SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly
period ended March 31, 2010
OR
|
|
|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the
transition period from
to
Commission file
number 1-08323
CIGNA Corporation
(Exact name of registrant as specified
in its charter)
|
|
|
Delaware |
|
06-1059331 |
|
|
|
(State or other jurisdiction of
incorporation or organization) |
|
(I.R.S. Employer Identification No.) |
Two Liberty
Place, 1601 Chestnut Street
Philadelphia, Pennsylvania 19192
(Address of principal executive offices)
(Zip Code)
Registrant’s
telephone number, including area code (215) 761-1000
Not Applicable
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes
þ No o
Indicate by check mark
whether the registrant has submitted electronically and posted on its corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to
submit and post such files). Yes þ No o
Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of “large
accelerated filer”, “accelerated filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act.
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|
|
|
|
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|
Large accelerated filer þ |
|
Accelerated filer o |
|
Non-accelerated filer o |
|
Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes o No
þ
As of April 16,
2010, 276,674,906 shares of the issuer’s common stock were outstanding.
CIGNA
CORPORATION
INDEX
As used herein,
“CIGNA” or the “Company” refers to one or more of CIGNA Corporation and its
consolidated subsidiaries.
|
|
|
Part I. |
|
FINANCIAL INFORMATION |
|
|
|
Item 1. |
|
FINANCIAL STATEMENTS |
CIGNA
Corporation
Consolidated
Statements of Income
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions, except per share amounts) |
|
2010 |
|
|
2009 |
|
Revenues |
|
|
|
|
|
|
|
|
Premiums and
fees |
|
$ |
4,543 |
|
|
$ |
4,051 |
|
Net investment
income |
|
|
266 |
|
|
|
229 |
|
Mail order pharmacy
revenues |
|
|
348 |
|
|
|
312 |
|
Other revenues |
|
|
54 |
|
|
|
217 |
|
Realized investment
losses: |
|
|
|
|
|
|
|
|
Other-than-temporary
impairments on debt securities, net |
|
|
(1 |
) |
|
|
(17 |
) |
Other realized
investment losses |
|
|
(5 |
) |
|
|
(19 |
) |
|
|
|
|
|
|
|
Total realized
investment losses |
|
|
(6 |
) |
|
|
(36 |
) |
|
|
|
|
|
|
|
Total revenues |
|
|
5,205 |
|
|
|
4,773 |
|
|
|
|
|
|
|
|
Benefits and
Expenses |
|
|
|
|
|
|
|
|
Health Care medical
claims expense |
|
|
2,209 |
|
|
|
1,780 |
|
Other benefit
expenses |
|
|
879 |
|
|
|
1,108 |
|
Mail order pharmacy
cost of goods sold |
|
|
285 |
|
|
|
252 |
|
GMIB fair value
gain |
|
|
(4 |
) |
|
|
(32 |
) |
Other operating
expenses |
|
|
1,414 |
|
|
|
1,392 |
|
|
|
|
|
|
|
|
Total benefits and
expenses |
|
|
4,783 |
|
|
|
4,500 |
|
|
|
|
|
|
|
|
Income from
Continuing Operations before Income Taxes |
|
|
422 |
|
|
|
273 |
|
|
|
|
|
|
|
|
Income taxes
(benefits): |
|
|
|
|
|
|
|
|
Current |
|
|
87 |
|
|
|
(85 |
) |
Deferred |
|
|
51 |
|
|
|
150 |
|
|
|
|
|
|
|
|
Total taxes |
|
|
138 |
|
|
|
65 |
|
|
|
|
|
|
|
|
Income from
Continuing Operations |
|
|
284 |
|
|
|
208 |
|
Income from
Discontinued Operations, Net of Taxes |
|
|
— |
|
|
|
1 |
|
|
|
|
|
|
|
|
Net
Income |
|
|
284 |
|
|
|
209 |
|
Less: Net Income
Attributable to Noncontrolling Interest |
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
Shareholders’ Net
Income |
|
$ |
283 |
|
|
$ |
208 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings Per
Share: |
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
1.03 |
|
|
$ |
0.76 |
|
Shareholders’ income
from discontinued operations |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ net
income |
|
$ |
1.03 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Earnings Per
Share: |
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
1.02 |
|
|
$ |
0.76 |
|
Shareholders’ income
from discontinued operations |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ net
income |
|
$ |
1.02 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends Declared Per
Share |
|
$ |
0.040 |
|
|
$ |
0.040 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Attributable
to CIGNA: |
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
283 |
|
|
$ |
207 |
|
Shareholders’ income
from discontinued operations |
|
|
— |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ Net
Income |
|
$ |
283 |
|
|
$ |
208 |
|
|
|
|
|
|
|
|
The accompanying
Notes to the Consolidated Financial Statements are an integral part of these
statements.
1
CIGNA
Corporation
Consolidated Balance
Sheets
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
|
|
|
|
As of |
|
|
|
|
|
|
|
March 31, |
|
|
|
|
|
|
December 31, |
|
(In
millions, except per share amounts) |
|
|
|
|
|
2010 |
|
|
|
|
|
|
2009 |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities, at
fair value (amortized cost, $12,958; $12,580) |
|
|
|
|
|
$ |
13,977 |
|
|
|
|
|
|
$ |
13,443 |
|
Equity securities, at
fair value (cost, $141; $137) |
|
|
|
|
|
|
122 |
|
|
|
|
|
|
|
113 |
|
Commercial mortgage
loans |
|
|
|
|
|
|
3,493 |
|
|
|
|
|
|
|
3,522 |
|
Policy loans |
|
|
|
|
|
|
1,529 |
|
|
|
|
|
|
|
1,549 |
|
Real estate |
|
|
|
|
|
|
160 |
|
|
|
|
|
|
|
124 |
|
Other long-term
investments |
|
|
|
|
|
|
597 |
|
|
|
|
|
|
|
595 |
|
Short-term
investments |
|
|
|
|
|
|
188 |
|
|
|
|
|
|
|
493 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
investments |
|
|
|
|
|
|
20,066 |
|
|
|
|
|
|
|
19,839 |
|
Cash and cash
equivalents |
|
|
|
|
|
|
1,299 |
|
|
|
|
|
|
|
924 |
|
Accrued investment
income |
|
|
|
|
|
|
278 |
|
|
|
|
|
|
|
238 |
|
Premiums, accounts and
notes receivable, net |
|
|
|
|
|
|
1,515 |
|
|
|
|
|
|
|
1,361 |
|
Reinsurance
recoverables |
|
|
|
|
|
|
6,520 |
|
|
|
|
|
|
|
6,597 |
|
Deferred policy
acquisition costs |
|
|
|
|
|
|
1,011 |
|
|
|
|
|
|
|
943 |
|
Property and
equipment |
|
|
|
|
|
|
860 |
|
|
|
|
|
|
|
862 |
|
Deferred income taxes,
net |
|
|
|
|
|
|
941 |
|
|
|
|
|
|
|
1,029 |
|
Goodwill |
|
|
|
|
|
|
2,879 |
|
|
|
|
|
|
|
2,876 |
|
Other assets, including
other intangibles |
|
|
|
|
|
|
1,004 |
|
|
|
|
|
|
|
1,056 |
|
Separate account
assets |
|
|
|
|
|
|
7,491 |
|
|
|
|
|
|
|
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
|
|
|
|
$ |
43,864 |
|
|
|
|
|
|
$ |
43,013 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractholder deposit
funds |
|
|
|
|
|
$ |
8,506 |
|
|
|
|
|
|
$ |
8,484 |
|
Future policy
benefits |
|
|
|
|
|
|
8,116 |
|
|
|
|
|
|
|
8,136 |
|
Unpaid claims and claim
expenses |
|
|
|
|
|
|
3,996 |
|
|
|
|
|
|
|
3,968 |
|
Health Care medical
claims payable |
|
|
|
|
|
|
1,341 |
|
|
|
|
|
|
|
921 |
|
Unearned premiums and
fees |
|
|
|
|
|
|
432 |
|
|
|
|
|
|
|
427 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance and
contractholder liabilities |
|
|
|
|
|
|
22,391 |
|
|
|
|
|
|
|
21,936 |
|
Accounts payable,
accrued expenses and other liabilities |
|
|
|
|
|
|
5,606 |
|
|
|
|
|
|
|
5,797 |
|
Short-term
debt |
|
|
|
|
|
|
326 |
|
|
|
|
|
|
|
104 |
|
Long-term debt |
|
|
|
|
|
|
2,212 |
|
|
|
|
|
|
|
2,436 |
|
Nonrecourse
obligations |
|
|
|
|
|
|
23 |
|
|
|
|
|
|
|
23 |
|
Separate account
liabilities |
|
|
|
|
|
|
7,491 |
|
|
|
|
|
|
|
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities |
|
|
|
|
|
|
38,049 |
|
|
|
|
|
|
|
37,584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingencies — Note
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock (par value
per share, $0.25; shares issued, 351) |
|
|
|
|
|
|
88 |
|
|
|
|
|
|
|
88 |
|
Additional paid-in
capital |
|
|
|
|
|
|
2,522 |
|
|
|
|
|
|
|
2,514 |
|
Net unrealized
appreciation, fixed maturities |
|
$ |
450 |
|
|
|
|
|
|
$ |
378 |
|
|
|
|
|
Net unrealized
appreciation, equity securities |
|
|
4 |
|
|
|
|
|
|
|
4 |
|
|
|
|
|
Net unrealized
depreciation, derivatives |
|
|
(26 |
) |
|
|
|
|
|
|
(30 |
) |
|
|
|
|
Net translation of
foreign currencies |
|
|
(8 |
) |
|
|
|
|
|
|
(12 |
) |
|
|
|
|
Postretirement benefits
liability adjustment |
|
|
(950 |
) |
|
|
|
|
|
|
(958 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other
comprehensive loss |
|
|
|
|
|
|
(530 |
) |
|
|
|
|
|
|
(618 |
) |
Retained
earnings |
|
|
|
|
|
|
8,840 |
|
|
|
|
|
|
|
8,625 |
|
Less treasury stock, at
cost |
|
|
|
|
|
|
(5,119 |
) |
|
|
|
|
|
|
(5,192 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total shareholders’
equity |
|
|
|
|
|
|
5,801 |
|
|
|
|
|
|
|
5,417 |
|
Noncontrolling
interest |
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity |
|
|
|
|
|
|
5,815 |
|
|
|
|
|
|
|
5,429 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
equity |
|
|
|
|
|
$ |
43,864 |
|
|
|
|
|
|
$ |
43,013 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ Equity
Per Share |
|
|
|
|
|
$ |
20.97 |
|
|
|
|
|
|
$ |
19.75 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying
Notes to the Consolidated Financial Statements are an integral part of these
statements.
2
CIGNA
Corporation
Consolidated
Statements of Comprehensive Income and Changes in Total Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
|
|
2010 |
|
|
2009 |
|
|
|
Compre- |
|
|
|
|
|
|
Compre- |
|
|
|
|
(In millions, except per share amounts) |
|
hensive |
|
|
Total |
|
|
hensive |
|
|
Total |
|
Three
Months Ended March 31, |
|
Income |
|
|
Equity |
|
|
Income |
|
|
Equity |
|
Common Stock,
January 1 and March 31, |
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In
Capital, January 1, |
|
|
|
|
|
|
2,514 |
|
|
|
|
|
|
|
2,502 |
|
Effects of stock
issuance for employee benefit plans |
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In
Capital, March 31, |
|
|
|
|
|
|
2,522 |
|
|
|
|
|
|
|
2,505 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other
Comprehensive Loss, January 1, |
|
|
|
|
|
|
(618 |
) |
|
|
|
|
|
|
(1,074 |
) |
Net unrealized
appreciation, fixed maturities |
|
$ |
72 |
|
|
|
72 |
|
|
$ |
53 |
|
|
|
53 |
|
Net unrealized
depreciation, equity securities |
|
|
— |
|
|
|
— |
|
|
|
(2 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation on securities |
|
|
72 |
|
|
|
|
|
|
|
51 |
|
|
|
|
|
Net unrealized
appreciation, derivatives |
|
|
4 |
|
|
|
4 |
|
|
|
11 |
|
|
|
11 |
|
Net translation of
foreign currencies |
|
|
4 |
|
|
|
4 |
|
|
|
(28 |
) |
|
|
(28 |
) |
Postretirement benefits
liability adjustment |
|
|
8 |
|
|
|
8 |
|
|
|
4 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive
income |
|
|
88 |
|
|
|
|
|
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other
Comprehensive Loss, March 31, |
|
|
|
|
|
|
(530 |
) |
|
|
|
|
|
|
(1,036 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings,
January 1, |
|
|
|
|
|
|
8,625 |
|
|
|
|
|
|
|
7,374 |
|
Shareholders’ net
income |
|
|
283 |
|
|
|
283 |
|
|
|
208 |
|
|
|
208 |
|
Effects of stock
issuance for employee benefit plans |
|
|
|
|
|
|
(57 |
) |
|
|
|
|
|
|
(35 |
) |
Common dividends
declared (per share: $0.04; $0.04) |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings,
March 31, |
|
|
|
|
|
|
8,840 |
|
|
|
|
|
|
|
7,536 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock,
January 1, |
|
|
|
|
|
|
(5,192 |
) |
|
|
|
|
|
|
(5,298 |
) |
Other, primarily
issuance of treasury stock for employee benefit plans |
|
|
|
|
|
|
73 |
|
|
|
|
|
|
|
36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock,
March 31, |
|
|
|
|
|
|
(5,119 |
) |
|
|
|
|
|
|
(5,262 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
Comprehensive Income and Shareholders’ Equity |
|
|
371 |
|
|
|
5,801 |
|
|
|
246 |
|
|
|
3,831 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling
interest, January 1, |
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
6 |
|
Net income attributable
to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
Accumulated other
comprehensive income attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling
interest, March 31, |
|
|
2 |
|
|
|
14 |
|
|
|
1 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Comprehensive
Income and Total Equity |
|
$ |
373 |
|
|
$ |
5,815 |
|
|
$ |
247 |
|
|
$ |
3,838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying
Notes to the Consolidated Financial Statements are an integral part of these
statements.
3
CIGNA
Corporation
Consolidated
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
|
|
Three Months Ended March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Cash Flows from
Operating Activities |
|
|
|
|
|
|
|
|
Net income |
|
$ |
284 |
|
|
$ |
209 |
|
Adjustments to
reconcile net income to net cash provided by operating
activities: |
|
|
|
|
|
|
|
|
Depreciation and
amortization |
|
|
61 |
|
|
|
69 |
|
Realized investment
losses |
|
|
6 |
|
|
|
36 |
|
Deferred income
taxes |
|
|
51 |
|
|
|
150 |
|
Gains on sale of
businesses (excluding discontinued operations) |
|
|
(6 |
) |
|
|
(8 |
) |
Income from
discontinued operations, net of taxes |
|
|
— |
|
|
|
(1 |
) |
Net changes in assets
and liabilities, net of non-operating effects: |
|
|
|
|
|
|
|
|
Premiums, accounts and
notes receivable |
|
|
(148 |
) |
|
|
(124 |
) |
Reinsurance
recoverables |
|
|
23 |
|
|
|
(11 |
) |
Deferred policy
acquisition costs |
|
|
(60 |
) |
|
|
(28 |
) |
Other assets |
|
|
41 |
|
|
|
78 |
|
Insurance
liabilities |
|
|
406 |
|
|
|
273 |
|
Accounts payable,
accrued expenses and other liabilities |
|
|
(299 |
) |
|
|
(464 |
) |
Current income
taxes |
|
|
79 |
|
|
|
(90 |
) |
Other, net |
|
|
(44 |
) |
|
|
(17 |
) |
|
|
|
|
|
|
|
Net cash provided by
operating activities |
|
|
394 |
|
|
|
72 |
|
|
|
|
|
|
|
|
Cash Flows from
Investing Activities |
|
|
|
|
|
|
|
|
Proceeds from
investments sold: |
|
|
|
|
|
|
|
|
Fixed
maturities |
|
|
240 |
|
|
|
119 |
|
Commercial mortgage
loans |
|
|
1 |
|
|
|
— |
|
Other (primarily
short-term and other long-term investments) |
|
|
443 |
|
|
|
267 |
|
Investment maturities
and repayments: |
|
|
|
|
|
|
|
|
Fixed
maturities |
|
|
172 |
|
|
|
199 |
|
Commercial mortgage
loans |
|
|
11 |
|
|
|
6 |
|
Investments
purchased: |
|
|
|
|
|
|
|
|
Fixed
maturities |
|
|
(752 |
) |
|
|
(543 |
) |
Equity
securities |
|
|
(4 |
) |
|
|
— |
|
Commercial mortgage
loans |
|
|
(32 |
) |
|
|
(8 |
) |
Other (primarily
short-term and other long-term investments) |
|
|
(145 |
) |
|
|
(146 |
) |
Property and equipment
purchases |
|
|
(52 |
) |
|
|
(60 |
) |
Other (primarily other
acquisitions/dispositions) |
|
|
(5 |
) |
|
|
— |
|
|
|
|
|
|
|
|
Net cash used in
investing activities |
|
|
(123 |
) |
|
|
(166 |
) |
|
|
|
|
|
|
|
Cash Flows from
Financing Activities |
|
|
|
|
|
|
|
|
Deposits and interest
credited to contractholder deposit funds |
|
|
354 |
|
|
|
373 |
|
Withdrawals and benefit
payments from contractholder deposit funds |
|
|
(309 |
) |
|
|
(322 |
) |
Change in cash
overdraft position |
|
|
40 |
|
|
|
14 |
|
Net change in
short-term debt |
|
|
— |
|
|
|
74 |
|
Repayment of long-term
debt |
|
|
(2 |
) |
|
|
(2 |
) |
Issuance of common
stock |
|
|
24 |
|
|
|
— |
|
|
|
|
|
|
|
|
Net cash provided by
financing activities |
|
|
107 |
|
|
|
137 |
|
|
|
|
|
|
|
|
Effect of foreign
currency rate changes on cash and cash equivalents |
|
|
(3 |
) |
|
|
(10 |
) |
|
|
|
|
|
|
|
Net increase in cash
and cash equivalents |
|
|
375 |
|
|
|
33 |
|
Cash and cash
equivalents, January 1, |
|
|
924 |
|
|
|
1,342 |
|
|
|
|
|
|
|
|
Cash and cash
equivalents, March 31, |
|
$ |
1,299 |
|
|
$ |
1,375 |
|
|
|
|
|
|
|
|
Supplemental
Disclosure of Cash Information: |
|
|
|
|
|
|
|
|
Income taxes paid, net
of refunds |
|
$ |
6 |
|
|
$ |
9 |
|
Interest paid |
|
$ |
32 |
|
|
$ |
35 |
|
The accompanying
Notes to the Consolidated Financial Statements are an integral part of these
statements.
4
CIGNA CORPORATION
NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 — Basis of
Presentation
The Consolidated
Financial Statements include the accounts of CIGNA Corporation and its
significant subsidiaries (referred to collectively as “the Company”).
Intercompany transactions and accounts have been eliminated in consolidation.
These Consolidated Financial Statements were prepared in conformity with
accounting principles generally accepted in the United States of America
(“GAAP”).
The interim
consolidated financial statements are unaudited but include all adjustments
(including normal recurring adjustments) necessary, in the opinion of
management, for a fair statement of financial position and results of operations
for the periods reported. The interim consolidated financial statements and
notes should be read in conjunction with the Consolidated Financial Statements
and Notes in the Company’s Form 10-K for the year ended December 31, 2009.
The preparation of
interim consolidated financial statements necessarily relies heavily on
estimates. This and certain other factors, such as the seasonal nature of
portions of the health care and related benefits business as well as competitive
and other market conditions, call for caution in estimating full year results
based on interim results of operations.
Certain
reclassifications have been made to prior period amounts to conform to the
current presentation.
Discontinued
operations for the three months ended March 31, 2009 represented a
$1 million after-tax benefit from the settlement of certain issues related
to a past divestiture.
Unless otherwise
indicated, amounts in these Notes exclude the effects of discontinued
operations.
Note 2 — Recent
Accounting Pronouncements
Variable
interest entities. Effective January 1, 2010, the Company adopted
the Financial Accounting Standards Board’s (“FASB”) amended guidance that
requires ongoing qualitative analysis to determine whether a variable interest
entity must be consolidated based on the entity’s purpose and design, the
Company’s ability to direct the entity’s activities that most significantly
impact its economic performance, and the Company’s right or obligation to
participate in that performance (ASC 810). A variable interest entity is
insufficiently capitalized or is not controlled by its equity owners through
voting or similar rights. These amendments must be applied to qualifying
special-purpose entities and troubled debt restructures formerly excluded from
such analysis. On adoption, the Company was not required to consolidate any
variable interest entities and there were no effects to its results of
operations or financial condition. Although consolidation was not required,
disclosures about the Company’s involvement with variable interest entities have
been provided in Note 10.
Transfers of
financial assets. Effective January 1, 2010, the Company adopted
the FASB’s guidance for accounting for transfers of financial assets (ASC 860)
that changes the requirements for recognizing the transfer of financial assets
and requires additional disclosures about a transferor’s continuing involvement
in transferred financial assets. The guidance also eliminates the concept of a
“qualifying special purpose entity” when assessing transfers of financial
instruments. On adoption, there were no effects to the Company’s results of
operations or financial condition.
Fair value
measurements. The Company adopted the FASB’s updated guidance on fair
value measurements (ASU 2010-06) in the first quarter of 2010, which requires
separate disclosures of significant transfers between levels in the fair value
hierarchy. See Note 7 for additional information.
Other-than-temporary impairments. On April 1,
2009, the Company adopted the FASB’s updated guidance for evaluating whether an
impairment is other than temporary for fixed maturities with declines in fair
value below amortized cost (ASC 320). A reclassification adjustment from
retained earnings to accumulated other comprehensive income was required for
previously impaired fixed maturities that had a non-credit loss as of the date
of adoption, net of related tax effects.
The cumulative effect
of adoption increased the Company’s retained earnings in the second quarter of
2009 with an offsetting decrease to accumulated other comprehensive income of
$18 million, with no overall change to shareholders’ equity. See Note 8 for
information on the Company’s other-than-temporary impairments including
additional required disclosures.
5
Note 3 — Earnings
Per Share (“EPS”)
Basic and diluted
earnings per share were computed as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in millions, except per share amounts) Three Months Ended
March 31, |
|
Basic |
|
|
Effect of Dilution |
|
|
Diluted |
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
283 |
|
|
|
|
|
|
$ |
283 |
|
|
|
|
|
|
|
|
|
|
|
Shares (in
thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average |
|
|
275,688 |
|
|
|
|
|
|
|
275,688 |
|
Common stock
equivalents |
|
|
|
|
|
|
2,412 |
|
|
|
2,412 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
275,688 |
|
|
|
2,412 |
|
|
|
278,100 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
1.03 |
|
|
$ |
(0.01 |
) |
|
$ |
1.02 |
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
207 |
|
|
|
|
|
|
$ |
207 |
|
|
|
|
|
|
|
|
|
|
|
Shares (in
thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average |
|
|
272,591 |
|
|
|
|
|
|
|
272,591 |
|
Common stock
equivalents |
|
|
|
|
|
|
277 |
|
|
|
277 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
272,591 |
|
|
|
277 |
|
|
|
272,868 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
0.76 |
|
|
$ |
— |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
The following
outstanding employee stock options were not included in the computation of
diluted earnings per share because their effect would have increased diluted
earnings per share (antidilutive) as their exercise price was greater than
the average share price of the Company’s common stock for the period.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Antidilutive
options |
|
|
5.2 |
|
|
|
11.3 |
|
The Company held
74,283,513 shares of common stock in Treasury as of March 31, 2010, and
78,169,190 shares as of March 31, 2009.
6
Note 4 — Health
Care Medical Claims Payable
Medical claims payable
for the Health Care segment reflects estimates of the ultimate cost of claims
that have been incurred but not yet reported, those which have been reported but
not yet paid (reported claims in process) and other medical expense payable,
which primarily comprises accruals for provider incentives and other amounts
payable to providers. Incurred but not yet reported comprises the majority of
the reserve balance as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Incurred but not yet
reported |
|
$ |
1,185 |
|
|
$ |
790 |
|
Reported claims in
process |
|
|
137 |
|
|
|
114 |
|
Other medical expense
payable |
|
|
19 |
|
|
|
17 |
|
|
|
|
|
|
|
|
Medical claims
payable |
|
$ |
1,341 |
|
|
$ |
921 |
|
|
|
|
|
|
|
|
Activity in medical
claims payable was as follows:
|
|
|
|
|
|
|
|
|
|
|
For the period ended |
|
|
|
March 31, |
|
|
December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Balance at
January 1, |
|
$ |
921 |
|
|
$ |
924 |
|
Less: Reinsurance and
other amounts recoverable |
|
|
206 |
|
|
|
211 |
|
|
|
|
|
|
|
|
Balance at
January 1, net |
|
|
715 |
|
|
|
713 |
|
|
Incurred claims related
to: |
|
|
|
|
|
|
|
|
Current year |
|
|
2,259 |
|
|
|
6,970 |
|
Prior years |
|
|
(50 |
) |
|
|
(43 |
) |
|
|
|
|
|
|
|
Total incurred |
|
|
2,209 |
|
|
|
6,927 |
|
Paid claims related
to: |
|
|
|
|
|
|
|
|
Current year |
|
|
1,321 |
|
|
|
6,278 |
|
Prior years |
|
|
507 |
|
|
|
647 |
|
|
|
|
|
|
|
|
Total paid |
|
|
1,828 |
|
|
|
6,925 |
|
Ending Balance,
net |
|
|
1,096 |
|
|
|
715 |
|
Add: Reinsurance and
other amounts recoverable |
|
|
245 |
|
|
|
206 |
|
|
|
|
|
|
|
|
Ending Balance |
|
$ |
1,341 |
|
|
$ |
921 |
|
|
|
|
|
|
|
|
7
Reinsurance and other
amounts recoverable reflect amounts due from reinsurers and policyholders to
cover incurred but not reported and pending claims for minimum premium products
and certain administrative services only business where the right of offset does
not exist. See Note 11 for additional information on reinsurance. For the three
months ended March 31, 2010, actual experience differed from the Company’s
key assumptions resulting in favorable incurred claims related to prior years’
medical claims payable of $50 million, or 0.7% of the current year incurred
claims as reported for the year ended December 31, 2009. Actual completion
factors resulted in a reduction in medical claims payable of $24 million,
or 0.3% of the current year incurred claims as reported for the year ended
December 31, 2009 for the insured book of business. Actual medical cost
trend resulted in a reduction in medical claims payable of $26 million, or
0.4% of the current year incurred claims as reported for the year ended
December 31, 2009 for the insured book of business.
For the year ended
December 31, 2009, actual experience differed from the Company’s key
assumptions, resulting in favorable incurred claims related to prior years’
medical claims payable of $43 million, or 0.6% of the current year incurred
claims as reported for the year ended December 31, 2008. Actual completion
factors resulted in a reduction of the medical claims payable of $21 million, or
0.3% of the current year incurred claims as reported for the year ended
December 31, 2008 for the insured book of business. Actual medical cost
trend resulted in a reduction of the medical claims payable of $22 million,
or 0.3% of the current year incurred claims as reported for the year ended
December 31, 2008 for the insured book of business.
The favorable impacts
in 2010 and 2009 relating to completion factors and medical cost trend variances
are primarily due to the release of the provision for moderately adverse
conditions, which is a component of the assumptions for both completion factors
and medical cost trend, established for claims incurred related to prior years.
This release was substantially offset by the provision for moderately adverse
conditions established for claims incurred related to the current year.
The corresponding
impact of prior year development on shareholders’ net income was not material
for the three months ended March 31, 2010 and 2009. The change in the
amount of the incurred claims related to prior years in the medical claims
payable liability does not directly correspond to an increase or decrease in the
Company’s shareholders’ net income recognized for the following reasons:
First, due to the
nature of the Company’s retrospectively experience-rated business, only
adjustments to medical claims payable on accounts in deficit affect
shareholders’ net income. An increase or decrease to medical claims payable on
accounts in deficit, in effect, accrues to the Company and directly impacts
shareholders’ net income. An account is in deficit when the accumulated medical
costs and administrative charges, including profit charges, exceed the
accumulated premium received. Adjustments to medical claims payable on accounts
in surplus accrue directly to the policyholder with no impact on the Company’s
shareholders’ net income. An account is in surplus when the accumulated premium
received exceeds the accumulated medical costs and administrative charges,
including profit charges.
Second, the Company
consistently recognizes the actuarial best estimate of the ultimate liability
within a level of confidence, as required by actuarial standards of practice,
which require that the liabilities be adequate under moderately adverse
conditions. As the Company establishes the liability for each incurral year, the
Company ensures that its assumptions appropriately consider moderately adverse
conditions. When a portion of the development related to the prior year incurred
claims is offset by an increase determined appropriate to address moderately
adverse conditions for the current year incurred claims, the Company does not
consider that offset amount as having any impact on shareholders’ net income.
The determination of
liabilities for Health Care medical claims payable required the Company to make
critical accounting estimates. See Note 2(N) to the Consolidated Financial
Statements in the Company’s 2009 Form 10-K.
8
Note 5 — Cost
Reduction
As part of its
strategy, the Company has undertaken several initiatives to realign its
organization and consolidate support functions in an effort to increase
efficiency and responsiveness to customers and to reduce costs.
During 2008 and 2009,
the Company conducted a comprehensive review to reduce the operating expenses of
its ongoing businesses (“cost reduction program”). As a result, the Company
recognized severance-related and real estate charges in other operating
expenses.
Substantially all of
these charges were recorded in the Health Care segment, and are expected to be
paid in cash by the end of 2010.
Cost reduction
activity for 2010 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In
millions) |
|
Severance |
|
|
Real estate |
|
|
Total |
|
Balance,
January 1, 2010 |
|
$ |
33 |
|
|
$ |
8 |
|
|
$ |
41 |
|
Less: Payments |
|
|
10 |
|
|
|
1 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31,
2010 |
|
$ |
23 |
|
|
$ |
7 |
|
|
$ |
30 |
|
|
|
|
|
|
|
|
|
|
|
Note 6 — Guaranteed
Minimum Death Benefit Contracts
The Company’s
reinsurance operations, which were discontinued in 2000 and are now an inactive
business in run-off mode, reinsured a guaranteed minimum death benefit (“GMDB”),
also known as variable annuity death benefits (“VADBe”), under certain variable
annuities issued by other insurance companies. These variable annuities are
essentially investments in mutual funds combined with a death benefit. The
Company has equity and other market exposures as a result of this product. In
periods of declining equity markets and in periods of flat equity markets
following a decline, the Company’s liabilities for these guaranteed minimum
death benefits increase. Conversely, in periods of rising equity markets, the
Company’s liabilities for these guaranteed minimum death benefits decrease.
In order to
substantially reduce the equity market exposures relating to guaranteed minimum
death benefit contracts, the Company operates a dynamic hedge program (“GMDB
equity hedge program”), using exchange-traded futures contracts. The hedge
program is designed to offset both positive and negative impacts of changes in
equity markets on the GMDB liability. The hedge program involves detailed, daily
monitoring of equity market movements and rebalancing the futures contracts
within established parameters. While the hedge program is actively managed, it
may not exactly offset changes in the GMDB liability due to, among other things,
divergence between the performance of the underlying mutual funds and the hedge
instruments, high levels of volatility in the equity markets, and differences
between actual contractholder behavior and what is assumed. The performance of
the underlying mutual funds compared to the hedge instruments is further
impacted by a time lag, since the data is not reported and incorporated into the
required hedge position on a real time basis. Although this hedge program does
not qualify for GAAP hedge accounting, it is an economic hedge because it is
designed to reduce and is effective in reducing equity market exposures
resulting from this product. The results of the futures contracts are included
in other revenue and amounts reflecting corresponding changes in liabilities for
these GMDB contracts are included in benefits and expenses.
In 2000, the Company
determined that the GMDB reinsurance business was premium deficient because the
recorded future policy benefit reserve was less than the expected present value
of future claims and expenses less the expected present value of future premiums
and investment income using revised assumptions based on actual and expected
experience. As a result, the Company increased its reserves. Since that time,
the Company has tested for premium deficiency by performing a reserve review on
a quarterly basis using current market conditions and assumptions. Under premium
deficiency accounting, if the recorded reserve is determined insufficient, an
increase to the reserve is reflected as a charge to current period income.
Consistent with GAAP, the Company does not recognize gains on premium deficient
long duration products.
9
The Company had future
policy benefit reserves for GMDB contracts of $1.2 billion as of
March 31, 2010, and $1.3 billion as of December 31, 2009. The
determination of liabilities for GMDB requires the Company to make critical
accounting estimates. The Company estimates its liabilities for GMDB exposures
using a complex internal model run using many scenarios and based on assumptions
regarding lapse, future partial surrenders, claim mortality (deaths that result
in claims), interest rates (mean investment performance and discount rate) and
volatility. Lapse refers to the full surrender of an annuity prior to a
contractholder’s death. Future partial surrender refers to the fact that most
contractholders have the ability to withdraw substantially all of their mutual
fund investments while retaining the death benefit coverage in effect at the
time of the withdrawal. Mean investment performance for underlying equity mutual
funds refers to market rates expected to be earned on the hedging instruments
over the life of the GMDB equity hedge program, and for underlying fixed income
mutual funds refers to the expected market return over the life of the
contracts. Market volatility refers to market fluctuation. These assumptions are
based on the Company’s experience and future expectations over the long-term
period, consistent with the long-term nature of this product. The Company
regularly evaluates these assumptions and changes its estimates if actual
experience or other evidence suggests that assumptions should be revised. If
actual experience differs from the assumptions (including lapse, future partial
surrenders, claim mortality, interest rates and volatility) used in estimating
these liabilities, the result could have a material adverse effect on the
Company’s consolidated results of operations, and in certain situations, could
have a material adverse effect on the Company’s financial condition.
The following provides
information about the Company’s reserving methodology and assumptions for GMDB
as of March 31, 2010:
• |
|
The reserves represent estimates of the present value of net amounts
expected to be paid, less the present value of net future premiums.
Included in net amounts expected to be paid is the excess of the
guaranteed death benefits over the values of the contractholders’ accounts
(based on underlying equity and bond mutual fund
investments). |
• |
|
The reserves include an estimate for partial surrenders that
essentially lock in the death benefit for a particular policy based on
annual election rates that vary from 0-21% depending on the net amount at
risk for each policy and whether surrender charges
apply. |
• |
|
The assumed mean investment performance for the underlying equity
mutual funds considers the Company’s GMDB equity hedge program using
futures contracts, and is based on the Company’s view that short-term
interest rates will average 5% over future periods, but considers that
current short-term rates are less than 5%. The mean investment performance
assumption for the underlying fixed income mutual funds (bonds and money
market) is 5% based on a review of historical returns. The investment
performance for underlying equity and fixed income mutual funds is reduced
by fund fees ranging from 1-3% across all funds. The results of futures
contracts are reflected in the liability calculation as a component of
investment returns. |
• |
|
The volatility assumption is based on a review of historical monthly
returns for each key index (e.g. S&P 500) over a period of at least
ten years. Volatility represents the dispersion of historical returns
compared to the average historical return (standard deviation) for each
index. The assumption is 16-27%, varying by equity fund type; 4-10%,
varying by bond fund type; and 2% for money market funds. These volatility
assumptions are used along with the mean investment performance assumption
to project future return scenarios. |
• |
|
The discount rate is 5.75%. |
• |
|
The claim mortality assumption is 65-89% of the 1994 Group Annuity
Mortality table, with 1% annual improvement beginning January 1,
2000. For certain contracts, a spousal beneficiary is allowed to elect to
continue a contract by becoming its new owner, thereby, postponing the
death claim rather than receiving the death benefit currently. For certain
issuers of these contracts, the claim mortality assumption depends on age,
gender, and net amount at risk for the policy. |
• |
|
The lapse rate assumption is 0-21%, depending on contract type, policy
duration and the ratio of the net amount at risk to account
value. |
No reserve
strengthening was required for GMDB in the first quarter of 2010, primarily due
to the stabilization and recovery of equity markets.
In the first quarter
of 2009, the Company reported a loss related to GMDB of $75 million pre-tax
($49 million after-tax), which included a charge of $73 million
pre-tax ($47 million after-tax) to strengthen GMDB reserves. The reserve
strengthening primarily reflected an increase in the provision for future
partial surrenders due to market declines, adverse volatility-related impacts
due to turbulent equity market conditions, and interest rate impacts.
10
Activity in future
policy benefit reserves for the GMDB business was as follows:
|
|
|
|
|
|
|
|
|
|
|
For the period ended |
|
|
|
March 31, |
|
|
December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Balance at January
1 |
|
$ |
1,285 |
|
|
$ |
1,609 |
|
Add: Unpaid
Claims |
|
|
36 |
|
|
|
34 |
|
Less: Reinsurance and
other amounts recoverable |
|
|
53 |
|
|
|
83 |
|
|
|
|
|
|
|
|
Balance at
January 1, net |
|
|
1,268 |
|
|
|
1,560 |
|
Add: Incurred
benefits |
|
|
(23 |
) |
|
|
(122 |
) |
Less: Paid
benefits |
|
|
27 |
|
|
|
170 |
|
|
|
|
|
|
|
|
Ending balance,
net |
|
|
1,218 |
|
|
|
1,268 |
|
Less: Unpaid
Claims |
|
|
36 |
|
|
|
36 |
|
Add: Reinsurance and
other amounts recoverable |
|
|
49 |
|
|
|
53 |
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
1,231 |
|
|
$ |
1,285 |
|
|
|
|
|
|
|
|
Benefits paid and
incurred are net of ceded amounts. Incurred benefits reflect the favorable or
unfavorable impact of a rising or falling equity market on the liability, and
include the charges discussed above. As discussed below, losses or gains have
been recorded in other revenues as a result of the GMDB equity hedge program to
reduce equity market exposures.
The aggregate value of
the underlying mutual fund investments was $17.2 billion as of
March 31, 2010 and December 31, 2009. The death benefit coverage in
force was $6.3 billion as of March 31, 2010 and $7.0 billion as
of December 31, 2009. The death benefit coverage in force represents the
excess of the guaranteed benefit amount over the value of the underlying mutual
fund investments for all contractholders (approximately 570,000 as of
March 31, 2010 and 590,000 as of December 31, 2009).
As discussed above,
the Company operates a GMDB equity hedge program to substantially reduce the
equity market exposures of this business by selling exchange-traded futures
contracts, which are expected to rise in value as the equity market declines and
decline in value as the equity market rises. In addition, the Company uses
foreign currency futures contracts to reduce the international equity market and
foreign currency risks associated with this business. The notional amount of
futures contract positions held by the Company at March 31, 2010 was
$1.0 billion. The Company recorded in other revenues pre-tax losses of
$45 million for the three months ended March 31, 2010, and pre-tax gains of
$117 million for the three months ended March 31, 2009.
The Company has also
written reinsurance contracts with issuers of variable annuity contracts that
provide annuitants with certain guarantees related to minimum income benefits
(“GMIB”). All reinsured GMIB policies also have a GMDB benefit reinsured by the
Company. See Note 7 for further information.
11
Note 7 — Fair Value
Measurements
The Company carries
certain financial instruments at fair value in the financial statements
including fixed maturities, equity securities, short-term investments and
derivatives. Other financial instruments are measured at fair value under
certain conditions, such as when impaired.
Fair value is defined
as the price at which an asset could be exchanged in an orderly transaction
between market participants at the balance sheet date. A liability’s fair value
is defined as the amount that would be paid to transfer the liability to a
market participant, not the amount that would be paid to settle the liability
with the creditor.
Fair values are based
on quoted market prices when available. When market prices are not available,
fair value is generally estimated using discounted cash flow analyses,
incorporating current market inputs for similar financial instruments with
comparable terms and credit quality. In instances where there is little or no
market activity for the same or similar instruments, the Company estimates fair
value using methods, models and assumptions that the Company believes a
hypothetical market participant would use to determine a current transaction
price. These valuation techniques involve some level of estimation and judgment
by the Company which becomes significant with increasingly complex instruments
or pricing models.
The Company’s
financial assets and liabilities carried at fair value have been classified
based upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking
to fair values determined using unadjusted quoted prices in active markets for
identical assets and liabilities (Level 1) and the lowest ranking to fair values
determined using methodologies and models with unobservable inputs (Level 3). An
asset’s or a liability’s classification is based on the lowest level of input
that is significant to its measurement. For example, a financial asset or
liability carried at fair value would be classified in Level 3 if unobservable
inputs were significant to the instrument’s fair value, even though the
measurement may be derived using inputs that are both observable (Levels 1 and
2) and unobservable (Level 3).
The Company performs
ongoing analyses of prices used to value the Company’s invested assets to
determine that they represent appropriate estimates of fair value. This process
involves quantitative and qualitative analysis including reviews of pricing
methodologies, judgments of valuation inputs, the significance of any
unobservable inputs, pricing statistics and trends. The Company also performs
sample testing of sales values to confirm the accuracy of prior fair value
estimates. These procedures are overseen by the Company’s investment
professionals.
12
Financial Assets
and Financial Liabilities Carried at Fair Value
The following tables
provide information as of March 31, 2010 and December 31, 2009 about
the Company’s financial assets and liabilities carried at fair value. Similar
disclosures for separate account assets, which are also recorded at fair value
on the Company’s Consolidated Balance Sheets, are provided separately as gains
and losses related to these assets generally accrue directly to policyholders.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in |
|
|
|
|
|
|
Significant |
|
|
|
|
|
|
Active Markets for |
|
|
Significant Other |
|
|
Unobservable |
|
|
|
|
March
31, 2010 |
|
Identical Assets |
|
|
Observable Inputs |
|
|
Inputs |
|
|
|
|
(In
millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Financial assets at
fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal government and
agency |
|
$ |
36 |
|
|
$ |
528 |
|
|
$ |
1 |
|
|
$ |
565 |
|
State and local
government
|
|
|
— |
|
|
|
2,523 |
|
|
|
— |
|
|
|
2,523 |
|
Foreign government |
|
|
— |
|
|
|
1,154 |
|
|
|
15 |
|
|
|
1,169 |
|
Corporate |
|
|
— |
|
|
|
8,658 |
|
|
|
351 |
|
|
|
9,009 |
|
Federal agency
mortgage-backed |
|
|
— |
|
|
|
30 |
|
|
|
— |
|
|
|
30 |
|
Other mortgage-backed
|
|
|
— |
|
|
|
114 |
|
|
|
8 |
|
|
|
122 |
|
Other asset-backed |
|
|
— |
|
|
|
84 |
|
|
|
475 |
|
|
|
559 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed
maturities
(1) |
|
|
36 |
|
|
|
13,091 |
|
|
|
850 |
|
|
|
13,977 |
|
Equity securities |
|
|
2 |
|
|
|
86 |
|
|
|
34 |
|
|
|
122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
38 |
|
|
|
13,177 |
|
|
|
884 |
|
|
|
14,099 |
|
Short-term
investments
|
|
|
— |
|
|
|
188 |
|
|
|
— |
|
|
|
188 |
|
GMIB assets (2) |
|
|
— |
|
|
|
— |
|
|
|
479 |
|
|
|
479 |
|
Other derivative
assets
(3) |
|
|
— |
|
|
|
18 |
|
|
|
— |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial assets
at fair value, excluding separate accounts |
|
$ |
38 |
|
|
$ |
13,383 |
|
|
$ |
1,363 |
|
|
$ |
14,784 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities
at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB liabilities |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
886 |
|
|
$ |
886 |
|
Other derivative
liabilities
|
|
|
— |
|
|
|
27 |
|
|
|
— |
|
|
|
27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial
liabilities at fair value |
|
$ |
— |
|
|
$ |
27 |
|
|
$ |
886 |
|
|
$ |
913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Fixed maturities includes $320 million of net appreciation
required to adjust future policy benefits for the run-off settlement
annuity business including $56 million of appreciation for securities
classified in Level 3. |
|
(2) |
|
The guaranteed minimum income benefit (“GMIB”) assets represent
retrocessional contracts in place from two external reinsurers which cover
55% of the exposures on these contracts. The assets are net of a liability
of $16 million for the future cost of reinsurance. |
|
(3) |
|
Other derivative assets includes $14 million of interest rate
and foreign currency swaps qualifying as cash flow hedges and
$4 million of interest rate swaps not designated as accounting
hedges. |
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in |
|
|
Significant |
|
|
|
|
|
|
|
|
|
Active Markets |
|
|
Other |
|
|
Significant |
|
|
|
|
|
|
for Identical |
|
|
Observable |
|
|
Unobservable |
|
|
|
|
December
31, 2009 |
|
Assets |
|
|
Inputs |
|
|
Inputs |
|
|
|
|
(In
millions)
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Financial assets at
fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal government and
agency |
|
$ |
43 |
|
|
$ |
527 |
|
|
$ |
1 |
|
|
$ |
571 |
|
State and local
government
|
|
|
— |
|
|
|
2,521 |
|
|
|
— |
|
|
|
2,521 |
|
Foreign government |
|
|
— |
|
|
|
1,056 |
|
|
|
14 |
|
|
|
1,070 |
|
Corporate |
|
|
— |
|
|
|
8,241 |
|
|
|
344 |
|
|
|
8,585 |
|
Federal agency
mortgage-backed |
|
|
— |
|
|
|
34 |
|
|
|
— |
|
|
|
34 |
|
Other mortgage-backed
|
|
|
— |
|
|
|
114 |
|
|
|
7 |
|
|
|
121 |
|
Other asset-backed |
|
|
— |
|
|
|
92 |
|
|
|
449 |
|
|
|
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed
maturities
(1) |
|
|
43 |
|
|
|
12,585 |
|
|
|
815 |
|
|
|
13,443 |
|
Equity securities |
|
|
2 |
|
|
|
81 |
|
|
|
30 |
|
|
|
113 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
45 |
|
|
|
12,666 |
|
|
|
845 |
|
|
|
13,556 |
|
Short-term
investments
|
|
|
— |
|
|
|
493 |
|
|
|
— |
|
|
|
493 |
|
GMIB assets (2) |
|
|
— |
|
|
|
— |
|
|
|
482 |
|
|
|
482 |
|
Other derivative
assets
(3) |
|
|
— |
|
|
|
16 |
|
|
|
— |
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial assets
at fair value, excluding separate accounts |
|
$ |
45 |
|
|
$ |
13,175 |
|
|
$ |
1,327 |
|
|
$ |
14,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities
at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB liabilities |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
903 |
|
|
$ |
903 |
|
Other derivative
liabilities
|
|
|
— |
|
|
|
30 |
|
|
|
— |
|
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial
liabilities at fair value |
|
$ |
— |
|
|
$ |
30 |
|
|
$ |
903 |
|
|
$ |
933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Fixed maturities includes $274 million of net appreciation
required to adjust future policy benefits for the run-off settlement
annuity business including $38 million of appreciation for securities
classified in Level 3. |
|
(2) |
|
The GMIB assets represent retrocessional contracts in place from
two external reinsurers which cover 55% of the exposures on these
contracts. The assets are net of a liability of $15 million for the
future cost of reinsurance. |
|
(3) |
|
Other derivative assets include $12 million of interest rate
and foreign currency swaps qualifying as cash flow hedges and
$4 million of interest rate swaps not designated as accounting
hedges. |
Level 1
Financial Assets
Inputs for instruments
classified in Level 1 include unadjusted quoted prices for identical assets in
active markets accessible at the measurement date. Active markets provide
pricing data for trades occurring at least weekly and include exchanges and
dealer markets.
Assets in Level 1
include actively-traded U.S. government bonds and exchange-listed equity
securities. Given the narrow definition of Level 1 and the Company’s investment
asset strategy to maximize investment returns, a relatively small portion of the
Company’s investment assets are classified in this category.
Level 2
Financial Assets and Financial Liabilities
Inputs for instruments
classified in Level 2 include quoted prices for similar assets or liabilities in
active markets, quoted prices from those willing to trade in markets that are
not active, or other inputs that are market observable or can be corroborated by
market data for the term of the instrument. Such other inputs include market
interest rates and volatilities, spreads and yield curves. An instrument is
classified in Level 2 if the Company determines that unobservable inputs are
insignificant.
14
Fixed maturities
and equity securities. Approximately 93% of the Company’s investments in
fixed maturities and equity securities are classified in Level 2 including most
public and private corporate debt and equity securities, federal agency and
municipal bonds, non-government mortgage-backed securities and preferred stocks.
Because many fixed maturities and preferred stocks do not trade daily, fair
values are often derived using recent trades of securities with similar features
and characteristics. When recent trades are not available, pricing models are
used to determine these prices. These models calculate fair values by
discounting future cash flows at estimated market interest rates. Such market
rates are derived by calculating the appropriate spreads over comparable U.S.
Treasury securities, based on the credit quality, industry and structure of the
asset. Typical inputs and assumptions to pricing models include, but are not
limited to, a combination of benchmark yields, reported trades, issuer spreads,
liquidity, benchmark securities, bids, offers, reference data, and industry and
economic events. For mortgage-backed securities, inputs and assumptions may also
include characteristics of the issuer, collateral attributes, prepayment speeds
and credit rating.
Nearly all of these
instruments are valued using recent trades or pricing models. Less than 1% of
the fair value of investments classified in Level 2 represents foreign bonds
that are valued, consistent with local market practice, using a single
unadjusted market-observable input derived by averaging multiple broker-dealer
quotes.
Short-term
investments are carried at fair value, which approximates cost. On a
regular basis the Company compares market prices for these securities to
recorded amounts to validate that current carrying amounts approximate exit
prices. The short-term nature of the investments and corroboration of the
reported amounts over the holding period support their classification in Level
2.
Other
derivatives classified in Level 2 represent over-the-counter instruments
such as interest rate and foreign currency swap contracts. Fair values for these
instruments are determined using market observable inputs including forward
currency and interest rate curves and widely published market observable
indices. Credit risk related to the counterparty and the Company is considered
when estimating the fair values of these derivatives. However, the Company is
largely protected by collateral arrangements with counterparties, and determined
that no adjustment for credit risk was required as of March 31, 2010 or
December 31, 2009. The nature and use of these other derivatives are
described in Note 9.
Level 3
Financial Assets and Financial Liabilities
Certain inputs for
instruments classified in Level 3 are unobservable (supported by little or no
market activity) and significant to their resulting fair value measurement.
Unobservable inputs reflect the Company’s best estimate of what hypothetical
market participants would use to determine a transaction price for the asset or
liability at the reporting date.
The Company classifies
certain newly issued, privately placed, complex or illiquid securities, as well
as assets and liabilities relating to GMIB in Level 3.
Fixed maturities
and equity securities. Approximately 6% of fixed maturities and equity
securities are priced using significant unobservable inputs and classified in
this category, including:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Mortgage and
asset-backed securities |
|
$ |
483 |
|
|
$ |
456 |
|
Corporate
bonds |
|
|
286 |
|
|
|
288 |
|
Subordinated loans and
private equity investments |
|
|
115 |
|
|
|
101 |
|
|
|
|
|
|
|
|
Total |
|
$ |
884 |
|
|
$ |
845 |
|
|
|
|
|
|
|
|
Fair values of
mortgage and asset-backed securities and corporate bonds are determined using
pricing models that incorporate the specific characteristics of each asset and
related assumptions including the investment type and structure, credit quality,
industry and maturity date in comparison to current market indices, spreads and
liquidity of assets with similar characteristics. For mortgage and asset-backed
securities, inputs and assumptions to pricing may also include collateral
attributes and prepayment speeds. Recent trades in the subject security or
similar securities are assessed when available, and the Company may also review
published research as well as the issuer’s financial statements in its
evaluation. Subordinated loans and private equity investments are valued at
transaction price in the absence of market data indicating a change in the
estimated fair values.
15
Guaranteed
minimum income benefit contracts. Because cash flows of the GMIB
liabilities and assets are affected by equity markets and interest rates but are
without significant life insurance risk and are settled in lump sum payments,
the Company reports these liabilities and assets as derivatives at fair value.
The Company estimates the fair value of the assets and liabilities for GMIB
contracts using assumptions regarding capital markets (including market returns,
interest rates and market volatilities of the underlying equity and bond mutual
fund investments), future annuitant behavior (including mortality, lapse, and
annuity election rates), and non-performance risk, as well as risk and profit
charges. As certain assumptions (primarily related to future annuitant behavior)
used to estimate fair values for these contracts are largely unobservable, the
Company classifies GMIB assets and liabilities in Level 3. The Company
considered the following in determining the view of a hypothetical market
participant:
• |
|
that the most likely transfer of these assets and liabilities would be
through a reinsurance transaction with an independent insurer having a
market capitalization and credit rating similar to that of the Company;
and |
• |
|
that because this block of contracts is in run-off mode, an insurer
looking to acquire these contracts would have similar existing contracts
with related administrative and risk management
capabilities. |
These GMIB assets and
liabilities are estimated with a complex internal model using many scenarios to
determine the present value of net amounts expected to be paid, less the present
value of net future premiums expected to be received adjusted for risk and
profit charges that the Company estimates a hypothetical market participant
would require to assume this business. Net amounts expected to be paid include
the excess of the expected value of the income benefits over the values of the
annuitants’ accounts at the time of annuitization. Generally, market return,
interest rate and volatility assumptions are based on market observable
information. Assumptions related to annuitant behavior reflect the Company’s
belief that a hypothetical market participant would consider the actual and
expected experience of the Company as well as other relevant and available
industry resources in setting policyholder behavior assumptions. The significant
assumptions used to value the GMIB assets and liabilities as of March 31,
2010 were as follows:
• |
|
The market return and discount rate assumptions are based on the
market-observable LIBOR swap curve. |
|
• |
|
The projected interest rate used to calculate the reinsured income
benefits is indexed to the 7-year Treasury Rate at the time of
annuitization (claim interest rate) based on contractual terms. That rate
was 3.28% at March 31, 2010 and must be projected for future time
periods. These projected rates vary by economic scenario and are
determined by an interest rate model using current interest rate curves
and the prices of instruments available in the market including various
interest rate caps and zero-coupon bonds. For a subset of the business,
there is a contractually guaranteed floor of 3% for the claim interest
rate. |
|
• |
|
The market volatility assumptions for annuitants’ underlying mutual
fund investments that are modeled based on the S&P 500, Russell 2000
and NASDAQ Composite are based on the market-implied volatility for these
indices for three to seven years grading to historical volatility levels
thereafter. For the remaining 55% of underlying mutual fund investments
modeled based on other indices (with insufficient market-observable data),
volatility is based on the average historical level for each index over
the past 10 years. Using this approach, volatility ranges from 17% to
31% for equity funds, 4% to 12% for bond funds and 1% to 2% for money
market funds. |
|
• |
|
The mortality assumption is 70% of the 1994 Group Annuity Mortality
table, with 1% annual improvement beginning January 1, 2000. |
|
• |
|
The annual lapse rate assumption reflects experience that differs by
the company issuing the underlying variable annuity contracts, ranges from
2% to 17% and depends on the time since contract issue and the relative
value of the guarantee. |
|
• |
|
The annual annuity election rate assumption reflects experience that
differs by the company issuing the underlying variable annuity contracts
and depends on the annuitant’s age, the relative value of the guarantee
and whether a contractholder has had a previous opportunity to elect the
benefit. Immediately after the expiration of the waiting period, the
assumed probability that an individual will annuitize their variable
annuity contract is up to 80%. For the second and subsequent annual
opportunities to elect the benefit, the assumed probability of election is
up to 30%. Actual data is still emerging for the Company as well as the
industry and the estimates are based on this limited data.
|
• |
|
The nonperformance risk adjustment is incorporated by adding an
additional spread to the discount rate in the calculation of both
(1) the GMIB liability to reflect a hypothetical market participant’s
view of the risk of the Company not fulfilling its GMIB obligations, and
(2) the GMIB asset to reflect a hypothetical market participant’s
view of the reinsurers’ credit risk, after considering collateral. The
estimated market-implied spread is company-specific for each party
involved to the extent that company-specific market data is available and
is based on industry averages for similarly rated companies when
company-specific data is not available. The spread is impacted by the
credit default swap spreads of the specific parent companies, adjusted to
reflect subsidiaries’ credit ratings relative to their parent company. The
additional spread over LIBOR incorporated into the discount rate ranged
from 20 to 115 basis points for the GMIB liability and from 0 to 60 basis
points for the GMIB reinsurance asset for that portion of the interest
rate curve most relevant to these policies. |
|
• |
|
The risk and profit charge assumption is based on the Company’s
estimate of the capital and return on capital that would be required by a
hypothetical market participant. |
16
The Company regularly
evaluates each of the assumptions used in establishing these assets and
liabilities by considering how a hypothetical market participant would set
assumptions at each valuation date. Capital markets assumptions are expected to
change at each valuation date reflecting current observable market conditions.
Other assumptions may also change based on a hypothetical market participant’s
view of actual experience as it emerges over time or other factors that impact
the net liability. If the emergence of future experience or future assumptions
differs from the assumptions used in estimating these assets and liabilities,
the resulting impact could be material to the Company’s consolidated results of
operations, and in certain situations, could be material to the Company’s
financial condition.
GMIB liabilities are
reported in the Company’s Consolidated Balance Sheets in Accounts payable,
accrued expenses and other liabilities. GMIB assets associated with these
contracts represent net receivables in connection with reinsurance that the
Company has purchased from two external reinsurers and are reported in the
Company’s Consolidated Balance Sheets in Other assets, including other
intangibles. The current S&P financial strength rating of one reinsurer is
AA-. The receivable from the second reinsurer is fully collateralized by assets
held in a trust.
17
Changes in Level
3 Financial Assets and Financial Liabilities Carried at Fair Value
The following tables
summarize the changes in financial assets and financial liabilities classified
in Level 3 for the three months ended March 31, 2010 and 2009. These tables
exclude separate account assets as changes in fair values of these assets accrue
directly to policyholders. Gains and losses reported in these tables may include
changes in fair value that are attributable to both observable and unobservable
inputs.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the
Three Months Ended March 31, 2010 |
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In
millions) |
|
Equity Securities |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at
January 1, 2010
|
|
$ |
845 |
|
|
$ |
482 |
|
|
$ |
(903 |
) |
|
$ |
(421 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
(losses) included in shareholders’ net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value
gain/(loss)
|
|
|
— |
|
|
|
— |
|
|
|
4 |
|
|
|
4 |
|
Other |
|
|
4 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains
(losses) included in shareholders’ net income |
|
|
4 |
|
|
|
— |
|
|
|
4 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains included in other
comprehensive income
|
|
|
12 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Gains required to
adjust future policy benefits for settlement annuities (1) |
|
|
18 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Purchases, issuances,
settlements
|
|
|
(11 |
) |
|
|
(3 |
) |
|
|
13 |
|
|
|
10 |
|
Transfers into/(out
of) Level 3:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level
3 |
|
|
54 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Transfers out of Level
3 |
|
|
(38 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers
into/(out of) Level 3 |
|
|
16 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
March 31, 2010 |
|
$ |
884 |
|
|
$ |
479 |
|
|
$ |
(886 |
) |
|
$ |
(407 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains
(losses) included in income attributable to instruments held at the
reporting date |
|
$ |
4 |
|
|
$ |
— |
|
|
$ |
4 |
|
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the
Three Months Ended March 31, 2009 |
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In
millions)
|
|
Equity Securities |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at
January 1, 2009
|
|
$ |
889 |
|
|
$ |
953 |
|
|
$ |
(1,757 |
) |
|
$ |
(804 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
(losses) included in shareholders’ net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value
gain/(loss)
|
|
|
— |
|
|
|
(38 |
) |
|
|
70 |
|
|
|
32 |
|
Other |
|
|
(4 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains
(losses) included in shareholders’ net income |
|
|
(4 |
) |
|
|
(38 |
) |
|
|
70 |
|
|
|
32 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses included in
other comprehensive income |
|
|
(19 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Losses required to
adjust future policy benefits for settlement annuities (1) |
|
|
(76 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Purchases, sales,
settlements
|
|
|
(3 |
) |
|
|
(7 |
) |
|
|
46 |
|
|
|
39 |
|
Transfers into/(out
of) Level 3:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level
3 |
|
|
155 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Transfers out of Level
3 |
|
|
(32 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers
into/(out of) Level 3 |
|
|
123 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
March 31, 2009 |
|
$ |
910 |
|
|
$ |
908 |
|
|
$ |
(1,641 |
) |
|
$ |
(733 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains
(losses) included in income attributable to instruments held at the
reporting date
|
|
$ |
(4 |
) |
|
$ |
(38 |
) |
|
$ |
70 |
|
|
$ |
32 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
18
As noted in the tables
above, total gains and losses included in net income are reflected in the
following captions in the Consolidated Statements of Income:
• |
|
Realized investment gains (losses) and net investment income for
amounts related to fixed maturities and equity securities;
and |
• |
|
GMIB fair value (gain) loss for amounts related to GMIB assets
and liabilities. |
Reclassifications
impacting Level 3 financial instruments are reported as transfers into or out of
the Level 3 category as of the beginning of the quarter in which the transfer
occurs. Therefore gains and losses in income only reflect activity for the
period the instrument was classified in Level 3.
Transfers into or out
of the Level 3 category occur when unobservable inputs, such as the Company’s
best estimate of what a market participant would use to determine a current
transaction price, become more or less significant to the fair value
measurement. For the three months ended March 31, 2009, transfers into Level 3
from Level 2 primarily reflect an increase in the unobservable inputs used to
value certain private corporate bonds, principally related to credit risk of the
issuers.
The Company provided
reinsurance for other insurance companies that offer a guaranteed minimum income
benefit, and then retroceded a portion of the risk to other insurance companies.
These arrangements with third-party insurers are the instruments still held at
the reporting date for GMIB assets and liabilities in the table above. Because
these reinsurance arrangements remain in effect at the reporting date, the
Company has reflected the total gain or loss for the period as the total gain or
loss included in income attributable to instruments still held at the reporting
date. However, the Company reduces the GMIB assets and liabilities resulting
from these reinsurance arrangements when annuitants lapse, die, elect their
benefit, or reach the age after which the right to elect their benefit expires.
Under FASB’s guidance
for fair value measurements, the Company’s GMIB assets and liabilities are
expected to be volatile in future periods because the underlying capital markets
assumptions will be based largely on market-observable inputs at the close of
each reporting period including interest rates and market-implied volatilities.
The net GMIB fair
value gain was $4 million for the three months ended March 31, 2010,
and due primarily to favorable equity market returns, offset by declining
interest rates.
The net GMIB fair
value gain was $32 million for the three months ended March 31, 2009.
The gain was due primarily to increases in interest rates since
December 31, 2008 partially offset by declines in equity markets and bond
fund returns and updates to the lapse assumption.
19
Separate account
assets
Fair values and
changes in the fair values of separate account assets generally accrue directly
to the policyholders and are excluded from the Company’s revenues and expenses.
As of March 31, 2010 and December 31, 2009 separate account assets
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in Active |
|
|
Significant Other |
|
|
Significant Unobservable |
|
|
|
|
March
31, 2010 |
|
Markets for Identical Assets |
|
|
Observable Inputs |
|
|
Inputs |
|
|
|
|
(In
millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Guaranteed separate
accounts (See Note 17) |
|
$ |
276 |
|
|
$ |
1,462 |
|
|
$ |
— |
|
|
$ |
1,738 |
|
Non-guaranteed separate
accounts (1) |
|
|
1,957 |
|
|
|
3,252 |
|
|
|
544 |
|
|
|
5,753 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total separate
account assets |
|
$ |
2,233 |
|
|
$ |
4,714 |
|
|
$ |
544 |
|
|
$ |
7,491 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Non-guaranteed separate accounts include $2.6 billion in
assets supporting the Company’s pension plans, including $524 million
classified in Level 3. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in Active |
|
|
Significant Other |
|
|
Significant Unobservable |
|
|
|
|
December
31, 2009 |
|
Markets for Identical Assets |
|
|
Observable Inputs |
|
|
Inputs |
|
|
|
|
(In
millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Guaranteed separate
accounts (See Note 17) |
|
$ |
275 |
|
|
$ |
1,480 |
|
|
$ |
— |
|
|
$ |
1,755 |
|
Non-guaranteed separate
accounts (1) |
|
|
1,883 |
|
|
|
3,100 |
|
|
|
550 |
|
|
|
5,533 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total separate
account assets |
|
$ |
2,158 |
|
|
$ |
4,580 |
|
|
$ |
550 |
|
|
$ |
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Non-guaranteed separate accounts include $2.6 billion in
assets supporting the Company’s pension plans, including $517 million
classified in Level 3. |
Separate account
assets in Level 1 include exchange-listed equity securities. Level 2 assets
primarily include:
• |
|
equity securities and corporate and structured bonds valued using
recent trades of similar securities or pricing models that discount future
cash flows at estimated market interest rates as described above;
and |
• |
|
actively-traded institutional and retail mutual fund investments and
separate accounts priced using the daily net asset value which is their
exit price. |
Separate account
assets classified in Level 3 include investments primarily in securities
partnerships and real estate generally valued based on the separate account’s
ownership share of the equity of the investee including changes in the fair
values of its underlying investments. In addition, certain fixed income funds
priced using the net asset values are classified in Level 3 due to restrictions
on their withdrawal.
20
The following table
summarizes the changes in separate account assets reported in Level 3 for the
three months ended March 31, 2010 and 2009.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Balance at January
1 |
|
$ |
550 |
|
|
$ |
475 |
|
Policyholder gains
(losses) (1) |
|
|
16 |
|
|
|
(46 |
) |
Purchases, issuances,
settlements |
|
|
(3 |
) |
|
|
8 |
|
Transfers into/(out
of) Level 3: |
|
|
|
|
|
|
|
|
Transfers into Level
3 |
|
|
— |
|
|
|
174 |
|
Transfers out of Level
3 |
|
|
(19 |
) |
|
|
(14 |
) |
|
|
|
|
|
|
|
Net transfers
into/(out of) Level 3 |
|
|
(19 |
) |
|
|
160 |
|
|
|
|
|
|
|
|
Balance at March
31 |
|
$ |
544 |
|
|
$ |
597 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes losses of $15 million and losses of $46 million
attributable to instruments still held at March 31, 2010 and
March 31, 2009 respectively. |
For the three months
ended March 31, 2009, transfers into Level 3 primarily represented fixed
income funds that are priced using the net asset value where restrictions were
placed on withdrawal.
Assets and
Liabilities Measured at Fair Value under Certain Conditions
Some financial assets
and liabilities are not carried at fair value each reporting period, but may be
measured using fair value only under certain conditions, such as investments in
real estate entities and commercial mortgage loans when they become impaired.
During the three months ended March 31, 2010, impaired real estate entities
carried at cost of $35 million were written down to their fair values of
$21 million, resulting in pre-tax realized investment losses of
$14 million. Also during the three months ended March 31, 2010,
impaired commercial mortgage loans with carrying values of $64 million were
written down to their fair values of $53 million, resulting in pre-tax
realized investment losses of $11 million. During 2009, impaired commercial
mortgage loans with carrying values of $143 million were written down to their
fair values of $126 million, resulting in pre-tax realized investment losses of
$17 million. Also, during 2009, impaired real estate entities with carrying
values of $48 million were written down to their fair values of $12 million,
resulting in realized investment losses of $26 million. These fair values were
calculated by discounting the expected future cash flows at estimated market
interest rates. Such market rates were derived by calculating the appropriate
spread over comparable U.S. Treasury rates, based on the characteristics of the
underlying collateral including; the type, quality and location of the assets.
The fair value measurements were classified in Level 3 because these cash flow
models incorporate significant unobservable inputs.
Fair Value
Disclosures for Financial Instruments Not Carried at Fair Value
Most financial
instruments that are subject to fair value disclosure requirements are carried
in the Company’s consolidated financial statements at amounts that approximate
fair value. The following table provides the fair values and carrying values of
the Company’s financial instruments not recorded at fair value that are subject
to fair value disclosure requirements at March 31, 2010 and
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
|
|
|
|
|
Carrying |
|
|
|
|
|
|
Carrying |
|
(In
millions) |
|
Fair Value |
|
|
Value |
|
|
Fair Value |
|
|
Value |
|
Commercial mortgage
loans |
|
$ |
3,407 |
|
|
$ |
3,493 |
|
|
$ |
3,323 |
|
|
$ |
3,522 |
|
Contractholder deposit
funds, excluding universal life products |
|
$ |
997 |
|
|
$ |
992 |
|
|
$ |
940 |
|
|
$ |
941 |
|
Long-term debt,
including current maturities, excluding capital leases |
|
$ |
2,578 |
|
|
$ |
2,427 |
|
|
$ |
2,418 |
|
|
$ |
2,427 |
|
The fair values
presented in the table above have been estimated using market information when
available. The following is a description of the valuation methodologies and
inputs used by the Company to determine fair value.
21
Commercial
mortgage loans. The Company estimates the fair value of
commercial mortgage loans generally by discounting the contractual cash flows at
estimated market interest rates that reflect the Company’s assessment of the
credit quality of the loans. Market interest rates are derived by calculating
the appropriate spread over comparable U.S. Treasury rates, based on the
property type, quality rating and average life of the loan. The quality ratings
reflect the relative risk of the loan, considering debt service coverage, the
loan-to-value ratio and other factors. Fair values of impaired mortgage loans
are based on the estimated fair value of the underlying collateral generally
determined using an internal discounted cash flow model.
Contractholder
deposit funds, excluding universal life products. Generally,
these funds do not have stated maturities. Approximately 45% of these balances
can be withdrawn by the customer at any time without prior notice or penalty.
The fair value for these contracts is the amount estimated to be payable to the
customer as of the reporting date, which is generally the carrying value. Most
of the remaining contractholder deposit funds are reinsured by the buyers of the
individual life and annuity and retirement benefits businesses. The fair value
for these contracts is determined using the fair value of these buyers’ assets
supporting these reinsured contracts. The Company had a reinsurance recoverable
equal to the carrying value of these reinsured contracts.
Long-term debt,
including current maturities, excluding capital leases. The fair
value of long-term debt is based on quoted market prices for recent trades. When
quoted market prices are not available, fair value is estimated using a
discounted cash flow analysis and the Company’s estimated current borrowing rate
for debt of similar terms and remaining maturities.
Fair values of
off-balance-sheet financial instruments were not material.
Note 8 —
Investments
Total Realized
Investment Gains and Losses
The following total
realized gains and losses on investments include other-than-temporary
impairments on debt securities but exclude amounts required to adjust future
policy benefits for the run-off settlement annuity business:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Fixed
maturities |
|
$ |
15 |
|
|
$ |
(16 |
) |
Equity
securities |
|
|
4 |
|
|
|
(17 |
) |
Commercial mortgage
loans |
|
|
(11 |
) |
|
|
(1 |
) |
Other investments,
including derivatives |
|
|
(14 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
|
Realized investment
losses, before income taxes |
|
|
(6 |
) |
|
|
(36 |
) |
Less income tax
benefits |
|
|
(3 |
) |
|
|
(12 |
) |
|
|
|
|
|
|
|
Net realized investment
losses |
|
$ |
(3 |
) |
|
$ |
(24 |
) |
|
|
|
|
|
|
|
22
Included in pre-tax
realized investment gains (losses) above were other-than-temporary
impairments on debt securities, asset write-downs and changes in valuation
reserves as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Credit-related
(1) |
|
$ |
25 |
|
|
$ |
11 |
|
Other
(2) |
|
|
1 |
|
|
|
10 |
|
|
|
|
|
|
|
|
Total
(3) |
|
$ |
26 |
|
|
$ |
21 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Credit-related losses include other-than-temporary declines in
value of fixed maturities and equity securities, and impairments of
commercial mortgage loans and real estate entities. The amount related to
credit losses on fixed maturities for which a portion of the impairment
was recognized in other comprehensive income was not
significant. |
|
(2) |
|
Prior to adoption of GAAP guidance for other-than-temporary
impairments on April 1, 2009, other primarily represented the impact
of rising market yields on investments where the Company could not
demonstrate the intent and ability to hold until recovery. |
|
(3) |
|
Includes other-than-temporary impairments on debt securities of
$1 million in the first quarter of 2010 and $17 million in the
first quarter of 2009. These impairments are included in the other
category in 2010 and in both the credit-related and other categories for
2009. |
Fixed Maturities
and Equity Securities
Securities in the
following table are included in fixed maturities and equity securities on the
Company’s Consolidated Balance Sheets. These securities are carried at fair
value with changes in fair value reported in other realized investment gains and
interest and dividends reported in net investment income. The Company’s hybrid
investments include preferred stock or debt securities with call or conversion
features.
|
|
|
|
|
|
|
|
|
|
|
As of March 31, |
|
|
As of December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Included in fixed
maturities: |
|
|
|
|
|
|
|
|
Trading securities
(amortized cost: $8; $8) |
|
$ |
8 |
|
|
$ |
8 |
|
Hybrid securities
(amortized cost: $36; $37) |
|
|
42 |
|
|
|
43 |
|
|
|
|
|
|
|
|
Total |
|
$ |
50 |
|
|
$ |
51 |
|
|
|
|
|
|
|
|
Included in equity
securities: |
|
|
|
|
|
|
|
|
Hybrid securities
(amortized cost: $109; $109) |
|
$ |
86 |
|
|
$ |
81 |
|
|
|
|
|
|
|
|
Fixed maturities and
equity securities included $163 million at March 31, 2010, which were
pledged as collateral to brokers as required under certain futures contracts.
These fixed maturities and equity securities were primarily corporate
securities.
The following
information about fixed maturities excludes trading and hybrid securities. The
amortized cost and fair value by contractual maturity periods for fixed
maturities were as follows at March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
Amortized |
|
|
Fair |
|
(In
millions) |
|
Cost |
|
|
Value |
|
Due in one year or
less |
|
$ |
742 |
|
|
$ |
761 |
|
Due after one year
through five years |
|
|
4,004 |
|
|
|
4,266 |
|
Due after five years
through ten years |
|
|
4,928 |
|
|
|
5,268 |
|
Due after ten
years |
|
|
2,601 |
|
|
|
2,922 |
|
Mortgage and other
asset-backed securities |
|
|
639 |
|
|
|
710 |
|
|
|
|
|
|
|
|
Total |
|
$ |
12,914 |
|
|
$ |
13,927 |
|
|
|
|
|
|
|
|
Actual maturities
could differ from contractual maturities because issuers may have the right to
call or prepay obligations, with or without penalties. Also, in some cases the
Company may extend maturity dates.
23
Mortgage-backed assets
consist principally of commercial mortgage-backed securities and collateralized
mortgage obligations of which $33 million were residential mortgages and
home equity lines of credit, all of which were originated using standard
underwriting practices and are not considered sub-prime loans.
Gross unrealized
appreciation (depreciation) on fixed maturities (excluding trading
securities and hybrid securities) by type of issuer is shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010 |
|
|
|
|
|
|
|
Unrealized |
|
|
Unrealized |
|
|
|
|
|
|
Amortized |
|
|
Appre- |
|
|
Depre- |
|
|
Fair |
|
(In
millions) |
|
Cost |
|
|
ciation |
|
|
ciation |
|
|
Value |
|
Federal government and
agency |
|
$ |
392 |
|
|
$ |
174 |
|
|
$ |
(1 |
) |
|
$ |
565 |
|
State and local
government |
|
|
2,350 |
|
|
|
182 |
|
|
|
(9 |
) |
|
|
2,523 |
|
Foreign
government |
|
|
1,122 |
|
|
|
52 |
|
|
|
(5 |
) |
|
|
1,169 |
|
Corporate |
|
|
8,411 |
|
|
|
606 |
|
|
|
(57 |
) |
|
|
8,960 |
|
Federal agency
mortgage-backed |
|
|
29 |
|
|
|
1 |
|
|
|
— |
|
|
|
30 |
|
Other
mortgage-backed |
|
|
120 |
|
|
|
8 |
|
|
|
(7 |
) |
|
|
121 |
|
Other
asset-backed |
|
|
490 |
|
|
|
74 |
|
|
|
(5 |
) |
|
|
559 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
12,914 |
|
|
$ |
1,097 |
|
|
$ |
(84 |
) |
|
$ |
13,927 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
December 31, 2009 |
Federal government and
agency |
|
$ |
398 |
|
|
$ |
174 |
|
|
$ |
(1 |
) |
|
$ |
571 |
|
State and local
government |
|
|
2,341 |
|
|
|
188 |
|
|
|
(8 |
) |
|
|
2,521 |
|
Foreign
government |
|
|
1,040 |
|
|
|
38 |
|
|
|
(8 |
) |
|
|
1,070 |
|
Corporate |
|
|
8,104 |
|
|
|
529 |
|
|
|
(98 |
) |
|
|
8,535 |
|
Federal agency
mortgage-backed |
|
|
33 |
|
|
|
1 |
|
|
|
— |
|
|
|
34 |
|
Other
mortgage-backed |
|
|
125 |
|
|
|
5 |
|
|
|
(10 |
) |
|
|
120 |
|
Other
asset-backed |
|
|
494 |
|
|
|
55 |
|
|
|
(8 |
) |
|
|
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
12,535 |
|
|
$ |
990 |
|
|
$ |
(133 |
) |
|
$ |
13,392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above table
includes investments with a fair value of $2.3 billion supporting the
Company’s run-off settlement annuity business, with gross unrealized
appreciation of $354 million and gross unrealized depreciation of
$34 million at March 31, 2010. Such unrealized amounts are required to
support future policy benefit liabilities of this business and, as such, are not
included in accumulated other comprehensive income. At December 31, 2009,
investments supporting this business had a fair value of $2.3 billion,
gross unrealized appreciation of $326 million and gross unrealized
depreciation of $52 million.
Sales information for
available-for-sale fixed maturities and equity securities were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Proceeds from
sales |
|
$ |
240 |
|
|
$ |
119 |
|
Gross gains on
sales |
|
$ |
15 |
|
|
$ |
3 |
|
Gross losses on
sales |
|
$ |
(1 |
) |
|
$ |
(3 |
) |
24
Review of
declines in fair value. Management reviews fixed maturities with
a decline in fair value from cost for impairment based on criteria that include:
• |
|
length of time and severity of decline; |
• |
|
financial health and specific near term prospects of the
issuer; |
• |
|
changes in the regulatory, economic or general market environment of
the issuer’s industry or geographic region; and |
• |
|
the Company’s intent to sell or the likelihood of a required sale
prior to recovery. |
Excluding trading and
hybrid securities, as of March 31, 2010, fixed maturities with a decline in
fair value from amortized cost (which were primarily investment grade corporate
bonds) were as follows, including the length of time of such decline:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair |
|
|
Amortized |
|
|
Unrealized |
|
|
Number |
|
(In
millions) |
|
Value |
|
|
Cost |
|
|
Depreciation |
|
|
of Issues |
|
Fixed
maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year or
less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
grade |
|
$ |
838 |
|
|
$ |
856 |
|
|
$ |
(18 |
) |
|
|
222 |
|
Below investment
grade |
|
$ |
89 |
|
|
$ |
92 |
|
|
$ |
(3 |
) |
|
|
49 |
|
More than one
year: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
grade |
|
$ |
605 |
|
|
$ |
661 |
|
|
$ |
(56 |
) |
|
|
109 |
|
Below investment
grade |
|
$ |
43 |
|
|
$ |
50 |
|
|
$ |
(7 |
) |
|
|
16 |
|
The unrealized
depreciation of investment grade fixed maturities is primarily due to increases
in market yields since purchase. Approximately $22 million of the
unrealized depreciation is due to securities with a decline in value of greater
than 20%. The remaining $62 million of the unrealized depreciation is due
to securities with declines in value of less than 20%. There were no equity
securities with a fair value significantly lower than cost as of March 31,
2010.
Short-term
investments and cash equivalents. Short-term investments and cash
equivalents includes corporate securities of $921 million, federal
government securities of $171 million and money market funds of
$75 million at March 31, 2010. The Company’s short-term investments
and cash equivalents at December 31, 2009 included corporate securities of
$624 million, federal government securities of $402 million and money
market funds of $104 million.
Note 9 — Derivative
Financial Instruments
The Company’s
investment strategy is to manage the characteristics of investment assets (such
as duration, yield, currency and liquidity) to meet the varying demands of the
related insurance and contractholder liabilities (such as paying claims,
investment returns and withdrawals). As part of this investment strategy, the
Company typically uses derivatives to minimize interest rate, foreign currency
and equity price risks. The Company routinely monitors exposure to credit risk
associated with derivatives and diversifies the portfolio among approved dealers
of high credit quality to minimize credit risk. From time to time, the Company
has used derivatives to enhance investment returns. In addition, the Company has
written or sold contracts to guarantee minimum income benefits.
The Company uses hedge
accounting when derivatives are designated, qualified and highly effective as
hedges. Effectiveness is formally assessed and documented at inception and each
period throughout the life of a hedge using various quantitative methods
appropriate for each hedge, including regression analysis and dollar offset.
Under hedge accounting, the changes in fair value of the derivative and the
hedged risk are generally recognized together and offset each other when
reported in shareholders’ net income.
25
The Company accounts
for derivative instruments as follows:
• |
|
Derivatives are reported on the balance sheet at fair value with
changes in fair values reported in net income or accumulated other
comprehensive income. |
• |
|
Changes in the fair value of derivatives that hedge market risk
related to future cash flows – and that qualify for hedge accounting – are
reported in a separate caption in accumulated other comprehensive income.
These hedges are referred to as cash flow
hedges. |
• |
|
A change in the fair value of a derivative instrument may not always
equal the change in the fair value of the hedged item; this difference is
referred to as hedge ineffectiveness. Where hedge accounting is used, the
Company reflects hedge ineffectiveness in net income (generally as part of
realized investment gains and losses). |
Certain subsidiaries
of the Company are parties to over-the-counter derivative instruments that
contain provisions requiring both parties to such instruments to post collateral
depending on net liability thresholds and the party’s financial strength or
credit rating. The collateral posting requirements vary by counterparty. The
aggregate fair value of derivative instruments with such credit-risk-related
contingent features where a subsidiary of the Company was in a net liability
position as of March 31, 2010 was $25 million for which the Company
was not required to post collateral with its counterparties. If the various
contingent features underlying the agreements were triggered as of
March 31, 2010, the Company would be required to post collateral equal to
the total net liability. Such subsidiaries are parties to certain other
derivative instruments that contain termination provisions for which the
counterparties could demand immediate payment of the total net liability
position if the financial strength rating of the subsidiary were to decline
below specified levels. As of March 31, 2010, there was no net liability
position under such derivative instruments.
The tables below
present information about the nature and accounting treatment of the Company’s
primary derivative financial instruments including the Company’s purpose for
entering into specific derivative transactions, and their locations in and
effect on the financial statements as of and for the three months ended
March 31, 2010. Derivatives in the Company’s separate accounts are excluded
from the tables because associated gains and losses generally accrue directly to
policyholders.
26
|
|
|
|
|
|
|
|
|
Instrument / Volume of |
|
|
|
|
|
|
|
|
Activity |
|
Primary Risk |
|
Purpose |
|
Cash
Flows |
|
Accounting Policy |
|
|
Derivatives Designated as
Accounting Hedges — Cash Flow Hedges |
|
Interest rate swaps —
$159 million of par value of related
investments
Foreign currency swaps — $179 million of U.S.
dollar equivalent par value of related investments
Combination
swaps (interest rate and foreign currency) — $54 million of U.S.
dollar equivalent par value of related investments |
|
Interest rate and foreign currency |
|
To hedge the interest and/or foreign currency
cash flows of fixed maturities and commercial mortgage loans to match
associated liabilities. Currency swaps are primarily euros, Australian
dollars, Canadian dollars and British pounds for periods of up to
11 years. |
|
The Company periodically exchanges cash flows
between variable and fixed interest rates and/or between two currencies
for both principal and interest. Net interest cash flows are reported in
net investment income and included in operating activities. |
|
Using cash flow hedge accounting, fair values
are reported in other long-term investments or other liabilities and
accumulated other comprehensive income and amortized into net investment
income or reported in other realized investment gains and losses as
interest or principal payments are received. |
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (Loss) Recognized in |
|
|
|
|
|
|
|
|
|
|
|
Accounts Payable, Accrued Expenses
and |
|
|
Other Comprehensive |
|
|
|
Other Long-Term Investments |
|
|
Other Liabilities |
|
|
Income |
|
|
|
As of |
|
|
As of |
|
|
As of |
|
|
As of |
|
|
Three Months Ended March 31, |
|
Instrument |
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
2010 |
|
|
2009 |
|
Interest rate
swaps |
|
$ |
9 |
|
|
$ |
8 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
1 |
|
|
$ |
(1 |
) |
Foreign currency
swaps |
|
|
5 |
|
|
|
4 |
|
|
|
21 |
|
|
|
24 |
|
|
|
4 |
|
|
|
2 |
|
Interest rate and
foreign currency swaps |
|
|
— |
|
|
|
— |
|
|
|
6 |
|
|
|
6 |
|
|
|
— |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
14 |
|
|
$ |
12 |
|
|
$ |
27 |
|
|
$ |
30 |
|
|
$ |
5 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased options —
$315 million of cash surrender value of related life insurance
policies |
|
Interest rate |
|
To hedge the possibility of early policyholder
cash surrender when the amortized cost of underlying invested assets is
greater than their fair values. |
|
The Company pays a fee and may receive or pay
cash, based on the difference between the amortized cost and fair values
of underlying invested assets at the time of policyholder surrender. These
cash flows will be reported in financing activities. |
|
Using cash flow hedge accounting, fair values
are reported in other assets or other liabilities, with changes in fair
value reported in accumulated other comprehensive income and amortized to
other benefit expenses over the life of the underlying invested assets. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the periods ended March 31,
2010 and March 31, 2009, fair values reported in other assets and
other comprehensive income were not significant. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury lock
|
|
Interest rate |
|
To hedge the variability of and fix at inception
date, the benchmark Treasury rate component of future interest payments on
debt to be issued. |
|
The Company paid the fair value of the contract
at the expiration. Cash flows were reported in operating activities. |
|
Using cash flow hedge accounting, fair values
are reported in short-term investments or other liabilities, with changes
in fair value reported in accumulated other comprehensive income and
amortized to interest expense over the life of the debt issued. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the first quarter of 2009, all
treasury locks matured and the Company recognized a gain of
$14 million in other comprehensive income, resulting in net
cumulative losses of $26 million, to be amortized to interest expense over
the life of the debt. In the second quarter of 2009, the Company issued
debt and began amortizing this loss to interest expense. |
For the periods ended
March 31, 2010 and March 31, 2009, the amount of gains (losses)
reclassified from accumulated other comprehensive income into income was not
significant. No gains (losses) were recognized due to ineffectiveness and
no amounts were excluded from the assessment of hedge ineffectiveness.
27
|
|
|
|
|
|
|
|
|
|
Instrument / Volume of |
|
|
|
|
|
|
|
|
|
Activity |
|
Primary Risk |
|
Purpose |
|
Cash
Flows |
|
Accounting Policy |
|
|
|
|
|
|
|
Derivatives Not Designated As
Accounting Hedges |
|
|
Futures — $985 million
of U.S. dollar equivalent market price of outstanding contracts
|
|
Equity and foreign currency |
|
To reduce domestic and international equity
market exposures for certain reinsurance contracts that guarantee minimum
death benefits (GMDB) resulting from changes in variable annuity account
values based on underlying mutual funds. Currency futures are primarily
euros, Japanese yen and British pounds. |
|
The Company receives (pays) cash daily in
the amount of the change in fair value of the futures contracts. Cash
flows are included in operating activities. |
|
Fair value changes are reported in other
revenues. Amounts not yet settled from the previous day’s fair value
change (daily variation margin) are reported in premiums, accounts and
notes receivable, net or accounts payable, accrued expenses and other
liabilities. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Revenues |
|
|
|
Three Months Ended March 31, |
|
|
|
2010 |
|
|
2009 |
|
Futures |
|
$ |
(45 |
) |
|
$ |
117 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps —
$76 million of par value of related investments |
|
Interest rate |
|
To hedge the interest cash flows of fixed
maturities to match associated liabilities. |
|
The Company periodically exchanges cash flows
between variable and fixed interest rates for both principal and interest.
Net interest cash flows are reported in other realized investment gains
(losses) and included in operating activities. |
|
Fair values are reported in other long-term
investments or other liabilities, with changes in fair value reported in
other realized investment gains and losses. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized Investment |
|
|
|
Other Long-Term Investments |
|
|
(Losses) Three Months
Ended |
|
|
|
As of |
|
|
As of |
|
|
March 31, |
|
|
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
2010 |
|
|
2009 |
|
Interest rate
swaps |
|
$ |
4 |
|
|
$ |
4 |
|
|
$ |
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Written options (GMIB
liability) — $1,165 million of maximum potential undiscounted future
payments as defined in Note 17
Purchased options (GMIB asset) —
$641 million of maximum potential undiscounted future receipts as defined
in Note 17 |
|
Equity and interest rate |
|
The Company has written reinsurance contracts
with issuers of variable annuity contracts that provide annuitants with
certain guarantees of minimum income benefits, resulting from the level of
variable annuity account values compared with a contractually guaranteed
amount. Payment by the Company depends on the actual account value in the
underlying mutual funds and the level of interest rates when the
contractholders elect to receive minimum income payments. The Company
purchased reinsurance contracts to reduce a portion of the market risks
assumed. These contracts are accounted for as written and purchased
options. |
|
The Company periodically receives (pays) fees
based on either contractholders’ account values or deposits increased at a
contractual rate. The Company will also pay (receive) cash depending
on changes in account values and interest rates when contractholders first
elect to receive minimum income payments. These cash flows are reported in
operating activities. |
|
Fair values are reported in other liabilities
(GMIB liability) and other assets (GMIB asset). Changes in fair value are
reported in GMIB fair value (gain)/loss. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial
Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts Payable, Accrued Expenses
and |
|
|
GMIB Fair Value |
|
|
|
Other Assets |
|
|
Other Liabilities |
|
|
(Gain)/Loss |
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
As of |
|
|
As of |
|
|
As of |
|
|
As of |
|
|
March 31, |
|
Instrument |
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
2010 |
|
|
2009 |
|
Written options (GMIB
liability) |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
886 |
|
|
$ |
903 |
|
|
$ |
(4 |
) |
|
$ |
(70 |
) |
Purchased options (GMIB
asset) |
|
|
479 |
|
|
|
482 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
479 |
|
|
$ |
482 |
|
|
$ |
886 |
|
|
$ |
903 |
|
|
$ |
(4 |
) |
|
$ |
(32 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
Note 10 — Variable
Interest Entities
In the normal course
of its activities, the Company is involved with special-purpose or other
entities that are considered variable interest entities. When the Company
becomes involved with a variable interest entity and when the nature of the
Company’s involvement with the entity changes, in order to determine if the
Company is the primary beneficiary and must consolidate the entity, it
evaluates:
• |
|
the structure and purpose of the entity; |
• |
|
the risks and rewards created by and shared through the entity;
and |
• |
|
the entity’s participants’ ability to direct the activities, receive
its benefits and absorb its losses. Participants include the entity’s
sponsors, equity holders, guarantors, creditors and
servicers. |
Although the Company
is involved with certain variable interest entities, it determined that
consolidation was not required because either:
• |
|
it has no power or shares equally in the power to direct the
activities that most significantly impact the entities’ economic
performance; or |
• |
|
the Company has no right to receive benefits nor obligation to absorb
losses that could be significant to these variable interest
entities. |
The Company performs
ongoing qualitative analyses of its involvement with these variable interest
entities to determine if consolidation is required.
The following table
presents information about the nature and activities of the more significant
variable interest entities including carrying amounts and their locations in and
effect on the Company’s financial statements as of and for the three months
ended March 31, 2010.
|
|
|
|
|
|
|
|
|
|
Variable |
|
|
|
Factors Considered in
Determining |
|
Risk Exposure and Effect on
the |
Interests |
|
Nature, Purpose and Activities |
|
Consolidation Not Required |
|
Financial Statements |
|
Fixed maturities —
Foreign bank obligations — $410 million par value interest of total
$1,131 million par value |
|
To create a more active market for
perpetual floating-rate subordinated notes issued by foreign banks,
special-purpose trusts are formed to purchase these notes and sell
participation interests to investors in the form of fixed-rate debt
securities and equity interests. The trusts also purchase derivative
contracts to exchange the floating-rate cash flows for fixed-rate and
obtain guarantees from third parties to support these fixed-rate payments
to its debt holders. In certain trusts, the foreign bank perpetual notes
were replaced with U.S. government-sponsored bonds. The Company owns a
share of the debt securities issued by the trust and receives fixed-rate
cash flows for a stated period. |
|
The third-party guarantors of the debt
securities issued by the trust generally control the activities that most
significantly impact the trusts’ economic performance, are obligated to
absorb any losses, and are the primary beneficiaries. |
|
The Company’s maximum exposure to loss
is equal to the fair value of its variable interests reported on the
balance sheet in fixed maturities. Unrealized changes in fair value are
reported in accumulated other comprehensive income. Realized changes in
fair value (impairment or sale) are reported in realized investment gains
(losses), and interest earned is reported in net investment income. |
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements
(In millions)
|
|
|
|
|
|
|
Three Months Ended March 31, 2010 |
|
|
As of March 31, 2010 |
|
Gain (Loss) Recognized in
Other |
|
Income from Continuing Operations
before |
|
|
Fixed Maturities |
|
Comprehensive Income (1) |
|
Income Taxes (1) |
|
|
$ |
450 |
|
$ |
2 |
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
(1) |
|
Other comprehensive income excludes $17 million and income
from continuing operations before income taxes excludes $7 million of
amounts required to adjust future policy benefits for the run-off
settlement annuity business.
|
29
|
|
|
|
|
|
|
|
|
|
Variable |
|
|
|
Factors Considered in
Determining |
|
Risk Exposure and Effect on
the |
Interests |
|
Nature, Purpose and Activities |
|
Consolidation Not Required |
|
Financial Statements |
|
Fixed maturities —
Mortgage and other asset backed securities — $294 million par value
interest of total $47,841 million par value |
|
Special-purpose entities are created
by third-party sponsors to increase the availability of financing for
commercial or residential mortgages or other assets and provide investors
with diversified exposure to these assets. The entities purchase mortgage
loans or other assets, assemble pools of these assets and sell senior or
subordinated securities to investors based on their risk tolerance. The
securities represent a right to a share of the cash flows from the
underlying assets in the pool. Typically, the most subordinate holder
bears the first risk of loss and potential for higher returns. The Company
owns a minority share of senior securities and receives fixed-rate cash
flows. |
|
Third-party sponsors generally control
the activities that most significantly impact the entities’ economic
performance, bear the first risk of loss and receive any residual returns,
and are primary beneficiaries. In certain circumstances (such as when
unexpected losses occur), the sponsor may lose the power to direct the
entity’s activities and control would rest with the next most subordinate
investor. |
|
The Company’s maximum exposure to loss
is equal to the fair value of its variable interests reported on the
balance sheet in fixed maturities. Unrealized changes in fair value are
reported in accumulated other comprehensive income. Realized changes in
fair value (impairment or sale) are reported in realized investment gains
(losses), and interest earned is reported in net investment income. |
|
|
|
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements
(in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2010 |
|
|
As of March 31, 2010 |
|
Gain (Loss) Recognized in
Other |
|
Income from Continuing Operations
before |
|
|
Fixed Maturities |
|
Comprehensive Income |
|
Income Taxes |
|
|
$ |
261 |
|
$ |
9 |
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
Equity securities and
fixed maturities — Other — $59 million par value interest of total
$6,795 million par value |
|
Special-purpose trust entities are
created by banks to gain access to capital markets, maintain required
regulatory capital and receive tax deductions for interest paid on debt
obligations. These entities purchase subordinated notes issued and
guaranteed by the sponsoring banks and sell debt or equity securities.
Equity interests in these entities are held by their sponsoring banks. The
Company owns a minority share of these debt and equity securities and
receives fixed cash flows. |
|
The banks that create these trusts
control the activities that most significantly impact their economic
performance, are obligated to absorb any losses and are the primary
beneficiaries. |
|
The Company’s maximum exposure to loss
is equal to the fair value of its variable interests reported on the
balance sheet in equity securities and fixed maturities. Realized changes
in fair value (impairment or sale) are reported in realized investment
gains (losses), and interest earned is reported in net investment income.
|
|
|
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements
(in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2010 |
|
Three Months Ended March 31, 2010 |
|
|
Equity Securities and |
|
Gain (Loss) Recognized in
Other |
|
Income from Continuing Operations
before |
|
|
Fixed Maturities |
|
Comprehensive Income (1) |
|
Income Taxes (1) |
|
|
$ |
52 |
|
$ |
— |
|
$ |
3 |
|
|
|
(1) |
|
Other comprehensive income excludes $5 million and income from
continuing operations before income taxes excludes $1 million of amounts
required to adjust future policy benefits for the run-off settlement
annuity business.
|
In addition to the
variable interest entities described in this table, as of March 31, 2010
the Company was also involved in:
• |
|
trusts that are variable interest entities controlled by contractual
provisions and holding investments that secure certain reinsurance
recoverables resulting from the sales of the retirement benefits and
individual life insurance and annuity businesses (see Note 11 for further
information); |
• |
|
real estate joint ventures with carrying values of $17 million
where all decisions significantly affecting the entities’ economic
performance are subject to unanimous approval by the equity holders. As a
result, the Company determined that the power over these entities is
shared equally, and there is no primary beneficiary. The Company’s maximum
exposure to loss was equal to its carrying value;
and |
• |
|
certain fixed maturities with an aggregate fair value of
$13 million issued by entities subject to troubled debt
restructurings or bankruptcy proceedings. As a result, the equity owners
no longer have the power to direct the significant activities of the
entities. The Company’s maximum exposure to loss was equal to its fair
value. |
The Company does not
have the power to direct these entities’ activities; therefore, it was not the
primary beneficiary and did not consolidated these entities.
30
Note 11 —
Reinsurance
The Company’s
insurance subsidiaries enter into agreements with other insurance companies to
assume and cede reinsurance. Reinsurance is ceded primarily to limit losses from
large exposures and to permit recovery of a portion of direct losses.
Reinsurance is also used in acquisition and disposition transactions where the
underwriting company is not being acquired. Reinsurance does not relieve the
originating insurer of liability. The Company regularly evaluates the financial
condition of its reinsurers and monitors its concentrations of credit risk.
Retirement
benefits business. The Company had a reinsurance recoverable of
$1.7 billion as of March 31, 2010 and December 31, 2009 from
Prudential Retirement Insurance and Annuity Company resulting from the sale of
the retirement benefits business, which was primarily in the form of a
reinsurance arrangement. The reinsurance recoverable, which is reduced as the
Company’s reinsured liabilities are paid or directly assumed by the reinsurer,
is secured primarily by fixed maturities whose book value is equal to or greater
than 100% of the reinsured liabilities. These fixed maturities are held in a
trust established for the benefit of the Company. As of March 31, 2010, the
book value of the trust assets exceeded the recoverable and S&P had assigned
this reinsurer a rating of AA-.
Individual life
and annuity reinsurance. The Company had reinsurance recoverables of
$4.4 billion as of March 31, 2010 and December 31, 2009 from The
Lincoln National Life Insurance Company and Lincoln Life & Annuity of New
York resulting from the 1998 sale of the Company’s individual life insurance and
annuity business through indemnity reinsurance arrangements. At March 31,
2010, the $4 billion reinsurance recoverable from The Lincoln National Life
Insurance Company was secured by assets held in a trust established for the
benefit of the Company, and was less than the market value of the trust assets.
The remaining recoverable from Lincoln Life & Annuity of New York of
$414 million is currently unsecured, however, if this reinsurer does not
maintain a specified minimum credit or claims paying rating, it is required to
fully secure the outstanding balance. As of March 31, 2010 S&P has
assigned both The Lincoln National Life Insurance Company and Lincoln Life &
Annuity of New York a rating of AA-.
Other Ceded and
Assumed Reinsurance
Ceded
Reinsurance: Ongoing operations. The Company’s insurance subsidiaries
have reinsurance recoverables from various reinsurance arrangements in the
ordinary course of business for its Health Care, Disability and Life, and
International segments as well as the non-leveraged and leveraged
corporate-owned life insurance business. Reinsurance recoverables of
$282 million as of March 31, 2010 are expected to be collected from
more than 90 reinsurers which have been assigned the following financial
strength ratings from S&P:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of Reinsurance |
|
|
|
Reinsurance |
|
|
Percent |
|
|
Recoverable Protected |
|
(In
millions) |
|
Recoverable |
|
|
of Total |
|
|
by Collateral |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA- (Single
reinsurer) |
|
$ |
48 |
|
|
|
17 |
% |
|
|
0 |
% |
AA- or higher (Other
reinsurers) |
|
|
31 |
|
|
|
11 |
% |
|
|
0 |
% |
A (Single
reinsurer) |
|
|
26 |
|
|
|
9 |
% |
|
|
0 |
% |
A+ to A- (Other
reinsurers) |
|
|
106 |
|
|
|
38 |
% |
|
|
3 |
% |
Unrated (Single
reinsurer) |
|
|
34 |
|
|
|
12 |
% |
|
|
100 |
% |
Below A- or unrated
(Other reinsurers) |
|
|
37 |
|
|
|
13 |
% |
|
|
64 |
% |
|
|
|
|
|
|
|
|
|
|
Total ongoing
operations |
|
$ |
282 |
|
|
|
100 |
% |
|
|
22 |
% |
|
|
|
|
|
|
|
|
|
|
The collateral
protecting the recoverables includes assets held in trust and letters of credit.
The Company reviews its reinsurance arrangements and establishes reserves
against the recoverables in the event that recovery is not considered probable.
As of March 31, 2010, the Company’s recoverables related to these segments
were net of a reserve of $9 million.
Assumed and
Ceded reinsurance: Run-off Reinsurance segment. The Company’s Run-off
Reinsurance operations assumed risks related to GMDB contracts, GMIB contracts,
workers’ compensation, and personal accident business. The Company’s Run-off
Reinsurance operations also purchased retrocessional coverage to reduce the risk
of loss on these contracts.
31
Liabilities related to
GMDB, workers’ compensation and personal accident are included in future policy
benefits and unpaid claims. Because the GMIB contracts are treated as
derivatives under GAAP, the asset related to GMIB is recorded in the caption
Other assets, including other intangibles and the liability related to GMIB is
recorded in the caption Accounts payable, accrued expenses, and other
liabilities on the Company’s Consolidated Balance Sheets (see Notes 7 and 17 for
additional discussion of the GMIB assets and liabilities).
The reinsurance
recoverables for GMDB, workers’ compensation, and personal accident of
$109 million as of March 31, 2010 are expected to be collected from
approximately 80 retrocessionaires which have been assigned the following
financial strength ratings from S&P:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of Reinsurance |
|
|
|
Reinsurance |
|
|
Percent |
|
|
Recoverable Protected |
|
(In
millions) |
|
Recoverable |
|
|
of Total |
|
|
by Collateral |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA- or higher |
|
$ |
32 |
|
|
|
29 |
% |
|
|
10 |
% |
A (Single
reinsurer) |
|
|
32 |
|
|
|
29 |
% |
|
|
100 |
% |
A- (Single
reinsurer) |
|
|
17 |
|
|
|
16 |
% |
|
|
80 |
% |
A+ to A- (Other
reinsurers) |
|
|
16 |
|
|
|
15 |
% |
|
|
5 |
% |
Below A- or
unrated |
|
|
12 |
|
|
|
11 |
% |
|
|
50 |
% |
|
|
|
|
|
|
|
|
|
|
Total Run-off
Reinsurance segment |
|
$ |
109 |
|
|
|
100 |
% |
|
|
51 |
% |
|
|
|
|
|
|
|
|
|
|
The collateral
protecting the recoverables includes letters of credit and assets held in trust.
The Company reviews its reinsurance arrangements and establishes reserves
against the recoverables in the event that recovery is not considered probable.
As of March 31, 2010, the Company’s recoverables related to this segment
were net of a reserve of $6 million.
The Company’s payment
obligations for underlying reinsurance exposures assumed by the Company under
these contracts are based on the ceding companies’ claim payments. For GMDB,
claim payments vary because of changes in equity markets and interest rates, as
well as claim mortality and contractholder behavior. For workers’ compensation
and personal accident, the payments relate to accidents and injuries. Any of
these claim payments can extend many years into the future, and the amount of
the ceding companies’ ultimate claims, and therefore the amount of the Company’s
ultimate payment obligations and corresponding ultimate collection from
retrocessionaires, may not be known with certainty for some time.
Summary.
The Company’s reserves for underlying reinsurance exposures assumed by
the Company, as well as for amounts recoverable from
reinsurers/retrocessionaires for both ongoing operations and the run-off
reinsurance operation, are considered appropriate as of March 31, 2010,
based on current information. However, it is possible that future developments
could have a material adverse effect on the Company’s consolidated results of
operations and, in certain situations, such as if actual experience differs from
the assumptions used in estimating reserves for GMDB, could have a material
adverse effect on the Company’s financial condition. The Company bears the risk
of loss if its retrocessionaires do not meet or are unable to meet their
reinsurance obligations to the Company.
Effects of
reinsurance. In the Company’s Consolidated Statements of Income,
Premiums and fees were net of ceded premiums, and Total benefits and expenses
were net of reinsurance recoveries, in the following amounts:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Ceded premiums and
fees |
|
|
|
|
|
|
|
|
Individual life
insurance and annuity business sold |
|
$ |
46 |
|
|
$ |
51 |
|
Other |
|
|
64 |
|
|
|
60 |
|
|
|
|
|
|
|
|
Total |
|
$ |
110 |
|
|
$ |
111 |
|
|
|
|
|
|
|
|
Reinsurance
recoveries |
|
|
|
|
|
|
|
|
Individual life
insurance and annuity business sold |
|
$ |
67 |
|
|
$ |
68 |
|
Other |
|
|
44 |
|
|
|
58 |
|
|
|
|
|
|
|
|
Total |
|
$ |
111 |
|
|
$ |
126 |
|
|
|
|
|
|
|
|
32
Note 12 — Pension
and Other Postretirement Benefit Plans
The Company and
certain of its subsidiaries provide pension, health care and life insurance
defined benefits to eligible retired employees, spouses and other eligible
dependents through various domestic and foreign plans. The effect of its foreign
pension and other postretirement benefit plans is immaterial to the Company’s
results of operations, liquidity and financial position. Effective July 1,
2009, the Company froze its primary domestic defined benefit pension plans.
For the three months
ended March 31, 2010, the Company’s postretirement benefits liability
adjustment decreased by $3 million pre-tax ($8 million after-tax)
resulting in an increase to shareholders’ equity. The decrease in this
adjustment was primarily due to amortization of actuarial losses.
Pension
benefits. Components of net pension cost were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Service cost |
|
$ |
— |
|
|
$ |
21 |
|
Interest cost |
|
|
59 |
|
|
|
61 |
|
Expected long-term
return on plan assets |
|
|
(63 |
) |
|
|
(60 |
) |
Amortization
of: |
|
|
|
|
|
|
|
|
Net loss from past
experience |
|
|
7 |
|
|
|
17 |
|
Prior service
cost |
|
|
— |
|
|
|
(3 |
) |
|
|
|
|
|
|
|
Net pension
cost |
|
$ |
3 |
|
|
$ |
36 |
|
|
|
|
|
|
|
|
The Company funds its
qualified pension plans at least at the minimum amount required by the Pension
Protection Act of 2006, which requires companies to fully fund defined benefit
pension plans over a seven-year period beginning in 2008. For the three months
ended March 31, 2010, the Company contributed $55 million, of which
$12 million was required and $43 million was voluntary. For the
remainder of 2010, the Company expects to make additional required contributions
of $57 million and voluntary contributions of $100 million.
Other
postretirement benefits. Components of net other postretirement benefit
cost were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Service cost |
|
$ |
— |
|
|
$ |
— |
|
Interest cost |
|
|
5 |
|
|
|
6 |
|
Expected long-term
return on plan assets |
|
|
— |
|
|
|
— |
|
Amortization
of: |
|
|
|
|
|
|
|
|
Net gain from past
experience |
|
|
— |
|
|
|
(2 |
) |
Prior service
cost |
|
|
(4 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
|
Net other
postretirement benefit cost |
|
$ |
1 |
|
|
$ |
(1 |
) |
|
|
|
|
|
|
|
33
Note 13 — Debt
Short-term and
long-term debt were as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Short-term: |
|
|
|
|
|
|
|
|
Commercial
paper |
|
$ |
100 |
|
|
$ |
100 |
|
Current maturities of
long-term debt |
|
|
226 |
|
|
|
4 |
|
|
|
|
|
|
|
|
Total short-term
debt |
|
$ |
326 |
|
|
$ |
104 |
|
|
|
|
|
|
|
|
Long-term: |
|
|
|
|
|
|
|
|
Uncollateralized
debt: |
|
|
|
|
|
|
|
|
7% Notes due
2011 |
|
$ |
— |
|
|
$ |
222 |
|
6.375% Notes due
2011 |
|
|
226 |
|
|
|
226 |
|
5.375% Notes due
2017 |
|
|
250 |
|
|
|
250 |
|
6.35% Notes due
2018 |
|
|
300 |
|
|
|
300 |
|
8.5% Notes due
2019 |
|
|
349 |
|
|
|
349 |
|
6.37% Notes due
2021 |
|
|
78 |
|
|
|
78 |
|
7.65% Notes due
2023 |
|
|
100 |
|
|
|
100 |
|
8.3% Notes due
2023 |
|
|
17 |
|
|
|
17 |
|
7.875% Debentures due
2027 |
|
|
300 |
|
|
|
300 |
|
8.3% Step Down Notes
due 2033 |
|
|
83 |
|
|
|
83 |
|
6.15% Notes due
2036 |
|
|
500 |
|
|
|
500 |
|
Other |
|
|
9 |
|
|
|
11 |
|
|
|
|
|
|
|
|
Total long-term
debt |
|
$ |
2,212 |
|
|
$ |
2,436 |
|
|
|
|
|
|
|
|
In the first quarter
of 2010, the 7% Notes due 2011 were reclassified into current maturities of
long-term debt since they will mature in less than one year.
34
Note 14 —
Accumulated Other Comprehensive Loss
Accumulated other
comprehensive loss excludes amounts required to adjust future policy benefits
for the run-off settlement annuity business. Changes in accumulated other
comprehensive loss were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax |
|
|
|
|
(In
millions) Three Months Ended March 31, |
|
Pre-Tax |
|
|
(Expense) Benefit |
|
|
After- Tax |
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation on securities arising during the period |
|
$ |
127 |
|
|
$ |
(42 |
) |
|
$ |
85 |
|
Reclassification
adjustment for (gains) included in shareholders’ net income |
|
|
(19 |
) |
|
|
6 |
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, securities |
|
$ |
108 |
|
|
$ |
(36 |
) |
|
$ |
72 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, derivatives |
|
$ |
6 |
|
|
$ |
(2 |
) |
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
|
Net translation of
foreign currencies |
|
$ |
6 |
|
|
$ |
(2 |
) |
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
|
Postretirement
benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification
adjustment for amortization of net losses from past experience and prior
service costs |
|
$ |
3 |
|
|
$ |
5 |
|
|
$ |
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation on securities arising during the period |
|
$ |
43 |
|
|
$ |
(13 |
) |
|
$ |
30 |
|
Reclassification
adjustment for losses included in shareholders’ net income |
|
|
33 |
|
|
|
(12 |
) |
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, securities |
|
$ |
76 |
|
|
$ |
(25 |
) |
|
$ |
51 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized
appreciation, derivatives |
|
$ |
17 |
|
|
$ |
(6 |
) |
|
$ |
11 |
|
|
|
|
|
|
|
|
|
|
|
Net translation of
foreign currencies |
|
$ |
(44 |
) |
|
$ |
16 |
|
|
$ |
(28 |
) |
|
|
|
|
|
|
|
|
|
|
Postretirement
benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification
adjustment for amortization of net losses from past experience and prior
service costs |
|
$ |
7 |
|
|
$ |
(3 |
) |
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
|
Note 15 — Income
Taxes
A. Income Tax
Expense
The Company has
historically accrued U.S. income taxes on the undistributed earnings of foreign
subsidiaries. During the first quarter of 2010, the Company determined that the
prospective earnings of its Hong Kong operations are to be permanently invested
overseas. The Company made a similar determination as related to the prospective
earnings of its South Korea operations in 2009. This permanent investment of
earnings increased shareholders’ net income for the three months ended
March 31, 2010 by $14 million, which included $6 million
(including $1 million related to realized investment gains) related to the
Hong Kong implementation and $8 million attributable to recording taxes for
the first quarter of 2010 at the foreign jurisdiction’s tax rate. As of March
31, 2010, deferred tax liabilities not recognized as a result of the permanent
investment of South Korea and Hong Kong operation earnings was $37 million.
35
B. Unrecognized Tax
Benefits
Gross unrecognized tax
benefits declined for the three months ended March 31, 2010 by
$22 million which was primarily due to the reversal of previously
established liabilities that were reevaluated in light of new factors and
technical developments. The effect on shareholders’ net income was not material.
During the first
quarter of 2009, the IRS completed its examination of the Company’s 2005 and
2006 consolidated federal income tax returns, resulting in an increase to
shareholders’ net income of $21 million ($20 million in continuing
operations and $1 million in discontinued operations). This increase
reflected a reduction in net unrecognized tax benefits of $8 million
($17 million reported in income tax expense, partially offset by a
$9 million pre-tax charge) and a reduction of interest and penalties of
$13 million (reported in income tax expense).
Over the next 12
months, the Company has determined it reasonably possible that the level of
unrecognized tax benefits could increase or decrease significantly, subject to
developments in certain matters in dispute with the IRS. It is also reasonably
possible there could be a significant decline in the level of valuation
allowances recorded against deferred tax benefits of the reinsurance operations
within the next 12 months. The Company, however, is currently unable to
reasonably estimate the potential impact of such changes.
C. Other Tax
Matters
During the first
quarter of 2009, final resolution was reached in one of the two disputed issues
associated with the IRS examination of the Company’s 2003 and 2004 consolidated
federal income tax returns. The second of these disputed matters remains
unresolved and on June 4, 2009, the Company initiated litigation of this
matter by filing a petition in the United States Tax Court. Due to the nature of
the litigation process, the timing of the resolution of this matter is
uncertain. Though the Company expects to prevail, an unfavorable resolution of
this litigation would result in a charge to shareholder’s net income of up to
$17 million, representing net interest expense on the cumulative
incremental tax for all affected years. In addition, two issues remain
unresolved from the IRS examination of the Company’s 2005 and 2006 consolidated
federal income tax returns. One of these unresolved issues is the same matter
which remains in dispute from the prior IRS examination. The Company is
attempting to resolve the other matter through the administrative appeals
process, and filed a formal protest of the proposed adjustments on
March 31, 2009.
The recently enacted
Patient Protection & Affordable Care Act, including the Reconciliation Act
of 2010, included provisions limiting the tax deductibility of certain future
retiree benefit and compensation-related payments. The effect of these
provisions reduced shareholders’ net income for the first quarter of 2010 by
$5 million. The Company will continue to evaluate the tax effect of these
provisions.
36
Note 16 — Segment
Information
The Company’s
operating segments generally reflect groups of related products, except for the
International segment which is generally based on geography. In accordance with
GAAP, operating segments that do not require separate disclosure have been
combined into Other Operations. The Company measures the financial results of
its segments using “segment earnings (loss),” which is defined as shareholders’
income (loss) from continuing operations excluding after-tax realized
investment gains and losses.
Beginning in 2010, the
Company began reporting the expense associated with its frozen pension plans in
Corporate. Prior periods were not restated. The effect on prior periods is not
material.
Summarized segment
financial information was as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and fees,
Mail order pharmacy revenues and Other revenues |
|
|
|
|
|
|
|
|
Health Care |
|
$ |
3,731 |
|
|
$ |
3,289 |
|
Disability and
Life |
|
|
690 |
|
|
|
701 |
|
International |
|
|
534 |
|
|
|
439 |
|
Run-off
Reinsurance |
|
|
(38 |
) |
|
|
121 |
|
Other
Operations |
|
|
43 |
|
|
|
44 |
|
Corporate |
|
|
(15 |
) |
|
|
(14 |
) |
|
|
|
|
|
|
|
Total |
|
$ |
4,945 |
|
|
$ |
4,580 |
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
|
|
|
|
|
|
|
Health Care |
|
$ |
167 |
|
|
$ |
155 |
|
Disability and
Life |
|
|
70 |
|
|
|
63 |
|
International |
|
|
72 |
|
|
|
42 |
|
Run-off
Reinsurance |
|
|
4 |
|
|
|
(26 |
) |
Other
Operations |
|
|
19 |
|
|
|
19 |
|
Corporate |
|
|
(46 |
) |
|
|
(22 |
) |
|
|
|
|
|
|
|
Segment
Earnings |
|
|
286 |
|
|
|
231 |
|
Realized investment
losses, net of taxes |
|
|
(3 |
) |
|
|
(24 |
) |
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
$ |
283 |
|
|
$ |
207 |
|
|
|
|
|
|
|
|
37
Note 17 —
Contingencies and Other Matters
The Company, through
its subsidiaries, is contingently liable for various financial guarantees
provided in the ordinary course of business.
Financial
Guarantees Primarily Associated with the Sold Retirement Benefits Business
Separate account
assets are contractholder funds maintained in accounts with specific investment
objectives. The Company records separate account liabilities equal to separate
account assets. In certain cases, primarily associated with the sold retirement
benefits business (which was sold in April 2004), the Company guarantees a
minimum level of benefits for retirement and insurance contracts written in
separate accounts. The Company establishes an additional liability if management
believes that the Company will be required to make a payment under these
guarantees.
The Company guarantees
that separate account assets will be sufficient to pay certain retiree or life
benefits. The sponsoring employers are primarily responsible for ensuring that
assets are sufficient to pay these benefits and are required to maintain assets
that exceed a certain percentage of benefit obligations. This percentage varies
depending on the asset class within a sponsoring employer’s portfolio (for
example, a bond fund would require a lower percentage than a riskier equity
fund) and thus will vary as the composition of the portfolio changes. If
employers do not maintain the required levels of separate account assets, the
Company or an affiliate of the buyer has the right to redirect the management of
the related assets to provide for benefit payments. As of March 31, 2010,
employers maintained assets that exceeded the benefit obligations. Benefit
obligations under these arrangements were $1.7 billion as of March 31,
2010. Approximately 75% of these guarantees are reinsured by an affiliate of the
buyer of the retirement benefits business. The remaining guarantees are provided
by the Company with minimal reinsurance from third parties. There were no
additional liabilities required for these guarantees as of March 31, 2010.
Separate account assets supporting these guarantees are classified in Levels 1
and 2 of the GAAP fair value hierarchy. See Note 7 for further information on
the fair value hierarchy.
The Company does not
expect that these financial guarantees will have a material effect on the
Company’s consolidated results of operations, liquidity or financial condition.
Other Financial
Guarantees
Guaranteed
minimum income benefit contracts. The Company’s reinsurance operations,
which were discontinued in 2000 and are now an inactive business in run-off
mode, reinsured minimum income benefits under certain variable annuity contracts
issued by other insurance companies. A contractholder can elect the guaranteed
minimum income benefit (“GMIB”) within 30 days of any eligible policy
anniversary after a specified contractual waiting period. The Company’s exposure
arises when the guaranteed annuitization benefit exceeds the annuitization
benefit based on the policy’s current account value. At the time of
annuitization, the Company pays the excess (if any) of the guaranteed benefit
over the benefit based on the current account value in a lump sum to the direct
writing insurance company.
In periods of
declining equity markets or declining interest rates, the Company’s GMIB
liabilities increase. Conversely, in periods of rising equity markets and rising
interest rates, the Company’s liabilities for these benefits decrease.
The Company estimates
the fair value of the GMIB assets and liabilities using assumptions for market
returns and interest rates, volatility of the underlying equity and bond mutual
fund investments, mortality, lapse, annuity election rates, nonperformance risk,
and risk and profit charges. See Note 7 for additional information on how fair
values for these liabilities and related receivables for retrocessional coverage
are determined.
The Company is
required to disclose the maximum potential undiscounted future payments for GMIB
contracts. Under these guarantees, the future payment amounts are dependent on
equity and bond fund market and interest rate levels prior to and at the date of
annuitization election, which must occur within 30 days of a policy
anniversary, after the appropriate waiting period. Therefore, the future
payments are not fixed and determinable under the terms of the contract.
Accordingly, the Company has estimated the maximum potential undiscounted future
payments using hypothetical adverse assumptions, defined as follows:
• |
|
no annuitants surrendered their accounts; |
• |
|
all annuitants lived to elect their benefit; |
• |
|
all annuitants elected to receive their benefit on the next available
date (2010 through 2014); and |
• |
|
all underlying mutual fund investment values remained at the
March 31, 2010 value of $1.3 billion with no future
returns. |
38
The maximum potential
undiscounted payments that the Company would make under those assumptions would
aggregate $1.2 billion before reinsurance recoveries. The Company expects
the amount of actual payments to be significantly less than this hypothetical
undiscounted aggregate amount. The Company has retrocessional coverage in place
from two external reinsurers which covers 55% of the exposures on these
contracts. The Company bears the risk of loss if its retrocessionaires do not
meet or are unable to meet their reinsurance obligations to the Company.
Certain other
guarantees. The Company had indemnification obligations to lenders of up
to $236 million as of March 31, 2010, related to borrowings by certain
real estate joint ventures which the Company either records as an investment or
consolidates. These borrowings, which are nonrecourse to the Company, are
secured by the joint ventures’ real estate properties with fair values in excess
of the loan amounts and mature at various dates beginning in 2010 through 2017.
The Company’s indemnification obligations would require payment to lenders for
any actual damages resulting from certain acts such as unauthorized ownership
transfers, misappropriation of rental payments by others or environmental
damages. Based on initial and ongoing reviews of property management and
operations, the Company does not expect that payments will be required under
these indemnification obligations. Any payments that might be required could be
recovered through a refinancing or sale of the assets. In some cases, the
Company also has recourse to partners for their proportionate share of amounts
paid. There were no liabilities required for these indemnification obligations
as of March 31, 2010.
As of March 31,
2010, the Company guaranteed that it would compensate the lessors for a
shortfall of up to $44 million in the market value of certain leased
equipment at the end of the lease. Guarantees of $28 million expire in 2012
and $16 million expire in 2016. The Company had liabilities for these
guarantees of $8 million as of March 31, 2010.
As part of the
reinsurance and administrative service arrangements acquired from Great-West
Life and Annuity, Inc., the Company is responsible to pay claims for the group
medical and long-term disability business of Great-West Healthcare and collect
related amounts due from their third party reinsurers. Any such amounts not
collected will represent additional assumed liabilities of the Company and
decrease shareholders’ net income if and when these amounts are determined
uncollectible. At March 31, 2010, there were no receivables recorded for
paid claims due from third party reinsurers for this business and unpaid claims
related to this business were estimated at $22 million.
The Company had
indemnification obligations as of March 31, 2010 in connection with
acquisition and disposition transactions. These indemnification obligations are
triggered by the breach of representations or covenants provided by the Company,
such as representations for the presentation of financial statements, the filing
of tax returns, compliance with law or the identification of outstanding
litigation. These obligations are typically subject to various time limitations,
defined by the contract or by operation of law, such as statutes of limitation.
In some cases, the maximum potential amount due is subject to contractual
limitations based on a percentage of the transaction purchase price, while in
other cases limitations are not specified or applicable. The Company does not
believe that it is possible to determine the maximum potential amount due under
these obligations, since not all amounts due under these indemnification
obligations are subject to limitation. There were no liabilities required for
these indemnification obligations as of March 31, 2010.
The Company contracts
on an administrative services only (“ASO”) basis with customers who fund their
own claims. The Company charges these customers administrative fees based on the
expected cost of administering their self-funded programs. In some cases, the
Company provides performance guarantees associated with meeting certain service
related and other performance standards. If these standards are not met, the
Company may be financially at risk up to a stated percentage of the contracted
fee or a stated dollar amount. The Company establishes liabilities for estimated
payouts associated with these performance guarantees. Approximately 12% of
reported ASO fees are at risk, with actual reimbursements of less than 1% of
reported ASO fees.
The Company has
agreements with certain banks that provide banking services to settle claim
checks processed by the Company for ASO and certain minimum premium customers.
The customers are responsible for adequately funding their accounts as claim
checks are presented for payment. Under these agreements, the Company guarantees
that the banks will not incur a loss if a customer fails to properly fund its
account. The guarantee will fluctuate daily. As of March 31, 2010, the
aggregate maximum exposure under these guarantees was approximately
$700 million. Through April 29, 2010, the exposure that existed at
March 31, 2010 has been reduced by approximately 85% from customers’
funding of claim checks when presented for payment. In addition, the Company can
limit its exposure under these guarantees by suspending claim payments for any
customer who has not adequately funded their bank account.
The Company does not
expect that these guarantees will have a material adverse effect on the
Company’s consolidated results of operations, liquidity or financial condition.
39
Regulatory and
Industry Developments
Employee
benefits regulation. The business of administering and insuring employee
benefit programs, particularly health care programs, is heavily regulated by
federal and state laws and administrative agencies, such as state departments of
insurance and the Federal Departments of Labor and Justice, as well as the
courts. Regulation, legislation and judicial decisions have resulted in changes
to industry and the Company’s business practices and will continue to do so in
the future. In addition, the Company’s subsidiaries are routinely involved with
various claims, lawsuits and regulatory and IRS audits and investigations that
could result in financial liability, changes in business practices, or both.
Health care regulation and legislation in its various forms, including the
implementation of the Patient Protection and Affordable Care Act (including the
Reconciliation Act) that was signed into law during the first quarter of 2010,
could have an adverse effect on the Company’s health care operations if it
inhibits the Company’s ability to respond to market demands, adversely affects
the way the Company does business, or results in increased medical or
administrative costs without improving the quality of care or services.
Other possible
regulatory and legislative changes or judicial decisions that could have an
adverse effect on the Company’s employee benefits businesses include:
• |
|
additional mandated benefits or services that increase
costs; |
• |
|
legislation that would grant plan participants broader rights to sue
their health plans; |
• |
|
changes in public policy and in the political environment, which could
affect state and federal law, including legislative and regulatory
proposals related to health care issues, which could increase cost and
affect the market for the Company’s health care products and
services; |
• |
|
changes in Employee Retirement Income Security Act of 1974 (“ERISA”)
regulations resulting in increased administrative burdens and
costs; |
• |
|
additional restrictions on the use of prescription drug formularies
and rulings from pending purported class action litigation, which could
result in adjustments to or the elimination of the average wholesale price
or “AWP” of pharmaceutical products as a benchmark in establishing certain
rates, charges, discounts, guarantees and fees for various prescription
drugs; |
• |
|
additional privacy legislation and regulations that interfere with the
proper use of medical information for research, coordination of medical
care and disease and disability management; |
• |
|
additional variations among state laws mandating the time periods and
administrative processes for payment of health care provider
claims; |
• |
|
legislation that would exempt independent physicians from antitrust
laws; and |
• |
|
changes in federal tax laws, such as amendments that could affect the
taxation of employer provided benefits. |
The employee benefits
industry remains under scrutiny by various state and federal government agencies
and could be subject to government efforts to bring criminal actions in
circumstances that could previously have given rise only to civil or
administrative proceedings.
Concentration of
risk. For the Company’s International segment, South Korea is the single
largest geographic market. South Korea generated 32% of the segment’s revenues
and 39% of the segment’s earnings for the three months ended March 31,
2010. Due to the concentration of business in South Korea, the International
segment is exposed to potential losses resulting from economic and geopolitical
developments in that country, as well as foreign currency movements affecting
the South Korean currency, which could have a significant impact on the
segment’s results and the Company’s consolidated financial results.
Litigation and
Other Legal Matters
The Company is
routinely involved in numerous claims, lawsuits, regulatory and IRS audits,
investigations and other legal matters arising, for the most part, in the
ordinary course of the business of administering and insuring employee benefit
programs including payments to providers and benefit level disputes. Litigation
of income tax matters is accounted for under FASB’s accounting guidance for
uncertainty in income taxes. Further information can be found in Note 15. An
increasing number of claims are being made for substantial non-economic,
extra-contractual or punitive damages. The outcome of litigation and other legal
matters is always uncertain, and outcomes that are not justified by the evidence
can occur. The Company believes that it has valid defenses to the legal matters
pending against it and is defending itself vigorously and has recorded accruals
in accordance with GAAP. Nevertheless, it is possible that resolution of one or
more of the legal matters currently pending or threatened could result in losses
material to the Company’s consolidated results of operations, liquidity or
financial condition.
40
Managed care
litigation. On April 7, 2000, several pending actions were
consolidated in the United States District Court for the Southern District of
Florida in a multi-district litigation proceeding captioned In re Managed
Care Litigation challenging, in general terms, the mechanisms used by
managed care companies in connection with the delivery of or payment for health
care services. The consolidated cases include Shane v. Humana, Inc., et
al., Mangieri v. CIGNA Corporation, Kaiser and Corrigan v. CIGNA
Corporation, et al. and Amer. Dental Ass’n v. CIGNA Corp. et al.
In 2004, the court
approved a settlement agreement between the physician class and CIGNA. However,
a dispute over disallowed claims under the settlement submitted by a
representative of certain class member physicians is in arbitration. Separately,
in 2005, the court approved a settlement between CIGNA and a class of
non-physician health care providers. Only the American Dental Association case
remains unresolved. On March 2, 2009, the Court dismissed with prejudice
five of the six counts of the complaint. On March 20, 2009, the Court
declined to exercise supplemental jurisdiction over the remaining state law
claim and dismissed the case. Plaintiffs appealed on February 26, 2010
before the United States Court of Appeals for the Eleventh Circuit. CIGNA denies
the allegations and will continue to vigorously defend itself.
CIGNA has received
insurance recoveries related to the In re Managed Care Litigation. In
2008, the Court of Common Pleas of Philadelphia County ruled that the Company is
not entitled to insurance recoveries from one of the two insurers from which the
Company is pursuing further recoveries. CIGNA appealed that decision and on
June 3, 2009, the Superior Court of Pennsylvania reversed the trial court’s
decision, remanding the case to the trial court for further proceedings.
Broker
compensation. Beginning in 2004, the Company, other insurance companies
and certain insurance brokers received subpoenas and inquiries from various
regulators, including the New York and Connecticut Attorneys General, the
Florida Office of Insurance Regulation, the U.S. Attorney’s Office for the
Southern District of California and the U.S. Department of Labor relating to
their investigations of insurance broker compensation. CIGNA cooperated with the
inquiries and investigations.
On August 1,
2005, two CIGNA subsidiaries, Connecticut General Life Insurance Company and
Life Insurance Company of North America, were named as defendants in a
multi-district litigation proceeding, In re Insurance Brokerage Antitrust
Litigation, consolidated in the United States District Court for the
District of New Jersey. The complaint alleges that brokers and insurers
conspired to hide commissions, thus increasing the cost of employee benefit
plans, and seeks treble damages and injunctive relief. Numerous insurance
brokers and other insurance companies are named as defendants. In 2008, the
court ordered the clerk to enter judgment against plaintiffs and in favor of the
defendants. Plaintiffs appealed. CIGNA denies the allegations and will continue
to vigorously defend itself.
Amara cash
balance pension plan litigation. On December 18, 2001, Janice Amara
filed a class action lawsuit, captioned Janice C. Amara, Gisela R. Broderick,
Annette S. Glanz, individually and on behalf of all others similarly situated v.
CIGNA Corporation and CIGNA Pension Plan, in the United States District
Court for the District of Connecticut against CIGNA Corporation and the CIGNA
Pension Plan on behalf of herself and other similarly situated participants in
the CIGNA Pension Plan affected by the 1998 conversion to a cash balance
formula. The plaintiffs allege various ERISA violations including, among other
things, that the Plan’s cash balance formula discriminates against older
employees; the conversion resulted in a wear away period (during which the
pre-conversion accrued benefit exceeded the post-conversion benefit); and these
conditions are not adequately disclosed in the Plan.
In 2008, the court
issued a decision finding in favor of CIGNA Corporation and the CIGNA Pension
Plan on the age discrimination and wear away claims. However, the court found in
favor of the plaintiffs on many aspects of the disclosure claims and ordered an
enhanced level of benefits from the existing cash balance formula for the
majority of the class, requiring class members to receive their frozen benefits
under the pre-conversion CIGNA Pension Plan and their accrued benefits under the
post-conversion CIGNA Pension Plan. The court also ordered, among other things,
pre-judgment and post-judgment interest. Both parties appealed the court’s
decisions to the United States Court of Appeals for the Second Circuit which
issued a decision on October 6, 2009 affirming the District Court’s
judgment and order on all issues. On January 4, 2010, the Company and the
plaintiffs filed separate petitions for a writ of certiorari to the United
States Supreme Court, both of which are fully briefed and pending. The
implementation of the judgment is currently stayed. The Company will continue to
vigorously defend itself in this case. In the second quarter of 2008, the
Company recorded a charge of $80 million pre-tax ($52 million
after-tax), which principally reflects the Company’s best estimate of the
liabilities related to the court order.
41
Ingenix.
On February 13, 2008, State of New York Attorney General Andrew M.
Cuomo announced an industry-wide investigation into the use of data provided by
Ingenix, Inc., a subsidiary of UnitedHealthcare, used to calculate payments for
services provided by out-of-network providers. The Company received four
subpoenas from the New York Attorney General’s office in connection with this
investigation and responded appropriately. On February 17, 2009, the
Company entered into an Assurance of Discontinuance resolving the investigation.
In connection with the industry-wide resolution, the Company contributed
$10 million to the establishment of a new non-profit company that will
compile and provide the data currently provided by Ingenix. In addition, on
March 28, 2008, the Company received a voluntary request for production of
documents from the Connecticut Attorney General’s office seeking certain
out-of-network claim payment information. The Company has responded
appropriately. Since January 2009, the Company has received and responded
to inquiries regarding the use of Ingenix data from the Illinois and Texas
Attorneys General and the Departments of Insurance in Illinois, Florida,
Vermont, Georgia, Pennsylvania, Connecticut, and Alaska.
The Company was named
as a defendant in seven putative nationwide class actions asserting that due to
the use of data from Ingenix, Inc., the Company improperly underpaid claims, an
industry-wide issue. Two actions were brought on behalf of members, (Franco
v. CIGNA Corp. et al., and Chazen v. CIGNA Corp. et al.), and five
actions were brought on behalf of providers, (American Medical Association et
al. v. CIGNA Corp. et al., Shiring et al. v. CIGNA Corp. et al.; Higashi
et al. v. CGLIC et al.; Pain Management and Surgery Center of Southeast Indiana
v. CGLIC et al.; and North Peninsula Surgical Center v. Connecticut
General Life Insurance Co. et al.), all of which have been consolidated into
the Franco case pending in the United States District Court for the
District of New Jersey. The consolidated amended complaint, filed on
August 7, 2009, asserts claims under ERISA, the RICO statute, the Sherman
Antitrust Act and New Jersey state law. CIGNA filed a motion to dismiss the
consolidated amended complaint on September 9, 2009, which is now fully
briefed and pending. Discovery is ongoing and class certification is scheduled
to be briefed in the second quarter of 2010.
On June 9, 2009,
CIGNA filed motions in the United States District Court for the Southern
District of Florida to enforce the In re Managed Care Litigation
settlement described above by enjoining the RICO and antitrust causes of
action asserted by the provider and medical association plaintiffs in the
Ingenix litigation on the ground that they arose prior to and were
released in the April 2004 settlement. On November 30, 2009, the Court
granted the motions and ordered the provider and association plaintiffs to
withdraw their RICO and antitrust claims from the Ingenix litigation by
December 21, 2009. The plaintiffs filed notices of appeal with the United
States Court of Appeals for the Eleventh Circuit on December 10 and 11,
2009, along with motions to stay the order pending appeal. On January 12,
2010, the United States Court of Appeals for the Eleventh Circuit stayed the
order pending resolution of the appeal. The appeal is fully briefed and pending.
One of the provider
plaintiffs, Pain Management and Surgery Center of Southern Indiana, filed a
voluntary dismissal of its claims on November 11, 2009.
It is reasonably
possible that others could initiate additional litigation or additional
regulatory action against the Company with respect to use of data provided by
Ingenix, Inc. The Company denies the allegations asserted in the investigations
and litigation and will vigorously defend itself in these matters.
42
|
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Item 2. |
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Management’s Discussion and Analysis of Financial Condition and
Results of Operations |
INDEX
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43 |
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46 |
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49 |
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49 |
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50 |
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53 |
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54 |
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56 |
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58 |
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59 |
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59 |
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60 |
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61 |
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65 |
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70 |
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71 |
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INTRODUCTION
In this filing and in
other marketplace communications, CIGNA Corporation and its subsidiaries (“the
Company”) make certain forward-looking statements relating to the Company’s
financial condition and results of operations, as well as to trends and
assumptions that may affect the Company. Generally, forward-looking statements
can be identified through the use of predictive words (e.g., “Outlook for
2010”). Actual results may differ from the Company’s predictions. Some factors
that could cause results to differ are discussed throughout Management’s
Discussion and Analysis (“MD&A”), including in the Cautionary Statement
beginning on page 71. The forward-looking statements contained in this filing
represent management’s current estimate as of the date of this filing.
Management does not assume any obligation to update these estimates.
The following
discussion addresses the financial condition of the Company as of March 31,
2010, compared with December 31, 2009, and its results of operations for
the three months ended March 31, 2010 compared with the same period last
year. This discussion should be read in conjunction with MD&A included in
the Company’s 2009 Form 10-K, to which the reader is directed for additional
information.
The preparation of
interim consolidated financial statements necessarily relies heavily on
estimates. This and certain other factors, such as the seasonal nature of
portions of the health care and related benefits business as well as competitive
and other market conditions, call for caution in estimating full year results
based on interim results of operations.
Certain
reclassifications have been made to prior period amounts to conform to the
current presentation.
Overview
The Company
constitutes one of the largest investor-owned health service organizations in
the United States. Its subsidiaries are major providers of health care and
related benefits, the majority of which are offered through the workplace. In
addition, the Company has an international operation that offers supplemental
health, life and accident insurance products as well as international health
care products and services to businesses and individuals in selected markets.
The Company also has certain inactive businesses, including a Run-off
Reinsurance segment.
43
Ongoing
Operations
The Company’s ability
to increase revenue, shareholders’ net income and operating cash flow from
ongoing operations is directly related to progress in executing on its strategic
initiatives, the success of which is measured by certain key factors, including
the Company’s ability to:
• |
|
profitably price products and services at competitive levels that
reflect emerging experience; |
• |
|
maintain and grow its customer base; |
• |
|
cross sell its various health and related benefit
products; |
• |
|
invest available cash at attractive rates of return for appropriate
durations; |
• |
|
reduce other operating expenses in the Health Care segment;
and |
• |
|
effectively deploy capital. |
Strategy
As a global health
service organization, CIGNA’s mission remains focused on helping the people it
serves improve their health, well-being and sense of security. CIGNA’s long-term
growth strategy is based on: (1) growth in targeted geographies, product
lines, buying segments and distribution channels; (2) improving its
strategic and financial flexibility; and (3) pursuing additional
opportunities in high-growth markets with particular focus on individuals.
CIGNA expects to focus
on the following areas it believes represent the markets or areas with the most
potential for profitable growth:
• |
|
In the Health Care segment, the Company is concentrating on:
(1) further enhancing its geographic focus in the middle market in
order to create geographic density; (2) growing the “Select” market, which
generally includes employers with more than 50 but fewer than 250
employees, by leveraging the Company’s customer knowledge, differentiated
service model, product portfolio and distribution model; and
(3) engaging those national account employers who share and will
benefit from the Company’s value proposition of using health advocacy and
employee engagement to increase productivity, performance and the health
outcomes of their employees. |
• |
|
In the Disability and Life segment, CIGNA’s strategy is to grow its
disability business by fully leveraging the key components of its
industry-leading disability management model to reduce medical costs for
its clients and return their employees to work sooner through:
(1) early claim notification and outreach; (2) a full suite of
clinical and return-to-work resources; and (3) specialized case
management services. |
• |
|
In the International segment, the Company is targeting growth through:
(1) product and channel expansion in its supplemental health, life and
accident insurance business in key Asian geographies; (2) the
introduction of new expatriate benefits products; and (3) further
geographic expansion. |
The Company plans to
improve its strategic and financial flexibility by driving further reductions in
its Health Care operating expenses, improving its medical cost competitiveness
in targeted markets and effectively managing balance sheet exposures.
Also, in connection
with CIGNA’s long-term business strategy, the Company remains committed to
health advocacy as a means of creating sustainable solutions for employers,
improving the health of the individuals that the Company serves, and lowering
the costs of health care for all constituencies.
Health Care
Reform
In the first quarter
of 2010, the Patient Protection and Affordable Care Act, including the
Reconciliation Act of 2010, (collectively, “the Act”) was signed into law. The
Act mandates broad changes in the delivery of health care benefits that may
impact the Company’s current business model, including its relationship with
current and future customers, producers and health care providers, products,
services, processes and technology. The Company is evaluating potential business
opportunities resulting from the Act that will enable it to leverage the
strengths and capabilities of its broad health and wellness portfolio. The Act
includes provisions for mandatory coverage of benefits and a minimum medical
loss ratio, eliminates lifetime and annual benefit limits and creates health
insurance exchanges. These provisions are expected to take effect over the next
several years from 2010 to 2018.
44
The Act will require
that health services companies such as CIGNA and others in the healthcare
industry help fund the additional insurance benefits and coverages provided from
this legislation through the assessment of fees and excise taxes. The amount
which the Company will be required to pay starting in 2014 for these fees and
excise taxes will result in charges to the Company’s financial statements in
future periods. In addition, since these fees and excise taxes will not be tax
deductible, the Company’s effective tax rate is expected to increase in future
periods. However, the Company is unable to estimate the amount of these fees and
excise taxes or the increase in the effective tax rate because guidance for
their calculation has not been finalized.
The Act also changes
certain tax laws which affect the Company’s 2010 financial statements. Although
these provisions do not become effective until 2013, they are expected to limit
the tax deductibility of certain future retiree benefit and compensation-related
payments. For the three months ended March 31, 2010, the Company recorded
an after-tax charge of approximately $5 million related to these changes.
The Company expects to record additional after-tax charges of $5 million
for the balance of the year with respect to the known effects of the tax
provisions, but will continue to evaluate their impact as further guidance is
made available.
Management is
currently unable to estimate the ultimate impact of the Act on the Company’s
results of operations, financial condition and liquidity due to the
uncertainties of interpretation, implementation and timing of the many
provisions of the Act. Management is closely monitoring this legislation and has
formed a task force to implement and report on the Company’s compliance with the
Act, to actively engage with regulators to assist with the conversion of
legislation to regulation and to assess potential opportunities arising from the
Act.
Run-off
Operations
Effectively managing
the various exposures of its run-off operations is important to the Company’s
ongoing profitability, operating cash flows and available capital. The results
are influenced by a range of economic factors, especially movements in equity
markets and interest rates. In order to substantially reduce the impact of
equity market movements on the liability for guaranteed minimum death benefits
(“GMDB”, also known as “VADBe”), the Company operates an equity hedge program.
The Company actively monitors the performance of the hedge program, and
evaluates the cost/benefit of hedging other risks. Results are also influenced
by behavioral factors, including future partial surrender election rates for
GMDB contracts, annuity election rates for guaranteed minimum income benefits
(“GMIB”) contracts, annuitant lapse rates, as well as the collection of amounts
recoverable from retrocessionaires. The Company actively studies policyholder
behavior experience and adjusts future expectations based on the results of the
studies, as warranted. The Company also performs regular audits of ceding
companies to ensure that premiums received and claims paid properly reflect the
underlying risks, and to maximize the probability of subsequent collection of
claims from retrocessionaires. Finally, the Company monitors the financial
strength and credit standing of its retrocessionaires and requests or collects
collateral when warranted.
Summary
The Company’s overall
results are influenced by a range of economic and other factors, especially:
• |
|
cost trends and inflation for medical and related
services; |
• |
|
utilization patterns of medical and other
services; |
• |
|
the tort liability system; |
• |
|
developments in the political environment both domestically and
internationally, including U.S. health care
reform; |
• |
|
interest rates, equity market returns, foreign currency fluctuations
and credit market volatility, including the availability and cost of
credit in the future; and |
• |
|
federal, state and international regulation. |
The Company regularly
monitors the trends impacting operating results from the above mentioned key
factors and economic and other factors affecting its operations. The Company
develops strategic and tactical plans designed to improve performance and
maximize its competitive position in the markets it serves. The Company’s
ability to achieve its financial objectives is dependent upon its ability to
effectively execute on these plans and to appropriately respond to emerging
economic and company-specific trends.
45
CONSOLIDATED
RESULTS OF OPERATIONS
The Company measures
the financial results of its segments using “segment earnings (loss)”, which is
defined as shareholders’ income (loss) from continuing operations before
after-tax realized investment results. Adjusted income from operations is
defined as consolidated segment earnings (loss) excluding special items
(defined below) and the results of the GMIB business. Adjusted income from
operations is another measure of profitability used by the Company’s management
because it presents the underlying results of operations of the Company’s
businesses and permits analysis of trends in underlying revenue, expenses and
shareholders’ net income. This measure is not determined in accordance with
accounting principles generally accepted in the United States (“GAAP”) and
should not be viewed as a substitute for the most directly comparable GAAP
measure, which is shareholders’ income from continuing operations.
Summarized below is a
reconciliation between shareholders’ income from continuing operations and
adjusted income from operations.
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
4,543 |
|
|
$ |
4,051 |
|
Net investment
income |
|
|
266 |
|
|
|
229 |
|
Mail order pharmacy
revenues |
|
|
348 |
|
|
|
312 |
|
Other revenues |
|
|
54 |
|
|
|
217 |
|
Total realized
investment losses |
|
|
(6 |
) |
|
|
(36 |
) |
|
|
|
|
|
|
|
Total revenues |
|
|
5,205 |
|
|
|
4,773 |
|
Benefits and
expenses |
|
|
4,783 |
|
|
|
4,500 |
|
|
|
|
|
|
|
|
Income from continuing
operations before taxes |
|
|
422 |
|
|
|
273 |
|
Income taxes |
|
|
138 |
|
|
|
65 |
|
|
|
|
|
|
|
|
Income from continuing
operations |
|
|
284 |
|
|
|
208 |
|
Less: Net income
attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
Shareholders’ income
from continuing operations |
|
|
283 |
|
|
|
207 |
|
Less: realized
investment losses, net of taxes |
|
|
(3 |
) |
|
|
(24 |
) |
|
|
|
|
|
|
|
Segment
earnings |
|
|
286 |
|
|
|
231 |
|
Less: adjustments to
reconcile to adjusted income from operations: |
|
|
|
|
|
|
|
|
Results of GMIB
business (after-tax) |
|
|
5 |
|
|
|
23 |
|
Special item
(after-tax): |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
20 |
|
|
|
|
|
|
|
|
Adjusted income from
operations |
|
$ |
281 |
|
|
$ |
188 |
|
|
|
|
|
|
|
|
Summarized below is
adjusted income from operations by segment:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Adjusted Income
(Loss) From Operations |
|
|
|
|
|
|
|
|
Health Care |
|
$ |
167 |
|
|
$ |
154 |
|
Disability and
Life |
|
|
70 |
|
|
|
58 |
|
International |
|
|
72 |
|
|
|
41 |
|
Run-off
Reinsurance |
|
|
(1 |
) |
|
|
(49 |
) |
Other
Operations |
|
|
19 |
|
|
|
18 |
|
Corporate |
|
|
(46 |
) |
|
|
(34 |
) |
|
|
|
|
|
|
|
Total |
|
$ |
281 |
|
|
$ |
188 |
|
|
|
|
|
|
|
|
46
Overview of
March 31, 2010 Consolidated Results of Operations
Adjusted income from
operations increased significantly for the first three months of 2010 compared
to the same period in 2009, primarily reflecting stronger earnings in the
ongoing business segments (Health Care, Disability and Life and International)
as well as improved results in the Run-off Reinsurance segment primarily due to
the absence of a charge in the first quarter of 2009 related to the GMDB
business.
Shareholders’ income
from continuing operations for the first three months of 2010 also increased
significantly compared with the same period in 2009 due to higher adjusted
income from operations as cited above as well as improved realized investment
results. These favorable effects were partially offset by lower earnings in the
GMIB business along with the absence of the 2009 benefit from the completion of
an IRS examination.
Special Item and
GMIB
Management does not
believe that the special item noted in the table above is representative of the
Company’s underlying results of operations. Accordingly, the Company excluded
this special item from adjusted income from operations in order to facilitate an
understanding and comparison of results of operations and permit analysis of
trends in underlying revenue, expenses and shareholders’ income from continuing
operations.
There were no special
items for the first three months of 2010.
The special item for
the first three months of 2009 resulted from the completion of the 2005 and 2006
IRS examinations. See Note 15 to the Consolidated Financial Statements for
additional information.
The Company also
excludes the results of the GMIB business from adjusted income from operations
because the fair value of GMIB assets and liabilities must be recalculated each
quarter using updated capital market assumptions. The resulting changes in fair
value, which are reported in shareholders’ net income, are volatile and
unpredictable. See the Critical Accounting Estimates section of the MD&A
beginning on page 55 of the Company’s 2009 Form 10-K for more information on the
effect of capital market assumption changes on shareholders’ net income. Because
of this volatility, and since the GMIB business is in run-off, management does
not believe that its results are meaningful in assessing underlying results of
operations.
Outlook for
2010
The Company expects
2010 adjusted income from operations to be comparable to or slightly higher than
2009. Information is not available for management to reasonably estimate the
future results of the GMIB business or realized investment results due in part
to interest rate and stock market volatility and other internal and external
factors. This outlook includes an assumption that GMDB (also known as “VADBe”)
results will be approximately break-even for full-year 2010, reflecting the
Company’s view that the long-term reserve assumptions are appropriate and
assuming that capital markets remain stable during the year. In addition, the
Company is not able to identify or reasonably estimate the financial impact of
special items in 2010 however they may include potential adjustments associated
with cost reduction, litigation, and tax-related items.
This outlook reflects
the Company’s best estimate of the impacts of Health Care Reform (“the Act”, see
the Introduction section of this MD&A beginning on page 43) on its 2010
results of operations subject to the factors cited in the Cautionary Statement
beginning on page 71 of the MD&A. If unfavorable equity market and interest
rate movements occur, the Company could experience losses related to investment
impairments and the GMIB and GMDB businesses. These losses could adversely
impact the Company’s consolidated results of operations and financial condition
by potentially reducing the capital of the Company’s insurance subsidiaries and
reducing their dividend-paying capabilities.
47
Revenues
Total revenue
increased by 9% for the first three months of 2010, compared with the first
three months of 2009. Changes in the components of total revenue are described
more fully below.
Premiums and
Fees
Premiums and fees
increased by 12% for the first three months of 2010, compared with the first
three months of 2009, primarily reflecting membership growth in the Health Care
segment’s risk businesses as well as growth in the International segment. See
segment reporting discussions for additional detail and drivers.
Net Investment
Income
Net investment income
increased by 16% for the first three months of 2010, compared with the first
three months of 2009, primarily reflecting improved income on security
partnerships and higher yields on investment assets.
Mail Order
Pharmacy Revenues
Mail order pharmacy
revenues increased by 12% for the first three months of 2010, compared with the
first three months of 2009, primarily reflecting an increase in volume and
price.
Other
Revenues
Other revenues
included the impact of the futures contracts associated with the GMDB equity
hedge program. The Company reported losses of $45 million for the first
three months of 2010 and gains of $117 million for the first three months
of 2009 associated with the GMDB equity hedge program. The losses in 2010
reflected increases in stock market values, while the gains in 2009 primarily
reflected declines in stock market values. Excluding the impact of these futures
contracts, other revenues remained flat for the first three months of 2010
compared with the same period in 2009.
Realized
Investment Results
Realized investment
results improved for the first three months of 2010, compared with the first
three months of 2009 primarily due to:
• |
|
increases in the value of hybrid securities in the first three months
of 2010 compared with decreases in the same period in 2009 (changes in
fair value for these securities are reported in realized investment
results); |
• |
|
absence of securities credit impairments in the first three months of
2010 reflecting improved market conditions; and |
• |
|
gains on sales of fixed maturities in the first three months of
2010. |
These improvements
were partially offset by increased impairments on real estate funds and mortgage
loans in 2010 due to the impact of the continued weak economic environment on
the commercial real estate market.
See Note 8 to the
Consolidated Financial Statements for additional information.
48
CRITICAL ACCOUNTING
ESTIMATES
The preparation of
consolidated financial statements in accordance with GAAP requires management to
make estimates and assumptions that affect reported amounts and related
disclosures in the consolidated financial statements. Management considers an
accounting estimate to be critical if:
• |
|
it requires assumptions to be made that were uncertain at the time the
estimate was made; and |
• |
|
changes in the estimate or different estimates that could have been
selected could have a material effect on the Company’s consolidated
results of operations or financial condition. |
Management has
discussed the development and selection of its critical accounting estimates
with the Audit Committee of the Company’s Board of Directors and the Audit
Committee has reviewed the disclosures presented below.
The Company’s most
critical accounting estimates, as well as the effects of hypothetical changes in
material assumptions used to develop each estimate, are described in the
Company’s 2009 Form 10-K beginning on page 55 and are as follows:
• |
|
future policy benefits — guaranteed minimum death
benefits; |
• |
|
Health Care medical claims payable; |
• |
|
accounts payable, accrued expenses and other liabilities, and other
assets — guaranteed minimum income benefits; |
• |
|
reinsurance recoverables for Run-off
Reinsurance; |
• |
|
accounts payable, accrued expenses and other liabilities — pension
liabilities; |
• |
|
investments — fixed maturities; and |
• |
|
investments — commercial mortgage loans — valuation
reserves. |
The Company regularly
evaluates items which may impact critical accounting estimates. As of March 31,
2010, there are no significant changes to the critical accounting estimates from
what was reported in the Company’s 2009 Form 10-K.
Summary
There are other
accounting estimates used in the preparation of the Company’s Consolidated
Financial Statements, including estimates of liabilities for future policy
benefits other than those identified above, as well as estimates with respect to
goodwill, unpaid claims and claim expenses, post-employment and postretirement
benefits other than pensions, certain compensation accruals and income taxes.
Management believes
the current assumptions used to estimate amounts reflected in the Company’s
Consolidated Financial Statements are appropriate. However, if actual experience
differs from the assumptions used in estimating amounts reflected in the
Company’s Consolidated Financial Statements, the resulting changes could have a
material adverse effect on the Company’s consolidated results of operations, and
in certain situations, could have a material adverse effect on liquidity and the
Company’s financial condition.
SEGMENT
REPORTING
Operating segments
generally reflect groups of related products, but the International segment is
generally based on geography. The Company measures the financial results of its
segments using “segment earnings (loss),” which is defined as shareholders’
income (loss) from continuing operations excluding after-tax realized
investment gains and losses. “Adjusted income from operations” for each segment
is defined as segment earnings excluding special items and the results of the
Company’s GMIB business. Adjusted income from operations is another measure of
profitability used by the Company’s management because it presents the
underlying results of operations of the segment and permits analysis of trends.
This measure is not determined in accordance with GAAP and should not be viewed
as a substitute for the most directly comparable GAAP measure, which is segment
earnings. Each segment provides a reconciliation between segment earnings and
adjusted income from operations.
Beginning in 2010, the
Company began reporting the expense associated with its frozen pension plans in
Corporate. Prior periods were not restated; the effect on prior periods is not
material.
49
Health Care
Segment
Segment
Description
The Health Care
segment includes medical, dental, behavioral health, prescription drug and other
products and services that may be integrated to provide consumers with
comprehensive health care solutions. This segment also includes group disability
and life insurance products that were historically sold in connection with
certain experience-rated medical products. These products and services are
offered through a variety of funding arrangements such as guaranteed cost,
retrospectively experience-rated and administrative services only arrangements.
The Company measures
the operating effectiveness of the Health Care segment using the following key
factors:
• |
|
segment earnings and adjusted income from
operations; |
• |
|
sales of specialty products to core medical
customers; |
• |
|
changes in operating expenses per member;
and |
• |
|
medical expense as a percentage of premiums (medical care ratio) in
the guaranteed cost business. |
Results of
Operations
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
3,319 |
|
|
$ |
2,911 |
|
Net investment
income |
|
|
54 |
|
|
|
34 |
|
Mail order pharmacy
revenues |
|
|
348 |
|
|
|
312 |
|
Other revenues |
|
|
64 |
|
|
|
66 |
|
|
|
|
|
|
|
|
Segment
revenues |
|
|
3,785 |
|
|
|
3,323 |
|
|
|
|
|
|
|
|
Mail order pharmacy
cost of goods sold |
|
|
285 |
|
|
|
252 |
|
Benefits and other
expenses |
|
|
3,240 |
|
|
|
2,833 |
|
|
|
|
|
|
|
|
Benefits and
expenses |
|
|
3,525 |
|
|
|
3,085 |
|
|
|
|
|
|
|
|
Income before
taxes |
|
|
260 |
|
|
|
238 |
|
Income taxes |
|
|
93 |
|
|
|
83 |
|
|
|
|
|
|
|
|
Segment
earnings |
|
|
167 |
|
|
|
155 |
|
Less: special item
(after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
1 |
|
|
|
|
|
|
|
|
Adjusted income from
operations |
|
$ |
167 |
|
|
$ |
154 |
|
|
|
|
|
|
|
|
Realized investment
losses, net of taxes |
|
$ |
(3 |
) |
|
$ |
(5 |
) |
|
|
|
|
|
|
|
50
The Health Care
segment’s adjusted income from operations for the first three months of 2010
increased by 8%, compared with the same period in 2009 primarily due to:
• |
|
increased membership in risk businesses resulting in higher specialty
penetration; and |
• |
|
higher net investment income primarily reflecting higher security
partnership income and yields. |
These favorable
effects were partially offset by:
• |
|
lower earnings on experience-rated business;
and |
• |
|
higher medical care ratio in the guaranteed cost
business. |
Revenues
The table below shows
premiums and fees for the Health Care segment:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Medical: |
|
|
|
|
|
|
|
|
Guaranteed cost (1),(2) |
|
$ |
928 |
|
|
$ |
857 |
|
Experience-rated(2),(3) |
|
|
483 |
|
|
|
432 |
|
Stop loss |
|
|
321 |
|
|
|
333 |
|
Dental |
|
|
200 |
|
|
|
186 |
|
Medicare |
|
|
362 |
|
|
|
138 |
|
Medicare Part
D |
|
|
170 |
|
|
|
110 |
|
Other (4) |
|
|
138 |
|
|
|
131 |
|
|
|
|
|
|
|
|
Total medical |
|
|
2,602 |
|
|
|
2,187 |
|
Life and other
non-medical |
|
|
33 |
|
|
|
50 |
|
|
|
|
|
|
|
|
Total premiums |
|
|
2,635 |
|
|
|
2,237 |
|
Fees(2),(5) |
|
|
684 |
|
|
|
674 |
|
|
|
|
|
|
|
|
Total premiums and
fees |
|
$ |
3,319 |
|
|
$ |
2,911 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes guaranteed cost premiums primarily associated with open
access, commercial HMO and voluntary/limited benefits, as well as other
risk-related products. |
|
(2) |
|
Premiums and/or fees associated with certain specialty products are
also included. |
|
(3) |
|
Includes minimum premium members who have a risk profile similar to
experience-rated funding arrangements. The risk portion of minimum premium
revenue is reported in experience-rated medical premium whereas the self
funding portion of minimum premium revenue is recorded in fees. Also,
includes certain non-participating cases for which special customer level
reporting of experience is required. |
|
(4) |
|
Other medical premiums include risk revenue for specialty
products. |
|
(5) |
|
Represents administrative service fees for medical members and
related specialty product fees for non-medical members as well as fees
related to Medicare Part D of $10 million for the three months ended
March 31, 2010 and $8 million for the three months ended
March 31, 2009. |
Premiums and
fees increased by 14% for the first three months of 2010 compared with
the same period of 2009 reflecting membership growth in most products, as well
as rate increases partially offset by lower service membership.
Net investment
income increased by 59% for the first three months of 2010 compared with
the same period of 2009 reflecting higher security partnership income and higher
yields.
Other revenues
for the Health Care segment consist of revenues earned on direct channel
sales of certain specialty products, including behavioral health and disease
management.
51
Benefits and
Expenses
Health Care segment
benefits and expenses consist of the following:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Medical claims
expense |
|
$ |
2,209 |
|
|
$ |
1,780 |
|
Other benefit
expenses |
|
|
28 |
|
|
|
48 |
|
Mail order pharmacy
cost of goods sold |
|
|
285 |
|
|
|
252 |
|
Other operating
expenses |
|
|
1,003 |
|
|
|
1,005 |
|
|
|
|
|
|
|
|
Total benefits and
expenses |
|
$ |
3,525 |
|
|
$ |
3,085 |
|
|
|
|
|
|
|
|
Medical claims
expense increased by 24% for the first three months of 2010 compared
with the same period in 2009 largely due to higher medical membership,
particularly in the Medicare Private Fee For Service (“Medicare PFFS”) and
commercial risk business as well as increases in medical cost inflation.
Other operating
expenses for the first three months of 2010 were lower than the same
period last year reflecting the impact of pension changes, lower amortization
and staffing reductions, partially offset by volume driven increases, as a
result of membership growth in risk products.
Other Items
Affecting Health Care Results
Health Care Medical
Claims Payable
Medical claims payable
also increased $420 million largely driven by medical membership growth,
particularly in the Medicare PFFS and commercial risk business as noted above,
reflecting new business, as well as seasonality in the Stop Loss products (see
Note 4 to the Consolidated Financial Statements for additional information).
Medical
Membership
The Health Care
segment’s medical membership includes any individual for whom the Company
retains medical underwriting risk, who uses the Company’s network for services
covered under their medical coverage or for whom the Company administers medical
claims. As of March 31, estimated medical membership was as follows:
|
|
|
|
|
|
|
|
|
(In
thousands) |
|
2010 |
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
Guaranteed cost (1) |
|
|
1,083 |
|
|
|
1,021 |
|
Experience-rated (2) |
|
|
811 |
|
|
|
804 |
|
|
|
|
|
|
|
|
Total commercial
risk |
|
|
1,894 |
|
|
|
1,825 |
|
Medicare |
|
|
145 |
|
|
|
47 |
|
|
|
|
|
|
|
|
Total risk |
|
|
2,039 |
|
|
|
1,872 |
|
Service |
|
|
9,314 |
|
|
|
9,497 |
|
|
|
|
|
|
|
|
Total medical
membership |
|
|
11,353 |
|
|
|
11,369 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes members primarily associated with open access, commercial
HMO and voluntary/limited benefits as well as other risk-related
products. |
|
(2) |
|
Includes minimum premium members, who have a risk profile similar
to experience-rated members. Also, includes certain non-participating
cases for which special customer level reporting of experience is
required. |
The Company’s overall
medical membership as of March 31, 2010 is consistent when compared with
March 31, 2009, primarily driven by significant new business sales and
improved persistency in the risk businesses, offset by a decline in service
membership largely reflecting disenrollment after March 31, 2009.
52
Disability and
Life Segment
Segment
Description
The Disability and
Life segment includes group disability, life, accident and specialty insurance
and case management services for disability and workers’ compensation.
Key factors for this
segment are:
• |
|
premium and fee growth, including new business and customer
retention; |
• |
|
benefits expense as a percentage of earned premium (loss ratio);
and |
• |
|
other operating expense as a percentage of earned premiums and fees
(expense ratio). |
Results of
Operations
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
661 |
|
|
$ |
672 |
|
Net investment
income |
|
|
64 |
|
|
|
57 |
|
Other revenues |
|
|
29 |
|
|
|
29 |
|
|
|
|
|
|
|
|
Segment
revenues |
|
|
754 |
|
|
|
758 |
|
Benefits and
expenses |
|
|
656 |
|
|
|
678 |
|
|
|
|
|
|
|
|
Income before
taxes |
|
|
98 |
|
|
|
80 |
|
Income taxes |
|
|
28 |
|
|
|
17 |
|
|
|
|
|
|
|
|
Segment
earnings |
|
|
70 |
|
|
|
63 |
|
Less: special item
(after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
5 |
|
|
|
|
|
|
|
|
Adjusted income from
operations |
|
$ |
70 |
|
|
$ |
58 |
|
|
|
|
|
|
|
|
Realized investment
gains (losses), net of taxes |
|
$ |
1 |
|
|
$ |
(10 |
) |
|
|
|
|
|
|
|
The Disability and
Life segment’s adjusted income from operations increased 21% for the first three
months of 2010 compared with the same period in 2009 reflecting:
|
• |
|
higher net investment income; |
|
• |
|
favorable accident claims experience; and |
|
• |
|
continued strong disability claims management
experience. |
These favorable
impacts were partially offset by less favorable life claims experience. Results
in 2010 include the $10 million after-tax favorable impact of reserve
studies as compared with the $9 million after-tax favorable impact of reserve
studies in 2009.
Revenues
Premiums and
fees decreased 2% for the first three months of 2010 compared with the
same period of 2009 reflecting the Company’s decision to exit a large, low
margin assumed government life insurance program (-$38 million) and the
sale of the renewal rights to the student and participant accident business
(-$5 million). Excluding the impact of those two items, premiums and fees
increased 5% as a result of disability and life sales growth and continued solid
persistency.
Net investment
income increased 12% for the first three months of 2010 compared with
the same period of 2009 due to higher security partnership income and invested
assets.
53
Benefits and
Expenses
Benefits and expenses
decreased 3% for the first three months of 2010 compared with the same period of
2009, primarily as a result of the Company’s exit from the government life
insurance program and the sale of renewal rights to the student and participant
accident business. Excluding the impact of those two items, benefits and
expenses increased 3%, reflecting disability and life business growth and less
favorable life claims experience partially offset by favorable accident claim
experience and a lower operating expense ratio. The less favorable life claims
experience was primarily driven by higher new claim counts. The favorable
accident claims experience was driven by the absence of the catastrophic plane
crash in the first quarter of 2009 and lower new claims. The lower operating
expense ratio reflects the Company’s continued focus on operating expense
management partially offset by strategic investments in information technology
and the claims operations. Benefits and expenses in 2010 include the
$15 million before-tax favorable impact of reserve studies as compared to
the $13 million favorable before-tax impact of reserve studies in 2009.
International
Segment
Segment
Description
The International
segment includes supplemental health, life and accident insurance products and
international health care products and services, including those offered to
expatriate employees of multinational corporations.
The key factors for
this segment are:
• |
|
premium growth, including new business and customer
retention; |
• |
|
benefits expense as a percentage of earned premium (loss
ratio); |
• |
|
operating expense as a percentage of earned premium (expense ratio);
and |
• |
|
impact of foreign currency movements. |
Results of
Operations
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
527 |
|
|
$ |
434 |
|
Net investment
income |
|
|
19 |
|
|
|
16 |
|
Other revenues |
|
|
7 |
|
|
|
5 |
|
|
|
|
|
|
|
|
Segment
revenues |
|
|
553 |
|
|
|
455 |
|
Benefits and
expenses |
|
|
459 |
|
|
|
390 |
|
|
|
|
|
|
|
|
Income before
taxes |
|
|
94 |
|
|
|
65 |
|
Income taxes |
|
|
21 |
|
|
|
22 |
|
Income attributable to
noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
Segment
earnings |
|
|
72 |
|
|
|
42 |
|
Less: special item
(after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
1 |
|
|
|
|
|
|
|
|
Adjusted income from
operations |
|
$ |
72 |
|
|
$ |
41 |
|
|
|
|
|
|
|
|
Impact of foreign
currency movements included in segment earnings |
|
$ |
7 |
|
|
$ |
(9 |
) |
|
|
|
|
|
|
|
Realized investment
gains (losses), net of taxes |
|
$ |
2 |
|
|
$ |
(2 |
) |
|
|
|
|
|
|
|
54
During the first
quarter of 2010, the Company’s International segment implemented a capital
management strategy to permanently invest the earnings of its Hong Kong
operation overseas. Income taxes for this operation, and the Korea operation
which implemented a similar strategy in the second quarter of 2009, will be
recorded at the tax rate of the respective foreign jurisdiction. The
International segment’s adjusted income from operations reflected favorable tax
adjustments of $5 million from the implementation of this strategy and
$8 million from the impact of the lower tax rates on the permanently
invested earnings in Korea and Hong Kong for first quarter of 2010. Excluding
the impact of these tax adjustments and foreign currency movements, the
International segment’s adjusted income from operations increased 27% for the
first quarter of 2010 compared with the same period last year. The increase is
primarily due to strong revenue growth and higher persistency, partially offset
by unfavorable claims experience in the supplemental health, life and accident
insurance business, particularly in South Korea. Favorable loss ratios in the
expatriate employee benefits business also contributed to the increase. Both
businesses continue to deliver competitively strong margins. The impact of
foreign currency movements was calculated by comparing the reported results to
what the results would have been had the exchange rates remained constant with
the prior year’s comparable period exchange rates.
Revenues
Premiums and
fees. Excluding the effect of foreign currency movements, premiums and
fees were $477 million for the first quarter of 2010 compared with reported
premiums of $434 million for the same period last year, an increase of 10%.
The increase was primarily attributable to new sales growth in the supplemental
health, life and accident insurance operations, particularly in South Korea, and
rate actions and membership growth in the expatriate employee benefits business.
To exclude the effect
of foreign currency movements, premiums and fees were calculated using the prior
year’s comparable period exchange rates, allowing foreign currency neutral
comparison to the prior years’ reported premiums and fees.
Net investment
income increased by 19% in the first quarter of 2010, compared with the
same period last year. The increase was primarily due to favorable foreign
currency movements, particularly in South Korea.
Benefits and
Expenses
Excluding the impact
of foreign currency movements, benefits and expenses were $416 million for
the first quarter of 2010 compared with reported benefits and expenses of
$390 million for the same period last year, an increase of 7%. The increase
in the first quarter of 2010 was primarily due to business growth and higher
claims in the supplemental health, life and accident insurance business,
particularly in South Korea, partially offset by lower claims in the expatriate
employee benefits business.
Loss ratios increased
for the first quarter of 2010 in the supplemental health, life and accident
insurance business and decreased in the expatriate benefits businesses compared
to the same period last year.
Policy acquisition
expenses increased for the first quarter of 2010, reflecting foreign currency
movements and business growth partially offset by lower amortization of deferred
acquisition costs associated with higher persistency in the supplemental health,
life and accident insurance business.
Expense ratios
decreased for the first quarter of 2010 compared to the same period last year,
reflecting effective expense management.
Other Items
Affecting International Results
For the Company’s
International segment, South Korea is the single largest geographic market.
South Korea generated 32% of the segment’s revenues and 39% of the segment’s
earnings for the first quarter of 2010. Due to the concentration of business in
South Korea, the International segment is exposed to potential losses resulting
from economic and geopolitical developments in that country, as well as foreign
currency movements affecting the South Korean currency, which could have a
significant impact on the segment’s results and the Company’s consolidated
financial results.
55
Run-off
Reinsurance Segment
Segment
Description
The Company’s
reinsurance operations were discontinued and are now an inactive business in
run-off mode since the sale of the U.S. individual life, group life and
accidental death reinsurance business in 2000. This segment is predominantly
comprised of guaranteed minimum death benefit (“GMDB”, also known as “VADBe”),
guaranteed minimum income benefit (“GMIB”), workers’ compensation and personal
accident reinsurance products.
The determination of
liabilities for GMDB and GMIB requires the Company to make assumptions and
critical accounting estimates. The Company describes the assumptions used to
develop the reserves for GMDB in Note 6 to the Consolidated Financial Statements
and for the assets and liabilities associated with GMIB in Note 7 to the
Consolidated Financial Statements. The Company also provides the effects of
hypothetical changes in assumptions in the Critical Accounting Estimates section
of the MD&A beginning on page 55 of the Company’s 2009 Form 10-K.
The Company excludes
the results of the GMIB business from adjusted income from operations because
the fair value of GMIB assets and liabilities must be recalculated each quarter
using updated capital market assumptions. The resulting changes in fair value,
which are reported in shareholders’ net income, are volatile and unpredictable.
Results of
Operations
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
8 |
|
|
$ |
6 |
|
Net investment
income |
|
|
28 |
|
|
|
24 |
|
Other revenues |
|
|
(46 |
) |
|
|
115 |
|
|
|
|
|
|
|
|
Segment
revenues |
|
|
(10 |
) |
|
|
145 |
|
Benefits and
expenses |
|
|
(17 |
) |
|
|
185 |
|
|
|
|
|
|
|
|
Income
(loss) before income tax benefits |
|
|
7 |
|
|
|
(40 |
) |
Income taxes
(benefits) |
|
|
3 |
|
|
|
(14 |
) |
|
|
|
|
|
|
|
Segment earnings
(loss) |
|
|
4 |
|
|
|
(26 |
) |
Less: results of GMIB
business |
|
|
5 |
|
|
|
23 |
|
|
|
|
|
|
|
|
Adjusted loss from
operations |
|
$ |
(1 |
) |
|
$ |
(49 |
) |
|
|
|
|
|
|
|
Realized investment
losses, net of taxes |
|
$ |
(1 |
) |
|
$ |
(3 |
) |
|
|
|
|
|
|
|
Segment results for
the first three months of 2010 improved from the same period last year due to
the absence of a charge for reserve strengthening in the GMDB business in 2009,
partially offset by less favorable results for the GMIB business (presented in
the table above). Excluding the results of the GMIB and GMDB business, adjusted
loss from operations for Run-off Reinsurance for the first three months of 2010
was flat compared to the same period of 2009.
See the Benefits and
Expenses section for further discussion around the results of the GMIB and GMDB
businesses.
Other Revenues
Other revenues
included pre-tax losses of $45 million for the first three months of 2010
from futures contracts used in the GMDB equity hedge program (see Note 6 to the
Consolidated Financial Statements), compared with gains of $117 million for
the same period of 2009. Amounts reflecting corresponding changes in liabilities
for GMDB contracts were included in benefits and expenses consistent with GAAP
when a premium deficiency exists (see below “Other Benefits and Expenses”). The
Company held futures contract positions related to this program with a notional
amount of $1 billion at March 31, 2010.
56
Benefits and
Expenses
Benefits and expenses
were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
GMIB fair value
gain |
|
$ |
(4 |
) |
|
$ |
(32 |
) |
Other benefits and
expenses |
|
|
(13 |
) |
|
|
217 |
|
|
|
|
|
|
|
|
Benefits and
expenses |
|
$ |
(17 |
) |
|
$ |
185 |
|
|
|
|
|
|
|
|
GMIB fair value
gain. Under the GAAP guidance for fair value measurements, the Company’s
results of operations are expected to be volatile in future periods because
capital market assumptions needed to estimate the assets and liabilities for the
GMIB business are based largely on market-observable inputs at the close of each
reporting period including interest rates (LIBOR swap curve) and market-implied
volatilities. See Note 7 to the Consolidated Financial Statements for additional
information about assumptions and asset and liability balances related to GMIB.
For the first three
months of 2010, GMIB fair value gain was $4 million, primarily due to
favorable equity market and bond fund returns, partially offset by generally
lower interest rates.
For the first three
months of 2009, GMIB fair value gain was $32 million, primarily a result of
increases in interest rates since December 31, 2008, partially offset by
declines in equity markets and bond returns and updates to the lapse assumption.
The GMIB liabilities
and related assets are calculated using a complex internal model and assumptions
from the viewpoint of a hypothetical market participant. This resulting
liability (and related asset) is higher than the Company believes will
ultimately be required to settle claims primarily because market-observable
interest rates are used to project growth in account values of the underlying
mutual funds to estimate fair value from the viewpoint of a hypothetical market
participant. The Company’s payments for GMIB claims are expected to occur over
the next 15 to 20 years and will be based on actual values of the underlying
mutual funds and the 7-year Treasury rate at the dates benefits are elected.
Management does not believe that current market-observable interest rates
reflect actual growth expected for the underlying mutual funds over that
timeframe, and therefore believes that the recorded liability and related asset
do not represent what management believes will ultimately be required as this
business runs off.
However, significant
declines in mutual fund values that underlie the contracts (increasing the
exposure to the Company) together with declines in the 7-year Treasury rates
(used to determine claim payments) similar to what occurred during 2008 and
early 2009 would increase the expected amount of claims that would be paid out
for contractholders who choose to annuitize. It is also possible that such
unfavorable market conditions would have an impact on the level of
contractholder annuitizations, particularly if such unfavorable market
conditions persisted for an extended period.
Other Benefits
and Expenses. Other benefits and expenses reflected income for the first
three months of 2010, compared to expense during the same period in 2009 due
primarily to the absence of a $73 million pre-tax charge to strengthen GMDB
reserves in the first quarter of 2009 (see below). Changes in equity markets on
GMDB contracts also contributed to the decrease in benefits and expenses. Equity
market improvements in 2010 increased the underlying annuity account values,
which decreased the exposure under the contracts and benefits expense. Equity
market declines in 2009 decreased the underlying annuity account values, which
increased the exposure under the contracts and benefits expense. These changes
in benefits expense are partially offset by futures gains and losses, discussed
in Other Revenues above.
For the first three
months of 2010, no reserve strengthening for GMDB reserves was required. In the
first quarter of 2009, the Company recorded additional other benefits and
expenses of $73 million ($47 million after-tax) to strengthen GMDB
reserves. The amounts were primarily due to an increase in the provision for
future partial surrenders due to overall market declines, adverse
volatility-related impacts due to turbulent equity market conditions and adverse
interest rate impacts.
See Note 6 to the
Consolidated Financial Statements for additional information about assumptions
and reserve balances related to GMDB.
57
Segment Summary
The Company’s payment
obligations for underlying reinsurance exposures assumed by the Company under
these contracts are based on ceding companies’ claim payments. For GMDB and
GMIB, claim payments vary because of changes in equity markets and interest
rates, as well as mortality and policyholder behavior. For workers’ compensation
and personal accident, the claim payments relate to accidents and injuries. Any
of these claim payments can extend many years into the future, and the amount of
the ceding companies’ ultimate claims, and therefore the amount of the Company’s
ultimate payment obligations and corresponding ultimate collection from its
retrocessionaires may not be known with certainty for some time.
The Company’s reserves
for underlying reinsurance exposures assumed by the Company, as well as for
amounts recoverable from retrocessionaires, are considered appropriate as of
March 31, 2010, based on current information. However, it is possible that
future developments, which could include but are not limited to worse than
expected claim experience and higher than expected volatility, could have a
material adverse effect on the Company’s consolidated results of operations and
could have a material adverse effect on the Company’s financial condition. The
Company bears the risk of loss if its payment obligations to cedents increase or
if its retrocessionaires are unable to meet, or successfully challenge, their
reinsurance obligations to the Company.
Other Operations
Segment
Segment
Description
Other Operations
consist of:
• |
|
non-leveraged and leveraged corporate-owned life insurance
(“COLI”); |
• |
|
deferred gains recognized from the 1998 sale of the individual life
insurance and annuity business and the 2004 sale of the retirement
benefits business; and |
• |
|
run-off settlement annuity business. |
Results of
Operations
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Premiums and
fees |
|
$ |
28 |
|
|
$ |
28 |
|
Net investment
income |
|
|
101 |
|
|
|
98 |
|
Other revenues |
|
|
15 |
|
|
|
16 |
|
|
|
|
|
|
|
|
Segment
revenues |
|
|
144 |
|
|
|
142 |
|
Benefits and
expenses |
|
|
115 |
|
|
|
126 |
|
|
|
|
|
|
|
|
Income before
taxes |
|
|
29 |
|
|
|
16 |
|
Income taxes |
|
|
10 |
|
|
|
(3 |
) |
|
|
|
|
|
|
|
Segment
earnings |
|
|
19 |
|
|
|
19 |
|
Less: special item
(after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
1 |
|
|
|
|
|
|
|
|
Adjusted income from
operations |
|
$ |
19 |
|
|
$ |
18 |
|
|
|
|
|
|
|
|
Realized investment
losses, net of taxes |
|
$ |
(2 |
) |
|
$ |
(4 |
) |
|
|
|
|
|
|
|
Adjusted income from
operations for Other Operations increased in the first three months of 2010
compared with the same period in 2009, reflecting higher earnings driven by
higher investment income offset by a continued decline in deferred gain
amortization associated with the sold businesses.
58
Revenues
Net investment
income. Net investment income increased 3% in the first three
months of 2010 compared with the same period in 2009, reflecting higher average
invested assets for COLI business and higher yields.
Other
revenues. Other revenues decreased 6% in the first three months
of 2010 compared with the same period in 2009 primarily due to lower deferred
gain amortization related to the sold retirement benefits and individual life
insurance and annuity businesses. The amount of the deferred gain amortization
recorded was $6 million in the first quarter of 2010 and $8 million in
the first quarter of 2009.
Corporate
Description
Corporate reflects
amounts not allocated to segments, such as net interest expense (defined as
interest on corporate debt less net investment income on investments not
supporting segment operations), interest on uncertain tax positions, certain
litigation matters, intersegment eliminations, compensation cost for stock
options and certain corporate overhead expenses such as directors’ expenses and,
beginning in 2010, pension expense related to the Company’s frozen pension
plans.
FINANCIAL
SUMMARY
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Segment loss |
|
$ |
(46 |
) |
|
$ |
(22 |
) |
Less: special item
(after-tax) included in segment loss: |
|
|
|
|
|
|
|
|
Completion of IRS
examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
— |
|
|
|
12 |
|
|
|
|
|
|
|
|
Adjusted loss from
operations |
|
$ |
(46 |
) |
|
$ |
(34 |
) |
|
|
|
|
|
|
|
Corporate’s adjusted
loss from operations was higher in the first three months of 2010, compared with
the same period in 2009, primarily reflecting:
• |
|
higher net interest expense, primarily driven by a higher long-term
debt balance; |
• |
|
tax expense for postretirement benefits resulting from health care
reform (“the Act”, see the Introduction section of the MD&A beginning
on page 43); and |
• |
|
pension expense related to the Company’s frozen pension plans which
was reported in Corporate beginning in 2010. |
DISCONTINUED
OPERATIONS
Description
Discontinued
operations represent results associated with certain investments or businesses
that have been sold or are held for sale.
Discontinued
operations for the first three months of 2009 primarily represented a tax
benefit from a past divestiture resolved at the completion of the 2005 and 2006
IRS examinations.
59
INDUSTRY
DEVELOPMENTS
The disability
industry is under continuing review by regulators and legislators with respect
to its offset practices regarding Social Security Disability Insurance (“SSDI”).
There has been specific inquiry as to the industry’s role in providing
assistance to individuals with their applications for SSDI. The Company has
received one Congressional inquiry and has responded to the information request.
Also, legislation prohibiting the offset of SSDI payments against private
disability insurance payments for prospectively issued policies was introduced
but not enacted in the Connecticut state legislature. The Company is also
involved in related pending litigation. If the industry is forced to change its
offset SSDI procedures, the practices and products for the Company’s Disability
and Life segment could be significantly impacted.
60
LIQUIDITY AND
CAPITAL RESOURCES
Liquidity
The Company maintains
liquidity at two levels: the subsidiary level and the parent company level.
Liquidity requirements
at the subsidiary level generally consist of:
• |
|
claim and benefit payments to policyholders; and |
|
• |
|
operating expense requirements, primarily for employee compensation
and benefits. |
The Company’s
subsidiaries normally meet their operating requirements by:
• |
|
maintaining appropriate levels of cash, cash equivalents and
short-term investments; |
|
• |
|
using cash flows from operating activities; |
|
• |
|
selling investments; |
|
• |
|
matching investment durations to those estimated for the related
insurance and contractholder liabilities; and |
|
• |
|
borrowing from its parent company. |
Liquidity requirements
at the parent company level generally consist of:
• |
|
debt service and dividend payments to shareholders; and |
|
• |
|
pension plan funding. |
The parent normally
meets its liquidity requirements by:
• |
|
maintaining appropriate levels of cash, cash equivalents and
short-term investments; |
|
• |
|
collecting dividends from its subsidiaries; |
|
• |
|
using proceeds from issuance of debt and equity securities; and |
|
• |
|
borrowing from its subsidiaries. |
Cash flows for the
three months ended March 31, were as follows:
|
|
|
|
|
|
|
|
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Operating
activities |
|
$ |
394 |
|
|
$ |
72 |
|
Investing
activities |
|
$ |
(123 |
) |
|
$ |
(166 |
) |
Financing
activities |
|
$ |
107 |
|
|
$ |
137 |
|
Cash flows from
operating activities consist of cash receipts and disbursements for premiums and
fees, mail order pharmacy and other revenues, gains (losses) recognized in
connection with the Company’s GMDB equity hedge program, investment income,
taxes, and benefits and expenses.
Because certain income
and expense transactions do not generate cash, and because cash transactions
related to revenue and expenses may occur in periods different from when those
revenues and expenses are recognized in shareholders’ net income, cash flows
from operating activities can be significantly different from shareholders’ net
income.
Cash flows from
investing activities generally consist of net investment purchases or sales and
net purchases of property and equipment, which includes capitalized software, as
well as cash used to acquire businesses.
Cash flows from
financing activities are generally comprised of issuances and re-payment of debt
at the parent company level, proceeds on the issuance of common stock resulting
from stock option exercises, and stock repurchases. In addition, the
subsidiaries report net deposits/withdrawals to/from investment contract
liabilities (which include universal life insurance liabilities) because such
liabilities are considered financing activities with policyholders.
61
2010:
Operating
activities
For the three months
ended March 31, 2010, cash flows from operating activities were higher than
net income by $110 million. Net income contains certain after-tax non-cash
income and expense items, including:
• |
|
Favorable results of the GMIB business of $5 million; |
|
• |
|
depreciation and amortization charges of $40 million; and |
|
• |
|
realized investment losses of
$3 million. |
Cash flows from
operating activities were higher than net income excluding the non-cash items
noted above by $72 million. Excluding cash outflows of $45 million
associated with the GMDB equity hedge program which did not affect shareholders’
net income, cash flows from operating activities were higher than net income by
$117 million. This result primarily reflects premium growth in the Health
Care segment’s risk businesses due to significant new business in 2010. Since
paid claims on new business tend to lag premium collections, cash flow from
operating activities was favorably affected by this new business. In addition,
the Company was not required to make a federal tax payment in the first quarter.
These favorable effects were partially offset by the annual payment of
management incentive compensation in the first quarter.
Cash flows from
operating activities increased by $322 million compared with the three
months ended March 31, 2009. Excluding the results of the GMDB equity hedge
program (which did not affect shareholders’ net income), cash flows from
operating activities increased by $484 million. This increase primarily
reflects premium growth in the Health Care segment’s risk businesses as noted
above, earnings growth in the Disability and Life and International segments as
well as lower contributions to the qualified domestic pension plan of
$55 million for the three months ended March 31, 2010, compared with
$300 million for the three months ended March 31, 2009. These
favorable effects were partially offset by higher management compensation
payments for the three months ended March 31, 2010, compared with the same
period last year.
Investing
activities
Cash used in investing
activities was $123 million. This use of cash primarily consisted of net
purchases of investments of $66 million and net purchases of property and
equipment of $52 million.
Financing
activities
Cash provided from
financing activities primarily consisted of changes in cash overdraft position
of $40 million, proceeds from issuances of common stock from employee
benefit plans of $24 million and net deposits to contractholder deposit
funds of $45 million.
2009:
Operating
activities
For the three months
ended March 31, 2009, cash flows from operating activities were less than
net income by $137 million. Net income contains certain after-tax non-cash
income and expense items, including:
• |
|
favorable results of the GMIB business of $23 million; |
|
• |
|
depreciation and amortization charges of $45 million; |
|
• |
|
realized investment losses of $24 million; and |
|
• |
|
tax benefits related to the IRS examination of
$20 million. |
Cash flows from
operating activities were lower than net income excluding the non-cash items
noted above by $163 million. This decrease was primarily due to
contributions to the domestic pension plan of $300 million partially offset
by cash inflows associated with the GMDB equity hedge program of
$117 million.
Investing
activities
Cash used in investing
activities was $166 million. This use of cash primarily consisted of net
purchases of investments of $106 million and net purchases of property and
equipment of $60 million.
62
Financing
activities
Cash provided from
financing activities primarily consisted of proceeds from the net issuance of
short-term debt of $74 million. These borrowing arrangements were entered
into for general corporate purposes. Financing activities also included net
deposits to contractholder deposit funds of $51 million.
Interest
Expense
Interest expense on
long-term debt, short-term debt and capital leases was as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Interest
expense |
|
$ |
43 |
|
|
$ |
38 |
|
|
|
|
|
|
|
|
The increase in
interest expense for the three months ended March 31, 2010 was primarily
due to more long-term debt outstanding in 2010, caused by the issuance of debt
in May, 2009 used for general corporate purposes, including the repayment of
some of the Company’s commercial paper issued to finance the acquisition of the
Healthcare division of Great West Life and Annuity, Inc.
Capital
Resources
The Company’s capital
resources (primarily retained earnings and the proceeds from the issuance of
debt and equity securities) provide protection for policyholders, furnish the
financial strength to underwrite insurance risks and facilitate continued
business growth.
Management, guided by
regulatory requirements and rating agency capital guidelines, determines the
amount of capital resources that the Company maintains. Management allocates
resources to new long-term business commitments when returns, considering the
risks, look promising and when the resources available to support existing
business are adequate.
The Company
prioritizes its use of capital resources to:
• |
|
provide capital necessary to support growth and maintain or improve
the financial strength ratings of subsidiaries; |
• |
|
consider acquisitions that are strategically and economically
advantageous; and |
• |
|
return capital to investors through share
repurchase. |
The availability of
capital resources will be impacted by equity and credit market conditions.
Extreme volatility in credit or equity market conditions may reduce the
Company’s ability to issue debt or equity securities.
Share
Repurchase
The Company maintains
a share repurchase program, which was authorized by its Board of Directors. The
decision to repurchase shares depends on market conditions and alternate uses of
capital. The Company has, and may continue from time to time, to repurchase
shares on the open market through a Rule 10b5-1 plan which permits a
company to repurchase its shares at times when it otherwise might be precluded
from doing so under insider trading laws or because of self-imposed trading
blackout periods. The Company suspends activity under this program from time to
time and also removes such suspensions, generally without public announcement.
Through May 6,
2010, the Company has not repurchased any shares during 2010, and did not
repurchase any shares during 2009. The total remaining share repurchase
authorization as of May 6, 2010 was $449 million.
63
Liquidity and
Capital Resources Outlook
At March 31,
2010, there was approximately $700 million in cash and short-term
investments available at the parent company level. For the remainder of 2010,
the parent company’s cash requirements include scheduled interest payments of
approximately $136 million on outstanding long-term debt (including current
maturities) of $2.4 billion at March 31, 2010, and expected pre-tax
contributions to the pension plan of $157 million, of which
$57 million are required. In addition, approximately $100 million of
commercial paper will mature over the next 2 months and scheduled long-term
debt repayments of $222 million are due in January of 2011. The parent
company expects to fund these cash requirements by using available cash,
subsidiary dividends, by refinancing the maturing commercial paper borrowings
with new commercial paper and by issuing new long-term debt, if necessary.
The availability of
resources at the parent company level is partially dependent on dividends from
the Company’s subsidiaries, most of which are subject to regulatory restrictions
and rating agency capital guidelines, and partially dependent on the
availability of liquidity from the issuance of debt or equity securities.
The Company expects,
based on current projections for cash activity, to have sufficient liquidity to
meet its obligations.
However, the Company’s
cash projections may not be realized and the demand for funds could exceed
available cash if:
• |
|
ongoing businesses experience unexpected shortfalls in earnings; |
|
• |
|
regulatory restrictions or rating agency capital guidelines reduce the
amount of dividends available to be distributed to the parent company from
the insurance and HMO subsidiaries (including the impact of equity market
deterioration and volatility on subsidiary capital); |
|
• |
|
significant disruption or volatility in the capital and credit markets
reduces the Company’s ability to raise capital or creates unexpected
losses related to the GMDB and GMIB businesses; |
|
• |
|
a substantial increase in funding over current projections is required
for the Company’s pension plans; or |
|
• |
|
a substantial increase in funding is required for the Company’s GMDB
equity hedge program. |
In those cases, the
Company expects to have the flexibility to satisfy liquidity needs through a
variety of measures, including intercompany borrowings and sales of liquid
investments. The parent company may borrow up to $600 million from
Connecticut General Life Insurance Company (“CGLIC”) without prior state
approval. As of March 31, 2010, the parent company had no outstanding
borrowings from CGLIC.
In addition, the
Company may use short-term borrowings, such as the commercial paper program and
the committed revolving credit and letter of credit agreement of up to
$1.75 billion subject to the maximum debt leverage covenant in its line of
credit agreement. This agreement permits up to $1.25 billion to be used for
letters of credit. As of March 31, 2010, there were two letters totaling
$107 million issued out of the credit facility. As of March 31, 2010,
the Company had an additional $1.64 billion of borrowing capacity under the
credit facility.
Though the Company
believes it has adequate sources of liquidity, continued significant disruption
or volatility in the capital and credit markets could affect the Company’s
ability to access those markets for additional borrowings or increase costs
associated with borrowing funds.
Guarantees and
Contractual Obligations
The Company, through
its subsidiaries, is contingently liable for various contractual obligations
entered into in the ordinary course of business. See Note 17 to the Consolidated
Financial Statements for additional information.
64
INVESTMENT
ASSETS
The Company’s
investment assets do not include separate account assets. Additional information
regarding the Company’s investment assets and related accounting policies is
included in Notes 2, 7, 8, 9, 10 and 14 to the Consolidated Financial
Statements. More detailed information about the fixed maturities and mortgage
loan portfolios by type of issuer, maturity dates, and, for mortgages by
property type and location is included in Note 8 to the Consolidated Financial
Statements and Notes 2, 11, 12 and 17 to the Consolidated Financial Statements
in the Company’s 2009 Form 10-K.
As of March 31,
2010, the Company’s mix of investments and their primary characteristics have
not materially changed since December 31, 2009. The Company’s fixed
maturity portfolio is diversified by issuer and industry type, with no single
industry constituting more than 10% of total invested assets as of
March 31, 2010. The Company’s commercial mortgage loan portfolio is
diversified by property type, location and borrower to reduce exposure to
potential losses.
Fixed
Maturities
Investments in fixed
maturities (bonds) include publicly traded and privately placed debt
securities, mortgage and other asset-backed securities, preferred stocks
redeemable by the investor and trading securities. Fixed maturities and equity
securities include hybrid securities. Fair values are based on quoted market
prices when available. When market prices are not available, fair value is
generally estimated using discounted cash flow analyses, incorporating current
market inputs for similar financial instruments with comparable terms and credit
quality. In instances where there is little or no market activity for the same
or similar instruments, the Company estimates fair value using methods, models
and assumptions that the Company believes a hypothetical market participant
would use to determine a current transaction price.
The Company performs
ongoing analyses of prices used to value the Company’s invested assets to
determine that they represent appropriate estimates of fair value. This process
involves quantitative and qualitative analysis including reviews of pricing
methodologies, judgments of valuation inputs, the significance of any
unobservable inputs, pricing statistics and trends. The Company also performs
sample testing of sales values to confirm the accuracy of prior fair value
estimates. These procedures are overseen by the Company’s investment
professionals.
The value of the
Company’s fixed maturity portfolio increased $156 million in the first
quarter of 2010 driven by a decline in market yields. Although overall asset
values are well in excess of amortized cost, there are specific securities with
amortized cost in excess of fair value by $84 million as of March 31, 2010.
As of March 31,
2010, approximately 63% or $1,597 million of the Company’s total
investments in state and local government securities of $2,523 million were
guaranteed by monoline bond insurers. The quality ratings of these investments
with and without this guaranteed support as of March 31, 2010 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
|
|
|
March 31, |
|
|
|
|
|
2010 |
|
|
|
|
|
Fair Value |
|
|
|
|
|
With |
|
|
Without |
|
(In
millions) |
|
Quality Rating |
|
Guarantee |
|
|
Guarantee |
|
State and local
governments |
|
Aaa |
|
$ |
66 |
|
|
$ |
64 |
|
|
|
Aa1-Aa3 |
|
|
1,116 |
|
|
|
946 |
|
|
|
A1-A3 |
|
|
354 |
|
|
|
463 |
|
|
|
Baa1-Baa3 |
|
|
61 |
|
|
|
69 |
|
|
|
Not available |
|
|
— |
|
|
|
55 |
|
|
|
|
|
|
|
|
|
|
Total state and local
governments |
|
|
|
$ |
1,597 |
|
|
$ |
1,597 |
|
|
|
|
|
|
|
|
|
|
65
As of March 31,
2010, approximately 81% or $450 million of the Company’s total investments
in other asset-backed securities of $559 million were guaranteed by
monoline bond insurers. All of these securities had quality ratings of Baa2 or
better. Quality ratings without considering the guarantees for these other
asset-backed securities were not available.
As of March 31,
2010, the Company had no direct investments in monoline bond insurers.
Guarantees provided by various monoline bond insurers for certain of the
Company’s investments in state and local governments and other asset-backed
securities as of March 31, 2010 were:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
|
|
|
March 31, |
|
(In
millions) |
|
|
|
2010 |
|
|
|
Guarantor |
|
|
|
Guarantor |
|
Quality Rating |
|
Indirect Exposure |
|
AMBAC |
|
Caa2 |
|
$ |
196 |
|
National Public Finance
Guarantee (formerly MBIA, Inc.) |
|
Baa1 |
|
|
1,222 |
|
Assured Guaranty
Municipal Corp (formerly Financial Security Assurance) |
|
Aa3 |
|
|
590 |
|
Financial Guaranty
Insurance Co. |
|
NR |
|
|
39 |
|
|
|
|
|
|
|
Total |
|
|
|
$ |
2,047 |
|
|
|
|
|
|
|
The Company continues
to underwrite investments in these securities focusing on the underlying
issuer’s credit quality, without regard for guarantees. As such, this portfolio
of state and local government securities, guaranteed by monoline bond insurers
is of high quality with approximately 92% rated A3 or better without their
guarantees.
Commercial
Mortgage Loans
The Company’s
commercial mortgage loans are fixed rate loans, diversified by property type,
location and borrower to reduce exposure to potential losses. Loans are secured
by the related property and are generally made at less than 75% of the
property’s value at origination of the loan. In addition to property value, debt
service coverage, which is the ratio of the estimated cash flows from the
property to the required loan payments (principal and interest), is an important
underwriting consideration.
The Company completed
its annual in depth review of its commercial mortgage loan portfolio in the
third quarter of 2009. This review included an analysis of each property’s
financial statements as of December 31, 2008, rent rolls and operating
plans and budgets for 2009, a physical inspection of the property and other
pertinent factors. Based on property values and cash flows estimated as part of
this review, along with updates for certain loans where material changes were
subsequently identified, the portfolio’s average loan-to-value ratio increased
from 64% as of December 31, 2008 to 77% at March 31, 2010 and the
overall estimated cash flows from the portfolio’s properties exceeded their
required debt payments by approximately 50% (debt service coverage) as of
March 31, 2010.
66
The following table
reflects the commercial mortgage loan portfolio as of March 31, 2010
summarized by loan-to-value ratio based on the annual loan review completed in
July, 2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan-to-Value Distribution |
|
Loan-to-Value Ratios |
|
Amortized Cost |
|
|
% of Mortgage Loans |
|
|
|
Senior |
|
|
Subordinated |
|
|
Total |
|
|
|
|
Below 50% |
|
$ |
197 |
|
|
$ |
159 |
|
|
$ |
356 |
|
|
|
10 |
% |
50% to 59% |
|
|
296 |
|
|
|
— |
|
|
|
296 |
|
|
|
9 |
% |
60% to 69% |
|
|
421 |
|
|
|
37 |
|
|
|
458 |
|
|
|
13 |
% |
70% to 79% |
|
|
487 |
|
|
|
76 |
|
|
|
563 |
|
|
|
16 |
% |
80% to 89% |
|
|
846 |
|
|
|
43 |
|
|
|
889 |
|
|
|
25 |
% |
90% to 99% |
|
|
595 |
|
|
|
17 |
|
|
|
612 |
|
|
|
18 |
% |
100% or above |
|
|
304 |
|
|
|
15 |
|
|
|
319 |
|
|
|
9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
3,146 |
|
|
$ |
347 |
|
|
$ |
3,493 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
As summarized above,
$347 million or 10% of the commercial mortgage loan portfolio is comprised
of subordinated notes and loans, including $313 million of loans secured by
first mortgages, which were fully underwritten and originated by the Company
using its standard underwriting procedures. Senior interests in these first
mortgage loans were then sold to other institutional investors. This strategy
allowed the Company to effectively utilize its origination capabilities to
underwrite high quality loans with strong borrower sponsorship, limit individual
loan exposures, and achieve attractive risk adjusted yields. In the event of a
default, the Company would pursue remedies up to and including foreclosure
jointly with the holders of the senior interest, but would receive repayment
only after satisfaction of the senior interest.
There are nine loans
where the aggregate carrying value of the mortgage loans exceeds the value of
the underlying properties by $25 million. Six of these loans have current
debt service coverage of 1.0 or greater and three with debt service coverage
below 1.0 have other mitigating factors including strong borrower sponsorship.
Although the property value declines increased the portfolio’s loan-to-value
ratios, all but six of the approximately 180 loans that comprise the Company’s
total mortgage loan portfolio continue to perform under their contractual terms,
and the actual aggregate default rate is 5%. Given the quality and diversity of
the underlying real estate, positive debt service coverage, significant borrower
cash investment averaging nearly 30%, and only $219 million of loans
maturing in the next twelve months, the Company remains confident that the vast
majority of borrowers will continue to perform as required.
Commercial real estate
fundamentals and values continued to decline after completion of the portfolio
review in mid-year 2009. While the vast majority of loans in the Company’s
portfolio have positive debt service coverage of at least 1.0, the Company
expects declines in debt service coverage to reflect further deterioration in
fundamentals (higher vacancy rates and lower rental rates) resulting from
ongoing weak economic conditions. Management’s current view is that property
values have fallen by approximately 10% on average from values estimated as part
of the 2009 portfolio review. This means that approximately 20% of the
portfolio’s loans would have carrying values in excess of their underlying
properties’ fair values totaling approximately $95 million. However, the
value of well located, well leased, institutional quality real estate
demonstrated signs of stabilization during the fourth quarter of 2009 and has
continued to stabilize, and in some instances increase, during the first quarter
of 2010.
Other Long-term
Investments
The Company’s other
long-term investments include $562 million in private equity and real
estate funds as well as direct investments in real estate joint ventures. The
funds typically invest in mezzanine debt or equity of privately held companies
and equity real estate. Because these investments have a subordinate position in
the capital structure, the Company assumes a higher level of risk for higher
expected returns. Many of these entities have experienced a decline in value
over the last several quarters due to economic weakness and the disruption in
the capital markets, particularly in the commercial real estate market. These
total asset values exceeded their carrying values as of March 31, 2010.
However, the fair value of the Company’s ownership interest in certain funds
(those carried at cost) was less than its carrying value by $59 million.
The Company believes these declines in value are temporary and expects to
recover its carrying value over the remaining lives of the funds. To mitigate
risk, these investments are diversified across approximately 60 separate
partnerships, and approximately 35 general partners who manage one or more of
these partnerships. Also, the funds’ underlying investments are diversified by
industry sector, property type, and geographic region. No single partnership
investment exceeds 8% of the Company’s private equity and real estate
partnership portfolio. Given the current economic environment, future
impairments are possible; however, management does not expect those losses to
have a material effect on the Company’s financial condition.
67
Problem and
Potential Problem Investments
“Problem” bonds and
commercial mortgage loans are either delinquent by 60 days or more or have
been restructured as to terms (interest rate or maturity date). “Potential
problem” bonds and commercial mortgage loans are considered current (no payment
more than 59 days past due), but management believes they have certain
characteristics that increase the likelihood that they may become problems. The
characteristics management considers include, but are not limited to, the
following:
• |
|
request from the borrower for restructuring; |
• |
|
principal or interest payments past due by more than 30 but fewer than
60 days; |
• |
|
downgrade in credit rating; |
• |
|
collateral losses on asset-backed securities;
and |
• |
|
for commercial mortgages, deterioration of debt service coverage below
1.0 or value declines resulting in estimated loan-to-value ratios
increasing to 100% or more. |
The Company recognizes
interest income on problem bonds and commercial mortgage loans only when payment
is actually received because of the risk profile of the underlying investment.
The additional amount that would have been reflected in net income if interest
on non-accrual investments had been recognized in accordance with the original
terms was not significant for the first three months of 2010 or 2009.
The following table
shows problem and potential problem investments at amortized cost, net of
valuation reserves and write-downs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In
millions) |
|
March 31, 2010 |
|
|
December 31, 2009 |
|
|
|
Gross |
|
|
Reserve |
|
|
Net |
|
|
Gross |
|
|
Reserve |
|
|
Net |
|
Problem bonds |
|
$ |
102 |
|
|
$ |
(49 |
) |
|
$ |
53 |
|
|
$ |
103 |
|
|
$ |
(49 |
) |
|
$ |
54 |
|
Problem commercial
mortgage loans |
|
|
202 |
|
|
|
(28 |
) |
|
|
174 |
|
|
|
169 |
|
|
|
(11 |
) |
|
|
158 |
|
Foreclosed real
estate |
|
|
95 |
|
|
|
— |
|
|
|
95 |
|
|
|
59 |
|
|
|
— |
|
|
|
59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total problem
investments |
|
$ |
399 |
|
|
$ |
(77 |
) |
|
$ |
322 |
|
|
$ |
331 |
|
|
$ |
(60 |
) |
|
$ |
271 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Potential problem
bonds |
|
$ |
42 |
|
|
$ |
(10 |
) |
|
$ |
32 |
|
|
$ |
94 |
|
|
$ |
(10 |
) |
|
$ |
84 |
|
Potential problem
commercial mortgage loans |
|
|
254 |
|
|
|
— |
|
|
|
254 |
|
|
|
245 |
|
|
|
(6 |
) |
|
|
239 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total potential problem
investments |
|
$ |
296 |
|
|
$ |
(10 |
) |
|
$ |
286 |
|
|
$ |
339 |
|
|
$ |
(16 |
) |
|
$ |
323 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net problem
investments represent 1.7% of total investments excluding policy loans. Net
problem investments increased $51 million during the first quarter of 2010
primarily reflecting the reclassification of two mortgage loans totaling
$53 million from potential problem loans to problem loans.
Net potential problem
investments represent 1.5% of total investments excluding policy loans. Net
potential problem investments decreased $37 million during the first
quarter of 2010 primarily reflecting improved bond performance and the
reclassification of two commercial mortgage loans to problem investments, offset
by the addition of three commercial mortgage loans totaling $81 million to the
potential problem loan list that were exhibiting signs of distress such as an
elevated loan-to-value ratio or a low or negative debt service coverage. These
loans are all performing according to their original contractual terms as of
March 31, 2010.
Commercial mortgage
loans are considered impaired when it is probable that the Company will not
collect amounts due according to the terms of the original loan agreement. In
the above table, problem commercial mortgage loans totaling $174 million,
at March 31, 2010 are considered impaired. During the first quarter of
2010, the Company recorded an $11 million pre-tax ($7 million
after-tax) increase to valuation reserves on impaired commercial mortgage loans.
68
Summary
The Company recorded
after-tax realized investment losses for investment asset write-downs and
changes in valuation reserves as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(In
millions) |
|
2010 |
|
|
2009 |
|
Credit-related (1) |
|
$ |
16 |
|
|
$ |
7 |
|
Other (2) |
|
|
1 |
|
|
|
7 |
|
|
|
|
|
|
|
|
Total (3) |
|
$ |
17 |
|
|
$ |
14 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Credit-related losses include other-than-temporary declines in
value of fixed maturities and equity securities, and impairments of
commercial mortgage loans and real estate entities. The amount related to
credit losses on fixed maturities for which a portion of the impairment
was recognized in other comprehensive income was not
significant. |
|
(2) |
|
Prior to adoption of new GAAP guidance for other-than-temporary
impairments on April 1, 2009, Other primarily represented the impact
of rising market yields on investments where the Company could not
demonstrate the intent and ability to hold until recovery. |
|
(3) |
|
Includes other-than-temporary impairments on debt securities of
$1 million in the first quarter of 2010 and $11 million in the
first quarter of 2009. These impairments are included in the other
category in 2010 and in both the credit related and other categories in
2009. |
The financial markets
were generally stable to improving during the first quarter of 2010. Both
investment grade and below investment grade corporate credit indices remained
fairly consistent with the fourth quarter of 2009 and the S&P 500 posted a
return of approximately 5% during this period. While credit spreads and asset
values were stable in the first quarter of 2010, substantial uncertainty remains
concerning the economic environment. As a result of this economic environment,
risks in the Company’s investment portfolio, while declining, remain elevated.
Continued economic
weakness for an extended period could cause default rates to increase and
recoveries to decline resulting in additional impairment losses for the Company.
Future realized and unrealized investment results will be impacted largely by
market conditions that exist when a transaction occurs or at the reporting date.
These future conditions are not reasonably predictable. Management believes that
the vast majority of the Company’s fixed maturity investments will continue to
perform under their contractual terms, and that declines in their fair values
below carrying value are temporary. Based on the strategy to match the duration
of invested assets to the duration of insurance and contractholder liabilities,
the Company expects to hold a significant portion of these assets for the long
term. Future credit-related losses are not expected to have a material adverse
effect on the Company’s liquidity or financial condition.
While management
believes the commercial mortgage loan portfolio is positioned to perform well
due to the solid aggregate loan to value ratio, strong debt service coverage and
minimal underwater position, the commercial real estate market continues to
exhibit significant signs of distress and if these conditions remain for an
extended period or worsen substantially, it could result in an increase in
problem and potential problem loans. Given the current economic environment,
future impairments are possible; however, management does not expect those
losses to have a material effect on the Company’s financial condition.
69
MARKET RISK
Financial
Instruments
The Company’s assets
and liabilities include financial instruments subject to the risk of potential
losses from adverse changes in market rates and prices. The Company’s primary
market risk exposures are interest-rate risk, foreign currency exchange rate
risk and equity price risk.
The Company uses
futures contracts as part of a GMDB equity hedge program to substantially reduce
the effect of equity market changes on certain reinsurance contracts that
guarantee minimum death benefits based on unfavorable changes in underlying
variable annuity account values. The hypothetical effect of a 10% increase in
the S&P 500, S&P 400, Russell 2000, NASDAQ, TOPIX (Japanese), EUROSTOXX
and FTSE (British) equity indices and a 10% weakening in the U.S. dollar to the
Japanese yen, British pound and euro would have been a decrease of approximately
$90 million in the fair value of the futures contracts outstanding under
this program as of March 31, 2010. A corresponding decrease in liabilities
for GMDB contracts would result from the hypothetical 10% increase in these
equity indices and 10% weakening in the U.S. dollar. See Note 6 to the
Consolidated Financial Statements for further discussion of this program and
related GMDB contracts.
Stock Market
Performance
The performance of
equity markets can have a significant effect on the Company’s businesses,
including on:
• |
|
risks and exposures associated with GMDB (see Note 6 to the
Consolidated Financial Statements) and GMIB contracts (see Note 7 to the
Consolidated Financial Statements); and |
• |
|
pension liabilities since equity securities comprise a significant
portion of the assets of the Company’s employee pension plans. See
“Liquidity and Capital Resources” section of the MD&A beginning on
page 61 for further information. |
70
CAUTIONARY
STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
The Company and its
representatives may from time to time make written and oral forward-looking
statements, including statements contained in press releases, in the Company’s
filings with the Securities and Exchange Commission, in its reports to
shareholders and in meetings with analysts and investors. Forward-looking
statements may contain information about financial prospects, economic
conditions, trends and other uncertainties. These forward-looking statements are
based on management’s beliefs and assumptions and on information available to
management at the time the statements are or were made. Forward-looking
statements include but are not limited to the information concerning possible or
assumed future business strategies, financing plans, competitive position,
potential growth opportunities, potential operating performance improvements,
trends and, in particular, the Company’s productivity initiatives, litigation
and other legal matters, operational improvement in the health care operations,
and the outlook for the Company’s full year 2010 results. Forward-looking
statements include all statements that are not historical facts and can be
identified by the use of forward-looking terminology such as the words
“believe”, “expect”, “plan”, “intend”, “anticipate”, “estimate”, “predict”,
“potential”, “may”, “should” or similar expressions.
You should not place
undue reliance on these forward-looking statements. The Company cautions that
actual results could differ materially from those that management expects,
depending on the outcome of certain factors. Some factors that could cause
actual results to differ materially from the forward-looking statements include:
1. |
|
increased medical costs that are higher than anticipated in
establishing premium rates in the Company’s health care operations,
including increased use and costs of medical
services; |
2. |
|
increased medical, administrative, technology or other costs resulting
from new legislative and regulatory requirements imposed on the Company’s
employee benefits businesses; |
3. |
|
challenges and risks associated with implementing operational
improvement initiatives and strategic actions in the ongoing operations of
the businesses, including those related to: (i) growth in targeted
geographies, product lines, buying segments and distribution channels,
(ii) offering products that meet emerging market needs,
(iii) strengthening underwriting and pricing effectiveness,
(iv) strengthening medical cost and medical membership results, (v)
delivering quality member and provider service using effective technology
solutions, (vi) lowering administrative costs and (vii) transitioning
to an integrated operating company model, including operating efficiencies
related to the transition; |
4. |
|
risks associated with pending and potential state and federal class
action lawsuits, disputes regarding reinsurance arrangements, other
litigation and regulatory actions challenging the Company’s businesses,
including disputes related to payments to providers, government
investigations and proceedings, and tax audits and related
litigation; |
5. |
|
heightened competition, particularly price competition, which could
reduce product margins and constrain growth in the Company’s businesses,
primarily the Health Care business; |
6. |
|
risks associated with the Company’s mail order pharmacy business
which, among other things, includes any potential operational deficiencies
or service issues as well as loss or suspension of state pharmacy
licenses; |
7. |
|
significant changes in interest rates and deterioration in the loan to
value ratios of commercial real estate investments for a sustained period
of time; |
8. |
|
downgrades in the financial strength ratings of the Company’s
insurance subsidiaries, which could, among other things, adversely affect
new sales and retention of current business as well as the downgrade in
the financial strength ratings of reinsurers which could result in
increased statutory reserve or capital
requirements; |
9. |
|
limitations on the ability of the Company’s insurance subsidiaries to
dividend capital to the parent company as a result of downgrades in the
subsidiaries’ financial strength ratings, changes in statutory reserve or
capital requirements or other financial
constraints; |
10. |
|
the inability of the hedge program adopted by the Company to
substantially reduce equity market risks for reinsurance contracts that
guarantee minimum death benefits under certain variable annuities
(including possible market difficulties in entering into appropriate
futures contracts and in matching such contracts to the underlying equity
risk); |
11. |
|
adjustments to the reserve assumptions (including lapse, partial
surrender, claim mortality, interest rates and volatility) used in
estimating the Company’s liabilities for reinsurance contracts covering
guaranteed minimum death benefits under certain variable
annuities; |
12. |
|
adjustments to the assumptions (including annuity election rates and
amounts collectible from reinsurers) used in estimating the Company’s
assets and liabilities for reinsurance contracts covering guaranteed
minimum income benefits under certain variable
annuities; |
13. |
|
significant stock market declines, which could, among other things,
result in increased expenses for guaranteed minimum income benefit
contracts, guaranteed minimum death benefit contracts and the Company’s
pension plan in future periods as well as the recognition of additional
pension obligations; |
14. |
|
unfavorable claims experience related to workers’ compensation and
personal accident exposures of the run-off reinsurance business, including
losses attributable to the inability to recover claims from
retrocessionaires; |
71
15. |
|
significant deterioration in economic conditions and significant
market volatility, which could have an adverse effect on the Company’s
operations, investments, liquidity and access to capital
markets; |
16. |
|
significant deterioration in economic conditions and significant
market volatility, which could have an adverse effect on the businesses of
our customers (including the amount and type of healthcare services
provided to their workforce and our customers’ ability to pay receivables)
and our vendors (including their ability to provide
services); |
17. |
|
adverse changes in state and federal law, including health care reform
legislation and regulation which could, among other items, affect the way
the Company does business, increase cost, limit the ability to effectively
estimate, price for and manage medical costs, and affect the Company’s
health care products, services, technology and
processes; |
18. |
|
amendments to income tax laws, which could affect the taxation of
employer provided benefits and certain insurance products such as
corporate-owned life insurance; |
19. |
|
potential public health epidemics and bio-terrorist activity, which
could, among other things, cause the Company’s covered medical and
disability expenses, pharmacy costs and mortality experience to rise
significantly, and cause operational disruption, depending on the severity
of the event and number of individuals affected; |
20. |
|
risks associated with security or interruption of information systems,
which could, among other things, cause operational
disruption; |
21. |
|
challenges and risks associated with the successful management of the
Company’s outsourcing projects or key vendors, including the agreement
with IBM for provision of technology infrastructure and related
services; |
22. |
|
the ability to successfully integrate and operate the businesses
acquired from Great-West by, among other things, renewing insurance and
administrative services contracts on competitive terms, retaining and
growing membership, realizing revenue, expense and other synergies,
successfully leveraging the information technology platform of the
acquired businesses, and retaining key personnel;
and |
23. |
|
the ability of the Company to execute its growth plans by successfully
managing Great-West Healthcare’s outsourcing projects and leveraging the
Company’s capabilities and those of the businesses acquired from
Great-West to further enhance the combined organization’s network access
position, underwriting effectiveness, delivery of quality member and
provider service, and increased penetration of its membership base with
differentiated product offerings. |
This list of important
factors is not intended to be exhaustive. Other sections of the Company’s 2009
Annual Report on Form 10-K, including
the “Risk Factors” section and other documents filed with the Securities and
Exchange Commission include both expanded discussion of these factors and
additional risk factors and uncertainties that could preclude the Company from
realizing the forward-looking statements. The Company does not assume any
obligation to update any forward-looking statements, whether as a result of new
information, future events or otherwise, except as required by law.
72
|
|
|
Item 3. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK |
Information responsive
to this item is contained under the caption “Market Risk” in Item 2 above,
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
73
|
|
|
Item 4. |
|
CONTROLS AND PROCEDURES |
Based
on an evaluation of the effectiveness of CIGNA’s disclosure controls and
procedures conducted under the supervision and with the participation of CIGNA’s
management, CIGNA’s Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this report, CIGNA’s
disclosure controls and procedures are effective to ensure that information
required to be disclosed by CIGNA in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the SEC’s rules and forms.
During the period covered by this report, there have been no changes
in CIGNA’s internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, CIGNA’s internal
control over financial reporting.
74
Part II.
OTHER INFORMATION
|
|
|
Item 1. |
|
LEGAL PROCEEDINGS |
The information
contained under “Litigation and Other Legal Matters” in Note 17 to the
Consolidated Financial Statements is incorporated herein by reference.
75
Item 1A.
RISK FACTORS
CIGNA’s Annual Report
on Form 10-K for the year ended December 31, 2009 includes a detailed
description of its risk factors.
76
|
|
|
Item 2. |
|
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS |
(c) Purchases of
Equity Securities by the Issuer and Affiliated Purchasers
The following table
provides information about CIGNA’s share repurchase activity for the quarter
ended March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuer Purchases of Equity Securities |
|
|
|
Total # of |
|
|
|
|
|
|
|
|
|
|
Approximate dollar value of shares
that |
|
|
|
shares |
|
|
Average price paid |
|
|
Total # of shares purchased as part |
|
|
may yet be purchased as part of
publicly |
|
Period |
|
purchased (1) |
|
|
per share |
|
|
of publicly announced program (2) |
|
|
announced program (3) |
|
January 1-31,
2010 |
|
|
294,790 |
|
|
$ |
35.80 |
|
|
|
0 |
|
|
$ |
448,919,605 |
|
February 1-28,
2010 |
|
|
53,602 |
|
|
$ |
33.21 |
|
|
|
0 |
|
|
$ |
448,919,605 |
|
March 1-31,
2010 |
|
|
177,790 |
|
|
$ |
34.06 |
|
|
|
0 |
|
|
$ |
448,919,605 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
526,182 |
|
|
$ |
34.95 |
|
|
|
0 |
|
|
|
N/A |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes shares tendered by employees as payment of taxes withheld on
the exercise of stock options and the vesting of restricted stock granted
under the Company’s equity compensation plans. Employees tendered 294,790
shares in January, 53,602 shares in February and 177,790 shares in
March. |
|
(2) |
|
CIGNA has had a repurchase program for many years, and has had varying
levels of repurchase authority and activity under this program. The
program has no expiration date. CIGNA suspends activity under this program
from time to time and also removes such suspensions, generally without
public announcement. Remaining authorization under the program was
approximately $449 million as of March 31, 2010 and May 6,
2010. |
|
(3) |
|
Approximate dollar value of shares is as of the last date of the
applicable month. |
77
SIGNATURE
Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
|
|
|
|
|
|
CIGNA CORPORATION |
|
|
By: |
/s/
Annmarie T. Hagan |
|
|
|
Annmarie T. Hagan |
|
|
|
Executive Vice President and Chief
Financial Officer (Principal Financial Officer) |
|
Date: May 6, 2010
79
INDEX TO
EXHIBITS
|
|
|
|
|
|
|
Number |
|
Description |
|
Method
of Filing |
|
|
|
|
|
|
|
|
3.1 |
|
|
Restated Certificate of
Incorporation of the registrant as last amended April 23, 2008 |
|
Filed as Exhibit 3.1 to the registrant’s
Form 10-Q for the period ended March 31, 2008 and incorporated herein
by reference. |
|
|
|
|
|
|
|
|
3.2 |
|
|
By-Laws of the registrant
as last amended and restated October 28, 2009 |
|
Filed as Exhibit 3.2 to the registrant’s
Form 10-K for the year ended December 31, 2009 and incorporated
herein by reference. |
|
|
|
|
|
|
|
|
4.1 |
|
|
Indenture dated
August 16, 2006 between CIGNA Corporation and U.S. Bank National
Association |
|
Filed as Exhibit 4.1 to the registrant’s
Form S-3ASR on August 17, 2006 and incorporated herein by
reference. |
|
|
|
|
|
|
|
|
4.2 |
|
|
Indenture dated
January 1, 1994 between CIGNA Corporation and Marine Midland Bank
|
|
Filed as Exhibit 4.2 to the registrant’s
Form 10-K for the year ended December 31, 2009 and incorporated
herein by reference. |
|
|
|
|
|
|
|
|
4.3 |
|
|
Indenture dated
June 30, 1988 between CIGNA Corporation and Bankers Trust |
|
Filed as Exhibit 4.3 to the registrant’s
Form 10-K for the year ended December 31, 2009 and incorporated
herein by reference. |
|
|
|
|
|
|
|
|
10.1 |
|
|
Description of Strategic
Performance Share Program |
|
Filed herewith. |
|
|
|
|
|
|
|
|
10.2 |
|
|
CIGNA Long-Term Incentive
Plan as amended and restated effective April 28, 2010 |
|
Filed herewith. |
|
|
|
|
|
|
|
|
10.3 |
|
|
CIGNA Corporation
Directors Equity Plan |
|
Filed herewith. |
|
|
|
|
|
|
|
|
12 |
|
|
Computation of Ratio of
Earnings to Fixed Charges |
|
Filed herewith. |
|
|
|
|
|
|
|
|
31.1 |
|
|
Certification of Chief
Executive Officer of CIGNA Corporation pursuant to Rule 13a-14(a) or
Rule 15d-14(a) of the Securities Exchange Act of 1934 |
|
Filed herewith. |
|
|
|
|
|
|
|
|
31.2 |
|
|
Certification of Chief
Financial Officer of CIGNA Corporation pursuant to Rule 13a-14(a) or
Rule 15d-14(a) of the Securities Exchange Act of 1934 |
|
Filed herewith. |
|
|
|
|
|
|
|
|
32.1 |
|
|
Certification of Chief
Executive Officer of CIGNA Corporation pursuant to Rule 13a-14(b) or
Rule 15d-14(b) and 18 U.S.C. Section 1350 |
|
Furnished herewith. |
|
|
|
|
|
|
|
|
32.2 |
|
|
Certification of Chief
Financial Officer of CIGNA Corporation pursuant to Rule 13a-14(b) or
Rule 15d-14(b) and 18 U.S.C. Section 1350 |
|
Furnished
herewith. |
E-1