Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2018

 

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.)

900 Cottage Grove Road Bloomfield, Connecticut

 

06002

(Address of principal executive offices)

 

(Zip Code)

(860) 226-6000

Registrant’s telephone number, including area code

(860) 226-6741 or (215) 761-5511

Registrant’s facsimile number, including area code

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark

 

YES

 

NO

 

· 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.

 

R

 

o

 

· 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).

 

R

 

o

 

· whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer R

Accelerated filer o

Non-accelerated filer o

Smaller Reporting Company o

Emerging growth company  o

 

 

·  If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

·  whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

o

 

 

R

 

As of April 20, 2018, 243,268,191 shares of the issuer’s common stock were outstanding.

 



Table of Contents

 

Cigna Corporation

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

PART I

FINANCIAL INFORMATION

Page

 

 

 

Item 1. 

Financial Statements (Unaudited)

 

 

Consolidated Statements of Income

1

 

Consolidated Statements of Comprehensive Income

2

 

Consolidated Balance Sheets

3

 

Consolidated Statements of Changes in Total Equity

4

 

Consolidated Statements of Cash Flows

5

 

Notes to the Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

43

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

62

Item 4.

Controls and Procedures

62

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

63

Item 1.A.

Risk Factors

63

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

67

Item 6.

Exhibits

68

SIGNATURE

70

 

 

As used herein, “Cigna” or the “Company” refers to one or more of Cigna Corporation and its consolidated subsidiaries.

 



Table of Contents

 

 

 

 

 

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)

 

2018

 

2017

 

Revenues

 

 

 

 

 

Premiums

 

$

8,999

 

$

8,151

 

Fees and other revenues

 

1,368

 

1,264

 

Net investment income

 

329

 

303

 

Mail order pharmacy revenues

 

717

 

710

 

Realized investment gains (losses)

 

 

 

 

 

Other-than-temporary impairments on fixed maturities

 

(13)

 

(7)

 

Other realized investment (losses) gains, net

 

(20)

 

53

 

Net realized investment (losses) gains

 

(33)

 

46

 

TOTAL REVENUES

 

11,380

 

10,474

 

Benefits and expenses

 

 

 

 

 

Global Health Care medical costs

 

5,317

 

4,949

 

Other benefit expenses

 

1,455

 

1,367

 

Mail order pharmacy costs

 

561

 

581

 

Other operating expenses

 

2,802

 

2,655

 

Amortization of other acquired intangible assets

 

27

 

32

 

TOTAL BENEFITS AND EXPENSES

 

10,162

 

9,584

 

Income before income taxes

 

1,218

 

890

 

Income taxes

 

 

 

 

 

Current

 

292

 

286

 

Deferred

 

9

 

11

 

TOTAL INCOME TAXES

 

301

 

297

 

Net income

 

917

 

593

 

Less: Net income (loss) attributable to noncontrolling interests

 

2

 

(5)

 

SHAREHOLDERS’ NET INCOME

 

$

915

 

$

598

 

Shareholders’ net income per share

 

 

 

 

 

 

 

Basic

 

$

3.78

 

$

2.34

 

Diluted

 

$

3.72

 

$

2.30

 

Dividends declared per share

 

$

0.04

 

$

0.04

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

1



Table of Contents

 

Cigna Corporation

Consolidated Statements of Comprehensive Income

 

 

 

Unaudited

Three Months Ended

March 31,

 

(In millions)

 

2018

 

2017

 

Shareholders’ net income

 

$

915

 

$

598

 

Shareholders’ other comprehensive income, net of tax

 

 

 

 

 

Net unrealized (depreciation) appreciation, securities

 

(279)

 

7

 

Net unrealized (depreciation), derivatives

 

(5)

 

(3)

 

Net translation of foreign currencies

 

45

 

112

 

Postretirement benefits liability adjustment

 

13

 

14

 

Shareholders’ other comprehensive (loss) income, net of tax

 

(226)

 

130

 

Shareholders’ comprehensive income

 

689

 

728

 

Comprehensive income (loss) attributable to noncontrolling interests

 

 

 

 

 

Net income (loss) attributable to redeemable noncontrolling interests

 

2

 

(2)

 

Net (loss) attributable to other noncontrolling interests

 

-

 

(3)

 

Other comprehensive (loss) attributable to redeemable noncontrolling interests

 

(2)

 

(2)

 

Total comprehensive income (loss) attributable to noncontrolling interests

 

-

 

(7)

 

TOTAL COMPREHENSIVE INCOME

 

$

689

 

$

721

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

2



Table of Contents

 

Cigna Corporation

Consolidated Balance Sheets

 

 

 

Unaudited

 

 

 

As of

 

As of

 

 

 

March 31,

 

December 31,

 

(In millions, except per share amounts)

 

2018

 

2017

 

Assets:

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost, $23,416; $21,867)

 

$

24,178

 

$

23,138

 

Equity securities

 

567

 

588

 

Commercial mortgage loans

 

1,801

 

1,761

 

Policy loans

 

1,404

 

1,415

 

Other long-term investments

 

1,669

 

1,518

 

Short-term investments

 

245

 

199

 

Total investments

 

29,864

 

28,619

 

Cash and cash equivalents

 

2,771

 

2,972

 

Premiums, accounts and notes receivable, net

 

3,455

 

3,380

 

Reinsurance recoverables

 

5,945

 

6,046

 

Deferred policy acquisition costs

 

2,315

 

2,237

 

Property and equipment

 

1,552

 

1,563

 

Deferred tax assets, net

 

96

 

39

 

Goodwill

 

6,170

 

6,164

 

Other assets, including other intangibles

 

2,720

 

2,316

 

Separate account assets

 

8,253

 

8,423

 

TOTAL ASSETS

 

$

63,141

 

$

61,759

 

Liabilities:

 

 

 

 

 

Contractholder deposit funds

 

$

8,153

 

$

8,196

 

Future policy benefits

 

9,934

 

10,040

 

Unpaid claims and claim expenses

 

5,215

 

5,168

 

Global Health Care medical costs payable

 

2,925

 

2,719

 

Unearned premiums

 

1,291

 

724

 

Total insurance and contractholder liabilities

 

27,518

 

26,847

 

Accounts payable, accrued expenses and other liabilities

 

7,825

 

7,290

 

Short-term debt

 

110

 

240

 

Long-term debt

 

5,191

 

5,199

 

Separate account liabilities

 

8,253

 

8,423

 

TOTAL LIABILITIES

 

48,897

 

47,999

 

Contingencies — Note 16

 

 

 

 

 

Redeemable noncontrolling interests

 

49

 

49

 

Shareholders’ Equity:

 

 

 

 

 

Common stock (par value per share, $0.25; shares issued, 296; authorized, 600)

 

74

 

74

 

Additional paid-in capital

 

2,963

 

2,940

 

Accumulated other comprehensive (loss)

 

(1,547)

 

(1,082)

 

Retained earnings

 

16,933

 

15,800

 

Less treasury stock, at cost

 

(4,228)

 

(4,021)

 

TOTAL SHAREHOLDERS’ EQUITY

 

14,195

 

13,711

 

Total liabilities and shareholders’ equity

 

$

63,141

 

$

61,759

 

SHAREHOLDERS’ EQUITY PER SHARE

 

$

58.36

 

$

56.20

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

3



Table of Contents

 

Cigna Corporation

Consolidated Statements of Changes in Total Equity

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

Unaudited

 

 

 

Additional

 

Other

 

 

 

 

 

 

 

Other Non-

 

 

 

Non-

 

For the three months ended March 31, 2018

 

Common

 

Paid-in

 

Comprehensive

 

Retained

 

Treasury

 

Shareholders’

 

controlling

 

Total

 

controlling

 

(In millions)

 

Stock

 

Capital

 

(Loss)

 

Earnings

 

Stock

 

Equity

 

Interests

 

Equity

 

Interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2017 as retrospectively adjusted

 

$

74

 

$

2,940

 

$

(1,082)

 

$

15,800

 

$

(4,021)

 

$

13,711

 

$

-

 

$

13,711

 

$

49

 

Cumulative effect of accounting for financial instruments and hedging (1)

 

 

 

 

 

(10)

 

68

 

 

 

58

 

 

 

58

 

 

 

Reclassification adjustment related to U.S. tax reform legislation (1)

 

 

 

 

 

(229)

 

229

 

 

 

-

 

 

 

-

 

 

 

Effect of issuing stock for employee benefit plans

 

 

 

23

 

 

 

(69)

 

68

 

22

 

 

 

22

 

 

 

Other comprehensive (loss)

 

 

 

 

 

(226)

 

 

 

 

 

(226)

 

 

 

(226)

 

(2)

 

Net income

 

 

 

 

 

 

 

915

 

 

 

915

 

 

 

915

 

2

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(275)

 

(275)

 

 

 

(275)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

-

 

 

 

-

 

 

 

BALANCE AT MARCH 31, 2018

 

$

74

 

$

2,963

 

$

(1,547)

 

$

16,933

 

$

(4,228)

 

$

14,195

 

$

-

 

$

14,195

 

$

49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended March 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2016 as reported

 

$

74

 

$

2,892

 

$

(1,382)

 

$

13,855

 

$

(1,716)

 

$

13,723

 

$

4

 

$

13,727

 

$

58

 

Cumulative effect of accounting for revenue recognition (1)

 

 

 

 

 

 

 

(24)

 

 

 

(24)

 

 

 

(24)

 

 

 

Balance at December 31, 2016 as retrospectively adjusted

 

74

 

2,892

 

(1,382)

 

13,831

 

(1,716)

 

13,699

 

4

 

13,703

 

58

 

Effect of issuing stock for employee benefit plans

 

 

 

23

 

 

 

(87)

 

102

 

38

 

 

 

38

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

130

 

 

 

 

 

130

 

 

 

130

 

(2)

 

Net income (loss)

 

 

 

 

 

 

 

598

 

 

 

598

 

(3)

 

595

 

(2)

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(250)

 

(250)

 

 

 

(250)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

(3)

 

 

 

 

 

 

 

(3)

 

2

 

(1)

 

2

 

BALANCE AT MARCH 31, 2017

 

$

74

 

$

2,912

 

$

(1,252)

 

$

14,332

 

$

(1,864)

 

$

14,202

 

$

3

 

$

14,205

 

$

56

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

(1) See Note 2 for further information about adjustments resulting from the Company’s adoption of new accounting standards in 2018.

 

4



Table of Contents

 

Cigna Corporation

Consolidated Statements of Cash Flows

 

 

 

Unaudited

 

 

 

Three Months Ended March 31,

 

(In millions)

 

2018

 

2017

 

Cash Flows from Operating Activities

 

 

 

 

 

Net income

 

$

917

 

$

593

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

140

 

146

 

Realized investment losses (gains)

 

33

 

(46)

 

Deferred income taxes

 

9

 

11

 

Net changes in assets and liabilities, net of non-operating effects:

 

 

 

 

 

Premiums, accounts and notes receivable

 

(53)

 

(55)

 

Reinsurance recoverables

 

31

 

41

 

Deferred policy acquisition costs

 

(76)

 

(76)

 

Other assets

 

114

 

(22)

 

Insurance liabilities

 

849

 

868

 

Accounts payable, accrued expenses and other liabilities

 

(191)

 

(186)

 

Current income taxes

 

260

 

291

 

Distributions from partnership investments

 

34

 

45

 

Other, net

 

(42)

 

(31)

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

2,025

 

1,579

 

Cash Flows from Investing Activities

 

 

 

 

 

Proceeds from investments sold:

 

 

 

 

 

Fixed maturities and equity securities

 

499

 

414

 

Investment maturities and repayments:

 

 

 

 

 

Fixed maturities and equity securities

 

297

 

475

 

Commercial mortgage loans

 

28

 

21

 

Other sales, maturities and repayments (primarily short-term and other long-term investments)

 

112

 

667

 

Investments purchased or originated:

 

 

 

 

 

Fixed maturities and equity securities

 

(2,259)

 

(1,240)

 

Commercial mortgage loans

 

(68)

 

(107)

 

Other (primarily short-term and other long-term investments)

 

(206)

 

(256)

 

Property and equipment purchases

 

(103)

 

(91)

 

NET CASH (USED IN) INVESTING ACTIVITIES

 

(1,700)

 

(117)

 

Cash Flows from Financing Activities

 

 

 

 

 

Deposits and interest credited to contractholder deposit funds

 

292

 

374

 

Withdrawals and benefit payments from contractholder deposit funds

 

(306)

 

(385)

 

Net change in short-term debt

 

(3)

 

(10)

 

Repayment of long-term debt

 

(131)

 

(250)

 

Repurchase of common stock

 

(310)

 

(239)

 

Issuance of common stock

 

20

 

38

 

Other, net

 

(92)

 

(43)

 

NET CASH (USED IN) FINANCING ACTIVITIES

 

(530)

 

(515)

 

Effect of foreign currency rate changes on cash and cash equivalents

 

4

 

23

 

Net (decrease) increase in cash and cash equivalents

 

(201)

 

970

 

Cash and cash equivalents, January 1,

 

2,972

 

3,185

 

Cash and cash equivalents, March 31,

 

$

2,771

 

$

4,155

 

Supplemental Disclosure of Cash Information:

 

 

 

 

 

Income taxes paid, net of refunds

 

$

31

 

$

(8)

 

Interest paid

 

$

46

 

$

70

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

5



 Table of Contents

 

CIGNA CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

TABLE OF CONTENTS

 

Note
Number

Footnote

Page

 

 

 

BUSINESS AND CAPITAL STRUCTURE

 

1

Description of Business

7

2

Significant Accounting Policies

8

3

Mergers and Acquisitions

12

4

Earnings Per Share

13

5

Debt

14

INSURANCE INFORMATION

 

6

Global Health Care Medical Costs Payable

16

7

Liabilities for Unpaid Claims and Claim Expenses

17

8

Reinsurance

18

INVESTMENTS

 

9

Fair Value Measurements

21

10

Investments

27

11

Derivative Financial Instruments

31

12

Variable Interest Entities

34

13

Accumulated Other Comprehensive Income (Loss)

34

WORKFORCE MANAGEMENT AND COMPENSATION

 

14

Pension and Other Postretirement Benefit Plans

36

COMPLIANCE, REGULATION AND CONTINGENCIES

 

15

Income Taxes

36

16

Contingencies and Other Matters

37

RESULTS DETAILS

 

17

Segment Information

40

 

6



Table of Contents

 

Note 1 – Description of Business

 

 

Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”)  is a global health services organization dedicated to a mission of helping individuals improve their health, well-being and sense of security.  To execute on our mission, Cigna’s evolved strategy is to “Go Deeper”, “Go Local” and “Go Beyond” with a differentiated set of medical, dental, disability, life and accident insurance and related products and services offered by our insurance and other subsidiaries.  The majority of these products are offered through employers and other groups such as governmental and non-governmental organizations, unions and associations.  Cigna also offers commercial health and dental insurance, Medicare and Medicaid products and health, life and accident insurance coverages to individuals in the United States and selected international markets.  In addition to its ongoing operations described above, Cigna also has certain run-off operations.

 

The financial results of the Company’s businesses are reported in the following segments:

 

Global Health Care aggregates the Commercial and Government operating segments due to their similar economic characteristics, products and services and regulatory environment:

 

·

The Commercial operating segment (“Commercial segment”) encompasses both the U.S. commercial and certain international health care businesses serving employers and their employees, other groups and individuals.  Products and services include medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services to insured and self-insured customers.

 

 

·

The Government operating segment (“Government segment”) offers Medicare Advantage and Medicare Part D plans to seniors.  This segment also offers Medicaid plans in selected markets.

 

Global Supplemental Benefits includes supplemental health, life and accident insurance products offered primarily in selected international markets and in the United States.

 

Group Disability and Life provides group long-term and short-term disability, group life, accident and specialty insurance products and related services.

 

Other Operations consist of:

 

·

corporate-owned life insurance (“COLI”);

 

 

·

run-off reinsurance business that is predominantly comprised of guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) business effectively exited through reinsurance with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) in 2013;

 

·

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.

 

Corporate reflects amounts not allocated to operating 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, intersegment eliminations, compensation cost for stock options and related excess tax benefits, expense associated with frozen pension plans and certain litigation matters and costs for corporate projects, including overhead.

 

7



Table of Contents

 

Note 2 – Significant Accounting Policies

 

 

Basis of Presentation

 

The Consolidated Financial Statements include the accounts of Cigna Corporation and its subsidiaries.  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”).  Amounts recorded in the Consolidated Financial Statements necessarily reflect management’s estimates and assumptions about medical costs, investment valuation, interest rates and other factors.  Significant estimates are discussed throughout these Notes; however, actual results could differ from those estimates.  The impact of a change in estimate is generally included in earnings in the period of adjustment.  Certain reclassifications have been made to prior year amounts to conform to the current presentation.

 

These 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 included in the Company’s 2017 Annual Report on Form 10-K (“2017 Form 10-K”).  The preparation of interim Consolidated Financial Statements necessarily relies heavily on estimates.  This and certain other factors, including 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.

 

Recent Accounting Pronouncements

 

The Company’s 2017 Form 10-K includes discussion of significant recent accounting pronouncements that either have impacted or may impact our financial statements in the future.

 

The following tables provide information about recently adopted and recently issued or changed accounting guidance (applicable to Cigna) that have occurred since the Company filed its 2017 Form 10-K.

 

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Recently Adopted Accounting Guidance

 

Accounting Standard and
Adoption Date

 

 

Requirements and Effects of Adopting New Guidance

Revenue from Contracts with Customers (Accounting Standards Update (“ASU”) 2014-09 and related amendments)

 

 

Adopted as of January 1, 2018

 

Requires:

 

· Revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services

· Additional revenue-related disclosures

 

Effects of adoption:

 

· Applies only to the Company’s service and mail order pharmacy contracts with customers

· Adopted through full retrospective restatement 

· Cumulative effect adjustment of $24 million after-tax was recorded, reducing the December 31, 2016 balance of retained earnings.  Adjustment established a contract liability for service fee revenue billed that must be deferred and allocated to services performed after a customer contract terminates.  Subsequent changes in the contract liability and the related impact to net income and per share amounts since adoption were immaterial.

· Immaterial reclassifications were made to prior periods in the Consolidated Statements of Income to conform to the current presentation.  The ASU and related interpretive guidance provide clarification on topics including whether all or a part of a contract is within its scope, and the definition of a customer.  Companies are required to identify and evaluate distinct performance obligations within their contracts.  These clarifications resulted in reclassifications within the Global Health Care Segment affecting premiums, fees and other revenues, Global Health Care medical costs, and other operating expenses and had no impact on recognition patterns or net income.

· Prior period balances in the Company’s footnote disclosures have been updated to reflect adjustments resulting from the adoption of this ASU.

 

Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01 and related amendments)

 

 

Adopted as of January 1, 2018

 

Requires entities to measure equity investments at fair value in net income if they are neither consolidated nor accounted for under the equity method

 

Effects of adoption:

 

· Certain limited partnership interests previously carried at cost of approximately $200 million were increased to fair value of approximately $275 million on January 1, 2018.  Subsequent changes in fair value are reported in net investment income.

· Changes in fair value for equity securities that have a readily determinable fair value that were previously reported in accumulated other comprehensive income are now reported in net realized investment gains.

· Cumulative effect adjustment of $62 million after-tax was recorded, increasing the opening balance of retained earnings in 2018.

· See Notes 9 and 10 for updated disclosures about equity securities.

 

Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12)

 

 

Early adopted as of January 1, 2018

 

Guidance:

 

· Relaxes requirements for financial and nonfinancial hedging strategies to be eligible for hedge accounting and changes how companies assess effectiveness

· Amends presentation and disclosure requirements to improve transparency about the uses and results of hedging programs

 

Effects of adoption:

 

· An immaterial amount of retained earnings related to the portion of the hedging instruments that was excluded from the assessment of hedge effectiveness for fair value hedges was reclassified to accumulated other comprehensive income, decreasing the opening balance in 2018. 

· See Note 11 for the Company’s disclosures about derivatives.

 

 

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Recently Adopted Accounting Guidance

 

Accounting Standard and
Adoption Date

 

 

Requirements and Effects of Adopting New Guidance

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02)

 

 

Early adopted as of January 1, 2018

 

Guidance:

 

· Allows companies to reclassify to retained earnings the tax effects stranded in accumulated other comprehensive income as a result of H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (referred to throughout this Form 10-Q as “U.S. tax reform” or “U.S. tax reform legislation”)

· Requires additional disclosures of the Company’s accounting policy for releasing income tax effects from accumulated other comprehensive income

· Allows companies to apply the guidance retrospectively or in the period of adoption

 

Effects of adoption:  Accumulated other comprehensive income of $229 million was reclassified to retained earnings, increasing the opening balance in 2018.  See Note 13 for additional information including accounting policy disclosures.

 

 

In addition to the standards listed above, the Company adopted the following guidance in first quarter 2018 with no material impact to our financial statements:  Intra-Entity Transfers of Assets Other than Inventory (ASU 2016-16), Clarifying the Definition of a Business (ASU 2017-01), Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07), Statement of Cash Flows: Restricted Cash (ASU 2016-18), Gains and Losses from the Derecognition of Nonfinancial Assets (ASU 2017-05) and Stock Compensation Scope of Modification Accounting (ASU 2017-09).

 

Accounting Guidance Not Yet Adopted

 

Accounting Standard and
Effective Date Applicable
for Cigna

 

 

Requirements and Expected Effects of Guidance Not Yet Adopted

Leases (ASU 2016-02)

 

 

Required as of January 1, 2019

 

Requires:

 

· Balance sheet recognition of assets and liabilities arising from leases, including leases embedded in other contracts

· Additional disclosures of the amount, timing and uncertainty of cash flows from leases

· Modified retrospective approach for leases in effect as of and after the date of adoption with a cumulative-effect adjustment recorded in retained earnings

 

Expected effects:

 

· The Company is continuing to evaluate the impact this standard will have on its financial statements.

· While not yet quantified, the Company expects a material impact to its Consolidated Balance Sheets from recognizing additional assets and liabilities of operating leases upon adoption.  The actual increase in assets and liabilities will depend on the volume and terms of leases in place at the time of adoption.

· The Company plans to elect the optional practical expedient to retain the current classification of leases, and therefore, does not anticipate a material impact to the Consolidated Statements of Income or Cash Flows.

· The Company is implementing a new lease system and also expects that adoption of the new standard will require changes to internal controls over financial reporting.

 

 

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Updates to Significant Accounting Policies

 

The Company’s 2017 Form 10-K includes discussion of significant accounting policies in Note 2 or the applicable Notes to the Consolidated Financial StatementsUpdates to these policies resulting from the adoption of new accounting guidance in 2018 are provided as follows:

 

 

·

ASU 2016-1 (Recognition and Measurement of Financial Assets and Liabilities):  see Notes 9 and 10

 

·

ASU 2017-12 (Targeted Improvements to Accounting for Hedging Activities):  see Note 11

 

·

ASU 2014-09 (Revenue from Contracts with Customers), also referred to as Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers and related guidance (“ASC 606”):  see below.

 

The majority of the Company’s revenues are not subject to the guidance in ASC 606, including premiums from insurance contracts and fees for investment-related products accounted for under insurance guidance (ASC 944).  ASC 606 applies only to the Company’s service and mail order pharmacy contracts with clients.  See Note 17 for disaggregated revenue from external customers by segment and by major product or service identified with applicable accounting guidance (ASC 944 or ASC 606).

 

Accounting for Contracts with Customers – Service and Mail Order Pharmacy Arrangements

 

Service Fees and Expenses

 

The majority of the Company’s service fees are derived from administrative services only (“ASO”) arrangements that allow corporate clients to self-fund claims and assume the risk of medical or other benefit costs.  Most of the Company’s ASO arrangements are for Global Health Care medical and specialty services, including pharmacy benefits and, to a lesser extent, ASO services in its Group Disability and Life and Global Supplemental Benefits segments.  Generally, the Company’s ASO arrangements are short-term.  Contract modifications typically occur on renewal and are prospective in nature.

 

In return for fees from these clients, the Company provides or makes available various services supporting benefit management and claims administration.  In addition, Global Health Care’s services include access to the Company’s participating provider networks, disease management, utilization management, and cost containment services.

 

In general, the Company considers these services to be a combined performance obligation to provide cost effective administration of plan benefits over the contract period.  Fees are billed, due and recognized monthly at contracted rates based on current membership or utilization.  This recognition pattern aligns with the benefits from services provided to clients.  These revenues are reported in fees and other revenues in the Consolidated Statements of Income.

 

For most ASO arrangements, the Company is required to perform services for a limited period after a client cancels.  If these services will not be separately billed to the client as they are performed, the Company estimates and defers a portion of compensation attributable to this service obligation received in advance.  Deferred revenue is recorded as a contract liability in accounts payable, accrued expenses and other liabilities and recognized when the related services are performed.

 

The Company may also provide performance guarantees that provide potential refunds to clients if certain service standards, clinical outcomes or financial metrics are not met.  If these standards, outcomes and metrics 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 defers revenue and records a liability for estimated payouts associated with these guarantees within accounts payable, accrued expenses and other liabilities.  The amount of revenue deferred is estimated for each type of guarantee, using either a most likely amount or expected value method depending upon the nature of the guarantee and the information available to estimate refunds.  Estimates are refined each reporting period as additional information on the Company’s performance becomes available, and upon final reconciliation and settlement at the end of the guarantee period.  Amounts accrued and paid for performance guarantees during the reporting periods were not material.

 

Service fees are recognized net of estimated pharmaceutical manufacturer rebates payable to ASO clients using our network of retail pharmacies.  Net rebates retained by the Company from pharmaceutical manufacturers resulting from ASO client utilization at retail pharmacies represent compensation for pharmacy services and are reflected as fee revenue.  Rebates generally represent a per script amount from the manufacturer and are determined based on scripts filled during the reporting period.

 

Expenses associated with administrative programs and services are recognized in other operating expenses as incurred.

 

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Mail Order Pharmacy Revenues and Costs

 

Mail order pharmacy revenues are due and recognized as each prescription is shipped.  Mail order pharmacy revenues are presented net of estimated pharmaceutical manufacturer rebates payable to ASO clients that use our mail order business.  Rebates are generally determined based on actual prescriptions filled during the reporting period.

 

Mail order pharmacy costs are recognized as each prescription is shipped and include the cost of prescriptions sold and other costs to operate this business (including supplies, shipping and handling), net of estimated pharmaceutical rebates from manufacturers for prescriptions filled through our mail order business.

 

Contract Balances

 

The following table provides information about receivables and contract liabilities from service and mail order pharmacy contracts with clients.  The allowance for doubtful accounts for receivables and the Company’s contract assets were not material as of the dates presented.

 

(In millions)

 

March 31, 2018

 

December 31, 2017

 

Receivables, net

 

$

1,019

 

$

885

 

Contract liabilities

 

$

57

 

$

54

 

 

Revenue recognized for the three months ended March 31, 2018 and March 31, 2017 that was included in the contract liability balance at the beginning of the reporting period was not material.

 

The amount of revenue recognized for the three months ended March 31, 2018 and March 31, 2017 from performance obligations satisfied in prior periods was not material.

 

The incremental costs of obtaining ASO and mail order pharmacy contracts (such as sales commissions) are expensed as incurred and the Company does not disclose information about remaining performance obligations for these contracts in accordance with elections made by the Company as they are generally short-term with original expected durations of one year or less.

 

Note 3 – Mergers and Acquisitions

 

 

Proposed Acquisition of Express Scripts

 

On March 8, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Express Scripts Holding Company (“Express Scripts”), Halfmoon Parent, Inc., a direct wholly owned subsidiary of the Company (“New Cigna”), Halfmoon I, Inc., a direct wholly owned subsidiary of New Cigna (“Cigna Merger Sub”), and Halfmoon II, Inc., a direct wholly owned subsidiary of New Cigna (“Express Scripts Merger Sub”).  Subject to the terms and conditions of the Merger Agreement, the Company will acquire Express Scripts in a cash and stock transaction through (1) the merger of Cigna Merger Sub with and into the Company, with the Company surviving as a direct wholly owned subsidiary of New Cigna and (2) the merger of Express Scripts Merger Sub with and into Express Scripts, with Express Scripts surviving as a direct wholly owned subsidiary of New Cigna (collectively, the “Merger”).  New Cigna will be renamed “Cigna Corporation” immediately after the Merger.

 

Upon completion of the Merger, Cigna stockholders will receive one share of New Cigna common stock in exchange for each share of Cigna common stock held immediately prior to the Merger, and Express Scripts stockholders will receive (1) 0.2434 of a share of New Cigna common stock and (2) the right to receive $48.75 in cash, without interest, subject to applicable withholding taxes (the “Merger Consideration”) , in exchange for each share of Express Scripts common stock held immediately prior to the Merger.  After completion of the Merger, shares of New Cigna common stock are expected to be listed for trading on the New York Stock Exchange.

 

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The Merger is subject to adoption of the Merger Agreement by the stockholders of the Company and Express Scripts and the satisfaction of customary closing conditions, including receipt of applicable regulatory approvals.  The Merger is not subject to a financing condition.  The Company intends to fund the cash portion of the Merger Consideration through a combination of cash on hand, assumed Express Scripts debt and new debt issuance.  See Note 5 for additional information about the financing of the Merger.  The Merger is expected to be completed by December 31, 2018.

 

The Merger Agreement provides for certain termination rights and fees for both the Company and Express Scripts.  If the Merger Agreement is terminated (1) by Express Scripts because the board of directors of the Company has changed its recommendation prior to obtaining the required approval of the stockholders of the Company, (2) by Express Scripts or the Company if the board of directors of the Company has changed its recommendation and the stockholders of the Company have voted against adopting the Merger Agreement or (3) by the Company in order to enter into an alternative acquisition agreement with respect to a Parent Superior Proposal that did not result from a breach of the Company’s non-solicitation obligations, then the Company will be required to pay Express Scripts a fee equal to $1.6 billion (the “Parent Termination Fee”).  Further, if the Merger Agreement is terminated under certain circumstances and within 12 months after the date of such termination the Company enters into an agreement regarding a sale of a majority of the Company’s assets or equity or consummates such a sale, then the Company will be required to pay the Parent Termination Fee prior to or contemporaneously with such entry or consummation.  Express Scripts has reciprocal obligations under specified circumstances to pay a $1.6 billion termination fee to the Company.

 

Additionally, in the event that the Merger Agreement is terminated by either the Company or Express Scripts due to (1) a legal restraint relating to a regulatory law prohibiting consummation of the Merger having become final and non-appealable or (2) the Merger not having been consummated on or prior to December 8, 2018 (subject to an extension to June 8, 2019 if extended by the Company or Express Scripts under certain circumstances); and, in the case of clause (2), at the time of such termination, all of the conditions to the Company’s obligation to consummate the Merger have been satisfied other than those that relate to the absence of a legal restraint relating to a regulatory law or the receipt of a regulatory approval, the Company may be required to pay Express Scripts a reverse termination fee of $2.1 billion.

 

Transaction-related costs

 

In connection with the proposed acquisition of Express Scripts, as well as other transactions including the terminated merger with Anthem, Inc. (“Anthem”), the Company has incurred costs of $60 million pre-tax ($50 million after-tax) for the three months ended March 31, 2018.  Transaction-related costs for the three months ended March 31, 2017 were $63 million pre-tax ($49 million after-tax).  These costs consisted primarily of fees for legal, advisory and other professional services as well as amortization of the Bridge Facility fees.  If the Express Scripts acquisition is consummated, a significant portion of the costs related to that acquisition will not be deductible for federal income tax purposes.

 

Note 4 – Earnings Per Share

 

 

Basic and diluted earnings per share (“EPS”) were computed as follows:

 

 

 

Three Months Ended

 

 

 

March 31, 2018

 

March 31, 2017

 

(Shares in thousands, dollars in millions, except per
share amounts)

 

Basic

 

Effect of
Dilution

 

Diluted

 

Basic

 

Effect of
Dilution

 

Diluted

 

Shareholders’ net income

 

$

915

 

 

 

$

915

 

$

598

 

 

 

$

598

 

Shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average

 

242,179

 

 

 

242,179

 

255,680

 

 

 

255,680

 

Common stock equivalents

 

 

 

3,609

 

3,609

 

 

 

4,094

 

4,094

 

Total shares

 

242,179

 

3,609

 

245,788

 

255,680

 

4,094

 

259,774

 

EPS

 

$

3.78

 

$

(0.06)

 

$

3.72

 

$

2.34

 

$

(0.04)

 

$

2.30

 

 

The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months ended March 31, 2018 and 2017 because their effect was anti-dilutive.

 

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Three Months Ended
March 31,

 

(In millions)

 

2018

 

2017

 

Anti-dilutive options

 

0.9

 

2.5

 

 

The Company held approximately 52.9 million shares of common stock in Treasury as of March 31, 2018, and 39.9 million shares as of March 31, 2017.

 

Note 5 Debt

 

 

The outstanding amounts of debt and capital leases were as follows:

 

 

 

March 31,

 

December 31,

 

(In millions)

 

2018

 

2017

 

Short-term

 

 

 

 

 

Commercial paper

 

$

100

 

$

100

 

Current maturities of long-term debt

 

 

-

 

 

131

 

Other, including capital leases

 

10

 

9

 

Total short-term debt

 

$

110

 

$

240

 

Long-term

 

 

 

 

 

$250 million, 4.375% Notes due 2020

 

$

247

 

$

249

 

$300 million, 5.125% Notes due 2020

 

297

 

299

 

$78 million, 6.37% Notes due 2021

 

78

 

78

 

$300 million, 4.5% Notes due 2021

 

296

 

299

 

$750 million, 4% Notes due 2022

 

745

 

745

 

$100 million, 7.65% Notes due 2023

 

100

 

100

 

$17 million, 8.3% Notes due 2023

 

17

 

17

 

$900 million, 3.25% Notes due 2025

 

894

 

894

 

$600 million, 3.05% Notes due 2027

 

594

 

594

 

$259 million, 7.875% Debentures due 2027

 

258

 

258

 

$45 million, 8.3% Step Down Notes due 2033

 

45

 

45

 

$191 million, 6.15%  Notes due 2036

 

190

 

190

 

$121 million, 5.875% Notes due 2041

 

119

 

119

 

$317 million, 5.375% Notes due 2042

 

315

 

315

 

$1,000 million, 3.875% Notes due 2047

 

988

 

988

 

Other, including capital leases

 

8

 

9

 

Total long-term debt

 

$

5,191

 

$

5,199

 

 

Bridge Facility.  In March 2018, in connection with the proposed Merger, the Company and New Cigna entered into a commitment letter (the “Commitment Letter”) with Morgan Stanley Senior Funding, Inc., The Bank of Tokyo-Mitsubishi UFJ, Ltd and 21 additional banks, to provide a $26.7 billion 364-day senior unsecured bridge facility (the “Bridge Facility”)The Bridge Facility commitment will be reduced if the Company, New Cigna or, in some instances, any of their domestic subsidiaries obtains certain other debt financing, completes certain asset sales or certain equity issuances.  Concurrently with entry into the Term Loan Credit Agreement described below, the Bridge Facility commitment under the Commitment Letter was reduced to $23.7 billion.  The proceeds of the Bridge Facility may be used to finance the Merger, repay certain existing Express Scripts debt and pay related fees and expenses.

 

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The definitive documentation related to the Bridge Facility, if drawn upon at closing of the proposed Merger, will contain customary covenants and restrictions, including a financial covenant that the Company or New Cigna may not permit its leverage ratio – which is the ratio of total consolidated debt to total consolidated capitalization on the last day of each fiscal quarter for which financial statements are delivered (or required to be delivered) – to be greater than 60%.

 

The Company incurred approximately $140 million in fees upon entering into the Commitment Letter.  The Company paid $70 million during the first quarter of 2018 and expects to pay the remainder of the fees over the balance of 2018.  The fees were capitalized in other assets and will be amortized over the period the Bridge Facility is outstanding.  The Company recorded $20 million of amortization of the Bridge Facility fees during the three months ended March 31, 2018.

 

Revolving Credit Agreement.  On April 6, 2018, in connection with the proposed Merger, the Company and New Cigna entered into the Revolving Credit and Letter of Credit Agreement (the “Revolving Credit Agreement”), which matures on April 6, 2023 and is diversified among 23 banks.

 

Prior to the Merger, the Company can borrow up to $1.5 billion for general corporate purposes, of which up to $500 million is available for the issuance of letters of credit.  On and after the Merger, New Cigna can borrow up to $3.25 billion for general corporate purposes, of which up to $500 million is available for the issuance of letters of credit.  The Revolving Credit Agreement also includes an option to increase the facility amount by up to $500 million and an option to extend the termination date for additional one year periods, subject to the consent of the banks.

 

The Revolving Credit Agreement contains customary covenants and restrictions, including a financial covenant that the Company or New Cigna may not permit its leverage ratio to be greater than 50% prior to the Merger or 60% after the Merger.

 

Term Loan Credit Agreement.  On April 6, 2018, the Company and New Cigna entered into a Term Loan Credit Agreement (the “Term Loan Credit Agreement”), which is diversified among 26 banks.  The Term Loan Credit Agreement provides for a three-year unsecured term loan facility in aggregate principal amount of $3.0 billion, which will be available to finance the Merger, repay certain existing indebtedness of Express Scripts, and pay fees and expenses in connection with the Merger.

 

The Term Loan Credit Agreement contains customary covenants and restrictions, including a financial covenant that the Company, or after the Merger, New Cigna may not permit its leverage ratio to be greater than 60%.

 

Prior to the Merger, the Company is the borrower under the Bridge Facility, the Revolving Credit Agreement and the Term Loan Credit Agreement. On and after the Merger, New Cigna will be the borrower under each of these agreements. In certain circumstances, certain subsidiaries of the Company, or after the Merger, New Cigna will be required to guarantee the obligations of the Company or New Cigna, as applicable, under the Bridge Facility, Term Loan Credit Agreement and the Revolving Credit Agreement.

 

The Company was in compliance with its debt covenants as of March 31, 2018.

 

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Note 6 Global Health Care Medical Costs Payable

 

 

Medical costs payable for the Global Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not reported, including expected development on reported claims, those that have been reported but not yet paid (reported claims in process), and other medical care expenses and services payable that are primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities.  See Note 7 to the Consolidated Financial Statements in the Company’s 2017 Form 10-K for further information about the assumptions and estimates used to establish this liability.

 

Activity in medical costs payable was as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

March 31,

 

(In millions)

 

2018

 

2017

 

Beginning balance

 

$

2,719

 

$

2,532

 

Less: Reinsurance and other amounts recoverable

 

265

 

275

 

Beginning balance, net

 

2,454

 

2,257

 

Incurred costs related to:

 

 

 

 

 

Current year

 

5,447

 

5,125

 

Prior years

 

(130)

 

(176)

 

Total incurred

 

5,317

 

4,949

 

Paid costs related to:

 

 

 

 

 

Current year

 

3,423

 

3,183

 

Prior years

 

1,665

 

1,509

 

Total paid

 

5,088

 

4,692

 

Ending balance, net

 

2,683

 

2,514

 

Add: Reinsurance and other amounts recoverable

 

242

 

256

 

Ending balance

 

$

2,925

 

$

2,770

 

 

Reinsurance and other amounts recoverable in the above table includes amounts due from reinsurers and policyholders to cover incurred but not reported and pending claims for certain business where the Company administers the plan benefits but the right of offset does not exist.  See Note 8 for additional information on reinsurance.

 

The total of incurred but not reported liabilities plus expected development on reported claims, including reported claims in process, was $2.8 billion at March 31, 2018 and $2.6 billion at March 31, 2017.  The remaining balance in both periods reflects amounts due for physician incentives and other medical care expenses and services payable.

 

For the period ended March 31, incurred costs related to prior years were attributable to the following factors:

 

 

 

Three Months Ended

 

(Dollars in millions)

 

March 31, 2018

 

March 31, 2017

 

 

 

$

 

%(1)

 

$

 

%(2)

 

Actual completion factors

 

$

71

 

0.4

  %

$

78

 

0.4

  %

Medical cost trend

 

50

 

0.2

 

98

 

0.5

 

Other

 

9

 

-

 

-

 

-

 

Total favorable (unfavorable) variance

 

$

130

 

0.6

  %

$

176

 

0.9

  %

 

(1) Percentage of current year incurred costs as reported for the year ended December 31, 2017.

(2) Percentage of current year incurred costs as reported for the year ended December 31, 2016.

 

Incurred costs related to prior years in the table above, although adjusted through shareholders’ net income, do not directly correspond to an increase or decrease to shareholders’ net income.  The primary reason for this difference is that decreases to prior year incurred costs pertaining to the portion of the liability established for moderately adverse conditions are not considered as impacting shareholders’ net income if they are offset by increases in the current year provision for moderately adverse conditions.

 

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Favorable prior year development increased shareholders’ net income by $43 million for the three months ended March 31, 2018 compared with $61 million for the three months ended March 31, 2017.  This development was attributed to both medical cost trend and completion factors resulting from lower than expected utilization of medical services.

 

Note 7 — Liabilities for Unpaid Claims and Claim Expenses

 

 

The following information relates to unpaid claims and claim expense liabilities for short-duration insurance contracts other than those sold by the Global Health Care segment.  See Note 8 to the Consolidated Financial Statements in the Company’s 2017 Form 10-K for further information about the assumptions and estimates used to establish this liability.

 

The liability for unpaid claims and claim expenses by segment as of March 31 is as follows:

 

(In millions)

 

March 31, 2018

 

March 31, 2017

 

Group Disability and Life

 

$

4,549

 

$

4,384

 

Global Supplemental Benefits

 

492

 

425

 

Other Operations

 

174

 

197

 

Unpaid claims and claim expenses

 

$

5,215

 

$

5,006

 

 

Activity in the Group Disability and Life and the Global Supplemental Benefits segments’ liabilities for unpaid claims and claim expenses is presented in the following table.  Liabilities associated with Other Operations are excluded because they pertain to obligations for long-duration insurance contracts or, if short-duration, the liabilities have been fully reinsured.

 

 

 

Three Months Ended

 

(In millions)

 

March 31, 2018

 

March 31, 2017

 

Beginning balance

 

$

4,975

 

$

4,726

 

Less: Reinsurance

 

137

 

121

 

Beginning balance, net

 

4,838

 

4,605

 

Incurred claims related to:

 

 

 

 

 

Current year

 

1,230

 

1,148

 

Prior years:

 

 

 

 

 

Interest accretion

 

38

 

43

 

All other incurred

 

(46)

 

(64)

 

Total incurred

 

1,222

 

1,127

 

Paid claims related to:

 

 

 

 

 

Current year

 

430

 

371

 

Prior years

 

728

 

691

 

Total paid

 

1,158

 

1,062

 

Foreign currency

 

2

 

16

 

Ending balance, net

 

4,904

 

4,686

 

Add: Reinsurance

 

137

 

123

 

Ending balance

 

$

5,041

 

$

4,809

 

 

Reinsurance in the table above reflects amounts due from reinsurers related to unpaid claims liabilities.  The Company’s insurance subsidiaries enter into agreements with other companies primarily to limit losses from large exposures and to permit recovery of a portion of incurred losses.  See Note 8 for additional information on reinsurance.

 

The majority of the liability for unpaid claims and claim expenses is related to disability claims with long-tailed payouts.  Interest earned on assets backing these liabilities is an integral part of pricing and reserving.  Therefore, interest accreted on prior year balances is shown as a separate component of prior year incurred claims.  This interest is calculated by applying the average discount rate used in determining the liability balance to the average liability balance over the period.  The remaining prior year incurred claims amount primarily reflects updates to the Company’s liability estimates and variances between actual experience during the period relative to the assumptions and expectations reflected in determining the liability.  Assumptions reflect the Company’s expectations over the life of the book of business and will vary from actual experience in any period, both favorably and unfavorably, with variation in resolution rates being the most significant driver for the long-term disability business and variations in mortality and morbidity being the most significant factors for other business.  Favorable prior year incurred claims reported for the three months ended March 31, 2018 largely reflect favorable life loss ratio experience relative to expectations for claims incurred in 2017.  Favorable prior year incurred claims reported for the three months ended March 31, 2017 largely reflect favorable long-term disability resolution rate experience relative to expectations.

 

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Note 8 — 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 or assumed losses.  Reinsurance is also used in acquisition and disposition transactions when the underwriting company is not being acquired.  Because reinsurance does not relieve the originating insurer of liability, such liabilities must continue to be reported along with the related reinsurance recoverables.  The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of its credit risk.

 

Reinsurance Recoverables

 

The majority of the Company’s reinsurance recoverables resulted from acquisition and disposition transactions in which the underwriting company was not acquired.  Components of the Company’s reinsurance recoverables are presented below:

 

(In millions)

Line of Business

 

Reinsurer(s)

 

March 31,
2018

 

December 31,
2017

 

Collateral and Other Terms
at March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

Ongoing operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Health Care, Global Supplemental Benefits, Group Disability and Life, COLI

 

Various

 

$

446

 

$

454

 

Recoverables from approximately 85 reinsurers, used in the ordinary course of business.  Current balances range from less than $1 million up to $76 million.  Over 70% of the balance is from companies rated as investment grade by Standard & Poor’s, and 12% is secured by assets in trusts or letters of credit. 

 

 

 

 

 

 

 

 

 

 

 

Total recoverables related to ongoing operations

 

 

 

446

 

454

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition, disposition or runoff activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individual Life and Annuity (sold in 1998)

 

Lincoln National Life and Lincoln Life & Annuity of New York

 

3,382

 

3,436

 

Both companies’ ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.

 

 

 

 

 

 

 

 

 

 

 

GMDB

 

Berkshire

 

915

 

928

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

35

 

34

 

100% secured by assets in a trust or letters of credit.

 

 

 

 

 

 

 

 

 

 

 

Retirement Benefits Business (sold in 2004)

 

Prudential Retirement Insurance and Annuity

 

832

 

850

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Supplemental Benefits Business (2012 acquisition)

 

Great American Life

 

277

 

283

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Other run-off reinsurance

 

Various

 

58

 

61

 

100% secured by assets in trusts.

 

 

 

 

 

 

 

 

 

 

 

Total recoverables related to acquisition, disposition or runoff activities

 

 

 

5,499

 

5,592

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total reinsurance recoverables

 

 

 

$

5,945

 

$

6,046

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.  The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable.

 

Effects of Reinsurance

 

In the Company’s Consolidated Statements of Income, premiums were reported net of amounts ceded to reinsurers and Global Health Care medical costs and other benefit expenses were reported net of reinsurance recoveries in the following amounts:

 

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Three Months Ended

 

(In millions)

 

March 31, 2018

 

March 31, 2017

 

Ceded premiums

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

37

 

$

39

 

Other

 

98

 

81

 

Total ceded premiums

 

$

135

 

$

120

 

Reinsurance recoveries

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

57

 

$

70

 

Other

 

47

 

29

 

Total reinsurance recoveries

 

$

104

 

$

99

 

 

Effective Exit of GMDB and GMIB Business

 

In 2013, the Company entered into an agreement with Berkshire to effectively exit the GMDB and GMIB business via a reinsurance transaction.  Berkshire reinsured 100% of the Company’s future claim payments of this business, net of other reinsurance arrangements existing at that time.  The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.4 billion remaining as of March 31, 2018.

 

GMDB is accounted for as reinsurance and GMIB assets and liabilities are reported as derivatives at fair value as discussed below.  GMIB assets are reported in other assets, including intangibles, and GMIB liabilities are reported in accounts payable, accrued expenses and other liabilities.

 

GMDB

 

The Company estimates the gross liability and reinsurance recoverable with an internal model based on the Company’s experience and future expectations over an extended period, consistent with the long-term nature of this product.  As a result of the reinsurance transaction, reserve increases have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB asset presented below).  The ending net retained reserve covers ongoing administrative expenses, as well as minor claim exposure retained by the Company.

 

The following table presents the account value, net amount at risk and number of underlying contractholders for guarantees assumed by the Company in the event of death.  The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date.  Unless the Berkshire reinsurance limit is exceeded, the Company should be reimbursed in full for these payments.

 

(Dollars in millions, excludes impact of reinsurance ceded)

 

March 31, 2018

 

December 31, 2017

 

Account value

 

$

9,762

 

$

10,109

 

Net amount at risk

 

$

2,120

 

$

2,112

 

Number of contractholders

 

240,000

 

245,000

 

 

GMIB

 

In this business, the Company reinsured contracts with issuers of GMIB products.  The Company’s exposure represents the excess of a contractually guaranteed amount over the level of variable annuity account values.  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 that must occur within 30 days of a policy anniversary after the appropriate waiting period.  The Company has purchased retrocessional coverage (“GMIB assets”) for these contracts.

 

The Company reports GMIB liabilities and assets as derivatives at fair value because the cash flows of these 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.

 

As of March 31, 2018 and December 31, 2017, there were three reinsurers for GMIB as follows:

 

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Table of Contents

 

(In millions)

Line of Business

 

Reinsurer

 

March 31,
2018

 

December 31,
2017

 

Collateral and Other Terms
at March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

GMIB

 

Berkshire

 

  $

337

 

  $

359

 

100% secured by assets in a trust.

 

 

 

Sun Life Assurance Company of Canada

 

199

 

221

 

 

 

 

 

Liberty Re (Bermuda) Ltd.

 

181

 

197

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total GMIB recoverables reported in other assets

 

  $

717

 

  $

777

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assumptions used in fair value measurement.  GMIB assets and liabilities are established using capital market assumptions (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments) and assumptions related to future annuitant behavior (including mortality, lapse, and annuity election rates).  As assumptions related to future annuitant behavior are largely unobservable, the Company classifies GMIB assets and liabilities in Level 3 in the fair value hierarchy presented in Note 9.

 

The only assumption expected to impact future shareholders’ net income is non-performance risk.  The non-performance risk adjustment reflects a market participant’s view of nonpayment risk by adding an additional spread to the discount rate in the fair value calculation of both (a) the GMIB liabilities to be paid by the Company, and (b) the GMIB assets to be paid by the reinsurers, after considering collateral.

 

The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities.  Significant decreases in assumed lapse rates or spreads used to calculate non-performance risk of the Company, or significant increases in assumed annuity election rates or spreads used to calculate the non-performance risk of the reinsurers, would result in higher fair value measurements.  A change in one of these assumptions is not necessarily accompanied by a change in another assumption.

 

GMIB guarantees.  Future payments are not fixed and determinable under the terms of these contracts.  Accordingly, the Company calculated the exposure, without considering any reinsurance coverage, using the following hypothetical assumptions:

 

·                  no annuitants surrendered their accounts;

·                  all annuitants lived to elect their benefit;

·                  all annuitants elected to receive their benefit on the next available date (2018 through 2022); and

·                  all underlying mutual fund investment values remained at the March 31, 2018 value of $798 million with no future returns.

 

The Company has reinsurance coverage in place that covers the exposures on these contracts.  Using these hypothetical assumptions, the GMIB exposure of $568 million is lower than the recorded liability for GMIB calculated using fair value assumptions.

 

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Note 9 — Fair Value Measurements

 

 

The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, certain equity securities, short-term investments and derivatives.  Other financial instruments are measured at fair value only 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.

 

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 estimates fair values using prices from third parties or internal pricing methods.  Fair value estimates received from third-party pricing services are based on reported trade activity and quoted market prices when available, and other market information that a market participant may use to estimate fair value.  The internal pricing methods are performed by the Company’s investment professionals and generally involve using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality, as well as other qualitative factors.  In instances where there is little or no market activity for the same or similar instruments, fair value is estimated 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 that becomes significant with increasingly complex instruments or pricing models.

 

The Company is responsible for determining fair value, as well as for assigning the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs.  The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates.  The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value.  The controls executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations.  The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates.  The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations.  Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls.  This on-site review includes a walk-through of inputs for a sample of securities held across various asset types to validate the documented pricing process.

 

Financial Assets and Financial Liabilities Carried at Fair Value

 

The following table provides information as of March 31, 2018 and December 31, 2017 about the Company’s financial assets and liabilities carried at fair value.  Separate account assets that are also recorded at fair value on the Company’s Consolidated Balance Sheets are reported separately in the Separate Accounts section as gains and losses related to these assets generally accrue directly to policyholders.

 

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Table of Contents

 

 

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable Inputs
(Level 3)

 

Total

 

(In millions)

 

As of
March 31,
2018

 

As of
December 31,
2017

 

As of
March 31,
2018

 

As of
December 31,
2017

 

As of
March 31,
2018

 

As of
December 31,
2017

 

As of
March 31,
2018

 

As of
December 31,
2017

 

Financial assets at fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal government and agency

 

$

356

 

$

253

 

$

512

 

$

526

 

$

-

 

$

-

 

$

868

 

$

779

 

State and local government

 

-

 

-

 

1,129

 

1,287

 

-

 

-

 

1,129

 

1,287

 

Foreign government

 

-

 

-

 

2,454

 

2,442

 

45

 

45

 

2,499

 

2,487

 

Corporate

 

-

 

-

 

18,802

 

17,658

 

371

 

430

 

19,173

 

18,088

 

Mortgage and other asset-backed

 

-

 

-

 

362

 

343

 

147

 

154

 

509

 

497

 

Total fixed maturities

 

356

 

253

 

23,259

 

22,256

 

563

 

629

 

24,178

 

23,138

 

Equity securities (1)

 

399

 

412

 

69

 

73

 

33

 

103

 

501

 

588

 

Subtotal

 

755

 

665

 

23,328

 

22,329

 

596

 

732

 

24,679

 

23,726

 

Short-term investments

 

-

 

-

 

245

 

199

 

-

 

-

 

245

 

199

 

GMIB assets

 

-

 

-

 

-

 

-

 

717

 

777

 

717

 

777

 

Other derivative assets

 

-

 

-

 

2

 

2

 

-

 

-

 

2

 

2

 

Total financial assets at fair value, excluding separate accounts and real estate funds

 

$

755

 

$

665

 

$

23,575

 

$

22,530

 

$

1,313

 

$

1,509

 

$

25,643

 

$

24,704

 

Real estate funds priced at NAV as a practical expedient (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

273

 

N/A

 

Financial liabilities at fair value