Tobacco Settlement Money Going Into Tobacco Stocks; 16 States Invest Proceeds without Tobacco Restrictions IRRC Finds

3/11/2002

From: Doug Cogan of the Investor Responsibility Research Center, 603-675-9274 or email: doug.cogan@irrc.org

WASHINGTON, March 11 -- The tobacco industry, after having agreed in 1998 to hand over billions of dollars a year to the states to settle their Medicaid reimbursement claims, is starting to gain some of that money back by way of state investments of the proceeds, according to the Investor Responsibility Research Center (IRRC).

Of 33 states investing tobacco settlement proceeds, at least 16 states have no restrictions on investing in tobacco companies, according to a just-completed survey of state treasurers by the IRRC, an impartial firm serving institutional investors. Texas, Connecticut, New Mexico, North Carolina, North Dakota, Utah and West Virginia are among the states now investing a portion of their tobacco settlement proceeds in tobacco companies, according to IRRC. (See attached chart for a complete listing of state policies.)

More states are poised to invest some settlement proceeds in tobacco. Iowa, Louisiana, South Dakota, Virginia and Wisconsin have either sold bonds or are planning bond sales in order to receive larger up-front payments that they can invest through endowments. "Much of these state investments end up in index funds, tracking indexes like the S&P 500, which have tobacco company representation," explained Doug Cogan, director of IRRC's Tobacco Information Service. "For each dollar invested in such funds, usually only about a penny goes into tobacco stocks. But given the huge size of the settlement pool, it still adds up to tens of millions of dollars flowing back into the tobacco industry." Texas alone is investing more than $10 million.

"For the tobacco control community, which already feels short-changed by states' allocation of settlement dollars, these investments surely add insult to injury," Cogan said. Nationwide, only about 5 percent of tobacco settlement dollars are being spent on tobacco prevention and control, far short of the 20-25 percent target recommended by the U.S. Centers for Disease Control and Prevention. Trusts and endowments that invest settlement proceeds are a way to secure long-term funding for tobacco prevention, Cogan stressed, but they come with the risk of adding states' exposure to the tobacco industry.

12 States Investing Proceeds 'Tobacco-free'

States can avoid investing settlement proceeds in tobacco if they choose to, Cogan pointed out. In its survey of state treasurers, IRRC identified 12 states with policies banning such investments. More than half of the restricted assets are in Florida, Minnesota and Mississippi -- three of the first states to settle their lawsuits with the tobacco industry. Other states are just now setting their investment policies. The investment board overseeing Pennsylvania's $248-million settlement endowment voted on Jan. 17 to ban tobacco investments. Oklahoma's $80-million Tobacco Settlement Endowment Trust Fund adopted a tobacco investment ban on Feb. 14.

Altogether, the IRRC survey identified more than $10.6 billion of settlement proceeds that will be available for investment in 33 states by the end of Fiscal Year 2003. The 12 states with policies prohibiting tobacco investments will have more than $6.0 billion to invest by 2003, while the 16 states without tobacco restrictions will have at least $4.6 billion to invest. Five other states that have set up tobacco endowments and trust funds have either not yet funded them or have not conveyed their investment policy decisions to IRRC.

Seventeen states are not making any long-term investments with tobacco settlement proceeds, according to the IRRC survey and other research conducted by the National Conference of State Legislatures. These states are passing all of the proceeds through to their general treasuries and are funding myriad state programs on a "pay-as-you-go" basis.

The IRRC survey found that states investing tobacco settlement proceeds are employing a wide range of strategies. The targeted rate of return in states with broadly diversified portfolios typically is 8 or 9 percent a year -- roughly double the expected return for fixed-income funds.

Accordingly, states taking a more aggressive approach to investing settlement proceeds can expect to generate more income for tobacco prevention over time, provided that the returns are earmarked for such programs. "But our survey shows that states with the more aggressive strategies also are more likely to be investing in tobacco companies, unless they set clear policies to prevent that from happening," Cogan said.

"Some key states to watch are the ones securitizing their settlement payments through bond sales and then investing the proceeds," Cogan noted. "By taking their settlement money up- front, they are guarding against the risk of tobacco companies going bankrupt and defaulting on their payments over time. But if these states allow proceeds from the bond sales to be invested in tobacco companies, they are re-introducing exposure to that risk."

Founded in 1972, IRRC is an independent firm that conducts impartial research on investment policy and proxy voting decisions for institutional investors.

------ Media Backgrounder on Investment of Tobacco Settlement Proceeds

Tobacco settlement agreements: The November 1998 Master Settlement Agreement established one of the largest new revenue streams in state history. Under the agreement, 46 states will receive an estimated $206 billion from tobacco companies over 25 years, with annual payments rising from $4.5 billion to $9 billion by 2018. The payments will stay at the $9 billion level in perpetuity, provided that tobacco sales by parties to the agreement remain at 1998 levels. Four states reaching earlier settlements -- Mississippi, Florida, Texas and Minnesota -- will divide another $40 billion over 25 years, with similar perpetuity provisions. To date, the 50 states have received nearly $30 billion in payments; the latest payments came due in January 2002.

Investment of settlement proceeds: Thirty-three states have established endowments or trusts in which more than $10.6 billion of settlement proceeds will be deposited by the end of FY 2003, according to the IRRC survey of state treasurers. The survey found that 16 states, managing $4.6 billion of these proceeds, are free to invest in tobacco companies -- though not all are doing so at present. Twelve other states, investing more than $6.0 billion, have policies prohibiting such investments. Five other states with tobacco settlement endowments have not yet funded them or have not conveyed their investment policy decisions to IRRC.

States not investing settlement proceeds: Seventeen states are not making any long-term investments with tobacco settlement proceeds, according to the IRRC survey and research by the National Conference of State Legislatures. States passing all proceeds through to their general treasuries are: Alabama, Alaska, Arizona, California, Georgia, Illinois, Kentucky, Maine, Maryland, Michigan, Missouri, New Hampshire, New Jersey, New York, Oregon, Rhode Island and Washington. A key question going forward is whether states investing settlement proceeds will secure more long-term funding for tobacco prevention programs than states commingling the proceeds with other revenue streams in their general treasuries.

Tobacco representation in index funds: Popular indexes such as those offered by Standard & Poor's, Russell and Morgan Stanley have tobacco company representation. The S&P 500, for example, includes Philip Morris, Loews and UST, while the S&P MidCap 400 includes Reynolds Tobacco and Universal Corp., the world's largest tobacco leaf processor. Tobacco-free indexes are available from some fund managers, providing investment alternatives to the states.

About the IRRC survey: In November 2001, IRRC's Tobacco Information Service began contacting treasurers in all 50 states regarding investment of tobacco settlement proceeds. Forty states responded to a one-page written survey, consisting of five questions. States that did not respond were contacted on at least four occasions by phone or fax.

About IRRC's Tobacco Information Service: The Tobacco Information Service is a clearinghouse for impartial, comprehensive research on tobacco companies and tobacco investments worldwide. The service publishes an on-line directory, updated quarterly, of more than 100 public companies engaged in tobacco product manufacturing and leaf tobacco processing. The service also reports on legal, financial and regulatory developments affecting the global tobacco industry and related investments. In 2000, the Tobacco Information Service published Tobacco Divestment and Fiduciary Responsibility: A Legal and Financial Analysis, with funding support from The Robert Wood Johnson Foundation.

------ STATES INVESTING SETTLEMENT PROCEEDS WITHOUT TOBACCO RESTRICTIONS (16) ------ STATE PAYMENTS-1 PERMANENT TRUSTS TRUST ALLOCATION-2 ------ Connecticut-3 $260 million Tobacco & Health Trust, Biomedical Research Trust $68 million by 2003 -- Delaware-4 $55 million Delaware Health Fund $65 million by 2002 -- Iowa-4 $125 million Tobacco Settlement Authority (partial securitization) $200 million by 2003 -- Kansas-4 $120 million Endowment for Youth Fund $17 million by 2002 -- Montana-4 $61 million Tobacco Settlement Trust Fund $14 million by 2002 -- Louisiana-4 $322 million Millennium Trust (partial securitization) $1.100 billion by 2003 -- New Mexico-3 $86 million Tobacco Settlement Permanent Fund $61 million by 2002 -- North Carolina-3 $327 million Golden LEAF Foundation, Health and Wellness Trust $298 million by 2003 -- North Dakota-3 $53 million Common Schools Trust $27 million by 2002 -- South Dakota-4 $50 million Education Trust Fund (awaiting securitization) $200 million by 2003 -- Texas-3 $1.917 billion 21 trust funds and endowments $1.490 billion by 2002 -- Utah-3 $64 million Permanent State Trust Fund $46 million by 2003 -- Virginia-5 $294 million Community Revitalization, Tobacco Settlement Found. $59 million by 2002 -- West Virginia-3 $127 million Medical Trust Fund Endowment $70 million by 2002 -- Wisconsin-4 $291 million Permanent Endowment Fund (awaiting securitization) $794 million by 2003 -- Wyoming-4 $35 million Tobacco Settlement Trust Fund $47 million by 2003

------ STATES INVESTING SETTLEMENT PROCEEDS WITH TOBACCO RESTRICTIONS (12) -- Colorado $197 million Tobacco Settlement Trust Fund $133 million by 2003 -- Florida $2.478 billion Lawton Chiles Endowment Fund $1.700 billion by 2003 -- Hawaii $84 million Tobacco Prevention & Control Trust Fund $34 million by 2002 -- Idaho $52 million Millennium Fund 100 million by 2003 -- Massachusetts $566 million Health Care Security Trust $378 million by 2003 -- Minnesota $1.504 billion Tobacco Prevention Fund and two other trust funds $1.275 billion by 2003 -- Mississippi $679 million Heath Care Trust Fund $725 million by 2003 -- Nevada $88 million Fund for a Healthy Nevada and two other trust funds $115 million by 2003 -- Ohio $724 million Tobacco Use Prevention and seven other trust funds $355 million by 2002-6 -- Oklahoma $149 million Tobacco Settlement Endowment Trust Fund $115 million by 2003 -- Pennsylvania $664 million Health Care Endowment and Health Venture Investment $317 million by 2003 -- South Carolina $912 million Four trust funds (securitization) $785 million by 2002

------ STATES INVESTING SETTLEMENT PROCEEDS -- TOBACCO RESTRICTIONS NOT DETERMINED (5) -- Arkansas-7 $121 million Health Century Trust Fund $100 million in 2001 -- Indiana-7 $293 million Tobacco Cessation Trust and five other trust funds Figure not available -- Nebraska-7 $85 million Tobacco Settlement Trust Fund Figure not available -- Tennessee-7 $354 million Tobacco Indemnification and Community Revitalization Not yet funded -- Vermont-7 $58 million Tobacco Trust Fund $10 million by 2002

------ FOOTNOTES: 1. Payments received as of Dec. 2001. 2. Cumulative deposits through fiscal year listed. 3. State has tobacco holdings. 4. No tobacco holdings at present. 5. Tobacco holdings not determined. 6. Tobacco Use Prevention trust. 7. No survey response.