Form 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2010
OR
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o |
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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)
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Delaware
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06-1059331 |
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(State or other jurisdiction
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(I.R.S. Employer |
of incorporation or organization)
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Identification No.) |
Two Liberty Place, 1601 Chestnut Street
Philadelphia, Pennsylvania 19192
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code (215) 761-1000
Registrants facsimile number, including area code (215) 761-3596
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes
þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ
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Accelerated filer o
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Non-accelerated filer o
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Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
As of October 15, 2010, 270,920,033 shares of the issuers common stock were
outstanding.
CIGNA CORPORATION
INDEX
As used herein, CIGNA or the Company refers to one or more of CIGNA Corporation and its consolidated
subsidiaries.
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CIGNA Corporation
Consolidated Statements of Income
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Unaudited |
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Unaudited |
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
|
(In millions, except per share amounts) |
|
2010 |
|
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2009 |
|
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2010 |
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2009 |
|
Revenues |
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|
|
|
|
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|
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Premiums and fees |
|
$ |
4,621 |
|
|
$ |
3,985 |
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|
$ |
13,668 |
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|
$ |
12,049 |
|
Net investment income |
|
|
280 |
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|
|
263 |
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|
829 |
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|
752 |
|
Mail order pharmacy revenues |
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354 |
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|
316 |
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1,053 |
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|
944 |
|
Other revenues |
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(17 |
) |
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(61 |
) |
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|
230 |
|
|
|
73 |
|
Realized investment gains (losses): |
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|
|
|
|
|
|
|
|
|
|
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Other-than-temporary impairments on debt securities, net |
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(16 |
) |
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(1 |
) |
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(42 |
) |
Other realized investment gains |
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28 |
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30 |
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45 |
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2 |
|
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|
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|
|
|
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|
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|
Total realized investment gains (losses) |
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28 |
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14 |
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44 |
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(40 |
) |
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|
|
|
|
|
|
|
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Total revenues |
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|
5,266 |
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|
|
4,517 |
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|
15,824 |
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|
13,778 |
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|
|
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|
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|
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|
|
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Benefits and Expenses |
|
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|
|
|
|
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|
|
|
|
|
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Health Care medical claims expense |
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2,148 |
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|
1,698 |
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|
6,435 |
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|
5,226 |
|
Other benefit expenses |
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|
892 |
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|
754 |
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2,748 |
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|
2,551 |
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Mail order pharmacy cost of goods sold |
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291 |
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|
255 |
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866 |
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|
762 |
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GMIB fair value (gain) loss |
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22 |
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|
(19 |
) |
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|
182 |
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|
(215 |
) |
Other operating expenses |
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1,449 |
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|
1,342 |
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4,268 |
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|
4,064 |
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|
|
|
|
|
|
|
|
|
|
|
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Total benefits and expenses |
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4,802 |
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|
4,030 |
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|
14,499 |
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|
12,388 |
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|
|
|
|
|
|
|
|
|
|
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Income from Continuing Operations before Income Taxes |
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|
464 |
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|
|
487 |
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|
1,325 |
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|
1,390 |
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|
|
|
|
|
|
|
|
|
|
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Income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Current |
|
|
101 |
|
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|
68 |
|
|
|
256 |
|
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|
138 |
|
Deferred |
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|
55 |
|
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|
89 |
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|
182 |
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|
279 |
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|
|
|
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|
|
|
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Total taxes |
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156 |
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|
157 |
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|
|
438 |
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|
417 |
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|
|
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Income from Continuing Operations |
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308 |
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330 |
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|
887 |
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|
973 |
|
Income from Discontinued Operations, Net of Taxes |
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1 |
|
|
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|
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Net Income |
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308 |
|
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|
330 |
|
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|
887 |
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|
974 |
|
Less: Net Income Attributable to Noncontrolling Interest |
|
|
1 |
|
|
|
1 |
|
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3 |
|
|
|
2 |
|
|
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Shareholders Net Income |
|
$ |
307 |
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|
$ |
329 |
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$ |
884 |
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$ |
972 |
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Basic Earnings Per Share: |
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Shareholders income from continuing operations |
|
$ |
1.13 |
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$ |
1.20 |
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$ |
3.23 |
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$ |
3.55 |
|
Shareholders income from discontinued operations |
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|
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Shareholders net income |
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$ |
1.13 |
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$ |
1.20 |
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$ |
3.23 |
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$ |
3.55 |
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Diluted Earnings Per Share: |
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Shareholders income from continuing operations |
|
$ |
1.13 |
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$ |
1.19 |
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$ |
3.20 |
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$ |
3.54 |
|
Shareholders income from discontinued operations |
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|
|
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|
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Shareholders net income |
|
$ |
1.13 |
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|
$ |
1.19 |
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$ |
3.20 |
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$ |
3.54 |
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|
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Dividends Declared Per Share |
|
$ |
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|
$ |
|
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|
$ |
0.040 |
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|
$ |
0.040 |
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Amounts Attributable to CIGNA: |
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|
|
|
|
|
|
|
|
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|
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Shareholders income from continuing operations |
|
$ |
307 |
|
|
$ |
329 |
|
|
$ |
884 |
|
|
$ |
971 |
|
Shareholders income from discontinued operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Net Income |
|
$ |
307 |
|
|
$ |
329 |
|
|
$ |
884 |
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|
$ |
972 |
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The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
1
CIGNA Corporation
Consolidated Balance Sheets
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Unaudited |
|
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|
|
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As of |
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As of |
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|
September 30, |
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December 31, |
|
(In millions, except per share amounts) |
|
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2010 |
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|
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|
2009 |
|
Assets |
|
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|
|
|
|
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|
|
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Investments: |
|
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|
|
|
|
|
|
|
|
|
|
|
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|
Fixed maturities, at fair value (amortized cost, $13,488; $12,580) |
|
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|
$ |
15,354 |
|
|
|
|
|
|
$ |
13,443 |
|
Equity securities, at fair value (cost, $139; $137) |
|
|
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|
|
|
124 |
|
|
|
|
|
|
|
113 |
|
Commercial mortgage loans |
|
|
|
|
|
|
3,486 |
|
|
|
|
|
|
|
3,522 |
|
Policy loans |
|
|
|
|
|
|
1,577 |
|
|
|
|
|
|
|
1,549 |
|
Real estate |
|
|
|
|
|
|
180 |
|
|
|
|
|
|
|
124 |
|
Other long-term investments |
|
|
|
|
|
|
670 |
|
|
|
|
|
|
|
595 |
|
Short-term investments |
|
|
|
|
|
|
132 |
|
|
|
|
|
|
|
493 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
|
|
|
|
21,523 |
|
|
|
|
|
|
|
19,839 |
|
Cash and cash equivalents |
|
|
|
|
|
|
1,404 |
|
|
|
|
|
|
|
924 |
|
Accrued investment income |
|
|
|
|
|
|
266 |
|
|
|
|
|
|
|
238 |
|
Premiums, accounts and notes receivable, net |
|
|
|
|
|
|
1,438 |
|
|
|
|
|
|
|
1,361 |
|
Reinsurance recoverables |
|
|
|
|
|
|
6,406 |
|
|
|
|
|
|
|
6,597 |
|
Deferred policy acquisition costs |
|
|
|
|
|
|
1,069 |
|
|
|
|
|
|
|
943 |
|
Property and equipment |
|
|
|
|
|
|
894 |
|
|
|
|
|
|
|
862 |
|
Deferred income taxes, net |
|
|
|
|
|
|
602 |
|
|
|
|
|
|
|
1,029 |
|
Goodwill |
|
|
|
|
|
|
3,119 |
|
|
|
|
|
|
|
2,876 |
|
Other assets, including other intangibles |
|
|
|
|
|
|
1,460 |
|
|
|
|
|
|
|
1,056 |
|
Separate account assets |
|
|
|
|
|
|
7,798 |
|
|
|
|
|
|
|
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
|
|
|
|
$ |
45,979 |
|
|
|
|
|
|
$ |
43,013 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractholder deposit funds |
|
|
|
|
|
$ |
8,532 |
|
|
|
|
|
|
$ |
8,484 |
|
Future policy benefits |
|
|
|
|
|
|
8,460 |
|
|
|
|
|
|
|
8,136 |
|
Unpaid claims and claim expenses |
|
|
|
|
|
|
3,985 |
|
|
|
|
|
|
|
3,968 |
|
Health Care medical claims payable |
|
|
|
|
|
|
1,300 |
|
|
|
|
|
|
|
921 |
|
Unearned premiums and fees |
|
|
|
|
|
|
415 |
|
|
|
|
|
|
|
427 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance and contractholder liabilities |
|
|
|
|
|
|
22,692 |
|
|
|
|
|
|
|
21,936 |
|
Accounts payable, accrued expenses and other liabilities |
|
|
|
|
|
|
6,144 |
|
|
|
|
|
|
|
5,797 |
|
Short-term debt |
|
|
|
|
|
|
326 |
|
|
|
|
|
|
|
104 |
|
Long-term debt |
|
|
|
|
|
|
2,510 |
|
|
|
|
|
|
|
2,436 |
|
Nonrecourse obligations |
|
|
|
|
|
|
23 |
|
|
|
|
|
|
|
23 |
|
Separate account liabilities |
|
|
|
|
|
|
7,798 |
|
|
|
|
|
|
|
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
|
|
|
|
39,493 |
|
|
|
|
|
|
|
37,584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingencies Note 18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock (par value per share, $0.25; shares issued, 351) |
|
|
|
|
|
|
88 |
|
|
|
|
|
|
|
88 |
|
Additional paid-in capital |
|
|
|
|
|
|
2,530 |
|
|
|
|
|
|
|
2,514 |
|
Net unrealized appreciation, fixed maturities |
|
$ |
767 |
|
|
|
|
|
|
$ |
378 |
|
|
|
|
|
Net unrealized appreciation, equity securities |
|
|
3 |
|
|
|
|
|
|
|
4 |
|
|
|
|
|
Net unrealized depreciation, derivatives |
|
|
(21 |
) |
|
|
|
|
|
|
(30 |
) |
|
|
|
|
Net translation of foreign currencies |
|
|
15 |
|
|
|
|
|
|
|
(12 |
) |
|
|
|
|
Postretirement benefits liability adjustment |
|
|
(1,049 |
) |
|
|
|
|
|
|
(958 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss |
|
|
|
|
|
|
(285 |
) |
|
|
|
|
|
|
(618 |
) |
Retained earnings |
|
|
|
|
|
|
9,421 |
|
|
|
|
|
|
|
8,625 |
|
Less treasury stock, at cost |
|
|
|
|
|
|
(5,285 |
) |
|
|
|
|
|
|
(5,192 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total shareholders equity |
|
|
|
|
|
|
6,469 |
|
|
|
|
|
|
|
5,417 |
|
Noncontrolling interest |
|
|
|
|
|
|
17 |
|
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity |
|
|
|
|
|
|
6,486 |
|
|
|
|
|
|
|
5,429 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and equity |
|
|
|
|
|
$ |
45,979 |
|
|
|
|
|
|
$ |
43,013 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Equity Per Share |
|
|
|
|
|
$ |
23.88 |
|
|
|
|
|
|
$ |
19.75 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
2
CIGNA Corporation
Consolidated Statements of Comprehensive Income and Changes in Total Equity
(In millions, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
Three Months Ended September 30, |
|
2010 |
|
|
2009 |
|
|
|
Compre- |
|
|
|
|
|
|
Compre- |
|
|
|
|
|
|
hensive |
|
|
Total |
|
|
hensive |
|
|
Total |
|
|
|
Income |
|
|
Equity |
|
|
Income |
|
|
Equity |
|
Common Stock, July 1 and September 30, |
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In Capital, July 1, |
|
|
|
|
|
|
2,526 |
|
|
|
|
|
|
|
2,506 |
|
Effects of stock issuance for employee benefit plans |
|
|
|
|
|
|
4 |
|
|
|
|
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In Capital, September 30, |
|
|
|
|
|
|
2,530 |
|
|
|
|
|
|
|
2,510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Loss, July 1, |
|
|
|
|
|
|
(539 |
) |
|
|
|
|
|
|
(837 |
) |
Net unrealized appreciation, fixed maturities |
|
$ |
198 |
|
|
|
198 |
|
|
$ |
302 |
|
|
|
302 |
|
Net unrealized depreciation, equity securities |
|
|
|
|
|
|
|
|
|
|
(3 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation on securities |
|
|
198 |
|
|
|
|
|
|
|
299 |
|
|
|
|
|
Net unrealized depreciation, derivatives |
|
|
(11 |
) |
|
|
(11 |
) |
|
|
(6 |
) |
|
|
(6 |
) |
Net translation of foreign currencies |
|
|
66 |
|
|
|
66 |
|
|
|
29 |
|
|
|
29 |
|
Postretirement benefits liability adjustment |
|
|
1 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income |
|
|
254 |
|
|
|
|
|
|
|
321 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Loss, September 30, |
|
|
|
|
|
|
(285 |
) |
|
|
|
|
|
|
(516 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings, July 1, |
|
|
|
|
|
|
9,129 |
|
|
|
|
|
|
|
7,986 |
|
Shareholders net income |
|
|
307 |
|
|
|
307 |
|
|
|
329 |
|
|
|
329 |
|
Effects of stock issuance for employee benefit plans |
|
|
|
|
|
|
(15 |
) |
|
|
|
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings, September 30, |
|
|
|
|
|
|
9,421 |
|
|
|
|
|
|
|
8,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock, July 1, |
|
|
|
|
|
|
(5,228 |
) |
|
|
|
|
|
|
(5,254 |
) |
Repurchase of common stock |
|
|
|
|
|
|
(78 |
) |
|
|
|
|
|
|
|
|
Other, primarily issuance of treasury stock for employee benefit plans |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock, September 30, |
|
|
|
|
|
|
(5,285 |
) |
|
|
|
|
|
|
(5,228 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Comprehensive Income and Shareholders Equity |
|
|
561 |
|
|
|
6,469 |
|
|
|
650 |
|
|
|
5,157 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest, July 1, |
|
|
|
|
|
|
15 |
|
|
|
|
|
|
|
9 |
|
Net income attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
Accumulated other comprehensive income attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest, September 30, |
|
|
2 |
|
|
|
17 |
|
|
|
2 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Comprehensive Income and Total Equity |
|
$ |
563 |
|
|
$ |
6,486 |
|
|
$ |
652 |
|
|
$ |
5,168 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
3
CIGNA Corporation
Consolidated Statements of Comprehensive Income and Changes in Total Equity
(In millions, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
Nine Months Ended September 30, |
|
2010 |
|
|
2009 |
|
|
|
Compre- |
|
|
|
|
|
|
Compre- |
|
|
|
|
|
|
hensive |
|
|
Total |
|
|
hensive |
|
|
Total |
|
|
|
Income |
|
|
Equity |
|
|
Income |
|
|
Equity |
|
Common Stock, January 1 and September 30, |
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
$ |
88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In Capital, January 1, |
|
|
|
|
|
|
2,514 |
|
|
|
|
|
|
|
2,502 |
|
Effects of stock issuance for employee benefit plans |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Paid-In Capital, September 30, |
|
|
|
|
|
|
2,530 |
|
|
|
|
|
|
|
2,510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Loss, January 1, |
|
|
|
|
|
|
(618 |
) |
|
|
|
|
|
|
(1,074 |
) |
Implementation effect of updated guidance on other-than-temporary impairments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18 |
) |
Net unrealized appreciation, fixed maturities |
|
$ |
389 |
|
|
|
389 |
|
|
$ |
567 |
|
|
|
567 |
|
Net unrealized depreciation, equity securities |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(3 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation on securities |
|
|
388 |
|
|
|
|
|
|
|
564 |
|
|
|
|
|
Net unrealized appreciation (depreciation), derivatives |
|
|
9 |
|
|
|
9 |
|
|
|
(14 |
) |
|
|
(14 |
) |
Net translation of foreign currencies |
|
|
27 |
|
|
|
27 |
|
|
|
43 |
|
|
|
43 |
|
Postretirement benefits liability adjustment |
|
|
(91 |
) |
|
|
(91 |
) |
|
|
(17 |
) |
|
|
(17 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income |
|
|
333 |
|
|
|
|
|
|
|
576 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Loss, September 30, |
|
|
|
|
|
|
(285 |
) |
|
|
|
|
|
|
(516 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings, January 1, |
|
|
|
|
|
|
8,625 |
|
|
|
|
|
|
|
7,374 |
|
Shareholders net income |
|
|
884 |
|
|
|
884 |
|
|
|
972 |
|
|
|
972 |
|
Effects of stock issuance for employee benefit plans |
|
|
|
|
|
|
(77 |
) |
|
|
|
|
|
|
(50 |
) |
Implementation effect of updated guidance on other-than-temporary impairments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18 |
|
Common dividends declared (per share: $0.04; $0.04) |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained Earnings, September 30, |
|
|
|
|
|
|
9,421 |
|
|
|
|
|
|
|
8,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock, January 1, |
|
|
|
|
|
|
(5,192 |
) |
|
|
|
|
|
|
(5,298 |
) |
Repurchase of common stock |
|
|
|
|
|
|
(201 |
) |
|
|
|
|
|
|
|
|
Other, primarily issuance of treasury stock for employee
benefit plans |
|
|
|
|
|
|
108 |
|
|
|
|
|
|
|
70 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury Stock, September 30, |
|
|
|
|
|
|
(5,285 |
) |
|
|
|
|
|
|
(5,228 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Comprehensive Income and Shareholders Equity |
|
|
1,217 |
|
|
|
6,469 |
|
|
|
1,548 |
|
|
|
5,157 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest, January 1, |
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
6 |
|
Net income attributable to noncontrolling interest |
|
|
3 |
|
|
|
3 |
|
|
|
2 |
|
|
|
2 |
|
Accumulated other comprehensive income attributable to noncontrolling interest |
|
|
2 |
|
|
|
2 |
|
|
|
3 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest, September 30, |
|
|
5 |
|
|
|
17 |
|
|
|
5 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Comprehensive Income and Total Equity |
|
$ |
1,222 |
|
|
$ |
6,486 |
|
|
$ |
1,553 |
|
|
$ |
5,168 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
4
CIGNA Corporation
Consolidated Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
Unaudited |
|
|
|
Nine Months Ended September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Cash Flows from Operating Activities |
|
|
|
|
|
|
|
|
Net income |
|
$ |
887 |
|
|
$ |
974 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
204 |
|
|
|
207 |
|
Realized investment (gains) losses |
|
|
(44 |
) |
|
|
40 |
|
Deferred income taxes |
|
|
182 |
|
|
|
279 |
|
Gains on sale of businesses (excluding discontinued operations) |
|
|
(20 |
) |
|
|
(24 |
) |
Income from discontinued operations, net of taxes |
|
|
|
|
|
|
(1 |
) |
Net changes in assets and liabilities, net of non-operating effects: |
|
|
|
|
|
|
|
|
Premiums, accounts and notes receivable |
|
|
(55 |
) |
|
|
(72 |
) |
Reinsurance recoverables |
|
|
12 |
|
|
|
(1 |
) |
Deferred policy acquisition costs |
|
|
(118 |
) |
|
|
(60 |
) |
Other assets |
|
|
(191 |
) |
|
|
350 |
|
Insurance liabilities |
|
|
409 |
|
|
|
(271 |
) |
Accounts payable, accrued expenses and other liabilities |
|
|
16 |
|
|
|
(1,126 |
) |
Current income taxes |
|
|
38 |
|
|
|
(29 |
) |
Other, net |
|
|
(37 |
) |
|
|
3 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
1,283 |
|
|
|
269 |
|
|
|
|
|
|
|
|
Cash Flows from Investing Activities |
|
|
|
|
|
|
|
|
Proceeds from investments sold: |
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
685 |
|
|
|
655 |
|
Equity securities |
|
|
3 |
|
|
|
21 |
|
Commercial mortgage loans |
|
|
45 |
|
|
|
23 |
|
Other (primarily short-term and other long-term investments) |
|
|
800 |
|
|
|
485 |
|
Investment maturities and repayments: |
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
575 |
|
|
|
791 |
|
Commercial mortgage loans |
|
|
60 |
|
|
|
44 |
|
Investments purchased: |
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
(2,047 |
) |
|
|
(2,257 |
) |
Equity securities |
|
|
(5 |
) |
|
|
(8 |
) |
Commercial mortgage loans |
|
|
(160 |
) |
|
|
(121 |
) |
Other (primarily short-term and other long-term investments) |
|
|
(473 |
) |
|
|
(489 |
) |
Property and equipment purchases |
|
|
(209 |
) |
|
|
(218 |
) |
Acquisitions, net of cash acquired |
|
|
(332 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(1,058 |
) |
|
|
(1,074 |
) |
|
|
|
|
|
|
|
Cash Flows from Financing Activities |
|
|
|
|
|
|
|
|
Deposits and interest credited to contractholder deposit funds |
|
|
1,019 |
|
|
|
1,011 |
|
Withdrawals and benefit payments from contractholder deposit funds |
|
|
(920 |
) |
|
|
(946 |
) |
Change in cash overdraft position |
|
|
38 |
|
|
|
82 |
|
Net change in short-term debt |
|
|
|
|
|
|
(199 |
) |
Issuance of long-term debt |
|
|
296 |
|
|
|
346 |
|
Repayment of long-term debt |
|
|
(2 |
) |
|
|
(2 |
) |
Repurchase of common stock |
|
|
(201 |
) |
|
|
|
|
Issuance of common stock |
|
|
31 |
|
|
|
9 |
|
Common dividends paid |
|
|
(11 |
) |
|
|
(11 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
250 |
|
|
|
290 |
|
|
|
|
|
|
|
|
Effect of foreign currency rate changes on cash and cash equivalents |
|
|
5 |
|
|
|
9 |
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents |
|
|
480 |
|
|
|
(506 |
) |
Cash and cash equivalents, January 1, |
|
|
924 |
|
|
|
1,342 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, September 30, |
|
$ |
1,404 |
|
|
$ |
836 |
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Information: |
|
|
|
|
|
|
|
|
Income taxes paid, net of refunds |
|
$ |
215 |
|
|
$ |
171 |
|
Interest paid |
|
$ |
116 |
|
|
$ |
107 |
|
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
5
CIGNA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 Basis of Presentation
The Consolidated Financial Statements include the accounts of CIGNA Corporation and its significant
subsidiaries (referred to collectively as the Company). Intercompany transactions and accounts
have been eliminated in consolidation. These Consolidated Financial Statements were prepared in
conformity with accounting principles generally accepted in the United States of America
(GAAP).
The interim consolidated financial statements are unaudited but include all adjustments (including
normal recurring adjustments) necessary, in the opinion of management, for a fair statement of
financial position and results of operations for the periods reported. The interim consolidated
financial statements and notes should be read in conjunction with the Consolidated Financial
Statements and Notes in the Companys Form 10-K for the year ended December 31, 2009.
The preparation of interim consolidated financial statements necessarily relies heavily on
estimates. This and certain other factors, such as the seasonal nature of portions of the health
care and related benefits business as well as competitive and other market conditions, call for
caution in estimating full year results based on interim results of operations.
Certain reclassifications have been made to prior period amounts to conform to the current
presentation.
Discontinued operations for the nine months ended September 30, 2009 primarily represented a tax
benefit associated with a past divestiture related to the completion of the 2005 and 2006 IRS
examinations.
Unless otherwise indicated, amounts in these Notes exclude the effects of discontinued operations.
Note 2 Recent Accounting Pronouncements
Deferred acquisition costs. In October 2010, the Financial Accounting Standards Board (FASB)
amended guidance (ASC 944) for the accounting of costs related to the acquisition or renewal of
insurance contracts to require costs such as certain sales compensation or telemarketing
costs that are related to unsuccessful efforts and any indirect costs to be expensed as incurred.
This new guidance must be implemented on January 1, 2012 or may be implemented earlier and any
changes in the Companys consolidated financial statements may be recognized prospectively for
acquisition costs incurred beginning in 2012 or through retrospective adjustment of comparative
prior periods. The Companys deferred acquisition costs arise from sales and renewal activities
primarily in its International segment and, to a lesser extent, the Health Care and corporate-owned
life insurance businesses. The Company is presently evaluating these new requirements to determine
the timing, method and potential effects of their implementation.
Variable interest entities. Effective January 1, 2010, the Company adopted the FASBs amended
guidance that requires ongoing qualitative analysis to determine whether a variable interest entity
must be consolidated based on the entitys purpose and design, the Companys ability to direct the
entitys activities that most significantly impact its economic performance, and the Companys
right or obligation to participate in that performance (ASC 810). A variable interest entity is
insufficiently capitalized or is not controlled by its equity owners through voting or similar
rights. These amendments must be applied to qualifying special-purpose entities and troubled debt
restructures formerly excluded from such analysis. On adoption and through September 30, 2010, the
Company was not required to consolidate any variable interest entities and there were no effects to
its results of operations or financial condition. Although consolidation was not required,
disclosures about the Companys involvement with variable interest entities have been provided in
Note 11.
Transfers of financial assets. Effective January 1, 2010, the Company adopted the FASBs guidance
for accounting for transfers of financial assets (ASC 860) that changes the requirements for
recognizing the transfer of financial assets and requires additional disclosures about a
transferors continuing involvement in transferred financial assets. The guidance also eliminates
the concept of a qualifying special purpose entity when assessing transfers of financial
instruments. On adoption, there were no effects to the Companys results of operations or
financial condition.
Fair value measurements. The Company adopted the FASBs updated guidance on fair value measurements
(ASU 2010-06) in the first quarter of 2010, which requires separate disclosures of significant
transfers between levels in the fair value hierarchy. See Note 8 for additional information.
6
Other-than-temporary impairments. On April 1, 2009, the Company adopted the FASBs updated
guidance for evaluating whether an impairment is other than temporary for fixed maturities with
declines in fair value below amortized cost (ASC 320). A reclassification adjustment from retained
earnings to accumulated other comprehensive income was required for previously impaired fixed
maturities that had a non-credit loss as of the date of adoption, net of related tax effects.
The cumulative effect of adoption increased the Companys retained earnings in the second quarter
of 2009 with an offsetting decrease to accumulated other comprehensive income of $18 million, with
no overall change to shareholders equity. See Note 9 for information on the Companys
other-than-temporary impairments including additional required disclosures.
Note 3 Acquisitions
The Company may from time to time acquire or dispose of assets, subsidiaries or lines of business.
Significant transactions are described below.
Vanbreda International. On August 31, 2010, the Company acquired 100% of the voting stock of
Vanbreda International NV (Vanbreda International), based in Antwerp, Belgium for a cash purchase
price of approximately $410 million. Vanbreda International specializes in providing worldwide
medical insurance and employee benefits to intergovernmental and non-governmental organizations,
including international humanitarian operations, as well as corporate clients. Vanbreda
Internationals strong presence in Europe complements the Companys position in providing
expatriate benefits primarily to corporate clients in North America, as well as Europe and Asia.
In accordance with GAAP, the total estimated purchase price has been allocated on a provisional
basis to the tangible and intangible net assets acquired based on managements estimates of their
fair values and may change when appraisals are finalized and as additional information becomes
available over the next several months. The condensed balance sheet at the acquisition date was
estimated as follows:
|
|
|
|
|
(In millions) |
|
|
|
|
Tangible net assets acquired |
|
$ |
41 |
|
Intangible assets (primarily customer relationships) |
|
|
220 |
|
Goodwill |
|
|
223 |
|
Deferred tax liability |
|
|
(74 |
) |
|
|
|
|
Net assets acquired |
|
$ |
410 |
|
|
|
|
|
Goodwill is allocated to the International segment. For foreign tax purposes, the acquisition of
Vanbreda International is being treated as a stock purchase.
Accordingly, goodwill and other intangible assets will not be
amortized for foreign tax purposes but may reduce the taxability of
earnings repatriated to the U.S. by Vanbreda International. Since the
difference between the Belgium and U.S. corporate tax rates is only
1%, U.S. income taxes on repatriated earnings are expected to be immaterial.
The results of Vanbreda International are included in the Companys Consolidated Financial
Statements from the date of acquisition. The pro forma effect on total revenues and net income
assuming the acquisition had occurred as of January 1, 2009 was not material to the Companys total
revenues and shareholders net income for the three months and nine months ended September 30, 2010
or 2009.
7
Note 4 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 September 30, |
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
$ |
307 |
|
|
|
|
|
|
$ |
307 |
|
|
|
|
|
|
|
|
|
|
|
|
Shares (in thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average |
|
|
270,497 |
|
|
|
|
|
|
|
270,497 |
|
Common stock equivalents |
|
|
|
|
|
|
2,343 |
|
|
|
2,343 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
270,497 |
|
|
|
2,343 |
|
|
|
272,840 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
1.13 |
|
|
$ |
|
|
|
$ |
1.13 |
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
$ |
329 |
|
|
|
|
|
|
$ |
329 |
|
|
|
|
|
|
|
|
|
|
|
|
Shares (in thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average |
|
|
274,398 |
|
|
|
|
|
|
|
274,398 |
|
Common stock equivalents |
|
|
|
|
|
|
1,732 |
|
|
|
1,732 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
274,398 |
|
|
|
1,732 |
|
|
|
276,130 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
1.20 |
|
|
$ |
(0.01 |
) |
|
$ |
1.19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of |
|
|
|
|
(Dollars in millions, except per share amounts) |
|
Basic |
|
|
Dilution |
|
|
Diluted |
|
Nine Months Ended September 30, |
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
$ |
884 |
|
|
|
|
|
|
$ |
884 |
|
|
|
|
|
|
|
|
|
|
|
|
Shares (in thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average |
|
|
273,748 |
|
|
|
|
|
|
|
273,748 |
|
Common stock equivalents |
|
|
|
|
|
|
2,395 |
|
|
|
2,395 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
273,748 |
|
|
|
2,395 |
|
|
|
276,143 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
3.23 |
|
|
$ |
(0.03 |
) |
|
$ |
3.20 |
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
$ |
971 |
|
|
|
|
|
|
$ |
971 |
|
|
|
|
|
|
|
|
|
|
|
|
Shares (in thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average |
|
|
273,698 |
|
|
|
|
|
|
|
273,698 |
|
Common stock equivalents |
|
|
|
|
|
|
993 |
|
|
|
993 |
|
|
|
|
|
|
|
|
|
|
|
Total shares |
|
|
273,698 |
|
|
|
993 |
|
|
|
274,691 |
|
|
|
|
|
|
|
|
|
|
|
EPS |
|
$ |
3.55 |
|
|
$ |
(0.01 |
) |
|
$ |
3.54 |
|
|
|
|
|
|
|
|
|
|
|
The following outstanding employee stock options were not included in the computation of diluted
earnings per share because their effect would have increased diluted earnings per share
(antidilutive) as their exercise price was greater than the average share price of the Companys
common stock for the period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Antidilutive options |
|
|
6.7 |
|
|
|
8.7 |
|
|
|
6.2 |
|
|
|
10.0 |
|
8
The Company held 80,096,166 shares of common stock in Treasury as of September 30, 2010, and
77,475,700 shares as of September 30, 2009.
Note 5 Health Care Medical Claims Payable
Medical claims payable for the Health Care segment reflects estimates of the ultimate cost of
claims that have been incurred but not yet reported, those which have been reported but not yet
paid (reported claims in process) and other medical expense payable, which primarily comprises
accruals for provider incentives and other amounts payable to providers. Incurred but not yet
reported comprises the majority of the reserve balance as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Incurred but not yet reported |
|
$ |
1,127 |
|
|
$ |
790 |
|
Reported claims in process |
|
|
158 |
|
|
|
114 |
|
Other medical expense payable |
|
|
15 |
|
|
|
17 |
|
|
|
|
|
|
|
|
Medical claims payable |
|
$ |
1,300 |
|
|
$ |
921 |
|
|
|
|
|
|
|
|
Activity in medical claims payable was as follows:
|
|
|
|
|
|
|
|
|
|
|
For the period ended |
|
|
|
September 30, |
|
|
December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Balance at January 1, |
|
$ |
921 |
|
|
$ |
924 |
|
Less: Reinsurance and other amounts recoverable |
|
|
206 |
|
|
|
211 |
|
|
|
|
|
|
|
|
Balance at January 1, net |
|
|
715 |
|
|
|
713 |
|
|
|
|
|
|
|
|
|
|
Incurred claims related to: |
|
|
|
|
|
|
|
|
Current year |
|
|
6,527 |
|
|
|
6,970 |
|
Prior years |
|
|
(92 |
) |
|
|
(43 |
) |
|
|
|
|
|
|
|
Total incurred |
|
|
6,435 |
|
|
|
6,927 |
|
Paid claims related to: |
|
|
|
|
|
|
|
|
Current year |
|
|
5,514 |
|
|
|
6,278 |
|
Prior years |
|
|
584 |
|
|
|
647 |
|
|
|
|
|
|
|
|
Total paid |
|
|
6,098 |
|
|
|
6,925 |
|
Ending Balance, net |
|
|
1,052 |
|
|
|
715 |
|
Add: Reinsurance and other amounts recoverable |
|
|
248 |
|
|
|
206 |
|
|
|
|
|
|
|
|
Ending Balance |
|
$ |
1,300 |
|
|
$ |
921 |
|
|
|
|
|
|
|
|
9
Reinsurance and other amounts recoverable reflect amounts due from reinsurers and policyholders to
cover incurred but not reported and pending claims for minimum premium products and certain
administrative services only business where the right of offset does not exist. See Note 12 for
additional information on reinsurance. For the nine months ended September 30, 2010, actual
experience differed from the Companys key assumptions resulting in favorable incurred claims
related to prior years medical claims payable of $92 million, or 1.3% of the current year incurred
claims as reported for the year ended December 31, 2009. Actual completion factors resulted in a
reduction in medical claims payable of $49 million, or 0.7% of the current year incurred claims as
reported for the year ended December 31, 2009 for the insured book of business. Actual medical cost
trend resulted in a reduction in medical claims payable of $43 million, or 0.6% of the current year
incurred claims as reported for the year ended December 31, 2009 for the insured book of business.
For the year ended December 31, 2009, actual experience differed from the Companys key
assumptions, resulting in favorable incurred claims related to prior years medical claims payable
of $43 million, or 0.6% of the current year incurred claims as reported for the year ended December
31, 2008. Actual completion factors resulted in a reduction of the medical claims payable of $21
million, or 0.3% of the current year incurred claims as reported for the year ended December 31,
2008 for the insured book of business. Actual medical cost trend resulted in a reduction of the
medical claims payable of $22 million, or 0.3% of the current year incurred claims as reported for
the year ended December 31, 2008 for the insured book of business.
The favorable impacts in 2010 and 2009 relating to completion factors and medical cost trend
variances are primarily due to the release of the provision for moderately adverse conditions,
which is a component of the assumptions for both completion factors and medical cost trend,
established for claims incurred related to prior years. This release was substantially offset by
the provision for moderately adverse conditions established for claims incurred related to the
current year.
The corresponding impact of prior year development on shareholders net income was not material for
the nine months ended September 30, 2010 and 2009. The change in the amount of the incurred claims
related to prior years in the medical claims payable liability does not directly correspond to an
increase or decrease in the Companys shareholders net income recognized for the following
reasons:
First, due to the nature of the Companys retrospectively experience-rated business, only
adjustments to medical claims payable on experience-rated accounts in deficit affect shareholders
net income. An increase or decrease to medical claims payable on accounts in deficit, in effect,
accrues to the Company and directly impacts shareholders net income. An account is in deficit when
the accumulated medical costs and administrative charges, including profit charges, exceed the
accumulated premium received. Adjustments to medical claims payable on accounts in surplus accrue
directly to the policyholder with no impact on the Companys shareholders net income. An account
is in surplus when the accumulated premium received exceeds the accumulated medical costs and
administrative charges, including profit charges.
Second, the Company consistently recognizes the actuarial best estimate of the ultimate liability
within a level of confidence, as required by actuarial standards of practice, which require that
the liabilities be adequate under moderately adverse conditions. As the Company establishes the
liability for each incurral year, the Company ensures that its assumptions appropriately consider
moderately adverse conditions. When a portion of the development related to the prior year incurred
claims is offset by an increase determined appropriate to address moderately adverse conditions for
the current year incurred claims, the Company does not consider that offset amount as having any
impact on shareholders net income.
The determination of liabilities for Health Care medical claims payable required the Company to
make critical accounting estimates. See Note 2(N) to the Consolidated Financial Statements in the
Companys 2009 Form 10-K.
10
Note 6 Cost Reduction
As part of its strategy, the Company has undertaken several initiatives to realign its organization
and consolidate support functions in an effort to increase efficiency and responsiveness to
customers and to reduce costs.
During 2008 and 2009, the Company conducted a comprehensive review to reduce the operating expenses
of its ongoing businesses (cost reduction program). As a result, the Company recognized
severance-related and real estate charges in other operating expenses as follows:
|
|
during the fourth quarter of 2009, a charge of $20 million pre-tax ($13 million after-tax),
for severance resulting from reductions of approximately 470 positions in its workforce; |
|
|
during the third quarter of 2009, a charge of $10 million pre-tax ($7 million after-tax),
for severance resulting from reductions of approximately 230 positions in its workforce; and |
|
|
during the second quarter of 2009, a charge of $14 million pre-tax ($9 million after-tax),
for severance resulting from reductions of approximately 480 positions in its workforce. There have been no
charges in 2010. |
Substantially all of these charges were recorded in the Health Care segment, and are expected to be
paid in cash by the end of 2010.
Cost reduction activity, related to the 2009 charges listed above, for 2010 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Severance |
|
|
Real estate |
|
|
Total |
|
Balance, January 1, 2010 |
|
$ |
33 |
|
|
$ |
8 |
|
|
$ |
41 |
|
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
First quarter payments |
|
|
10 |
|
|
|
1 |
|
|
|
11 |
|
Second quarter payments |
|
|
8 |
|
|
|
5 |
|
|
|
13 |
|
Third quarter payments |
|
|
7 |
|
|
|
1 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2010 |
|
$ |
8 |
|
|
$ |
1 |
|
|
$ |
9 |
|
|
|
|
|
|
|
|
|
|
|
Note 7 Guaranteed Minimum Death Benefit Contracts
The Company had future policy benefit reserves for guaranteed minimum death benefit (GMDB)
contracts of $1.2 billion as of September 30, 2010 and $1.3 billion as of December 31, 2009. The
determination of liabilities for GMDB requires the Company to make critical accounting
estimates. The Company estimates its liabilities for GMDB exposures using a complex internal model
run using many scenarios and based on assumptions regarding lapse, future partial surrenders, claim
mortality (deaths that result in claims), interest rates (mean investment performance and discount
rate) and volatility. These assumptions are based on the Companys experience and future
expectations over the long-term period, consistent with the long-term nature of this product. The
Company regularly evaluates these assumptions and changes its estimates if actual experience or
other evidence suggests that assumptions should be revised. If actual experience differs from the
assumptions (including lapse, future partial surrenders, claim mortality, interest rates and
volatility) used in estimating these liabilities, the result could have a material adverse effect
on the Companys consolidated results of operations, and in certain situations, could have a
material adverse effect on the Companys financial condition.
In 2000, the Company determined that the GMDB reinsurance business was premium deficient because
the recorded future policy benefit reserve was less than the expected present value of future
claims and expenses less the expected present value of future premiums and investment income using
revised assumptions based on actual and expected experience. The Company tests for premium
deficiency by reviewing its reserve each quarter using current market conditions and its long-term
assumptions. Under premium deficiency accounting, if the recorded reserve is determined
insufficient, an increase to the reserve is reflected as a charge to current period income.
Consistent with GAAP, the Company does not recognize gains on premium deficient long duration
products.
During the third quarter of 2010, the Company performed its periodic review of assumptions
resulting in a charge of $52 million pre-tax ($34 million after-tax) to strengthen GMDB reserves.
At December 31, 2009, the Company considered the low level of current short-term interest rates in
determining the mean investment performance assumption. As of September 30, 2010, current
short-term interest rates had declined from the level anticipated at December 31, 2009, leading the
Company to increase reserves. Interest rate risk is not covered by the GMDB equity hedge program
discussed below. The Company also updated the lapse assumption for policies that have already
taken or may take a significant partial withdrawal, which had a lesser reserve impact.
11
In the first quarter of 2009, the Company reported a charge of $73 million pre-tax ($47 million
after-tax) to strengthen GMDB reserves. The reserve strengthening primarily reflected an increase in the provision for future
partial surrenders due to market declines, adverse volatility-related impacts due to turbulent
equity market conditions, and interest rate impacts.
The following provides updates to the Companys long-term assumptions for GMDB since December 31,
2009:
|
|
The annual election rates used to estimate the provision for partial surrenders that
essentially lock in the death benefit for a particular policy were updated from 0%-22% at
December 31, 2009 to 0%-21% at September 30, 2010. The range of rates reflects the variation
in the net amount at risk for each policy and whether surrender charges apply. |
|
|
The volatility assumption is based on a review of historical monthly returns for each key
index (e.g. S&P 500) over a period of at least ten years. Volatility represents the
dispersion of historical returns compared to the average historical return (standard
deviation) for each index. The volatility assumption for equity fund types has been updated
from 16%-30% at December 31, 2009 to 16%-26% at September 30, 2010. |
|
|
The claim mortality assumption has been updated from 70%-75% of the 1994 Group Annuity
Mortality table at December 31, 2009 to 65%-89% at September 30, 2010, with 1% annual
improvement beginning January 1, 2000 applying to both periods. The update reflects that for
certain contracts, a spousal beneficiary is allowed to elect to continue a contract by
becoming its new owner, thereby postponing the death claim rather than receiving the death
benefit currently. For certain issuers of these contracts, the claim mortality assumption
depends on age, gender, and net amount at risk for the policy. Overall assumed claim
mortality rates have increased since December 31, 2009. |
|
|
The lapse rate assumption has been updated from 0%-21% at December 31, 2009 to 0%-24% at
September 30, 2010, depending on contract type, policy duration and the ratio of the net
amount at risk to account value. Although the upper end of the range has increased, there is
also a higher proportion of policies experiencing lower lapse rates, so overall, assumed lapse
rates have declined since December 31, 2009. |
|
|
The assumed mean investment performance for the underlying equity mutual funds considers
the Companys GMDB equity hedge program using futures contracts, and is based on the Companys
view of average short-term interest rates over future periods, but considers the current level
of short-term interest rates. The current level of short-term rates remains below the level
anticipated when the impact of the current level of short-term interest rates was last
reviewed at December 31, 2009. As a result, in consideration of the current level of
short-term rates, the liability was increased as of September 30, 2010. |
Activity in future policy benefit reserves for the GMDB business was as follows:
|
|
|
|
|
|
|
|
|
|
|
For the period ended |
|
|
|
September 30, |
|
|
December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Balance at January 1 |
|
$ |
1,285 |
|
|
$ |
1,609 |
|
Add: Unpaid Claims |
|
|
36 |
|
|
|
34 |
|
Less: Reinsurance and other amounts recoverable |
|
|
53 |
|
|
|
83 |
|
|
|
|
|
|
|
|
Balance at January 1, net |
|
|
1,268 |
|
|
|
1,560 |
|
Add: Incurred benefits |
|
|
44 |
|
|
|
(122 |
) |
Less: Paid benefits |
|
|
94 |
|
|
|
170 |
|
|
|
|
|
|
|
|
Ending balance, net |
|
|
1,218 |
|
|
|
1,268 |
|
Less: Unpaid Claims |
|
|
39 |
|
|
|
36 |
|
Add: Reinsurance and other amounts recoverable |
|
|
56 |
|
|
|
53 |
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
1,235 |
|
|
$ |
1,285 |
|
|
|
|
|
|
|
|
Benefits paid and incurred are net of ceded amounts. Incurred benefits reflect the favorable or
unfavorable impact of a rising or falling equity market on the liability, and include the charge
discussed above. As discussed below, losses or gains have been recorded in other revenues as a
result of the GMDB equity hedge program to reduce equity market exposures.
The aggregate value of the underlying mutual fund investments was $16.0 billion as of September 30,
2010 and $17.2 billion as of December 31, 2009. The death benefit coverage in force was $6.2
billion as of September 30, 2010 and $7.0 billion as of December 31, 2009. The death benefit
coverage in force represents the excess of the guaranteed benefit amount over the value of the
underlying mutual fund investments for all contractholders (approximately 540,000 as of September
30, 2010 and 590,000 as of December 31, 2009).
12
The Company operates a GMDB equity hedge program to substantially reduce the equity market
exposures of this business by selling exchange-traded futures contracts, which are expected to rise in value as the equity market
declines, and decline in value as the equity market rises. In addition, the Company uses foreign
currency futures contracts to reduce the international equity market and foreign currency risks
associated with this business. The notional amount of futures contract positions held by the
Company at September 30, 2010 was $1.1 billion. The Company recorded in other revenues pre-tax
losses of $119 million for the three months and $72 million for the nine months ended September 30,
2010, and pre-tax losses of $161 million for the three months and $232 million for the nine months
ended September 30, 2009.
The Company has also written reinsurance contracts with issuers of variable annuity contracts that
provide annuitants with certain guarantees related to minimum income benefits (GMIB). All
reinsured GMIB policies also have a GMDB benefit reinsured by the Company. See Note 8 for further
information.
Note 8 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.
Fair values are based on quoted market prices when available. When market prices are not
available, fair value is generally estimated using discounted cash flow analyses, incorporating
current market inputs for similar financial instruments with comparable terms and credit
quality. In instances where there is little or no market activity for the same or similar
instruments, the Company estimates fair value using methods, models and assumptions that the
Company believes a hypothetical market participant would use to determine a current transaction
price. These valuation techniques involve some level of estimation and judgment by the Company
which becomes significant with increasingly complex instruments or pricing models.
The 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 performs ongoing analyses of prices used to value the Companys invested assets to
determine that they represent appropriate estimates of fair value. This process involves
quantitative and qualitative analysis including reviews of pricing methodologies, judgments of
valuation inputs, the significance of any unobservable inputs, pricing statistics and trends. The
Company also performs sample testing of sales values to confirm the accuracy of prior fair value
estimates. These procedures are overseen by the Companys investment professionals.
13
Financial Assets and Financial Liabilities Carried at Fair Value
The following tables provide information as of September 30, 2010 and December 31, 2009 about the
Companys financial assets and liabilities carried at fair value. Similar disclosures for separate
account assets, which are also recorded at fair value on the Companys Consolidated Balance Sheets,
are provided separately as gains and losses related to these assets generally accrue directly to
policyholders.
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in |
|
|
|
|
|
|
Significant |
|
|
|
|
|
|
Active Markets for |
|
|
Significant Other |
|
|
Unobservable |
|
|
|
|
|
|
Identical Assets |
|
|
Observable Inputs |
|
|
Inputs |
|
|
|
|
(In millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Financial assets at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal government and agency |
|
$ |
136 |
|
|
$ |
685 |
|
|
$ |
4 |
|
|
$ |
825 |
|
State and local government |
|
|
|
|
|
|
2,604 |
|
|
|
|
|
|
|
2,604 |
|
Foreign government |
|
|
|
|
|
|
1,143 |
|
|
|
19 |
|
|
|
1,162 |
|
Corporate |
|
|
|
|
|
|
9,580 |
|
|
|
368 |
|
|
|
9,948 |
|
Federal agency mortgage-backed |
|
|
|
|
|
|
17 |
|
|
|
|
|
|
|
17 |
|
Other mortgage-backed |
|
|
|
|
|
|
85 |
|
|
|
5 |
|
|
|
90 |
|
Other asset-backed |
|
|
|
|
|
|
152 |
|
|
|
556 |
|
|
|
708 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities (1) |
|
|
136 |
|
|
|
14,266 |
|
|
|
952 |
|
|
|
15,354 |
|
Equity securities |
|
|
3 |
|
|
|
87 |
|
|
|
34 |
|
|
|
124 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
139 |
|
|
|
14,353 |
|
|
|
986 |
|
|
|
15,478 |
|
Short-term investments |
|
|
|
|
|
|
129 |
|
|
|
3 |
|
|
|
132 |
|
GMIB assets (2) |
|
|
|
|
|
|
|
|
|
|
673 |
|
|
|
673 |
|
Other derivative assets (3) |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial assets at fair value, excluding separate accounts |
|
$ |
139 |
|
|
$ |
14,503 |
|
|
$ |
1,662 |
|
|
$ |
16,304 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB liabilities |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,246 |
|
|
$ |
1,246 |
|
Other derivative liabilities (3) |
|
|
|
|
|
|
26 |
|
|
|
|
|
|
|
26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial liabilities at fair value |
|
$ |
|
|
|
$ |
26 |
|
|
$ |
1,246 |
|
|
$ |
1,272 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Fixed maturities includes $683 million of net appreciation required to adjust future policy
benefits for the run-off settlement annuity business including $129 million of appreciation for
securities classified in Level 3. |
|
(2) |
|
The GMIB assets represent retrocessional contracts in place from two external reinsurers which
cover 55% of the exposures on these contracts. |
|
(3) |
|
Other derivative assets includes $17 million of interest rate and foreign currency swaps
qualifying as cash flow hedges and $4 million of interest rate swaps not designated as accounting
hedges. Other derivative liabilities reflect foreign currency and interest rate swaps qualifying
as cash flow hedges. See Note 10 for additional information. |
14
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in |
|
|
|
|
|
|
Significant |
|
|
|
|
|
|
Active Markets for |
|
|
Significant Other |
|
|
Unobservable |
|
|
|
|
|
|
Identical Assets |
|
|
Observable Inputs |
|
|
Inputs |
|
|
|
|
(In millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Financial assets at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal government and agency |
|
$ |
43 |
|
|
$ |
527 |
|
|
$ |
1 |
|
|
$ |
571 |
|
State and local government |
|
|
|
|
|
|
2,521 |
|
|
|
|
|
|
|
2,521 |
|
Foreign government |
|
|
|
|
|
|
1,056 |
|
|
|
14 |
|
|
|
1,070 |
|
Corporate |
|
|
|
|
|
|
8,241 |
|
|
|
344 |
|
|
|
8,585 |
|
Federal agency mortgage-backed |
|
|
|
|
|
|
34 |
|
|
|
|
|
|
|
34 |
|
Other mortgage-backed |
|
|
|
|
|
|
114 |
|
|
|
7 |
|
|
|
121 |
|
Other asset-backed |
|
|
|
|
|
|
92 |
|
|
|
449 |
|
|
|
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities (1) |
|
|
43 |
|
|
|
12,585 |
|
|
|
815 |
|
|
|
13,443 |
|
Equity securities |
|
|
2 |
|
|
|
81 |
|
|
|
30 |
|
|
|
113 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
45 |
|
|
|
12,666 |
|
|
|
845 |
|
|
|
13,556 |
|
Short-term investments |
|
|
|
|
|
|
493 |
|
|
|
|
|
|
|
493 |
|
GMIB assets (2) |
|
|
|
|
|
|
|
|
|
|
482 |
|
|
|
482 |
|
Other derivative assets (3) |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial assets at fair value, excluding separate accounts |
|
$ |
45 |
|
|
$ |
13,175 |
|
|
$ |
1,327 |
|
|
$ |
14,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial liabilities at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB liabilities |
|
$ |
|
|
|
$ |
|
|
|
$ |
903 |
|
|
$ |
903 |
|
Other derivative liabilities (3) |
|
|
|
|
|
|
30 |
|
|
|
|
|
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial liabilities at fair value |
|
$ |
|
|
|
$ |
30 |
|
|
$ |
903 |
|
|
$ |
933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Fixed maturities includes $274 million of net appreciation required to adjust future policy
benefits for the run-off settlement annuity business including $38 million of appreciation for
securities classified in Level 3. |
|
(2) |
|
The GMIB assets represent retrocessional contracts in place from two external reinsurers which
cover 55% of the exposures on these contracts. |
|
(3) |
|
Other derivative assets include $12 million of interest rate and foreign currency swaps
qualifying as cash flow hedges and $4 million of interest rate swaps not designated as accounting
hedges. Other derivative liabilities reflect foreign currency and interest rate swaps qualifying
as cash flow hedges. See Note 10 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.
15
Fixed maturities and equity securities. Approximately 93% 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 and preferred
stocks do not trade daily, fair values are often derived using recent trades of securities with
similar features and characteristics. When recent trades are not available, pricing models are
used to determine these prices. These models calculate fair values by discounting future cash
flows at estimated market interest rates. Such market rates are derived by calculating the
appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry
and structure of the asset. Typical inputs and assumptions to pricing models include, but are not
limited to, a combination of benchmark yields, reported trades, issuer spreads, liquidity,
benchmark securities, bids, offers, reference data, and industry and economic events. For
mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer,
collateral attributes, prepayment speeds and credit rating.
Nearly all of these instruments are valued using recent trades or pricing models. Less than 1% of
the fair value of investments classified in Level 2 represents foreign bonds that are valued,
consistent with local market practice, using a single unadjusted market-observable input derived by
averaging multiple broker-dealer quotes.
Short-term investments are carried at fair value, which approximates cost. On a regular basis the
Company compares market prices for these securities to recorded amounts to validate that current
carrying amounts approximate exit prices. The short-term nature of the investments and
corroboration of the reported amounts over the holding period support their classification in Level
2.
Other derivatives classified in Level 2 represent over-the-counter instruments such as interest
rate and foreign currency swap contracts. Fair values for these instruments are determined using
market observable inputs including forward currency and interest rate curves and widely published
market observable indices. Credit risk related to the counterparty and the Company is considered
when estimating the fair values of these derivatives. However, the Company is largely protected by
collateral arrangements with counterparties, and determined that no adjustment for credit risk was
required as of September 30, 2010 or December 31, 2009. The nature and use of these other
derivatives are described in Note 10.
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.
Fixed maturities and equity securities. Approximately 6% of fixed maturities and equity securities
are priced using significant unobservable inputs and classified in this category, including:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Other asset and mortgage-backed securities |
|
$ |
561 |
|
|
$ |
456 |
|
Corporate bonds (1) |
|
|
320 |
|
|
|
288 |
|
Subordinated loans and private equity investments |
|
|
108 |
|
|
|
101 |
|
|
|
|
|
|
|
|
Total |
|
$ |
989 |
|
|
$ |
845 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
As of September 30, 2010, corporate bonds include $3 million of short-term investments. |
Fair values of mortgage and asset-backed securities and corporate bonds are determined using
pricing models that incorporate the specific characteristics of each asset and related assumptions
including the investment type and structure, credit quality, industry and maturity date in
comparison to current market indices, spreads and liquidity of assets with similar
characteristics. For mortgage and asset-backed securities, inputs and assumptions to pricing may
also include collateral attributes and prepayment speeds. Recent trades in the subject security or
similar securities are assessed when available, and the Company may also review published research,
as well as the issuers financial statements, in its evaluation. Subordinated loans and private
equity investments are valued at transaction price in the absence of market data indicating a
change in the estimated fair values.
16
Guaranteed minimum income benefit contracts. Because cash flows of the GMIB liabilities and assets
are affected by equity markets and interest rates but are without significant life insurance risk
and are settled in lump sum payments, the Company reports these liabilities and assets as
derivatives at fair value. The Company estimates the fair value of the assets and liabilities for
GMIB contracts using assumptions regarding capital markets (including market returns, interest
rates and market volatilities of the underlying equity and bond mutual fund investments), future
annuitant behavior (including mortality, lapse, and annuity election rates), and non-performance
risk, as well as risk and profit charges. As certain assumptions (primarily related to future
annuitant behavior) used to estimate fair values for these contracts are largely unobservable, the
Company classifies GMIB assets and liabilities in Level 3. The Company considered the following in
determining the view of a hypothetical market participant:
|
|
that the most likely transfer of these assets and liabilities would be through a
reinsurance transaction with an independent insurer having a market capitalization and credit
rating similar to that of the Company; and |
|
|
that because this block of contracts is in run-off mode, an insurer looking to acquire
these contracts would have similar existing contracts with related administrative and risk
management capabilities. |
These GMIB assets and liabilities are estimated with a complex internal model using many scenarios
to determine the present value of net amounts expected to be paid, less the present value of net
future premiums expected to be received adjusted for risk and profit charges that the Company
estimates a hypothetical market participant would require to assume this business. Net amounts
expected to be paid include the excess of the expected value of the income benefits over the values
of the annuitants accounts at the time of annuitization. Generally, market return, interest rate
and volatility assumptions are based on market observable information. Assumptions related to
annuitant behavior reflect the Companys belief that a hypothetical market participant would
consider the actual and expected experience of the Company as well as other relevant and available
industry resources in setting policyholder behavior assumptions. The significant assumptions used
to value the GMIB assets and liabilities as of September 30, 2010 were as follows:
|
|
The market return and discount rate assumptions are based on the market-observable LIBOR swap curve. |
|
|
The projected interest rate used to calculate the reinsured income benefits is indexed to the 7-year Treasury Rate at
the time of annuitization (claim interest rate) based on contractual terms. That rate was 1.91% at September 30, 2010
and must be projected for future time periods. These projected rates vary by economic scenario and are determined by an
interest rate model using current interest rate curves and the prices of instruments available in the market including
various interest rate caps and zero-coupon bonds. For a subset of the business, there is a contractually guaranteed
floor of 3% for the claim interest rate. |
|
|
The market volatility assumptions for annuitants underlying mutual fund investments that are modeled based on the S&P
500, Russell 2000 and NASDAQ Composite are based on the market-implied volatility for these indices for three to seven
years grading to historical volatility levels thereafter. For the remaining 55% of underlying mutual fund investments
modeled based on other indices (with insufficient market-observable data), volatility is based on the average
historical level for each index over the past 10 years. Using this approach, volatility ranges from 17% to 34% for
equity funds, 4% to 12% for bond funds, and 1% to 2% for money market funds. |
|
|
The mortality assumption is 70% of the 1994 Group Annuity Mortality table, with 1% annual improvement beginning January
1, 2000. |
|
|
The annual lapse rate assumption reflects experience that differs by the company issuing the underlying variable
annuity contracts. This range has been updated from 2% to 17% at December 31, 2009 to 1% to 19% as of September 30,
2010, and depends on the time since contract issue and the relative value of the guarantee. Although the upper end of
the range has increased, there is also a higher proportion of policies experiencing lower lapse rates, so overall,
assumed lapse rates have declined since December 31, 2009. |
|
|
The annual annuity election rate assumption reflects experience that differs by the company issuing the underlying
variable annuity contracts and depends on the annuitants age, the relative value of the guarantee and whether a
contractholder has had a previous opportunity to elect the benefit. Immediately after the expiration of the waiting
period, the assumed probability that an individual will annuitize their variable annuity contract is up to 80%. For
the second and subsequent annual opportunities to elect the benefit, the assumed probability of election is up to 30%.
Actual data is still emerging for the Company as well as the industry and the estimates are based on this limited data. |
17
|
|
The nonperformance risk adjustment is incorporated by adding an additional spread to the
discount rate in the calculation of both (1) the GMIB liability to reflect a hypothetical market participants view of the risk of the
Company not fulfilling its GMIB obligations, and (2) the GMIB asset to reflect a hypothetical
market participants view of the reinsurers credit risk, after considering collateral. The
estimated market-implied spread is company-specific for each party involved to the extent that
company-specific market data is available and is based on industry averages for similarly rated
companies when company-specific data is not available. The spread is impacted by the credit
default swap spreads of the specific parent companies, adjusted to reflect subsidiaries credit
ratings relative to their parent company and any available collateral. The additional spread
over LIBOR incorporated into the discount rate ranged from 15 to 115 basis points for the GMIB
liability and from 20 to 85 basis points for the GMIB reinsurance asset for that portion of the
interest rate curve most relevant to these policies. |
|
|
The risk and profit charge assumption is based on the Companys estimate of the capital and
return on capital that would be required by a hypothetical market participant. |
The Company regularly evaluates each of the assumptions used in establishing these assets and
liabilities by considering how a hypothetical market participant would set assumptions at each
valuation date. Capital markets assumptions are expected to change at each valuation date
reflecting currently observable market conditions. Other assumptions may also change based on a
hypothetical market participants view of actual experience as it emerges over time or other
factors that impact the net liability. If the emergence of future experience or future assumptions
differs from the assumptions used in estimating these assets and liabilities, the resulting impact
could be material to the Companys consolidated results of operations, and in certain situations,
could be material to the Companys financial condition.
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 two external
reinsurers and are reported in the Companys Consolidated Balance Sheets in Other assets, including
other intangibles.
18
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 and nine months ended September 30, 2010 and 2009. These tables exclude
separate account assets as changes in fair values of these assets accrue directly to policyholders.
Gains and losses reported in these tables may include net changes in fair value that are
attributable to both observable and unobservable inputs.
For the Three Months Ended September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Equity Securities (2) |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at July 1, 2010 |
|
$ |
945 |
|
|
$ |
658 |
|
|
$ |
(1,221 |
) |
|
$ |
(563 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value gain/(loss) |
|
|
|
|
|
|
24 |
|
|
|
(46 |
) |
|
|
(22 |
) |
Other |
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in shareholders net income |
|
|
5 |
|
|
|
24 |
|
|
|
(46 |
) |
|
|
(22 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains included in other comprehensive income |
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains required to adjust future policy benefits for settlement annuities (1) |
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases, issuances, settlements, net |
|
|
(3 |
) |
|
|
(9 |
) |
|
|
21 |
|
|
|
12 |
|
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers out of Level 3 |
|
|
(24 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2010 |
|
$ |
989 |
|
|
$ |
673 |
|
|
$ |
(1,246 |
) |
|
$ |
(573 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in income attributable to
instruments held at the reporting date |
|
$ |
5 |
|
|
$ |
24 |
|
|
$ |
(46 |
) |
|
$ |
(22 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
|
(2) |
|
Amounts include $3 million of short-term investments. |
For the Three Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Equity Securities |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at July 1, 2009 |
|
$ |
923 |
|
|
$ |
685 |
|
|
$ |
(1,224 |
) |
|
$ |
(539 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value gain/(loss) |
|
|
|
|
|
|
(27 |
) |
|
|
46 |
|
|
|
19 |
|
Other |
|
|
(9 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in shareholders net income |
|
|
(9 |
) |
|
|
(27 |
) |
|
|
46 |
|
|
|
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains included in other comprehensive income |
|
|
36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains required to adjust future policy benefits for settlement annuities |
|
|
56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases, sales, settlements, net |
|
|
7 |
|
|
|
(44 |
) |
|
|
52 |
|
|
|
8 |
|
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
40 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers out of Level 3 |
|
|
(53 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2009 |
|
$ |
1,000 |
|
|
$ |
614 |
|
|
$ |
(1,126 |
) |
|
$ |
(512 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in income attributable to
instruments held at the reporting date |
|
$ |
(9 |
) |
|
$ |
(27 |
) |
|
$ |
46 |
|
|
$ |
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
19
For the Nine Months Ended September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Equity Securities (2) |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at January 1, 2010 |
|
$ |
845 |
|
|
$ |
482 |
|
|
$ |
(903 |
) |
|
$ |
(421 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value gain/(loss) |
|
|
|
|
|
|
211 |
|
|
|
(393 |
) |
|
|
(182 |
) |
Other |
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in shareholders net income |
|
|
17 |
|
|
|
211 |
|
|
|
(393 |
) |
|
|
(182 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains included in other comprehensive income |
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains required to adjust future policy benefits for settlement annuities (1) |
|
|
91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases, issuances, settlements, net |
|
|
(29 |
) |
|
|
(20 |
) |
|
|
50 |
|
|
|
30 |
|
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
99 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers out of Level 3 |
|
|
(64 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
35 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2010 |
|
$ |
989 |
|
|
$ |
673 |
|
|
$ |
(1,246 |
) |
|
$ |
(573 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in income attributable to
instruments held at the reporting date |
|
$ |
14 |
|
|
$ |
211 |
|
|
$ |
(393 |
) |
|
$ |
(182 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
|
(2) |
|
Amounts include $3 million of short-term investments. |
For the Nine Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities & |
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Equity Securities |
|
|
GMIB Assets |
|
|
GMIB Liabilities |
|
|
GMIB Net |
|
Balance at January 1, 2009 |
|
$ |
889 |
|
|
$ |
953 |
|
|
$ |
(1,757 |
) |
|
$ |
(804 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses) included in shareholders net income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value gain/(loss) |
|
|
|
|
|
|
(263 |
) |
|
|
478 |
|
|
|
215 |
|
Other |
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in shareholders net income |
|
|
(19 |
) |
|
|
(263 |
) |
|
|
478 |
|
|
|
215 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains included in other comprehensive income |
|
|
46 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses required to adjust future policy benefits for settlement annuities(1) |
|
|
(51 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Purchases, issuances, settlements, net |
|
|
(3 |
) |
|
|
(76 |
) |
|
|
153 |
|
|
|
77 |
|
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
275 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers out of Level 3 |
|
|
(137 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
138 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2009 |
|
$ |
1,000 |
|
|
$ |
614 |
|
|
$ |
(1,126 |
) |
|
$ |
(512 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gains (losses) included in income attributable to
instruments held at the reporting date |
|
$ |
(19 |
) |
|
$ |
(263 |
) |
|
$ |
478 |
|
|
$ |
215 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts do not accrue to shareholders. |
As noted in the tables above, total gains and losses included in net income are reflected in
the following captions in the Consolidated Statements of Income:
|
|
Realized investment gains (losses) and net investment income for amounts related to fixed
maturities and equity securities; and |
|
|
GMIB fair value (gain) loss for amounts related to GMIB assets and liabilities. |
20
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 nine months ended September
30, 2009, transfers into Level 3 from Level 2 primarily reflect an increase in the unobservable
inputs used to value certain private corporate bonds, principally related to credit risk of the
issuers.
The Company provided reinsurance for other insurance companies that offer a guaranteed minimum
income benefit, and then retroceded a portion of the risk to other insurance companies. These
arrangements with third-party insurers are the instruments still held at the reporting date for
GMIB assets and liabilities in the table above. Because these reinsurance arrangements remain in
effect at the reporting date, the Company has reflected the total gain or loss for the period as
the total gain or loss included in income attributable to instruments still held at the reporting
date. However, the Company reduces the GMIB assets and liabilities resulting from these
reinsurance arrangements when annuitants lapse, die, elect their benefit, or reach the age after
which the right to elect their benefit expires.
Under FASBs guidance for fair value measurements, the Companys GMIB assets and liabilities are
expected to be volatile in future periods because the underlying capital markets assumptions will
be based largely on market-observable inputs at the close of each reporting period including
interest rates and market-implied volatilities.
GMIB fair value losses of $22 million for the three months ended September 30, 2010, and $182
million for the nine months ended September 30, 2010 were primarily due to declining interest
rates, partially offset by increases in underlying account values that occurred during the three
and nine months ended September 30, 2010.
GMIB fair value gains of $19 million for the three months ended September 30, 2009 were primarily a
result of increases in underlying account values during the period and updates to the risk and
profit charge estimates, partially offset by decreases in interest rates and experience varying
from assumptions. GMIB fair value gains of $215 million for the nine months ended September 30,
2009, were primarily a result of increases in interest rates, increases in underlying account
values and updates to the risk and profit charge estimates, partially offset by increases to the
annuitization assumption, experience varying from assumptions and updates to the lapse assumption.
21
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. As of September 30,
2010 and December 31, 2009 separate account assets were as follows:
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in Active |
|
|
|
|
|
|
|
|
|
|
|
|
Markets for Identical |
|
|
Significant Other |
|
|
Significant |
|
|
|
|
|
|
Assets |
|
|
Observable Inputs |
|
|
Unobservable Inputs |
|
|
|
|
(In millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Guaranteed separate accounts (See Note 18) |
|
$ |
271 |
|
|
$ |
1,496 |
|
|
$ |
|
|
|
$ |
1,767 |
|
Non-guaranteed separate accounts (1) |
|
|
1,801 |
|
|
|
3,666 |
|
|
|
564 |
|
|
|
6,031 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total separate account assets |
|
$ |
2,072 |
|
|
$ |
5,162 |
|
|
$ |
564 |
|
|
$ |
7,798 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
As of September 30, 2010, non-guaranteed separate accounts include $2.7 billion in assets
supporting the Companys pension plans, including $515 million classified in Level 3. |
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in Active |
|
|
|
|
|
|
|
|
|
|
|
|
Markets for Identical |
|
|
Significant Other |
|
|
Significant |
|
|
|
|
|
|
Assets |
|
|
Observable Inputs |
|
|
Unobservable Inputs |
|
|
|
|
(In millions) |
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
Guaranteed separate accounts (See Note 18) |
|
$ |
275 |
|
|
$ |
1,480 |
|
|
$ |
|
|
|
$ |
1,755 |
|
Non-guaranteed separate accounts (1) |
|
|
1,883 |
|
|
|
3,100 |
|
|
|
550 |
|
|
|
5,533 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total separate account assets |
|
$ |
2,158 |
|
|
$ |
4,580 |
|
|
$ |
550 |
|
|
$ |
7,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
As of December 31, 2009, non-guaranteed separate accounts include $2.6 billion in assets
supporting the Companys pension plans, including $517 million classified in Level 3. |
Separate account assets in Level 1 include exchange-listed equity securities. Level 2 assets
primarily include:
|
|
equity securities and corporate and structured bonds valued using recent trades of similar
securities or pricing models that discount future cash flows at estimated market interest
rates as described above; and |
|
|
actively-traded institutional and retail mutual fund investments and separate accounts
priced using the daily net asset value which is their exit price. |
Separate account assets classified in Level 3 include investments primarily in securities
partnerships and real estate generally valued based on the separate accounts ownership share of
the equity of the investee including changes in the fair values of its underlying investments. In
addition, certain fixed income funds priced using their net asset values are classified in Level 3
due to restrictions on their withdrawal.
The following tables summarize the changes in separate account assets reported in Level 3 for the
three months and nine months ended September 30, 2010 and 2009.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Balance at July 1 |
|
$ |
534 |
|
|
$ |
625 |
|
Policyholder gains (losses) (1) |
|
|
17 |
|
|
|
(18 |
) |
Purchases, issuances, settlements |
|
|
12 |
|
|
|
(23 |
) |
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
3 |
|
|
|
|
|
Transfers out of Level 3 |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30 |
|
$ |
564 |
|
|
$ |
584 |
|
|
|
|
|
|
|
|
22
|
|
|
(1) |
|
Includes gains of $5 million attributable to instruments still held at September 30, 2010 and
losses of $20 million attributable to instruments still held at September 30, 2009. |
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Balance at January 1 |
|
$ |
550 |
|
|
$ |
475 |
|
Policyholder gains (losses) (1) |
|
|
31 |
|
|
|
(85 |
) |
Purchases, issuances, settlements, net |
|
|
1 |
|
|
|
34 |
|
Transfers into/(out of) Level 3: |
|
|
|
|
|
|
|
|
Transfers into Level 3 |
|
|
4 |
|
|
|
174 |
|
Transfers out of Level 3 |
|
|
(22 |
) |
|
|
(14 |
) |
|
|
|
|
|
|
|
Total transfers into/(out of) Level 3 |
|
|
(18 |
) |
|
|
160 |
|
|
|
|
|
|
|
|
Balance at September 30 |
|
$ |
564 |
|
|
$ |
584 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes gains of $16 million attributable to instruments still held at September 30, 2010 and
losses of $88 million attributable to instruments still held at September 30, 2009. |
For the nine months ended September 30, 2009, transfers into Level 3 primarily represented fixed
income funds that are priced using the net asset value where restrictions were placed on
withdrawal.
Assets and Liabilities Measured at Fair Value under Certain Conditions
Some financial assets and liabilities are not carried at fair value each reporting period, but may
be measured using fair value only under certain conditions, such as investments in real estate
entities and commercial mortgage loans when they become impaired. During the three months ended
September 30, 2010, impaired commercial mortgage loans with carrying values of $47 million were
written down to their fair values of $46 million, resulting in pre-tax realized investment losses
of $1 million. During the nine months ended September 30, 2010, impaired commercial mortgage loans
with carrying values of $138 million were written down to their fair values of $121 million,
resulting in pre-tax realized investment losses of $17 million. Also during the nine months ended
September 30, 2010, impaired real estate entities carried at cost of $35 million were written down
to their fair values of $21 million, resulting in pre-tax realized investment losses of $14
million.
During 2009, impaired commercial mortgage loans with carrying values of $143 million were written
down to their fair values of $126 million, resulting in pre-tax realized investment losses of $17
million. Also during 2009, impaired real estate entities with carrying values of $48 million were
written down to their fair values of $12 million, resulting in pre-tax realized investment losses
of $36 million.
These fair values were calculated by discounting the expected future cash flows at estimated market
interest rates. Such market rates were derived by calculating the appropriate spread over
comparable U.S. Treasury rates, based on the characteristics of the underlying collateral,
including the type, quality and location of the assets. The fair value measurements were
classified in Level 3 because these cash flow models incorporate significant unobservable inputs.
Fair Value Disclosures for Financial Instruments Not Carried at Fair Value
Most financial instruments that are subject to fair value disclosure requirements are carried in
the Companys consolidated financial statements at amounts that approximate fair value. The
following table provides the fair values and carrying values of the Companys financial instruments
not recorded at fair value that are subject to fair value disclosure requirements at September 30,
2010 and December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010 |
|
|
December 31, 2009 |
|
|
|
|
|
|
|
Carrying |
|
|
|
|
|
|
Carrying |
|
(In millions) |
|
Fair Value |
|
|
Value |
|
|
Fair Value |
|
|
Value |
|
Commercial mortgage loans |
|
$ |
3,508 |
|
|
$ |
3,486 |
|
|
$ |
3,323 |
|
|
$ |
3,522 |
|
Contractholder deposit funds, excluding universal life products |
|
$ |
1,008 |
|
|
$ |
986 |
|
|
$ |
940 |
|
|
$ |
941 |
|
Long-term debt, including current maturities, excluding capital leases |
|
$ |
3,087 |
|
|
$ |
2,727 |
|
|
$ |
2,418 |
|
|
$ |
2,427 |
|
23
The fair values presented in the table above have been estimated using market information when
available. The following is a description of the valuation methodologies and inputs used by the
Company to determine fair value.
Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans
generally by discounting the contractual cash flows at estimated market interest rates that reflect
the Companys assessment of the credit quality of the loans. Market interest rates are derived by
calculating the appropriate spread over comparable U.S. Treasury rates, based on the property type,
quality rating and average life of the loan. The quality ratings reflect the relative risk of the
loan, considering debt service coverage, the loan-to-value ratio and other factors. Fair values of
impaired mortgage loans are based on the estimated fair value of the underlying collateral
generally determined using an internal discounted cash flow model.
Contractholder deposit funds, excluding universal life products. Generally, these funds do not
have stated maturities. Approximately 45% of these balances can be withdrawn by the customer at
any time without prior notice or penalty. The fair value for these contracts is the amount
estimated to be payable to the customer as of the reporting date, which is generally the carrying
value. Most of the remaining contractholder deposit funds are reinsured by the buyers of the
individual life and annuity and retirement benefits businesses. The fair value for these contracts
is determined using the fair value of these buyers assets supporting these reinsured contracts.
The Company had a reinsurance recoverable equal to the carrying value of these reinsured contracts.
Long-term debt, including current maturities, excluding capital leases. The fair value of
long-term debt is based on quoted market prices for recent trades. When quoted market prices are
not available, fair value is estimated using a discounted cash flow analysis and the Companys
estimated current borrowing rate for debt of similar terms and remaining maturities.
Fair values of off-balance-sheet financial instruments were not material.
Note 9 Investments
Total Realized Investment Gains and Losses
The following total realized gains and losses on investments include other-than-temporary
impairments on debt securities but exclude amounts required to adjust future policy benefits for
the run-off settlement annuity business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Fixed maturities |
|
$ |
14 |
|
|
$ |
2 |
|
|
$ |
48 |
|
|
$ |
(9 |
) |
Equity securities |
|
|
4 |
|
|
|
16 |
|
|
|
7 |
|
|
|
10 |
|
Commercial mortgage loans |
|
|
(1 |
) |
|
|
(4 |
) |
|
|
(16 |
) |
|
|
(4 |
) |
Other investments, including derivatives |
|
|
11 |
|
|
|
|
|
|
|
5 |
|
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), before income taxes |
|
|
28 |
|
|
|
14 |
|
|
|
44 |
|
|
|
(40 |
) |
Less income taxes (benefits) |
|
|
10 |
|
|
|
5 |
|
|
|
15 |
|
|
|
(16 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) |
|
$ |
18 |
|
|
$ |
9 |
|
|
$ |
29 |
|
|
$ |
(24 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
24
Included in pre-tax realized investment gains (losses) above were other-than-temporary impairments
on debt securities, asset write-downs and changes in valuation reserves as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Credit-related (1) |
|
$ |
1 |
|
|
$ |
18 |
|
|
$ |
31 |
|
|
$ |
72 |
|
Other (2) |
|
|
|
|
|
|
3 |
|
|
|
1 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total (3) |
|
$ |
1 |
|
|
$ |
21 |
|
|
$ |
32 |
|
|
$ |
84 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Credit-related losses include other-than-temporary declines in value of fixed
maturities and equity securities, and impairments of commercial mortgage loans and real
estate entities. The amount related to credit losses on fixed maturities for which a
portion of the impairment was recognized in other comprehensive income was not
significant.
|
|
(2) |
|
Prior to adoption of GAAP guidance for other-than-temporary impairments on April 1,
2009, other primarily represented the impact of rising market yields on investments where
the Company could not demonstrate the intent and ability to hold until recovery.
|
|
(3) |
|
Includes other-than-temporary impairments on debt securities of $1 million for the
nine months ended September 30, 2010 and $16 million for the three months ended September
30, 2009 and $42 million for the nine months ended September 30, 2009. These impairments
are included in the other category in 2010 and in both the credit-related and other
categories for 2009. |
Fixed Maturities and Equity Securities
Securities in the following table are included in fixed maturities and equity securities on the
Companys Consolidated Balance Sheets. These securities are carried at fair value with changes in
fair value reported in other realized investment gains and interest and dividends reported in net
investment income. The Companys hybrid investments include preferred stock or debt securities
with call or conversion features.
|
|
|
|
|
|
|
|
|
|
|
As of September 30, |
|
|
As of December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Included in fixed maturities: |
|
|
|
|
|
|
|
|
Trading securities (amortized cost: $7; $8) |
|
$ |
7 |
|
|
$ |
8 |
|
Hybrid securities (amortized cost: $36; $37) |
|
|
43 |
|
|
|
43 |
|
|
|
|
|
|
|
|
Total |
|
$ |
50 |
|
|
$ |
51 |
|
|
|
|
|
|
|
|
Included in equity securities: |
|
|
|
|
|
|
|
|
Hybrid securities (amortized cost: $106; $109) |
|
$ |
87 |
|
|
$ |
81 |
|
|
|
|
|
|
|
|
Fixed maturities included $181 million at September 30, 2010, which were pledged as collateral to
brokers as required under certain futures contracts. These fixed maturities were primarily
corporate securities.
The following information about fixed maturities excludes trading and hybrid securities. The
amortized cost and fair value by contractual maturity periods for fixed maturities were as follows
at September 30, 2010:
|
|
|
|
|
|
|
|
|
|
|
Amortized |
|
|
Fair |
|
(In millions) |
|
Cost |
|
|
Value |
|
Due in one year or less |
|
$ |
876 |
|
|
$ |
896 |
|
Due after one year through five years |
|
|
4,424 |
|
|
|
4,777 |
|
Due after five years through ten years |
|
|
4,907 |
|
|
|
5,538 |
|
Due after ten years |
|
|
2,582 |
|
|
|
3,279 |
|
Other asset and mortgage-backed securities |
|
|
656 |
|
|
|
814 |
|
|
|
|
|
|
|
|
Total |
|
$ |
13,445 |
|
|
$ |
15,304 |
|
|
|
|
|
|
|
|
Actual maturities could differ from contractual maturities because issuers may have the right to
call or prepay obligations, with or without penalties. Also, in some cases the Company may extend
maturity dates.
25
Mortgage-backed securities consist principally of commercial mortgage-backed securities and
collateralized mortgage obligations of which $20 million of fair value were residential mortgages
and home equity lines of credit, all of which were originated using standard underwriting practices
and are not sub-prime loans.
Gross unrealized appreciation (depreciation) on fixed maturities (excluding trading securities and
hybrid securities with a fair value of $50 million at September 30, 2010 and $51 million at
December 31, 2009) by type of issuer is shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010 |
|
|
|
|
|
|
|
Unrealized |
|
|
Unrealized |
|
|
|
|
|
|
Amortized |
|
|
Appre- |
|
|
Depre- |
|
|
Fair |
|
(In millions) |
|
Cost |
|
|
ciation |
|
|
ciation |
|
|
Value |
|
Federal government and agency |
|
$ |
514 |
|
|
$ |
311 |
|
|
$ |
|
|
|
$ |
825 |
|
State and local government |
|
|
2,337 |
|
|
|
270 |
|
|
|
(3 |
) |
|
|
2,604 |
|
Foreign government |
|
|
1,074 |
|
|
|
89 |
|
|
|
(1 |
) |
|
|
1,162 |
|
Corporate |
|
|
8,864 |
|
|
|
1,056 |
|
|
|
(21 |
) |
|
|
9,899 |
|
Federal agency mortgage-backed |
|
|
16 |
|
|
|
1 |
|
|
|
|
|
|
|
17 |
|
Other mortgage-backed |
|
|
85 |
|
|
|
10 |
|
|
|
(6 |
) |
|
|
89 |
|
Other asset-backed |
|
|
555 |
|
|
|
160 |
|
|
|
(7 |
) |
|
|
708 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
13,445 |
|
|
$ |
1,897 |
|
|
$ |
(38 |
) |
|
$ |
15,304 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
December 31, 2009 |
|
Federal government and agency |
|
$ |
398 |
|
|
$ |
174 |
|
|
$ |
(1 |
) |
|
$ |
571 |
|
State and local government |
|
|
2,341 |
|
|
|
188 |
|
|
|
(8 |
) |
|
|
2,521 |
|
Foreign government |
|
|
1,040 |
|
|
|
38 |
|
|
|
(8 |
) |
|
|
1,070 |
|
Corporate |
|
|
8,104 |
|
|
|
529 |
|
|
|
(98 |
) |
|
|
8,535 |
|
Federal agency mortgage-backed |
|
|
33 |
|
|
|
1 |
|
|
|
|
|
|
|
34 |
|
Other mortgage-backed |
|
|
125 |
|
|
|
5 |
|
|
|
(10 |
) |
|
|
120 |
|
Other asset-backed |
|
|
494 |
|
|
|
55 |
|
|
|
(8 |
) |
|
|
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
12,535 |
|
|
$ |
990 |
|
|
$ |
(133 |
) |
|
$ |
13,392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above table includes investments with a fair value of $2.7 billion supporting the Companys
run-off settlement annuity business, with gross unrealized appreciation of $697 million and gross
unrealized depreciation of $14 million at September 30, 2010. Such unrealized amounts are required
to support future policy benefit liabilities of this business and, as such, are not included in
accumulated other comprehensive income. At December 31, 2009, investments supporting this business
had a fair value of $2.3 billion, gross unrealized appreciation of $326 million and gross
unrealized depreciation of $52 million.
Sales information for available-for-sale fixed maturities and equity securities were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Proceeds from sales |
|
$ |
239 |
|
|
$ |
266 |
|
|
$ |
688 |
|
|
$ |
676 |
|
Gross gains on sales |
|
$ |
9 |
|
|
$ |
24 |
|
|
$ |
36 |
|
|
$ |
39 |
|
Gross losses on sales |
|
$ |
|
|
|
$ |
(5 |
) |
|
$ |
(3 |
) |
|
$ |
(8 |
) |
26
Review of declines in fair value. Management reviews fixed maturities with a decline in fair value
from cost for impairment based on criteria that include:
|
|
length of time and severity of decline; |
|
|
financial health and specific near term prospects of the issuer; |
|
|
changes in the regulatory, economic or general market environment of the issuers industry
or geographic region; and |
|
|
the Companys intent to sell or the likelihood of a required sale prior to recovery. |
Excluding trading and hybrid securities, as of September 30, 2010, fixed maturities with a decline
in fair value from amortized cost (which were primarily investment grade corporate bonds) were as
follows, including the length of time of such decline:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair |
|
|
Amortized |
|
|
Unrealized |
|
|
Number |
|
(In millions) |
|
Value |
|
|
Cost |
|
|
Depreciation |
|
|
of Issues |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year or less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade |
|
$ |
180 |
|
|
$ |
183 |
|
|
$ |
(3 |
) |
|
|
75 |
|
Below investment grade |
|
$ |
43 |
|
|
$ |
45 |
|
|
$ |
(2 |
) |
|
|
30 |
|
More than one year: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade |
|
$ |
297 |
|
|
$ |
325 |
|
|
$ |
(28 |
) |
|
|
60 |
|
Below investment grade |
|
$ |
52 |
|
|
$ |
57 |
|
|
$ |
(5 |
) |
|
|
30 |
|
The unrealized depreciation of investment grade fixed maturities is primarily due to increases in
market yields since purchase. There were no equity securities with a fair value significantly
lower than cost as of September 30, 2010.
Short-term investments and cash equivalents. Short-term investments and cash equivalents includes
corporate securities of $933 million, federal government securities of $82 million and money market
funds of $78 million at September 30, 2010. Short-term investments also include $3 million of
hybrid securities carried at fair value. The Companys short-term investments and cash equivalents
at December 31, 2009 included corporate securities of $624 million, federal government securities
of $402 million and money market funds of $104 million.
27
Note 10 Derivative Financial Instruments
The Companys investment strategy is to manage the characteristics of investment assets (such as
duration, yield, currency and liquidity) to meet the varying demands of the related insurance and
contractholder liabilities (such as paying claims, investment returns and withdrawals). As part of
this investment strategy, the Company typically uses derivatives to minimize interest rate, foreign
currency and equity price risks. The Company routinely monitors exposure to credit risk associated
with derivatives and diversifies the portfolio among approved dealers of high credit quality to
minimize credit risk. From time to time, the Company has used derivatives to enhance investment
returns. In addition, the Company has written or sold contracts to guarantee minimum income
benefits.
The Company uses hedge accounting when derivatives are designated, qualified and highly effective
as hedges. Effectiveness is formally assessed and documented at inception and each period
throughout the life of a hedge using various quantitative methods appropriate for each hedge,
including regression analysis and dollar offset. Under hedge accounting, the changes in fair value
of the derivative and the hedged risk are generally recognized together and offset each other when
reported in shareholders net income.
The Company accounts for derivative instruments as follows:
|
|
Derivatives are reported on the balance sheet at fair value with changes in fair values
reported in net income or accumulated other comprehensive income. |
|
|
Changes in the fair value of derivatives that hedge market risk related to future cash
flows and that qualify for hedge accounting are reported in a separate caption in
accumulated other comprehensive income. These hedges are referred to as cash flow hedges. |
|
|
A change in the fair value of a derivative instrument may not always equal the change in
the fair value of the hedged item; this difference is referred to as hedge ineffectiveness.
Where hedge accounting is used, the Company reflects hedge ineffectiveness in net income
(generally as part of realized investment gains and losses). |
Certain subsidiaries of the Company are parties to over-the-counter derivative instruments that
contain provisions requiring both parties to such instruments to post collateral depending on net
liability thresholds and the partys financial strength or credit rating. The collateral posting
requirements vary by counterparty. The aggregate fair value of derivative instruments with such
credit-risk-related contingent features where a subsidiary of the Company was in a net liability
position as of September 30, 2010 was $24 million for which the Company was not required to post
collateral with its counterparties. If the various contingent features underlying the agreements
were triggered as of September 30, 2010, the Company would be required to post collateral equal to
the total net liability. Such subsidiaries are parties to certain other derivative instruments
that contain termination provisions for which the counterparties could demand immediate payment of
the total net liability position if the financial strength rating of the subsidiary were to decline
below specified levels. As of September 30, 2010, there was no net liability position under such
derivative instruments.
See Note 7 for a discussion of derivatives associated with GMDB contracts and Note 8 for a
discussion of derivatives associated with GMIB contracts. The effects of other derivatives were
not material to the Companys consolidated results of operations, liquidity or financial condition
for the nine months ended September 30, 2010 and 2009.
The tables below present information about the nature and accounting treatment of the Companys
primary derivative financial instruments including the Companys purpose for entering into specific
derivative transactions, and their locations in and effect on the financial statements as of
September 30, 2010 and December 31, 2009 and for the three and nine months ended September 30, 2010
and 2009. Derivatives in the Companys separate accounts are excluded from the tables because
associated gains and losses generally accrue directly to policyholders.
28
|
|
|
|
|
|
|
|
|
Instrument / Volume |
|
|
|
|
|
|
|
|
of Activity |
|
Primary Risk |
|
Purpose |
|
Cash Flows |
|
Accounting Policy |
|
|
|
|
|
|
|
|
Derivatives Designated as Accounting Hedges Cash Flow Hedges |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
$157 million of
par value of
related investments
Foreign currency
swaps $169
million of U.S.
dollar equivalent
par value of
related investments
Combination swaps
(interest rate and
foreign currency)
$64 million of U.S.
dollar equivalent
par value of
related investments
|
|
Interest rate and
foreign currency
|
|
To hedge the interest and/or foreign
currency cash flows of fixed maturities
and commercial mortgage loans to match
associated liabilities. Currency swaps
are primarily euros, Australian dollars,
Canadian dollars and British pounds for
periods of up to 11 years.
|
|
The Company periodically exchanges cash
flows between variable and fixed
interest rates and/or between two
currencies for both principal and
interest. Net interest cash flows are
reported in operating activities.
|
|
Using cash flow hedge accounting, fair values are reported in other long-term investments or other
liabilities and accumulated other comprehensive income
and amortized into net investment income or reported in
other realized investment gains and losses as interest or
principal payments are received. |
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts Payable, Accrued |
|
|
Gain (Loss) Recognized in Other |
|
|
|
Other Long-Term Investments |
|
|
Expenses and Other Liabilities |
|
|
Comprehensive Income (1) |
|
|
|
As of |
|
|
As of |
|
|
As of |
|
|
As of |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
December 31, |
|
|
September 30, |
|
|
December 31, |
|
|
September 30, |
|
|
September 30, |
|
Instrument |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Interest rate swaps |
|
$ |
12 |
|
|
$ |
8 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
1 |
|
|
$ |
1 |
|
|
$ |
4 |
|
|
$ |
(4 |
) |
Foreign currency
swaps |
|
|
5 |
|
|
|
4 |
|
|
|
19 |
|
|
|
24 |
|
|
|
(11 |
) |
|
|
(7 |
) |
|
|
7 |
|
|
|
(22 |
) |
Interest rate and
foreign currency
swaps |
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
6 |
|
|
|
(9 |
) |
|
|
(4 |
) |
|
|
(1 |
) |
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
17 |
|
|
$ |
12 |
|
|
$ |
26 |
|
|
$ |
30 |
|
|
$ |
(19 |
) |
|
$ |
(10 |
) |
|
$ |
10 |
|
|
$ |
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Other comprehensive income for foreign currency swaps excludes amounts required to adjust future policy benefits for the run-off settlement annuity business. |
|
|
|
|
|
|
|
|
|
Purchased options
$318 million of
cash surrender
value of related
life insurance
policies
|
|
Interest rate
|
|
To hedge the possibility of early
policyholder cash surrender when the
amortized cost of underlying invested
assets is greater than their fair
values.
|
|
The Company pays a fee and may receive
or pay cash, based on the difference
between the amortized cost and fair
values of underlying invested assets at
the time of policyholder surrender.
These cash flows will be reported in
financing activities.
|
|
Using cash flow hedge accounting, fair values are
reported in other assets or other liabilities, with
changes in fair value reported in accumulated other
comprehensive income and amortized to other benefit
expenses over the life of the underlying invested assets. |
|
|
|
|
|
|
Fair Value Effect on the Financial Statements |
|
|
|
|
|
|
|
|
|
|
|
Fair values reported in other assets and other comprehensive income were not significant. |
|
|
|
|
|
|
|
|
|
Treasury lock
|
|
Interest rate
|
|
To hedge the variability of and fix at
inception date, the benchmark Treasury
rate component of future interest
payments on debt to be issued.
|
|
The Company paid the fair value of the
contract at the expiration. Cash flows
were reported in operating activities.
|
|
Using cash flow hedge accounting, fair values are
reported in other assets or other liabilities, with
changes in fair value reported in accumulated other
comprehensive income and amortized to interest expense
over the life of the debt issued. |
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial Statements |
|
|
|
|
|
|
|
|
|
|
|
In the first quarter of 2009, all treasury locks matured and the Company recognized a gain of $14 million in other comprehensive income, resulting in net cumulative losses of
$26 million, to be amortized to interest expense over the life of the debt. In the second quarter of 2009, the Company issued debt and began amortizing this loss to interest
expense. |
For the three and nine months ended September 30, 2010 and 2009, the amount of gains (losses)
reclassified from accumulated other comprehensive income into income was not significant. No gains
(losses) were recognized due to ineffectiveness and no amounts were excluded from the assessment of
hedge ineffectiveness.
29
|
|
|
|
|
|
|
|
|
Instrument / Volume |
|
|
|
|
|
|
|
|
of Activity |
|
Primary Risk |
|
Purpose |
|
Cash Flows |
|
Accounting Policy |
Derivatives Not Designated As Accounting Hedges |
|
|
|
|
|
|
|
|
|
Futures $1,103
million of U.S.
dollar equivalent
market price of
outstanding
contracts
|
|
Equity and foreign
currency
|
|
To reduce domestic and international equity market
exposures for certain reinsurance contracts that
guarantee minimum death benefits (GMDB) resulting
from changes in variable annuity account values based
on underlying mutual funds. Currency futures are
primarily euros, Japanese yen and British pounds.
|
|
The Company receives (pays) cash daily in the amount
of the change in fair value of the futures contracts.
Cash flows are included in operating activities.
|
|
Fair value changes are reported in other revenues. Amounts not yet settled from
the previous days fair value change (daily variation margin) are reported in
premiums, accounts and notes receivable, net or accounts payable, accrued
expenses and other liabilities. |
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Futures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(119 |
) |
|
$ |
(161 |
) |
|
$ |
(72 |
) |
|
$ |
(232 |
) |
|
|
|
|
|
|
|
|
|
Interest rate swaps
$45 million of
par value of
related investments
|
|
Interest rate
|
|
To hedge the interest cash flows of fixed maturities
to match associated liabilities.
|
|
The Company periodically exchanges cash flows between
variable and fixed interest rates and these cash
flows are included in investing activities.
|
|
Fair values are reported in other long-term investments or other liabilities,
with changes in fair value reported in other realized investment gains and
losses. |
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Long-Term Investments |
|
|
|
|
|
|
|
|
|
|
Realized Investment Gains (Losses) |
|
|
|
As of |
|
|
As of |
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
December 31, |
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2010 |
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Interest rate swaps |
|
$ |
4 |
|
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
2 |
|
|
$ |
(1 |
) |
|
|
|
|
|
|
|
|
|
Written options
(GMIB liability)
$1,289 million of
maximum potential
undiscounted future
payments as defined
in Note 18
Purchased options
(GMIB asset) $709
million of maximum
potential
undiscounted future
receipts as defined
in Note 18
|
|
Equity and interest
rate
|
|
The Company has written reinsurance contracts with
issuers of variable annuity contracts that provide
annuitants with certain guarantees of minimum income
benefits, resulting from the level of variable
annuity account values compared with a contractually
guaranteed amount. Payment by the Company depends on
the actual account value in the underlying mutual
funds and the level of interest rates when the
contractholders elect to receive minimum income
payments. The Company purchased reinsurance
contracts to reduce a portion of the market risks
assumed. These contracts are accounted for as
written and purchased options.
|
|
The Company periodically receives (pays) fees based
on either contractholders account values or deposits
increased at a contractual rate. The Company will
also pay (receive) cash depending on changes in
account values and interest rates when
contractholders first elect to receive minimum income
payments. These cash flows are reported in operating
activities.
|
|
Fair values are reported in other liabilities (GMIB liability) and other assets
(GMIB asset). Changes in fair value are reported in GMIB fair value (gain)/loss. |
|
|
|
|
|
|
|
|
|
|
|
Fair Value Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts Payable, Accrued |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses and Other |
|
|
|
|
|
|
Other Assets |
|
|
Liabilities |
|
|
GMIB Fair Value (Gain)/Loss |
|
|
|
As of |
|
|
As of |
|
|
As of |
|
|
As of |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
December 31, |
|
|
September 30, |
|
|
December 31, |
|
|
September 30, |
|
|
September 30, |
|
Instrument |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Written options
(GMIB liability) |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,246 |
|
|
$ |
903 |
|
|
$ |
46 |
|
|
$ |
(46 |
) |
|
$ |
393 |
|
|
$ |
(478 |
) |
Purchased options
(GMIB asset) |
|
|
673 |
|
|
|
482 |
|
|
|
|
|
|
|
|
|
|
|
(24 |
) |
|
|
27 |
|
|
|
(211 |
) |
|
|
263 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
673 |
|
|
$ |
482 |
|
|
$ |
1,246 |
|
|
$ |
903 |
|
|
$ |
22 |
|
|
$ |
(19 |
) |
|
$ |
182 |
|
|
$ |
(215 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30
Note 11 Variable Interest Entities
When the Company becomes involved with a variable interest entity and when the nature of the
Companys involvement with the entity changes, in order to determine if the Company is the primary
beneficiary and must consolidate the entity, it evaluates:
|
|
the structure and purpose of the entity; |
|
|
|
the risks and rewards created by and shared through the entity; and |
|
|
|
the entitys participants ability to direct the activities, receive its benefits and
absorb its losses. Participants include the entitys sponsors, equity holders, guarantors,
creditors and servicers. |
In the normal course of its investing activities, the Company makes passive investments in debt and
equity securities that are issued by variable interest entities. The Company does not consolidate
these entities because either:
|
|
it was not the sponsor or manager and had no power to direct the activities that most
significantly impacted the entities economic performance; or |
|
|
it had no right to receive benefits nor obligation to absorb losses that could be
significant to these variable interest entities. |
The Companys maximum exposure to loss related to these entities is limited to the carrying amount
of its investment. The Company performs ongoing qualitative analyses of its involvement with these
variable interest entities to determine if consolidation is required.
The Company recorded pre-tax income of $9 million for the three months and $22 million for the nine
months ended September 30, 2010 from these investments. Additional information about the nature
and activities of these unconsolidated variable interest entities is provided below.
|
|
|
|
|
|
|
Variable |
|
|
|
Factors Considered in Determining |
|
Risk Exposure and Effect on the |
Interests |
|
Nature, Purpose and Activities |
|
Consolidation Not Required |
|
Financial Statements |
|
Fixed maturities
Foreign bank
obligations $409
million par value
interest of total
$1,125 million par
value
|
|
To create a more active
market for perpetual
floating-rate subordinated
notes issued by foreign
banks, special-purpose trusts
are formed to purchase these
notes and sell participation
interests to investors in the
form of fixed-rate debt
securities and equity
interests. The trusts also
purchase derivative contracts
to exchange the floating-rate
cash flows for fixed-rate and
obtain guarantees from third
parties to support these
fixed-rate payments to its
debt holders. In certain
trusts, the foreign bank
perpetual notes were replaced
with U.S.
government-sponsored bonds.
The Company owns a share of
the debt securities issued by
the trust and receives
fixed-rate cash flows for a
stated period.
|
|
The third-party guarantors of the debt
securities issued by the trust generally
control the activities that most
significantly impact the trusts economic
performance, are obligated to absorb any
losses, and are the primary beneficiaries.
|
|
The Companys maximum exposure to loss is
equal to the fair value of its variable
interests reported on the balance sheet in
fixed maturities. Unrealized changes in fair
value are reported in accumulated other
comprehensive income. Realized changes in
fair value (impairment or sale) are reported
in realized investment gains (losses), and
interest earned is reported in net investment
income. |
|
|
|
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (Loss) Recognized in Other |
|
|
Income from Continuing Operations before |
|
Fixed Maturities |
|
|
Comprehensive Income (1) |
|
|
Income Taxes (1) |
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
As of September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
$ |
534 |
|
|
$ |
3 |
|
|
$ |
10 |
|
|
$ |
1 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Other comprehensive income excludes gains of $30 million for the three months and gains of $87 million for the nine months ended
September 30, 2010 and income from continuing operations before income taxes excludes gains of $7 million for the three months and
gains of $20 million for the nine months ended September 30, 2010 of amounts required to adjust future policy benefits for the
run-off settlement annuity business. |
31
|
|
|
|
|
|
|
Variable |
|
|
|
Factors Considered in Determining |
|
Risk Exposure and Effect on the |
Interests |
|
Nature, Purpose and Activities |
|
Consolidation Not Required |
|
Financial Statements |
|
|
Fixed maturities
Mortgage and other
asset backed
securities $338
million par value
interest of total
$44,075 million par
value
|
|
Special-purpose
entities are created by
third-party sponsors to
increase the
availability of
financing for
commercial or
residential mortgages
or other assets and
provide investors with
diversified exposure to
these assets.
Generally, the entities
purchase mortgage loans
or other assets,
assemble pools of these
assets and sell senior
or subordinated
securities to investors
based on their risk
tolerance. The
securities represent a
right to a share of the
cash flows from the
underlying assets in
the pool. Typically,
the most subordinate
holder bears the first
risk of loss and
potential for higher
returns. The Company
owns a minority share
of senior securities
and receives fixed-rate
cash flows.
|
|
Third-party sponsors generally control the
activities that most significantly impact the
entities economic performance, bear the
first risk of loss and receive any residual
returns, and are primary beneficiaries. In
certain circumstances (such as when
unexpected losses occur), the sponsor may
lose the power to direct the entitys
activities and control would rest with the
next most subordinate investor.
|
|
The Companys maximum exposure to loss is
equal to the fair value of its variable
interests reported on the balance sheet in
fixed maturities. Unrealized changes in fair
value are reported in accumulated other
comprehensive income. Realized changes in
fair value (impairment or sale) are reported
in realized investment gains (losses), and
interest earned is reported in net investment
income. |
|
|
|
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (Loss) Recognized in Other |
|
|
Income from Continuing Operations before |
|
Fixed Maturities |
|
|
Comprehensive Income |
|
|
Income Taxes |
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
As of September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
$ |
319 |
|
|
$ |
4 |
|
|
$ |
19 |
|
|
$ |
5 |
|
|
$ |
14 |
|
|
|
|
|
|
|
|
Equity securities
and fixed
maturities Other
$56 million par
value interest of
total $6,145
million par value
|
|
Special-purpose trust
entities are created by
banks to gain access to
capital markets,
maintain required
regulatory capital and
receive tax deductions
for interest paid on
debt obligations.
These entities purchase
subordinated notes
issued and guaranteed
by the sponsoring banks
and sell debt or equity
securities. Equity
interests in these
entities are held by
their sponsoring banks.
The Company owns a
minority share of these
debt and equity
securities and receives
fixed cash flows.
|
|
The banks that create these trusts control
the activities that most significantly impact
their economic performance, are obligated to
absorb any losses and are the primary
beneficiaries.
|
|
The Companys maximum exposure to loss is
equal to the fair value of its variable
interests reported on the balance sheet in
equity securities and fixed maturities.
Unrealized changes in fair value are reported
in accumulated other comprehensive income.
Realized changes in fair value (impairment or
sale) are reported in realized investment
gains (losses), and interest earned is
reported in net investment income. |
|
|
|
|
|
|
|
|
|
|
|
|
Effect on the Financial Statements (In millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Securities and |
|
|
Gain (Loss) Recognized in Other
|
|
|
Income from Continuing Operations before |
|
Fixed Maturities |
|
|
Comprehensive Income (1) |
|
|
Income Taxes (1) |
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
As of September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
|
September 30, 2010 |
|
$ |
52 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
3 |
|
|
$ |
5 |
|
|
|
|
(1) |
|
Other comprehensive income excludes gains of $2 million for the three months and gains of $6 million for the nine months
ended September 30, 2010 and income from continuing operations before income taxes excludes gains of $1 million for the three
months and gains of $2 million for the nine months ended September 30, 2010 of amounts required to adjust future policy
benefits for the run-off settlement annuity business. |
32
In addition to the variable interest entities described above, as of September 30, 2010 the Company
was also involved in:
|
|
trusts that are variable interest entities controlled by contractual provisions and holding
investments that secure certain reinsurance recoverables resulting from the sales of the
retirement benefits and individual life insurance and annuity businesses (see Note 12 for
further information); |
|
|
a real estate joint venture with a carrying value of $11 million where all decisions
significantly affecting the entitys economic performance are subject to unanimous approval by
the equity holders. As a result, the Company determined that the power over this entity is
shared equally, and there is no primary beneficiary. The Companys maximum exposure to loss
was equal to its carrying value; and |
|
|
certain fixed maturities with an aggregate fair value of $13 million issued by entities
subject to troubled debt restructurings or bankruptcy proceedings. As a result, the equity
owners no longer have the power to direct the significant activities of the entities. The
Companys maximum exposure to loss was equal to its fair value. |
The Company does not have the power to direct these entities activities; therefore, it was not the
primary beneficiary and did not consolidate these entities.
Note 12 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 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.
Retirement benefits business. The Company had reinsurance recoverables of $1.7 billion as of
September 30, 2010 and December 31, 2009 from Prudential Retirement Insurance and Annuity Company
resulting from the sale of the retirement benefits business, which was primarily in the form of a
reinsurance arrangement. The reinsurance recoverable, which is reduced as the Companys reinsured
liabilities are paid or directly assumed by the reinsurer, is secured primarily by fixed maturities
whose book value is equal to or greater than 100% of the reinsured liabilities. These fixed
maturities are held in a trust established for the benefit of the Company. As of September 30,
2010, the book value of the trust assets exceeded the recoverable.
Individual life and annuity reinsurance. The Company had reinsurance recoverables of $4.3 billion
as of September 30, 2010 and $4.4 billion as of December 31, 2009 from The Lincoln National Life
Insurance Company and Lincoln Life & Annuity of New York resulting from the 1998 sale of the
Companys individual life insurance and annuity business through indemnity reinsurance
arrangements. At September 30, 2010, the $3.9 billion reinsurance recoverable from The Lincoln
National Life Insurance Company was secured by assets held in a trust established for the benefit
of the Company, and was less than the market value of the trust assets. The remaining recoverable
from Lincoln Life & Annuity of New York of $410 million is currently unsecured, however, if this
reinsurer does not maintain a specified minimum credit or claims paying rating, it is required to
fully secure the outstanding balance. As of September 30, 2010 both companies had ratings
sufficient to avoid triggering a contractual obligation.
Other Ceded and Assumed Reinsurance
Ceded Reinsurance: Ongoing operations. The Companys insurance subsidiaries have reinsurance
recoverables from various reinsurance arrangements in the ordinary course of business for its
Health Care, Disability and Life, and International segments as well as the non-leveraged and
leveraged corporate-owned life insurance business. Reinsurance recoverables of $295 million as of
September 30, 2010 are expected to be collected from more than 90 reinsurers.
The Company reviews its reinsurance arrangements and establishes reserves against the recoverables
in the event that recovery is not considered probable. As of September 30, 2010, the Companys
recoverables related to these segments were net of a reserve of $8 million.
Assumed and Ceded reinsurance: Run-off Reinsurance segment. The Companys Run-off Reinsurance
operations assumed risks related to GMDB contracts, GMIB contracts, workers compensation, and
personal accident business. The Companys Run-off Reinsurance operations also purchased
retrocessional coverage to reduce the risk of loss on these contracts.
33
Liabilities related to GMDB, workers compensation and personal accident are included in future
policy benefits and unpaid claims. Because the GMIB contracts are treated as derivatives under
GAAP, the asset related to GMIB is recorded in the caption Other assets, including other
intangibles and the liability related to GMIB is recorded in the caption Accounts payable, accrued
expenses, and other liabilities on the Companys Consolidated Balance Sheets (see Notes 8 and 18
for additional discussion of the GMIB assets and liabilities).
The reinsurance recoverables for GMDB, workers compensation, and personal accident of $108 million
as of September 30, 2010 are expected to be collected from approximately 80 retrocessionaires.
The Company reviews its reinsurance arrangements and establishes reserves against the recoverables
in the event that recovery is not considered probable. As of September 30, 2010, the Companys
recoverables related to this segment were net of a reserve of $6 million.
The Companys payment obligations for underlying reinsurance exposures assumed by the Company under
these contracts are based on the ceding companies claim payments. For GMDB, claim payments vary
because of changes in equity markets and interest rates, as well as claim mortality and
contractholder behavior. For workers compensation and personal accident, the payments relate to
accidents and injuries. Any of these claim payments can extend many years into the future, and the
amount of the ceding companies ultimate claims, and therefore the amount of the Companys ultimate
payment obligations and corresponding ultimate collection from retrocessionaires, may not be known
with certainty for some time.
Summary. The Companys reserves for underlying reinsurance exposures assumed by the Company, as
well as for amounts recoverable from reinsurers/retrocessionaires for both ongoing operations and
the run-off reinsurance operation, are considered appropriate as of September 30, 2010, based on
current information. However, it is possible that future developments could have a material
adverse effect on the Companys consolidated results of operations and, in certain situations, such
as if actual experience differs from the assumptions used in estimating reserves for GMDB, could
have a material adverse effect on the Companys financial condition. The Company bears the risk of
loss if its retrocessionaires do not meet or are unable to meet their reinsurance obligations to
the Company.
Effects of reinsurance. In the Companys 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 |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Ceded premiums and fees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Individual life insurance and annuity business sold |
|
$ |
47 |
|
|
$ |
49 |
|
|
$ |
142 |
|
|
$ |
150 |
|
Other |
|
|
52 |
|
|
|
56 |
|
|
|
181 |
|
|
|
171 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
99 |
|
|
$ |
105 |
|
|
$ |
323 |
|
|
$ |
321 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance recoveries |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Individual life insurance and annuity business sold |
|
$ |
87 |
|
|
$ |
87 |
|
|
$ |
235 |
|
|
$ |
214 |
|
Other |
|
|
45 |
|
|
|
42 |
|
|
|
138 |
|
|
|
124 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
132 |
|
|
$ |
129 |
|
|
$ |
373 |
|
|
$ |
338 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34
Note 13 Pension and Other Postretirement Benefit Plans
The Company and certain of its subsidiaries provide pension, health care and life insurance defined
benefits to eligible retired employees, spouses and other eligible dependents through various
domestic and foreign plans. The effect of its foreign pension and other postretirement benefit
plans is immaterial to the Companys results of operations, liquidity and financial position.
Effective July 1, 2009, the Company froze its primary domestic defined benefit pension plans.
For the nine months ended September 30, 2010, the Companys postretirement benefits liability
increased by $150 million pre-tax ($91 million after-tax). This was primarily a result of the
completion of the annual actuarial study during second quarter. The Company updated its mortality
assumption to provide for mortality improvement, which resulted in most of the increase in the
liability.
As a result of the 2009 plan freeze discussed above, a curtailment of benefits occurred in the
second quarter of 2009 because it eliminated all future service for active employees in the
domestic plans. Accordingly, the Company recognized a pre-tax curtailment gain of $46 million ($30
million after-tax) during the second quarter of 2009, which was the remaining unamortized negative
prior service cost at May 31, 2009.
Pension and Other Postretirement Benefits. Components of net pension and net other postretirement
benefit costs were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits |
|
|
Other Postretirement Benefits |
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Service cost |
|
$ |
|
|
|
$ |
1 |
|
|
$ |
1 |
|
|
$ |
43 |
|
|
$ |
|
|
|
$ |
1 |
|
|
$ |
1 |
|
|
$ |
1 |
|
Interest cost |
|
|
61 |
|
|
|
64 |
|
|
|
181 |
|
|
|
187 |
|
|
|
7 |
|
|
|
6 |
|
|
|
17 |
|
|
|
18 |
|
Expected long-term return on plan
assets |
|
|
(63 |
) |
|
|
(60 |
) |
|
|
(189 |
) |
|
|
(180 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
(1 |
) |
Amortization of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (gain) loss from past experience |
|
|
7 |
|
|
|
3 |
|
|
|
21 |
|
|
|
30 |
|
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
(3 |
) |
Prior service cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4 |
) |
|
|
(5 |
) |
|
|
(5 |
) |
|
|
(14 |
) |
|
|
(14 |
) |
Curtailment gain |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(46 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net pension cost |
|
$ |
5 |
|
|
$ |
8 |
|
|
$ |
14 |
|
|
$ |
30 |
|
|
$ |
1 |
|
|
$ |
1 |
|
|
$ |
3 |
|
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company funds its qualified pension plans at least at the minimum amount required by the
Pension Protection Act of 2006. For the nine months ended September 30, 2010, the Company
contributed $212 million, of which $69 million was required and $143 million was voluntary. For
the remainder of 2010, the Company is not required to make any additional contributions.
35
Note 14 Debt
Short-term and long-term debt were as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
Short-term: |
|
|
|
|
|
|
|
|
Commercial paper |
|
$ |
100 |
|
|
$ |
100 |
|
Current maturities of long-term debt |
|
|
226 |
|
|
|
4 |
|
|
|
|
|
|
|
|
Total short-term debt |
|
$ |
326 |
|
|
$ |
104 |
|
|
|
|
|
|
|
|
Long-term: |
|
|
|
|
|
|
|
|
Uncollateralized debt: |
|
|
|
|
|
|
|
|
7% Notes due 2011 |
|
$ |
|
|
|
$ |
222 |
|
6.375% Notes due 2011 |
|
|
226 |
|
|
|
226 |
|
5.375% Notes due 2017 |
|
|
250 |
|
|
|
250 |
|
6.35% Notes due 2018 |
|
|
300 |
|
|
|
300 |
|
8.5% Notes due 2019 |
|
|
349 |
|
|
|
349 |
|
5.125% Notes due 2020 |
|
|
299 |
|
|
|
|
|
6.37% Notes due 2021 |
|
|
78 |
|
|
|
78 |
|
7.65% Notes due 2023 |
|
|
100 |
|
|
|
100 |
|
8.3% Notes due 2023 |
|
|
17 |
|
|
|
17 |
|
7.875% Debentures due 2027 |
|
|
300 |
|
|
|
300 |
|
8.3% Step Down Notes due 2033 |
|
|
83 |
|
|
|
83 |
|
6.15% Notes due 2036 |
|
|
500 |
|
|
|
500 |
|
Other |
|
|
8 |
|
|
|
11 |
|
|
|
|
|
|
|
|
Total long-term debt |
|
$ |
2,510 |
|
|
$ |
2,436 |
|
|
|
|
|
|
|
|
In the first quarter of 2010, the 7% Notes due 2011 were reclassified into current maturities of
long-term debt because they will mature in less than one year.
On May 12, 2010, the Company issued $300 million of 5.125% Notes ($299 million, net of discount,
with an effective interest rate of 5.36% per year). Interest is payable on June 15 and December 15
of each year beginning December 15, 2010. The proceeds of this debt were used for general
corporate purposes. These Notes will mature on June 15, 2020.
On May 4, 2009, the Company issued $350 million of 8.5% Notes ($349 million, net of debt discount,
with an effective interest rate of 9.90% per year). The difference between the stated and
effective interest rates primarily reflects the effect of treasury locks. Interest is payable on
May 1 and November 1 of each year beginning November 1, 2009. The proceeds of this debt were used
for general corporate purposes, including the repayment of some of the Companys outstanding
commercial paper. These Notes will mature on May 1, 2019.
The Company may redeem these Notes, at any time, in whole or in part, at a redemption price equal
to the greater of:
|
|
100% of the principal amount of the Notes to be redeemed; or |
|
|
the present value of the remaining principal and interest payments on the Notes being
redeemed discounted at the applicable treasury rate plus 25 basis points (5.125% Notes due
2020) or 50 basis points (8.5% Notes due 2019). |
36
Note 15 Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss excludes amounts required to adjust future policy benefits for
the run-off settlement annuity business. Changes in accumulated other comprehensive loss were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax |
|
|
|
|
|
|
|
|
|
|
(Expense) |
|
|
After- |
|
(In millions) |
|
Pre-Tax |
|
|
Benefit |
|
|
Tax |
|
Three Months Ended September 30, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation on securities arising during the period |
|
$ |
320 |
|
|
$ |
(110 |
) |
|
$ |
210 |
|
Reclassification adjustment for (gains) included in shareholders net income |
|
|
(18 |
) |
|
|
6 |
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities |
|
$ |
302 |
|
|
$ |
(104 |
) |
|
$ |
198 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized depreciation, derivatives |
|
$ |
(17 |
) |
|
$ |
6 |
|
|
$ |
(11 |
) |
|
|
|
|
|
|
|
|
|
|
Net translation of foreign currencies |
|
$ |
95 |
|
|
$ |
(29 |
) |
|
$ |
66 |
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for amortization of net losses from past
experience and prior service costs |
|
$ |
2 |
|
|
$ |
(1 |
) |
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
Net postretirement benefits liability adjustment |
|
$ |
2 |
|
|
$ |
(1 |
) |
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation on securities arising during the period |
|
$ |
479 |
|
|
$ |
(168 |
) |
|
$ |
311 |
|
Reclassification adjustment for (gains) included in shareholders net income |
|
|
(18 |
) |
|
|
6 |
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities |
|
$ |
461 |
|
|
$ |
(162 |
) |
|
$ |
299 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized depreciation, derivatives |
|
$ |
(9 |
) |
|
$ |
3 |
|
|
$ |
(6 |
) |
|
|
|
|
|
|
|
|
|
|
Net translation of foreign currencies |
|
$ |
46 |
|
|
$ |
(17 |
) |
|
$ |
29 |
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for amortization of net losses from past
experience and prior service costs |
|
$ |
(3 |
) |
|
$ |
2 |
|
|
$ |
(1 |
) |
|
|
|
|
|
|
|
|
|
|
Net postretirement benefits liability adjustment |
|
$ |
(3 |
) |
|
$ |
2 |
|
|
$ |
(1 |
) |
|
|
|
|
|
|
|
|
|
|
37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax |
|
|
|
|
|
|
|
|
|
|
(Expense) |
|
|
After- |
|
(In millions) |
|
Pre-Tax |
|
|
Benefit |
|
|
Tax |
|
Nine Months Ended September 30, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation on securities arising during the year |
|
$ |
645 |
|
|
$ |
(221 |
) |
|
$ |
424 |
|
Reclassification adjustment for (gains) included in shareholders net income |
|
|
(55 |
) |
|
|
19 |
|
|
|
(36 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities |
|
$ |
590 |
|
|
$ |
(202 |
) |
|
$ |
388 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, derivatives |
|
$ |
13 |
|
|
$ |
(4 |
) |
|
$ |
9 |
|
|
|
|
|
|
|
|
|
|
|
Net translation of foreign currencies |
|
$ |
42 |
|
|
$ |
(15 |
) |
|
$ |
27 |
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for amortization of net losses from past
experience and prior service costs |
|
$ |
7 |
|
|
$ |
4 |
|
|
$ |
11 |
|
Net change due to valuation update |
|
|
(157 |
) |
|
|
55 |
|
|
|
(102 |
) |
|
|
|
|
|
|
|
|
|
|
Net postretirement benefits liability adjustment |
|
$ |
(150 |
) |
|
$ |
59 |
|
|
$ |
(91 |
) |
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Implementation effect of updated guidance on other-than-temporary impairments |
|
$ |
(27 |
) |
|
$ |
9 |
|
|
$ |
(18 |
) |
Net unrealized appreciation on securities arising during the year |
|
|
867 |
|
|
|
(300 |
) |
|
|
567 |
|
Reclassification adjustment for losses included in shareholders net income |
|
|
(1 |
) |
|
|
(2 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation, securities |
|
$ |
839 |
|
|
$ |
(293 |
) |
|
$ |
546 |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized depreciation, derivatives |
|
$ |
(22 |
) |
|
$ |
8 |
|
|
$ |
(14 |
) |
|
|
|
|
|
|
|
|
|
|
Net translation of foreign currencies |
|
$ |
68 |
|
|
$ |
(25 |
) |
|
$ |
43 |
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits liability adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for amortization of net losses from past
experience and prior service costs |
|
$ |
9 |
|
|
$ |
(2 |
) |
|
$ |
7 |
|
Curtailment gain |
|
|
(46 |
) |
|
|
16 |
|
|
|
(30 |
) |
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for (gains) included in shareholders net income |
|
|
(37 |
) |
|
|
14 |
|
|
|
(23 |
) |
Net change due to valuation update |
|
|
10 |
|
|
|
(4 |
) |
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
Net postretirement benefits liability adjustment |
|
$ |
(27 |
) |
|
$ |
10 |
|
|
$ |
(17 |
) |
|
|
|
|
|
|
|
|
|
|
Note 16 Income Taxes
A. Income Tax Expense
The Company has historically accrued U.S. income taxes on the undistributed earnings of its foreign
subsidiaries. However, the Company recently began computing income taxes attributable to the South
Korea and Hong Kong operations using the foreign jurisdiction tax rate, as compared to the higher
U.S. statutory tax rate. This change, adopted in 2009 for South Korea and earlier in 2010 for Hong
Kong, was based upon a determination that the prospective earnings of these operations would be
permanently invested overseas.
As a result, shareholders net income for the nine months ended September 30, 2010 increased by $25
million, which included $15 million relative to South Korea and $10 million relative to Hong Kong.
The Hong Kong amount includes $6 million associated with first quarter transition. Shareholders
net income for the nine months of 2009 increased by $22 million, all attributable to South Korea.
Permanent investment of foreign operation earnings has resulted in cumulative unrecognized deferred
tax liabilities of $49 million through September 30, 2010.
B. Unrecognized Tax Benefits
Gross unrecognized tax benefits declined for the nine months ended September 30, 2010 by $36
million due primarily to the reversal of previously established liabilities which were reevaluated
in light of new factors and regulatory guidance. The effect on shareholders net income was not
material.
38
During the first quarter of 2009, the IRS completed its examination of the Companys 2005 and 2006
consolidated federal income tax returns, resulting in an increase to shareholders net income of
$21 million ($20 million in continuing operations and $1 million in discontinued operations). This
increase reflected a reduction in net unrecognized tax benefits of $8 million ($17 million reported
in income tax expense, partially offset by a $9 million pre-tax charge) and a reduction of interest
and penalties of $13 million (reported in income tax expense).
Within the next twelve months, the Company has determined it is reasonably possible that the level
of unrecognized tax benefits could change significantly, subject to the development of matters in
dispute with the IRS. These same developments could also, within the next twelve months, result in
a significant decline in the level of valuation allowances recorded against deferred tax benefits
of the reinsurance operations. These potential changes could increase shareholders net income by
approximately $30 million in the fourth quarter of 2010, subject to the settlement of certain
disputed matters for tax years 2005 and 2006, and an additional $60 million for post-2006 tax
years, the timing of which is uncertain.
C. Other Tax Matters
During the first quarter of 2009, final resolution was reached in one of the two disputed issues
associated with the IRS examination of the Companys 2003 and 2004 consolidated federal income tax
returns. The second of these disputed matters remains unresolved and on June 4, 2009 the Company
initiated litigation of this matter by filing a petition in the United States Tax Court. Due to
the nature of the litigation process, the timing of the resolution of this matter is uncertain.
Though the Company expects to prevail, an unfavorable resolution of this litigation would result in
a charge to shareholders net income of approximately $20 million, representing net interest
expense on the cumulative incremental tax for all affected years. In addition, two issues remain
unresolved from the IRS examination of the Companys 2005 and 2006 consolidated federal income tax
returns, for which a formal protest of the proposed adjustments was filed on March 31, 2009. One
of these unresolved issues relates to the same matter that is the subject of the litigation in the
U.S. Tax Court. The Company continues its effort to resolve the other matter through the
administrative appeals process.
The recently enacted Patient Protection & Affordable Care Act, including the Reconciliation Act of
2010, included provisions limiting the tax deductibility of certain future retiree benefit and
compensation related payments. The effect of these provisions reduced shareholders net income for
the nine months ended September 30, 2010 by $8 million. The Company will continue to evaluate
guidance as issued relative to these provisions.
39
Note 17 Segment Information
The Companys operating segments generally reflect groups of related products, except for the
International segment which is generally based on geography. In accordance with GAAP, operating
segments that do not require separate disclosure have been combined into Other Operations. The
Company measures the financial results of its segments using segment earnings (loss), which is
defined as shareholders income (loss) from continuing operations excluding after-tax realized
investment gains and losses.
Beginning in 2010, the Company began reporting the expense associated with its frozen pension plans
in Corporate. Prior periods were not restated. The effect on prior periods is not material.
Summarized segment financial information was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees, Mail order pharmacy revenues
and Other revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Health Care |
|
$ |
3,771 |
|
|
$ |
3,194 |
|
|
$ |
11,194 |
|
|
$ |
9,723 |
|
Disability and Life |
|
|
692 |
|
|
|
684 |
|
|
|
2,060 |
|
|
|
2,074 |
|
International |
|
|
582 |
|
|
|
486 |
|
|
|
1,666 |
|
|
|
1,392 |
|
Run-off Reinsurance |
|
|
(113 |
) |
|
|
(149 |
) |
|
|
(53 |
) |
|
|
(211 |
) |
Other Operations |
|
|
42 |
|
|
|
42 |
|
|
|
130 |
|
|
|
132 |
|
Corporate |
|
|
(16 |
) |
|
|
(17 |
) |
|
|
(46 |
) |
|
|
(44 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4,958 |
|
|
$ |
4,240 |
|
|
$ |
14,951 |
|
|
$ |
13,066 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Health Care |
|
$ |
240 |
|
|
$ |
200 |
|
|
$ |
654 |
|
|
$ |
549 |
|
Disability and Life |
|
|
60 |
|
|
|
64 |
|
|
|
219 |
|
|
|
220 |
|
International |
|
|
50 |
|
|
|
38 |
|
|
|
186 |
|
|
|
144 |
|
Run-off Reinsurance |
|
|
(37 |
) |
|
|
30 |
|
|
|
(137 |
) |
|
|
116 |
|
Other Operations |
|
|
22 |
|
|
|
23 |
|
|
|
65 |
|
|
|
63 |
|
Corporate |
|
|
(46 |
) |
|
|
(35 |
) |
|
|
(132 |
) |
|
|
(97 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment Earnings |
|
|
289 |
|
|
|
320 |
|
|
|
855 |
|
|
|
995 |
|
Realized investment gains (losses), net of taxes |
|
|
18 |
|
|
|
9 |
|
|
|
29 |
|
|
|
(24 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
$ |
307 |
|
|
$ |
329 |
|
|
$ |
884 |
|
|
$ |
971 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40
Note 18 Contingencies and Other Matters
The Company, through its subsidiaries, is contingently liable for various financial guarantees
provided in the ordinary course of business.
Financial Guarantees Primarily Associated with the Sold Retirement Benefits Business
Separate account assets are contractholder funds maintained in accounts with specific investment
objectives. The Company records separate account liabilities equal to separate account assets. In
certain cases, primarily associated with the sold retirement benefits business (which was sold in
April 2004), the Company guarantees a minimum level of benefits for retirement and insurance
contracts written in separate accounts. The Company establishes an additional liability if
management believes that the Company will be required to make a payment under these guarantees.
The Company guarantees that separate account assets will be sufficient to pay certain retiree or
life benefits. The sponsoring employers are primarily responsible for ensuring that assets are
sufficient to pay these benefits and are required to maintain assets that exceed a certain
percentage of benefit obligations. This percentage varies depending on the asset class within a
sponsoring employers portfolio (for example, a bond fund would require a lower percentage than a
riskier equity fund) and thus will vary as the composition of the portfolio changes. If employers
do not maintain the required levels of separate account assets, the Company or an affiliate of the
buyer has the right to redirect the management of the related assets to provide for benefit
payments. As of September 30, 2010, employers maintained assets that exceeded the benefit
obligations. Benefit obligations under these arrangements were $1.8 billion as of September 30,
2010. Approximately 75% of these guarantees are reinsured by an affiliate of the buyer of the
retirement benefits business. The remaining guarantees are provided by the Company with minimal
reinsurance from third parties. There were no additional liabilities required for these guarantees
as of September 30, 2010. Separate account assets supporting these guarantees are classified in
Levels 1 and 2 of the GAAP fair value hierarchy. See Note 8 for further information on the fair
value hierarchy.
The Company does not expect that these financial guarantees will have a material effect on the
Companys consolidated results of operations, liquidity or financial condition.
Other Financial Guarantees
Guaranteed minimum income benefit contracts. The Companys reinsurance operations, which were
discontinued in 2000 and are now an inactive business in run-off mode, reinsured minimum income
benefits under certain variable annuity contracts issued by other insurance companies. A
contractholder can elect the guaranteed minimum income benefit (GMIB) within 30 days of any
eligible policy anniversary after a specified contractual waiting period. The Companys exposure
arises when the guaranteed annuitization benefit exceeds the annuitization benefit based on the
policys current account value. At the time of annuitization, the Company pays the excess (if any)
of the guaranteed benefit over the benefit based on the current account value in a lump sum to the
direct writing insurance company.
In periods of declining equity markets or declining interest rates, the Companys GMIB liabilities
increase. Conversely, in periods of rising equity markets and rising interest rates, the Companys
liabilities for these benefits decrease.
The Company estimates the fair value of the GMIB assets and liabilities using assumptions for
market returns and interest rates, volatility of the underlying equity and bond mutual fund
investments, mortality, lapse, annuity election rates, nonperformance risk, and risk and profit
charges. See Note 8 for additional information on how fair values for these liabilities and
related receivables for retrocessional coverage are determined.
The Company is required to disclose the maximum potential undiscounted future payments for GMIB
contracts. Under these guarantees, the future payment amounts are dependent on equity and bond
fund market and interest rate levels prior to and at the date of annuitization election, which must
occur within 30 days of a policy anniversary, after the appropriate waiting period. Therefore, the
future payments are not fixed and determinable under the terms of the contract. Accordingly, the
Company has estimated the maximum potential undiscounted future payments using hypothetical adverse
assumptions, defined as follows:
|
|
no annuitants surrendered their accounts; |
|
|
all annuitants lived to elect their benefit; |
|
|
all annuitants elected to receive their benefit on the next available date (2010 through
2014); and |
|
|
all underlying mutual fund investment values remained at the September 30, 2010 value of
$1.2 billion with no future returns. |
41
The maximum potential undiscounted payments that the Company would make under those assumptions
would aggregate $1.3 billion before reinsurance recoveries. The Company expects the amount of
actual payments to be significantly less than this hypothetical undiscounted aggregate amount. The
Company has retrocessional coverage in place from two external reinsurers which covers 55% of the
exposures on these contracts. The receivable from one of these reinsurers is substantially
collateralized by assets held in a trust. The Company bears the risk of loss if its
retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
Certain other guarantees. The Company had indemnification obligations to lenders of up to $192
million as of September 30, 2010, related to borrowings by certain real estate joint ventures which
the Company either records as an investment or consolidates. These borrowings, which are
nonrecourse to the Company, are secured by the joint ventures real estate properties with fair
values in excess of the loan amounts and mature at various dates beginning in 2011 through 2017.
The Companys indemnification obligations would require payment to lenders for actual damages
resulting from certain acts such as unauthorized ownership transfers, misappropriation of rental
payments by others or environmental damages. Based on initial and ongoing reviews of property
management and operations, the Company does not expect that payments will be required under these
indemnification obligations. Any payments that might be required could be recovered through a
refinancing or sale of the assets. In some cases, the Company also has recourse to partners for
their proportionate share of amounts paid. There were no liabilities required for these
indemnification obligations as of September 30, 2010.
As of September 30, 2010, the Company guaranteed that it would compensate the lessors for a
shortfall of up to $44 million in the market value of certain leased equipment at the end of the
lease. Guarantees of $28 million expire in 2012 and $16 million expire in 2016. The Company had
liabilities for these guarantees of $10 million as of September 30, 2010.
As part of the reinsurance and administrative service arrangements acquired from Great-West Life
and Annuity, Inc., the Company is responsible to pay claims for the group medical and long-term
disability business of Great-West Healthcare and collect related amounts due from their third party
reinsurers. Any such amounts not collected will represent additional assumed liabilities of the
Company and decrease shareholders net income if and when these amounts are determined
uncollectible. At September 30, 2010, there were no receivables recorded for paid claims due from
third party reinsurers for this business and unpaid claims related to this business were estimated
at $20 million.
The Company had indemnification obligations as of September 30, 2010 in connection with acquisition
and disposition transactions. These indemnification obligations are triggered by the breach of
representations or covenants provided by the Company, such as representations for the presentation
of financial statements, the filing of tax returns, compliance with law or the identification of
outstanding litigation. These obligations are typically subject to various time limitations,
defined by the contract or by operation of law, such as statutes of limitation. In some cases, the
maximum potential amount due is subject to contractual limitations based on a percentage of the
transaction purchase price, while in other cases limitations are not specified or applicable. The
Company does not believe that it is possible to determine the maximum potential amount due under
these obligations, since not all amounts due under these indemnification obligations are subject to
limitation. There were no liabilities required for these indemnification obligations as of
September 30, 2010.
The Company has agreements with certain banks that provide banking services to settle claim checks
processed by the Company for ASO and certain minimum premium customers. The customers are
responsible for adequately funding their accounts as claim checks are presented for payment. Under
these agreements, the Company guarantees that the banks will not incur a loss if a customer fails
to properly fund its account. The amount of the guarantee fluctuates daily. As of September 30,
2010, the aggregate maximum exposure under these guarantees was approximately $329 million and
there were no liabilities required. After-tax charges related to these guarantees were
approximately $3 million for the nine months ended September 30, 2010 and there were no charges for
the same period in 2009. Through October 22, 2010, the exposure that existed at September 30, 2010
has been reduced by approximately 89% through customers funding of claim checks when presented for
payment. In addition, the Company can limit its exposure under these guarantees by suspending
claim payments for any customer who has not adequately funded their bank account.
The Company contracts on an administrative services only (ASO) basis with customers who fund
their own claims. The Company charges these customers administrative fees based on the expected
cost of administering their self-funded programs. In some cases, the Company provides performance
guarantees associated with meeting certain service-related and other performance standards. If
these standards are not met, the Company may be financially at risk up to a stated percentage of
the contracted fee or a stated dollar amount. The Company establishes liabilities for estimated
payouts associated with these performance guarantees. Approximately 12% of ASO fees reported for
the nine months ended September 30, 2010 were at risk, with reimbursements estimated to be less
than 1%.
42
The Company does not expect that these guarantees will have a material adverse effect on the
Companys consolidated results of operations, liquidity or financial condition.
Regulatory and Industry Developments
Employee benefits regulation. The business of administering and insuring employee benefit
programs, particularly health care programs, is heavily regulated by federal and state laws and
administrative agencies, such as state departments of insurance and the Federal Departments of
Labor and Justice, as well as the courts. Regulation, legislation and judicial decisions have
resulted in changes to industry and the Companys business practices and will continue to do so in
the future. In addition, the Companys subsidiaries are routinely involved with various claims,
lawsuits and regulatory and IRS audits and investigations that could result in financial liability,
changes in business practices, or both. Health care regulation and legislation in its various
forms, including the implementation of the Patient Protection and Affordable Care Act (including
the Reconciliation Act) that was signed into law during the first quarter of 2010, could have an
adverse effect on the Companys health care operations if it inhibits the Companys ability to
respond to market demands, adversely affects the way the Company does business, or results in
increased medical or administrative costs without improving the quality of care or services.
Other possible regulatory and legislative changes or judicial decisions that could have an adverse
effect on the Companys employee benefits businesses include:
|
|
additional mandated benefits or services that increase costs; |
|
|
legislation that would grant plan participants broader rights to sue their health plans; |
|
|
changes in public policy and in the political environment, which could affect state and
federal law, including legislative and regulatory proposals related to health care issues,
which could increase cost and affect the market for the Companys health care products and
services; |
|
|
changes in Employee Retirement Income Security Act of 1974 (ERISA) regulations resulting
in increased administrative burdens and costs; |
|
|
additional restrictions on the use of prescription drug formularies and rulings from
pending purported class action litigation, which could result in adjustments to or the
elimination of the average wholesale price of pharmaceutical products as a benchmark in
establishing certain rates, charges, discounts, guarantees and fees for various prescription
drugs; |
|
|
additional privacy legislation and regulations that interfere with the proper use of
medical information for research, coordination of medical care and disease and disability
management; |
|
|
additional variations among state laws mandating the time periods and administrative
processes for payment of health care provider claims; |
|
|
legislation that would exempt independent physicians from antitrust laws; and |
|
|
changes in federal tax laws, such as amendments that could affect the taxation of employer
provided benefits. |
The employee benefits industry remains under scrutiny by various state and federal government
agencies and could be subject to government efforts to bring criminal actions in circumstances that
could previously have given rise only to civil or administrative proceedings.
Concentration of risk. For the Companys International segment, South Korea is the single largest
geographic market. South Korea generated 32% of the segments revenues and 53% of the segments
earnings for the three months ended September 30, 2010. For the nine months ended September 30,
2010, South Korea generated 32% of the segments revenues and 45% of the segments earnings. Due
to the concentration of business in South Korea, the International segment is exposed to potential
losses resulting from economic and geopolitical developments in that country, as well as foreign
currency movements affecting the South Korean currency, which could have a significant impact on
the segments results and the Companys consolidated financial results.
43
Litigation and Other Legal Matters
The Company is routinely involved in numerous claims, lawsuits, regulatory and IRS audits,
investigations and other legal matters arising, for the most part, in the ordinary course of the
business of administering and insuring employee benefit programs including payments to providers
and benefit level disputes. Litigation of income tax matters is accounted for under FASBs
accounting guidance for uncertainty in income taxes. Further information can be found in Note 16.
An increasing number of claims are being made for substantial non-economic, extra-contractual or
punitive damages. The outcome of litigation and other legal matters is always uncertain, and
outcomes that are not justified by the evidence can occur. The Company believes that it has valid
defenses to the legal matters pending against it and is defending itself vigorously and has
recorded accruals in accordance with GAAP. Nevertheless, it is possible that resolution of one or
more of the legal matters currently pending or threatened could result in losses material to the
Companys consolidated results of operations, liquidity or financial condition.
Managed care litigation. On April 7, 2000, several pending actions were consolidated in the United
States District Court for the Southern District of Florida in a multi-district litigation
proceeding captioned In re Managed Care Litigation challenging, in general terms, the mechanisms
used by managed care companies in connection with the delivery of or payment for health care
services. The consolidated cases include Shane v. Humana, Inc., et al., Mangieri v. CIGNA
Corporation, Kaiser and Corrigan v. CIGNA Corporation, et al. and Amer. Dental Assn v. CIGNA Corp.
et al.
In 2004, the court approved a settlement agreement between the physician class and CIGNA. However,
a dispute over disallowed claims under the settlement submitted by a representative of certain
class member physicians is in arbitration. Separately, in 2005, the court approved a settlement
between CIGNA and a class of non-physician health care providers. Only the American Dental
Association case remains unresolved. On March 2, 2009, the Court dismissed with prejudice five of
the six counts of the complaint. On March 20, 2009, the Court declined to exercise supplemental
jurisdiction over the remaining state law claim and dismissed the case. Plaintiffs filed a notice
of appeal with the Eleventh Circuit Court of Appeals on April 17, 2009. On May 14, 2010, the Court
of Appeals issued a decision affirming the District Courts dismissal.
CIGNA has received insurance recoveries related to the In re Managed Care Litigation. In 2008, the
Court of Common Pleas of Philadelphia County ruled that the Company is not entitled to insurance
recoveries from one of the two insurers from which the Company is pursuing further recoveries.
CIGNA appealed that decision and on June 3, 2009, the Superior Court of Pennsylvania reversed the
trial courts decision, remanding the case to the trial court for further proceedings. Trial is
scheduled for the week of November 8, 2010.
Broker compensation. Beginning in 2004, the Company, other insurance companies and certain
insurance brokers received subpoenas and inquiries from various regulators, including the New York
and Connecticut Attorneys General, the Florida Office of Insurance Regulation, the U.S. Attorneys
Office for the Southern District of California and the U.S. Department of Labor relating to their
investigations of insurance broker compensation. CIGNA cooperated with the inquiries and
investigations.
On August 1, 2005, two CIGNA subsidiaries, Connecticut General Life Insurance Company and Life
Insurance Company of North America, were named as defendants in a multi-district litigation
proceeding, In re Insurance Brokerage Antitrust Litigation, consolidated in the United States
District Court for the District of New Jersey. The complaint alleges that brokers and insurers
conspired to hide commissions, thus increasing the cost of employee benefit plans, and seeks treble
damages and injunctive relief. Numerous insurance brokers and other insurance companies are named
as defendants. In 2008, the court ordered the clerk to enter judgment against plaintiffs and in
favor of the defendants. Plaintiffs appealed. On August 16, 2010, the Third Circuit Court of
Appeals affirmed that decision as to employee benefit companies. On September 27, 2010, the
District Court entered final judgment against plaintiffs consistent with the Third Circuit Court of
Appeals opinion.
Amara cash balance pension plan litigation. On December 18, 2001, Janice Amara filed a class action
lawsuit, captioned Janice C. Amara, Gisela R. Broderick, Annette S. Glanz, individually and on
behalf of all others similarly situated v. CIGNA Corporation and CIGNA Pension Plan, in the United
States District Court for the District of Connecticut against CIGNA Corporation and the CIGNA
Pension Plan on behalf of herself and other similarly situated participants in the CIGNA Pension
Plan affected by the 1998 conversion to a cash balance formula. The plaintiffs allege various ERISA
violations including, among other things, that the Plans cash balance formula discriminates
against older employees; the conversion resulted in a wear away period (during which the
pre-conversion accrued benefit exceeded the post-conversion benefit); and these conditions are not
adequately disclosed in the Plan.
44
In 2008, the court issued a decision finding in favor of CIGNA Corporation and the CIGNA Pension
Plan on the age discrimination and wear away claims. However, the court found in favor of the
plaintiffs on many aspects of the disclosure claims and ordered an enhanced level of benefits from
the existing cash balance formula for the majority of the class, requiring class members to receive
their frozen benefits under the pre-conversion CIGNA Pension Plan and their accrued benefits under
the post-conversion CIGNA Pension Plan. The court also ordered, among other things, pre-judgment
and post-judgment interest. Both parties appealed the courts decisions to the United States
Court of Appeals for the Second Circuit which issued a decision on October 6, 2009 affirming the
District Courts judgment and order on all issues. On January 4, 2010, the Company and the
plaintiffs filed separate petitions for a writ of certiorari to the United States Supreme Court.
On June 28, 2010, CIGNAs petition was granted and is scheduled to be argued on November 30, 2010.
The United States Supreme Court held the plaintiffs petition for writ of certiorari and the
Company expects it to be disposed of when an opinion is issued. The implementation of the judgment
is currently stayed. The Company will continue to vigorously defend itself in this case. In the
second quarter of 2008, the Company recorded a charge of $80 million pre-tax ($52 million
after-tax), which principally reflects the Companys best estimate of the liabilities related to
the court order.
Ingenix. On February 13, 2008, State of New York Attorney General Andrew M. Cuomo announced an
industry-wide investigation into the use of data provided by Ingenix, Inc., a subsidiary of
UnitedHealthcare, used to calculate payments for services provided by out-of-network providers. The
Company received four subpoenas from the New York Attorney Generals office in connection with this
investigation and responded appropriately. On February 17, 2009, the Company entered into an
Assurance of Discontinuance resolving the investigation. In connection with the industry-wide
resolution, the Company contributed $10 million to the establishment of a new non-profit company
that will compile and provide the data currently provided by Ingenix. In addition, on March 28,
2008, the Company received a voluntary request for production of documents from the Connecticut
Attorney Generals office seeking certain out-of-network claim payment information. The Company has
responded appropriately. Since January 2009, the Company has received and responded to inquiries
regarding the use of Ingenix data from the Illinois and Texas Attorneys General and the Departments
of Insurance in Illinois, Florida, Vermont, Georgia, Pennsylvania, Connecticut, and Alaska.
The Company was named as a defendant in eight putative nationwide class actions asserting that due
to the use of data from Ingenix, Inc., the Company improperly underpaid claims, an industry-wide
issue. Three actions were brought on behalf of members, (Franco v. CIGNA Corp. et al., Chazen v.
CIGNA Corp. et al and Nelson v. Connecticut General Life Insurance Co. et al.), and five actions
were brought on behalf of providers, (American Medical Association et al. v. CIGNA Corp. et al.,
Shiring et al. v. CIGNA Corp. et al.; Higashi et al. v. CGLIC et al.; Pain Management and Surgery
Center of Southern Indiana v. CGLIC et al.; and North Peninsula Surgical Center v. Connecticut
General Life Insurance Co. et al.), all of which were consolidated into the Franco case pending in
the United States District Court for the District of New Jersey. The consolidated amended
complaint, filed on August 7, 2009, asserts claims under ERISA, the RICO statute, the Sherman
Antitrust Act and New Jersey state law. CIGNA filed a motion to dismiss the consolidated amended
complaint on September 9, 2009, which is fully briefed and pending. Plaintiffs filed a motion for
class certification on May 28, 2010, which is also fully briefed and pending.
On June 9, 2009, CIGNA filed motions in the United States District Court for the Southern District
of Florida to enforce the In re Managed Care Litigation settlement described above by enjoining the
RICO and antitrust causes of action asserted by the provider and medical association plaintiffs in
the Ingenix litigation on the ground that they arose prior to and were released in the April 2004
settlement. On November 30, 2009, the Court granted the motions and ordered the provider and
association plaintiffs to withdraw their RICO and antitrust claims from the Ingenix litigation by
December 21, 2009. The plaintiffs filed notices of appeal with the United States Court of Appeals
for the Eleventh Circuit on December 10 and 11, 2009. On April 21, 2010 and June 16, 2010, the
appeals were dismissed for lack of appellate jurisdiction. Plaintiffs motion for reconsideration
was denied on August 18, 2010.
Two of the provider plaintiffs, Higashi and Pain Management and Surgery Center of Southern Indiana,
have voluntarily dismissed their claims.
It is reasonably possible that others could initiate additional litigation or additional regulatory
action against the Company with respect to use of data provided by Ingenix, Inc. The Company denies
the allegations asserted in the investigations and litigation and will vigorously defend itself in
these matters.
45
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
INDEX
|
|
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|
|
|
|
|
46 |
|
|
|
|
|
|
|
|
|
50 |
|
|
|
|
|
|
|
|
|
54 |
|
|
|
|
|
|
|
|
|
54 |
|
|
|
|
|
|
|
|
|
55 |
|
|
|
|
|
|
|
|
|
59 |
|
|
|
|
|
|
|
|
|
61 |
|
|
|
|
|
|
|
|
|
63 |
|
|
|
|
|
|
|
|
|
65 |
|
|
|
|
|
|
|
|
|
66 |
|
|
|
|
|
|
|
|
|
67 |
|
|
|
|
|
|
|
|
|
68 |
|
|
|
|
|
|
|
|
|
72 |
|
|
|
|
|
|
|
|
|
78 |
|
|
|
|
|
|
|
|
|
79 |
|
INTRODUCTION
In this filing and in other marketplace communications, CIGNA Corporation and its subsidiaries
(the Company) make certain forward-looking statements relating to the Companys financial
condition and results of operations, as well as to trends and assumptions that may affect the
Company. Generally, forward-looking statements can be identified through the use of predictive
words (e.g., Outlook for 2010). Actual results may differ from the Companys predictions. Some
factors that could cause results to differ are discussed throughout Managements Discussion and
Analysis (MD&A), including in the Cautionary Statement beginning on page 79. The forward-looking
statements contained in this filing represent managements current estimate as of the date of this
filing. Management does not assume any obligation to update these estimates.
The following discussion addresses the financial condition of the Company as of September 30, 2010,
compared with December 31, 2009, and its results of operations for the three and nine months ended
September 30, 2010 compared with the same periods last year. This discussion should be read in
conjunction with MD&A included in the Companys 2009 Form 10-K, to which the reader is directed for
additional information.
The preparation of interim consolidated financial statements necessarily relies heavily on
estimates. This and certain other factors, such as the seasonal nature of portions of the health
care and related benefits business as well as competitive and other market conditions, call for
caution in estimating full year results based on interim results of operations.
Certain reclassifications have been made to prior period amounts to conform to the current
presentation.
Overview
The Company constitutes one of the largest investor-owned health service organizations in the
United States. Its subsidiaries are major providers of health care and related benefits, the
majority of which are offered through the workplace. In addition, the Company has an international
operation that offers supplemental health, life and accident insurance products as well as
international health care products and services to businesses and individuals in selected markets.
The Company also has certain inactive businesses, including a Run-off Reinsurance segment.
46
Ongoing Operations
The Companys ability to increase revenue, shareholders net income and operating cash flow from
ongoing operations is directly related to progress in executing on its strategic initiatives, the
success of which is measured by certain key factors, including the Companys ability to:
|
|
profitably price products and services at competitive levels that reflect emerging
experience; |
|
|
maintain and grow its customer base; |
|
|
cross sell its various health and related benefit products; |
|
|
invest available cash at attractive rates of return for appropriate durations; |
|
|
reduce other operating expenses in the Health Care segment; and |
|
|
effectively deploy capital. |
Strategy
As a global health service organization, CIGNAs mission remains focused on helping the people it
serves improve their health, well-being and sense of security. CIGNAs long-term growth strategy
is based on: (1) growth in targeted geographies, product lines, buying segments and distribution
channels; (2) pursuing additional opportunities in high-growth markets with particular focus on
individuals; and (3) improving its strategic and financial flexibility.
CIGNA expects to focus on the following areas it believes represent the markets or areas with the
most potential for profitable growth:
|
|
In the Health Care segment, the Company is concentrating on: (1) further enhancing its
geographic focus in the middle market in order to create geographic density; (2) growing the
Select market, which generally includes employers with more than 50 but fewer than 250
employees, by leveraging the Companys customer knowledge, differentiated service model,
product portfolio and distribution model; and (3) engaging those national account employers
who share and will benefit from the Companys value proposition of using health advocacy and
employee engagement to increase productivity, performance and the health outcomes of their
employees. |
|
|
In the Disability and Life segment, CIGNAs strategy is to grow its disability business by
fully leveraging the key components of its industry-leading disability management model to
reduce medical costs for its clients and return their employees to work sooner through: (1)
early claim notification and outreach; (2) a full suite of clinical and return-to-work
resources; and (3) specialized case management services. |
|
|
In the International segment, the Company is targeting growth through: (1) product and
channel expansion in its supplemental health, life and accident insurance business in key
Asian geographies; (2) the introduction of new expatriate benefits products; and (3) further
geographic expansion. |
The Company plans to improve its strategic and financial flexibility by driving further reductions
in its Health Care operating expenses, improving its medical cost competitiveness in targeted
markets and effectively managing balance sheet exposures.
In addition, the Company is focused on improving its strategic and financial flexibility in an
effort to optimize value for its shareholders, including the
consideration of various financing alternatives. The Company is also continually evaluating various
strategic options and risk mitigation alternatives related to the Run-off Reinsurance business
including expanding its current hedging program to cover unhedged equity risks and interest rate
risk inherent in our growth assumptions related to the GMDB and GMIB products.
Also, in connection with CIGNAs long-term business strategy, the Company remains committed to
health advocacy as a means of creating sustainable solutions for employers, improving the health of
the individuals that the Company serves, and lowering the costs of health care for all
constituencies.
Acquisition of Vanbreda International
On August 31, 2010, the Company acquired 100% of the voting stock of Vanbreda International NV
(Vanbreda International), based in Antwerp, Belgium for a cash purchase price of approximately $410
million. Vanbreda International specializes in providing worldwide medical insurance and employee
benefits to intergovernmental and non-governmental organizations, including international
humanitarian operations, as well as corporate clients. Vanbreda Internationals strong presence in
Europe complements the Companys position in providing expatriate benefits primarily to corporate
clients in North America, as well as Europe and Asia. See Note 3 to the Consolidated Financial
Statements for additional information about the acquisition of Vanbreda International.
47
Health Care Reform
In the first quarter of 2010, the Patient Protection and Affordable Care Act, including the
Reconciliation Act of 2010, (collectively, the Act) was signed into law. The Act mandates broad
changes in the delivery of health care benefits that may impact the Companys current business
model, including its relationship with current and future customers, producers and health care
providers, products, services, processes and technology. The Act includes provisions for mandatory
coverage of benefits and a minimum medical loss ratio, eliminates lifetime and annual benefit
limits and creates health insurance exchanges. These provisions are expected to take effect over
the next several years from 2010 to 2018 and several have yet to be finalized. Given the broad
scope of these changes, many of which have yet to be finalized, it is possible that the effects of
the Act could have a material impact on the Companys results of operations. The Company is
evaluating potential business opportunities resulting from the Act that will enable it to leverage
the strengths and capabilities of its broad health and wellness portfolio.
The Act will require that health services companies such as CIGNA and others in the healthcare
industry help fund the additional insurance benefits and coverages provided from this legislation
through the assessment of fees and excise taxes. The amount which the Company will be required to
pay starting in 2014 for these fees and excise taxes will result in charges to the Companys
financial statements in future periods. In addition, since these fees and excise taxes will not be
tax deductible, the Companys effective tax rate is expected to increase in future periods.
However, the Company is unable to estimate the amount of these fees and excise taxes or the
increase in the effective tax rate because guidance for their calculation has not been finalized.
The Act also changes certain tax laws which affect the Companys 2010 financial statements.
Although these provisions do not become effective until 2013, they are expected to limit the tax
deductibility of certain future retiree benefit and compensation-related payments. The Company
recorded after-tax charges of approximately $2 million for the three months ended and $8 million
for the nine months ended September 30, 2010 related to these changes. The Company expects to
record additional after-tax charges of approximately $2 million in the fourth quarter of 2010 with
respect to the known effects of the tax provisions, but will continue to evaluate their impact as
further guidance is made available.
Management is currently unable to estimate the ultimate impact of the Act on the Companys results
of operations, and its financial condition and liquidity due to the uncertainties of
interpretation, implementation and timing of the many provisions of the Act. It is possible,
however, that this impact could be material to results of operations. Management is closely
monitoring this legislation and has formed a task force to implement and report on the Companys
compliance with the Act, to actively engage with regulators to assist with the conversion of
legislation to regulation and to assess potential opportunities arising from the Act.
Run-off Operations
Effectively managing the various exposures of its run-off operations is important to the Companys
ongoing profitability, operating cash flows and available capital. The results are influenced by a
range of economic factors, especially movements in equity markets and interest rates. In order to
substantially reduce the impact of equity market movements on the liability for guaranteed minimum
death benefits (GMDB, also known as VADBe), the Company operates an equity hedge program. The
Company actively monitors the performance of the hedge program, and evaluates the cost/benefit of
hedging other risks. Results are also influenced by behavioral factors, including future partial
surrender election rates for GMDB contracts, annuity election rates for guaranteed minimum income
benefits (GMIB) contracts, annuitant lapse rates, as well as the collection of amounts
recoverable from retrocessionaires. The Company actively studies policyholder behavior experience
and adjusts future expectations based on the results of the studies, as warranted. The Company
also performs regular audits of ceding companies to ensure that premiums received and claims paid
properly reflect the underlying risks, and to maximize the probability of subsequent collection of
claims from retrocessionaires. Finally, the Company monitors the financial strength and credit
standing of its retrocessionaires and requests or collects collateral when warranted.
48
Summary
The Companys overall results are influenced by a range of economic and other factors, especially:
|
|
cost trends and inflation for medical and related services; |
|
|
utilization patterns of medical and other services; |
|
|
the tort liability system; |
|
|
developments in the political environment both domestically and internationally; |
|
|
interest rates, equity market returns, foreign currency fluctuations and credit market
volatility, including the availability and cost of credit in the future; and |
|
|
federal, state and international regulation, including the implementation of U.S. health
care reform. |
The Company regularly monitors the trends impacting operating results from the above mentioned key
factors and economic and other factors affecting its operations. The Company develops strategic and
tactical plans designed to improve performance and maximize its competitive position in the markets
it serves. The Companys ability to achieve its financial objectives is dependent upon its ability
to effectively execute on these plans and to appropriately respond to emerging economic and
company-specific trends.
49
CONSOLIDATED RESULTS OF OPERATIONS
The Company measures the financial results of its segments using segment earnings (loss), which
is defined as shareholders income (loss) from continuing operations before after-tax realized
investment results. Adjusted income from operations is defined as consolidated segment earnings
(loss) excluding special items (defined below) and the results of the GMIB business. Adjusted
income from operations is another measure of profitability used by the Companys management because
it presents the underlying results of operations of the Companys businesses and permits analysis
of trends in underlying revenue, expenses and shareholders net income. This measure is not
determined in accordance with accounting principles generally accepted in the United States
(GAAP) and should not be viewed as a substitute for the most directly comparable GAAP measure,
which is shareholders income from continuing operations.
Summarized below is a reconciliation between shareholders income from continuing operations and
adjusted income from operations.
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
4,621 |
|
|
$ |
3,985 |
|
|
$ |
13,668 |
|
|
$ |
12,049 |
|
Net investment income |
|
|
280 |
|
|
|
263 |
|
|
|
829 |
|
|
|
752 |
|
Mail order pharmacy revenues |
|
|
354 |
|
|
|
316 |
|
|
|
1,053 |
|
|
|
944 |
|
Other revenues |
|
|
(17 |
) |
|
|
(61 |
) |
|
|
230 |
|
|
|
73 |
|
Total realized investment gains (losses) |
|
|
28 |
|
|
|
14 |
|
|
|
44 |
|
|
|
(40 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
|
5,266 |
|
|
|
4,517 |
|
|
|
15,824 |
|
|
|
13,778 |
|
Benefits and expenses |
|
|
4,802 |
|
|
|
4,030 |
|
|
|
14,499 |
|
|
|
12,388 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before taxes |
|
|
464 |
|
|
|
487 |
|
|
|
1,325 |
|
|
|
1,390 |
|
Income taxes |
|
|
156 |
|
|
|
157 |
|
|
|
438 |
|
|
|
417 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
|
308 |
|
|
|
330 |
|
|
|
887 |
|
|
|
973 |
|
Less: Net income attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
3 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders income from continuing operations |
|
|
307 |
|
|
|
329 |
|
|
|
884 |
|
|
|
971 |
|
Less: realized investment gains (losses), net of taxes |
|
|
18 |
|
|
|
9 |
|
|
|
29 |
|
|
|
(24 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings |
|
|
289 |
|
|
|
320 |
|
|
|
855 |
|
|
|
995 |
|
Less adjustments to reconcile to adjusted income from operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results of GMIB business (after-tax) |
|
|
(10 |
) |
|
|
16 |
|
|
|
(109 |
) |
|
|
149 |
|
Special items (after-tax): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtailment gain (See Note 13 to the Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30 |
|
Cost reduction charge (See Note 6 to the Consolidated Financial Statements) |
|
|
|
|
|
|
(7 |
) |
|
|
|
|
|
|
(16 |
) |
Completion of IRS examination (See Note 16 to the Consolidated Financial
Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations |
|
$ |
299 |
|
|
$ |
311 |
|
|
$ |
964 |
|
|
$ |
812 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Summarized below is adjusted income from operations by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Adjusted Income (Loss) From Operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Health Care |
|
$ |
240 |
|
|
$ |
204 |
|
|
$ |
654 |
|
|
$ |
535 |
|
Disability and Life |
|
|
60 |
|
|
|
65 |
|
|
|
219 |
|
|
|
213 |
|
International |
|
|
50 |
|
|
|
40 |
|
|
|
186 |
|
|
|
144 |
|
Run-off Reinsurance |
|
|
(27 |
) |
|
|
14 |
|
|
|
(28 |
) |
|
|
(33 |
) |
Other Operations |
|
|
22 |
|
|
|
23 |
|
|
|
65 |
|
|
|
62 |
|
Corporate |
|
|
(46 |
) |
|
|
(35 |
) |
|
|
(132 |
) |
|
|
(109 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
299 |
|
|
$ |
311 |
|
|
$ |
964 |
|
|
$ |
812 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50
Overview of September 30, 2010 Consolidated Results of Operations
Three Months Ended September 30, 2010 Compared with Three Months Ended September 30, 2009
Adjusted income from operations decreased for the three months ended September 30, 2010 compared to
the same period in 2009, due to losses in the Run-off Reinsurance segment resulting from a required
reserve strengthening in 2010 related to the GMDB business, partially offset by improved results in
the Health Care and International segments. See the individual segment sections of this MD&A for
further discussion.
Shareholders income from continuing operations decreased for the three months ended September 30,
2010 compared with the same period in 2009 due to a loss in the GMIB business in 2010 compared to a
gain in 2009 and losses in the Run-off Reinsurance segment resulting from a required reserve
strengthening in 2010 related to the GMDB business. These losses were partially offset by improved
results in the Health Care and International segments in 2010. See the Run-off Reinsurance section
of this MD&A beginning on page 63 for further discussion about the GMIB and GMDB businesses.
Nine Months Ended September 30, 2010 Compared with Nine Months Ended September 30, 2009
Adjusted income from operations increased for the nine months ended September 30, 2010 compared to
the same period in 2009, primarily reflecting strong earnings growth in the ongoing business
segments (Health Care, Disability and Life and International) as well as improved results in the
Run-off Reinsurance segment primarily due to less reserve strengthening required in 2010 related to
the GMDB business.
Shareholders income from continuing operations decreased for the nine months ended September 30,
2010 compared with the same period in 2009 due to a loss in the GMIB business in 2010 compared to a
gain in 2009 as well as the absence in 2010 of a pension curtailment gain and a benefit from the
completion of an IRS examination recognized in 2009. See the Special Items and GMIB section
below for further description of these special items. These effects were partially offset by
higher adjusted income from operations as discussed above and the absence in 2010 of charges for
cost reduction initiatives.
Special Items and GMIB
Management does not believe that the special items noted in the table above are representative of
the Companys underlying results of operations. Accordingly, the Company excluded these special
items from adjusted income from operations in order to facilitate an understanding and comparison
of results of operations and permit analysis of trends in underlying revenue, expenses and
shareholders income from continuing operations.
There were no special items for the three or nine months ended September 30, 2010.
The special item for the three months ended September 30, 2009 reflects charges related to cost
reduction actions. The special items for the nine months ended September 30, 2009 reflect benefits
for the pension curtailment and completion of the 2005 and 2006 IRS examination and charges related
to cost reduction actions. See Notes 6, 13 and 16 to the Consolidated Financial Statements for
additional information.
The Company also excludes the results of the GMIB business from adjusted income from operations
because the fair value of GMIB assets and liabilities must be recalculated each quarter using
updated capital market assumptions. The resulting changes in fair value, which are reported in
shareholders net income, are volatile and unpredictable. See the Critical Accounting Estimates
section of the MD&A beginning on page 55 of the Companys 2009 Form 10-K for more information on
the effect of capital market assumption changes on shareholders net income. Because of this
volatility, and since the GMIB business is in run-off, management does not believe that its results
are meaningful in assessing underlying results of operations.
51
Outlook for 2010
The Company expects 2010 adjusted income from operations to be higher than 2009. Information is
not available for management to reasonably estimate the future results of the GMIB business or
realized investment results due in part to interest rate and stock market volatility and other
internal and external factors. This outlook reflects break-even results for GMDB (also known as
VADBe) for the fourth quarter of 2010, which assumes that actual experience, including capital
markets performance, will be consistent with long-term reserve assumptions. See Note 7 to the
Consolidated Financial Statements and the Critical Accounting Estimates section on page 56 of the
MD&A of the Companys 2009 Form 10-K for more information on the effect of capital market
assumption changes on shareholders net income. In addition, the Company is not able to identify
or reasonably estimate the financial impact of special items in 2010; however they may include
potential adjustments associated with cost reduction, litigation, and tax-related items.
This outlook reflects the Companys best estimate of the impacts of Health Care Reform (the Act,
see the Introduction section of this MD&A beginning on page 46) on its 2010 results of operations
subject to the factors cited in the Cautionary Statement beginning on page 79 of the MD&A. If
unfavorable equity market and interest rate movements occur, the Company could experience losses
related to investment impairments and the GMIB and GMDB businesses. These losses could adversely
impact the Companys consolidated results of operations and financial condition by potentially
reducing the capital of the Companys insurance subsidiaries and reducing their dividend-paying
capabilities.
Revenues
Total revenues increased by 17% for the three months and 15% for the nine months ended September
30, 2010, compared with the same periods in 2009. Changes in the components of total revenue are
described more fully below.
Premiums and Fees
Premiums and fees increased by 16% for the three months and 13% for the nine months ended September
30, 2010, compared with the same periods in 2009, primarily reflecting membership growth in the
Health Care segments risk business as well as growth in the International segment. Excluding the
Medicare Private Fee For Service (Medicare PFFS) Individual business, premiums and fees increased
by 11% for the three months and 9% for the nine months ended September 30, 2010.
Net Investment Income
Net investment income increased by 6% for the three months and 10% for the nine months ended
September 30, 2010, compared with the same periods in 2009, primarily reflecting improved results
from security partnerships and real estate investments and higher assets due to business growth,
partially offset by lower reinvestment yields.
Mail Order Pharmacy Revenues
Mail order pharmacy revenues increased by 12% for the three and nine months ended September 30,
2010, compared with the same periods in 2009, primarily reflecting increases in volume and price.
Other Revenues
Other revenues included the impact of the futures contracts associated with the GMDB equity hedge
program. Losses on futures contracts reflect stock market gains, whereas gains reflect stock
market losses. The Company reported losses of $119 million for the three months ended September
30, 2010 compared to losses of $161 million in the same period of 2009 associated with the GMDB
equity hedge program. The Company recorded losses of $72 million for the nine months ended
September 30, 2010 compared to losses of $232 million for the same period in 2009 associated with
the GMDB equity hedge program. Amounts reflecting corresponding changes in liabilities for GMDB
contracts were included in benefits and expenses consistent with GAAP when a premium deficiency
exists. Excluding the impact of these futures contracts, other revenues were flat for the three
and nine months ended September 30, 2010 compared with the same periods in 2009.
52
Realized Investment Results
Realized investment results improved for the three months ended September 30, 2010, compared with
the same period in 2009 primarily due to:
|
|
the absence in 2010 of impairments on fixed maturities recorded in 2009; and |
|
|
gain on the sale of real estate held in a joint venture in 2010. |
These favorable effects were partially offset by a decrease in realized gains recorded on the sale
of fixed maturities and equity securities.
Realized investment results improved for the nine months ended September 30, 2010, compared with
the same period in 2009 primarily due to:
|
|
lower impairments on real estate funds and fixed maturities in 2010; |
|
|
gains on sales of real estate held in joint ventures and other investments in 2010; and |
|
|
increased prepayment fees on fixed maturities received in 2010 as a result of debt
restructurings, compared to 2009. |
These favorable effects were partially offset by an increase in commercial mortgage loan
impairments recorded in 2010, reflecting continued weakness in the commercial real estate markets.
See Note 9 to the Consolidated Financial Statements for additional information.
53
CRITICAL ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in accordance with GAAP requires management to
make estimates and assumptions that affect reported amounts and related disclosures in the
consolidated financial statements. Management considers an accounting estimate to be critical if:
|
|
it requires assumptions to be made that were uncertain at the time the estimate was made;
and |
|
|
changes in the estimate or different estimates that could have been selected could have a
material effect on the Companys consolidated results of operations or financial condition. |
Management has discussed the development and selection of its critical accounting estimates and
reviewed the disclosures presented below with the Audit Committee of the Companys Board of
Directors.
The Companys most critical accounting estimates, as well as the effects of hypothetical changes in
material assumptions used to develop each estimate, are described in the Companys 2009 Form 10-K
beginning on page 55 and are as follows:
|
|
future policy benefits guaranteed minimum death benefits; |
|
|
Health Care medical claims payable; |
|
|
accounts payable, accrued expenses and other liabilities, and other assets guaranteed
minimum income benefits; |
|
|
reinsurance recoverables for Run-off Reinsurance; |
|
|
accounts payable, accrued expenses and other liabilities pension liabilities; |
|
|
investments fixed maturities; and |
|
|
investments commercial mortgage loans valuation reserves. |
The Company regularly evaluates items which may impact critical accounting estimates. As of
September 30, 2010, there are no significant changes to the critical accounting estimates from what
was reported in the Companys 2009 Form 10-K.
Summary
There are other accounting estimates used in the preparation of the Companys Consolidated
Financial Statements, including estimates of liabilities for future policy benefits other than
those identified above, as well as estimates with respect to goodwill, unpaid claims and claim
expenses, post-employment and postretirement benefits other than pensions, certain compensation
accruals and income taxes.
Management believes the current assumptions used to estimate amounts reflected in the Companys
Consolidated Financial Statements are appropriate. However, if actual experience differs from the
assumptions used in estimating amounts reflected in the Companys Consolidated Financial
Statements, the resulting changes could have a material adverse effect on the Companys
consolidated results of operations, and in certain situations, could have a material adverse effect
on liquidity and the Companys financial condition.
SEGMENT REPORTING
Operating segments generally reflect groups of related products, but the International segment is
generally based on geography. The Company measures the financial results of its segments using
segment earnings (loss), which is defined as shareholders income (loss) from continuing
operations excluding after-tax realized investment gains and losses. Adjusted income from
operations for each segment is defined as segment earnings excluding special items and the results
of the Companys GMIB business. Adjusted income from operations is another measure of
profitability used by the Companys management because it presents the underlying results of
operations of the segment and permits analysis of trends. This measure is not determined in
accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP
measure, which is segment earnings. Each segment provides a reconciliation between segment
earnings and adjusted income from operations.
Beginning in 2010, the Company began reporting the expense associated with its frozen pension plans
in Corporate. Prior periods were not restated; the effect on prior periods was not material.
54
Health Care Segment
Segment Description
The Health Care segment includes medical, dental, behavioral health, prescription drug and other
products and services that may be integrated to provide consumers with comprehensive health care
solutions. This segment also includes group disability and life insurance products that were
historically sold in connection with certain experience-rated medical products. These products and
services are offered through a variety of funding arrangements such as guaranteed cost,
retrospectively experience-rated and administrative services only arrangements.
The Company measures the operating effectiveness of the Health Care segment using the following key
factors:
|
|
segment earnings and adjusted income from operations; |
|
|
sales of specialty products to core medical customers; |
|
|
changes in operating expenses per member; and |
|
|
medical expense as a percentage of premiums (medical care ratio) in the guaranteed cost
business. |
Results of Operations
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
3,350 |
|
|
$ |
2,812 |
|
|
$ |
9,945 |
|
|
$ |
8,578 |
|
Net investment income |
|
|
63 |
|
|
|
52 |
|
|
|
181 |
|
|
|
132 |
|
Mail order pharmacy revenues |
|
|
354 |
|
|
|
316 |
|
|
|
1,053 |
|
|
|
944 |
|
Other revenues |
|
|
67 |
|
|
|
66 |
|
|
|
196 |
|
|
|
201 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
|
3,834 |
|
|
|
3,246 |
|
|
|
11,375 |
|
|
|
9,855 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mail order pharmacy cost of goods sold |
|
|
291 |
|
|
|
255 |
|
|
|
866 |
|
|
|
762 |
|
Benefits and other expenses |
|
|
3,167 |
|
|
|
2,681 |
|
|
|
9,489 |
|
|
|
8,243 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and expenses |
|
|
3,458 |
|
|
|
2,936 |
|
|
|
10,355 |
|
|
|
9,005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
376 |
|
|
|
310 |
|
|
|
1,020 |
|
|
|
850 |
|
Income taxes |
|
|
136 |
|
|
|
110 |
|
|
|
366 |
|
|
|
301 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings |
|
|
240 |
|
|
|
200 |
|
|
|
654 |
|
|
|
549 |
|
Less special items (after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtailment gain (See Note 12 to the Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25 |
|
Cost reduction charge (See Note 5 to the Consolidated Financial Statements) |
|
|
|
|
|
|
(4 |
) |
|
|
|
|
|
|
(12 |
) |
Completion of IRS examination (See Note 15 to the Consolidated Financial
Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations |
|
$ |
240 |
|
|
$ |
204 |
|
|
$ |
654 |
|
|
$ |
535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net of taxes |
|
$ |
10 |
|
|
$ |
(1 |
) |
|
$ |
15 |
|
|
$ |
(17 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
55
The Health Care segments adjusted income from operations for the three months ended September 30,
2010 increased by 18%, compared with the same period in 2009 primarily due to:
|
|
increased membership in risk businesses, as well as higher specialty earnings; |
|
|
a lower guaranteed cost medical care ratio and higher experience-rated margins driven by
favorable prior year and current year claim development reflecting lower utilization levels;
and |
|
|
higher investment results due to improved real estate and security partnership income and
higher assets driven by membership growth, partially offset by lower yields. |
These favorable effects were partially offset by:
|
|
higher operating expenses reflecting the impact of membership growth in risk products and
investment in individual segment expansion, partially offset by the effect of cost reduction
initiatives including pension plan changes and staffing reductions, as well as lower
amortization expenses; and |
|
|
a higher medical care ratio in Medicare HMO and lower revenue driven by lower utilization
in the Companys wholly-owned physician practice. |
The Health Care segments adjusted income from operations for the nine months ended September 30,
2010 increased by 22%, compared with the same period in 2009 primarily due to:
|
|
increased membership in risk businesses, as well as higher specialty earnings; |
|
|
a lower guaranteed cost medical care ratio and higher experience-rated margins driven by
favorable prior year claim development and current year experience reflecting lower
utilization levels. In addition, results reflect the impact of a change in business mix
resulting from significant growth in high deductible plans, which generally experience lower
dollar value of claims in the first half of the year followed by higher dollar value of claims
in the second half of the year; and |
|
|
higher net investment income due to improved real estate and security partnership income
and higher assets driven by membership growth, partially offset by lower yields. |
These favorable effects were partially offset by:
|
|
higher operating expenses reflecting the impact of membership growth in risk products and
investment in individual segment expansion, partially offset by the effect of cost reduction
initiatives including pension plan changes and staffing reductions, as well as lower
amortization expenses; and |
|
|
a higher medical care ratio in stop loss products and Medicare HMO due to unfavorable claim
experience, as well as lower revenue driven by lower utilization in the Companys wholly-owned
physician practice. |
56
Revenues
The table below shows premiums and fees for the Health Care segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Medical: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guaranteed cost(1),(2) |
|
$ |
1,007 |
|
|
$ |
842 |
|
|
$ |
2,890 |
|
|
$ |
2,543 |
|
Experience-rated(2),(3) |
|
|
453 |
|
|
|
418 |
|
|
|
1,363 |
|
|
|
1,276 |
|
Stop loss |
|
|
323 |
|
|
|
312 |
|
|
|
965 |
|
|
|
965 |
|
Dental |
|
|
204 |
|
|
|
179 |
|
|
|
602 |
|
|
|
550 |
|
Medicare |
|
|
372 |
|
|
|
152 |
|
|
|
1,105 |
|
|
|
443 |
|
Medicare Part D |
|
|
118 |
|
|
|
71 |
|
|
|
434 |
|
|
|
273 |
|
Other (4) |
|
|
138 |
|
|
|
124 |
|
|
|
409 |
|
|
|
382 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total medical |
|
|
2,615 |
|
|
|
2,098 |
|
|
|
7,768 |
|
|
|
6,432 |
|
Life and other non-medical |
|
|
24 |
|
|
|
46 |
|
|
|
86 |
|
|
|
142 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums |
|
|
2,639 |
|
|
|
2,144 |
|
|
|
7,854 |
|
|
|
6,574 |
|
Fees(2),(5) |
|
|
711 |
|
|
|
668 |
|
|
|
2,091 |
|
|
|
2,004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums and fees |
|
$ |
3,350 |
|
|
$ |
2,812 |
|
|
$ |
9,945 |
|
|
$ |
8,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes guaranteed cost premiums primarily associated with open access, commercial HMO
and voluntary/limited benefits, as well as other risk-related products. |
|
(2) |
|
Premiums and/or fees associated with certain specialty products are also included. |
|
(3) |
|
Includes minimum premium members who have a risk profile similar to experience-rated
funding arrangements. The risk portion of minimum premium revenue is reported in
experience-rated medical premium whereas the self funding portion of minimum premium
revenue is recorded in fees. Also, includes certain non-participating cases for which
special customer level reporting of experience is required. |
|
(4) |
|
Other medical premiums include risk revenue for specialty products. |
|
(5) |
|
Represents administrative service fees for medical members and related specialty
product fees for non-medical members as well as fees related to Medicare Part D of $17
million for the three months and $39 million for the nine months ended September 30, 2010
and $11 million for three months and $28 million for the nine months ended September 30,
2009. |
Premiums and fees increased by 19% for the three months and 16% for the nine months ended September
30, 2010 compared with the same periods of 2009 primarily reflecting membership growth in most
products, predominantly in Medicare and guaranteed cost products, as well as rate increases,
partially offset by modestly lower service membership. The membership growth was driven by strong
retention and new sales in targeted market segments. These increases also reflect the Companys
efforts to enhance customer access, improve the quality of care and provide products and services
on a cost effective basis. Excluding the Medicare PFFS Individual business, premiums and fees
increased by 12% for the three months and 9% for the nine months ended September 30, 2010.
Net investment income increased by 21% for the three months and 37% for the nine months ended
September 30, 2010 compared with the same periods of 2009 reflecting improved real estate and
security partnership income, as well as, higher assets driven by membership growth, partially
offset by lower yields.
Other revenues for the Health Care segment consist of revenues earned on direct channel sales of
certain specialty products, including behavioral health and disease management.
57
Benefits and Expenses
Health Care segment benefits and expenses consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Medical claims expense |
|
$ |
2,148 |
|
|
$ |
1,698 |
|
|
$ |
6,435 |
|
|
$ |
5,226 |
|
Other benefit expenses |
|
|
22 |
|
|
|
48 |
|
|
|
79 |
|
|
|
134 |
|
Mail order pharmacy cost of goods sold |
|
|
291 |
|
|
|
255 |
|
|
|
866 |
|
|
|
762 |
|
Other operating expenses excluding special item(s) |
|
|
997 |
|
|
|
928 |
|
|
|
2,975 |
|
|
|
2,902 |
|
Special item(s) (1) |
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total benefits and expenses |
|
$ |
3,458 |
|
|
$ |
2,936 |
|
|
$ |
10,355 |
|
|
$ |
9,005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Pre-tax special items of $7 million for the three months ended September 30, 2009,
included a cost reduction charge and pre-tax special items of ($19 million) for the nine
months ended September 30, 2009 included a $39 million curtailment gain associated with the
freeze of the Companys pension plan, partially offset by a $20 million cost reduction
charge. For further discussion of special items, see the Consolidated Results of
Operations section of this MD&A beginning on page 50. |
Medical claims expense increased by 27% for the three months and 23% for the nine months ended
September 30, 2010 compared with the same periods in 2009 largely due to higher medical membership,
particularly in the Medicare PFFS Individual business which resulted in an increase of
approximately $190 million for the three months ended and
approximately $560 million for the nine
months ended September 30, 2010 compared with the same periods last year. The increases also
reflect higher membership in the commercial risk business as well as increases in medical cost
inflation.
Other operating expenses increased by 7% for the three months and 3% for the nine months ended
September 30, 2010 compared to the same periods in 2009 reflecting the impact of membership growth
in risk products and investment in individual segment expansion, partially offset by the effect of
cost reduction initiatives including pension plan changes and staffing reductions, as well as lower
amortization expenses.
Other Items Affecting Health Care Results
Health Care Medical Claims Payable
Medical claims payable increased $379 million for the nine months ended September 30, 2010 largely
driven by medical membership growth, particularly in the Medicare PFFS and commercial risk business
as noted above, as well as seasonality in the Stop Loss products (see Note 5 to the Consolidated
Financial Statements for additional information).
Medical Membership
The Health Care segments medical membership includes any individual for whom the Company retains
medical underwriting risk, who uses the Companys network for services covered under their medical
coverage or for whom the Company administers medical claims. As of September 30, estimated medical
membership was as follows:
|
|
|
|
|
|
|
|
|
(In thousands) |
|
2010 |
|
|
2009 |
|
Guaranteed cost (1) |
|
|
1,157 |
|
|
|
982 |
|
Experience-rated (2) |
|
|
859 |
|
|
|
764 |
|
|
|
|
|
|
|
|
Total commercial risk |
|
|
2,016 |
|
|
|
1,746 |
|
Medicare |
|
|
148 |
|
|
|
51 |
|
|
|
|
|
|
|
|
Total risk |
|
|
2,164 |
|
|
|
1,797 |
|
Service |
|
|
9,279 |
|
|
|
9,307 |
|
|
|
|
|
|
|
|
Total medical membership |
|
|
11,443 |
|
|
|
11,104 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes members primarily associated with open access, commercial HMO and
voluntary/limited benefits as well as other risk-related products. |
|
(2) |
|
Includes minimum premium members, who have a risk profile similar to experience-rated
members. Also, includes certain non-participating cases for which special customer level
reporting of experience is required. |
58
The Companys overall medical membership as of September 30, 2010 increased 3% when compared with
September 30, 2009, primarily driven by new business sales and improved persistency in
the risk businesses, offset by a modest decline in service membership largely reflecting
disenrollment after September 30, 2009.
Disability and Life Segment
Segment Description
The Disability and Life segment includes group disability, life, accident and specialty insurance
and case management services for disability and workers compensation.
Key factors for this segment are:
|
|
premium and fee growth, including new business and customer retention; |
|
|
benefits expense as a percentage of earned premium (loss ratio); and |
|
|
other operating expense as a percentage of earned premiums and fees (expense ratio). |
Results of Operations
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
663 |
|
|
$ |
654 |
|
|
$ |
1,974 |
|
|
$ |
1,987 |
|
Net investment income |
|
|
66 |
|
|
|
62 |
|
|
|
197 |
|
|
|
180 |
|
Other revenues |
|
|
29 |
|
|
|
30 |
|
|
|
86 |
|
|
|
87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
|
758 |
|
|
|
746 |
|
|
|
2,257 |
|
|
|
2,254 |
|
Benefits and expenses |
|
|
675 |
|
|
|
656 |
|
|
|
1,949 |
|
|
|
1,952 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
83 |
|
|
|
90 |
|
|
|
308 |
|
|
|
302 |
|
Income taxes |
|
|
23 |
|
|
|
26 |
|
|
|
89 |
|
|
|
82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings |
|
|
60 |
|
|
|
64 |
|
|
|
219 |
|
|
|
220 |
|
Less special items (after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtailment gain (See Note 13 to the Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4 |
|
Cost reduction charge (See Note 6 to the Consolidated Financial Statements) |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
(2 |
) |
Completion of IRS examination (See Note 16 to the Consolidated Financial
Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations |
|
$ |
60 |
|
|
$ |
65 |
|
|
$ |
219 |
|
|
$ |
213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net of taxes |
|
$ |
5 |
|
|
$ |
5 |
|
|
$ |
8 |
|
|
$ |
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment adjusted income from operations for the three months ended September 30, 2010 was flat
compared with the same period in 2009, excluding the $5 million favorable after-tax impact of a
reserve study in the third quarter of 2009. These results reflect:
|
|
|
higher net investment income; |
|
|
|
a lower operating expense ratio; and |
|
|
|
favorable disability claims experience. |
These factors were partially offset by less favorable life claims experience.
59
Segment adjusted income from operations increased 3% for the nine months ended September 30, 2010
compared with the same period in 2009 reflecting:
|
|
|
higher net investment income; |
|
|
|
a lower operating expense ratio; and |
|
|
|
continued strong disability claims management. |
These favorable impacts were partially offset by less favorable life claims experience. Results in
2010 include the $39 million after-tax favorable impact of reserve studies as compared with the $34
million after-tax favorable impact of reserve studies in 2009.
Revenues
Premiums and fees increased 1% for the three months and decreased 1% for the nine months ended
September 30, 2010 compared with the same periods of 2009 reflecting the Companys decision to exit
two large, non-strategic assumed government life insurance programs (a reduction of $48 million for
the three months and $125 million for the nine months ended
September 30, 2010) and the sale of the
renewal rights for the student and participant accident business (a reduction of $2 million for the
three months and $12 million for the nine months ended September 30, 2010). Excluding the impact
of these two items, premiums and fees increased 10% for the three months and 7% for the nine months
ended September 30, 2010 compared to the same periods in 2009 as a result of disability and life
sales growth and continued solid persistency.
Net investment income increased 6% for the three months and 9% for the nine months ended September
30, 2010 compared with the same periods of 2009 due to higher income from security and real estate
partnerships and higher invested assets, somewhat offset by lower yields.
Benefits and Expenses
Benefits and expenses excluding special items for the three months ended September 30, 2010
increased by 3% as compared with the same period of 2009, which included the impact of the
Companys exit from the two large, non-strategic assumed
government life insurance programs and the sale
of the renewal rights for the student and participant accident business. Excluding the impact of these
two items, benefits and expenses increased 11%, reflecting disability and life business growth,
less favorable life claims and the absence of the favorable impact of the 2009 reserve study,
partially offset by a lower operating expense ratio and favorable disability claims experience.
The less favorable life results reflect higher claims in the group universal life and waiver of
premium products. The lower operating expense ratio is driven by the absence of a 2009 expense
charge related to a settlement. The favorable disability claims experience was due to continued
strong claims management performance.
Benefits and expenses excluding special items for the nine months ended September 30, 2010 were
essentially flat as compared with the same period of 2009, which included the Companys exit from
the two large, non-strategic assumed government life insurance programs and the sale of the renewal rights
to the student and participant accident business. Excluding the impact of those two items,
benefits and expenses increased 7%, reflecting disability and life business growth, less favorable
life claims experience, partially offset by a lower operating expense ratio. The less favorable
life claims experience was primarily driven by lower experience rated margins and the impact of the
Gulf oil rig accident. The lower operating expense ratio reflects the absence of a 2009 expense
charge related to a settlement and strong expense management partially offset by the Companys
strategic investments in information technology and the claims operations. Benefits and expenses
in 2010 include the $56 million pre-tax favorable impact of reserve studies as compared to the $49
million favorable pre-tax impact of reserve studies in 2009.
60
International Segment
Segment Description
The International segment includes supplemental health, life and accident insurance products and
international health care products and services, including those offered to expatriate employees of
multinational corporations.
The key factors for this segment are:
|
|
premium growth, including new business and customer retention; |
|
|
benefits expense as a percentage of earned premium (loss ratio); |
|
|
operating expense as a percentage of earned premium (expense ratio); and |
|
|
impact of foreign currency movements. |
Results of Operations
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
574 |
|
|
$ |
482 |
|
|
$ |
1,643 |
|
|
$ |
1,378 |
|
Net investment income |
|
|
20 |
|
|
|
17 |
|
|
|
59 |
|
|
|
50 |
|
Other revenues |
|
|
8 |
|
|
|
4 |
|
|
|
23 |
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
|
602 |
|
|
|
503 |
|
|
|
1,725 |
|
|
|
1,442 |
|
Benefits and expenses |
|
|
525 |
|
|
|
447 |
|
|
|
1,463 |
|
|
|
1,251 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
77 |
|
|
|
56 |
|
|
|
262 |
|
|
|
191 |
|
Income taxes |
|
|
26 |
|
|
|
17 |
|
|
|
73 |
|
|
|
45 |
|
Income attributable to noncontrolling interest |
|
|
1 |
|
|
|
1 |
|
|
|
3 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings |
|
|
50 |
|
|
|
38 |
|
|
|
186 |
|
|
|
144 |
|
Less special items (after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost reduction charge (See Note 6 to the Consolidated Financial Statements) |
|
|
|
|
|
|
(2 |
) |
|
|
|
|
|
|
(2 |
) |
Curtailment gain (See Note 13 to the Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Completion of IRS examination (See Note 16 to the Consolidated Financial
Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations |
|
$ |
50 |
|
|
$ |
40 |
|
|
$ |
186 |
|
|
$ |
144 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impact of foreign currency movements on current period segment earnings |
|
$ |
1 |
|
|
|
|
|
|
$ |
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impact of permanent investment of overseas earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Implementation effect |
|
$ |
|
|
|
$ |
|
|
|
$ |
5 |
|
|
$ |
14 |
|
Effect of recording taxes at the tax rates of respective foreign jurisdictions |
|
|
4 |
|
|
|
3 |
|
|
|
18 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4 |
|
|
$ |
3 |
|
|
$ |
23 |
|
|
$ |
22 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains, net of taxes |
|
$ |
|
|
|
$ |
|
|
|
$ |
2 |
|
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
61
Excluding the impact of the tax adjustments discussed below and foreign currency movements
(presented in the table above), the International segments adjusted income from operations
increased 22% for the three months and 24% for the nine months ended September 30, 2010 compared
with the same periods last year. The increases for the three and nine months ended September 30,
2010, were primarily due to strong revenue growth and higher persistency in the supplemental
health, life and accident insurance business, particularly in South Korea, as well as favorable
loss ratios and membership growth in the expatriate employee benefits business. Both businesses
continue to deliver attractive margins.
During the first quarter of 2010, the Companys International segment implemented a capital
management strategy to permanently invest the earnings of its Hong Kong operation overseas.
Income taxes for this operation, and the South Korean operation that implemented a similar strategy
in the second quarter of 2009, are recorded at the tax rate of the respective foreign jurisdiction.
See the Financial Summary table for the effect of these capital management strategies on
Internationals adjusted income from operations for each applicable period.
Throughout this discussion, the impact of foreign currency movements was calculated by comparing
the reported results to what the results would have been had the exchange rates remained constant
with the prior years comparable period exchange rates.
Revenues
Premiums and fees. Excluding the effect of foreign currency movements, premiums and fees were $568
million for the third quarter of 2010, compared with reported premiums of $482 million for the
third quarter of 2009, an increase of 18%, and $1.6 billion for the nine months ended September 30,
2010, compared with reported premiums of $1.4 billion for the same period last year, an increase of
14%. These increases were primarily attributable to new sales growth in the supplemental health,
life and accident insurance operations, particularly in South Korea, and rate increases and
membership growth in the expatriate employee benefits business.
Net investment income increased by 18% for the three months and the nine months ended September 30,
2010, compared with the same periods last year. The increase was primarily due to favorable
foreign currency movements and asset growth, particularly in South Korea.
Benefits and Expenses
Excluding the impact of foreign currency movements, benefits and expenses were $520 million for the
third quarter of 2010, compared with reported benefits and expenses of $447 million for the third
quarter of 2009, an increase of 16% and $1.4 billion for the nine months ended September 30, 2010,
compared to reported benefits and expenses of $1.3 billion for the nine months ended September 30,
2009, an increase of 12%. These increases were primarily due to business growth and higher claims
in the supplemental health, life and accident insurance business, particularly in South Korea.
Loss ratios were flat for the three months and increased for the nine months ended September 30,
2010 in the supplemental health, life and accident insurance business compared to the same periods
last year. In the expatriate benefits business, loss ratios improved for the three and nine months
ended September 30, 2010, compared to the same periods last year, reflecting favorable claim
experience and rate increases on renewal business.
Policy acquisition expenses increased for the three and nine months ended September 30, 2010,
reflecting business growth and foreign currency movements partially offset by lower amortization of
deferred acquisition costs associated with higher persistency in the supplemental health, life and
accident insurance business.
Expense ratios increased for the third quarter of 2010 and for the nine months ended September 30,
2010, compared to the same periods last year. The increase for the three months ended September
30, 2010, reflects the acquisition costs associated with the purchase of Vanbreda International.
Other Items Affecting International Results
For the Companys International segment, South Korea is the single largest geographic market. South
Korea generated 32% of the segments revenues for the three and nine months ended September 30,
2010. South Korea generated 53% of the segments earnings for the third quarter of 2010 and 45% of
the segments earnings for the nine months ended September 30, 2010. Due to the concentration of
business in South Korea, the International segment is exposed to potential losses resulting from
economic and geopolitical developments in that country, as well as foreign currency movements
affecting the South Korean currency, which could have a significant impact on the segments results
and the Companys consolidated financial results.
62
Run-off Reinsurance Segment
Segment Description
The Companys reinsurance operations were discontinued and are now an inactive business in run-off
mode since the sale of the U.S. individual life, group life and accidental death reinsurance
business in 2000. This segment is predominantly comprised of guaranteed minimum death benefit
(GMDB, also known as VADBe), guaranteed minimum income benefit (GMIB), workers compensation
and personal accident reinsurance products.
The determination of liabilities for GMDB and GMIB requires the Company to make assumptions and
critical accounting estimates. The Company describes the assumptions used to develop the reserves
for GMDB in Note 7 to the Consolidated Financial Statements and for the assets and liabilities
associated with GMIB in Note 8 to the Consolidated Financial Statements. The Company also provides
the effects of hypothetical changes in assumptions in the Critical Accounting Estimates section of
the MD&A beginning on page 55 of the Companys 2009 Form 10-K.
The Company excludes the results of the GMIB business from adjusted income from operations because
the fair value of GMIB assets and liabilities must be recalculated each quarter using updated
capital market assumptions. The resulting changes in fair value, which are reported in
shareholders net income, are volatile and unpredictable.
Results of Operations
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
6 |
|
|
$ |
11 |
|
|
$ |
20 |
|
|
$ |
23 |
|
Net investment income |
|
|
31 |
|
|
|
28 |
|
|
|
87 |
|
|
|
86 |
|
Other revenues |
|
|
(119 |
) |
|
|
(160 |
) |
|
|
(73 |
) |
|
|
(234 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
|
(82 |
) |
|
|
(121 |
) |
|
|
34 |
|
|
|
(125 |
) |
Benefits and expenses |
|
|
(21 |
) |
|
|
(159 |
) |
|
|
247 |
|
|
|
(295 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(61 |
) |
|
|
38 |
|
|
|
(213 |
) |
|
|
170 |
|
Income taxes (benefits) |
|
|
(24 |
) |
|
|
8 |
|
|
|
(76 |
) |
|
|
54 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings (loss) |
|
|
(37 |
) |
|
|
30 |
|
|
|
(137 |
) |
|
|
116 |
|
Less: results of GMIB business |
|
|
(10 |
) |
|
|
16 |
|
|
|
(109 |
) |
|
|
149 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income (loss) from operations |
|
$ |
(27 |
) |
|
$ |
14 |
|
|
$ |
(28 |
) |
|
$ |
(33 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net of taxes |
|
$ |
1 |
|
|
$ |
4 |
|
|
$ |
2 |
|
|
$ |
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment results for the three months ended September 30, 2010 reflect losses for both the GMDB and
GMIB businesses (presented in the table above) compared with essentially break-even results for the
GMDB business and earnings for the GMIB business for the same period last year. The GMDB results
for the three months ended September 30, 2010 included a reserve strengthening of $34 million
after-tax primarily to reflect managements consideration of the anticipated impact of the
continued low level of current short-term interest rates and, to a lesser extent, a reduction in
assumed lapse rates for policies that have taken or are assumed to take significant partial
withdrawals. Losses on the GMIB business are primarily attributable to the impact of declines in
interest rates on the GMIB fair value calculation during the three months ended September 30, 2010,
partially offset by the impact of improvements in equity markets. Segment results also include
favorable after-tax impacts of reserve studies for the workers compensation and personal accident
businesses of $4 million for the three months ended September 30, 2010 and $14 million for the same
period of 2009.
Segment results for the nine months ended September 30, 2010 reflect losses for both the GMDB and
GMIB businesses (presented in the table above) compared to losses for the GMDB business and
favorable results for the GMIB business during the nine months ended September 30, 2009. The GMDB
results include charges for strengthening reserves during each of these periods ($34 million
after-tax for the nine months ended September 30, 2010, compared to $47 million after-tax for the
nine months ended September 30, 2009). Significant losses for the GMIB business for the nine
months ended September 30, 2010 are attributed to declining market interest rates during the
period, while significant gains on the GMIB business for the nine months ended September 30, 2009
are attributed to increasing interest rates and equity markets during that period. Segment results
also include favorable after-tax impacts of reserve studies for the workers compensation and
personal accident businesses of $1 million for the nine months ended September 30, 2010 and $16
million for the same period of 2009.
63
See the Benefits and Expenses section for further discussion around the results of the GMIB and
GMDB businesses.
Other Revenues
Other revenues included pre-tax losses of $119 million for the three months and $72 million for the
nine months ended September 30, 2010 from futures contracts used in the GMDB equity hedge program
(see Note 7 to the Consolidated Financial Statements), compared with losses of $161 million for the
three months and $232 million for the nine months ended September 30, 2009. Amounts reflecting
corresponding changes in liabilities for GMDB contracts were included in benefits and expenses
consistent with GAAP when a premium deficiency exists (see below Other Benefits and
Expenses). The Company held futures contract positions related to this program with a notional
amount of $1.1 billion at September 30, 2010.
Benefits and Expenses
Benefits and expenses were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
GMIB fair value (gain) loss |
|
$ |
22 |
|
|
$ |
(19 |
) |
|
$ |
182 |
|
|
$ |
(215 |
) |
Other benefits and expenses |
|
|
(43 |
) |
|
|
(140 |
) |
|
|
65 |
|
|
|
(80 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and expenses |
|
$ |
(21 |
) |
|
$ |
(159 |
) |
|
$ |
247 |
|
|
$ |
(295 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
GMIB fair value (gain) loss. Under the GAAP guidance for fair value measurements, the Companys
results of operations are expected to be volatile in future periods because capital market
assumptions needed to estimate the assets and liabilities for the GMIB business are based largely
on market-observable inputs at the close of each reporting period including interest rates (LIBOR
swap curve) and market-implied volatilities. See Note 8 to the Consolidated Financial Statements
for additional information about assumptions and asset and liability balances related to GMIB.
GMIB fair value losses of $22 million for the three months ended September 30, 2010, and $182
million for the nine months ended September 30, 2010, were primarily due to declining interest
rates, partially offset by improving equity markets which result in decreased exposures.
GMIB fair value gains of $19 million for the three months ended September 30, 2009 were primarily
due to increases in underlying account values in the period, driven by favorable equity market and
bond fund returns, resulting in reduced exposures and updates to the risk and profit charge
estimates. These favorable effects were partially offset by decreases in interest rates and other
amounts, including experience varying from assumptions, model and in-force updates.
GMIB fair value gains of $215 million and for the nine months ended September 30, 2009, were
primarily due to increases in interest rates, increases in underlying account values in the period
and updates to the risk and profit charge estimates. These favorable effects were partially offset
by increases to the annuitization assumption, updates to the lapse assumption and other amounts,
including experience varying from assumptions, model and in-force updates.
The GMIB liabilities and related assets are calculated using a complex internal model and
assumptions from the viewpoint of a hypothetical market participant. This resulting liability (and
related asset) is higher than the Company believes will ultimately be required to settle claims
primarily because market-observable interest rates are used to project growth in account values of
the underlying mutual funds to estimate fair value from the viewpoint of a hypothetical market
participant. The Companys payments for GMIB claims are expected to occur over the next 15 to 20
years and will be based on actual values of the underlying mutual funds and the 7-year Treasury
rate at the dates benefits are elected. Management does not believe that current market-observable
interest rates reflect actual growth expected for the underlying mutual funds over that timeframe,
and therefore believes that the recorded liability and related asset do not represent what
management believes will ultimately be required as this business runs off.
However, significant declines in mutual fund values that underlie the contracts (increasing the
exposure to the Company) together with declines in the 7-year Treasury rates (used to determine
claim payments) similar to what occurred periodically during the last few years would increase the
expected amount of claims that would be paid out for contractholders who choose to annuitize. It
is also possible that such unfavorable market conditions would have an impact on the level of
contractholder annuitizations, particularly if such unfavorable market conditions persisted for an
extended period.
64
Other Benefits and Expenses. Other benefits and expenses reflected income for the three months and
expense for the nine months ended September 30, 2010, compared to income for the three months and
nine months ended September 30, 2009. These fluctuations reflect the impacts of changes in equity
markets on the Companys liabilities for guaranteed minimum death benefit contracts. Equity market
improvements during the third quarter 2010 increased the underlying annuity account values, which
decreased the exposure under the contracts and related benefits expense for the three months ended
September 30, 2010. However, this was partially offset by additional other benefits and expenses
of $52 million to strengthen GMDB reserves (see below) during the three months ended September 30,
2010. The nine months ended September 30, 2010 reflects this additional benefits expense, as well
as the impact of decreases in equity markets earlier in the year, partially offset by increasing
equity markets in the third quarter. Equity market improvements during the second and third
quarters of 2009 increased the underlying annuity account values, which decreased the exposure
under the contracts and related benefits expense. For the nine months ended September 30, 2009,
this activity was partially offset by the impacts of equity market declines during the first
quarter of 2009, in addition to a pre-tax charge of $73 million to strengthen GMDB reserves (see
below). These changes in benefits expense are partially offset by futures gains and losses,
discussed in Other Revenues above.
During the third quarter of 2010, the Company recorded additional other benefits and expenses of
$52 million ($34 million after-tax) to strengthen GMDB reserves. The reserve strengthening was
primarily to reflect managements consideration of the anticipated impact of the continued low
level of current short-term interest rates and, to a lesser extent, a reduction in assumed lapse
rates for policies that have taken or are assumed to take significant partial withdrawals. In the
first quarter of 2009, the Company recorded additional other benefits and expenses of $73 million
($47 million after-tax) to strengthen GMDB reserves. The amounts were primarily due to an increase
in the provision for future partial surrenders due to overall market declines, adverse
volatility-related impacts due to turbulent equity market conditions and adverse interest rate
impacts.
See Note 7 to the Consolidated Financial Statements for additional information about assumptions
and reserve balances related to GMDB.
Segment Summary
The Companys payment obligations for underlying reinsurance exposures assumed by the Company under
these contracts are based on ceding companies claim payments. For GMDB and GMIB, claim payments
vary because of changes in equity markets and interest rates, as well as mortality and policyholder
behavior. For workers compensation and personal accident, the claim payments relate to accidents
and injuries. Any of these claim payments can extend many years into the future, and the amount of
the ceding companies ultimate claims, and therefore the amount of the Companys ultimate payment
obligations and corresponding ultimate collection from its retrocessionaires may not be known with
certainty for some time.
The Companys reserves for underlying reinsurance exposures assumed by the Company, as well as for
amounts recoverable from retrocessionaires, are considered appropriate as of September 30, 2010,
based on current information. However, it is possible that future developments, which could
include but are not limited to worse than expected claim experience and higher than expected
volatility, could have a material adverse effect on the Companys consolidated results of
operations and could have a material adverse effect on the Companys financial condition. The
Company bears the risk of loss if its payment obligations to cedents increase or if its
retrocessionaires are unable to meet, or successfully challenge, their reinsurance obligations to
the Company.
Other Operations Segment
Segment Description
Other Operations consist of:
|
|
non-leveraged and leveraged corporate-owned life insurance (COLI); |
|
|
deferred gains recognized from the 1998 sale of the individual life insurance and annuity
business and the 2004 sale of the retirement benefits business; and |
|
|
run-off settlement annuity business. |
65
Results of Operations
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Premiums and fees |
|
$ |
28 |
|
|
$ |
26 |
|
|
$ |
86 |
|
|
$ |
83 |
|
Net investment income |
|
|
100 |
|
|
|
104 |
|
|
|
305 |
|
|
|
304 |
|
Other revenues |
|
|
14 |
|
|
|
16 |
|
|
|
44 |
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
|
142 |
|
|
|
146 |
|
|
|
435 |
|
|
|
436 |
|
Benefits and expenses |
|
|
113 |
|
|
|
111 |
|
|
|
342 |
|
|
|
353 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
29 |
|
|
|
35 |
|
|
|
93 |
|
|
|
83 |
|
Income taxes |
|
|
7 |
|
|
|
12 |
|
|
|
28 |
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment earnings |
|
|
22 |
|
|
|
23 |
|
|
|
65 |
|
|
|
63 |
|
Less special item (after-tax) included in segment earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Completion of IRS examination (See Note 16 to the
Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations |
|
$ |
22 |
|
|
$ |
23 |
|
|
$ |
65 |
|
|
$ |
62 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net of taxes |
|
$ |
2 |
|
|
$ |
1 |
|
|
$ |
2 |
|
|
$ |
(4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted income from operations for Other Operations decreased for the three months ended September
30, 2010 compared with the same period in 2009, reflecting lower COLI earnings driven by lower
investment income and a continued decline in deferred gain amortization associated with the sold
businesses, partially offset by a favorable state income tax benefit. Adjusted income from
operations increased for the nine months ended September 30, 2010 compared with the same period in
2009, reflecting higher COLI earnings driven by higher investment income and favorable mortality
and a favorable state income tax benefit, partially offsetting these factors was a continued
decline in deferred gain amortization associated with the sold businesses.
Revenues
Net investment income. Net investment income decreased 4% for the three months ended September 30,
2010, compared with the same period in 2009, reflecting lower average yields in both the COLI and
settlement annuity businesses. For the nine months ended September 30, 2010, net investment income
was in line with the same period in 2009, reflecting higher COLI average invested assets and higher
income on partnership investments, offset by lower settlement annuity average invested assets and
reinvestment yields.
Other revenues. Other revenues decreased 13% for three months and 10% for the nine months ended
September 30, 2010, compared with the same periods in 2009 primarily due to lower deferred gain
amortization related to the sold retirement benefits and individual life insurance and annuity
businesses. The amount of the deferred gain amortization recorded was $7 million in the three
months and $19 million in the nine months ended September 30, 2010, compared to $8 million in the
three months and $24 million in the nine months ended September 30, 2009.
Corporate
Description
Corporate reflects amounts not allocated to segments, such as net interest expense (defined as
interest on corporate debt less net investment income on investments not supporting segment
operations), interest on uncertain tax positions, certain litigation matters, intersegment
eliminations, compensation cost for stock options and certain corporate overhead expenses such as
directors expenses and, beginning in 2010, pension expense related to the Companys frozen pension
plans.
FINANCIAL SUMMARY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Segment loss |
|
$ |
(46 |
) |
|
$ |
(35 |
) |
|
$ |
(132 |
) |
|
$ |
(97 |
) |
Less special item (after-tax) included in segment loss: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Completion of IRS examination (See Note 16 to the
Consolidated Financial Statements) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted loss from operations |
|
$ |
(46 |
) |
|
$ |
(35 |
) |
|
$ |
(132 |
) |
|
$ |
(109 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
66
Corporates adjusted loss from operations was greater for the three months ended September 30, 2010
compared with the same period in 2009 reflecting:
|
|
higher net interest expense, primarily driven by a higher long-term debt balance; |
|
|
tax adjustments related to compensation resulting from health care reform; and |
|
|
pension expense related to the Companys frozen pension plans which was reported in
Corporate beginning in 2010. |
Corporates adjusted loss from operations was greater for the nine months ended September 30, 2010
compared with the same period in 2009, primarily reflecting:
|
|
higher net interest expense, primarily driven by a higher long-term debt balance; |
|
|
tax adjustments related to postretirement benefits and compensation resulting from health
care reform; and |
|
|
pension expense related to the Companys frozen pension plans which was reported in
Corporate beginning in 2010. |
DISCONTINUED OPERATIONS
Description
Discontinued operations represent results associated with certain investments or businesses that
have been sold or are held for sale.
Discontinued operations for the nine months ended 2009 primarily represented a tax benefit from a
past divestiture resolved at the completion of the 2005 and 2006 IRS examinations.
67
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The Company maintains liquidity at two levels: the subsidiary level and the parent company level.
Liquidity requirements at the subsidiary level generally consist of:
|
|
claim and benefit payments to policyholders; and |
|
|
operating expense requirements, primarily for employee compensation and benefits. |
The Companys subsidiaries normally meet their operating requirements by:
|
|
maintaining appropriate levels of cash, cash equivalents and short-term investments; |
|
|
using cash flows from operating activities; |
|
|
matching investment durations to those estimated for the related insurance and contractholder liabilities; and |
|
|
borrowing from its parent company. |
Liquidity requirements at the parent company level generally consist of:
|
|
debt service and dividend payments to shareholders; and |
The parent normally meets its liquidity requirements by:
|
|
maintaining appropriate levels of cash, cash equivalents and short-term investments; |
|
|
collecting dividends from its subsidiaries; |
|
|
using proceeds from issuance of debt and equity securities; and |
|
|
borrowing from its subsidiaries. |
Cash flows for the nine months ended September 30, were as follows:
|
|
|
|
|
|
|
|
|
(In millions) |
|
2010 |
|
|
2009 |
|
Operating activities |
|
$ |
1,283 |
|
|
$ |
269 |
|
Investing activities |
|
$ |
(1,058 |
) |
|
$ |
(1,074 |
) |
Financing activities |
|
$ |
250 |
|
|
$ |
290 |
|
Cash flows from operating activities consist of cash receipts and disbursements for premiums and
fees, mail order pharmacy and other revenues, gains (losses) recognized in connection with the
Companys GMDB equity hedge program, investment income, taxes, and benefits and expenses.
Because certain income and expense transactions do not generate cash, and because cash transactions
related to revenue and expenses may occur in periods different from when those revenues and
expenses are recognized in shareholders net income, cash flows from operating activities can be
significantly different from shareholders net income.
Cash flows from investing activities generally consist of net investment purchases or sales and net
purchases of property and equipment, which includes capitalized software, as well as cash used to
acquire businesses.
Cash flows from financing activities are generally comprised of issuances and re-payment of debt at
the parent company level, proceeds on the issuance of common stock resulting from stock option
exercises, and stock repurchases. In addition, the subsidiaries report net deposits/withdrawals
to/from investment contract liabilities (which include universal life insurance liabilities)
because such liabilities are considered financing activities with policyholders.
68
2010:
Operating activities
For the nine months ended September 30, 2010, cash flows from operating activities were higher than
net income by $396 million. Net income contains certain after-tax income and expense items which
neither provide nor use operating cash flow, including:
|
|
unfavorable results of the GMIB business of $109 million; |
|
|
|
depreciation and amortization charges of $133 million; and |
|
|
|
realized investment gains of $29 million. |
Cash flows from operating activities were higher than net income excluding the non-cash items noted
above by $183 million. Excluding cash outflows of $72 million associated with the GMDB equity
hedge program (which did not affect shareholders net income), cash flows from operating activities
were higher than net income by $255 million. This result primarily reflects premium growth in the
Health Care segments risk businesses due to significant new business in 2010, partially offset by
pension contributions of $212 million.
Cash flows from operating activities increased by $1,014 million compared with the nine months
ended September 30, 2009. Excluding the results of the GMDB equity hedge program (which did not
affect shareholders net income), cash flows from operating activities increased by $854
million. This increase primarily reflects premium growth in the Health Care segments risk
businesses as noted above and earnings growth in the Health Care, Disability and Life and
International segments as well as lower contributions to the qualified domestic pension plan ($212
million for the nine months ended September 30, 2010, compared with $354 million for the nine
months ended September 30, 2009). These favorable effects were partially offset by higher
management compensation and income tax payments for the nine months ended September 30, 2010
compared with the same period last year.
Investing activities
Cash used in investing activities was $1,058 million. This use of cash consisted primarily of net
purchases of investments of $517 million, cash used to fund acquisitions (net of cash acquired) of
$332 million, and net purchases of property and equipment of $209 million.
Financing activities
Cash provided from financing activities consisted primarily of net proceeds from the issuance of
long-term debt of $296 million, changes in cash overdraft position of $38 million, proceeds from
issuances of common stock from employee benefit plans of $31 million and net deposits to
contractholder deposit funds of $99 million. These inflows were partially offset by cash used for
common stock repurchases of $201 million.
2009:
Operating activities
For the nine months ended September 30, 2009, cash flows from operating activities were less than
net income by $705 million. Net income contains certain after-tax income and expense items which
neither provide nor use operating cash flow, including:
|
|
favorable results of the GMIB business of $149 million; |
|
|
|
a curtailment gain of $30 million, net of a cost reduction charge of $16 million; |
|
|
|
tax benefits related to the IRS examination of $20 million; |
|
|
|
depreciation and amortization charges of $135 million; and |
|
|
|
realized investment losses of $24 million. |
Cash flows from operating activities were lower than net income excluding the non-cash items noted
above by $681 million. This decrease was primarily due to cash outflows of $232 million associated
with the GMDB equity hedge program which did not affect shareholders net income, contributions to
the qualified domestic pension plan of approximately $354 million and increases in receivables.
69
Investing activities
Cash used in investing activities was $1.1 billion. This use of cash consisted primarily of net
purchases of investments of $856 million and net purchases of property and equipment of $218
million.
Financing activities
Cash provided from financing activities consisted primarily of proceeds from the net issuance of
long-term debt of $346 million, offset by repayments of short-term debt, primarily commercial
paper, of $199 million. Financing activities also included net deposits to contractholder deposit
funds of $65 million.
Interest Expense
Interest expense on long-term debt, short-term debt and capital leases was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
(In millions) |
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Interest expense |
|
$ |
47 |
|
|
$ |
43 |
|
|
$ |
135 |
|
|
$ |
122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in interest expense for the three and nine months ended September 30, 2010 was
primarily due to higher long-term debt outstanding in 2010, resulting from the issuance of debt in
May, 2010 and May, 2009 used for general corporate purposes.
Capital Resources
The Companys capital resources (primarily retained earnings and the proceeds from the issuance of
debt and equity securities) provide protection for policyholders, furnish the financial strength to
underwrite insurance risks and facilitate continued business growth.
Management, guided by regulatory requirements and rating agency capital guidelines, determines the
amount of capital resources that the Company maintains. Management allocates resources to new
long-term business commitments when returns, considering the risks, look promising and when the
resources available to support existing business are adequate.
The Company prioritizes its use of capital resources to:
|
|
provide capital necessary to support growth and maintain or improve the financial strength
ratings of subsidiaries which includes
evaluating potential solutions for the Companys run-off reinsurance business and pension
funding obligations; |
|
|
consider acquisitions that are strategically and economically advantageous; and |
|
|
return capital to investors through share repurchase. |
The availability of capital resources will be impacted by equity and credit market conditions.
Extreme volatility in credit or equity market conditions may reduce the Companys ability to issue
debt or equity securities.
Sources of Capital
On May 12, 2010, the Company issued $300 million of 5.125% Notes ($299 million, net of discount,
with an effective interest rate of 5.36% per year). Interest is payable on June 15 and December 15
of each year beginning December 15, 2010. The proceeds of this debt were used for general
corporate purposes. These Notes will mature on June 15, 2020.
On May 4, 2009, the Company issued $350 million of 8.5% Notes ($349 million, net of debt discount,
with an effective interest rate of 9.90% per year). The difference between the stated and
effective interest rates primarily reflects the effect of treasury locks. See Note 14 to the
Consolidated Financial Statements for further information. Interest is payable on May 1 and
November 1 of each year beginning November 1, 2009. The proceeds of this debt were used for
general corporate purposes, including the repayment of some of the Companys outstanding commercial
paper. These Notes will mature on May 1, 2019.
70
The Company may redeem these Notes, at any time, in whole or in part, at a redemption price equal
to the greater of:
|
|
100% of the principal amount of the Notes to be redeemed; or |
|
|
the present value of the remaining principal and interest payments on the Notes being
redeemed discounted at the applicable treasury rate plus 25 basis points (5.125% Notes due
2020) or 50 basis points (8.5% Notes due 2019). |
Uses of Capital
For the nine months ended September 30, 2010, the Companys uses of capital included the following.
Pension funding. The Company contributed $212 million to the pension plans, of which $69 million
was required and $143 million was voluntary.
Acquisition of Vanbreda International. In the third quarter of 2010, the Company acquired Vanbreda
International for approximately $410 million. The acquisition
was funded from available cash. Approximately $400 million was paid
during the third quarter of 2010, with the remainder expected to be
paid during the fourth quarter of 2010.
Share Repurchase. The Company maintains a share repurchase program, which was authorized by its
Board of Directors. The decision to repurchase shares depends on market conditions and alternate
uses of capital. The Company has, and may continue from time to time, to repurchase shares on the
open market through a Rule 10b5-1 plan which permits a company to repurchase its shares at times
when it otherwise might be precluded from doing so under insider trading laws or because of
self-imposed trading blackout periods. The Company suspends activity under this program from time
to time and also removes such suspensions, generally without public announcement.
Through October 29, 2010, the Company repurchased 6.2 million shares for approximately $200 million
but did not repurchase any shares during 2009. The total remaining share repurchase authorization
as of October 29, 2010 was $247 million.
Liquidity and Capital Resources Outlook
At September 30, 2010, there was $637 million in cash and short-term investments available at the
parent company level. For the remainder of 2010, the parent companys cash requirements include
scheduled interest payments of $58 million on outstanding long-term debt (including current
maturities) of $2.6 billion at September 30, 2010. In addition, approximately $100 million of
commercial paper will mature over the next three months and scheduled long-term debt repayments of $222
million are due in January of 2011. The Company is not required to make any additional
contributions to the pension plan for the remainder of the year. The parent company expects to
fund these cash requirements by using available cash, subsidiary dividends and by refinancing the
maturing commercial paper borrowings with new commercial paper.
The availability of resources at the parent company level is partially dependent on dividends from
the Companys subsidiaries, most of which are subject to regulatory restrictions and rating agency
capital guidelines, and partially dependent on the availability of liquidity from the issuance of
debt or equity securities.
The Company expects, based on current projections for cash activity, to have sufficient liquidity
to meet its obligations.
However, the Companys cash projections may not be realized and the demand for funds could exceed
available cash if:
|
|
ongoing businesses experience unexpected shortfalls in earnings; |
|
|
regulatory restrictions or rating agency capital guidelines reduce the amount of dividends available to be distributed
to the parent company from the insurance and HMO subsidiaries (including the impact of equity market deterioration and
volatility on subsidiary capital); |
|
|
significant disruption or volatility in the capital and credit markets reduces the Companys ability to raise capital
or creates unexpected losses related to the GMDB and GMIB businesses; |
|
|
a substantial increase in funding over current projections is required for the Companys pension plans; or |
|
|
a substantial increase in funding is required for the Companys GMDB equity hedge program. |
In those cases, the Company expects to have the flexibility to satisfy liquidity needs through a
variety of measures, including intercompany borrowings and sales of liquid investments. The parent
company may borrow up to $600 million from Connecticut General Life Insurance Company (CGLIC)
without prior state approval. As of September 30, 2010, the parent company had no outstanding
borrowings from CGLIC.
71
In addition, the Company may use short-term borrowings, such as the commercial paper program and
the committed revolving credit and letter of credit agreement of up to $1.75 billion subject to the
maximum debt leverage covenant in its line of credit agreement. This agreement permits up to $1.25
billion to be used for letters of credit. As of September 30, 2010, there were two letters
totaling $82 million issued out of the credit facility. As of September 30, 2010, the Company had
an additional $1.7 billion of borrowing capacity under the credit facility.
Though the Company believes it has adequate sources of liquidity, continued significant disruption
or volatility in the capital and credit markets could affect the Companys ability to access those
markets for additional borrowings or increase costs associated with borrowing funds.
As of September 30, 2010, discount rates used annually to measure pension liabilities had declined
by approximately 100 basis points since December 31, 2009. As required by GAAP, the Company will
update its pension liability at December 31, 2010 using an updated discount rate. The Critical
Accounting Estimates section of the Companys 2009 Form 10-K indicates that a 50 basis point
decrease in the discount rate would increase the pension liability by approximately $200 million.
Accordingly, if discount rates at September 30, 2010 remain level through year-end 2010, the
pension liability is expected to increase by approximately $400 million in the fourth quarter of
2010 resulting in an after-tax decline in shareholders equity of approximately $260 million. The
amount of the year-end adjustment will also be influenced by asset performance in 2010. The
potential decline in the discount rate is not expected to increase pension expense in 2011.
Because different discount rates are used for pension funding purposes, this potential increase in
the pension liability would not significantly increase the amount of required funding for the
pension plan in 2011. Accordingly, the Company believes there will be no change in its plan for
funding pension contributions in 2011, and it has adequate liquidity to fund those planned
contributions.
Guarantees and Contractual Obligations
The Company, through its subsidiaries, is contingently liable for various contractual obligations
entered into in the ordinary course of business. See Note 18 to the Consolidated Financial
Statements for additional information.
Contractual obligations. The Company has updated its contractual obligations previously provided
on page 85 of the Companys 2009 Form 10-K for certain items as follows:
|
|
Future policy benefit liabilities associated with GMDB contracts. See Note 7 to the
Consolidated Financial Statements; |
|
|
Long-term debt, primarily due to the issuance of new debt on May 12, 2010. See Note 14 to
the Consolidated Financial Statements for additional information; |
|
|
Other long-term liabilities associated with GMIB contracts. See Note 8 to the Consolidated
Financial Statements; and |
|
|
Off-balance sheet purchase obligations associated with contracts for certain outsourced
business processes and IT maintenance and support. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 1 |
|
|
1-3 |
|
|
4-5 |
|
|
After 5 |
|
(In millions, on an undiscounted basis) |
|
Total |
|
|
year |
|
|
years |
|
|
years |
|
|
years |
|
On-Balance Sheet: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future policy benefits |
|
$ |
11,264 |
|
|
$ |
485 |
|
|
$ |
885 |
|
|
$ |
885 |
|
|
$ |
9,009 |
|
Long-term debt |
|
$ |
5,071 |
|
|
$ |
174 |
|
|
$ |
800 |
|
|
$ |
309 |
|
|
$ |
3,788 |
|
Other long-term liabilities |
|
$ |
1,513 |
|
|
$ |
590 |
|
|
$ |
326 |
|
|
$ |
162 |
|
|
$ |
435 |
|
Off-Balance Sheet: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase obligations |
|
$ |
1,603 |
|
|
$ |
569 |
|
|
$ |
669 |
|
|
$ |
281 |
|
|
$ |
84 |
|
INVESTMENT ASSETS
The Companys investment assets do not include separate account assets. Additional information
regarding the Companys investment assets and related accounting policies is included in Notes 2,
8, 9, 10, 11 and 15 to the Consolidated Financial Statements. More detailed information about the
fixed maturities and mortgage loan portfolios by type of issuer, maturity dates, and, for mortgages
by property type and location is included in Note 9 to the Consolidated Financial Statements and
Notes 2, 11, 12 and 17 to the Consolidated Financial Statements in the Companys 2009 Form 10-K.
As of September 30, 2010, the Companys mix of investments and their primary characteristics had
not materially changed since December 31, 2009. The Companys fixed maturity portfolio is
diversified by issuer and industry type, with no single industry constituting more than 10% of
total invested assets as of September 30, 2010. The Companys commercial mortgage loan portfolio
is diversified by property type, location and borrower to reduce exposure to potential losses.
72
Fixed Maturities
Investments in fixed maturities (bonds) include publicly traded and privately placed debt
securities, mortgage and other asset-backed securities, preferred stocks redeemable by the
investor, hybrid and trading securities. Fair values are based on quoted market prices when
available. When market prices are not available, fair value is generally estimated using
discounted cash flow analyses, incorporating current market inputs for similar financial
instruments with comparable terms and credit quality. In instances where there is little or no
market activity for the same or similar instruments, the Company estimates fair value using
methods, models and assumptions that the Company believes a hypothetical market participant would
use to determine a current transaction price.
The Company performs ongoing analyses of prices used to value the Companys invested assets to
determine that they represent appropriate estimates of fair value. This process involves
quantitative and qualitative analysis including reviews of pricing methodologies, judgments of
valuation inputs, the significance of any unobservable inputs, pricing statistics and trends. The
Company also performs sample testing of sales values to confirm the accuracy of prior fair value
estimates. These procedures are overseen by the Companys investment professionals.
The net appreciation of the Companys fixed maturity portfolio increased $444 million in the three
months and $1,003 million in the nine months ended September 30, 2010 driven by a decline in market
yields. Although overall asset values are well in excess of amortized cost, there are specific
securities with amortized cost in excess of fair value by $38 million as of September 30, 2010.
See Note 9 to the Consolidated Financial Statements for further information.
As of September 30, 2010, approximately 62% or $1,625 million of the Companys total investments
in state and local government securities of $2,604 million were guaranteed by monoline bond
insurers. The quality ratings of these investments with and without this guaranteed support as of
September 30, 2010 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2010 |
|
|
|
|
|
Fair Value |
|
|
|
|
|
|
|
|
|
Without |
|
(In millions) |
|
Quality Rating |
|
With Guarantee |
|
|
Guarantee |
|
State and local governments |
|
Aaa |
|
$ |
87 |
|
|
$ |
83 |
|
|
|
Aa1-Aa3 |
|
|
1,241 |
|
|
|
1,159 |
|
|
|
A1-A3 |
|
|
257 |
|
|
|
277 |
|
|
|
Baa1-Baa3 |
|
|
40 |
|
|
|
50 |
|
|
|
Not available |
|
|
|
|
|
|
56 |
|
|
|
|
|
|
|
|
|
|
Total state and local governments |
|
|
|
$ |
1,625 |
|
|
$ |
1,625 |
|
|
|
|
|
|
|
|
|
|
As of September 30, 2010, approximately 76% or $535 million of the Companys total investments in
other asset-backed securities of $708 million were guaranteed by monoline bond insurers. All of
these securities had quality ratings of Baa2 or better. Quality ratings without considering the
guarantees for these other asset-backed securities were not available.
As of September 30, 2010, the Company had no direct investments in monoline bond insurers.
Guarantees provided by various monoline bond insurers for certain of the Companys investments in
state and local governments and other asset-backed securities as of September 30, 2010 were:
|
|
|
|
|
(In millions) |
|
As of September 30, 2010 |
|
Guarantor |
|
Indirect Exposure |
|
National Public Finance Guarantee (formerly MBIA, Inc.) |
|
$ |
1,317 |
|
Assured Guaranty Municipal Corp (formerly Financial Security Assurance) |
|
|
613 |
|
AMBAC |
|
|
190 |
|
Financial Guaranty Insurance Co. |
|
|
40 |
|
|
|
|
|
Total |
|
$ |
2,160 |
|
|
|
|
|
73
The Company continues to underwrite investments in these securities focusing on the underlying
issuers credit quality, without regard for guarantees. As such, this portfolio of state and local
government securities, guaranteed by monoline bond insurers is of high quality with approximately
93% rated A3 or better without their guarantees.
Commercial Mortgage Loans
The Companys commercial mortgage loans are fixed rate loans, diversified by property type,
location and borrower to reduce exposure to potential losses. Loans are secured by high quality
commercial and multi-family property and are generally made at less than 75% of the propertys
value at origination of the loan. In addition to property value, debt service coverage, which is
the ratio of the estimated cash flows from the property to the required loan payments (principal
and interest), is an important underwriting consideration.
The Company completed its annual in depth review of its commercial mortgage loan portfolio in July,
2010. This review included an analysis of each propertys year-end 2009 financial statements, rent
rolls, operating plans and budgets for 2010, a physical inspection of the property and other
pertinent factors. Based on property values and cash flows estimated as part of this review, along
with updates for portfolio activity subsequent to the review, the portfolios average loan-to-value
ratio modestly improved, decreasing from 77% as of December 31, 2009 to 75% at September 30, 2010.
The portfolios average debt service coverage was estimated to be 1.37 as of September 30, 2010,
down from 1.48 as of December 31, 2009.
Values estimated for the properties in CIGNAs mortgage portfolio reflect improving commercial real
estate capital markets, with stabilizing, and in some instances, increasing values, for well
leased, quality commercial real estate located in strong institutional investment markets, the
quality reflected by the vast majority of properties securing the mortgages. The deterioration in
property cash flows (and resulting debt service coverage levels) estimated as part of the review
reflects generally weak fundamentals (higher vacancy and reduced rental rates) across property
types and markets. While commercial real estate capital markets continued to improve and there are
some signs of improvement in fundamentals, a sustained recovery will be dependent on continued
improvement in local markets and the broader national economy.
The following table reflects the commercial mortgage loan portfolio as of September 30, 2010
summarized by loan-to-value ratio based on the annual loan review completed in July, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan-to-Value Distribution |
|
Loan-to-Value Ratios |
|
Amortized Cost |
|
|
% of Mortgage Loans |
|
(In millions) |
|
Senior |
|
|
Subordinated |
|
|
Total |
|
|
|
|
|
Below 50% |
|
$ |
179 |
|
|
$ |
158 |
|
|
$ |
337 |
|
|
|
10 |
% |
50% to 59% |
|
|
439 |
|
|
|
33 |
|
|
|
472 |
|
|
|
13 |
% |
60% to 69% |
|
|
588 |
|
|
|
59 |
|
|
|
647 |
|
|
|
19 |
% |
70% to 79% |
|
|
297 |
|
|
|
34 |
|
|
|
331 |
|
|
|
9 |
% |
80% to 89% |
|
|
822 |
|
|
|
34 |
|
|
|
856 |
|
|
|
25 |
% |
90% to 99% |
|
|
594 |
|
|
|
27 |
|
|
|
621 |
|
|
|
18 |
% |
100% or above |
|
|
222 |
|
|
|
|
|
|
|
222 |
|
|
|
6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
3,141 |
|
|
$ |
345 |
|
|
$ |
3,486 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
As summarized above, $345 million or 10% of the commercial mortgage loan portfolio is comprised of
subordinated notes and loans, including $311 million of loans secured by first mortgages, which
were fully underwritten and originated by the Company using its standard underwriting procedures.
Senior interests in these first mortgage loans were then sold t