Question

Much of the litigation against Philip Morris is related to exposure of persons to environmental tobacco smoke. This is addressed by Philip Morris in the following excerpts from its Year 8 annual report:
Pending claims related to tobacco products generally fall within three categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, and (iii) health care cost recovery cases brought by governmental and nongovernmental plaintiffs seeking reimbursement for health care expenditures allegedly caused by cigarette smoking. Governmental plaintiffs have included local, state, and certain foreign governmental entities. Non-governmental plaintiffs in these cases include union health and welfare trust funds, Blue Cross/Blue Shield groups, HMO's, hospitals, Native American tribes, taxpayers, and others. Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. Plaintiffs' theories of recovery and the defenses raised in those cases are discussed below.
In recent years, there has been a substantial increase in the number of smoking and health cases being filed. As of December 31, Year 8, there were approximately 510 smoking and health cases filed and served on behalf of individual plaintiffs in the United States against PM Inc. and, in some cases, the Company, compared with approximately 375 such cases on December 31, Year 7, and 185 such cases on December 31, Year 6. Many of these cases are pending in Florida, West Virginia and New York. Fifteen of the individual cases involve allegations of various personal injuries allegedly related to exposure to environmental tobacco smoke ("ETS").
In addition, as of December 31, Year 8, there were approximately 60 smoking and health putative class actions pending in the United States against PM Inc. and, in some cases, the Company (including eight that involve allegations of various personal injuries related to exposure to ETS), compared with approximately 50 such cases on December 31, Year 7, and 20 such cases on December 31, Year 6. Most of these actions purport to constitute statewide class actions and were filed after May Year 6 when the Fifth Circuit Court of Appeals, in the Castano case, reversed a federal district court's certification of a purported nationwide class action on behalf of persons who were allegedly "addicted" to tobacco products.
During Year 7 and Year 8, PM Inc. and certain other United States tobacco product manufacturers entered into agreements settling the asserted and unasserted health care cost recovery and other claims of all 50 states and several commonwealths and territories of the United States. The settlements are in the process of being approved by the courts, and some of the settlements are being challenged by various third parties. As of December 31, Year 8, there were approximately 95 health care cost recovery actions pending in the United States (excluding the cases covered by the settlements), compared with approximately 105 health care cost recovery cases pending on December 31, Year 7, and 25 such cases on December 31, Year 6.
There are also a number of tobacco-related actions pending outside the United States against PMI and its affiliates and subsidiaries including, as of December 31, Year 8, approximately 27 smoking and health cases initiated by one or more individuals (Argentina (20), Brazil (1), Canada (1), Italy (1), Japan (1), Scotland (1) and Turkey (2)), and six smoking and health class actions (Brazil (2), Canada (3) and Nigeria (1)). In addition, health care cost recovery actions have been brought in Israel, the Republic of the Marshall Islands and British Columbia, Canada, and, in the United States, by the Republics of Bolivia, Guatemala, Panama and Nicaragua.
Pending and upcoming trials: As of January 22, Year 9, trials against PM Inc. and, in one case, the Company, were underway in the Engle smoking and health class action in Florida (discussed below) and in individual smoking and health cases in California and Tennessee.
Additional cases are scheduled for trial during Year 9, including three health care cost recovery actions brought by unions in Ohio (February), Washington (September) and New York (September), and two smoking and health class actions in Illinois (August) and Alabama (August).
Also, twelve individual smoking and health cases against PM Inc. and, in some cases, the Company, are currently scheduled for trial during Year 9. Trial dates, however, are subject to change.

Required:
a. Philip Morris classifies pending tobacco lawsuits against the company into three general categories. What are these three categories? What is the number of claims for each of these categories at the end of Year 8?
b. Can you determine how much liability is recorded for each of these categories as of December 31, Year 8? Explain.
c. Can you determine what amount is charged against earnings in Year 8 for contingent tobacco litigation losses? Explain.
d. Do you believe the eventual losses will exceed the losses currently recorded on the balance sheet? Explain.
e. Describe adjustments to PM's financial statements, and to an investor's financial analysis of PM, to reflect estimates of under-or overaccrued losses.



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  • CreatedJanuary 22, 2015
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