Much of the litigation against Philip Morris is related to exposure CASE 3-5 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 andhealth cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking andhealth cases alleging personal injury and purporting to be brought on behalf of a class ofindividual plaintiffs, and (iii) health care cost recovery cases brought by governmental and nongovernmental plaintiffs seeking reimbursement for health care expenditures allegedly caused bycigarette smoking. Governmental plaintiffs have included local, state, and certain foreigngovernmental entities. Non-governmental plaintiffs in these cases include union health andwelfare 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 andhealth care cost recovery cases range into the billions of dollars. Plaintiffs' theories of recoveryand the defenses raised in those cases are discussed below.In recent years, there has been a substantial increase in the number of smoking andhealth cases being filed. As of December 31, Year 8, there were approximately 510 smokingand health cases filed and served on behalf of individual plaintiffs in the United States againstPM Inc. and, in some cases, the Company, compared with approximately 375 such cases onDecember 31, Year 7, and 185 such cases on December 31, Year 6. Many of these cases arepending in Florida, West Virginia and New York. Fifteen of the individual cases involveallegations of various personal injuries allegedly related to exposure to environmentaltobacco smoke ("ETS").In addition, as of December 31, Year 8, there were approximately 60 smoking and healthputative class actions pending in the United States against PM Inc. and, in some cases, theCompany (including eight that involve allegations of various personal injuries related to exposureto ETS), compared with approximately 50 such cases on December 31, Year 7, and 20 such caseson December 31, Year 6. Most of these actions purport to constitute statewide class actions andwere filed after May Year 6 when the Fifth Circuit Court of Appeals, in the Castano case, reverseda federal district court's certification of a purported nationwide class action on behalf of personswho were allegedly "addicted" to tobacco products.During Year 7 and Year 8, PM Inc. and certain other United States tobacco productmanufacturers entered into agreements settling the asserted and unasserted health care costrecovery and other claims of all 50 states and several commonwealths and territories of theUnited States. The settlements are in the process of being approved by the courts, and some ofthe settlements are being challenged by various third parties. As of December 31, Year 8, therewere approximately 95 health care cost recovery actions pending in the United States (excludingthe cases covered by the settlements), compared with approximately 105 health care costrecovery 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 Statesagainst PMI and its affiliates and subsidiaries including, as of December 31, Year 8, approximately27 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 classactions (Brazil (2), Canada (3) and Nigeria (1)). In addition, health care cost recovery actionshave 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, inone 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 recoveryactions 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.Verdicts in individual cases: During the past three years, juries have returned verdictsfor defendants in three individual smoking and health cases and in one individual ETS smokingand health case. In June Year 8, a Florida appeals court reversed a $750,000 jury verdict awardedin August Year 6 against another United States cigarette manufacturer. Plaintiff is seeking an appeal of this ruling to the Florida Supreme Court. Also in June Year 8, a Florida jury awardedthe estate of a deceased smoker in a smoking and health case against another United Statescigarette manufacturer $500,000 in compensatory damages, $52,000 for medical expenses and$450,000 in punitive damages. A Florida appeals court has ruled that this case was tried in thewrong venue and, accordingly, defendants are seeking to set aside the verdict and retry the casein the correct venue. In Brazil, a court in Year 7 awarded plaintiffs in a smoking and health casethe Brazilian currency equivalent of $81,000, attorneys' fees and a monthly annuity of 35 yearsequal to two-thirds of the deceased smoker's last monthly salary. Neither the Company nor itsaffiliates were parties to that action.Litigation settlements: In November Year 8, PM Inc. and certain other United Statestobacco product manufacturers entered into a Master Settlement Agreement (the "MSA") with46 states, the District of Columbia, the Commonwealth of Puerto Rico, Guam, the United StatesVirgin Islands, American Samoa and the Northern Marianas to settle asserted and unassertedhealth care cost recovery and other claims. PM Inc. and certain other United States tobaccoproduct manufacturers had previously settled similar claims brought by Mississippi, Florida,Texas and Minnesota (together with the MSA, the "State Settlement Agreements") and an ETSsmoking and health class action brought on behalf of airline attendants. The State SettlementAgreements and certain ancillary agreements are filed as exhibits to various of the Company'sreports filed with the Securities and Exchange Commission, and such agreements and the ETSsettlement are discussed in detail therein.PM Inc. recorded pre-tax charges of $3,081 million and $1,457 million during Year 8and Year 7, respectively, to accrue for its share of all fixed and determinable portions of itsobligations under the tobacco settlements, as well as $300 million during Year 8 for itsunconditional obligation under an agreement in principle to contribute to a tobacco growerstrust fund, discussed below. As of December 31, Year 8, PM Inc. had accrued costs of itsobligations under the settlements and to tobacco growers aggregating $1,359 million, payableprincipally before the end of the year Year 10. The settlement agreements require that thedomestic tobacco industry make substantial annual payments in the following amounts(excluding future annual payments contemplated by the agreement in principle with tobaccogrowers discussed below), subject to adjustment for several factors, including inflation, marketshare and industry volume: Year 9, $4.2 billion (of which $2.7 billion related to the MSA and hasalready been paid by the industry); Year 10, $9.2 billion; Year 11, $9.9 billion; Year 12, $11.3billion; Year 14 through Year 17, $8.4 billion; and thereafter, $9.4 billion. In addition, thedomestic tobacco industry is required to pay settling plaintiff 's attorneys' fees, subject to anannual cap of $500 million, as well as additional amounts as follows: Year 9, $450 million; Year10, $416 million; and Year 11 through Year 12, $250 million. These payment obligations are theseveral and not joint obligations of each settling defendant. PM Inc.'s portion of the futureadjusted payments and legal fees, which is not currently estimable, will be based on its share ofdomestic cigarette shipments in the year preceding that in which the payment is made. PM Inc.'sshipment share in Year 8 was approximately 50%.The State Settlement Agreements also include provisions relating to advertising andmarketing restrictions, public disclosure of certain industry documents, limitations on challengesto tobacco control and underage use laws and other provisions. As of January 22, Year 9, theMSA had been approved by courts in 41 states and in the District of Columbia, Puerto Rico,Guam, the United States Virgin Islands, American Samoa and Northern Marianas. If ajurisdiction does not obtain final judicial approval of the MSA by December 31, Year 11, theagreement will be terminated with respect to such jurisdiction.As part of the MSA, the settling defendants committed to work cooperatively with thetobacco grower community to address concerns about the potential adverse economic impact ofthe MSA on that community. To that end, in January Year 9, the four major domestic tobaccoproduct manufacturers, including PM Inc., agreed in principle to participate in the establishmentof a $5.15 billion trust fund to be administered by the tobacco growing states. It is currentlycontemplated that the trust will be funded by industry participants over twelve years, beginningin Year 9. PM Inc. has agreed to pay $300 million into the trust in Year 9, which amount hasbeen charged to Year 8 operating income. Subsequent annual industry payments are to beadjusted for several factors, including inflation and United States cigarette consumption, and areto be allocated based on each manufacturer's market share.The Company believes that the State Settlement Agreements may materially adverselyaffect the business, volume, results of operations, cash flows or financial position of PM Inc. andthe Company in future years. The degree of the adverse impact will depend, among other things, on the rates of decline in United States cigarette sales in the premium and discount segments,PM Inc.'s share of the domestic premium and discount cigarette segments, and the effect of anyresulting cost advantage of manufacturers not subject to the MSA and the other State SettlementAgreements. As of January 22, Year 9, manufacturers representing almost all domestic shipmentsin Year 8 had agreed to become subject to the terms of the MSA.

Required:

a. Philip Morris classifies pending tobacco lawsuits against the company into three general categories. What arethese 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 reflectestimates of under- or overaccrued losses.