http://www.azcentral.com/news/articles/0428tobacco0428.html
Tobacco payment to states in limbo Top companies point to diminishing sales
Jon Kamman The Arizona Republic Apr. 28, 2006 12:00 AM
As Americans kick the habit or smoke cheaper cigarettes, the reaction by major tobacco firms is proving hazardous to the financial health of 46 states, including Arizona.
For the first time since cigarette-makers agreed in 1998 to distribute billions of dollars a year to the states to compensate for the costly effects of tobacco use, Big Tobacco balked last week at paying the full amounts. The dispute puts in limbo at least $755 million the states expected to receive this year.
It also portends what could be protracted resistance by tobacco companies to paying huge compensation at a time when their sales and market share are eroding. The tobacco companies contend the states are allowing their competitors an unfair advantage.
Sixteen states have filed lawsuits in quick succession so far, seeking their full shares, and Arizona is moving toward filing its own, lawyers in the state Attorney General's Office said. Each suit is filed individually in state courts.
Arizona's portion of the frozen funds is $11.8 million, or 12 percent of the $96.9 million the state expected.
In Arizona, all tobacco settlement money goes to the state's health care program for the impoverished, as required by Proposition 204, a ballot measure passed in 2000.
Tom Betlach, deputy director of the Arizona Health Care Cost Containment System, said that the shortfall will not cause immediate harm but that effects will mount if the companies withhold funds every year.
The money withheld this year represents the companies' claims for refunds of part of their 2003 payments, so larger subtractions are possible in coming years.
Payments from tobacco companies are due annually, with no termination date.
As allowed under the master agreement, the companies put the money into a "disputed payments" account until a ruling determines whether the states should get the full amounts.
At its root, the dispute is caused by a significant change in Americans' smoking habits since the deal went into effect.
To cover the payouts, tobacco companies raised prices. That, combined with the growing number of people who quit smoking, put a dent in the companies' bottom lines.
The big companies lost even more sales because people who continued smoking flocked to cheaper brands. Those brands weren't obligated to pay the states because they were not part of the agreement.
The master agreement had anticipated these effects and tried to level the field for participants and non-participants in the settlement.
First, under the agreement, reductions in payments were to be allowed if sales dropped.
The companies have shown reduced sales, but the states maintain that some of the loss was because of overpricing of cigarettes.
Another provision is that if the big companies lost more than 2 percent of their near-total corner on the tobacco market, and if they showed that the master agreement was to blame, they could further reduce their payments.
An independent auditor has validated the companies' argument on this point.
A third element is at the crux of the dispute. Tobacco companies claim the states are not enforcing measures required of other companies that were not parties to the original deal.
Non-participants, mostly makers of bargain-priced brands, were required to set aside amounts as if they were paying the states. They were to hold the money in escrow in case the states made claims similar to those lodged against the big firms.
States are required to enforce this provision, and Big Tobacco contends that they aren't doing so.
Arizona, however, has "aggressively pursued" tobacco companies that have failed to set aside the funds, said Susan Segal, chief of the public advocacy division in the Attorney General's Office.
"We've filed suit every time," she said.
Segal and senior litigator Ann Uglietta said they hold little hope of an out-of-court settlement with the majors.
This year's distribution from the three largest companies, which account for 92 percent of sales, was to be $6.1 billion.
Philip Morris USA, the largest cigarette company, paid its full $3.4 billion share and indicated in a statement on its Web site that it favors negotiating whether it deserves a partial refund. According to the settlement's auditor, as much as $386 million would be at stake. A spokesman would not elaborate.
No. 2 maker R.J. Reynolds Tobacco Co. put up its required $2 billion but deposited $647 million of it into the dispute fund.
Lorillard Tobacco Co. sent $108 million of its $666 million obligation into the disputed account.
R.J. Reynolds spokesman David Howard said it is not up to the tobacco companies to determine which states may be lax in enforcement but for the states to show their compliance.
Arizona's lawyers take issue with that, saying the companies should cite specifics in their complaints.
The tobacco companies want the issue to go to arbitration, but state lawsuits would keep it in the courts.
The master agreement affects 46 states because four states negotiated their own agreements.