expenses and partially offsets the impact on operating income.

Operating income is also negatively impacted when Diamond Offshore performs certain regulatory inspections that are due every five years (“5-year survey”) for each of Diamond Offshore’s rigs as well as intermediate surveys, which are performed at interim periods between 5-year surveys. Contract drilling revenue decreases because these surveys are performed during scheduled downtime in a shipyard. No revenue is generally earned during periods of downtime for regulatory surveys. Contract drilling expenses increase as a result of these surveys due to the cost to mobilize the rigs to a shipyard, inspection costs incurred and repair and maintenance costs. Repair and maintenance costs may be required resulting from the survey or may have been previously planned to take place during this mandatory downtime. The number of rigs undergoing a 5-year survey will vary from year to year, as well as from quarter to quarter.

The global economy remained weak in the fourth quarter of 2009 and into the first quarter of 2010, and energy prices continued to be volatile. Given the unpredictable economic environment, the demand for Diamond Offshore’s services and the dayrates it was able to command for new contracts softened. This volatility and uncertainty could continue until the global economy improves. Absent global economic improvement, the decline in drilling activity could be further exacerbated by the influx of new build rigs over the next several years, particularly in regard to jack-up units. Diamond Offshore has experienced negative effects of the current market such as customer credit problems, customers attempting to renegotiate or terminate contracts, one customer seeking bankruptcy protection, a further slowing in the pace of new contracting activity, declines in dayrates for new contracts, declines in utilization and the stacking of idle equipment. Nevertheless, during 2009, Diamond Offshore added new commitments to its contract backlog. Diamond Offshore entered 2010 with a contract backlog approaching $8.5 billion, which it expects to help mitigate the impact of the current market in 2010.

Contract Drilling Backlog

The following table reflects Diamond Offshore’s contract drilling backlog as of February 1, 2010, October 22, 2009 (the date reported in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009) and February 5, 2009 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2008). The October 2009 period includes both firm commitments (typically represented by signed contracts), as well as previously-disclosed letters of intent (“LOIs”), where indicated. An LOI is subject to customary conditions, including the execution of a definitive agreement, and as such may not result in a binding contract. Contract drilling backlog is calculated by multiplying the contracted operating dayrate by the firm contract period and adding one-half of any potential rig performance bonuses. Diamond Offshore’s calculation also assumes full utilization of its drilling equipment for the contract period (excluding scheduled shipyard and survey days); however, the amount of actual revenue earned and the actual periods during which revenues are earned will be different than the amounts and periods shown in the tables below due to various factors. Utilization rates, which generally approach 95.0% - 98.0% during contracted periods, can be adversely impacted by downtime due to various operating factors including, but not limited to, weather conditions and unscheduled repairs and maintenance. Contract drilling backlog excludes revenues for mobilization, demobilization,

 

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contract preparation and customer reimbursables. No revenue is generally earned during periods of downtime for regulatory surveys. Changes in Diamond Offshore’s contract drilling backlog between periods are a function of the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts.

 

      February 1,
2010 (a)(b)
   October 22,
2009 (c)
   February 5,
2009
    
(In millions)    

High specification floaters (a) (c)

   $ 4,177    $ 4,450    $ 4,448  

Intermediate semisubmersible rigs (b)

     4,030      4,061      5,985  

Jack-ups

     249      249      421  
 

Total

   $ 8,456    $ 8,760    $ 10,854  
 

 

(a)

Contract drilling backlog as of February 1, 2010 for Diamond Offshore’s high specification floaters includes $1.3 billion attributable to expected operations offshore Brazil for the years 2010 to 2016.

(b)

Contract drilling backlog as of February 1, 2010 for Diamond Offshore’s intermediate semisubmersible rigs includes $2.9 billion attributable to expected operations offshore Brazil for the years 2010 to 2015.

(c)

Contract drilling backlog as of October 22, 2009 included an aggregate $124 million in contract drilling revenue related to future work for one of Diamond Offshore’s high specification floaters for which a definitive agreement was subsequently reached.

The following table reflects the amount of Diamond Offshore’s contract drilling backlog by year as of February 1, 2010.

 

Year Ended December 31    Total    2010    2011    2012    2013 - 2016     
(In millions)    

High specification floaters (a)

   $ 4,177    $ 1,536    $ 1,245    $ 570    $ 826  

Intermediate semisubmersible rigs (b)

     4,030      1,393      1,026      860      751  

Jack-ups

     249      210      39        
 

Total

   $ 8,456    $ 3,139    $ 2,310    $ 1,430    $ 1,577  
 

 

(a)

Contract drilling backlog as of February 1, 2010 for Diamond Offshore’s high specification floaters includes $374 million, $294 million and $135 million for the years 2010, 2011 and 2012, and $476 million in the aggregate for the years 2013 to 2016 attributable to expected operations offshore Brazil.

(b)

Contract drilling backlog as of February 1, 2010 for Diamond Offshore’s intermediate semisubmersible rigs includes $715 million, $788 million and $732 million for the years 2010, 2011 and 2012, and $698 million in the aggregate for the years 2013 to 2015 attributable to expected operations offshore Brazil.

The following table reflects the percentage of rig days committed by year as of February 1, 2010. The percentage of rig days committed is calculated as the ratio of total days committed under contracts and LOIs, as well as scheduled shipyard, survey and mobilization days for all rigs in Diamond Offshore’s fleet, to total available days (number of rigs multiplied by the number of days in a particular year). The total available days have been calculated based on the expected final commissioning date for the Ocean Valor.

 

Year Ended December 31    2010 (a)     2011 (a)     2012     2013 - 2016       

High specification floaters

   84.0   57.0   27.0   10.0  

Intermediate semisubmersible rigs

   78.0      54.0      44.0      10.0     

Jack-ups

   42.0      6.0         

 

(a)

Includes approximately 970 and 80 scheduled shipyard, survey and mobilization days for 2010 and 2011.

 

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Results of Operations

The following table summarizes the results of operations for Diamond Offshore for the years ended December 31, 2009, 2008 and 2007 as presented in Note 23 of the Notes to Consolidated Financial Statements included under Item 8:

 

Year Ended December 31    2009     2008     2007       
(In millions)      

Revenues:

        

Contract drilling

   $ 3,537      $ 3,476      $ 2,506     

Net investment income

     4        12        34     

Investment gains (losses)

     1        1        (1  

Other revenue

     112        (2     77     
 

Total

     3,654        3,487        2,616     
 

Expenses:

        

Contract drilling

     1,224        1,185        1,004     

Other operating

     515        448        355     

Interest

     50        10        20     
 

Total

     1,789        1,643        1,379     
 

Income before income tax

     1,865        1,844        1,237     

Income tax expense

     (540     (582     (429  
 

Net income

     1,325        1,262        808     

Amounts attributable to noncontrolling interests

     (682     (650     (415  
 

Net income attributable to Loews Corporation

   $ 643      $ 612      $ 393     
 

2009 Compared with 2008

Revenues increased $167 million, or 4.8%, and net income increased $31 million or 5.1%, in 2009, as compared to 2008. During 2009 Diamond Offshore’s contracted revenue backlog partially mitigated the impact of the global economic recession on its industry. However, Diamond Offshore’s operating results also reflect the negative impact of ready stacking the Ocean Star, Ocean Victory, Ocean Guardian and Ocean Scepter for extended periods and the cold stacking of three mat-supported jack-up rigs in the U.S. Gulf of Mexico. In addition, the international jack-up market, which had been strong throughout the majority of 2008, also reflected softening demand and reduced dayrates during 2009.

Revenues from high specification floaters and intermediate semisubmersible rigs increased $128 million in 2009, as compared to 2008. Revenues increased in 2009, primarily due to increased dayrates of $120 million and utilization of $8 million.

Revenues from jack-up rigs decreased $68 million in 2009, as compared to 2008, due primarily to decreased utilization of $80 million, partially offset by increased dayrates of $12 million in 2009.

Net income increased in 2009 as compared to 2008, primarily due to the changes in revenues as noted above. Operating costs are inclusive of normal operating costs for the recently upgraded Ocean Monarch and Diamond Offshore’s new jack-ups Ocean Shield and Ocean Scepter, as well as contract preparation, partially offset by lower operating costs resulting from the decline in utilization and overall lower survey and related costs compared to the prior period. Depreciation expense increased $59 million during 2009 due to a higher depreciable asset base. Interest expense increased in 2009, by $40 million due to the additional expense related to the issuance of 5.9% senior notes in May of 2009, the issuance of 5.7% senior notes in October of 2009 and the reduction of capitalized interest resulting from completion of construction projects.

 

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2008 Compared with 2007

Revenues increased by $871 million, or 33.3%, and net income increased by $219 million, or 55.7%, in 2008, as compared to 2007. Continued high overall utilization and historically high dayrates for Diamond Offshore’s floater fleet contributed to an overall increase in net income. In many of the floater markets in which Diamond Offshore operates, average realized dayrates increased as Diamond Offshore’s rigs operated under contracts at higher dayrates than those earned during 2007. Diamond Offshore’s results for the year ended December 31, 2008 were impacted by $54 million in pretax losses on foreign currency forward exchange contracts ($37 million in net unrealized losses resulting from mark-to-market accounting on Diamond Offshore’s open positions at December 31, 2008 and $17 million in net realized losses on settlement), which is included in Other revenues.

Revenues from high specification floaters and intermediate semisubmersible rigs increased by $892 million in 2008, as compared to 2007. The increase primarily reflects increased dayrates of $767 million and increased utilization of $110 million.

Revenues from jack-up rigs increased $79 million in 2008, as compared to 2007, due primarily to increased utilization of $96 million, partially offset by decreased dayrates of $20 million. Revenues were favorably impacted by an increase in the recognition of mobilization fees and other operating revenues, primarily for the Ocean Scepter, of $3 million in 2008.

Net income increased in 2008, as compared to 2007, due to the revenue increases as noted above, partially offset by increased contract drilling expenses. Overall cost increases for maintenance and repairs between the 2008 and 2007 periods reflect the impact of high, sustained utilization of Diamond Offshore’s drilling units across its fleet, additional survey and related maintenance costs, contract preparation and mobilization costs. Diamond Offshore’s results for 2008 also include normal operating costs for its newly constructed jack-up rigs, the Ocean Shield and Ocean Scepter, that began operating offshore Malaysia in the second quarter of 2008 and offshore Argentina during the third quarter of 2008. The increase in overall operating and overhead costs also reflects the impact of higher prices throughout the offshore drilling industry and its support businesses, including higher costs associated with hiring and retaining skilled personnel for Diamond Offshore’s worldwide offshore fleet. Results for 2008 were also adversely impacted by a $32 million provision for bad debt related to a North Sea semisubmersible rig contracted to a U.K. customer that has entered into administration.

Interest expense decreased $10 million in 2008, primarily due to the reduced interest expense and the absence of a $9 million write-off of debt issuance costs related to conversions of Diamond Offshore’s 1.5% debentures into common stock in 2007.

In connection with a non-recurring distribution of $850 million from a Diamond Offshore foreign subsidiary, a portion of which consisted of earnings of the subsidiary that had not previously been subjected to U.S. federal income tax, Diamond Offshore recognized $59 million of U.S. federal income tax expense in 2007.

HighMount

We use the following terms throughout this discussion of HighMount’s results of operations, with “equivalent” volumes computed with oil and NGL quantities converted to Mcf, on an energy equivalent ratio of one barrel to six Mcf:

 

Bbl

  

-

  

Barrel (of oil or NGLs)

Bcf

  

-

  

Billion cubic feet (of natural gas)

Bcfe

  

-

  

Billion cubic feet of natural gas equivalent

Mbbl

  

-

  

Thousand barrels (of oil or NGLs)

Mcf

  

-

  

Thousand cubic feet (of natural gas)

Mcfe

  

-

  

Thousand cubic feet of natural gas equivalent

MMBtu

  

-

  

Million British thermal units

HighMount’s revenues, profitability and future growth depend substantially on natural gas and NGL prices and HighMount’s ability to increase its natural gas and NGL production. In recent years, there has been significant price volatility in natural gas and NGL prices due to a variety of factors HighMount cannot control or predict. These factors,

 

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which include weather conditions, political and economic events, and competition from other energy sources, impact supply and demand for natural gas, which determines the pricing. In addition, the price HighMount realizes for its gas production is affected by HighMount’s hedging activities as well as locational differences in market prices. The level of natural gas production is dependent upon HighMount’s ability to realize attractive returns on its capital investment program. Returns are affected by commodity prices, capital and operating costs.

During 2009, natural gas prices decreased significantly compared to 2008, due largely to increased onshore natural gas production, plentiful levels of working gas in storage and reduced demand. The increase in onshore natural gas production was due largely to increased production from “unconventional” sources of natural gas such as shale gas, coalbed methane and tight sandstones, made possible in recent years by modern technology in creating extensive artificial fractures around well bores and advances in horizontal drilling technology. At the same time, drilling costs remained high in the first half of 2009 and did not decrease until late in the third quarter. In light of these developments, HighMount elected to substantially reduce its 2009 drilling activity earlier in the year and implemented a limited drilling program in the second half of the year. Also, as a result of the low natural gas prices, HighMount elected to curtail production during the third and fourth quarters. Reduced drilling activity and well curtailments negatively impact production volumes.

HighMount’s operating income, which represents revenues less operating expenses, is primarily affected by revenue factors, but is also a function of varying levels of production expenses, production and ad valorem taxes, as well as depreciation, depletion and amortization (“DD&A”) expenses. HighMount’s production expenses represent all costs incurred to operate and maintain wells and related equipment and facilities. The principal components of HighMount’s production expenses are, among other things, direct and indirect costs of labor and benefits, repairs and maintenance, materials, supplies and fuel. HighMount’s production and ad valorem taxes increase primarily when prices of natural gas and NGLs increase, but they are also affected by changes in production, as well as appreciated property values. HighMount calculates depletion using the units-of-production method, which depletes the capitalized costs and future development costs associated with evaluated properties based on the ratio of production volumes for the current period to total remaining reserve volumes for the evaluated properties. HighMount’s depletion expense is affected by its capital spending program and projected future development costs, as well as reserve changes resulting from drilling programs, well performance, and revisions due to changing commodity prices.

As part of the acquisition of exploration and production assets from Dominion Resources, Inc. in July of 2007, HighMount assumed an obligation to deliver specified quantities of natural gas under previously existing Volumetric Production Payment (“VPP”) agreements, which expired in February of 2009. Natural gas sales and production costs related to the VPP agreements were not recognized in HighMount’s results. Upon expiration of the VPP agreements, HighMount recognized additional gas sales volume of 7.9 Bcf and the related production costs during the year ended December 31, 2009.

 

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Presented below are production and sales statistics related to HighMount’s operations for the years ended December 31, 2009, 2008 and 2007:

 

Year Ended December 31    2009    2008    2007 (a)     

Gas production (Bcf)

     77.0      78.9      34.0  

Gas sales (Bcf)

     70.8      72.5      31.4  

Oil production/sales (Mbbls)

     363.0      351.3      114.0  

NGL production/sales (Mbbls)

     3,315.9      3,507.4      1,512.9  

Equivalent production (Bcfe)

     99.0      102.0      43.8  

Equivalent sales (Bcfe)

     92.9      95.7