States Face Loss of Funds From Tobacco Settlement

States could lose billions of dollars they now receive from tobacco companies under a 1998 national tobacco settlement because the big cigarette makers are losing market share to small companies that did not sign the agreement.

A finding released yesterday by an independent economic consultant concluded that the major companies are losing sales to smaller, generic-tobacco companies because of costs and restrictions imposed by the settlement -- a conclusion that could allow the cigarette makers to withhold as much as $1.2 billion this year.

The 1998 agreement requires companies to pay $246 billion to compensate states for the costs of treating people with smoking-related diseases. In return, the states agreed to end their lawsuits against the industry.

The National Association of Attorneys General, which is administering the tobacco settlement in conjunction with cigarette makers and the states, recently notified the states that they could lose 18 percent of their expected funds.

States have used the money to pay for many services -- including basic health care and smoking-cessation programs; staffing libraries and after-school care; and funding pension shortfalls -- and the loss could be very damaging.

But Iowa Attorney General Tom Miller said yesterday that he thinks the states will ultimately prevail. He said that to reduce their payments, the tobacco companies must prove that the states have not enforced a provision of the agreement that requires the smaller tobacco companies to deposit millions of dollars into escrow funds in case they are sued in the future and lose.

"The states have been diligent in trying to collect the escrow funds," Miller said. "We strongly believe that the companies will fail in their effort to show a lack of diligence by the states."

David Howard, spokesman for R.J. Reynolds Tobacco Co., said the company is pleased with the consultant's finding that the settlement was a significant factor in the loss of market share. He said R.J. Reynolds officials are "evaluating our options" on whether to reduce payments due next month.

Michael Neese, spokesman for Philip Morris USA, declined to comment.

Philip Morris, R.J. Reynolds and Lorillard Tobacco Co. asked for the consultant's review last year after an independent auditor determined that they had together lost more than 2 percent of their market share since 1997. The review, by the Brattle Group office in San Francisco, concluded that the settlement payments were a decisive factor in that loss.

The Brattle Group was selected by the companies and the state attorneys general. Its complete report is considered confidential.

The tobacco companies are scheduled to make a $6.5 billion payment for 2005 on April 17, and Miller said the attorneys general are negotiating with them to ensure that happens. He also said he expects the companies to continue their challenge in state courts.

After the agreement was signed, the tobacco companies raised cigarette prices significantly. Miller said the firms had raised prices higher than needed to cover settlement costs, and the loss of sales was partly a result of those higher prices. But he acknowledged that some small tobacco companies avoided paying into the escrow accounts early on.