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, 2016
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 |
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06-1059331 |
(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
900 Cottage Grove Road Bloomfield, Connecticut |
|
06002 |
(Address of principal executive offices) |
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(Zip Code) |
(860) 226-6000 | ||
Registrants telephone number, including area code | ||
(860) 226-6741 | ||
Registrants facsimile number, including area code | ||
Not Applicable | ||
(Former name, former address and former fiscal year, if changed since last report) |
Indicate by check mark |
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YES |
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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. |
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R |
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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). |
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R |
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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). |
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o |
|
R | |||
As of April 15, 2016, 256,513,083 shares of the issuer's common stock were outstanding.
Cigna Corporation
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3 | |
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4 | |
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5 | |
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6 | |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
38 | |
59 | ||
60 | ||
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61 | ||
62 | ||
63 | ||
63 | ||
64 | ||
65 | ||
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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Cigna Corporation
Consolidated Statements of Income
|
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Unaudited Three Months Ended March 31, |
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(In millions, except per share amounts) |
|
2016 |
|
2015 |
| ||
Revenues |
|
|
|
|
| ||
Premiums |
|
$ |
7,746 |
|
$ |
7,402 |
|
Fees and other revenues |
|
1,201 |
|
1,138 |
| ||
Net investment income |
|
272 |
|
276 |
| ||
Mail order pharmacy revenues |
|
697 |
|
578 |
| ||
Realized investment gains (losses): |
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|
|
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| ||
Other than temporary impairments on debt securities |
|
(27) |
|
(5) |
| ||
Other realized investment gains (losses), net |
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(5) |
|
78 |
| ||
Net realized investment gains (losses) |
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(32) |
|
73 |
| ||
Total revenues |
|
9,884 |
|
9,467 |
| ||
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|
|
|
|
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Benefits and Expenses |
|
|
|
|
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Global Health Care medical costs |
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4,761 |
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4,604 |
| ||
Other benefit expenses |
|
1,368 |
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1,269 |
| ||
Mail order pharmacy costs |
|
574 |
|
492 |
| ||
Other operating expenses |
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2,321 |
|
2,204 |
| ||
Amortization of other acquired intangible assets, net |
|
41 |
|
44 |
| ||
Total benefits and expenses |
|
9,065 |
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8,613 |
| ||
Income before Income Taxes |
|
819 |
|
854 |
| ||
Income taxes: |
|
|
|
|
| ||
Current |
|
294 |
|
308 |
| ||
Deferred |
|
11 |
|
15 |
| ||
Total income taxes |
|
305 |
|
323 |
| ||
Net Income |
|
514 |
|
531 |
| ||
Less: Net (Loss) Attributable to Noncontrolling Interests |
|
(5) |
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(2) |
| ||
Shareholders Net Income |
|
$ |
519 |
|
$ |
533 |
|
Shareholders Net Income Per Share: |
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|
|
|
| ||
Basic |
|
$ |
2.04 |
|
$ |
2.08 |
|
Diluted |
|
$ |
2.00 |
|
$ |
2.04 |
|
Dividends Declared Per Share |
|
$ |
0.04 |
|
$ |
0.04 |
|
The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.
Cigna Corporation
Consolidated Statements of Comprehensive Income
|
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Unaudited Three Months Ended March 31, |
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(In millions) |
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2016 |
|
|
2015 |
| ||
Shareholders net income |
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$ |
519 |
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|
$ |
533 |
|
Shareholders other comprehensive income (loss): |
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|
|
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|
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Net unrealized appreciation, securities |
|
173 |
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|
88 |
| ||
Net unrealized appreciation (depreciation), derivatives |
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(3) |
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|
7 |
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Net translation of foreign currencies |
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81 |
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(104) |
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Postretirement benefits liability adjustment |
|
11 |
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|
11 |
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Shareholders other comprehensive income |
|
262 |
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|
2 |
| ||
Shareholders comprehensive income |
|
781 |
|
|
535 |
| ||
Comprehensive income (loss) attributable to noncontrolling interests: |
|
|
|
|
|
| ||
Net (loss) attributable to redeemable noncontrolling interests |
|
(1) |
|
|
- |
| ||
Net (loss) attributable to other noncontrolling interests |
|
(4) |
|
|
(2) |
| ||
Other comprehensive income (loss) attributable to redeemable noncontrolling interests |
|
3 |
|
|
(9) |
| ||
Total comprehensive income |
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$ |
779 |
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$ |
524 |
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The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.
Cigna Corporation
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Unaudited |
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As of |
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As of |
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March 31, |
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December 31, |
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(In millions, except per share amounts) |
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2016 |
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2015 |
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Assets |
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Investments: |
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|
|
|
|
| ||
Fixed maturities, at fair value (amortized cost, $18,684; $18,456) |
|
$ |
20,087 |
|
|
$ |
19,455 |
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Equity securities, at fair value (cost, $193; $190) |
|
194 |
|
|
190 |
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Commercial mortgage loans |
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1,848 |
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|
1,864 |
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Policy loans |
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1,419 |
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|
1,419 |
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Other long-term investments |
|
1,434 |
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|
1,404 |
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Short-term investments |
|
465 |
|
|
381 |
| ||
Total investments |
|
25,447 |
|
|
24,713 |
| ||
Cash and cash equivalents |
|
2,401 |
|
|
1,968 |
| ||
Premiums, accounts and notes receivable, net |
|
3,956 |
|
|
3,694 |
| ||
Reinsurance recoverables |
|
6,725 |
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|
6,813 |
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Deferred policy acquisition costs |
|
1,743 |
|
|
1,659 |
| ||
Property and equipment |
|
1,534 |
|
|
1,534 |
| ||
Deferred tax assets, net |
|
276 |
|
|
379 |
| ||
Goodwill |
|
6,029 |
|
|
6,019 |
| ||
Other assets, including other intangibles |
|
2,788 |
|
|
2,476 |
| ||
Separate account assets |
|
7,985 |
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|
7,833 |
| ||
Total assets |
|
$ |
58,884 |
|
|
$ |
57,088 |
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Liabilities |
|
|
|
|
|
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Contractholder deposit funds |
|
$ |
8,455 |
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$ |
8,443 |
|
Future policy benefits |
|
9,735 |
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|
9,479 |
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Unpaid claims and claim expenses |
|
4,724 |
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|
4,574 |
| ||
Global Health Care medical costs payable |
|
2,646 |
|
|
2,355 |
| ||
Unearned premiums |
|
646 |
|
|
629 |
| ||
Total insurance and contractholder liabilities |
|
26,206 |
|
|
25,480 |
| ||
Accounts payable, accrued expenses and other liabilities |
|
6,746 |
|
|
6,493 |
| ||
Short-term debt |
|
399 |
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|
149 |
| ||
Long-term debt |
|
4,791 |
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|
5,020 |
| ||
Separate account liabilities |
|
7,985 |
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|
7,833 |
| ||
Total liabilities |
|
46,127 |
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|
44,975 |
| ||
Contingencies Note 16 |
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Redeemable noncontrolling interests |
|
73 |
|
|
69 |
| ||
Shareholders Equity |
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Common stock (par value per share, $0.25; shares issued, 296; authorized, 600) |
|
74 |
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|
74 |
| ||
Additional paid-in capital |
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2,874 |
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|
2,859 |
| ||
Accumulated other comprehensive loss |
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(988) |
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(1,250) |
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Retained earnings |
|
12,541 |
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|
12,121 |
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Less treasury stock, at cost |
|
(1,826) |
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(1,769) |
| ||
Total shareholders equity |
|
12,675 |
|
|
12,035 |
| ||
Noncontrolling interests |
|
9 |
|
|
9 |
| ||
Total equity |
|
12,684 |
|
|
12,044 |
| ||
Total liabilities and equity |
|
$ |
58,884 |
|
|
$ |
57,088 |
|
Shareholders Equity Per Share |
|
$ |
49.41 |
|
|
$ |
46.91 |
|
The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.
Cigna Corporation
Consolidated Statements of Changes in Total Equity
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Accumulated |
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Redeemable |
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Unaudited |
|
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Additional |
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Other |
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|
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|
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Non- |
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|
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Non- |
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For the three months ended March 31, 2016 |
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Common |
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Paid-in |
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Comprehensive |
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Retained |
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Treasury |
|
Shareholders |
|
controlling |
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Total |
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controlling |
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(In millions) |
|
Stock |
|
Capital |
|
Loss |
|
Earnings |
|
Stock |
|
Equity |
|
Interests |
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Equity |
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Interests |
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Balance at January 1, 2016 |
|
$ |
74 |
|
$ |
2,859 |
|
$ |
(1,250) |
|
$ |
12,121 |
|
$ |
(1,769) |
|
$ |
12,035 |
|
$ |
9 |
|
$ |
12,044 |
|
$ |
69 |
|
Effect of issuing stock for employee benefit plans |
|
|
|
21 |
|
|
|
(89) |
|
53 |
|
(15) |
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|
|
(15) |
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Other comprehensive income |
|
|
|
|
|
262 |
|
|
|
|
|
262 |
|
|
|
262 |
|
3 |
| |||||||||
Net income (loss) |
|
|
|
|
|
|
|
519 |
|
|
|
519 |
|
(4) |
|
515 |
|
(1) |
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Common dividends declared (per share: $0.04) |
|
|
|
|
|
|
|
(10) |
|
|
|
(10) |
|
|
|
(10) |
|
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Repurchase of common stock |
|
|
|
|
|
|
|
|
|
(110) |
|
(110) |
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|
|
(110) |
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|
| |||||||||
Other transactions impacting noncontrolling interests |
|
|
|
(6) |
|
|
|
|
|
|
|
(6) |
|
4 |
|
(2) |
|
2 |
| |||||||||
Balance at March 31, 2016 |
|
$ |
74 |
|
$ |
2,874 |
|
$ |
(988) |
|
$ |
12,541 |
|
$ |
(1,826) |
|
$ |
12,675 |
|
$ |
9 |
|
$ |
12,684 |
|
$ |
73 |
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
Redeemable |
| |||||||||
|
|
|
|
Additional |
|
Other |
|
|
|
|
|
|
|
Non- |
|
|
|
Non- |
| |||||||||
For the three months ended March 31, 2015 |
|
Common |
|
Paid-in |
|
Comprehensive |
|
Retained |
|
Treasury |
|
Shareholders |
|
controlling |
|
Total |
|
controlling |
| |||||||||
(In millions) |
|
Stock |
|
Capital |
|
Loss |
|
Earnings |
|
Stock |
|
Equity |
|
Interests |
|
Equity |
|
Interests |
| |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||
Balance at January 1, 2015 |
|
$ |
74 |
|
$ |
2,769 |
|
$ |
(936) |
|
$ |
10,289 |
|
$ |
(1,422) |
|
$ |
10,774 |
|
$ |
15 |
|
$ |
10,789 |
|
$ |
90 |
|
Effect of issuing stock for employee benefit plans |
|
|
|
55 |
|
|
|
(177) |
|
184 |
|
62 |
|
|
|
62 |
|
|
| |||||||||
Other comprehensive income (loss) |
|
|
|
|
|
2 |
|
|
|
|
|
2 |
|
|
|
2 |
|
(9) |
| |||||||||
Net income (loss) |
|
|
|
|
|
|
|
533 |
|
|
|
533 |
|
(2) |
|
531 |
|
|
| |||||||||
Common dividends declared (per share: $0.04) |
|
|
|
|
|
|
|
(10) |
|
|
|
(10) |
|
|
|
(10) |
|
|
| |||||||||
Repurchase of common stock |
|
|
|
|
|
|
|
|
|
(418) |
|
(418) |
|
|
|
(418) |
|
|
| |||||||||
Other transactions impacting noncontrolling interests |
|
|
|
(1) |
|
|
|
|
|
|
|
(1) |
|
3 |
|
2 |
|
2 |
| |||||||||
Balance at March 31, 2015 |
|
$ |
74 |
|
$ |
2,823 |
|
$ |
(934) |
|
$ |
10,635 |
|
$ |
(1,656) |
|
$ |
10,942 |
|
$ |
16 |
|
$ |
10,958 |
|
$ |
83 |
|
The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.
Cigna Corporation
Consolidated Statements of Cash Flows
|
|
Unaudited |
| |||||
|
|
Three Months Ended March 31, |
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(In millions) |
|
2016 |
|
|
2015 |
| ||
Cash Flows from Operating Activities |
|
|
|
|
|
| ||
Net income |
|
$ |
514 |
|
|
$ |
531 |
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
|
| ||
Depreciation and amortization |
|
158 |
|
|
151 |
| ||
Realized investment (gains) losses |
|
32 |
|
|
(73) |
| ||
Deferred income taxes |
|
11 |
|
|
15 |
| ||
Net changes in assets and liabilities, net of non-operating effects: |
|
|
|
|
|
| ||
Premiums, accounts and notes receivable |
|
(237) |
|
|
(549) |
| ||
Reinsurance recoverables |
|
24 |
|
|
(11) |
| ||
Deferred policy acquisition costs |
|
(62) |
|
|
(76) |
| ||
Other assets |
|
(57) |
|
|
(101) |
| ||
Insurance liabilities |
|
507 |
|
|
455 |
| ||
Accounts payable, accrued expenses and other liabilities |
|
(263) |
|
|
157 |
| ||
Current income taxes |
|
262 |
|
|
221 |
| ||
Other, net (1) |
|
5 |
|
|
17 |
| ||
Net cash provided by operating activities (1) |
|
894 |
|
|
737 |
| ||
Cash Flows from Investing Activities |
|
|
|
|
|
| ||
Proceeds from investments sold: |
|
|
|
|
|
| ||
Fixed maturities and equity securities |
|
361 |
|
|
393 |
| ||
Investment maturities and repayments: |
|
|
|
|
|
| ||
Fixed maturities and equity securities |
|
255 |
|
|
284 |
| ||
Commercial mortgage loans |
|
18 |
|
|
166 |
| ||
Other sales, maturities and repayments (primarily short-term and other long-term investments) |
|
102 |
|
|
488 |
| ||
Investments purchased or originated: |
|
|
|
|
|
| ||
Fixed maturities and equity securities |
|
(758) |
|
|
(648) |
| ||
Commercial mortgage loans |
|
(1) |
|
|
(90) |
| ||
Other (primarily short-term and other long-term investments) |
|
(198) |
|
|
(420) |
| ||
Property and equipment purchases |
|
(112) |
|
|
(115) |
| ||
Acquisitions, net of cash acquired |
|
- |
|
|
(107) |
| ||
Net cash used in investing activities |
|
(333) |
|
|
(49) |
| ||
Cash Flows from Financing Activities |
|
|
|
|
|
| ||
Deposits and interest credited to contractholder deposit funds |
|
383 |
|
|
386 |
| ||
Withdrawals and benefit payments from contractholder deposit funds |
|
(343) |
|
|
(361) |
| ||
Net change in short-term debt |
|
(6) |
|
|
(5) |
| ||
Net proceeds on issuance of long-term debt |
|
- |
|
|
894 |
| ||
Repurchase of common stock |
|
(139) |
|
|
(413) |
| ||
Issuance of common stock |
|
10 |
|
|
99 |
| ||
Other, net (1) |
|
(51) |
|
|
(70) |
| ||
Net cash provided by (used in) financing activities (1) |
|
(146) |
|
|
530 |
| ||
Effect of foreign currency rate changes on cash and cash equivalents |
|
18 |
|
|
(18) |
| ||
Net increase in cash and cash equivalents |
|
433 |
|
|
1,200 |
| ||
Cash and cash equivalents, January 1, |
|
1,968 |
|
|
1,420 |
| ||
Cash and cash equivalents, March 31, |
|
$ |
2,401 |
|
|
$ |
2,620 |
|
Supplemental Disclosure of Cash Information: |
|
|
|
|
|
| ||
Income taxes paid, net of refunds |
|
$ |
37 |
|
|
$ |
49 |
|
Interest paid |
|
$ |
69 |
|
|
$ |
69 |
|
(1) As required by the adoption of ASU 2016-09, the Company retrospectively reclassified $73 million of cash payments from operating to financing activities for the three months ended March 31, 2015. These payments were related to employee tax obligations associated with stock compensation. The comparable amount reported in financing activities for the three months ended March 31, 2016 was $67 million. See Note 2 for further discussion.
The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.
CIGNA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 Basis of Presentation and Significant Events
Basis of Presentation
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, Cignas strategy is to Go Deep, Go Global and Go Individual 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 (e.g. 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 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 managements 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. See Note 2 for further discussion.
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 Companys 2015 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.
Note 2 Recent Accounting Changes
The Companys 2015 Form 10-K includes discussion of significant recent accounting changes that either have impacted or may impact our financial statements in the future. The following issuances of, and changes in, accounting pronouncements that apply to the Company have occurred since the Company filed its 2015 Form 10-K.
Recently Adopted Accounting Guidance
Amendments to the Consolidation Analysis (Accounting Standards Update (ASU) 2015-02). The Company adopted this new consolidation guidance effective January 1, 2016 with no material effect on its financial statements. Among other provisions, the guidance defines limited partnerships as VIEs unless substantive kick-out rights or participating rights exist. See Note 10 for additional disclosures about various real estate and security limited partnerships that are newly identified as variable interest entities for which the Company is not the primary beneficiary.
Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). In March 2016, the Financial Accounting Standards Board (FASB) issued new guidance that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled, requires cash flows related to the excess tax benefits to be classified as an operating activity in the statement of cash flows, permits repurchasing more of an employees shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employees behalf for withheld shares are to be presented as a financing activity in the statement of cash flows, and provides an accounting policy election to account for forfeitures as they occur. In addition, the new guidance changes the calculation of common stock equivalents for earnings per share purposes. The new standard is required to be adopted as of January 1, 2017.
As permitted, the Company elected to early adopt the new guidance effective January 1, 2016. Adopting this new guidance resulted in $23 million of tax benefits recorded in net income in the first quarter of 2016 in Corporate that previously would have been reported in additional paid-in capital. The change in the calculation of common stock equivalents added approximately one million weighted average shares for the diluted earnings per share calculations. The Company applied these provisions prospectively.
The Company applied the provisions of the new guidance related to the presentation of employee taxes paid for withheld shares retrospectively that resulted in reclassifying $73 million of tax withholding from operating to financing activities in its Consolidated Statement of Cash Flows for the three months ended March 31, 2015. For the three months ended March 31, 2016, the Company reflected $67 million of tax withholding in financing activities. The ability under the new guidance to repurchase more employee shares for tax withholding purposes had no impact on the Companys financial statements. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.
Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2015-07). This amendment removed the requirement to categorize all investments for which fair value is measured using the practical expedient of net asset value (NAV) per share within the fair value hierarchy. The Company adopted this new guidance effective January 1, 2016. Upon adoption, the Company began to separately disclose certain Separate Account investments and provided comparable prior period disclosure. See Note 7 for this separate disclosure information.
Recently Issued Accounting Guidance Not Yet Adopted
Revenue from Contracts with Customers (ASU 2014-09). During 2016, the Financial Accounting Standards Board (FASB) has issued two new ASUs further clarifying the broader revenue guidance: 1) Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08) that clarifies the definition of principals and agents and 2) Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing (ASU 2016-10) that clarifies guidance and adds examples to help companies properly identify performance obligations. This ASU also illustrates when a license provides a customer with a right to use (point in time) versus a right to access (over time) benefit.
These clarifications, together with the broader revenue recognition guidance within ASU 2014-09, are required to be adopted beginning January 1, 2018. The Company continues to monitor developing implementation guidance and evaluate these new requirements for its non-insurance customer contracts to determine its method and timing of implementation and any resulting estimated effects on its financial statements.
Note 3 Mergers and Acquisitions
Proposed Merger
On July 23, 2015, the Company entered into a merger agreement with Anthem, Inc. (Anthem) and Anthem Merger Sub Corp. (Merger Sub), a direct wholly-owned subsidiary of Anthem. The merger agreement provides (a) for the merger of the Company and Merger Sub, with the Company continuing as the surviving corporation and (b) if certain tax opinions are delivered, immediately following the completion of the initial merger, for the surviving corporation to be merged with and into Anthem, with Anthem continuing as the surviving corporation (collectively, the merger). Subject to certain terms, conditions, and customary operating covenants, each share of Cigna common stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive (a) $103.40 in cash, without interest, and (b) 0.5152 of a share of Anthem common stock. The closing price of Anthem common stock on May 5, 2016 was $137.07.
At special shareholders meetings held in December 2015, Cigna shareholders approved the merger and Anthem shareholders approved the issuance of shares of Anthem common stock in connection with the merger. Completing the merger remains subject to certain customary conditions, including the receipt of certain necessary governmental and regulatory approvals and the absence of a legal restraint prohibiting the merger. Completing the merger is not subject to a financing condition.
If the merger agreement is terminated under certain circumstances, Anthem will be required to pay Cigna a termination fee of $1.85 billion. Anthems obligation to pay the termination fee arises if the merger agreement is terminated because: (1) a governmental entity, such as the Department of Justice or a state Department of Insurance, has prevented the merger for regulatory reasons and that decision is final and non-appealable; or (2) the merger has not closed by January 31, 2017 (subject to extension to April 30, 2017 under certain circumstances) only because all necessary regulatory approvals have not been received.
The merger agreement contains customary covenants, including covenants that Cigna conduct its business in the ordinary course during the period between entering into the merger agreement and closing. In addition, Cignas ability to take certain actions prior to closing without Anthems consent is subject to certain limitations. These limitations relate to, among other matters, the payment of dividends, capital expenditures, the payment or retirement of indebtedness or the incurrence of new indebtedness, settlement of material claims or proceedings, mergers or acquisitions, and certain employment-related matters.
While the Company continues to work toward achieving regulatory approval as quickly as possible and to target a closing date in the second half of 2016, the closing will ultimately be subject to the approval and timing of the regulators. In light of the complexity of the regulatory process and the dynamic environment, it is possible that such approvals may not be obtained in 2016.
During the three months ended March 31, 2016, the Company incurred $40 million pre-tax ($36 million after-tax) in costs directly related to the proposed merger. These costs primarily consisted of fees for legal, advisory and other professional services.
Note 4 Earnings Per Share (EPS)
Basic and diluted earnings per share were computed as follows:
|
|
|
|
Effect of |
|
|
| |||
(Shares in thousands, dollars in millions, except per share amounts) |
|
Basic |
|
Dilution |
|
Diluted |
| |||
Three Months Ended March 31, |
|
|
|
|
|
|
| |||
2016 |
|
|
|
|
|
|
| |||
Shareholders net income |
|
$ |
519 |
|
|
|
$ |
519 |
| |
Shares: |
|
|
|
|
|
|
| |||
Weighted average |
|
254,822 |
|
|
|
254,822 |
| |||
Common stock equivalents |
|
|
|
4,625 |
|
4,625 |
| |||
Total shares |
|
254,822 |
|
4,625 |
|
259,447 |
| |||
EPS |
|
$ |
2.04 |
|
$ |
(0.04) |
|
$ |
2.00 |
|
|
|
|
|
|
|
|
| |||
2015 |
|
|
|
|
|
|
| |||
Shareholders net income |
|
$ |
533 |
|
|
|
$ |
533 |
| |
Shares: |
|
|
|
|
|
|
| |||
Weighted average |
|
256,707 |
|
|
|
256,707 |
| |||
Common stock equivalents |
|
|
|
4,539 |
|
4,539 |
| |||
Total shares |
|
256,707 |
|
4,539 |
|
261,246 |
| |||
EPS |
|
$ |
2.08 |
|
$ |
(0.04) |
|
$ |
2.04 |
|
The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months ended March 31, 2016 and 2015 because their effect was anti-dilutive.
|
|
Three Months Ended |
| ||
|
|
March 31, |
| ||
(In millions) |
|
2016 |
|
2015 |
|
Anti-dilutive options |
|
1.3 |
|
1.4 |
|
The Company held 39,638,264 shares of common stock in Treasury as of March 31, 2016, and 38,421,636 shares as of March 31, 2015.
Note 5 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 yet reported, 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, as follows:
|
|
March 31, |
|
December 31, |
| ||
(In millions) |
|
2016 |
|
2015 |
| ||
Incurred but not yet reported |
|
$ |
1,960 |
|
$ |
1,757 |
|
Reported claims in process |
|
506 |
|
470 |
| ||
Physician incentives and other medical care expenses and services payable |
|
180 |
|
128 |
| ||
Global Health Care medical costs payable |
|
$ |
2,646 |
|
$ |
2,355 |
|
Activity in medical costs payable was as follows:
|
|
For the period ended | |||||
|
|
March 31, |
|
December 31, |
| ||
(In millions) |
|
2016 |
|
2015 |
| ||
Balance at January 1, |
|
$ |
2,355 |
|
$ |
2,180 |
|
Less: Reinsurance and other amounts recoverable |
|
243 |
|
252 |
| ||
Balance at January 1, net |
|
2,112 |
|
1,928 |
| ||
Incurred costs related to: |
|
|
|
|
| ||
Current year |
|
4,825 |
|
18,564 |
| ||
Prior years |
|
(64) |
|
(210) |
| ||
Total incurred |
|
4,761 |
|
18,354 |
| ||
Paid costs related to: |
|
|
|
|
| ||
Current year |
|
2,985 |
|
16,588 |
| ||
Prior years |
|
1,449 |
|
1,582 |
| ||
Total paid |
|
4,434 |
|
18,170 |
| ||
Ending Balance, net |
|
2,439 |
|
2,112 |
| ||
Add: Reinsurance and other amounts recoverable |
|
207 |
|
243 |
| ||
Ending Balance |
|
$ |
2,646 |
|
$ |
2,355 |
|
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 6 for additional information on reinsurance. For the three months ended March 31, 2016, actual experience differed from the Companys key assumptions resulting in favorable incurred costs related to prior years medical costs payable of $64 million, or 0.3% of the current year incurred costs as reported for the year ended December 31, 2015. Actual completion factors accounted for $51 million, or 0.3% of the favorability and actual medical cost trend resulted in $28 million, or 0.1%, offset by approximately $15 million, or 0.1%, related to increased medical costs in the Government segment because of additional provider risk sharing.
For the year ended December 31, 2015, actual experience differed from the Companys key assumptions, resulting in favorable incurred costs related to prior years medical costs payable of $210 million, or 1.3% of the current year incurred costs as reported for the year ended December 31, 2014. Actual completion factors accounted for $62 million, or 0.4% of favorability, while actual medical cost trend resulted in $115 million, or 0.7%. The remaining $33 million, or 0.2%, was related to an increase in the 2014 reinsurance reimbursement rate from the Centers for Medicare and Medicaid Services (CMS) under The Patient Protection and Affordable Care Act (Health Care Reform).
The impact of prior year development on shareholders net income was $14 million for the three months ended March 31, 2016 compared with $25 million for the three months ended March 31, 2015. The favorable effect of prior year development for both periods primarily reflects lower than expected utilization of medical services. Incurred costs related to prior years in the table above do not directly correspond to an increase or decrease to shareholders net income. The primary reason for the 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. The determination of liabilities for Global Health Care medical costs payable requires the Company to make critical accounting estimates. See Note 2(N) to the Consolidated Financial Statements in the Companys 2015 Form 10-K for further information about the assumptions and estimates used to establish this liability.
Note 6 Reinsurance
The Companys 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 concentrations of its credit risk.
Effective Exit of GMDB and GMIB Business
In 2013, the Company entered into an agreement with Berkshire Hathaway Life Insurance Company of Nebraska (Berkshire) to effectively exit the guaranteed minimum death benefit (GMDB) and guaranteed minimum income benefit (GMIB) businesses via a reinsurance transaction. Berkshire reinsured 100% of the Companys future claim payments in these businesses, net of other reinsurance arrangements existing at that time. The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.6 billion remaining.
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 for the methods and assumptions used to determine GMDB assets and liabilities.
GMDB
The Company estimates this liability with an internal model based on the Companys 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. 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 assets).
Activity in the future policy benefit reserve for the GMDB business was as follows:
|
|
For the period ended | |||||
|
|
March 31, |
|
December 31, |
| ||
(In millions) |
|
2016 |
|
2015 |
| ||
Balance at January 1 |
|
$ |
1,252 |
|
$ |
1,270 |
|
Add: Unpaid claims |
|
18 |
|
16 |
| ||
Less: Reinsurance and other amounts recoverable |
|
1,164 |
|
1,186 |
| ||
Balance at January 1, net |
|
106 |
|
100 |
| ||
Add: Incurred benefits |
|
1 |
|
3 |
| ||
Less: Paid benefits |
|
- |
|
(3) |
| ||
Ending balance, net |
|
107 |
|
106 |
| ||
Less: Unpaid claims |
|
22 |
|
18 |
| ||
Add: Reinsurance and other amounts recoverable |
|
1,201 |
|
1,164 |
| ||
Ending balance |
|
$ |
1,286 |
|
$ |
1,252 |
|
Benefits paid and incurred are net of ceded amounts. The ending net retained reserve is to cover ongoing administrative expenses, as well as the minor claims exposure retained by the Company.
The table below 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 limit is exceeded, the Company should be reimbursed in full for these payments.
(Dollars in millions, excludes impact of reinsurance ceded) |
|
March 31, 2016 |
|
December 31, 2015 |
| ||
Account value |
|
$ |
10,977 |
|
$ |
11,355 |
|
Net amount at risk |
|
$ |
2,854 |
|
$ |
2,870 |
|
Number of contractholders |
|
318,000 |
|
324,000 |
|
Effects of Reinsurance
In the Companys 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:
|
|
Three Months Ended |
| ||||
|
|
March 31, |
| ||||
(In millions) |
|
2016 |
|
2015 |
| ||
Ceded premiums |
|
|
|
|
| ||
Individual life insurance and annuity business sold |
|
$ |
41 |
|
$ |
41 |
|
Other |
|
95 |
|
89 |
| ||
Total |
|
$ |
136 |
|
$ |
130 |
|
Reinsurance recoveries |
|
|
|
|
| ||
Individual life insurance and annuity business sold |
|
$ |
68 |
|
$ |
86 |
|
Other |
|
96 |
|
73 |
| ||
Total |
|
$ |
164 |
|
$ |
159 |
|
Reinsurance Recoverables
Components of the Companys reinsurance recoverables are presented below:
(In millions)
Line of Business |
|
Reinsurer(s) |
|
March 31, |
|
December 31, |
|
Collateral and Other Terms |
| ||
|
|
|
|
|
|
|
|
|
| ||
GMDB |
|
Berkshire |
|
$ |
1,156 |
|
$ |
1,123 |
|
100% secured by assets in a trust. |
|
|
|
|
|
|
|
|
|
|
| ||
|
|
Other |
|
45 |
|
41 |
|
100% secured by assets in a trust or letter of credit. |
| ||
|
|
|
|
|
|
|
|
|
| ||
Individual Life and Annuity (sold in 1998) |
|
Lincoln National Life and Lincoln Life & Annuity of New York |
|
3,659 |
|
3,705 |
|
Both companies ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance. |
| ||
|
|
|
|
|
|
|
|
|
| ||
Retirement Benefits Business (sold in 2004) |
|
Prudential Retirement Insurance and Annuity |
|
976 |
|
995 |
|
100% secured by assets in a trust. |
| ||
|
|
|
|
|
|
|
|
|
| ||
Supplemental Benefits Business (2012 acquisition) |
|
Great American Life |
|
312 |
|
315 |
|
100% secured by assets in a trust. |
| ||
|
|
|
|
|
|
|
|
|
| ||
Global Health Care, Global Supplemental Benefits, Group Disability and Life |
|
Various |
|
497 |
|
553 |
|
Recoverables from approximately 80 reinsurers, including the U.S. Government, used in the ordinary course of business. Excluding the recoverable from the U.S. Government of approximately $100 million, current balances range from less than $1 million up to $90 million, with 18% secured by assets in trusts or letters of credit. |
| ||
|
|
|
|
|
|
|
|
|
| ||
Other run-off reinsurance |
|
Various |
|
80 |
|
81 |
|
100% of this balance is secured by assets in trusts. |
| ||
|
|
|
|
|
|
|
|
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Total reinsurance recoverables |
|
|
|
$ |
6,725 |
|
$ |
6,813 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Over 90% of the Companys reinsurance recoverables were from companies that were rated A or higher by Standard & Poors at March 31, 2016. The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable. As of March 31, 2016, the Companys recoverables were net of a reserve of approximately $3 million. 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.
Note 7 Fair Value Measurements
The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, equity securities, short-term investments and derivatives. Other financial instruments are measured at fair value under certain conditions, such as when impaired.
Fair value is defined as the price at which an asset could be exchanged in an orderly transaction between market participants at the balance sheet date. A liabilitys 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 Companys 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 assets or a liabilitys 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 instruments 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 Companys 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 designating 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 of 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 tables provide information as of March 31, 2016 and December 31, 2015 about the Companys financial assets and liabilities carried at fair value. Separate account assets that are also recorded at fair value on the Companys Consolidated Balance Sheets are reported separately under the heading Separate account assets as gains and losses related to these assets generally accrue directly to policyholders.
|
|
Quoted Prices in |
|
Significant Other |
|
Significant |
|
| ||||
(In millions) |
|
(Level 1) |
|
(Level 2) |
|
(Level 3) |
|
Total | ||||
March 31, 2016 |
|
|
|
|
|
|
|
| ||||
Financial assets at fair value: |
|
|
|
|
|
|
|
| ||||
Fixed maturities: |
|
|
|
|
|
|
|
| ||||
Federal government and agency |
|
$ |
183 |
|
$ |
569 |
|
$ |
- |
|
$ |
752 |
State and local government |
|
- |
|
1,603 |
|
- |
|
1,603 | ||||
Foreign government |
|
- |
|
2,068 |
|
4 |
|
2,072 | ||||
Corporate |
|
- |
|
14,661 |
|
406 |
|
15,067 | ||||
Mortgage-backed |
|
- |
|
40 |
|
1 |
|
41 | ||||
Other asset-backed |
|
- |
|
243 |
|
309 |
|
552 | ||||
Total fixed maturities (1) |
|
183 |
|
19,184 |
|
720 |
|
20,087 | ||||
Equity securities |
|
33 |
|
89 |
|
72 |
|
194 | ||||
Subtotal |
|
216 |
|
19,273 |
|
792 |
|
20,281 | ||||
Short-term investments |
|
- |
|
465 |
|
- |
|
465 | ||||
GMIB assets (2) |
|
- |
|
- |
|
957 |
|
957 | ||||
Other derivative assets (3) |
|
- |
|
11 |
|
- |
|
11 | ||||
Total financial assets at fair value, excluding separate accounts |
|
$ |
216 |
|
$ |
19,749 |
|
$ |
1,749 |
|
$ |
21,714 |
Financial liabilities at fair value: |
|
|
|
|
|
|
|
| ||||
GMIB liabilities |
|
$ |
- |
|
$ |
- |
|
$ |
941 |
|
$ |
941 |
Other derivative liabilities |
|
- |
|
1 |
|
- |
|
1 | ||||
Total financial liabilities at fair value |
|
$ |
- |
|
$ |
1 |
|
$ |
941 |
|
$ |
942 |
December 31, 2015 |
|
|
|
|
|
|
|
| ||||
Financial assets at fair value: |
|
|
|
|
|
|
|
| ||||
Fixed maturities: |
|
|
|
|
|
|
|
| ||||
Federal government and agency |
|
$ |
251 |
|
$ |
528 |
|
$ |
- |
|
$ |
779 |
State and local government |
|
- |
|
1,641 |
|
- |
|
1,641 | ||||
Foreign government |
|
- |
|
2,010 |
|
4 |
|
2,014 | ||||
Corporate |
|
- |
|
14,122 |
|
326 |
|
14,448 | ||||
Mortgage-backed |
|
- |
|
48 |
|
1 |
|
49 | ||||
Other asset-backed |
|
- |
|
198 |
|
326 |
|
524 | ||||
Total fixed maturities (1) |
|
251 |
|
18,547 |
|
657 |
|
19,455 | ||||
Equity securities |
|
32 |
|
89 |
|
69 |
|
190 | ||||
Subtotal |
|
283 |
|
18,636 |
|
726 |
|
19,645 | ||||
Short-term investments |
|
- |
|
381 |
|
- |
|
381 | ||||
GMIB assets (2) |
|
- |
|
- |
|
907 |
|
907 | ||||
Other derivative assets (3) |
|
- |
|
16 |
|
- |
|
16 | ||||
Total financial assets at fair value, excluding separate accounts |
|
$ |
283 |
|
$ |
19,033 |
|
$ |
1,633 |
|
$ |
20,949 |
Financial liabilities at fair value: |
|
|
|
|
|
|
|
| ||||
GMIB liabilities |
|
$ |
- |
|
$ |
- |
|
$ |
885 |
|
$ |
885 |
Total financial liabilities at fair value |
|
$ |
- |
|
$ |
- |
|
$ |
885 |
|
$ |
885 |
(1) |
Fixed maturities included $622 million as of March 31, 2016 and $483 million as of December 31, 2015 of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $42 million as of March 31, 2016 and $30 million as of December 31, 2015 of appreciation for securities classified in Level 3. See Note 8 for additional information. |
(2) |
The GMIB assets represent retrocessional contracts in place from three external reinsurers that cover the exposures on these contracts. |
(3) |
Other derivative assets included $10 million as of March 31, 2016 and $15 million as of December 31, 2015 of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million as of March 31, 2016 and December 31, 2015 of interest rate swaps qualifying as fair value hedges. See Note 9 for additional information. |
Level 1 Financial Assets
Inputs for instruments classified in Level 1 include unadjusted quoted prices for identical assets in active markets accessible at the measurement date. Active markets provide pricing data for trades occurring at least weekly and include exchanges and dealer markets.
Assets in Level 1 include actively-traded U.S. government bonds and exchange-listed equity securities. Given the narrow definition of Level 1 and the Companys investment asset strategy to maximize investment returns, a relatively small portion of the Companys investment assets are classified in this category.
Level 2 Financial Assets and Financial Liabilities
Inputs for instruments classified in Level 2 include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are market observable or can be corroborated by market data for the term of the instrument. Such other inputs include market interest rates and volatilities, spreads and yield curves. An instrument is classified in Level 2 if the Company determines that unobservable inputs are insignificant.
Fixed maturities and equity securities. Approximately 95% of the Companys investments in fixed maturities and equity securities are classified in Level 2 including most public and private corporate debt and equity securities, federal agency and municipal bonds, non-government mortgage-backed securities and preferred stocks. Because many fixed maturities do not trade daily, third-party pricing services and internal methods often use recent trades of securities with similar features and characteristics. When recent trades are not available, pricing models are used to determine these prices. These models calculate fair values by discounting future cash flows at estimated market interest rates. Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry and structure of the asset. Typical inputs and assumptions to pricing models include, but are not limited to, a combination of benchmark yields, reported trades, issuer spreads, liquidity, benchmark securities, bids, offers, reference data, and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit rating.
Nearly all of these instruments are valued using recent trades or pricing models. Less than 1% of the fair value of investments classified in Level 2 represents foreign bonds that are valued using a single unadjusted market-observable input derived by averaging multiple broker-dealer quotes, consistent with local market practice.
Short-term investments are carried at fair value which approximates cost. On a regular basis, the Company compares market prices for these securities to recorded amounts to validate that current carrying amounts approximate exit prices. The short-term nature of the investments and corroboration of the reported amounts over the holding period support their classification in Level 2.
Other derivatives classified in Level 2 represent over-the-counter instruments such as interest rate and foreign currency swap contracts. Fair values for these instruments are determined using market observable inputs including forward currency and interest rate curves and widely published market observable indices. Credit risk related to the counterparty and the Company is considered when estimating the fair values of these derivatives. However, the Company is largely protected by collateral arrangements with counterparties and determined that no adjustment for credit risk was required as of March 31, 2016 or December 31, 2015. Level 2 also includes exchange-traded interest rate swap contracts. Credit risk related to the clearinghouse counterparty and the Company is considered minimal when estimating the fair values of these derivatives because of upfront margin deposits and daily settlement requirements. The nature and use of these other derivatives are described in Note 9.
Level 3 Financial Assets and Financial Liabilities
Certain inputs for instruments classified in Level 3 are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement. Unobservable inputs reflect the Companys best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date.
The Company classifies certain newly issued, privately-placed, complex or illiquid securities, as well as assets and liabilities relating to GMIB, in Level 3. Approximately 4% of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category.
Fair values of other asset and mortgage-backed securities, corporate and government fixed maturities are primarily determined using pricing models that incorporate the specific characteristics of each asset and related assumptions including the investment type and structure, credit quality, industry and maturity date in comparison to current market indices, spreads and liquidity of assets with similar characteristics. For other asset and mortgage-backed securities, inputs and assumptions for pricing may also include collateral attributes and prepayment speeds. Recent trades in the subject security or similar securities are assessed when available, and the Company may also review published research in its evaluation, as well as the issuers financial statements.
Quantitative Information about Unobservable Inputs
The following tables summarize the fair value and significant unobservable inputs used in pricing the following securities that were developed directly by the Company as of March 31, 2016 and December 31, 2015. The range and weighted average basis point amounts (bps) for fixed maturity spreads (adjustment to discount rates) and price-to-earnings multiples for equity investments reflect the Companys best estimates of the unobservable adjustments a market participant would make to calculate these fair values.
Other asset and mortgage-backed securities. The significant unobservable inputs used to value the following other asset and mortgage-backed securities are liquidity and weighting of credit spreads. When there is limited trading activity for the security, an adjustment for liquidity is made as of the measurement date that considers current market conditions, issuer circumstances and complexity of the security structure. An adjustment to weight credit spreads is needed to value a more complex bond structure with multiple underlying collateral and no standard market valuation technique. The weighting of credit spreads is primarily based on the underlying collaterals characteristics and their proportional cash flows supporting the bond obligations. The resulting wide range of unobservable adjustments in the table below is due to the varying liquidity and quality of the underlying collateral, ranging from high credit quality to below investment grade.
Corporate and government fixed maturities. The significant unobservable input used to value the following corporate and government fixed maturities is an adjustment for liquidity. When there is limited trading activity for the security, an adjustment is needed to reflect current market conditions and issuer circumstances.
Equity securities. The significant unobservable input used to value the following equity securities is a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). These securities are comprised of private equity investments with limited trading activity and therefore a ratio of EBITDA is used to estimate value based on company circumstances and relative risk characteristics.
(Fair value in millions) |
|
Fair Value |
|
Unobservable |
|
Unobservable Adjustment |
| |
As of March 31, 2016 |
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
Other asset and mortgage-backed securities |
|
$ |
310 |
|
Liquidity |
|
60 - 450 (190) bps |
|
|
|
|
|
|
Weighting of credit spreads |
|
180 - 680 (230) bps |
|
Corporate and government fixed maturities |
|
|
360 |
|
Liquidity |
|
70 - 1,150 (360) bps |
|
Total fixed maturities |
|
|
670 |
|
|
|
|
|
Equity securities |
|
|
72 |
|
Price-to-earnings multiples |
|
4.2 - 11.6 (8.2) |
|
Subtotal |
|
|
742 |
|
|
|
|
|
Securities not priced by the Company(1) |
|
|
50 |
|
|
|
|
|
Total Level 3 securities |
|
$ |
792 |
|
|
|
|
|
As of December 31, 2015 |
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
Other asset and mortgage-backed securities |
|
$ |
327 |
|
Liquidity |
|
60 - 440 (200) bps |
|
|
|
|
|
|
Weighting of credit spreads |
|
170 - 630 (220) bps |
|
Corporate and government fixed maturities |
|
|
285 |
|
Liquidity |
|
70 - 930 (280) bps |
|
Total fixed maturities |
|
|
612 |
|
|
|
|
|
Equity securities |
|
|
69 |
|
Price-to-earnings multiples |
|
4.2 - 11.6 (8.3) |
|
Subtotal |
|
|
681 |
|
|
|
|
|
Securities not priced by the Company(1) |
|
|
45 |
|
|
|
|
|
Total Level 3 securities |
|
$ |
726 |
|
|
|
|
|
(1) The fair values for these securities use single, unadjusted non-binding broker quotes not developed directly by the Company.
Significant increases in fixed maturity spreads would result in a lower fair value measurement while decreases in these inputs would result in a higher fair value measurement. Significant decreases in equity price-to-earnings multiples would result in a lower fair value measurement while increases in these inputs would result in a higher fair value measurement. Generally, the unobservable inputs are not interrelated and a change in the assumption used for one unobservable input is not accompanied by a change in the other unobservable input.
GMIB contracts. As discussed in Note 6, the Company effectively exited the GMIB business in 2013. Although these GMIB assets and liabilities must continue to be reported as derivatives at fair value, the only assumption that is expected to impact future shareholders net income is the risk of non-performance. This assumption reflects a market participants view of (a) the risk of a subsidiary of the Company not fulfilling its GMIB obligations (GMIB liabilities) and (b) the credit risk that the reinsurers do not pay their obligations (GMIB assets). As of March 31, 2016, there were three reinsurers for GMIB, with collateral securing 68% of the balance.
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. Under the terms of these written and purchased contracts, the Company periodically receives and pays fees based on either contractholders account values or deposits increased at a contractual rate. The Company will also pay and receive cash depending on account values and interest rates when contractholders elect to begin to receive minimum income payments. The Company estimates the fair value of the assets and liabilities for GMIB contracts by calculating the results for many scenarios run through a model utilizing various assumptions that include non-performance risk, among other things.
The non-performance risk adjustment is incorporated by adding an additional spread to the discount rate in the calculation of both (a) the GMIB liabilities to reflect a market participants view of the risk of a subsidiary of the Company not fulfilling its GMIB obligations, and (b) the GMIB assets to reflect a market participants view of the credit risk of the reinsurers, after considering collateral.
Other assumptions that affect GMIB assets and liabilities include capital market assumptions (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments) and future annuitant behavior (including mortality, lapse and annuity election rates). As certain assumptions used to estimate fair values for these contracts are largely unobservable (primarily related to future annuitant behavior), the Company classifies GMIB assets and liabilities in Level 3.
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, or increases in assumed annuity election rates, 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 liabilities are reported in the Companys Consolidated Balance Sheets in accounts payable, accrued expenses and other liabilities. GMIB assets associated with these contracts represent net receivables in connection with reinsurance that the Company has purchased from three external reinsurers and are reported in the Companys Consolidated Balance Sheets in other assets, including other intangibles.
Changes in Level 3 Financial Assets and Financial Liabilities Carried at Fair Value
The following tables summarize the changes in financial assets and financial liabilities classified in Level 3 for the three months ended March 31, 2016 and 2015. Separate account asset changes are reported separately under the heading Separate account assets as the changes in fair values of these assets accrue directly to the policyholders. Gains and losses reported in these tables may include net changes in fair value that are attributable to both observable and unobservable inputs.
|
|
Changes in Level 3 financial assets and financial liabilities |
| ||||||||||
For the Three Months Ended March 31, 2016 |
|
Fixed Maturities & |
|
GMIB Assets |
|
GMIB Liabilities |
|
GMIB Net |
| ||||
Balance at January 1, 2016 |
|
$ |
726 |
|
$ |
907 |
|
$ |
(885) |
|
$ |
22 |
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
| ||||
GMIB fair value gain/(loss) |
|
- |
|
61 |
|
(61) |
|
- |
| ||||
Other |
|
(25) |
|
(1) |
|
(5) |
|
(6) |
| ||||
Total gains (losses) included in shareholders net income |
|
(25) |
|
60 |
|
(66) |
|
(6) |
| ||||
Gains included in other comprehensive income |
|
- |
|
- |
|
- |
|
- |
| ||||
Gains required to adjust future policy benefits for settlement annuities (1) |
|
11 |
|
- |
|
- |
|
- |
| ||||
Purchases, sales and settlements: |
|
|
|
|
|
|
|
|
| ||||
Purchases |
|
24 |
|
- |
|
- |
|
- |
| ||||
Sales |
|
- |
|
- |
|
- |
|
- |
| ||||
Settlements |
|
(11) |
|
(10 |
) |
10 |
|
- |
| ||||
Total purchases, sales and settlements |
|
13 |
|
(10 |
) |
10 |
|
- |
| ||||
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
| ||||
Transfers into Level 3 |
|
128 |
|
- |
|
- |
|
- |
| ||||
Transfers out of Level 3 |
|
(61) |
|
- |
|
- |
|
- |
| ||||
Total transfers into/(out of) Level 3 |
|
67 |
|
- |
|
- |
|
- |
| ||||
Balance at March 31, 2016 |
|
$ |
792 |
|
$ |
957 |
|
$ |
(941) |
|
$ |
16 |
|
Total gains (losses) included in shareholders net income attributable to instruments held at the reporting date |
|
$ |
(25) |
|
$ |
60 |
|
$ |
(66) |
|
$ |
(6) |
|
|
|
Changes in Level 3 financial assets and financial liabilities |
| ||||||||||
For the Three Months Ended March 31, 2015 |
|
Fixed Maturities & |
|
GMIB Assets |
|
GMIB Liabilities |
|
GMIB Net |
| ||||
Balance at January 1, 2015 |
|
$ |
857 |
|
$ |
953 |
|
$ |
(929) |
|
$ |
24 |
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
| ||||
GMIB fair value gain/(loss) |
|
- |
|
27 |
|
(27) |
|
- |
| ||||
Other |
|
13 |
|
(1) |
|
(1) |
|
(2 |
) | ||||
Total gains (losses) included in shareholders net income |
|
13 |
|
26 |
|
(28) |
|
(2 |
) | ||||
Gains included in other comprehensive income |
|
2 |
|
- |
|
- |
|
- |
| ||||
Gains required to adjust future policy benefits for settlement annuities (1) |
|
6 |
|
- |
|
- |
|
- |
| ||||
Purchases, sales and settlements: |
|
|
|
|
|
|
|
|
| ||||
Purchases |
|
11 |
|
- |
|
- |
|
- |
| ||||
Sales |
|
(18 |
) |
- |
|
- |
|
- |
| ||||
Settlements |
|
(3 |
) |
(9 |
) |
9 |
|
- |
| ||||
Total purchases, sales and settlements |
|
(10 |
) |
(9 |
) |
9 |
|
- |
| ||||
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
| ||||
Transfers into Level 3 |
|
1 |
|
- |
|
- |
|
- |
| ||||
Transfers out of Level 3 |
|
(51 |
) |
- |
|
- |
|
- |
| ||||
Total transfers into/(out of) Level 3 |
|
(50 |
) |
- |
|
- |
|
- |
| ||||
Balance at March 31, 2015 |
|
$ |
818 |
|
$ |
970 |
|
$ |
(948) |
|
$ |
22 |
|
Total gains (losses) included in shareholders net income attributable to instruments held at the reporting date |
|
$ |
- |
|
$ |
26 |
|
$ |
(28) |
|
$ |
(2) |
|
(1) Amounts do not accrue to shareholders.
As noted in the tables above, total gains and losses included in shareholders net income are reflected in the following captions in the Consolidated Statements of Income:
· |
Realized investment gains (losses) and net investment income for amounts related to fixed maturities and equity securities and realized investment gains (losses) for the impact of changes in non-performance risk related to GMIB assets and liabilities, similar to hedge ineffectiveness; and |
· |
Other operating expenses for amounts related to GMIB assets and liabilities (GMIB fair value gain/loss), except for the impact of changes in non-performance risk. |
In the tables above, gains and losses included in other comprehensive income are reflected in net unrealized appreciation (depreciation) on securities in the Consolidated Statements of Comprehensive Income.
Reclassifications impacting Level 3 financial instruments are reported as transfers into or out of the Level 3 category as of the beginning of the quarter in which the transfer occurs. Therefore gains and losses in income only reflect activity for the period the instrument was classified in Level 3.
Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Companys best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement. For the three months ended March 31, 2016, transfers between Level 2 and Level 3 primarily reflect changes in liquidity and credit risk estimates for certain private placement issuers in the metals, mining and energy sectors. For the three months ended March 31, 2015, transfers out of Level 3 primarily reflect a change in the significance of the unobservable inputs related to liquidity and credit estimates used to value several private corporate bonds.
Separate account assets
Fair values and changes in the fair values of separate account assets generally accrue directly to the policyholders and are excluded from the Companys revenues and expenses. Beginning in 2016, investments that are measured using the practical expedient of net asset value are excluded from the fair value hierarchy. Prior periods have been reclassified to conform to the current presentation. As of March 31, 2016 and December 31, 2015, separate account assets were as follows:
March 31, 2016 |
|
Quoted Prices in Active |
|
Significant Other |
|
Significant Unobservable |
|
Total |
| ||||
Guaranteed separate accounts (See Note 16) |
|
$ |
231 |
|
$ |
273 |
|
$ |
- |
|
$ |
504 |
|
Non-guaranteed separate accounts (1) |
|
1,372 |
|
4,862 |
|
317 |
|
6,551 |
| ||||
Subtotal |
|
$ |
1,603 |
|
$ |
5,135 |
|
$ |
317 |
|
7,055 |
| |
Non-guaranteed separate accounts priced at NAV as a practical expedient (1) |
|
|
|
|
|
|
|
930 |
| ||||
Total separate account assets |
|
|
|
|
|
|
|
$ |
7,985 |
< |