BorgWarner Inc.  and Consolidated Subsidiaries 31 30 Management’s Discussion and Analysis  of Financial Condition and Results of Operations OTHER MATTERS Contingencies In the normal course of business the Company and its subsidiaries  are parties to various legal claims, actions and complaints, including  matters involving intellectual property claims, general liability and  various other risks. It is not possible to predict with certainty whether  or not the Company and its subsidiaries will ultimately be successful  in any of these legal matters or, if not, what the impact might be.  The Company’s environmental and product liability contingencies are  discussed separately below. The Company’s management does not  expect that the results in any of these legal proceedings will have  a material adverse effect on the Company’s results of operations,  financial position or cash flows.  The Company and certain of its current and former direct and indirect  corporate predecessors, subsidiaries and divisions have been identi- fied by the United States Environmental Protection Agency and cer- tain state environmental agencies and private parties as potentially  responsible parties (PRPs) at various hazardous waste disposal sites  under the Comprehensive Environmental Response, Compensation  and Liability Act (Superfund) and equivalent state laws and, as such,  may presently be liable for the cost of clean-up and other remedial  activities at 39 such sites. Responsibility for clean-up and other  remedial activities at a Superfund site is typically shared among PRPs  based on an allocation formula. Environmental Based on information available to us, which in most cases, includes:  an estimate of allocation of liability among PRPs; the probability that  other PRPs, many of whom are large, solvent public companies, will  fully pay the cost apportioned to them; currently available informa- tion from PRPs and/or federal or state environmental agencies  concerning the scope of contamination and estimated remediation  and consulting costs; remediation alternatives; estimated legal fees;  and other factors, we have established an accrual for indicated  environmental liabilities with a balance at December 31, 2004 of  approximately $25.7 million. We expect this amount to be expended  over the next three to five years. The Company believes that none of these matters, individually or in  the aggregate, will have a material adverse effect on its financial con- dition or future operating results, generally either because estimates  of the maximum potential liability at a site are not large or because  liability will be shared with other PRPs, although no assurance can be  given with respect to the ultimate outcome of any such matter. In connection with the sale of Kuhlman Electric Corporation, the  Company agreed to indemnify the buyer and Kuhlman Electric for  certain environmental liabilities relating to the past operations of  Kuhlman Electric. The liabilities at issue result from operations of  Kuhlman Electric that pre-date the Company’s acquisition of Kuhlman  Electric’s parent company, Kuhlman Corporation, in 1999. During  2000, Kuhlman Electric notified us that it discovered potential envi- ronmental contamination at its Crystal Springs, Mississippi plant  while undertaking an expansion of the plant. The Company has been working with the Mississippi Department of  Environmental Quality and Kuhlman Electric to investigate the extent  of and remediate the contamination. The investigation revealed the  presence of polychlorinated biphenyls (PCBs) in portions of the soil  at the plant and neighboring areas. Clean up began in 2000 and is  continuing. Kuhlman Electric and others, including the Company,  have been sued in numerous related lawsuits, in which multiple claim- ants allege personal injury and property damage. The Company has  moved to be dismissed from some of these lawsuits. The first trial in  these lawsuits is currently scheduled to begin in March 2005. We believe that the accrual for environmental liabilities is sufficient  to cover any potential liability associated with this matter. However,  due to the nature of environmental liability matters, there can be no  assurance that the actual amount of environmental liabilities will not  exceed the amount accrued. Product Liability Prior to June 2004, all claims were covered by the Company’s pri- mary layer insurance coverage, and these carriers administered,  defended, settled and paid all claims under a funding agreement.  In June 2004, the Company was notified by primary layer insurance  A declaratory judgment action was filed in January 2004 in the Circuit  Court of Cook County, Illinois by Continental Casualty Company and  related companies (CNA) against the Company and certain of its other  historical general liability insurers. CNA provided the Company with  We cannot reasonably estimate possible losses, if any, in excess of  those for which we have accrued, because we cannot predict how  many additional claims may be brought against the Company (or  parties the Company has an obligation to indemnify) in the future,  the allegations in such claims, the possible outcomes, or the impact  of tort reform legislation currently being considered at the State and  Federal levels. The insurance receivable and accrued liability of $41.6 million in 2003  have been reclassified as outlined above and the reclassification is  not material to the Company’s Consolidated Financial Statements.  The amounts recorded in the Consolidated Balance Sheets are  as follows: At December 31, 2004, the Company recorded a liability of $40.8 mil- lion; with a related asset of $40.8 million to recognize the insurance  proceeds receivable to the Company for estimated claim losses. For  2003, the comparable value of the insurance receivable and accrued  liability was $41.6 million. The Company’s contractual relationship with the secondary layer car- riers provides a change in circumstances and allows the Company to  take a more direct role in defending and settling claims than with the  primary carriers. Previously, the Company’s arrangement utilized the  primary layer insurance carriers’ positions to defend and negotiate  the settlements with periodic input from the Company. carriers of the exhaustion of their policy limits. This led the Company  to access the next available layer of insurance coverage. Since June  2004, secondary layer insurers have paid asbestos-related litigation  defense and settlement expenses pursuant to a funding agreement.  Two secondary layer insurers are currently not participating in this  arrangement until they are satisfied through an audit process, that  the primary level of insurance is exhausted. The Company therefore  paid $1.0 million in defense and settlement costs in late 2004 and  expects to recover those amounts from either these insurers, or the  primary layer insurers if the exhaustion audit shows that primary layer  insurance is still available. both primary and additional layer insurance, and, in conjunction with  other insurers, is currently defending and indemnifying the Company  in all of its pending asbestos-related product liability claims. The  lawsuit seeks to determine the extent of insurance coverage available  to the Company including whether the available limits exhaust on a  “per occurrence” or an “aggregate” basis, and to determine how the  applicable coverage responsibilities should be apportioned. In addition  to the primary insurance available for asbestos-related claims, the  Company has substantial additional layers of insurance available for  potential future asbestos-related product claims. Although it is impossible to predict the outcome of pending or future  claims; due to the encapsulated nature of the products, our experi- ences in aggressively defending and resolving claims in the past, and  our significant insurance coverage with solvent carriers as of the date  of this filing, management does not believe that asbestos-related prod- uct liability claims are likely to have a material adverse effect on the  Company’s results of operations, cash flows or financial condition. The Consolidated Financial Statements are prepared in conformity  with accounting principles generally accepted in the United States  of America. The preparation of these financial statements requires  the use of estimates, judgments and assumptions that affect the  reported amounts of assets and liabilities at the date of the financial  statements and the reported amounts of revenues and expenses dur- ing the periods presented. In preparing these financial statements,  management has made its best estimates and judgments of certain  amounts included in the financial statements, giving due consider- ation to materiality. The significant accounting principles which man- agement believes are the most important to aid in fully understanding  our financial results are included below. Management also believes  that all of the accounting policies are important to investors.  Critical Accounting Policies The Company recognizes revenue upon shipment of product when  title and risk of loss pass to the customer. Although the Company may  enter into long-term supply agreements with its major customers,  each shipment of goods is treated as a separate sale and the price is  not fixed over the life of the agreements. The Company securitizes and sells certain receivables through third  party financial institutions without recourse. The amount sold can  vary each month based on the amount of underlying receivables. In  the fourth quarter of 2003, the Company reduced the maximum size  of the facility from $90 million to $50 million. In the fourth quarter of  2002, the Company reduced the maximum size of the facility from  $120 million to $90 million. Sales of Receivables Revenue Recognition  Like many other industrial companies who have historically oper- ated in the United States, the Company (or parties the Company  indemnifies) continues to be named as one of many defendants in  asbestos-related personal injury actions. Management believes that  the Company’s involvement is limited because, in general, these  claims relate to a few types of automotive friction products, manu- factured many years ago that contained encapsulated asbestos. The  nature of the fibers, the encapsulation and the manner of use lead  the Company to believe that these products are highly unlikely to  cause harm. At December 31, 2004, the Company had approximately  100,000 pending asbestos-related product liability claims. Of these  outstanding claims, approximately 92,000 are pending in just three  jurisdictions, where significant tort reform activities are underway.  The Company’s policy is to aggressively defend against these law- suits and the Company has been successful in obtaining dismissal  of many claims without any payment. The Company expects that the  vast majority of the pending asbestos-related product liability claims  where it is a defendant (or has an obligation to indemnify a defendant)  will result in no payment being made by the Company or its insurers.  In 2004 of the 4,062 claims settled, only 255 (6.3%) resulted in any  payment being made to a claimant by or on behalf of the Company.  In 2003 of the 4,664 claims settled, only 273 (5.9%) resulted in any  payment being made to claimants. The settlement costs of these  claims were paid by the insurance carriers, except for the $1.0  million in 2004 as described in the paragraph below. Based upon  the encapsulated nature of the products, our experiences in aggres- sively defending and resolving claims in the past, and our significant  insurance coverage with solvent carriers as of the date of this filing,  management does not believe that asbestos-related product liability  claims are likely to have a material adverse effect on the Company’s  results of operations, cash flows or financial condition. millions of dollars 2004 2003 Assets: Prepayments and other current assets  $13.5 $13.7  Other non-current assets  27.3  27.9 Total  insurance  receivable  $40.8 $41.6 Liabilities: Accounts payable and accrued expenses  $13.5 $13.7  Long-term liabilities – other  27.3 27.9 Total  accrued  liability  $40.8 $41.6