Edgar Filing: CIGNA CORP

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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 June 30, 2014

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
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, 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.
Large accelerated filer R	Accelerated filer o	Non-accelerated filer o	Smaller Reporting Company o
· whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).				o	R

As of July 15, 2014, 263,817,071 shares of the issuer’s common stock were outstanding.

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Cigna Corporation

INDEX


PART I	FINANCIAL INFORMATION	Page

Item 1.	Financial Statements (Unaudited)	1
	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	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64
Item 4.	Controls and Procedures	65


PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	66
Item 1.A.	Risk Factors	67
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	68
Item 4.	Mine Safety Disclosures	68
Item 6.	Exhibits	69
SIGNATURE		70
INDEX TO EXHIBITS		E-1

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

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Part I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

Cigna Corporation

Consolidated Statements of Income

	Unaudited				Unaudited
	Three Months Ended				Six Months Ended
	June 30,				June 30,
(In millions, except per share amounts)	2014		2013		2014		2013
Revenues
Premiums and fees	$	7,758	$	7,172	$	15,374	$	14,486
Net investment income	294		289		571		576
Mail order pharmacy revenues	547		437		1,042		862
Other revenues	69		56		135		74
Realized investment gains (losses):
Other-than-temporary impairments on fixed maturities	(1)		(8)		(1)		(8)
Other realized investment gains, net	66		34		108		173
Total realized investment gains, net	65		26		107		165
Total revenues	8,733		7,980		17,229		16,163
Benefits and Expenses
Global Health Care medical claims expense	4,219		3,904		8,250		7,951
Other benefit expenses	1,100		997		2,266		2,859
Mail order pharmacy costs	469		362		883		706
Other operating expenses	2,044		1,950		4,076		3,806
Total benefits and expenses	7,832		7,213		15,475		15,322
Income before Income Taxes	901		767		1,754		841
Income taxes:
Current	329		181		639		80
Deferred	-		80		14		196
Total income taxes	329		261		653		276
Net Income	572		506		1,101		565
Less: Net Income (Loss) Attributable to Noncontrolling Interests	(1)		1		-		3
Shareholders’ Net Income	$	573	$	505	$	1,101	$	562
Shareholders’ Net Income Per Share:
Basic	$	2.16	$	1.79	$	4.11	$	1.99
Diluted	$	2.12	$	1.76	$	4.05	$	1.95
Dividends Declared Per Share	$	-	$	-	$	0.04	$	0.04

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

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Cigna Corporation

Consolidated Statements of Comprehensive Income

	Unaudited				Unaudited
	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2014		2013		2014		2013
Shareholders’ net income	$	573	$	505	$	1,101	$	562
Shareholders’ other comprehensive income (loss):
Net unrealized appreciation (depreciation) on securities:
Fixed maturities	103		(269)		190		(341)
Equity securities	-		-		(1)		2
Net unrealized appreciation (depreciation), on securities	103		(269)		189		(339)
Net unrealized appreciation, derivatives	-		6		-		9
Net translation of foreign currencies	46		(16)		35		(74)
Postretirement benefits liability adjustment	11		21		23		61
Shareholders’ other comprehensive income (loss)	160		(258)		247		(343)
Shareholders’ comprehensive income	733		247		1,348		219
Comprehensive income attributable to noncontrolling interests:
Net income attributable to redeemable noncontrolling interests	2		1		5		3
Net (loss) attributable to other noncontrolling interest	(3)		-		(5)		-
Other comprehensive income (loss) attributable to redeemable noncontrolling interests	3		(6)		-		(9)
Other comprehensive income attributable to other noncontrolling interest	-		-		1		-
Total comprehensive income	$	735	$	242	$	1,349	$	213

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

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Cigna Corporation

Consolidated Balance Sheets

	Unaudited
	As of				As of
(In millions, except per share amounts)	June 30, 2014				December 31, 2013
Assets
Investments:
Fixed maturities, at fair value (amortized cost, $16,598; $15,273)			$	18,321			$	16,486
Equity securities, at fair value (cost, $136; $146)			131				141
Commercial mortgage loans			2,217				2,252
Policy loans			1,453				1,485
Real estate			62				97
Other long-term investments			1,336				1,273
Short-term investments			232				631
Total investments			23,752				22,365
Cash and cash equivalents			1,967				2,795
Accrued investment income			245				247
Premiums, accounts and notes receivable, net			2,657				1,991
Reinsurance recoverables			7,132				7,299
Deferred policy acquisition costs			1,510				1,395
Property and equipment			1,498				1,464
Deferred tax assets, net			-				92
Goodwill			6,033				6,029
Other assets, including other intangibles			2,492				2,407
Separate account assets			8,643				8,252
Total assets			$	55,929			$	54,336
Liabilities
Contractholder deposit funds			$	8,459			$	8,470
Future policy benefits			9,583				9,306
Unpaid claims and claim expenses			4,389				4,298
Global Health Care medical claims payable			2,276				2,050
Unearned premiums and fees			625				580
Total insurance and contractholder liabilities			25,332				24,704
Accounts payable, accrued expenses and other liabilities			5,726				5,456
Short-term debt			121				233
Long-term debt			5,022				5,014
Deferred tax liabilities, net			34				-
Separate account liabilities			8,643				8,252
Total liabilities			44,878				43,659
Contingencies — Note 16
Redeemable noncontrolling interests			99				96
Shareholders’ Equity
Common stock (par value per share, $0.25; shares issued, 366; authorized, 600)			92				92
Additional paid-in capital			3,405				3,356
Net unrealized appreciation, fixed maturities	$	663			$	473
Net unrealized appreciation, equity securities	3				4
Net unrealized depreciation, derivatives	(19)				(19)
Net translation of foreign currencies	117				82
Postretirement benefits liability adjustment	(1,037)				(1,060)
Accumulated other comprehensive loss			(273)				(520)
Retained earnings			14,677				13,676
Less treasury stock, at cost			(6,964)				(6,037)
Total shareholders’ equity			10,937				10,567
Noncontrolling interest			15				14
Total equity			10,952				10,581
Total liabilities and equity			$	55,929			$	54,336
Shareholders’ Equity Per Share			$	41.32			$	38.35

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

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Cigna Corporation

Consolidated Statements of Changes in Total Equity

					Accumulated												Redeemable
Unaudited			Additional		Other								Non-				Non-
For the three months ended June 30, 2014	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interest		Equity		Interests

Balance at April 1, 2014	$	92	$	3,392	$	(433)	$	14,136	$	(6,631)	$	10,556	$	13	$	10,569	$	96
Effect of issuing stock for employee benefit plans			13				(32)		81		62				62
Other comprehensive income					160						160		-		160		3
Net income (loss)							573				573		(3)		570		2
Repurchase of common stock									(414)		(414)				(414)
Capital contribution by noncontrolling interest													5		5		2
Distribution to redeemable noncontrolling interest																	(4)
Balance at June 30, 2014	$	92	$	3,405	$	(273)	$	14,677	$	(6,964)	$	10,937	$	15	$	10,952	$	99

					Accumulated												Redeemable
			Additional		Other								Non-				Non-
For the three months ended June 30, 2013	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interest		Equity		Interest

Balance at April 1, 2013	$	92	$	3,305	$	(756)	$	12,328	$	(5,309)	$	9,660	$	-	$	9,660	$	113
Effect of issuing stock for employee benefit plans			21				(27)		81		75				75
Other comprehensive loss					(258)						(258)				(258)		(6)
Net income							505				505				505		1
Repurchase of common stock									(207)		(207)				(207)
Distribution to redeemable noncontrolling interest																	(7)
Balance at June 30, 2013	$	92	$	3,326	$	(1,014)	$	12,806	$	(5,435)	$	9,775	$	-	$	9,775	$	101

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

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Cigna Corporation

Consolidated Statements of Changes in Total Equity

					Accumulated												Redeemable
Unaudited			Additional		Other								Non-				Non-
For the six months ended June 30, 2014	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interest		Equity		Interests

Balance at January 1, 2014	$	92	$	3,356	$	(520)	$	13,676	$	(6,037)	$	10,567	$	14	$	10,581	$	96
Effect of issuing stock for employee benefit plans			49				(89)		130		90				90
Other comprehensive income					247						247		1		248		-
Net income (loss)							1,101				1,101		(5)		1,096		5
Common dividends declared (per share: $0.04)							(11)				(11)				(11)
Repurchase of common stock									(1,057)		(1,057)				(1,057)
Capital contribution by noncontrolling interest													5		5		2
Distribution to redeemable non-controlling interest																	(4)
Balance at June 30, 2014	$	92	$	3,405	$	(273)	$	14,677	$	(6,964)	$	10,937	$	15	$	10,952	$	99

					Accumulated												Redeemable
			Additional		Other								Non-				Non-
For the six months ended June 30, 2013	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interest		Equity		Interest

Balance at January 1, 2013	$	92	$	3,295	$	(671)	$	12,330	$	(5,277)	$	9,769	$	-	$	9,769	$	114
Effect of issuing stock for employee benefit plans			31				(75)		146		102				102
Other comprehensive loss					(343)						(343)				(343)		(9)
Net income							562				562				562		3
Common dividends declared (per share: $0.04)							(11)				(11)				(11)
Repurchase of common stock									(304)		(304)				(304)
Distribution to redeemable non-controlling interest																	(7)
Balance at June 30, 2013	$	92	$	3,326	$	(1,014)	$	12,806	$	(5,435)	$	9,775	$	-	$	9,775	$	101

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

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Cigna Corporation

Consolidated Statements of Cash Flows

	Unaudited
	Six Months Ended June 30,
*(In millions)*	2014		2013
Cash Flows from Operating Activities
Net income	$	1,101	$	565
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	289		299
Realized investment gains	(107)		(165)
Deferred income taxes	14		196
Gains on sale of businesses	(7)		(8)
Net changes in assets and liabilities, net of non-operating effects:
Premiums, accounts and notes receivable	(660)		(192)
Reinsurance recoverables	67		356
Deferred policy acquisition costs	(100)		(140)
Other assets	(98)		251
Insurance liabilities	359		779
Accounts payable, accrued expenses and other liabilities	78		(359)
Current income taxes	100		(89)
Cash used to effectively exit run-off reinsurance business	-		(2,196)
Other, net	(34)		(20)
Net cash provided by / (used in) operating activities	1,002		(723)
Cash Flows from Investing Activities
Proceeds from investments sold:
Fixed maturities	476		1,269
Equity securities	34		3
Other (primarily short-term and other long-term investments)	1,404		411
Investment maturities and repayments:
Fixed maturities	898		821
Equity securities	-		18
Commercial mortgage loans	214		298
Investments purchased or originated:
Fixed maturities	(2,575)		(914)
Equity securities	(8)		(28)
Commercial mortgage loans	(183)		(22)
Other (primarily short-term and other long-term investments)	(868)		(460)
Property and equipment purchases	(236)		(209)
Other, net	12		(40)
Net cash (used in) / provided by investing activities	(832)		1,147
Cash Flows from Financing Activities
Deposits and interest credited to contractholder deposit funds	790		738
Withdrawals and benefit payments from contractholder deposit funds	(758)		(669)
Change in cash overdraft position	15		29
Net change in short-term debt	(96)		(48)
Repurchase of common stock	(1,029)		(277)
Issuance of common stock	80		91
Common dividends paid	(11)		(11)
Other, net	2		(7)
Net cash used in financing activities	(1,007)		(154)
Effect of foreign currency rate changes on cash and cash equivalents	9		(39)
Net (decrease) / increase in cash and cash equivalents	(828)		231
Cash and cash equivalents, January 1,	2,795		2,978
Cash and cash equivalents, June 30,	$	1,967	$	3,209
Supplemental Disclosure of Cash Information:
Income taxes paid, net of refunds	$	514	$	154
Interest paid	$	132	$	130

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

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CIGNA CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 — Basis of Presentation

Cigna Corporation and its subsidiaries (either individually or collectively referred to as “Cigna”, “the Company”, “we”, or “our”) is a global health services organization with a mission to help its customers improve their health, well-being and sense of security. Its insurance subsidiaries are major providers of medical, dental, disability, life and accident insurance and related products and services, the majority of which are offered through employers and other groups (e.g. governmental and non-governmental organizations, unions and associations). Cigna also offers Medicare and Medicaid products and health, life and accident insurance coverages primarily to individuals in the U.S. and selected international markets. In addition to its ongoing operations described above, Cigna also has certain run-off operations.

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 2013 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.

Beginning in the first quarter of 2014, the Company combined the results of its run-off reinsurance business with Other Operations for segment reporting purposes. Prior year information has been conformed to the current year presentation. See Note 15 for additional information.

Note 2 — Recent Accounting Changes

Accounting for Health Care Reform’s Risk Mitigation Programs. Beginning in 2014, as prescribed by the Patient Protection and Affordable Care Act (referred to as “Health Care Reform”), three programs went into effect to reduce the risk for participating health insurance companies selling coverage on the public exchanges.

· A three-year (2014-2016) reinsurance program is designed to provide reimbursement to insurers for high cost individual business sold on or off the public exchanges. The reinsurance entity established by the U.S. Department of Health and Human Services (“HHS”) is funded by a per-customer reinsurance fee assessed on all commercial medical plans, including self-insured group health plans. Only non-grandfathered individual plans are eligible for recoveries if claims exceed a specified threshold, up to a reinsurance cap. Reinsurance contributions associated with non-grandfathered individual plans are reported as a reduction in premium revenue, and estimated reinsurance recoveries are established with an offsetting reduction in Global Health Care medical claims expense. Reinsurance fee contributions for other insured business are reported in other operating expenses. The Company currently does not administer reinsurance fee contributions on behalf of its self-insured employer clients.

· A permanent risk adjustment program reallocates funds from insurers with lower risk populations to insurers with higher risk populations based on the relative risk scores of participants in non-grandfathered plans in the individual and small group markets, both on and off the exchanges. Based on the risk of our members compared to the risk of other members in the same state and market, considering data obtained from industry studies, we estimate our year-to-date risk adjustment. The Company records a risk adjustment receivable or payable, with an offsetting adjustment to premium revenue when the amounts are reasonably estimable and collection is reasonably assured.

· A three year (2014-2016) risk corridor program is designed to limit insurer gains and losses by comparing allowable medical costs to a target amount as defined by HHS. This program applies to individual and small group qualified health plans,

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operating on and off the exchanges. Variances from the target amount exceeding certain thresholds may result in amounts due to or due from HHS. The Company records a risk corridor receivable or payable as an adjustment to premium revenue based on our year-to-date experience when the amounts are reasonably estimable and collection is reasonably assured.

Revenue from Contracts with Customers (Accounting Standards Update (“ASU”) 2014-09). In May 2014, the Financial Accounting Standards Board (“FASB”) issued new revenue recognition guidance that will apply to various contracts with customers to provide goods or services, including the Company’s non-insurance, administrative services contracts. It will not apply to certain contracts within the scope of other GAAP, such as insurance contracts. This new guidance introduces a model that requires companies to estimate and allocate the expected contract revenue among distinct goods or services in the contract based on relative standalone selling prices. Revenue is recognized as goods or services are delivered. This new method replaces the current GAAP approach of recognizing revenue that is fixed and determinable primarily based on contract terms. In addition, extensive new disclosures will be required including the presentation of additional categories of revenues and information about related contract assets and liabilities. This new guidance must be implemented on January 1, 2017; early adoption is not permitted. The Company may choose to adopt these changes through retrospective restatement with or without using certain practical expedients or with a cumulative effect adjustment on adoption. The Company is currently evaluating these new requirements for its noninsurance customer contracts to determine the method of implementation and any resulting estimated effects on the financial statements.

Fees Paid to the Federal Government by Health Insurers (ASU 2011-06). Effective January 1, 2014, the Company adopted the FASB’s accounting guidance for the health insurance industry assessment (the “fee”) mandated by Health Care Reform. This non-deductible fee is being levied based on a ratio of an insurer’s net health insurance premiums written for the previous calendar year compared to the U.S. health insurance industry total. Based on a preliminary assessment from the Internal Revenue Service for the 2014 fee, the Company adjusted its liability reported in accounts payable, accrued expenses and other liabilities to $245 million during the second quarter of 2014. The corresponding deferred cost, recorded in other assets, including other intangibles was also adjusted. Through June 30, 2014, $122 million of the deferred cost was recognized in other operating expenses; the remainder will be recognized on a straight-line basis over the balance of 2014. The Company expects to be notified of and pay the final 2014 assessment in the third quarter.

Investment Company Accounting (ASU 2013-08). Effective January 1, 2014, the Company adopted FASB’s amended accounting guidance to change the criteria for reporting as an investment company, clarify the fair value measurement used by an investment company and require additional disclosures. This guidance also confirms that parent company accounting for an investment company should reflect fair value accounting. While this guidance applies to certain of the Company’s security and real estate partnership investments, its adoption did not have a material impact on the Company’s financial statements.

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“AOCI”) (ASU 2013-02). Effective January 1, 2013, the Company adopted new requirements to disclose the effect of items reclassified out of AOCI into net income for each individual line item impacted in the statement of income. See Note 13 for the Company’s disclosures.

Disclosures about Offsetting Assets and Liabilities (ASU 2011-11). The FASB’s new requirements to disclose information related to certain investments on both a gross and net basis became effective January 1, 2013. The Company had no transactions or arrangements subject to these new disclosure requirements.

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Note 3 — Earnings Per Share (“EPS”)

Basic and diluted earnings per share were computed as follows:

			Effect of
(Dollars in millions, except per share amounts)	Basic		Dilution		Diluted
Three Months Ended June 30,
2014
Shareholders’ net income	$	573			$	573
Shares (in thousands):
Weighted average	265,377				265,377
Common stock equivalents			4,544		4,544
Total shares	265,377		4,544		269,921
EPS	$	2.16	$	(0.04)	$	2.12
2013
Shareholders’ net income	$	505			$	505
Shares (in thousands):
Weighted average	282,043				282,043
Common stock equivalents			5,043		5,043
Total shares	282,043		5,043		287,086
EPS	$	1.79	$	(0.03)	$	1.76

			Effect of
(Dollars in millions, except per share amounts)	Basic		Dilution		Diluted
Six Months Ended June 30,
2014
Shareholders’ net income	$	1,101			$	1,101
Shares (in thousands):
Weighted average	267,665				267,665
Common stock equivalents			4,516		4,516
Total shares	267,665		4,516		272,181
EPS	$	4.11	$	(0.06)	$	4.05
2013
Shareholders’ net income	$	562			$	562
Shares (in thousands):
Weighted average	282,919				282,919
Common stock equivalents			5,248		5,248
Total shares	282,919		5,248		288,167
EPS	$	1.99	$	(0.04)	$	1.95

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The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three and six months ended June 30, 2014 and 2013 because their effect was anti-dilutive.

	Three Months Ended		Six Months Ended
	June 30,		June 30,
(In millions)	2014	2013	2014	2013
Antidilutive options	2.0	1.8	2.0	1.8

The Company held 101,424,330 shares of common stock in Treasury as of June 30, 2014, and 82,496,367 shares as of June 30, 2013.

Note 4 — Global Health Care Medical Claims Payable

Medical claims payable for the Global Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not yet reported, those that have been reported but not yet paid (reported claims in process), and other medical expenses payable that is primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities, as follows:

	June 30,		December 31,
(In millions)	2014		2013
Incurred but not yet reported	$	1,842	$	1,615
Reported claims in process	310		355
Physician incentives and other medical expense payable	124		80
Medical claims payable	$	2,276	$	2,050

Activity in medical claims payable was as follows:

	For the period ended
	June 30,		December 31,
(In millions)	2014		2013
Balance at January 1,	$	2,050	$	1,856
Less: Reinsurance and other amounts recoverable	194		242
Balance at January 1, net	1,856		1,614

Incurred claims related to:
Current year	8,390		16,049
Prior years	(140)		(182)
Total incurred	8,250		15,867
Paid claims related to:
Current year	6,606		14,267
Prior years	1,469		1,358
Total paid	8,075		15,625
Ending Balance, net	2,031		1,856
Add: Reinsurance and other amounts recoverable	245		194
Ending Balance	$	2,276	$	2,050

Reinsurance and other amounts recoverable includes 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 5 for additional information on reinsurance. For the six months ended June 30, 2014, actual experience differed from the Company’s key assumptions resulting in favorable incurred claims related to prior years’ medical claims payable of $140 million, or 0.9% of the current year incurred claims as reported for the year ended December 31, 2013. Actual completion factors accounted for $51 million, or 0.3% of the favorability while actual medical cost trend resulted in the remaining $89 million, or 0.6%.

For the year ended December 31, 2013, actual experience differed from the Company’s key assumptions, resulting in favorable incurred claims related to prior years’ medical claims payable of $182 million, or 1.3% of the current year incurred claims as reported for the year ended December 31, 2012. Actual completion factors accounted for $74 million, or 0.5% of favorability while actual medical cost trend resulted in the remaining $108 million, or 0.7%.

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The impact of prior year development on shareholders’ net income was $46 million for the six months ended June 30, 2014 compared with $68 million for the six months ended June 30, 2013. The favorable effect of prior year development for both years primarily reflects low utilization of medical services. 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, the Company consistently recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice that require 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 relates to a release of the prior year’s provision for moderately adverse conditions, the Company does not consider that amount as impacting shareholders’ net income to the extent that it is offset by an increase determined appropriate to address moderately adverse conditions for the current year incurred claims.

Second, as a result of the MLR provisions of Health Care Reform, changes in medical claim estimates due to prior year development may be offset by a change in the MLR rebate accrual.

Third, changes in reserves for the Company’s retrospectively experience-rated business for accounts in surplus do not usually impact shareholders’ net income because such amounts are generally offset by a change in the liability to the policyholder. An account is in surplus when the accumulated premium received exceeds the accumulated medical costs and administrative charges, including profit charges. For additional information regarding the Company’s retrospectively experience-rated business, see page 3 of the Company’s 2013 Form 10-K.

The determination of liabilities for the Global Health Care medical claims payable requires the Company to make critical accounting estimates. See Note 2(N) to the Consolidated Financial Statements in the Company’s 2013 Form 10-K.

Note 5 — 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. 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.

Effective Exit of GMDB and GMIB Business

On February 4, 2013, the Company entered into an agreement with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) to effectively exit the GMDB and GMIB business via a reinsurance transaction. Berkshire reinsured 100% of the Company’s future claim payments in these businesses, net of retrocessional arrangements existing at that time. The reinsurance agreement is subject to an overall limit of approximately $3.8 billion.

This transaction resulted in an after-tax charge to shareholders’ net income in the first quarter of 2013 of $507 million ($781 million pre-tax reported as follows: $727 million in other benefits expense; $45 million in GMIB fair value loss; and $9 million in other operating expenses). The payment to Berkshire under the agreement was $2.2 billion and was funded from the sale of investment assets, tax benefits related to the transaction and available parent cash.

Because this effective exit was accomplished via a reinsurance contract, the amounts related to the reinsured GMDB and GMIB contracts cannot be netted, so the gross assets and liabilities must continue to be measured and reported. The following disclosures provide further context to the methods and assumptions used to determine these assets and liabilities.

GMDB

The Company estimates this liability 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. Because the product is premium deficient, the Company records increases to the reserve if it is inadequate based on the model. Prior to the reinsurance transaction with Berkshire, any such reserve increases were recorded as a charge to shareholders’ net income. Reserve increases after the reinsurance transaction are expected to have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB assets).

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The Company’s dynamic hedge programs were discontinued during the first quarter of 2013 due to the Berkshire reinsurance transaction. These hedge programs generated losses (included in other revenues) of $32 million for the six months ended June 30, 2013.

Activity in the future policy benefit reserve for the GMDB business was as follows:

	For the period ended
	June 30,		December 31,
(In millions)	2014		2013
Balance at January 1	$	1,396	$	1,090
Add: Unpaid claims	18		24
Less: Reinsurance and other amounts recoverable	1,317		42
Balance at January 1, net	97		1,072
Add: Incurred benefits	2		699
Less: Paid benefits (including the $1,647 payment in 2013 for the Berkshire reinsurance transaction)	-		1,674
Ending balance, net	99		97
Less: Unpaid claims	19		18
Add: Reinsurance and other amounts recoverable	1,234		1,317
Ending balance	$	1,314	$	1,396

Benefits paid and incurred are net of ceded amounts. The ending net retained reserve is to cover ongoing administrative expenses, as well as claims retained by the Company.

The death benefit coverage in force for GMDB contracts assumed by the Company was $2.8 billion as of June 30, 2014 and $3.0 billion as of December 31, 2013 assuming no reinsurance. The death benefit coverage in force is the amount the Company would have to pay if all contract holders (approximately 373,000 as of June 30, 2014 and 390,000 as of December 31, 2013) died as of the specified date. Unless the Berkshire reinsurance limit is exceeded, the Company would be reimbursed in full for these payments. The aggregate value of the underlying mutual fund investments for these GMDB contracts was $13.8 billion as of June 30, 2014 and $14.1 billion as of December 31, 2013.

GMIB

As discussed further in Note 7, because GMIB contracts are without significant life insurance risk, they are not accounted for as insurance products. Instead, the Company reports GMIB liabilities and assets as derivatives at fair value. The GMIB assets are classified in other assets, including other intangibles, and the GMIB liabilities are classified in accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheet. Disclosures related to fair value are included in Note 7 and derivatives are further described in Note 9.

GMIB assets included $401 million as of June 30, 2014 and $352 million as of December 31, 2013 from Berkshire, and were 100% secured by assets in a trust. GMIB assets also included $462 million as of June 30, 2014 and $399 million as of December 31, 2013 from two other retrocessionaires, and 40% were secured by assets in a trust.

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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				Six Months Ended
	June 30,				June 30,
(In millions)	2014		2013		2014		2013
Ceded premiums and fees
Individual life insurance and annuity business sold	$	44	$	45	$	89	$	91
Other	84		104		180		183
Total	$	128	$	149	$	269	$	274
Reinsurance recoveries
Individual life insurance and annuity business sold	$	69	$	94	$	168	$	182
Other	88		68		170		(194)
Total	$	157	$	162	$	338	$	(12)

As noted in the GMDB section above, recoveries for the six months ended June 30, 2013 are net of a decrease in reinsurance recoverables from a change in the growth rate assumption, due to discontinuing the hedge programs after the reinsurance transaction with Berkshire.

Reinsurance Recoverables

Components of the Company’s reinsurance recoverables are presented below:

(In millions)

Line of Business	Reinsurer(s)	June 30, 2014		December 31, 2013		Collateral and Other Terms at June 30, 2014

GMDB	Berkshire	$	1,195	$	1,276	100% secured by assets in a trust.

	Other	40		41		97% secured by assets in a trust or letter of credit.

Individual Life and Annuity (sold)	Lincoln National Life and Lincoln Life & Annuity of New York	3,855		3,905		Both companies’ ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.

Retirement Benefits Business (sold)	Prudential Retirement Insurance and Annuity	1,148		1,200		100% secured by assets in a trust.

Supplemental Benefits Business	Great American Life	344		363		100% secured by assets in a trust.

Global Health Care, Global Supplemental Benefits, Group Disability and Life	Various	444		407		Recoverables from more than 80 reinsurers used in the ordinary course of business. Balances range from less than $1 million up to $70 million, with 12% secured by assets in trusts or letters of credit.