-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V3A5P38taRiC4EhWWBnRor+AdMpdrh5HdjKGdkG2ZCj+MGvI4nTCu8xAWK32szsd h6uVwzAQuoYWpKJDV1R1sw== 0000950123-98-002224.txt : 19980304 0000950123-98-002224.hdr.sgml : 19980304 ACCESSION NUMBER: 0000950123-98-002224 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980303 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AETNA INC CENTRAL INDEX KEY: 0001013761 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 020488491 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-11913 FILM NUMBER: 98556704 BUSINESS ADDRESS: STREET 1: 151 FARMINGTON AVE CITY: HARTFORD STATE: CT ZIP: 06156 BUSINESS PHONE: 8602730123 MAIL ADDRESS: STREET 1: 151 FARMINGTON AVE CITY: HARTFORD STATE: CT ZIP: 06156 10-K405 1 AETNA INC. 1 Page 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission file number 1-11913 Aetna Inc. ---------- (Exact name of registrant as specified in its charter) Connecticut 02-0488491 - ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation) Identification No.) 151 Farmington Avenue, Hartford, Connecticut 06156 - ------------------------------- ---------------- (Address of principal (ZIP Code) executive offices) Registrant's telephone number, including area code: (860) 273-0123 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ------------------------ Common Stock $.01 par value New York Stock Exchange 6.25% Class C Voting Mandatorily New York Stock Exchange Convertible Preferred Stock $.01 par value 9 1/2% Cumulative Monthly Income New York Stock Exchange Preferred Securities, Series A (issued by a subsidiary) 6 3/8% Notes due August 15, 2003 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None - -------------------------------------------------------------------------------- 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 |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| The aggregate market value of the voting stock held by nonaffiliates of the registrant as of January 31, 1998 was $11,485,043,678. As of January 31, 1998, 145,637,336 shares of the registrant's Common Stock $.01 par value were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's 1997 annual report to shareholders (the "Annual Report"). (Parts I, II and IV) Portions of the registrant's proxy statement to be filed on or about March 20, 1998 (the "Proxy Statement"). (Parts III and IV) 2 Page 2 TABLE OF CONTENTS Page ---- PART I Item 1. Business. A. Organization of Business 3 B. Financial Information about Industry Segments 4 C. Description of Industry Segments 1. Aetna U.S. Healthcare 4 2. Aetna Retirement Services 14 3. Aetna International 18 4. Large Case Pensions 20 5. General Account Investments 22 6. Other Matters a. Regulation 23 b. NAIC IRIS Ratios 26 c. Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends 27 d. Trademarks 27 e. Ratings 28 f. Miscellaneous 28 Item 2. Properties. 29 Item 3. Legal Proceedings. 29 Item 4. Submission of Matters to a Vote of Security Holders. 29 Executive Officers of Aetna Inc. 30 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. 32 Item 6. Selected Financial Data. 32 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 32 Item 8. Financial Statements and Supplementary Data. 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 32 PART III Item 10. Directors and Executive Officers of the Registrant. 33 Item 11. Executive Compensation. 33 Item 12. Security Ownership of Certain Beneficial Owners and Management. 33 Item 13. Certain Relationships and Related Transactions. 33 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 33 Index to Financial Statement Schedules 40 Signatures 58 3 Page 3 PART I Item 1. Business. A. Organization of Business Aetna Inc. and its subsidiaries (collectively, the "Company") constitute one of the nation's largest health benefits companies, based on membership, and one of the nation's largest insurance and financial services organizations centered around three core businesses: health care, retirement services and international. Aetna Inc., a Connecticut corporation, became the parent corporation of Aetna Services, Inc. ("Aetna Services") and Aetna U.S. Healthcare, Inc. (formerly U.S. Healthcare, Inc.) as a result of a merger transaction on July 19, 1996. The merger was accounted for as a purchase of U.S. Healthcare. (See Note 2 of Notes to Financial Statements in the Annual Report.) Aetna sold its property-casualty operations on April 2, 1996. (See Note 3 of Notes to Financial Statements in the Annual Report for a discussion of certain indemnifications and other information related to the property-casualty sale.) The Company's business operations are conducted in the following segments: Aetna U.S. Healthcare, Aetna Retirement Services, Aetna International and Large Case Pensions. The principal products included in these segments are: Aetna U.S. Healthcare: Health products (including health maintenance organization, point-of-service, preferred provider organization and indemnity products) Group life and disability insurance Long-term care insurance Aetna Retirement Services: Financial services Individual life insurance Aetna International: Primarily life and health insurance and financial services Large Case Pensions: Retirement products (including pension and annuity products) primarily for defined benefit and defined contribution plans In addition, the Corporate segment includes interest expense and corporate expenses not directly related to the Company's business segments, such as staff area expenses, national advertising and contributions. 4 Page 4 B. Financial Information about Industry Segments Required financial information by industry segment is set forth in Note 17 to the Financial Statements, which is incorporated herein by reference to the Annual Report. Revenue and income from continuing operations attributable to each industry segment are incorporated herein by reference to the Selected Financial Data in the Annual Report. Certain reclassifications have been made to 1996 and 1995 financial information to conform to 1997 presentation. C. Description of Industry Segments 1. Aetna U.S. Healthcare Products and Services Aetna U.S. Healthcare provides a full spectrum of health products (managed care and indemnity) and group insurance products (life, disability and long-term care) on both an insured and an employer-funded basis. Under insured plans, the Company assumes all or a majority of health care cost, utilization, mortality, morbidity or other risk depending on the product. Under employer-funded plans, the customer, and not the Company, assumes all or a majority of these risks. Aetna U.S. Healthcare consists of the Health Risk business and the Group Insurance and Other Health business. Health products include health maintenance organization, point-of-service, preferred provider organization and indemnity products. The Health Risk business includes health products offered on an insured basis. The Group Insurance and Other Health business includes group life and disability insurance and long-term care insurance, offered on both an insured and employer-funded basis, and all health products offered on an employer-funded basis. The following table summarizes premiums and fees and other income for the Health Risk and Group Insurance and Other Health businesses:
(Millions) 1997 1996 1995 ---- ---- ---- Health Risk $ 9,735.0 $6,749.5 $4,960.9 Group Insurance and Other Health 2,573.5 2,511.6 2,301.1 --------- -------- -------- Total Aetna U.S. Healthcare $12,308.5 $9,261.1* $7,262.0 ========= ======== ======== U.S. Healthcare Pre Merger (historical amounts) N/A*** $ 2,384.7** $3,542.1 ========= ========= ========
* Includes U.S. Healthcare premiums and fees and other income from July 19, 1996 through December 31, 1996. ** Reflects premiums and fees and other income from January 1, 1996 through July 18, 1996. *** Not applicable. Under insured plans, Aetna U.S. Healthcare charges a premium and under employer-funded plans, Aetna U.S. Healthcare charges a fee for administrative and claim services. 5 Page 5 The principal Commercial health products offered by Aetna U.S. Healthcare are: Health Maintenance Organization ("HMO") plans offer comprehensive managed care benefits generally through participating network physicians, hospitals and other providers. When an individual enrolls in one of the Company's HMOs, he or she selects a primary care physician ("PCP") from among the physicians participating in the Aetna U.S. Healthcare network. PCPs generally are family practitioners, internists, general practitioners or pediatricians who provide necessary preventive and primary medical care, and are generally responsible for coordinating other necessary health care, including making referrals to participating network specialists. Preventive care and quality improvement are emphasized in these plans. The Company offers HMO plans with varying levels of copayments which result in different levels of premium rates. HMO plans are principally offered on an insured basis. Commercial HMO membership totaled 3.3 million and 3.0 million as of December 31, 1997 and 1996, respectively. Point-of-Service ("POS") plans blend the characteristics of HMO and indemnity plans. Members can have comprehensive HMO-style benefits through network providers with minimum out-of-pocket expense (copayments) and also can go directly, without a referral, to any provider they choose, subject to, among other things, certain deductibles and coinsurance, with member cost sharing limited by out-of-pocket maximums. POS plans are offered on both an insured and employer-funded basis. Commercial POS membership totaled 3.7 million and 3.5 million as of December 31, 1997 and 1996, respectively. Preferred Provider Organization ("PPO") plans offer the member the ability to select any health care provider, with benefits paid at a higher level when care is received from a network provider. Coverage is subject to deductibles and coinsurance, with member cost sharing limited by out-of-pocket maximums. PPO plans are offered on both an insured and employer-funded basis. PPO membership totaled 3.6 million and 3.7 million as of December 31, 1997 and 1996, respectively. Indemnity plans offer the member the ability to select any health care provider for covered services. Some managed care and medical cost containment features may be included in these plans, such as inpatient precertification, limiting payments to reasonable and customary charges and additional benefits for preventive services (e.g. cancer screening). Coverage is subject to deductibles and coinsurance, with member cost sharing limited by out-of-pocket maximums. Indemnity plans are offered on both an insured and employer-funded basis. Indemnity membership totaled 2.6 million and 3.1 million as of December 31, 1997 and 1996, respectively. In addition to Commercial health products, the Company also offers coverage for Medicare beneficiaries and individuals eligible for Medicaid benefits. Such coverages include the following: 6 Page 6 Through contracts with the Health Care Financing Administration ("HCFA"), Aetna U.S. Healthcare HMOs offer coverage for Medicare-eligible individuals in certain geographic areas. Generally, services must be obtained through network providers, with the exception of emergency and urgent care. Members generally receive enhanced benefits over standard Medicare fee-for-service coverage, including vision, hearing and pharmacy coverage. Such Medicare plans are offered on an insured basis. Medicare membership totaled .4 million and .3 million as of December 31, 1997 and 1996, respectively. The Company also served as an administrator of Medicare benefits in certain states, providing claim services for physicians, hospitals, skilled nursing facilities and home health agencies in exchange for a fee. The contract with HCFA to provide these services expired on September 30, 1997. The Company has contracts with certain state and local agencies to offer coverage for Medicaid-eligible individuals. Benefits are determined by the contracting agencies. Medicaid is offered on an insured basis. Medicaid membership totaled .1 million as of December 31, 1997 and 1996. Aetna U.S. Healthcare offers a variety of specialty health care coverages offered as either supplements to health products or as stand-alone products. Such coverages include indemnity and managed dental plans, prescription drug and vision programs, and network-based workers' compensation case management services. These specialty health coverages and services are included in either Health Risk or Group Insurance and Other Health business, with the exception of behavioral health (including employee assistance programs) and network-based workers' compensation case management services, which are included in Group Insurance and Other Health. During 1997, the Company sold certain subsidiaries primarily to more effectively focus its health business resources. On December 5, 1997, the Company sold Human Affairs International ("HAI"), a behavioral health management business. Aetna U.S. Healthcare will continue to market HAI's behavioral health services, including employee assistance programs, through a long-term strategic arrangement with the acquiring company. During 1997, the Company also sold Healthcare Data Interchange Corporation, a provider of health care electronic data interchange services, and Aetna Professional Management Corporation, a physician practice management business. In addition, the Company acquired Virginia Mason Health Plan, Inc., and Frontier Health Holdings, Inc., both of which are health maintenance organizations, during 1997. The purchase price of these acquisitions, both individually and in the aggregate, was not material. Aetna U.S. Healthcare group insurance products consist primarily of the following: Group Life Insurance consists principally of renewable term coverage, the amounts of which may be fixed or linked to individual employee wage levels. Basic and supplemental term coverage and spouse and dependent coverages are available. Group universal life and accidental death benefit coverages are also available. Group life insurance is offered on an insured basis. Group life insurance membership totaled 9.9 million and 9.6 million as of December 31, 1997 and 1996, respectively. 7 Page 7 Group Disability Insurance provides coverage for disabled employees' income replacement benefits for both short-term disability and long-term disability. The Company also offers a managed disability product with additional case management features. Group disability insurance coverages are offered on both an insured and employer-funded basis. Group disability membership totaled 2.6 million and 2.4 million as of December 31, 1997 and 1996, respectively. Long-Term Care Insurance provides coverage for long-term care expenses in a nursing home, adult day care or home setting. Long-term care insurance is offered on an insured basis. Long-term care membership totaled .1 million as of December 31, 1997 and 1996. Many group insurance members participate in more than one type of Aetna U.S. Healthcare coverage and are counted in each. Provider Networks General Aetna U.S. Healthcare provides members of its managed care plans with access to health care services through networks of independent health care providers. The Company contracts with providers to participate in its provider networks as it expands into new geographic areas or as considered necessary in order to serve members. The providers in the Company's networks are independent contractors and are neither employees nor agents of the Company. The HMOs operated by Aetna U.S. Healthcare most closely adhere to the individual practice model. Under the individual practice model, the HMO contracts with independent physicians who are broadly dispersed throughout a community and who care for patients in their own offices. Participating physicians generally also have patients who are not members of the Company's HMOs. In the Company's HMOs, the primary care physician plays an important role in practicing preventive medicine and acts on behalf of the HMO member to coordinate the care provided by specialist physicians, hospitals, and other health care providers. Aetna U.S. Healthcare uses a variety of practices to help contain the rate of increase in the cost of medical services. In addition to contracts with health care providers, such procedures include the development and implementation of standards for the appropriate utilization of health care resources and working with health care providers to review data in order to help them improve consistency and quality. At December 31, 1997, Aetna U.S. Healthcare had approximately 330,000 providers in its networks nationwide. Contracting Primary Care Physicians Compensation by the Company's HMOs to PCPs is principally on a capitated basis, although fee-for-service contracts also exist. Under a capitation arrangement, physicians receive a monthly fixed fee for each HMO member, regardless of the medical services provided to the member. In some instances, the capitation rate is subject to adjustment based on the attainment of certain criteria including comprehensiveness of care, quality of care and utilization. This quality-based incentive program is administered via the Company's Quality Care Compensation System. In a fee-for-service arrangement, network physicians are paid for health care services provided to the member based upon a fee schedule. 8 Page 8 Hospitals The Company enters into contracts that provide for all-inclusive per diem, per case and capitated hospitalization rates, with fixed rates for ambulatory surgery and emergency room services. Certain contracted hospitals' final compensation is based upon attainment of agreed-upon quality and other measures. Aetna U.S. Healthcare HMOs generally require precertification of elective admissions and monitoring of the length of hospital stays. Participating physicians generally admit their HMO patients to hospitals using referral procedures that direct the hospital to contact the Company's patient management unit, which confirms the patient's membership status while obtaining pertinent data. This unit also coordinates related activities, including the subsequent transition to the home environment and home care, if necessary. Case management assistance for complex or "catastrophic" cases is provided by a special case unit. Specialist and Ancillary Services Specialist physicians participating in the Company's networks are generally reimbursed at contracted rates per visit or procedure. Aetna U.S. Healthcare's HMOs have fixed-fee capitated payment arrangements for most pharmacy, mental health, substance abuse, and laboratory services. In those HMO markets where the Company has a significant presence, most radiology, diagnostic imaging, podiatric and physical therapy services also have fixed-fee capitated payment arrangements. Integrated Delivery Systems Aetna U.S. Healthcare has developed and continues to develop contractual relationships with national and regional Integrated Delivery Systems ("IDS") to provide comprehensive medical services. Under these arrangements, the Company's HMOs contract with an IDS for a fixed, per member fee. This fee covers most or all of the care required by the member which is generally delivered by the IDS and its affiliated PCPs, hospitals and specialists. Quality Assessment Quality assessment programs begin with the initial selection of providers. Providers wanting to participate in the Company's HMO networks must satisfy an extensive set of criteria, including licensing, hospital admission privileges, demonstrated proficiency, written references, patient access, office standards, after-hours coverage and many other factors. Participating physicians are recertified regularly. Recertification covers many aspects of patient care including an analysis of member grievances filed with the Company, the transfer and termination rate of members from the practice, on-site interviews, analysis of utilization patterns, extensive member surveys and analysis of drug prescription patterns. Committees, each composed of a peer group of participating private physicians, review participating PCPs being considered for recertification. The Company also offers quality and outcome measurement and improvement programs, and health care data analysis systems for providers and purchasers of health care. 9 Page 9 With an emphasis on quality improvement, the Company seeks accreditation for certain of its HMO plans from the National Committee for Quality Assurance ("NCQA"), a national organization established to review the quality and medical management systems of HMOs and other managed care plans. Accreditation by NCQA is a nationally recognized standard. As of December 31, 1997, a majority of the Company's HMO membership is serviced by health plans which have been granted full, three-year accreditation. Principal Markets and Sales Total health membership is widely dispersed throughout the United States. One or more products offered by the Health Risk business are available in all 50 states. Health Risk membership is concentrated in the Mid-Atlantic and Northeast regions where the majority of HMO members are located. Products offered by the Group Insurance and Other Health business are available in all 50 states. This business consists primarily of large customers (i.e., those with at least 3,000 eligible lives). The following table presents total health membership by region and funding arrangement, for the years indicated:
(Thousands) 1997(1) 1996(1) 1995(1)(2) ------------------------ ------------------------ ------------------------ Risk Nonrisk Total Risk Nonrisk Total Risk Nonrisk Total ---- ------- ----- ---- ------- ----- ---- ------- ----- Mid-Atlantic 1,863 1,159 3,022 1,911 1,115 3,026 367 736 1,103 Northeast 1,089 735 1,824 1,127 776 1,903 438 698 1,136 Southeast 752 1,717 2,469 594 1,784 2,378 456 1,737 2,193 Mid-West 503 1,915 2,418 459 1,966 2,425 456 1,938 2,394 West Central 405 1,862 2,267 484 1,823 2,307 498 1,740 2,238 West(3) 723 1,011 1,734 730 969 1,699 1,449 978 2,427 ----- ----- ------ ----- ----- ------ ----- ----- ------ Total Health Membership(4) 5,335 8,399 13,734 5,305 8,433 13,738 3,664 7,827 11,491 ===== ===== ====== ===== ===== ====== ===== ===== ======
(1) Health membership as of December 31, 1997 reflects system and plan conversions. The conversions predominately affect Indemnity and PPO membership and have an immaterial impact on all other Health products. December 31, 1996 and 1995 reflects adjustments based on known corrected data from the conversions, as applied to December 31, 1996 and 1995 membership previously reported. (2) Excludes U.S. Healthcare membership of 2,433 thousand for 1995. U.S. Healthcare membership is primarily risk and concentrated in the Mid-Atlantic and Northeast regions. (3) Decreased membership as of December 31, 1996 resulted primarily from the award of a risk contract with the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") to another contractor. The Company remained the primary provider through March 31, 1996. (4) Includes the following products: Commercial, Medicare and Medicaid HMO, POS, PPO and Indemnity. For membership composition of Aetna U.S. Healthcare's products by funding arrangement, see Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") - Aetna U.S. Healthcare in the Annual Report. For both Health Risk and Group Insurance and Other Health businesses, products and services are marketed primarily to employers for the benefit of employees and their dependents. Frequently, employers offer employees a choice of coverages, from which the employee makes his or her selection during a designated annual open enrollment period. In some instances, Aetna U.S. Healthcare is the only health care coverage offered. Employers pay all or a portion of the monthly premiums, and employees, through payroll deductions, pay any premium not provided as an employee benefit. 10 Page 10 Within the Health Risk business, Medicare coverage is sold on an individual basis as well as through employer groups to their retirees. Medicaid is marketed to individuals rather than employer groups. Because these coverages are sold primarily on an individual basis, Medicare and Medicaid marketing costs are typically higher than for other products. Aetna U.S. Healthcare products are sold primarily through Company sales personnel who frequently work with independent consultants and brokers who assist in the production and servicing of business. Sales representatives also sell to employers on a direct basis. For large customers, independent consultants and brokers are frequently involved in employer health plan selection decisions and sales. Marketing and sales efforts are promoted by an advertising program which includes television, radio, billboards and print media, supported by market research and direct marketing efforts. Health Pricing For insured Commercial plans, customer contracts are generally established in advance of the policy period, for a duration of one year. In determining the premium rates to be charged to the customer, prospective and retrospective rating methodologies are used. Under prospective rating, a fixed premium rate is determined at the beginning of the policy period. Unanticipated increases in medical costs cannot be recovered in the current policy year; however, prior experience for a product in the aggregate is considered, among other factors, in determining premium rates for future periods. Federally-qualified HMOs are required to set premiums in this manner. Aetna U.S. Healthcare Commercial HMO plans establish premium rates prior to contract inception, without regard to actual utilization of services incurred by individual members, using one of three approved community rating methods. These rates may vary from account to account to reflect projected family size and contract mix, benefit levels, renewal date, and other factors. Under one of these methods, "traditional community rating", an HMO establishes premium rates based on its revenue requirements for its entire enrollment in a given community. Under "community rating by class", an HMO establishes premium rates based on its revenue requirements for broad classes of membership distinguished by factors such as age and sex. Under "group specific community rating", an HMO establishes premium rates based on the HMO's revenue requirements for providing services to the group. State laws, in certain of the states in which the Company operates HMOs, require the filing with and approval by the state of HMO premium rates, and certain states may prohibit the use of one or more of these rating methods. In addition to reviewing anticipated medical costs, some states also review anticipated administrative costs as part of the approval process. Future results of the Company could be affected if the premium rates requested by the Company are not approved or are adjusted downward by state regulators. 11 Page 11 Under retrospective rating, a preliminary premium rate is determined at the beginning of the policy period. Once the policy period has ended, the actual experience is reviewed. If the experience is positive (i.e., actual claim costs and other expenses are less than those expected) then a refund is credited to the policy. If the experience is negative, then the resulting deficit may, in certain instances, be recovered through contractual provisions; otherwise the deficit is considered in setting future premium levels. If a customer elects to terminate coverage, these deficits generally cannot be recovered. Retrospective rating is generally used for non-HMO health customers which exceed 300 lives. Aetna U.S. Healthcare has contracts with HCFA to provide HMO coverage to Medicare beneficiaries who choose health care coverage through an HMO. Under these contracts, which are typically executed annually, HCFA pays the HMO at a fixed, capitated rate based on membership and adjusted for demographic factors and a user fee. Inflation, changes in utilization patterns and benefit plans, demographic factors such as age and sex, and both local county and national fee for service average per capita Medicare costs are considered in the rate calculation process. Amounts payable under Medicare risk arrangements are subject to periodic unilateral revision by HCFA. In addition to premiums received from HCFA, some of the Medicare products offered by Aetna U.S. Healthcare require a modest premium to be paid by the member. Under Medicare risk arrangements, Aetna U.S. Healthcare assumes the risk of higher than expected medical expenses. Medicare contracts typically generate higher per member per month revenues, but also higher per member per month medical expenses, than Commercial plans. Aetna U.S. Healthcare also has HMO contracts with a variety of federal government employee groups under the Federal Employees Health Benefit Program. Premium rates are subject to federal government review and audit. Premium rates for these contracts are set prospectively but are subject to retrospective adjustments. Premiums and fees from the federal government accounted for 19% of Aetna U.S. Healthcare's revenue in 1997. Contracts with HCFA accounted for 82% of these premiums and fees, with the balance from federal employee related benefit programs. The Company has contracts with state and local agencies to provide fully-insured health benefits to persons eligible for Medicaid benefits. These contracts are generally for a period of one to three years. Aetna U.S. Healthcare receives a fixed monthly payment based on membership in return for the coverage of health care services. The rates are subject to unilateral revision by the contracting agencies upon renewal. Aetna U.S. Healthcare assumes the risk of higher than expected medical expenses. Contracts with the customer to provide administrative services for employer-funded plans are generally for a period of one to three years, frequently with built in inflation factors. Aetna U.S. Healthcare has entered into certain guarantees with respect to certain functions such as customer service response time, claim processing accuracy and claim processing turnaround time, as well as certain guarantees that claim expenses to be incurred by the customer will fall within a certain range. With any of these guarantees, Aetna U.S. Healthcare is financially at risk if the conditions of the arrangements are not met. 12 Page 12 Competition Competition in the health care industry has intensified in recent years, primarily due to more aggressive marketing and pricing, a proliferation of competing products, including new products developed in an effort to contain health care costs, and increased quality and price sensitivity. New entrants into the marketplace as well as significant consolidation within the industry have also contributed to the more intense competitive environment. Aetna U.S. Healthcare believes that the most significant factors which distinguish competing health plans are quality of service and managed care programs (including NCQA accreditation status), comprehensiveness of coverage, cost (including both premium and member out-of-pocket costs), product design, financial stability and the geographic scope of provider networks and the providers available in such networks. Aetna U.S. Healthcare believes that it is competitive in each of these areas. The ability to increase the number of persons covered by Aetna U.S. Healthcare benefits or to increase revenues is affected by competition in any particular area. In addition, the ability to increase the number of persons enrolled in Health Risk products is affected by the desire and ability of employers to self fund their employees' insurance. Competition may also affect the availability of services from health care providers, including primary care physicians, specialists and hospitals. Within the Health Risk business, Aetna U.S. Healthcare competes with local and regional managed care plans, in addition to managed care plans sponsored by large health insurance companies and Blue Cross/Blue Shield plans. Additional competitors include other types of medical and dental provider organizations, various specialty service providers, integrated health care delivery organizations, and in certain plans, with programs sponsored by the federal or state governments. Within the Other Health component of the Group Insurance and Other Health business, Aetna U.S. Healthcare competes primarily with other commercial insurance companies and third party administrators. For the Group Insurance industry, Aetna U.S. Healthcare believes that the most significant factors which distinguish competing companies are price, quality of service, comprehensiveness of coverage, and product array and design. Specialty carriers have increased market penetration in the disability business. The deeply-penetrated group life market remains highly competitive, while competition continues to intensify in the emerging long-term care market. Reserves For the Health Risk business, medical claims payable reflects estimates of the ultimate cost of claims that have been incurred but not yet reported and reported but not yet paid. Medical claims payable are based on a number of factors including those derived from historical claim experience. Medical claims payable are estimated periodically, and any resulting adjustments are reflected in current period results. 13 Page 13 For Group Insurance products, reserves are established as premiums become due to reflect the present value of expected future obligations net of the present value of expected future premiums. Policy reserves for group paid-up life insurance generally reflect long-term fixed obligations and are computed on the basis of assumed or guaranteed yield and benefit payments. Assumptions are based on the Company's historical claim experience. For long-term disability products, reserves are established for (i) lives currently in payment status (using both standard industry, as well as the Company's own morbidity and interest rate assumptions), (ii) lives who have not yet satisfied the waiting period, but are expected to do so and (iii) claims that have been incurred but not reported. Long-term care reserves are a long-term obligation calculated using industry data for morbidity and mortality assumptions. Group health and group insurance premiums are generally recorded as premium revenue over the term of the coverage. Some group contracts allow for premiums to be adjusted to reflect emerging experience. Such premiums are recognized as the related experience emerges. Reinsurance Aetna U.S. Healthcare uses reinsurance agreements with nonaffiliated insurers for Group Insurance businesses to control its exposure to large losses and certain other risks. The Company maintains catastrophic life reinsurance which provides protection against accidents involving five or more covered lives. For disability business, reinsurance arrangements for excess coverage are established on a case-by-case basis to reflect the circumstances of the specific disability risks. In addition, the Company carries excess medical malpractice professional liability insurance. Group Life Insurance In Force and Other Statistical Data The following table summarizes changes in group life insurance in force before deductions for reinsurance ceded to other companies for the years indicated:
(Dollars in Millions) 1997 1996 1995 ---- ---- ---- In force, end of year $284,978 $278,499 $274,429 ======== ======== ======== Terminations (lapses and all other) $ 14,576 $ 18,014 $ 14,119 ======== ======== ======== Number of policies and contracts in force, end of year: Group Life Contracts (1) 13,849 15,288 19,175 Group Conversion Policies (2) 32,660 33,538 33,358
(1) Due to the diversity of coverages and size of covered groups, statistics are not provided for average size of policies in force. (2) Reflects conversion privileges exercised by insureds under group life policies to replace those policies with individual life policies. Factors Affecting Forward-Looking Information For information regarding certain important factors that may materially affect Aetna U.S. Healthcare's business, see MD&A - Forward-Looking Information/Risk Factors and financial results discussions in the Annual Report. 14 Page 14 2. Aetna Retirement Services Products and Services Aetna Retirement Services ("ARS") offers financial services and individual life insurance products. Primarily all products are offered through Aetna Life Insurance and Annuity Company ("ALIAC")and Aetna Insurance Company of America ("AICA") indirect, wholly owned subsidiaries of the Company. Investment advisory services are offered through ALIAC and Aeltus Investment Management Inc. ("Aeltus"), registered investment advisers and indirect, wholly owned subsidiaries of the Company. Aeltus has also served as subadviser to Aetna mutual funds. Financial planning services are offered through Financial Network Investment Corporation ("FNIC"), a broker/dealer acquired in 1997 and Aetna Financial Services, Inc. ("AFSI"), indirect wholly owned subsidiaries of the Company. Financial Services Financial services products principally include annuity contracts that offer a variety of funding and payout options for individual and employer-sponsored retirement plans qualified under Internal Revenue Code Sections 401, 403, 408 and 457 (collectively, "qualified plans") and nonqualified annuity contracts. These contracts may be deferred or immediate ("payout annuities"). Financial services also include investment advisory services, financial planning and pension plan administrative services. Individual Life Insurance Individual life insurance products include universal life and variable universal life, which have both life insurance and investment characteristics, traditional whole life and term insurance. Universal life and variable universal life products accounted for approximately 96% of life insurance new business premiums in 1997. Investment Options ARS products provide annuity and certain life insurance customers with variable and/or fixed investment options. Variable ("nonguaranteed") options provide for full assumption by the customer of investment risks. Assets supporting variable options are held in separate accounts that invest in Aetna mutual funds and/or unaffiliated mutual funds. Aetna mutual funds include funds managed by Aeltus and beginning in 1997, funds managed by outside investment advisors under subadvisory arrangements. Separate account investment income and realized capital gains and losses are not reflected in the Company's consolidated results of operations. Fixed options can be either "fully guaranteed" or "experience rated". Fully guaranteed options provide guarantees on investment return, maturity values, and if applicable, benefit payments. Experience rated options require the customer to assume investment (including realized capital gains and losses) and other risks subject, among other things, to certain minimum guarantees. The effect of such realized gains and losses (as long as minimum guarantees are not triggered) does not impact the Company's results. 15 Page 15 Fees and Investment Margins Insurance charges, investment management or other fees earned by ARS, vary by product and depend, among other factors, on the funding option selected by the customer under the product. For variable annuities or life insurance products where assets are allocated to variable funding options, ARS charges the separate account an asset-based insurance fee and expense charge. In addition, where the customer selects an Aetna mutual fund as a variable funding option, ARS receives an asset-based investment management fee and, in the case of those funds subadvised by outside managers, ALIAC pays a subadvisory fee to the fund manager. For unaffiliated mutual funds, ARS receives distribution fees and/or expense reimbursements. For fixed funding options, ARS derives an investment margin, which is based on the difference between income earned on the investments supporting the liability and interest credited to customers. Other fees or charges, such as administrative fees, may be assessed depending on the nature of the product. ARS also provides direct investment advisory services to unaffiliated customers through Aeltus and FNIC generally for fees based on assets under management. FNIC and AFSI provide financial planning services generally for fees which may or may not be asset based. Assets Under Management The substantial portion of fees or other charges and investment margins are based on assets under management. Assets under management are principally affected by deposits, investment growth (i.e., interest credited to customer accounts for fixed options or market performance for variable options) and persistency (i.e., customer retention). Assets under management, excluding net unrealized capital gains and losses on debt securities other than those held in separate accounts, were $45.0 billion, $32.1 billion and $25.1 billion at December 31, 1997, 1996 and 1995, respectively. Approximately 94% and 93% of assets under management at December 31, 1997 and 1996, respectively, allowed for contractholder withdrawal, 77% and 75% of which, respectively, are subject to market value adjustments or deferred surrender charges at December 31, 1997. To encourage customer retention and recover acquisition expenses, contracts typically impose a surrender charge on policyholder balances withdrawn within a period of time after the contract's inception which may be waived at the Company's discretion. The period of time and level of the charge vary by product. In addition, an approach incorporated into recent variable annuity contracts with fixed funding options allows contractholders to receive an incremental interest rate if withdrawals from the fixed account are spread over a period of five years. Further, more favorable credited rates may be offered after policies have been in force for a period of time. Existing tax penalties on annuity distributions prior to age 59-1/2 provide further disincentive to customers for premature surrenders of annuity balances, but generally do not impede transfers of those balances to products of competitors. 16 Page 16 Life Insurance In Force and Other Statistical Data For individual life insurance products, life insurance in force is a key determinant of earnings as contract charges for cost of insurance coverage are typically based on amounts of coverage in force less accumulated policy reserves. The key drivers of life insurance in force are new sales, surrenders and mortality. The following table summarizes changes in life insurance in force before deductions for reinsurance ceded to other companies: (Amounts in millions, except number of policies and average size of policies in force)
1997 1996 1995 ---- ---- ---- Sales and additions: Permanent: Nonparticipating $ 4,281 $ 4,357 $ 5,212 Participating 13 12 12 Term: Nonparticipating 1,586 1,382 2,160 Participating 53 133 390 -------- -------- -------- Total $ 5,933 $ 5,884 $ 7,774 ======== ======== ======== Terminations: Surrenders and conversions $ 1,865 $ 1,646 $ 1,620 Lapses 2,126 2,098 1,874 Other 1,130 330 281 -------- -------- -------- Total $ 5,121 $ 4,074 $ 3,775 ======== ======== ======== In force, end of year: Permanent $ 36,614 $ 35,883 $ 34,614 Term 13,181 13,100 12,559 -------- -------- -------- Total $ 49,795 $ 48,983 $ 47,173 ======== ======== ======== Number of policies in force, end of year: Nonparticipating 597,221 627,233 626,880 Participating 97,533 105,098 113,045 -------- -------- -------- Total 694,754 732,331 739,925 ======== ======== ======== Average size of policies in force, end of year: Nonparticipating $ 72,654 $ 66,385 $ 62,009 Participating 65,664 69,883 73,433
See Note 12 of Notes to Financial Statements in the Annual Report for a discussion of participating life insurance contracts. The following table summarizes premiums and deposits for ARS:
(Millions) 1997 1996 1995 ---- ---- ---- Premiums $ 158.5 $ 180.7 $ 260.2 Deposits 4,969.0 4,564.8 3,785.1 --------- --------- --------- $ 5,127.5 $ 4,745.5 $ 4,045.3 ========= ========= =========
Principal Markets and Method of Distribution ARS products and services are offered primarily to individuals, pension plans, small businesses and employer-sponsored groups in the health care, government, education (collectively "not-for-profit" organizations) and corporate markets. ARS products generally are sold through pension professionals, independent agents and brokers, third party administrators, banks, dedicated career agents and financial planners. 17 Page 17 Competition ARS competes with other insurance companies, as well as an array of financial services companies including banks, mutual funds and other investment managers. Principal competitive factors are reputation for investment performance, product features, service, cost and the perceived financial strength of the investment manager or sponsor. Competition may affect, among other matters, both business growth and the pricing of ARS' products and services. Reserves Reserves for limited payment contracts (annuities with life contingent payout) are computed on the basis of assumed investment yield, mortality, morbidity and expenses and include a margin for adverse deviation. The assumptions vary by plan, year of issue and policy duration. Reserves for investment contracts (deferred annuities and immediate annuities without life contingent payouts) are equal to cumulative deposits plus credited interest less withdrawals and charges thereon. Of those investment contracts which are experience rated, the reserves also reflect net realized capital gains/losses (which ARS reflects through credited rates on an amortized basis) and unrealized capital gains/losses related to Financial Accounting Standard ("FAS") No. 115. Reserves for universal life products (which are all experience rated) are equal to cumulative deposits less withdrawals and charges plus credited interest thereon, plus/less net realized capital gains/losses (which ARS reflects through credited rates on an amortized basis). These reserves also reflect unrealized capital gains/losses related to FAS No. 115. Reserves for all other fixed individual life contracts are computed on a basis consistent with that described above for limited payment contracts. Reserves, as described above, are computed amounts that, with additions from premiums and deposits to be received, and with interest on such reserves compounded annually at assumed rates, are expected to be sufficient to meet the Company's policy obligations at their maturities or to pay expected death or retirement benefits or other withdrawal requests. Reinsurance ARS retains no more than $10 million of risk per individual life insured. Amounts in excess of the retention limit are reinsured with unaffiliated companies. Factors Affecting Forward-Looking Information For information regarding certain important factors that may materially affect ARS' business, see MD&A - Forward-Looking Information/Risk Factors and financial results discussions in the Annual Report. 18 Page 18 3. Aetna International Aetna International, through subsidiaries and joint venture operations, sells primarily life and health insurance and financial services products in non-U.S. markets. The Company continues to increase its investments in emerging international and financial services markets, primarily in Asia Pacific and Latin America, where it believes demographic and other characteristics afford the opportunity for long-term business growth. The Company seeks to enter new emerging markets in their early stages of development, seeking to be among the first foreign entrants, and then to build sufficient scale of operations to compete with local and other foreign companies. The Company also explores opportunities for additional investments, or divestitures where appropriate, in markets where it has established operations. The Company may invest in a new market or increase its position in a market through a combination of acquisitions, joint ventures or by starting new independent operations. Over the past 5 years, the Company has invested $882 million in its international operations, of which $473 million was invested in 1997, a majority of which related to the acquisition of 49% of a joint venture in Brazil with Sul America Seguros, Brazil's largest insurance company. In October 1997, the Company was granted approval to operate a joint venture insurance business in Shanghai. The approval was given by The People's Bank of China, a regulatory body for financial institutions in China. The joint venture, to be formed with China Pacific Insurance Company, the second largest insurer in China, will provide life insurance products to individual Chinese citizens and foreign nationals in the Shanghai region. The Company classifies its operations in international regions as either "established" or "start-up", depending on the stage of their business developments. Aetna International conducts its business in several geographic regions: o Asia Pacific - Operations are conducted through majority owned subsidiaries in Taiwan and Malaysia, as well as through other equity subsidiaries (where the Company has between a 20% and 50% interest) in Hong Kong and New Zealand. The products and services sold by these subsidiaries include individual and group life and health insurance, deposit administration and related financial products and services. 19 Page 19 o Latin America - Operations are conducted through wholly owned and majority-owned subsidiaries in Chile, and equity subsidiaries in Mexico, Peru and Brazil. The products and services sold by these subsidiaries include individual and group life and health insurance, annuities, personal and commercial property-casualty insurance, and pension fund administration services. o Canada - Operations are conducted through wholly owned subsidiaries. The products and services sold by these subsidiaries include individual and group life, health and disability insurance and administration services to group plans. o Other - Operations include primarily start-up operations (subsidiaries in the initial years of operation) in Argentina, the Philippines and Indonesia, as well as corporate overhead expenses. The products and services sold by these subsidiaries include individual and group life and health insurance, and health and pension fund administration services. Each of the subsidiaries through which Aetna International conducts business operates within guidelines established by the Company. Methods of distributing products vary by country and product depending on local laws, customs and the needs of the particular market. Distribution channels include career agents, independent agents and brokers, financial institutions and direct sales. Competition varies by country and includes well established local companies, as well as companies based in North America, Europe, Australia and Japan that have a strong international presence. The following table sets forth Aetna International's revenue (including only its share of net income for equity subsidiaries and excluding net realized capital gains or losses), and operating earnings or losses (i.e., net income or loss excluding net realized capital gains or losses) by region, premiums and life insurance in force, before deductions for reinsurance ceded to other companies:
Operating Revenue Earnings ------------------------------ ---------------------------- (Millions) 1997 1996 1995 1997 1996 1995 ---- ---- ---- ---- ---- ---- Asia Pacific $1,037.2 $ 845.1 $ 698.2 $ 60.1 $ 54.3 $ 46.0 Latin America 443.9 352.0 355.2 76.7 56.0 47.9 Start-ups and other 477.7 427.4 408.8 (8.1) (4.8) (5.2) -------- -------- -------- -------- ------- ------- $1,958.8 $1,624.5 $1,462.2 $ 128.7 $ 105.5 $ 88.7 ======== ======== ======== ======= ======= ======= Premiums (included in revenue above) $1,434.1 $1,166.1 $1,038.5 ======== ======== ======== Life insurance in force, end of year $ 78,750 $ 76,672 $ 59,384 ======== ======== ========
Factors Affecting Forward-Looking Information For information regarding certain important factors that may materially affect Aetna International's business, see MD&A - Forward-Looking Information/Risk Factors and financial results discussions in the Annual Report. 20 Page 20 4. Large Case Pensions Principal Products Large Case Pensions manages a variety of retirement products (including pension and annuity products) offered to IRC Section 401 qualified defined benefit and defined contribution plans. Contracts provide nonguaranteed, partially guaranteed (experience rated) and fully guaranteed investment options through General and Separate Account products. The majority of Large Case Pensions' products that use Separate Accounts provide contractholders with a vehicle for investments under which the contractholders assume the investment risks as well as the benefit of favorable performance. Large Case Pensions earns a management fee on these Separate Accounts. In 1993, the Company discontinued its fully guaranteed large case pension products. (For additional information, see MD&A - Large Case Pensions in the Annual Report.) At December 31, assets under management, including Separate Accounts and excluding net unrealized capital gains and losses on debt securities, were $29.7 billion in 1997, $35.3 billion in 1996 and $45.6 billion in 1995. The decline in assets under management is primarily attributable to the transfer of assets under management to the ARS segment, reflecting the consolidation of the Company's investment advisory services, the continuing runoff of the underlying liabilities and the sale of Insurance Company Investment Management, a specialized asset manager, in 1996. The following table summarizes premiums and deposits:
(Millions) 1997 1996 1995 ---- ---- ---- Premiums $ 155.0 $ 214.1 $ 244.4 Deposits 1,598.6 1,781.8 1,600.2 --------- --------- --------- Total $ 1,753.6 $ 1,995.9 $ 1,844.6 ========= ========= =========
Reserves When the Company discontinued the fully guaranteed large case pension products, it established a reserve for expected future losses on the runoff of the business. For additional information on this reserve, see Note 9 of Notes to Financial Statements in the Annual Report. The Company also maintains reserves for guaranteed investment contracts equal to amounts deposited plus credited interest thereon. Reserves for single premium annuity contracts reflect the present value of benefits based on actuarial assumptions established at the time of contract purchase. Such assumptions are based on the Company's experience, which is periodically reviewed against published industry data. These products provide guarantees on investment return, maturity values, and if applicable, benefit payments. The interest credited on these contracts during 1997 ranged from 3.5% to 17.7% with an average rate of 8.6% (compared with 8.7% in 1996). For the contracts in force at December 31, 1997, the average credited rate was 8.5%. None of these contracts allow for contractholder withdrawal, except in extraordinary circumstances. 21 Page 21 Reserves for experience rated contracts reflect cumulative deposits, less withdrawals and charges, plus credited interest thereon, plus/less net realized capital gains/losses (which the Company intends to reflect in credited rates) and net unrealized capital gains/losses related to FAS No. 115. Factors Affecting Forward-Looking Information For information regarding certain important factors that may materially affect Large Case Pension's business, see MD&A - Forward-Looking Information/Risk Factors and financial results discussions in the Annual Report. 22 Page 22 5. General Account Investments Consistent with the nature of the contract obligations involved in the Company's health, life, annuity and pension operations, the majority of general account assets have been invested in intermediate and long-term, fixed-income obligations such as treasury obligations, mortgage-backed securities, corporate debt securities and mortgage loans. For information concerning the valuation of investments, see Notes 1, 4, and 7 of Notes to Financial Statements in the Annual Report. The following table sets forth the distribution of invested assets, cash and cash equivalents and accrued investment income of the Company's general account portfolio (excluding Discontinued Operations) as of the end of the years indicated: (1) (2)
(Millions) 1997 1996 1995 ---- ---- ---- Debt securities: Bonds: United States Government and government agencies and authorities $ 3,928.6 $ 3,773.1 $ 3,720.5 States, municipalities and political subdivisions 206.6 355.3 81.5 U.S. Corporate securities: Utilities 2,505.5 2,420.3 2,333.0 Financial 5,216.8 4,546.5 4,704.3 Transportation/capital goods 2,589.4 2,492.8 2,729.9 Health care/consumer products 1,735.3 1,803.7 1,924.8 Natural resources 1,559.9 1,317.9 1,278.8 Other 1,506.2 1,519.8 1,859.2 --------- --------- --------- Total U.S. Corporate securities 15,113.1 14,101.0 14,830.0 Foreign: Government, including political subdivisions 2,629.8 2,505.4 1,968.3 Utilities 689.1 790.2 780.1 Other 3,830.4 3,513.1 2,986.3 --------- --------- --------- Total foreign securities 7,149.3 6,808.7 5,734.7 Residential mortgage-backed securities: Pass-throughs 1,812.5 1,848.4 1,864.4 Collateralized mortgage obligations 2,710.4 2,764.7 3,073.9 --------- --------- --------- Total residential mortgage-backed securities 4,522.9 4,613.1 4,938.3 Commercial/Multifamily mortgage- backed securities 1,622.0 1,144.3 774.0 Other asset-backed securities 1,635.1 1,464.6 1,772.5 --------- --------- --------- Total bonds 34,177.6 32,260.1 31,851.5 Redeemable preferred stocks 67.4 76.2 8.8 --------- --------- --------- Total debt securities 34,245.0 32,336.3 31,860.3 --------- --------- --------- Equity securities: Common stocks 866.4 1,185.3 566.9 Nonredeemable preferred stocks 175.0 147.5 92.8 --------- --------- --------- Total equity securities 1,041.4 1,332.8 659.7 --------- --------- --------- Short-term investments 1,003.9 723.2 607.8 Mortgage loans 4,207.8 6,700.9 8,327.2 Real estate 369.5 850.2 1,277.3 Policy loans 746.9 707.3 629.4 Other 947.4 835.5 688.6 --------- --------- --------- Total investments $42,561.9 $43,486.2 $44,050.3 ========= ========= ========= Cash and cash equivalents $ 1,805.8 $ 1,462.6 $ 1,712.7 ========= ========= ========= Accrued investment income $ 545.8 $ 598.6 $ 618.3 ========= ========= =========
(1) Excludes Separate Accounts. (2) Includes $7.9 billion, $8.7 billion and $10.3 billion of investments supporting discontinued products in 1997, 1996 and 1995, respectively. 23 Page 23 The following table summarizes the Company's investment results: (1) (Dollar amounts in millions)
Net Earned Net Net Realized Change in Net Investment Investment Capital Unrealized Capital Income (2) Income Rate (3) Gains (4) Gains and Losses (5) ---------- --------------- ---------- -------------------- For the year: 1997 $3,377.5 7.7% $ 334.2 $ (50.7) 1996 3,565.2 8.0 134.4 10.8 1995 3,575.1 7.9 47.2 1,002.8
(1) Excludes Separate Accounts, investments in affiliates and Discontinued Operations. (2) Net investment income excludes net realized capital gains and losses and is after deduction of investment expenses, but before deduction of income taxes. (3) The Earned Net Investment Income Rate for any given year is equal to (a) net investment income divided by (b) the average of cash, invested assets excluding unrealized, and investment income due and accrued at the beginning and end of the year. (4) Net realized capital gains are before income taxes and exclude gains and losses allocable to experience rated pension contractholders in all years. (5) Net unrealized capital gains (losses) are before federal income taxes and exclude changes in unrealized capital gains (losses) related to experience rated contractholders and discontinued products. 6. Other Matters a. Regulation General The Company's operations are subject to comprehensive regulation throughout the United States and the foreign jurisdictions in which it does business. The laws of these jurisdictions establish supervisory agencies, including state health, insurance and securities departments, with broad authority to grant licenses to transact business and regulate many aspects of the products and services offered by the Company, as well as solvency and reserve adequacy. Many agencies also regulate investment activities on the basis of quality, diversification, and other quantitative criteria. The Company's operations and accounts are subject to examination at regular intervals by certain of these regulators. Health Care The federal government and the states in which the Company conducts its HMO and other health operations have adopted laws and regulations that govern the business activities of the Company to varying degrees. These laws and regulations may restrict how the Company conducts its businesses and may result in additional burdens and costs to the Company. Areas of governmental regulation include licensure, premium rates, benefits, service areas, quality assurance procedures, plan design, eligibility requirements, provider rates of payment, surcharges on provider payments, provider contract forms, underwriting, financial arrangements, financial condition (including reserves) and corporate governance. These laws and regulations are subject to amendments and changing interpretations in each jurisdiction. 24 Page 24 States generally require HMOs to obtain a certificate of authority prior to commencing operations. To establish an HMO in any state where it does not presently operate an HMO, the Company generally has to obtain such a certificate. The time necessary to obtain such a certificate varies from state to state. Each HMO must file periodic financial and operating reports with the states in which it does business. In addition, the HMOs are subject to state examination and periodic license renewal. The provision of services to certain employee health benefit plans is subject to the Employee Retirement Income Security Act of 1974 ("ERISA"), a complex set of laws and regulations subject to interpretation and enforcement by the Internal Revenue Service and the Department of Labor ("DOL"). ERISA regulates certain aspects of the relationships between the Company and employers who maintain employee benefit plans subject to ERISA. Some of the administrative services and other activities of the Company may also be subject to regulation under ERISA. In addition, some states require licensure or registration of companies providing third party claims administration services for benefit plans. Certain legislative and regulatory changes related to health products have recently been enacted or proposed, and a variety of other potential legislative and regulatory changes are receiving a high level of attention at both the state and federal level. For a discussion of these matters see MD&A - Regulatory Environment in the Annual Report. For information regarding regulation of pricing by the Company's HMOs, see "Aetna U.S. Healthcare - Health Pricing", on page 10. Investment and Retirement Products and Services Operations conducted by ARS and Large Case Pensions are subject to regulation by various insurance agencies where the Company conducts business, in particular the insurance departments of Connecticut and New York. Among other matters, these agencies may regulate premium rates, trade practices, agent licensing, policy forms, underwriting and claims practices, the maximum interest rates that can be charged on life insurance policy loans, and the minimum rates that must be provided for accumulation of surrender value. The Securities and Exchange Commission ("SEC"), the National Association of Securities Dealers ("NASD") and, to a lesser extent, the states regulate the sales and investment management activities and operations of broker-dealer and investment advisory subsidiaries of the Company. Regulations of the SEC, Department of Labor and Internal Revenue Service also impact certain of the Company's pension, annuity, life insurance and other investment and retirement products. These products involve Separate Accounts of Aetna Life Insurance and Annuity Company and Aetna Insurance Company of America and mutual funds registered under the Investment Company Act of 1940. 25 Page 25 International The nature and extent of regulations affecting the Company's international operations varies by jurisdiction and line of business. Most operations are subject to local insurance laws. These laws typically regulate the types of business that can be written, policy forms and terms, currency, permitted investments, reserves, taxation and other matters affecting the conduct of the business. International operations are also subject to a variety of additional investment and other controls that may be imposed by governments. Certain jurisdictions may require that portions of the business be reinsured through designated state-affiliated institutions. As a foreign investor, the Company is also subject to a variety of restrictions regarding permitted levels of equity ownership, remittance of foreign earnings, repatriation of capital, exchange of currency, and entry into new lines of business. Regulation of international operations may also be subject to other political factors not typically associated with doing business in the United States, such as more rapid change of regulatory policy, possible nationalization of businesses, hostilities and unrest. Federal Employee Benefit Regulation ARS and Large Case Pensions also provide a variety of products and services to employee benefit plans that are covered by ERISA. In December 1993, in a case involving an employee benefit plan and an insurance company, the United States Supreme Court ruled that assets in the insurance company's general account that were attributable to a portion of a group pension contract issued to the plan that was not a "guaranteed benefit contract" were "plan assets" for purposes of ERISA and that the insurance company was an ERISA fiduciary with respect to those assets. In reaching its decision, the Court declined to follow a 1975 DOL interpretive bulletin that had suggested that insurance company general account assets were not plan assets. Congress recently enacted the Small Business Job Protection Act (the "Act"), which, among other matters, created a framework for resolving potential issues raised by the Supreme Court decision. The Act provides that, absent criminal conduct, insurers generally will not have liability with respect to general account assets held under contracts that are not guaranteed benefit contracts based on claims that those assets are plan assets. The relief afforded extends to conduct that occurred before the date that is eighteen months after the DOL issues final regulations required by the Act, except as provided in the anti-avoidance portion of the regulations. The regulations, which were proposed by the DOL on December 22, 1997, will address ERISA's application to the general account assets of insurers attributable to contracts issued on or before December 31, 1998 that are not guaranteed benefit contracts. The conference report relating to the Act states that contracts issued after December 31, 1998 that are not guaranteed benefit contracts will be subject to ERISA's fiduciary obligations. The Company is not currently able to predict how these matters may ultimately affect its businesses. 26 Page 26 HMO and Insurance Holding Company Laws A number of states, including Connecticut, regulate affiliated groups of HMOs and insurers such as the Company under holding company statutes. These laws may require these companies to maintain certain levels of equity. For information regarding restrictions on certain payments of dividends or other distributions by HMO and insurance company subsidiaries of the Company, see MD&A - Liquidity and Capital Resources in the Annual Report. Some of these laws also regulate changes in control (as do Connecticut corporate laws), and other matters such as transactions with affiliates. See also Note 16 of Notes to Financial Statements in the Annual Report. Insurance Company Guaranty Fund Assessments Under insurance guaranty fund laws existing in all states, insurers doing business in those states can be assessed (up to prescribed limits) for certain obligations of insolvent insurance companies to policyholders and claimants. The after-tax charges to earnings for guaranty fund obligations for the years ended December 31, 1997, 1996 and 1995 were $5 million, $4 million and $8 million, respectively. While the Company has historically recovered more than half of guaranty fund assessments through statutorily permitted premium tax offsets, significant increases in assessments could jeopardize future efforts to recover such assessments. For information regarding certain other potential regulatory changes relating to the Company's businesses, see MD&A - Forward-Looking Information/Risk Factors. b. NAIC IRIS Ratios The NAIC IRIS ratios cover 12 categories of financial data with defined usual ranges for each category. The ratios are intended to provide insurance regulators "early warnings" as to when a given company might warrant special attention. An insurance company may fall out of the usual range for one or more ratios and such variances may result from specific transactions that are in themselves immaterial or eliminated at the consolidated level. In 1997, none of Aetna Inc.'s significant insurance subsidiaries had more than two IRIS ratios that were outside of the NAIC usual ranges. Management does not expect that any of the Company's significant subsidiaries will have more than two IRIS ratios outside of the NAIC usual ranges for 1998. 27 Page 27 See MD&A - Liquidity and Capital Resources in the Annual Report for additional discussion regarding solvency regulation. c. Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends The following table sets forth the Company's and Aetna Services' ratios of earnings to fixed charges and ratios of earnings to combined fixed charges and preferred stock dividends for the years indicated:
(Millions) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Aetna Inc. Ratio of Earnings to Fixed Charges 5.74 2.45 4.97 4.74 (a) Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends 4.46 2.10 4.97 4.74 (a)
(a) The Company reported a pretax loss from continuing operations in 1993 which was inadequate to cover fixed charges by $1.0 billion.
(Millions) 1997 1996 ---- ---- Aetna Services, Inc. Ratio of Earnings to Fixed Charges 5.78 2.44 Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends 5.78 2.44
For purposes of computing both the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividends, "earnings" represent consolidated earnings from continuing operations before income taxes, cumulative effect adjustments and extraordinary items plus fixed charges and minority interest. "Fixed charges" consist of interest (and the portion of rental expense deemed representative of the interest factor) and include the dividends paid to preferred shareholders of a subsidiary. (See Note 14 of Notes to Financial Statements in the Annual Report.) During 1993, 1994 and 1995, there was no preferred stock outstanding. As a result, the ratios of earnings to combined fixed charges and preferred stock dividends were the same as the ratios of earnings to fixed charges. d. Trademarks The trademarks Aetna (Registered Trademark), Aetna U.S. Healthcare (Trademark application pending), U.S. Healthcare (Registered Trademark), and Aetna Retirement Services (Registered Trademark), together with the corresponding design logos are owned by the Company. The Company considers these trademarks and its other trademarks and trade names important in the operation of its business. However, the business of the Company is not dependent on any individual trademark or trade name. 28 Page 28 e. Ratings The ratings of certain of Aetna Inc.'s subsidiaries follow:
Rating Agencies ------------------------------------------------- Moody's Duff & Investors Standard A.M. Best Phelps Service & Poor's ------------------------------------------------- Aetna Services, Inc.(senior debt)** February 4, 1997 * A A2 A- February 4, 1998 * A A2 A Aetna Services, Inc.(commercial paper)** February 4, 1997 * D-1 P-1 A-2 February 4, 1998 * D-1 P-1 A-1 Aetna Life Insurance Company(claims paying) February 4, 1997 A AA- Aa3 A February 4, 1998 A AA- A1 A+ Aetna Life Insurance and Annuity Company(claims paying) February 4, 1997 A+ AA+ Aa2 AA- February 4, 1998 A+ AA+ Aa3 AA-
* Nonrated by the agency. ** Fully and unconditionally guaranteed by Aetna Inc. In addition, certain of the Company's HMO subsidiaries are rated on their claims paying ability by A.M. Best. All such ratings are in the "Excellent" or "Superior" categories. f. Miscellaneous The Company had approximately 27,100 domestic employees at December 31, 1997. In addition, the Company had approximately 13,200 international employees at December 31, 1997 in its majority and wholly owned non-U.S. subsidiaries. Management believes that the Company's computer facilities, systems and related procedures are adequate to meet its business needs. The Company's data processing systems and backup and security policies, practices and procedures are regularly evaluated by the Company's management and its internal auditors and are modified as considered necessary. See MD&A for information regarding the Company's efforts to prepare its systems, applications and facilities to accommodate Year 2000 date-sensitive information. The federal government is a significant customer of the Aetna U.S. Healthcare segment and the Company, accounting for approximately 13% of the Company's consolidated revenue in 1997. No other customer accounted for 10% or more of the Company's consolidated revenues in 1997. No other segment of the Company's business is dependent upon a single customer or a few customers, the loss of which would have a significant effect on the earnings of the segment. See Note 17 of Notes to Financial Statements in the Annual Report regarding segment information. The loss of business from any one, or a few, independent brokers or agents would not have a material adverse effect on the earnings of the Company or any of its segments. 29 Page 29 Item 2. Properties. The home office of the Company is a building complex located at 151 Farmington Avenue, Hartford, Connecticut, with approximately 1.6 million square feet. The Company and certain of its subsidiaries also own or lease other space in the greater Hartford area, Blue Bell, Pennsylvania and Fairfield, New Jersey, as well as various field locations throughout the country. The Company believes its properties are adequate and suitable for its business as presently conducted. The foregoing does not include numerous investment properties held by the Company in its general and separate accounts. Item 3. Legal Proceedings. Purported Class Action Complaints were filed in the United States District Court for the Eastern District of Pennsylvania on November 5, 1997 by Eileen Herskowitz and Michael Wolin, and on December 2, 1997 by Pamela Goodman and Michael J. Oring. Other purported Class Action Complaints were filed in the United States District Court for the District of Connecticut on November 25, 1997 by Evelyn Silvert, on November 26, 1997 by The Rainbow Fund, Inc., and on December 24, 1997 by Terry B. Cohen. The Complaints seek, among other remedies, unspecified damages resulting from defendants' alleged violations of federal securities laws. The Complaints allege that the Company and three of its current or former officers or directors, Ronald E. Compton, Richard L. Huber, and Leonard Abramson, are liable for certain misrepresentations and omissions regarding, among other matters, the integration of the merger with U.S. Healthcare and the Company's medical claim reserves. The litigation is still in the preliminary stages, and the Company is defending the actions vigorously. The Company also is involved in numerous other lawsuits arising, for the most part, in the ordinary course of its business operations including litigation in its health business concerning benefit plan coverage and other decisions made by the Company, and alleged medical malpractice by participating providers. While the ultimate outcome of these other lawsuits cannot be determined at this time, after consideration of the defenses available to the Company and any related reserves established, they are not expected to result in liability for amounts material to the financial condition of the Company, although they may adversely affect results of operations in future periods. Item 4. Submission of Matters to a Vote of Security Holders. None. 30 Page 30 EXECUTIVE OFFICERS OF AETNA INC.* The Chairman of the Company is elected and all other executive officers listed below are appointed by the Board of Directors of the Company at its Annual Meeting each year to hold office until the next Annual Meeting of the Board or until their successors are elected or appointed. None of these officers have family relationships with any other executive officer or Director.
Business Experience Name of Officer Principal Position Age * During Past Five Years * - --------------- ------------------ --- ---------------------- Richard L. Huber Chairman, Chief Executive 61 (1) Officer and President Thomas J. Calvocoressi Vice President and General Counsel 44 (2) Michael J. Cardillo Executive Vice President, Aetna U.S. Healthcare** 54 (3) Frederick C. Copeland, Jr. Executive Vice President, International** 56 (4) Timothy A. Holt Vice President, Aetna Investment Management 44 (5) Group Thomas J. McInerney Executive Vice President,** Aetna Retirement Services 41 (6)
* As of March 2, 1998. ** Executive Vice Presidents, in conjunction with certain other senior officers, are responsible for assisting the Chief Executive Officer in setting policy and overall direction for the Company. 31 Page 31 (1) Mr. Huber was named Chairman on March 1, 1998 and Chief Executive Officer and President on July 28, 1997. He had served as Vice Chairman for Strategy and Finance since February 1995. He served as President and Chief Operating Officer of Grupo Wasserstein Perella from September 1994 to February 1995 and as Vice Chairman of Continental Bank from 1990 to September 1994. (2) Mr. Calvocoressi assumed his current position on January 1, 1997. From March 1996 to January 1997, he served as Vice President and Deputy General Counsel of Aetna. He served as Vice President and Corporate Counsel from August 1994 to March 1996, as Vice President and Counsel from July 1993 to August 1994 and as Counsel, Office of General Counsel, from July 1991 to July 1993. (3) Mr. Cardillo has served in his current position since July 19, 1996. He also serves as President of Aetna U.S. Healthcare Inc. a position he assumed in March 1997 after serving as Co-President since July 19, 1996. Mr. Cardillo had been Co-President of U.S. Healthcare, Inc. since 1995 and Principal Marketing Officer since 1989. (4) Mr. Copeland assumed his current position on July 19, 1996. He also serves as President and Chief Executive Officer of Aetna International, Inc., a position he assumed in April 1996, after having served as President of Aetna International since July 1995. From January 1993 to July 1995, he served as Chairman, President and Chief Executive Officer of Fleet Bank, N.A., Connecticut. From September 1987 to January 1993, he served as President and Chief Executive Officer of Citibank Canada. (5) Mr. Holt assumed his current position on September 26, 1997, having served as Vice President and Chief Financial Officer of Aetna Retirement Services since 1996. He served as Vice President, Portfolio Management Group, from 1992 to 1996. (6) Mr. McInerney assumed his current position on August 18, 1997, having served as Vice President, Strategic Planning, since March 1997. He also currently serves as President, Aetna Retirement Services, Inc. From 1996 to 1997, he served as Vice President, National Accounts, for Aetna Health Plans and then as Vice President, National Accounts and Sales and Marketing, for the successor business, Aetna U.S. Healthcare. During 1995 and 1996, he also served as Vice President, Corporate Strategy. From 1992 to 1996, Mr. McInerney served as Vice President, Guaranteed Products. 32 Page 32 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Aetna Inc.'s common stock is listed on the New York Stock Exchange. Its symbol is AET. As of January 31, 1998, there were 20,910 record holders of the common stock. The dividends declared and the high and low sales prices with respect to the Company's common stock for each quarterly period for the past two years are incorporated herein by reference from "Quarterly Data" in the Annual Report. Information regarding restrictions on the Company's present and future ability to pay dividends is incorporated herein by reference from Note 16 of Notes to Financial Statements and MD&A - Liquidity and Capital Resources in the Annual Report. Item 6. Selected Financial Data. The information contained in "Selected Financial Data" in the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations-General Account Investments" in the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. The 1997 Consolidated Financial Statements and the report of the registrant's independent auditors and the unaudited information set forth under the caption "Quarterly Data" are incorporated herein by reference to the Annual Report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. 33 Page 33 PART III Item 10. Directors and Executive Officers of the Registrant. Information concerning Executive Officers is included in Part I pursuant to General Instruction G to Form 10-K. Information concerning Directors and concerning compliance with Section 16 (a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the Proxy Statement. Item 11. Executive Compensation. The information under the captions "Director Compensation in 1997" and "Executive Compensation" in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information under the caption "Security Ownership of Certain Beneficial Owners, Directors, Nominees and Executive Officers" in the Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. The information under the caption "Certain Transactions and Relationships" in the Proxy Statement is incorporated herein by reference. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.* (a) The following documents are filed as part of this report: 1. Financial statements: The Consolidated Financial Statements and the report of the registrant's independent auditors are incorporated herein by reference to the Annual Report. 2. Financial statement schedules: The supporting schedules of the consolidated entity are included in this Item 14. See Index to Financial Statement Schedules on page 40. 34 Page 34 3. Exhibits: (3) Articles of Incorporation and By-Laws. Aetna Inc. Amended and Restated Certificate of Incorporation, incorporated herein by reference to the Company's Registration Statement on Form S-4 (File No. 333-5791) filed on June 12, 1996. Aetna Inc. Bylaws, as amended, incorporated herein by reference to the Company's Form 10-K filed on February 28, 1997. (4) Instruments defining the rights of security holders, including indentures. Senior Indenture, dated July 1, 1996, between the Company, Aetna Services, Inc. (formerly Aetna Life and Casualty Company), and State Street Bank and Trust Company of Connecticut, National Association, as Trustee, incorporated herein reference to the Company's Form 10-Q filed on October 25, 1996. Form of Subordinated Indenture between Aetna Services, Inc., Aetna Inc. and State Street Bank and Trust Company of Connecticut, National Association, as Trustee (including the forms of Subordinated Debt Securities and Subordinated Debt Guarantees), incorporated herein by reference to the Company's and Aetna Services, Inc.'s Registration Statement on Form S-3 (File No. 333-07167) filed on June 28, 1996. Designations, Rights and Preferences of 6.25% Class C Voting Preferred Stock, incorporated herein by reference to the Company's 8-K filed on July 26, 1996. Aetna Inc. Rights Agreement, incorporated herein by reference to the Company's 8-K filed on July 26, 1996. Indenture, dated as of October 15, 1986, between Aetna Services, Inc. and The First National Bank of Boston, Trustee, incorporated herein by reference to Aetna Services, Inc.'s 1992 Form 10-K. First Indenture Supplement, dated as of August 1, 1996, to Indenture, dated as of October 15, 1986, between Aetna Services, Inc. and State Street Bank and Trust Company, as Successor Trustee, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996. Indenture, dated as of August 1, 1993, between Aetna Services, Inc. and State Street Bank and Trust Company of Connecticut, National Association, as Trustee, incorporated herein by reference to Aetna Services, Inc.'s Registration Statement on Form S-3 (File No. 33-50427). First Indenture Supplement, dated as of August 1, 1996, to the Indenture dated as of August 1, 1993 between Aetna Services, Inc. and State Street Bank and Trust Company of Connecticut, National Association, as Trustee, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996. Written Action, dated as of November 15, 1994, establishing the terms of Series A Preferred Securities of Aetna Capital L.L.C., incorporated herein by reference to Aetna Services, Inc.'s Form 8-K filed on November 22, 1994. 35 Page 35 3. Exhibits (Continued): Subordinated Indenture, dated as of November 1, 1994, between Aetna Services, Inc. and The First National Bank of Chicago, as Trustee, incorporated herein by reference to Aetna Services, Inc.'s Form 8-K filed on November 22, 1994. First Indenture Supplement, dated as of August 1, 1996, to the Indenture, dated as of November 1, 1994, between Aetna Services, Inc. and The First National Bank of Chicago, as Trustee, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996. Payment and Guarantee Agreement, dated November 22, 1994, of Aetna Services, Inc. with respect to Aetna Capital L.L.C., incorporated herein by reference to Aetna Services, Inc.'s Form 8-K filed on November 22, 1994. Payment and Guarantee Agreement, dated as of August 1, 1996, of Aetna Inc. with respect to Aetna Capital L.L.C., incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996. Amendment No. 1, dated as of August 1, 1996, to the Fiscal Agency Agreement, dated as of July 17, 1986, between Aetna Services, Inc. and State Street Bank and Trust Company, as successor Fiscal Agent, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996. (10) Material contracts. Employment Agreement, dated as of March 30, 1996, by and between U.S. Healthcare, Inc. and Joseph Sebastianelli, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996.** Employment Agreement, dated as of March 30, 1996, by and between U.S. Healthcare, Inc. and Michael Cardillo, incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996.** Stock Purchase Agreement, dated as of November 28, 1995, between The Travelers Insurance Group Inc. and Aetna Services, Inc. relating to the purchase and sale of 100% of the Common Stock of The Aetna Casualty and Surety Company and The Standard Fire Insurance Company, incorporated herein by reference to Aetna Services, Inc.'s 1995 Form 10-K. Letter Agreement, dated as of January 19, 1995, between Aetna Services, Inc. and Richard L. Huber, incorporated herein by reference to Aetna Services, Inc.'s 1995 Form 10-K.** Employment Agreement, dated as of January 29, 1996, between Aetna Services, Inc. and Ronald E. Compton, incorporated herein by reference to Aetna Services, Inc.'s 1995 Form 10-K.** Employment Agreement, dated as of December 19, 1995, between Aetna Services, Inc. and Daniel P. Kearney, incorporated herein by reference to Aetna Services, Inc.'s 1995 Form 10-K.** The 1984 Stock Option Plan of Aetna Life and Casualty Company and amendments thereto, incorporated herein by reference to the 1992 Form 10-K. ** Letter Agreement, dated as of January 31, 1996, between Aetna Services, Inc. and The Travelers Insurance Group Inc., incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996. 36 Page 36 3. Exhibits (Continued): Amendment, dated as of April 2, 1996, to Stock Purchase Agreement, dated as of November 28, 1995, between Aetna Services, Inc. and The Travelers Insurance Group Inc., incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996. Registration Rights Agreement, dated as of March 30, 1996, between the Company and Leonard Abramson, incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996. Amendment No. 1, dated as of May 30, 1996, to the Registration Rights Agreement, dated as of March 30, 1996, between the Company and Leonard Abramson, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996. Amended and Restated Agreement, dated as of May 30, 1996, between the Company and Leonard Abramson, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996. The Aetna Inc. 1996 Stock Incentive Plan, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996.** The Aetna Inc. Annual Incentive Plan, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996.** The Aetna Inc. Non-Employee Director Deferred Stock and Deferred Compensation Plan, as amended, incorporated herein by reference to Company's Form 10-K filed on February 28, 1997.** The Supplemental Pension Benefit Plan for Certain Employees of Aetna Services, Inc., incorporated herein by reference to the Company's Form 10-Q filed on October 25, 1996.** Amendment No. 1, dated March 1, 1996 to Letter Agreement, dated January 19, 1995, between Aetna Services, Inc. and Richard L. Huber, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996.** Amended and Restated U.S. Healthcare, Inc. Savings Plan, incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.** Amended and Restated Pension Plan for Employees of U.S. Healthcare, Inc., incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.** Split Dollar Insurance Agreement, dated as of February 1, 1990, among Madlyn K. Abramson, Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson and David B. Soll, and U.S. Healthcare, Inc., and the related Collateral Assignment Agreement, dated as of February 1, 1990, among Madlyn K. Abramson, Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson and David B. Soll, and U.S. Healthcare, Inc., incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996. 37 Page 37 3. Exhibits (Continued): Split Dollar Insurance Agreement, dated as of January 21, 1991, among Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson, David B. Soll, Jerome Goodman and Edward M. Glickman, and U.S. Healthcare, Inc., and the related Collateral Assignment Agreement, dated as of January 21, 1991, among Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson, David B. Soll, Jerome Goodman and Edward M. Glickman, and U.S. Healthcare, Inc., incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996. Description of Deferred Compensation Plan, incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.** Voting Agreement, dated as of March 30, 1996, among Leonard Abramson, Aetna Life Insurance Company and Aetna Life Insurance and Annuity Company, incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996. Agreement and Plan of Merger, dated as of March 30, 1996, among Aetna Services, Inc., U.S. Healthcare, Inc., the Company, Antelope Sub, Inc. and New Merger Corporation, incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996. Amendment No. 1, dated as of May 30, 1996, to the Agreement and Plan of Merger, dated as of March 30, 1996, among Aetna Services, Inc., U.S. Healthcare, Inc., the Company, Antelope Sub. Inc. and New Merger Corporation, incorporated herein by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996. Aetna Services, Inc. Credit Facility, incorporated herein by reference to Aetna Services, Inc.'s Report on Form 8-K filed on July 16, 1996. Notification from Aetna Services, Inc. dated October 22, 1996 electing to reduce Credit Facility to $1.5 billion, incorporated herein by reference to the Company's Form 10-K filed on February 28, 1997. Amendment, dated as of September 4, 1997, to the Amended and Restated Agreement, dated as of May 30, 1996, between the Company and Leonard Abramson, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on November 4, 1997. Amendment, dated as of September 8, 1997, to Employment Agreement, as of December 19, 1995, between Aetna Services, Inc. and Daniel P. Kearney, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on November 4, 1997.** Amendment No. 1, dated as of December 31, 1996, to the Supplemental Pension Benefit Plan for Certain Employees of Aetna Services, Inc., incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** Amendment No. 2, dated as of February 28, 1997, to the Supplemental Pension Benefit Plan for Certain Employees of Aetna Services, Inc., incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** 38 Page 38 3. Exhibits (Continued): Employment Agreement, dated as of March 6, 1997, by and between the Company and Joseph Sabastianelli, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** Amendment dated as of April 9, 1997, to the Amended and Restated Agreement, dated as of May 10, 1996, between the Company and Leonard Abramson, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997. Amendment dated as of July 22, 1996, to Letter Agreement, dated as of January 19, 1995, between the Company and Richard L. Huber incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** Amendment dated as of July 22, 1996, to Employment Agreement, dated as of January 19, 1995, between the Company and Ronald E. Compton, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** Amendment dated as of July 22, 1996, to Employment Agreement, dated as of December 19, 1995, between Aetna Services, Inc. and Daniel P. Kearney, incorporated herein by reference to Aetna Inc.'s Form 10-Q filed on May 6, 1997.** Employment Agreement, dated as of December 21, 1995, by and between Aetna Services, Inc. and Frederick C. Copeland, Jr., as amended.** Employment Agreement, dated as of December 21, 1995, by and between Aetna Services, Inc. and Thomas McInerney, as amended.** Description of certain arrangements not embodied in formal documents, as described under the headings "Director Compensation" and "Executive Compensation", incorporated herein by reference to the Aetna Services, Inc. 1997 Proxy Statement. (11) Statement re: computation of per share earnings. Incorporated herein by reference to Note 1 of Notes to Financial Statements in the Annual Report. (12) Statement re: computation of ratios. Statement re: computation of ratio of earnings to fixed charges for the Company for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 and Aetna Services for the years ended December 31, 1997 and 1996. Statement re: computation of ratio of earnings to combined fixed charges and preferred stock dividends for the Company for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 and Aetna Services for the years ended December 31, 1997 and 1996. (13) Annual Report to security holders. Selected Financial Data, Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements and the report of the Company's independent auditors, and unaudited Quarterly Data from the Annual Report. 39 Page 39 3. Exhibits (Continued): (21) Subsidiaries of the registrant. A listing of subsidiaries of Aetna Inc. (23) Consents of experts and counsel. Consent of Independent Auditors to Incorporation by Reference in the Registration Statements on Form S-3 and Form S-8. (24) Powers of attorney. (27) Financial data schedule. (b) Reports on Form 8-K None * Exhibits other than those listed are omitted because they are not required or are not applicable. Copies of exhibits are available without charge by writing to the Office of the Corporate Secretary, Aetna Inc., 151 Farmington Avenue, Hartford, Connecticut 06156. ** Management contract or compensatory plan or arrangement. 40 Page 40 INDEX TO FINANCIAL STATEMENT SCHEDULES AETNA INC. Page ---- Independent Auditors' Report 41 I Summary of Investments - Other than Investments in Affiliates as of December 31, 1997 42 II Condensed Financial Information of the Registrant: Aetna Inc. as of and for the years ended December 31, 1997 and 1996 43 Aetna Services, Inc. (formerly Aetna Life and Casualty Company) for the year ended December 31, 1995 49 III Supplementary Insurance Information as of and for the years ended December 31, 1997, 1996 and 1995 53 IV Reinsurance 56 V Valuation and Qualifying Accounts and Reserves for the years ended December 31, 1997, 1996 and 1995 57 Certain of the required information is shown in the Financial Statements or Notes thereto in the Annual Report. Certain information has been omitted from the schedules filed because the information is not applicable. Certain reclassifications have been made to 1996 and 1995 financial information to conform to 1997 presentation. 41 Page 41 INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors Aetna Inc.: Under date of February 3, 1998, we reported on the consolidated balance sheets of Aetna Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, as contained in the 1997 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1997. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP Hartford, Connecticut February 3, 1998 42 Page 42 AETNA INC. AND SUBSIDIARIES SCHEDULE I Summary of Investments - Other than Investments in Affiliates As of December 31, 1997
Amount at which shown in the Type of Investment Cost Value* balance sheet --------- --------- ------------- (Millions) Debt securities: Bonds: United States Government and government agencies and authorities $ 3,762.3 $ 3,928.6 $ 3,928.6 States, municipalities and political subdivisions 190.7 206.6 206.6 U.S. Corporate securities: Utilities 2,382.6 2,505.5 2,505.5 Financial 5,049.4 5,216.8 5,216.8 Transportation/capital goods 2,417.7 2,589.4 2,589.4 Health care/consumer products 1,641.5 1,735.3 1,735.3 Natural resources 1,467.1 1,559.9 1,559.9 Other 1,418.9 1,506.2 1,506.2 --------- --------- --------- Total U.S. Corporate securities 14,377.2 15,113.1 15,113.1 Foreign: Government, including political subdivisions 2,514.7 2,629.8 2,629.8 Utilities 612.4 689.1 689.1 Other 3,714.8 3,830.4 3,830.4 --------- --------- -------- Total foreign securities 6,841.9 7,149.3 7,149.3 Residential mortgage-backed securities: Pass-throughs 1,707.5 1,812.5 1,812.5 Collateralized mortgage obligations 2,549.6 2,710.4 2,710.4 --------- --------- --------- Total residential mortgage-backed securities 4,257.1 4,522.9 4,522.9 Commercial/Multifamily mortgage-backed securities 1,586.2 1,622.0 1,622.0 Other asset-backed securities 1,612.9 1,635.1 1,635.1 --------- --------- --------- Total bonds 32,628.3 34,177.6 34,177.6 Redeemable preferred stocks 65.7 67.4 67.4 --------- --------- --------- Total debt securities $32,694.0 $34,245.0 $34,245.0 ========= ========= ========= Equity securities: Common stocks: Public utilities $ 12.4 $ 17.5 $ 17.5 Banks, trust and insurance companies 92.8 232.2 232.2 Industrial, miscellaneous and all other 561.5 616.7 616.7 --------- --------- --------- Total common stocks 666.7 866.4 866.4 Nonredeemable preferred stocks 157.7 175.0 175.0 --------- --------- --------- Total equity securities $ 824.4 $ 1,041.4 $ 1,041.4 ========= ========= ========= Short-term investments $ 1,003.9 $ 1,003.9 Mortgage loans 4,207.8 4,207.8 Real estate 369.5 369.5 Policy loans 746.9 746.9 Other 574.8(1) 947.4(2) --------- --------- Total investments $40,421.3 $42,561.9 ========= =========
- ---------- * See Notes 1 and 4 of Notes to Financial Statements in the Company's 1997 Annual Report. (1) Excludes investments in affiliates of $372.6 million. (2) Includes investments in affiliates of $372.6 million. 43 Page 43 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Statements of Income
For the year ended December 31, (Millions) 1997 1996 ---- ---- Net investment income $ .5 $ 1.2 ------- ------- Total revenue .5 1.2 Operating expenses - .2 ------- ------- Total expenses - .2 ------- ------- Income before income taxes and equity in earnings of affiliates .5 1.0 Income taxes .1 .5 Equity in earnings of affiliates 900.7 204.6 ------- ------- Income from continuing operations 901.1 205.1 Discontinued Operations, net of tax: Income from operations - 182.2 Gain on sale - 263.7 ------- ------- Net income $ 901.1 $ 651.0 ======= =======
- ---------- See Notes to Condensed Financial Statements. 44 Page 44 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Balance Sheets
As of December 31, (Millions, except share data) 1997 1996 ---- ---- ASSETS Investments: Short-term investments $ 3.2 $ 8.8 Investments in affiliates 11,049.2 10,842.3 --------- --------- Total investments 11,052.4 10,851.1 Cash and cash equivalents 22.1 26.9 Due from affiliates 5.4 6.0 Affiliate dividends receivable 200.0 100.0 Deferred income taxes 1.1 4.0 --------- --------- Total assets $11,281.0 $10,988.0 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Dividends payable to shareholders $ 36.1 $ 36.9 Other liabilities 29.3 40.1 Current income taxes 20.2 21.3 --------- --------- Total liabilities 85.6 98.3 --------- --------- Shareholders' Equity: Class C Voting Mandatorily Convertible Preferred Stock ($.01 par value; 15,000,000 shares authorized; 11,655,206 in 1997 and 11,655,546 in 1996 issued and outstanding) 865.4 865.4 Common stock ($.01 par value; 500,000,000 shares authorized; 145,794,844 and 150,084,799 issued and outstanding in 1997 and 1996) 3,644.4 4,032.8 Accumulated other comprehensive income 307.1 340.0 Retained earnings 6,378.5 5,651.5 --------- --------- Total shareholders' equity 11,195.4 10,889.7 --------- --------- Total liabilities and shareholders' equity $11,281.0 $10,988.0 ========= =========
- ---------- See Notes to Condensed Financial Statements. 45 Page 45 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Statements of Shareholders' Equity
Class C Accumulated Other Voting Comprehensive Income Mandatorily For the two years ended Unrealized Convertible December 31, 1997 Retained Gains(Losses) Foreign Preferred Common (Millions, except share data) Total Earnings on Securities Currency Stock Stock - ----------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1995 $ 7,272.8 $ 5,195.6 $ 797.0 $ (155.9) - $ 1,436.1 - ------------------------------------=================================================================================== Comprehensive income: Net income 651.0 651.0 Other comprehensive loss, net of tax: Unrealized losses on securities (($527.6) pretax) (342.8) (342.8) Foreign currency ($64.2 pretax) 41.7 41.7 --------- Other comprehensive loss (301.1) --------- Total comprehensive income 349.9 ========= Issued for U.S. Healthcare merger: Class C Voting mandatorily convertible preferred stock (11,655,546 shares) 865.4 865.4 Common shares (34,988,615 shares) 2,580.1 2,580.1 Stock options 24.8 24.8 Common stock issued for benefit plans (1,563,491 shares) 75.1 75.1 Repurchase of common shares (1,194,400 shares) (83.3) (83.3) Common stock dividends (170.0) (170.0) Preferred stock dividends (25.1) (25.1) ----------------------------------------------------------------------------------- Balances at December 31, 1996 $10,889.7 $5,651.5 $ 454.2 $ (114.2) $ 865.4 $ 4,032.8 - ------------------------------------=================================================================================== Comprehensive income: Net income 901.1 901.1 Other comprehensive loss, net of tax: Unrealized gains on securities ($81.8 pretax) 49.9 49.9 Foreign currency (($127.3) pretax) (82.8) (82.8) --------- Other comprehensive loss (32.9) --------- Total comprehensive income 868.2 ========= Common stock issued for benefit plans (1,883,945 shares) 134.7 134.7 Repurchase of common shares (6,173,900 shares) (523.1) (523.1) Common stock dividends (118.6) (118.6) Preferred stock dividends (55.5) (55.5) ----------------------------------------------------------------------------------- Balances at December 31, 1997 $11,195.4 $6,378.5 $ 504.1 $ (197.0) $ 865.4 $ 3,644.4 - ------------------------------------===================================================================================
See Notes to Financial Statements. 46 Page 46 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Statements of Cash Flows
For the years ended December 31, (Millions) 1997 1996 ---- ---- Cash Flows from Operating Activities: Net income $ 901.1 $ 651.0 Adjustments to reconcile net income to net cash (used for) provided by operating activities: Income from Discontinued Operations - (182.2) Equity in earnings of affiliates (901.4) (204.6) Gain on sale of Discontinued Operations - (263.7) Other, net (8.4) 27.7 ------- ------- Net cash (used for) provided by operating activities (8.7) 28.2 ------- ------- Cash Flows from Investing Activities: Proceeds from sales of short-term investments 619.4 184.4 Cost of investments in short-term investments (613.8) (193.2) Cost of investment in U.S. Healthcare - (5,243.9) Capital contributions to affiliates (421.0) (500.0) Dividends received from affiliates 1,007.2 5,938.0 Other, net (24.6) 35.2 ------- ------- Net cash provided by investing activities 567.2 220.5 ------- ------- Cash Flows from Financing Activities: Common stock issued under benefit plans 134.7 75.1 Common shares repurchased (523.1) (83.3) Dividends paid to shareholders (174.9) (237.3) ------- ------- Net cash used for financing activities (563.3) (245.5) ------- ------- Net (decrease) increase in cash and cash equivalents (4.8) 3.2 Cash and cash equivalents, beginning of year 26.9 23.7 ------- ------- Cash and cash equivalents, end of year $ 22.1 $ 26.9 ======== ======= Supplemental disclosure of cash flow information: Interest paid $ - $ - ======== ======== Income taxes received, net $ 1.0 $ .5 ======== ========
- ---------- See Notes to Condensed Financial Statements. 47 Page 47 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Notes to Condensed Financial Statements 1. Background of Organization Aetna Inc. was incorporated under the Stock Corporation Act of the state of Connecticut on March 25, 1996 for the purpose of effecting the combination of Aetna Services, Inc. ("Aetna Services")(formerly Aetna Life and Casualty Company) and Aetna U.S. Healthcare, Inc. ("Aetna U.S. Healthcare") (formerly U.S. Healthcare, Inc. ("U.S. Healthcare")) in accordance with the terms of the Agreement and Plan of Merger dated as of March 30, 1996. Aetna's merger with Aetna U.S. Healthcare was consummated on July 19, 1996. As a result of the merger, Aetna Services and Aetna U.S. Healthcare are each direct wholly owned subsidiaries of Aetna Inc. The accompanying condensed financial statements include for 1996 the results of operations of Aetna Services from January 1, 1996 and of U.S. Healthcare from July 19, 1996 which are reflected as Equity in Earnings of Affiliates on the Statement of Income. These financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Annual Report. 2. Guarantee of Debt Securities Aetna Inc. has fully and unconditionally guaranteed the payment of all principal, premium, if any, and interest on all outstanding debt securities of Aetna Services, including the $348 million 9 1/2% Subordinated Debentures due 2024 (the "Subordinated Debentures") issued to Aetna Capital L.L.C., a wholly owned subsidiary of Aetna Services. Aetna Capital L.L.C. has issued $275 million of redeemable preferred stock and the Subordinated Debentures represent substantially all of the assets of Aetna Capital L.L.C. See Note 13 to the Consolidated Financial Statements in the Annual Report for a description of outstanding debt. 3. Dividends Cash dividends paid to Aetna Inc. by Aetna Services and Aetna U.S. Healthcare for the year ended December 31, 1997 were $.8 billion and $.3 billion, respectively, and for the year end December 31, 1996 were $5.3 billion and $.6 billion, respectively. The 1996 dividends included the dividend by Aetna Services of the net proceeds from the sale of the property-casualty operations. The 1996 dividends from Aetna Services were used to finance the cash portion of the U.S. Healthcare merger consideration. See Note 16 to the Consolidated Financial Statements in the Annual Report for a description of dividend restrictions. 48 Page 48 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA INC. Notes to Condensed Financial Statements (Continued) 4. New Accounting Standards See Note 1 to the Consolidated Financial Statements in the Annual Report for a description of new accounting standards. 5. Discontinued Products See Note 9 to the Consolidated Financial Statements in the Annual Report for a description of discontinued products. 6. Other Acquisitions and Dispositions See Note 3 to the Consolidated Financial Statements in the Annual Report for a description of other acquisitions and dispositions. 7. Severance and Facilities Charges See Note 8 to the Consolidated Financial Statements in the Annual Report for a description of the 1996 severance and facilities charges. 8. Income Taxes See Note 10 to the Consolidated Financial Statements in the Annual Report for a description of income taxes. 49 Page 49 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA SERVICES, INC. Statement of Income
For the year ended December 31, (Millions) 1995 ---- Premiums $ 1.2 Net investment income 1.0 Net realized capital losses (.2) ------- Total revenue 2.0 Current and future benefits .4 Operating expenses 39.2 Interest expense 108.3 ------- Total benefits and expenses 147.9 ------- Losses before income taxes (benefits) and equity in earnings of affiliates (145.9) Income taxes (benefits): Current (57.2) Deferred 3.1 Equity in earnings of affiliates 565.7 ------- Income from continuing operations 473.9 Loss from Discontinued Operations, net of tax (222.2) ------- Net income $ 251.7 =======
- ---------- See Notes to Condensed Financial Statements. 50 Page 50 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA SERVICES, INC. Statement of Shareholders' Equity
Accumulated Other Comprehensive Income -------------------- Unrealized The year ended December 31, 1995 Retained Gains (Losses) Foreign Common (Millions, except share data) Total Earnings on Securities Currency Stock - -------------------------------------------------------------------------------------------------------- Balances at December 31, 1994 $ 5,503.0 $ 5,259.6 $ (941.5) $ (130.0) $ 1,314.9 - -------------------------------------------------------------------------------------------------------- Comprehensive income: Net income 251.7 251.7 Other comprehensive income, net of tax: Unrealized gains on securities ($2,697.9 pretax) 1,738.5 1,738.5 Foreign currency (($39.8) pretax) (25.9) (25.9) ------ Other comprehensive income 1,712.6 ------- Total comprehensive income 1,964.3 ======= Common stock issued for benefit plans (74,400 shares) 5.2 5.2 Treasury stock issued for benefit plans (1,994,935 shares) 92.2 92.2 Gain on issuance of treasury stock 23.8 23.8 Common stock dividends (315.7) (315.7) -------------------------------------------------------------- Balances at December 31, 1995 $ 7,272.8 $ 5,195.6 $ 797.0 $ (155.9) $ 1,436.1 - ------------------------------------------==============================================================
See Notes to Condensed Financial Statements. 51 Page 51 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA SERVICES, INC. Statement of Cash Flows
For the year ended December 31, (Millions) 1995 ---- Cash Flows from Operating Activities: Net income $ 251.7 Adjustments to reconcile net income to net cash used for operating activities: Loss from Discontinued Operations 222.2 Decrease in premiums due and other receivables 116.4 Increase in accrued investment income (1.6) Depreciation and amortization 0.1 Increase in income taxes 0.5 Net decrease in other assets and other liabilities (70.3) Increase in insurance reserve liabilities 45.2 Equity in earnings of affiliates (565.7) Net realized capital losses 0.2 Amortization of net investment discounts (0.2) Other, net (36.0) -------- Net cash used for operating activities (37.5) -------- Cash Flows from Investing Activities: Proceeds from sales of: Short-term investments 1,289.3 Cost of investments in: Debt securities available for sale (0.1) Equity securities (0.1) Short-term investments (1,272.2) Capital contributions to affiliates (303.0) Dividends received from affiliates 451.7 Other, net (139.6) -------- Net cash provided by investing activities 26.0 -------- Cash Flows from Financing Activities: Issuance of long-term debt .6 Stock issued under benefit plans 121.2 Repayment of long-term debt (100.8) Net increase in short-term debt 329.9 Dividends paid to shareholders (315.7) -------- Net cash provided by financing activities 35.2 -------- Net increase in cash and cash equivalents 23.7 Cash and cash equivalents, beginning of year - -------- Cash and cash equivalents, end of year $ 23.7 ======== Supplemental disclosure of cash flow information: Interest paid $ 117.8 ======== Income taxes received, net $ 70.2 ========
- ---------- See Notes to Condensed Financial Statements. 52 Page 52 AETNA INC. AND SUBSIDIARIES SCHEDULE II Condensed Financial Information AETNA SERVICES, INC. Notes to Condensed Financial Statements The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Annual Report. 1. Merger with U.S. Healthcare, Inc. The merger between Aetna Services, Inc. ("Aetna Services") (formerly Aetna Life and Casualty Company) and Aetna U.S. Healthcare, Inc. ("Aetna U.S. Healthcare") (formerly U.S. Healthcare, Inc. ("U.S. Healthcare")) was consummated on July 19, 1996. As a result of the merger, Aetna Services and Aetna U.S. Healthcare are each direct, wholly owned subsidiaries of Aetna Inc. (See pages 43 through 48 for condensed financial information of Aetna Inc. for the years ended December 31, 1997 and 1996.) 2. Dividends The amounts of cash dividends paid to Aetna Services by insurance affiliates for the year ended December 31, 1995 were $451.7 million. See Note 16 to the Consolidated Financial Statements in the Annual Report for a description of dividend restrictions from the consolidated insurance subsidiaries to Aetna Services. 3. New Accounting Standards See Note 1 to the Consolidated Financial Statements in the Annual Report for a description of new accounting standards. 4. Other Acquisitions and Dispositions See Note 3 to the Consolidated Financial Statements in the Annual Report for a description of other acquisitions and dispositions. 5. Income Taxes See Note 10 to the Consolidated Financial Statements in the Annual Report for a description of income taxes. 53 Page 53 AETNA INC. AND SUBSIDIARIES SCHEDULE III Supplementary Insurance Information As of and for the year ended December 31, 1997
Deferred Unpaid Policyholders' policy Future claims funds left acquisition policy and claim Unearned with the Premium Segment costs benefits expenses premiums Company revenue - ------- ----------- --------- --------- ---------- ----------- --------- (Millions) Aetna U.S. Healthcare $ 19.5 $ 1,166.5 $ 3,163.5 $ 254.2 $ 556.9 $10,844.6 Aetna Retirement Services 1,645.3 4,111.9 40.4 - 11,339.5 158.5 International 702.5 3,430.7 89.0 105.0 384.1 1,434.1 Large Case Pensions - 9,128.0 1.5 - 6,480.7 155.0 --------- --------- --------- ---------- --------- --------- Total $ 2,367.3 $17,837.1 $ 3,294.4 $ 359.2 $18,761.2 $12,592.2 ========= ========= ========= ========== ========= ========= Other income (including Amortization of Net realized Current deferred policy Other investment capital gains and future acquisition operating Premiums Segment income (1) and losses) benefits costs expenses(3) written(4) - ------- ----------- ------------- ---------- ------------ --------- --------- (Millions) Aetna U.S. Healthcare $ 451.2 $ 1,605.6 $ 9,239.2 $ 20.3 $ 2,797.1 $10,001.9 Aetna Retirement Services 1,114.7 629.3 1,034.1 110.6 385.6 - International 384.4 157.0 1,206.3 86.6 486.1 465.0 Large Case Pensions 1,408.7 58.8 1,199.9(2) - 34.8 - Corporate 18.5 119.8 - - 428.4 - --------- ---------- ---------- --------- --------- --------- Total $ 3,377.5 $ 2,570.5 $12,679.5 $ 217.5 $ 4,132.0 $10,466.9 ========= ========= ========= ========== ========= =========
(1) The allocation of net investment income is based upon the investment year method or specific identification of certain portfolios within specific segments. (2) Includes reductions of the loss on discontinued products. (3) Includes operating expenses, interest expense, amortization of goodwill and other acquired intangible assets and severance and facilities charges (reserve reductions). (4) Excludes life insurance business pursuant to Regulation S-X. 54 Page 54 AETNA INC. AND SUBSIDIARIES SCHEDULE III Supplementary Insurance Information As of and for the year ended December 31, 1996
Deferred Unpaid Policyholders' policy Future claims funds left acquisition policy and claim Unearned with the Premium Segment costs benefits expenses premiums Company revenue - ------- ----------- --------- --------- --------- ----------- --------- (Millions) Aetna U.S. Healthcare $ 39.2 $ 1,309.2 $ 2,924.2 $ 252.8 $ 579.9 $ 7,765.2 Aetna Retirement Services 1,488.1 3,935.8 30.1 - 10,868.1 180.7 International 699.6 3,370.1 73.5 80.8 434.0 1,166.1 Large Case Pensions - 9,168.3 1.4 - 8,019.7 214.1 --------- --------- --------- --------- --------- --------- Total $ 2,226.9 $17,783.4 $ 3,029.2 $ 333.6 $19,901.7 $ 9,326.1 ========= ========= ========= ========= ========= ========= Other income (including Amortization of Net realized Current deferred policy Other investment capital gains and future acquisition operating Premiums Segment income (1) and losses) benefits costs expenses(3) written(4) - ------- ---------- ------------- ---------- ------------ --------- --------- (Millions) Aetna U.S. Healthcare $ 414.6 $ 1,553.9 $ 6,622.4 $ 11.9 $ 2,973.9 $ 6,982.8 Aetna Retirement Services 1,086.7 494.8 1,035.9 74.3 386.5 - International 334.2 130.7 996.8 73.9 388.4 292.0 Large Case Pensions 1,649.2 112.3 1,521.3 (2) - 58.6 - Corporate 80.5 17.5 - - 717.9 - --------- --------- --------- --------- --------- --------- Total $ 3,565.2 $ 2,309.2 $10,176.4 $ 160.1 $ 4,525.3 $ 7,274.8 ========= ========= ========= ========= ========= =========
(1) The allocation of net investment income is based upon the investment year method or specific identification of certain portfolios within specific segments. (2) Includes reductions of the loss on discontinued products. (3) Includes operating expenses, interest expense, amortization of goodwill and other acquired intangible assets and severance and facilities charges. (4) Excludes life insurance business pursuant to Regulation S-X. 55 Page 55 AETNA INC. AND SUBSIDIARIES SCHEDULE III Supplementary Insurance Information As of and for the year ended December 31, 1995
Deferred Unpaid Policyholders' policy Future claims funds left acquisition policy and claim Unearned with the Premium Segment costs benefits expenses premiums Company revenue - ------- ----------- --------- --------- --------- ----------- --------- (Millions) Aetna U.S. Healthcare $ 50.5 $ 1,344.2 $ 2,426.3 $ 86.8 $ 634.4 $ 5,949.7 Aetna Retirement Services 1,320.8 3,917.4 30.2 - 10,704.4 260.2 International 581.8 2,691.9 82.8 55.3 851.7 1,038.5 Large Case Pensions - 9,278.4 1.5 - 10,708.2 244.4 Corporate - - 163.3 .3 - - --------- --------- --------- --------- --------- --------- Total $ 1,953.1 $17,231.9 $ 2,704.1 $ 142.4 $22,898.7 $ 7,492.8 ========= ========= ========= ========= ========= ========= Other income (including Amortization of Net realized Current deferred policy Other investment capital gains and future acquisition operating Premiums Segment income (1) and losses) benefits costs expenses(2) written(3) - ------- ---------- ------------- ---------- ------------ --------- --------- (Millions) Aetna U.S. Healthcare $ 364.0 $ 1,301.7 $ 5,100.4 $ 22.2 $ 2,038.4 $ 5,016.5 Aetna Retirement Services 1,044.1 401.8 1,061.4 46.1 303.8 - International 308.7 112.6 911.2 70.8 350.5 234.8 Large Case Pensions 1,850.6 153.4 2,015.6 - 100.1 - Corporate 7.7 2.0 - - 292.7 - --------- --------- --------- --------- --------- --------- Total $ 3,575.1 $ 1,971.5 $ 9,088.6 $ 139.1 $ 3,085.5 $ 5,251.3 ========= ========= ========= ========= ========= =========
(1) The allocation of net investment income is based upon the investment year method or specific identification of certain portfolios within specific segments. (2) Includes operating expenses, interest expense and amortization of goodwill and other acquired intangible assets. (3) Excludes life insurance business pursuant to Regulation S-X. 56 Page 56 AETNA INC. AND SUBSIDIARIES SCHEDULE IV Reinsurance*
For the years ended December 31, (Millions) Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------ --------- --------- ------ ------ 1997** Premiums: Life insurance $ 2,209.5 $ 88.2 $ 29.5 $ 2,150.8 1.4% Accident and health insurance 10,441.5 62.6 5.5 10,384.4 .1 Property-casualty insurance 82.5 30.9 5.4 57.0 9.5 --------- --------- --------- --------- Total premiums $12,733.5 $ 181.7 $ 40.4 $12,592.2 .3% ========= ========= ========= ========= 1996** Premiums: Life insurance $ 2,285.5 $ 85.6 $ 42.8 $ 2,242.7 1.9% Accident and health insurance 7,073.2 62.1 23.5 7,034.6 .3 Property-casualty insurance 95.1 50.1 3.8 48.8 7.8 --------- --------- --------- --------- Total premiums $ 9,453.8 $ 197.8 $ 70.1 $ 9,326.1 .8% ========= ========= ========= ========= 1995** Premiums: Life insurance $ 2,232.9 $ 72.1 $ 43.9 $ 2,204.7 2.0% Accident and health insurance 5,286.4 48.3 9.4 5,247.5 .2 Property-casualty insurance 98.2 57.6 - 40.6 - --------- --------- --------- --------- Total premiums $ 7,617.5 $ 178.0 $ 53.3 $ 7,492.8 .7% ========= ========= ========= =========
* Excludes intercompany transactions. ** Net life insurance in force was $387.8 billion, $381.4 billion and $362.8 billion at December 31, 1997, 1996 and 1995, respectively. 57 Page 57 AETNA INC. AND SUBSIDIARIES SCHEDULE V Valuation and Qualifying Accounts and Reserves
For the years ended December 31, (Millions) Additions Balance ------------------------- at Charged beginning Charged (credited) Balance Balance at of period (credited) to other at end beginning as to costs and accounts- Deductions- of of period Adjustments adjusted expenses (1) describe (2) describe (3) period --------- ----------- -------- ------------ ------------ ------------ ------ 1997 Asset valuation reserves: Mortgage loans $ 247.0 $ - $ 247.0 $ (10.6) $ (45.0) $ (76.9) $ 114.5 Real estate 142.1 - 142.1 6.1 14.8 (61.7) 101.3 Other 2.8 - 2.8 - - - 2.8 ---------- ---------- -------- --------- --------- ---------- ------ $ 391.9 $ - $ 391.9 $ (4.5) $ (30.2) $ (138.6) $ 218.6 ========== ========== ======== ========== ========== ========== ======= 1996 Asset valuation reserves: Mortgage loans $ 604.9 $ - $ 604.9 $ (33.0) $ (67.6) $ (257.3) $ 247.0 Real estate 130.6 52.9 (4) 183.5 27.1 1.9 (70.4) 142.1 Other 2.8 - 2.8 - - - 2.8 ---------- ---------- -------- --------- --------- ---------- ------ $ 738.3 $ 52.9 $ 791.2 $ (5.9) $ (65.7) $ (327.7) $ 391.9 ========== ========== ======== ========= ========= ========== ======= 1995 Asset valuation reserves: Mortgage loans $ 647.5 $ 208.5 (5) $ 856.0 $ 10.4 $ (5.0) $ (256.5) $ 604.9 Real estate 111.4 - 111.4 3.3 55.5 (39.6) 130.6 Other 6.0 - 6.0 - - (3.2) 2.8 ---------- ---------- -------- --------- --------- ---------- ------ $ 764.9 $ 208.5 $ 973.4 $ 13.7 $ 50.5 $ (299.3) $ 738.3 ========== ========== ======== ========= ========= ========== =======
(1) Charged (credited) to net realized capital (gains) losses in the Consolidated Statements of Income. (2) Reflects additions to (reductions of) reserves related to assets supporting experience rated contracts and discontinued products for which a corresponding reduction was included in Policyholders' Funds Left with the Company in the Consolidated Balance Sheets and the reserve for future losses, respectively. (3) Reduction in reserves is primarily a result of related asset write-downs (including foreclosures of real estate) and sales. (4) As a result of the adoption of FAS No. 121, valuation reserves at January 1, 1996 were increased by $52.9 million in connection with the reversal of previously recorded accumulated depreciation related to properties held for sale. (5) The general reserve at December 31, 1997 excluded reserves of approximately $208.5 million related to experience rated products. 58 Page 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 2, 1998 AETNA INC. (Registrant) By /s/ Robert J. Price -------------------------------------- (Signature) Robert J. Price Vice President and Corporate Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 2, 1998. * * - ----------------------------------- -------------------------------------- Richard L. Huber, Gerald Greenwald, Director Chairman, Chief Executive Officer, President and Director (Principal Executive Officer and Principal Financial Officer) * * - ----------------------------------- -------------------------------------- Leonard Abramson, Director Ellen M. Hancock, Director * * - ----------------------------------- -------------------------------------- Betsy Z. Cohen, Director Michael H. Jordan, Director * * - ----------------------------------- -------------------------------------- William H. Donaldson, Director Jack D. Kuehler, Director * * - ----------------------------------- -------------------------------------- Barbara Hackman Franklin, Director Frank R. O'Keefe, Jr., Director * * - ----------------------------------- -------------------------------------- Jerome S. Goodman, Director Judith Rodin, Director * - ----------------------------------- Earl G. Graves, Director /s/ Robert J. Price - ----------------------------------- Robert J. Price, Vice President and Corporate Controller (Controller) * By /s/ Robert J. Price ------------------------------ Robert J. Price (Attorney-in-Fact) 59 Page 59 INDEX TO EXHIBITS Exhibit Filing Number Description of Exhibit Method (10) Material contracts. (10.1) Employment Agreement, dated as of December 21, 1995, Electronic by and between Aetna Services, Inc. and Frederick C. Copeland, Jr., as amended. (10.2) Employment Agreement, dated as of December 19, 1995, by Electronic and between Aetna Services, Inc. and Thomas McInerney, as amended. (12) Statement re computation of ratios. Electronic Statement re: computation of ratio of earnings to fixed charges for the Company for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 and Aetna Services for the year ended December 31, 1997 and 1996. Statement re: computation of ratio of earnings to combined fixed charges and preferred stock dividends for the Company for the years ended December 31, 1997, 1996, 1995, 1994, and 1993 and Aetna Services for the year ended December 31, 1997 and 1996. (13) Annual Report to security holders. Electronic Selected Financial Data, Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements and the report of the Company's independent auditors, and unaudited Quarterly Data from the Annual Report. (21) Subsidiaries of the registrant. Electronic A listing of subsidiaries of Aetna Inc. (23) Consents of experts and counsel. Electronic Consent of Independent Auditors to Incorporation by Reference in the Registration Statements on Form S-3 and Form S-8. (24) Powers of attorney. Electronic (27) Financial data schedule. (27.1) Financial data schedule for December 31, 1997. Electronic (27.2) Financial data schedule for March 31, 1997, June 30, Electronic 1997, September 30, 1997 and December 31, 1996. (27.3) Financial data schedule for March 31, 1996, June 30, Electronic 1996, September 30, 1996 and December 31, 1995. EX-10.1 2 EMPLOYMENT AGREEMENT - FREDERICK C. COPELAND, JR. 1 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT, dated as of December 21, 1995, by and between Aetna Life and Casualty Company, a Connecticut corporation (the "Company"), and Fredrick C. Copeland, Jr. ("Executive"). W I T N E S S E T H: WHEREAS, the Company is considering certain restructuring alternatives that could result in significant changes in the structure of its business, including, without limitation, dividing the business of the Company into two or more separate publicly traded companies or otherwise transferring a portion of the business to a third party; WHEREAS, the Company believes that Executive is a key employee and that it is in the Company's best interests to retain the services of Executive for the period during which such restructuring alternatives are considered and, to the extent applicable, implemented; WHEREAS, the Company therefore desires to retain the services of Executive and to enter into an agreement embodying the terms of such employment (the "Agreement"); and WHEREAS, Executive desires to accept such employment and enter into such Agreement; NOW, THEREFORE, in consideration of the mutual covenants herein contained, the Company and Executive hereby agree as follows: 1. Employment. Except as provided in Paragraph 6(a), the Company shall continue to employ Executive and Executive agrees to remain employed by the Company under the terms of this Agreement for the period commencing on the date first written above and ending December 8, 1998. The period during which Executive is employed pursuant to this Agreement shall be referred to as the "Contract Employment Period". Upon the expiration of the Contract Employment Period, Executive's employment with the Company shall continue on an at-will basis. 2. Position and Duties. During the Contract Employment Period, Executive shall serve in Executive's current position and in such other comparable or better position or positions with the Company and its subsidiaries as the Chief Executive Officer or the Board of Directors of the Company (the "Board") shall specify from time to time. During the Contract Employment Period, Executive shall have the duties, responsibilities and obligations customarily assigned to individuals serving in the position or positions in which Executive serves hereunder and such other duties, responsibilities and obligations as the Chief Executive Officer or the Board shall from time to time specify. Executive shall devote his full business time to the 1 2 services required of him hereunder, except for vacation time and reasonable periods of absence due to sickness, personal injury or other disability, and shall use his best efforts, judgment, skill and energy to perform such services in a manner consistent with the duties of his position and to improve and advance the business and interests of the Company and its subsidiaries. Nothing contained herein shall preclude Executive from (i) serving on any corporate or governmental board of directors on which he currently serves or, if the Board consents to such service, on any other board of directors, (ii) serving on the board of, or working for, any charitable, not-for profit or community organization, (iii) pursuing any other activity to which the Board consents or (iv) pursuing his personal, financial and legal affairs, so long as such activities, individually or collectively, do not interfere with the performance of Executive's duties hereunder. 3. Cash Compensation. a. Base Salary. During the Contract Employment Period, the Company shall pay Executive a base salary at the annual rate of $300,000. The Board shall periodically review Executive's base salary and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above, is referred to herein as "Base Salary". Executive's Base Salary, as in effect from time to time, may not be reduced by the Company without Executive's consent, provided that the Base Salary payable under this paragraph shall be reduced to the extent Executive elects to defer or reduce such salary under the terms of any deferred compensation or savings plan or other employee benefit arrangement maintained or established by the Company. The Company shall pay Executive the portion of his Base Salary not deferred in accordance with its customary periodic payroll practices. b. Incentive Compensation. During the term of the Contract Employment Period, Executive shall remain eligible for participation in the Company's existing and future annual and long term incentive compensation programs at a level consistent with his position at the Company and the Company's then current policies and practices; provided that following any assignment of this Agreement in accordance with the provisions of Paragraph 9(c) or a Change in Control of the Company (as defined in Paragraph 7(e)), the calculation of the amount payable as annual incentive compensation and the conditions upon which such bonus shall be payable shall be no less favorable to the Executive (taking into account reasonable changes in the Company's goals and objectives) than the annual bonus opportunity that had been made available to the Executive for the fiscal year ended immediately prior to such assignment or Change in Control. Without limiting the generality of the foregoing, for each calendar year ending during the term hereof, Executive shall receive the opportunity to receive an annual bonus of at least 60% of his Base Salary (the "Minimum Bonus Percentage"), subject to satisfaction of such reasonable performance criteria as shall be established with respect to such year. 4. Stock Option Grant. Contingent upon the execution of this Agreement by the Executive, the Company has granted Executive an option, having a ten-year term, to purchase 35,000 shares of the Company's Common Stock at an exercise price per share equal to $71.625 a 2 3 share (the "Option"). Except to the extent specified below, the terms of the Option shall be determined in accordance with the terms of the 1994 Stock Incentive Plan (the "1994 Plan") and shall be set forth in the separate agreement embodying the grant of such Option (the "Option Agreement"), the form of which is attached hereto as Exhibit A. 5. Benefits, Perquisites and Expenses. a. Benefits. During the Contract Employment Period, Executive shall be eligible to participate in (i) each welfare benefit plan sponsored or maintained by the Company, including, without limitation, each group life, hospitalization, medical, dental, health, accident or disability insurance or similar plan or program of the Company, and (ii) each pension, profit sharing, retirement, deferred compensation or savings plan sponsored or maintained by the Company, in each case, whether now existing or established hereafter, to the extent that Executive is eligible to participate in any such plan under the generally applicable provisions thereof. Nothing in this Paragraph 5(a) shall be construed to limit the ability of the Company to amend or terminate any particular plan, program or arrangements, provided that, following the occurrence of a Change in Control (as defined in Paragraph 7(e)) or the assignment of this Agreement to a New Entity (as defined in Paragraph 6(a)) pursuant to Paragraph 9(b), the benefits made available to the Executive thereafter shall be at least substantially comparable, in the aggregate, to the benefits made available to the Executive immediately prior to such Change in Control or assignment. With respect to the pension or retirement benefits payable to Executive, Executive's service credited for purposes of determining Executive's benefits and vesting shall be determined in accordance with the terms of the applicable plan or program or, if applicable, pursuant to any written agreement between Executive and the Company (whether now existing or hereafter adopted) that provides Executive a more favorable method of crediting service for any purpose thereunder. b. Perquisites. During the Contract Employment Period, Executive shall be entitled to receive such perquisites as are generally provided to other senior officers of the Company in accordance with the then current policies and practices of the Company. c. Business Expenses. During the Contract Employment Period, the Company shall pay or reimburse Executive for all reasonable expenses incurred or paid by Executive in the performance of Executive's duties hereunder, upon presentation of expense statements or vouchers and such other information as the Company may require and in accordance with the generally applicable policies and procedures of the Company. 3 4 6. Termination of Employment. a. Early Termination of the Contract Employment Period. Notwithstanding Paragraph 1, the Contract Employment Period shall end upon the earliest to occur of (i) a termination of Executive's employment on account of Executive's death, (ii) a Termination due to Disability, (iii) a Termination for Cause, (iv) a Termination Without Cause, (v) a Termination for Good Reason or (vi) a termination of Executive's employment by Executive other than a Termination for Good Reason. For purposes of this Agreement, a transfer of Executive's employment (i)to any other entity controlled by or under common control with the Company shall not be treated as a termination unless and until such entity ceases to be controlled by or under common control with the Company or (ii) as a result of the implementation of any restructuring of the Company (whether occurring by spin-off or otherwise) shall not be treated as a termination of employment, provided that, in either case, the successor employer (the "New Entity") expressly assumes and agrees to perform all of the Company's obligations under this Agreement. b. Benefits Payable Upon Termination. Following the end of the Contract Employment Period pursuant to Paragraph 6(a), Executive (or, in the event of his death, his surviving spouse, if any, or his estate) shall be paid the type or types of compensation determined to be payable in accordance with the following table at the times established pursuant to Paragraph 6(c):
Earned Vested Accrued Severance Salary Benefits Bonus Benefit ------ -------- ------- --------- Termination due Payable Payable Payable Not Payable to death Termination due to Payable Payable Payable Not Payable Disability Termination for Payable Payable Not Payable Not Payable Cause Termination Payable Payable Payable Payable Without Cause Termination for Payable Payable Payable Payable Good Reason Termination by Payable Payable Not Payable Not Payable Executive other than for Good Reason
4 5 c. Timing of Payments. Earned Salary and Accrued Bonus shall be paid in a single lump sum as soon as practicable, but in no event more than 30 days, following the end of the Contract Employment Period. Vested Benefits shall be payable in accordance with the terms of the plan, policy, practice, program, contract or agreement under which such benefits have accrued. Severance Benefits shall be paid in approximately equal installments, at the same intervals at which Executive was receiving his salary payments hereunder, for the greater of (i) one year, (ii) the period over which such benefits would be payable if paid to Executive under the Company's otherwise applicable plans, policies or procedures as currently in effect or (iii) the period over which such benefits would be payable if paid to Executive under the Company's otherwise applicable plans, policies or procedures, as in effect at the time of Executive's termination of employment. Notwithstanding the foregoing, Executive may elect, by written notice given to the Company prior to the first periodic payment and within ten business days after such termination, that, instead of periodic installments, Severance Benefits shall be paid in either a single lump sum, payable within ten business days of receipt by the Company of such election, or in two equal installments, the first payable within ten business days of receipt by the Company of such election, and the second payable on the first business day of the following calendar year. d. Definitions. For purposes of this Paragraph 6, capitalized terms have the following meanings: "Accrued Bonus" means a pro-rated amount equal to the product of (i) the annual incentive compensation Executive would have been entitled to receive under Paragraph 3(b) for the calendar year in which his active service for the Company terminates pursuant to Paragraph 6(a) had he remained employed for the entire year and assuming that all targets for such year had been met, multiplied by (ii) a fraction, the numerator of which is equal to the number of days in such calendar year occurring on or prior to the termination of Executive's active service for the Company (including any period of absence due to disability) and the denominator of which is 365. "Earned Salary" means any Base Salary earned, but unpaid, for services rendered to the Company on or prior to the date on which the Contract Employment Period ends (other than Base Salary deferred pursuant to Executive's election, as provided in Paragraph 3(a) hereof). "Severance Benefit" means an amount equal to the greater of: (i) the sum of (A) the annual Base Salary payable to Executive immediately prior to the end of the Contract Employment Period; and (B) an amount (the "Bonus Severance Amount") equal to the product of Executive's Base Salary times the greater of (1) the Minimum Bonus 5 6 Percentage and (2) the percentage of Base Salary that would have been payable to Executive for the year of such termination assuming achievement of target levels of performance and Executive's continued employment for the entire year, or (ii) the amount otherwise payable to Executive under the Company's otherwise applicable severance plans, policies or programs as in effect on the date hereof (or, if more favorable to Executive, as in effect on the date of Executive's termination), assuming for purposes of determining the amount payable thereunder that Executive's employment was terminated as a result of the elimination of his position, but calculated by including the Bonus Severance Amount as part of Executive's eligible compensation for purposes of calculating the benefits payable under such plans, policies or programs; except that, in the event that Executive becomes entitled to receive Severance Benefits hereunder following a Change in Control, the Severance Benefit payable to Executive shall be determined under Paragraph 7(c). Additionally, while Executive is receiving payment of Severance Benefits in periodic installments, Executive shall also be eligible to continue to participate in the welfare benefit plans and programs (excluding the long-term disability plan, the sick-pay plan and vacation accruals) generally made available to employees of the Company and in which he participated immediately prior to the termination of his employment on the same terms and conditions as would have applied had Executive continued to be employed. Upon an election to receive Severance Benefits in either a single lump sum payment or in two installments, Executive will forfeit any right to continue to receive any coverage under the Company's welfare benefit plans, other than COBRA coverage (determined from the original date of termination) at Executive's expense as required by applicable law; provided that, if Executive elects to receive Severance Benefits in two installments instead of periodic installments, the Company shall pay one-half of the cost of Executive's COBRA coverage from the date the first installment payment is made until the date the second installment payment is made. Notwithstanding the foregoing, receipt of a lump sum payment or two installment payments hereunder shall not cause Executive to cease to be eligible for any retiree benefit programs for which he is otherwise eligible under the terms of the Company's employee benefit plans, policies or programs. "Termination for Cause" means a termination of Executive's employment by the Company due to (i) the willful failure by Executive to perform substantially Executive's duties as an employee of the Company (other than due to physical or mental illness) after reasonable notice to Executive of such failure, (ii) Executive's engaging in misconduct that is materially injurious to the Company or any subsidiary or any affiliate of the Company, (iii) Executive's having been convicted of, or entered a plea of nolo contendere to, a crime that constitutes a felony, (iv) the material breach by Executive of any written covenant or agreement not to compete with the Company or any subsidiary or any affiliate or (v) the breach by Executive of his duty of loyalty to the Company which shall include, without limitation, (A) the disclosure by Executive of any confidential information pertaining to the Company or any subsidiary or any affiliate of the Company, other than (x) in the ordinary course of the performance of his duties on behalf of the Company or (y) pursuant to a judicial or administrative subpoena from a court or 6 7 governmental authority with jurisdiction over the matter in question, (B) the harmful interference by Executive in the business or operations of the Company or any subsidiary or any affiliate of the Company, (C) any attempt by Executive directly or indirectly to induce any employee, insurance agent, insurance broker or broker-dealer of the Company or any subsidiary or any affiliate to be employed or perform services elsewhere, other than actions taken by Executive that are intended to benefit the Company or any subsidiary or affiliate and do not benefit Executive financially other than as an employee or stockholder of the Company, (D) any attempt by Executive directly or indirectly to solicit the trade of any customer or supplier, or prospective customer or supplier, of the Company on behalf of any person other than the Company or a subsidiary thereof, other than actions taken by Executive that are intended to benefit the Company or any subsidiary or affiliate and do not benefit Executive financially other than as an employee or stockholder of the Company, provided, however, that this provision shall only apply to any product or service which is in competition with a product or service of the Company or any subsidiary or affiliate thereof or (E) any breach or violation of the Company's Code of Conduct, as amended from time to time sufficient to warrant a for cause termination consistent with the Company's past practice. Notwithstanding the foregoing, a breach of Executive's duty of loyalty to the Company as described in subclause (A) or a breach of the Company's Code of Conduct as described in subclause (E) of clause (v) of the preceding sentence shall not be grounds for a Termination for Cause unless such breach has had or could reasonably be expected to have a significant adverse effect on the business or reputation of the Company. "Termination due to Disability" means a termination of Executive's employment by the Company because Executive has been incapable, with or without reasonable accommodation, of substantially fulfilling the positions, essential duties, responsibilities and obligations of Executive's positions set forth in this Agreement because of physical, mental or emotional incapacity resulting from injury, sickness or disease for a period of (i) at least four consecutive months or (ii) more than six months in any twelve month period. Any question as to the existence, extent or potentiality of Executive's disability shall be made by a qualified, independent physician selected by the chief or assistant chief (or the equivalent position) of the department which treats the condition giving rise to Executive's absence at a nationally or regionally recognized teaching hospital chosen by the Company. The determination of any such physician shall be final and conclusive for all purposes of this Agreement. Notwithstanding the foregoing, (i) a Termination for Disability shall not affect Executive's right to receive any amount that would otherwise have been payable to Executive under the Company's plans, policies, practices or programs pertaining to short-term or long-term disability had Executive's employment continued and (ii) if it is determined, at the time Executive is first eligible to receive long-term disability benefits under the Company's plans, policies, practices or programs, that Executive is not entitled to receive such long-term disability benefits (other than due to Executive's failure to cooperate), Executive shall, for purposes of this Paragraph 6, be deemed to have been terminated as of the date of such determination pursuant to a Termination Without Cause and to be entitled to receive any additional benefits payable hereunder in respect of a Termination Without Cause. "Termination for Good Reason" means a termination of Executive's employment by Executive within 90 days following actual knowledge of (i) a reduction in Executive's annual 7 8 Base Salary or incentive compensation opportunity as provided under Paragraph 3(b), (ii) a material reduction in Executive's positions, duties and responsibilities from those described in Paragraph 2 hereof, (iii) the relocation of Executive's principal place of employment to a location more than 50 miles from the location at which he performed his principal duties on the date immediately prior to such relocation, (iv) a breach of the obligation to provide Executive with the benefits required to be provided in accordance with Paragraph 5(a), (v) a failure by the Company to pay any amounts due and owing to Executive within 10 days following written notice from Executive of such failure to pay, or (vi) any other material breach of the Company's obligations to Executive hereunder that materially affects the compensation or benefits payable to Executive or materially impairs Executive's ability to perform the duties and responsibilities of his position. Notwithstanding the foregoing, a termination shall not be treated as a Termination for Good Reason (i) if Executive shall have consented in writing to the occurrence of the event giving rise to the claim of Termination for Good Reason or (ii) unless Executive shall have delivered a written notice to the Chief Executive Officer of the Company within 60 days of his having actual knowledge of the occurrence of one of such events stating that he intends to terminate his employment for Good Reason and specifying the factual basis for such termination, and such event shall not have been cured within 30 days of the receipt of such notice. "Termination Without Cause" means any termination of Executive's employment by the Company other than (i) a Termination due to Disability or (ii) a Termination for Cause. Subject to the Company's obligations to make the payments, if any, required pursuant to this paragraph 6, nothing in this Agreement shall be construed to limit the right of the Company to terminate Executive's employment at any time for any reason or without reason. "Vested Benefits" means amounts payable under the terms of or in accordance with any plan, policy or practice or program of, or any contract or agreement with, the Company or any of its subsidiaries (including, without limitation, any supplemental pension plan, supplemental savings plan or other deferred compensation arrangement, the 1994 Plan and the Company's 1984 Stock Option Plan (the "1984 Plan") with respect to which Executive's rights to such amounts (i) have become vested and nonforfeitable on or before Executive's termination of employment or (ii) otherwise have or will become nonforfeitable at or subsequent to his termination of employment without regard to the performance by Executive of further services or the resolution of a contingency that is not satisfied at or after such termination, provided that, at any time during which Executive is entitled to receive the Severance Benefits hereunder, Executive shall not also be entitled to receive any benefits under the Company's generally applicable severance or other termination plans, policies or programs. e. Full Discharge of Company Obligations. Except to the extent provided in this Paragraph 6, the amounts payable to Executive pursuant to this Paragraph 6 shall be in full and complete satisfaction of Executive's rights under this Agreement and, except to the extent prohibited by law, any other claims he may have in respect of his employment by the Company or any of its subsidiaries. Such amounts shall constitute liquidated damages with respect to any and all such rights and claims and shall not be subject to any offset or mitigation. Notwithstanding anything else contained herein to the contrary, unless the Company shall waive its rights to any such release, the Company's obligations under this Paragraph 6 are expressly 8 9 conditioned upon Executive's execution simultaneously with or immediately following such termination of employment, of a release and waiver, substantially in the form attached hereto as Exhibit B (subject to, in the event any change of law occurring after the date hereof, to such modifications as shall be necessary or appropriate to place the Company in a substantially the same position as though no change in law had occurred), of any claims he may have in connection with the termination of, or arising out of, his employment with the Company, provided that such release shall not be construed to waive, release or otherwise limit any amounts required to be paid hereunder or any benefits due and payable to Executive under the terms of any employee pension benefit plan, as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended, any other Vested Benefit or any right of Executive to be indemnified by the Company pursuant to its applicable policies and practices from and against any third party claims arising out of or relating to Executive's employment with or other services on behalf of the Company or any subsidiary of the Company. f. Outplacement Services. In addition to any other benefits described in this Paragraph 6, in the event Executive is eligible to receive Severance Benefits, the Company shall also provide to Executive, at its expense, individual outplacement services from a qualified outplacement firm selected by the Company. The outplacement services to be provided to Executive shall be no less favorable to Executive than those made available to other executives prior to the date hereof under the Company's generally applicable policies, programs or arrangements. 7. Change in Control of the Company. a. Accelerated Vesting and Payment. Unless the Board (or the appropriate committee thereof) shall otherwise determine in the manner set forth in Paragraph 7(b), the Option shall become fully exercisable upon the occurrence of a Change in Control (as defined below) and shall remain exercisable for a period of one year thereafter regardless of whether Executive continues to be employed by the Company or, if longer, for the period during which such Option would otherwise be exercisable in accordance with its terms or the generally applicable provisions of the 1994 Plan. If no Alternative Option is provided as set forth in Section 7(b) below, and the Company does not survive as a publicly traded corporation following a Change in Control, the Company shall pay Executive, in full settlement of all rights with respect to the Option, an aggregate amount in cash equal to the product of (i) (A) the Fair Market Value of a Share of the Company's Common Stock on the date the Change in Control occurs minus (B) the per share exercise price for the Option times (ii) the number of shares as to which such Option has not been exercised at the time of the Change in Control. Any amount payable pursuant to the preceding sentence shall be paid within 30 days following such Change in Control. b. Alternative Options. Notwithstanding Paragraph 7(a), no acceleration of exercisability shall occur with respect to any Option if the Board (or the appropriate committee thereof) reasonably determines in good faith, prior to the occurrence of a Change in Control, that such Option shall be honored or assumed, or new rights substituted therefor (such honored, 9 10 assumed or substituted Option being hereinafter referred to as an "Alternative Option") by the successor in interest to the Company, provided that any such Alternative Option must: (i) provide Executive with rights and entitlements substantially equivalent to or better than the rights, terms and conditions applicable under the Option, including, but not limited to, an identical or better exercise and vesting schedule and identical or better timing and methods of payment; (ii) have substantially equivalent economic value to such Option (determined at the time of the Change in Control); and (iii) have terms and conditions which provide that, in the event that Executive's employment is terminated by the Company for any reason or is terminated by Executive pursuant to a Termination for Good Reason within two years following a Change in Control, (A) any conditions on Executive's rights under, or any restrictions on exercisability applicable to, each such Alternative Option shall be waived or shall lapse, as the case may be and (B) the Alternative Option shall remain exercisable until the second anniversary of the Change in Control or, if longer, for the period during which such Alternative Option would otherwise be exercisable in accordance with its terms or the provisions of the plan under which it is granted that permit the longest post-termination exercise period for involuntary terminations (other than due to death, disability or retirement). c. Enhanced Severance Payments. If Executive's employment is terminated following a Change in Control pursuant to a Termination for Good Reason or a Termination Without Cause, the Severance Benefit payable to Executive pursuant to Paragraph 6 shall be equal to two times the sum of Executive's annual Base Salary and the Bonus Severance Amount. d. Additional Payments by the Company. (i) Application of Paragraph 7(d). In the event that any amount or benefit paid or distributed to Executive pursuant to this Agreement, taken together with any amounts or benefits otherwise paid or distributed to Executive by the Company or any affiliated company (collectively, the "Covered Payments"), would be an "excess parachute payment" as defined in Section 280G of the Code and would thereby subject Executive to the tax (the "Excise Tax") imposed under Section 4999 of the Code (or any similar tax that may hereafter be imposed), the provisions of this Section 7(d) shall apply to determine the amounts payable to Executive pursuant to this Agreement. (ii) Calculation of Benefits. Immediately following delivery of any Notice of Termination, the Company shall notify Executive of the aggregate present value of all termination benefits to which he would be entitled under this Agreement and any other plan, program or arrangement as of the projected date of termination, together with the projected maximum payments, determined as of 10 11 such projected date of termination that could be paid without Executive being subject to the Excise Tax. (iii) Imposition of Payment Cap. If the aggregate value of all compensation payments or benefits to be paid or provided to Executive under this Agreement and any other plan, agreement or arrangement with the Company exceeds the amount which can be paid to Executive without Executive incurring an Excise Tax by less than 105%, then the amounts payable to Executive under this Agreement may, in the discretion of the Company, be reduced (but not below zero) to the maximum amount which may be paid hereunder without Executive becoming subject to such an Excise Tax (such reduced payments to be referred to as the "Payment Cap"). In the event that Executive receives reduced payments and benefits hereunder, Executive shall have the right to designate which of the payments and benefits otherwise provided for in this Agreement that he will receive in connection with the application of the Payment Cap. (iv) Further Payments by the Company. If the aggregate value of all compensation payments or benefits to be paid or provided to Executive under this Agreement and any other plan, agreement or arrangement with the Company exceeds the amount which can be paid to Executive without Executive incurring an Excise Tax by more than 105%, the Company shall pay to Executive immediately following Executive's termination of employment an additional amount (the "Tax Reimbursement Payment") such that the net amount retained by Executive with respect to such Covered Payments, after deduction of any Excise Tax on the Covered Payments and any Federal, state and local income tax and Excise Tax on the Tax Reimbursement Payment provided for by this Paragraph 7(d)(iv), but before deduction for any Federal, state or local income or employment tax withholding on such Covered Payments, shall be equal to the amount of the Covered Payments. (v) Application of Section 280G. For purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax, (A) such Covered Payments will be treated as "parachute payments" within the meaning of Section 280G of the Code, and all "parachute payments" in excess of the "base amount" (as defined under Section 280G(b)(3) of the Code) shall be treated as subject to the Excise Tax, unless, and except to the extent that, in the good faith judgment of the Company's independent certified public accountants appointed prior to the Effective Date or tax counsel selected by such Accountants (the "Accountants"), the Company has a reasonable basis to conclude that such Covered Payments (in whole or in part) either do not constitute "parachute payments" or represent reasonable compensation for personal services actually rendered (within the meaning of Section 280G(b)(4)(B) of the Code) in excess of the "base 11 12 amount," or such "parachute payments" are otherwise not subject to such Excise Tax, and (B) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Accountants in accordance with the principles of Section 280G of the Code. (vi) Applicable Tax Rates. For purposes of determining whether Executive would receive a greater net after-tax benefit were the amounts payable under this Agreement reduced in accordance with Paragraph 7(d)(iii), Executive shall be deemed to pay: (A) Federal income taxes at the highest applicable marginal rate of Federal income taxation for the calendar year in which the first amounts are to be paid hereunder, and (B) any applicable state and local income taxes at the highest applicable marginal rate of taxation for such calendar year, net of the maximum reduction in Federal incomes taxes which could be obtained from the deduction of such state or local taxes if paid in such year; provided, however, that Executive may request that such determination be made based on his individual tax circumstances, which shall govern such determination so long as Executive provides to the Accountants such information and documents as the Accountants shall reasonably request to determine such individual circumstances. (vii) Adjustments in Respect of the Payment Cap. If Executive receives reduced payments and benefits under this Paragraph 7(d) (or this Paragraph 7(d) is determined not to be applicable to Executive because the Accountants conclude that Executive is not subject to any Excise Tax) and it is established pursuant to a final determination of a court or an Internal Revenue Service proceeding (a "Final Determination") that, notwithstanding the good faith of Executive and the Company in applying the terms of this Agreement, the aggregate "parachute payments" within the meaning of Section 280G of the Code paid to Executive or for his benefit are in an amount that would result in Executive being subject an Excise Tax, then the amount equal to such excess parachute payments shall be deemed for all purposes to be a loan to Executive made on the date of receipt of such excess payments, which Executive shall have an obligation to repay to the Company on demand, together with interest on such amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the date of the payment hereunder to the date of repayment by Executive. If this Paragraph 7(d) is not applied to reduce Executive's entitlements under this Paragraph 7 because the Accountants determine that Executive would not receive a greater net-after tax benefit by applying this Paragraph 7(d) and it is established pursuant to a Final 12 13 Determination that, notwithstanding the good faith of Executive and the Company in applying the terms of this Agreement, Executive would have received a greater net after tax benefit by subjecting his payments and benefits hereunder to the Payment Cap, then the aggregate "parachute payments" paid to Executive or for his benefit in excess of the Payment Cap shall be deemed for all purposes a loan to Executive made on the date of receipt of such excess payments, which Executive shall have an obligation to repay to the Company on demand, together with interest on such amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the date of the payment hereunder to the date of repayment by Executive. If Executive receives reduced payments and benefits by reason of this Paragraph 7(d) and it is established pursuant to a Final Determination that Executive could have received a greater amount without exceeding the Payment Cap, then the Company shall promptly thereafter pay Executive the aggregate additional amount which could have been paid without exceeding the Payment Cap, together with interest on such amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the original payment due date to the date of actual payment by the Company. (viii) Adjustments in Respect of the Tax Reimbursement Payments. In the event that the Excise Tax is subsequently determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to be less than the amount taken into account hereunder in calculating the Tax Reimbursement Payment made, Executive shall repay to the Company, at the time that the amount of such reduction in the Excise Tax is finally determined, the portion of such prior Tax Reimbursement Payment that would not have been paid if such Excise Tax had been applied in initially calculating such Tax Reimbursement Payment, plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. Notwithstanding the foregoing, in the event any portion of the Tax Reimbursement Payment to be refunded to the Company has been paid to any Federal, state or local tax authority, repayment thereof shall not be required until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed interest received or credited to Executive by such tax authority for the period it held such portion. Executive and the Company shall mutually agree upon the course of action to be pursued (and the method of allocating the expenses thereof) if Executive's good faith claim for refund or credit is denied. In the event that the Excise Tax is later determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including, but not limited to, by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalty 13 14 payable with respect to such excess) at the time that the amount of such excess is finally determined. (ix) Timing of Payment. Any Tax Reimbursement Payment (or portion thereof) provided for in Paragraph 7(d)(iv) above shall be paid to Executive not later than 10 business days following the payment of the Covered Payments; provided, however, that if the amount of such Tax Reimbursement Payment (or portion thereof) cannot be finally determined on or before the date on which payment is due, the Company shall pay to Executive by such date an amount estimated in good faith by the Accountants to be the minimum amount of such Tax Reimbursement Payment and shall pay the remainder of such Tax Reimbursement Payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined, but in no event later than 45 calendar days after payment of the related Covered Payment. In the event that the amount of the estimated Tax Reimbursement Payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to Executive, payable on the fifth business day after written demand by the Company for payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code). e. Definition of "Change in Control". For purposes of this Paragraph 7, a "Change in Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act but excluding the Company and any subsidiary thereof and any employee benefit plan sponsored or maintained by the Company or any Subsidiary (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months after the Commencement Date, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof, provided that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Paragraph 7(e)(ii); or 14 15 (iii) The occurrence of a transaction requiring stockholder approval for the acquisition of the Company by an entity other than the Company or a subsidiary through purchase of assets, or by merger, or otherwise. 8. Noncompetition and Confidentiality. a. Noncompetition. During the Contract Employment Period and for a period of one year following Executive's termination of employment during the Contract Employment Period other than due to a Termination Without Cause or a Termination for Good Reason, Executive shall not become associated, whether as a principal, partner, employee, consultant or shareholder (other than as a holder of not in excess of 1% of the outstanding voting shares of any publicly traded company), with any entity that is actively engaged in any geographic area in any business which is in substantial and direct competition with the business or businesses of the Company for which Executive provides substantial services or for which Executive has substantial responsibility, provided that nothing in this Paragraph 8(a) shall preclude Executive from performing services solely and exclusively for a division or subsidiary of such an entity that is engaged in a non-competitive business. b. Nondisclosure, Nonsolicitation and Cooperation. (i) Executive shall not (except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency) disclose to any third person, whether during or subsequent to the Executive's employment with the Company, any trade secrets; customer lists; product development and related information; marketing plans and related information; sales plans and related information; operating policies and manuals; business plans; financial records; or other financial, commercial, business or technical information related to the Company or any subsidiary or affiliate thereof unless such information has been previously disclosed to the public by the Company or has become public knowledge other than by a breach of this Agreement; provided, however, that this limitation shall not apply to any such disclosure made while Executive is employed by the Company, or any subsidiary or affiliate thereof in the ordinary course of the performance of Executive's duties; (ii) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to induce any employee or Insurance Agent (as defined below) of the Company, or any subsidiary or any affiliate thereof to be employed or perform services elsewhere provided that this covenant shall not preclude Executive from taking any actions during the Contract Employment Period that (x) are intended to benefit the Company or any subsidiary or affiliate and (y) do not benefit Executive financially other than as an employee or stockholder of the Company; (iii) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to induce any insurance agent or agency, insurance broker, broker-dealer or supplier of the 15 16 Company, or any subsidiary or affiliate thereof to cease providing services to the Company, or any subsidiary or affiliate thereof provided that this covenant shall not preclude Executive from taking any actions during the Contract Employment Period that (x) are intended to benefit the Company or any subsidiary or affiliate and (y) do not benefit Executive financially other than as an employee or stockholder of the Company; (iv) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to solicit, on behalf of any person or entity other than the Company or any of its subsidiaries, the trade of any individual or entity which, at the time of the solicitation, is a customer of the Company, or any subsidiary or affiliate thereof, or which the Company, or any subsidiary or affiliate thereof is undertaking reasonable steps to procure as a customer at the time of or immediately preceding termination of the Contract Employment Period; provided, however, that this limitation shall only apply to (x) any product or service which is in competition with a product or service of the Company or any subsidiary or affiliate thereof and (y) with respect to any customer or prospective customer with whom Executive has or had (by virtue of Executive's position or otherwise) a personal relationship; and (v) following the termination of the Contract Employment Period, Executive shall provide assistance to and shall cooperate with the Company or any subsidiary or affiliate thereof, upon its reasonable request, with respect to matters within the scope of Executive's duties and responsibilities during the Contract Employment Period. (The Company agrees and acknowledges that it shall, to the maximum extent possible under the then prevailing circumstances, coordinate (or cause a subsidiary or affiliate thereof to coordinate) any such request with Executive's other commitments and responsibilities to minimize the degree to which such request interferes with such commitments and responsibilities). The Company agrees that it will reimburse Executive for reasonable travel expenses (i.e., travel, meals and lodging) that Executive may incur in providing assistance to the Company hereunder. Solely for purposes of Paragraph 8(b)(ii) above, the term "Insurance Agent" shall mean those insurance agents or agencies representing the Company or any subsidiary or affiliate thereof, that are exclusive or career agents or agencies of the Company or any subsidiary or affiliate thereof, or any insurance agents or agencies which derive 50% or more of their business revenue from the Company or any subsidiary or affiliate thereof (calculated on an aggregate basis for the 12-month period prior to the date of determination or such other similar period for which such information is more readily available). c. Company Property. Promptly following Executive's termination of employment, Executive shall return to the Company all property of the Company, and all copies thereof in Executive's possession or under his control. d. Intention of the Parties. If any provision of Paragraph 8 is determined by an arbitrator (or a court of competent jurisdiction asked to enforce the decision of the arbitrator) 16 17 not to be enforceable in the manner set forth in this Agreement, the Company and Executive agree that it is the intention of the parties that such provision should be enforceable to the maximum extent possible under applicable law and that such arbitrator (or court) shall reform such provision to make it enforceable in accordance with the intent of the parties. Executive acknowledges that a material part of the inducement for the Company to provide the salary and benefits evidenced hereby is Executive's covenants set forth in Paragraph 8(a), (b) and (c) and that the covenants and obligations of Executive with respect to nondisclosure and nonsolicitation relate to special, unique and extraordinary matters and that a violation of any of the terms of such covenants and obligations will cause the Company irreparable injury for which adequate remedies are not available at law. Therefore, Executive agrees that, if Executive shall materially breach any of those covenants following termination of employment, the Company shall have no further obligation to pay Executive any benefits otherwise payable hereunder and the Company shall be entitled to an injunction, restraining order or such other equitable relief (without the requirement to post a bond) restraining Executive from committing any violation of the covenants and obligations contained in Paragraph 8(a), (b) and (c). The remedies in the preceding sentence are cumulative and are in addition to any other rights and remedies the Company may have at law or in equity as an arbitrator (or court) shall reasonably determine. e. Waiver. Without limiting the generality of the foregoing, upon request of Executive prior to engaging in any conduct otherwise prohibited by this Paragraph 8, the Company may, in its sole discretion, waive in writing, on such terms and conditions as it may deem appropriate, any violation of this Paragraph 8 which would otherwise occur due to such conduct. 9. Miscellaneous. a. Survival. Paragraphs 5(c) (dealing with reimbursement of expenses), 7 (relating to a Change in Control), 8 (relating to noncompetition, nonsolicitation and confidentiality) and 9 (relating, among other things, to survival, assignment and governing law) shall survive the termination hereof, whether such termination shall be by expiration of the Contract Employment Period or an early termination pursuant to Paragraph 6 hereof. Paragraph 6 (relating to early termination) shall survive the termination hereof to the extent that, prior thereto, or at the time of termination, Executive (or his beneficiary) has become or becomes entitled to receive any of the benefits payable thereunder. The option referred to in Paragraph 4 survives for the term specified in Attachment A. b. Binding Effect. This Agreement shall be binding on, and shall inure to the benefit of, the Company and any person or entity that succeeds to the interest of the Company (regardless of whether such succession does or does not occur by operation of law) by reason of the sale of all or a portion of the Company's stock, a merger, consolidation or reorganization involving the Company or, unless in the case of a sale involving less than all or substantially all of the Company's assets the Company otherwise elects in writing, a sale of the assets of the business of the Company (or portion thereof) in which Executive performs a majority of his services. Any successor in interest to the Company shall acknowledge in writing to Executive that it has assumed this Agreement and is responsible to Executive for the performance of the 17 18 Company's obligations under this Agreement. Without limiting the generality of the foregoing, the Company shall have the right, without the consent of Executive, to assign this Agreement and its obligations hereunder to any New Entity or any subsidiary of any New Entity by which Executive becomes employed, at the discretion of the Company, by reason of the implementation of any restructuring of the Company, and, following any such assignment, such New Entity or subsidiary shall be treated as the Company for all purposes of this Agreement. This Agreement shall also enure to the benefit of Executive's heirs, executors, administrators and legal representatives. c. Assignment. Except as provided under Paragraph 9(b), neither this Agreement nor any of the rights or obligations hereunder shall be assigned or delegated by any party hereto without the prior written consent of the other party. In the event the Company assigns this Agreement pursuant to Section 9(b), the Company shall guarantee payment to Executive of any amounts at any time due and payable hereunder in the event (and only to the extent) that the assignee has become a debtor in bankruptcy, is the subject of a receivership or similar preceding or has become insolvent, provided that Executive shall be required to assign his rights against the assignee through subrogation as a condition of receiving any payment under the Company's guarantee. In consideration of such guarantee, Executive agrees that following such assignment, the covenants of Executive in Paragraphs 8(b)(i) and (v) shall continue to inure to the benefit of the Company, as well as the assignee. The Company and Executive agree that following any assignment all other covenants described herein in favor of the Company shall, from and after the date of such assignment, inure solely to the benefit of the assignee. d. Entire Agreement. Except as expressly provided below, this Agreement, the Option Agreement and the portion, if any, of any other agreement relating to pension service or credits referred to in Paragraph 5(a) shall constitute the entire agreement between the parties hereto with respect to the matters referred to herein and any other agreement or any portion of any such other agreement not expressly preserved hereby shall cease to be effective upon the execution hereof and shall not become reinstated upon the expiration or other termination of this Agreement. There are no promises, representations, inducements or statements between the parties other than those that are expressly contained herein. Executive acknowledges that he is entering into this Agreement of his own free will and accord, and with no duress, that he has read this Agreement and that he understands it and its legal consequences. Other than the provisions of Paragraph 6 which limit Executive's eligibility to receive severance benefits under the Company's generally applicable plans, programs or agreements, nothing in this Agreement shall be construed to limit or otherwise supersede Executive's rights or entitlements under any compensatory plan, program or arrangement made available generally to all employees or all officers of the Company or under the 1994 Plan or the 1984 Plan and this Paragraph 9(d) shall not preclude reference to the documents governing any such plan, program or arrangement to determine such rights and entitlements. e. Severability; Reformation. In the event that one or more of the provisions of this Agreement shall become invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not be affected thereby. In the event any of Paragraph 8(a), (b) or (c) is not enforceable in accordance with its 18 19 terms, Executive and the Company agree that such Paragraph shall be reformed to make such Paragraph enforceable in a manner which provides the Company the maximum rights permitted at law. f. Waiver. Waiver by any party hereto of any breach or default by the other party of any of the terms of this Agreement shall not operate as a waiver of any other breach or default, whether similar to or different from the breach or default waived. No waiver of any provision of this Agreement shall be implied from any course of dealing between the parties hereto or from any failure by either party hereto to assert its or his rights hereunder on any occasion or series of occasions. g. Notices. Any notice required or desired to be delivered under this Agreement shall be in writing and shall be delivered personally, by courier service, by registered mail, return receipt requested, or by telecopy and shall be effective upon actual receipt by the party to which such notice shall be directed, and shall be addressed as follows (or to such other address as the party entitled to notice shall hereafter designate in accordance with the terms hereof): If to the Company: Aetna Life and Casualty Company 151 Farmington Avenue Hartford, Connecticut Attention: Corporate Secretary 19 20 If to Executive: Fredrick C. Copeland, Jr. 75 Bloomfield Avenue West Hartford, Connecticut 06015 h. Arbitration. The Company and Executive agree that any claim, dispute or controversy arising under or in connection with this Agreement, or otherwise in connection with Executive's employment by the Company (including, without limitation, any such claim, dispute or controversy arising under any federal, state or local statute, regulation or ordinance or any of the Company's employee benefit plans, policies or programs) shall be resolved solely and exclusively by binding arbitration. The arbitration shall be held in the city of Hartford, Connecticut (or at such other location as shall be mutually agreed by the parties). The arbitration shall be conducted in accordance with the Expedited Employment Arbitration Rules (the "Rules") of the American Arbitration Association (the "AAA") in effect at the time of the arbitration, except that the arbitrator shall be selected by alternatively striking from a list of five arbitrators supplied by the AAA. All fees and expenses of the arbitration, including a transcript if either requests, shall be borne equally by the parties. If Executive prevails as to any material issue presented to the arbitrator, the entire cost of such proceedings (including, without limitation, Executive's reasonable attorneys fees) shall be borne by the Company. If Executive does not prevail as to any material issue, each party will pay for the fees and expenses of its own attorneys, experts, witnesses, and preparation and presentation of proofs and post-hearing briefs (unless the party prevails on a claim for which attorney's fees are recoverable under the Rules). Any action to enforce or vacate the arbitrator's award shall be governed by the Federal Arbitration Act, if applicable, and otherwise by applicable state law. If either the Company or Executive pursues any claim, dispute or controversy against the other in a proceeding other than the arbitration provided for herein, the responding party shall be entitled to dismissal or injunctive relief regarding such action and recovery of all costs, losses and attorney's fees related to such action. i. Amendments. This Agreement may not be altered, modified or amended except by a written instrument signed by each of the parties hereto. j. Headings. Headings to paragraphs in this Agreement are for the convenience of the parties only and are not intended to be part of or to affect the meaning or interpretation hereof. k. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. l. Withholding. Any payments provided for herein shall be reduced by any amounts required to be withheld by the Company from time to time under applicable Federal, State or local income or employment tax laws or similar statutes or other provisions of law then in effect. 20 21 m. Governing Law. This Agreement shall be governed by the laws of the State of Connecticut, without reference to principles of conflicts or choice of law under which the law of any other jurisdiction would apply. IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer and Executive has hereunto set his hand as of the day and year first above written. Aetna Life and Casualty Company /s/ Ronald E. Compton --------------------- Ronald E. Compton Chairman /s/ Fredrick C. Copeland, Jr. ----------------------------- Fredrick C. Copeland, Jr. 21 22 EXHIBIT A TO EMPLOYMENT AGREEMENT AETNA LIFE AND CASUALTY COMPANY 1994 STOCK INCENTIVE PLAN PERFORMANCE VESTED NONSTATUTORY STOCK OPTION AGREEMENT Pursuant to its 1994 Stock Incentive Plan, Aetna Life and Casualty Company hereby grants to the person named below the right and option to purchase the stated number of shares of Common Stock on the terms and conditions hereinafter set forth.
- -------------------------------------------------------------------------------- Effective Date Aetna No. Grantee Total Optioned Shares Option Price - --------------------------------------------------------------------------------
ARTICLE I DEFINITIONS (a) "Board" means the Board of Directors of Aetna Life and Casualty Company. (b) "Committee" means the Board's Committee on Compensation and Organization or any successor thereto. (c) "Common Stock" means shares of the Company's Common Capital Stock, without par value. (d) "Company" means Aetna Life and Casualty Company. (e) "Disability" means long-term disability as defined under the terms of the Company's applicable long-term disability plans or policies. (f) "Effective Date" means the date of grant of this Option, as set forth above. (g) "Fair Market Value" means the closing price of the Common Stock as reported by the Consolidated Tape of the New York Stock Exchange Listed Shares on the date such value is to be determined, or, if no shares were traded on such day, on the next preceding day on which the Common Stock was traded. (h) "For Cause" means a termination of Grantee's employment by the Company due to (i) the willful failure by Grantee to perform substantially Grantee's duties as an employee of the Company (other than due to physical or mental illness) after reasonable notice to Grantee of such failure, (ii) Grantee's engaging in serious misconduct that is injurious to the Company or any subsidiary or any affiliate of the Company, (iii) Grantee's having been convicted of, or entered a plea of nolo 22 23 contendere to, a crime involving an act that is immoral or wrong in and of itself (e.g., burglary, larceny, murder or arson) or a crime involving deceit, fraud, perjury or embezzlement, (iv) the breach by Grantee of any written covenant or agreement not to compete with the Company or any subsidiary or any affiliate or (v) the breach by Grantee of his duty of loyalty to the Company which shall include, without limitation, (A) the disclosure by Grantee of any confidential information pertaining to the Company or any Subsidiary or any affiliate of the Company, other than (x) in the ordinary course of the performance of his duties on behalf of the Company or (y) pursuant to a judicial or administrative subpoena from a court or governmental authority with jurisdiction over the matter in question, (B) the harmful interference by Grantee in the business or operations of the Company or any Subsidiary or any affiliate of the Company, (C) any attempt by Grantee directly or indirectly to induce any employee, insurance agent, insurance broker or broker-dealer of the Company or any Subsidiary or any affiliate to be employed or perform services elsewhere, (D) any attempt by Grantee directly or indirectly to solicit the trade of any customer or supplier, or prospective customer or supplier, of the Company on behalf of any person other than the Company or a Subsidiary thereof or (E) any breach or violation of the Company's Code of Conduct, as amended from time to time. Notwithstanding the foregoing, a breach of Grantee's duty of loyalty to the Company as described in subclause (A) or (E) of clause (v) of the preceding sentence shall not be grounds for a termination For Cause unless such breach has had or could reasonably be expected to have a significant adverse effect on the business or reputation of the Company. (i) "Fundamental Corporate Event" shall mean any stock dividend, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below fair market value, or similar event. (j) "Good Reason" means a termination of Grantee's employment by Grantee within 90 days following (i) a reduction in Grantee's annual Base Salary or incentive compensation opportunity as provided under Paragraph 3(b) of the employment agreement signed by Grantee and the Company dated as of December 8, 1995 (the "Employment Agreement"), (ii) a material reduction in Grantee's positions, duties and responsibilities from those described in Paragraph 2 of the Employment Agreement, (iii) the relocation of Grantee's principal place of employment to a location more than 50 miles from the location at which he performed his principal duties on the date immediately prior to such relocation, (iv) a breach of the obligation to provide Grantee with the benefits required to be provided in accordance with Paragraph 5(a) of the Employment Agreement, (v) a failure by the Company to pay any amounts due and owing to Grantee within 10 days following written notice from Grantee of such failure to pay, or (vi) any other material breach of the Company's obligations to Grantee under the Employment Agreement that significantly affects the compensation or benefits payable to Grantee or materially impairs Grantee's ability to perform the duties and responsibilities of his position. Notwithstanding the foregoing, a termination shall not be treated as a termination for Good Reason (i) if Grantee shall 23 24 have consented in writing to the occurrence of the event giving rise to the claim of termination for Good Reason or (ii) unless Grantee shall have delivered a written notice to the Chief Executive Officer of the Company within 60 days of his having actual knowledge of the occurrence of one or such events stating that he intends to terminate his employment for Good Reason and specifying the factual basis for such termination, and such event shall not have been cured within 30 days of the receipt of such notice. (k) "Grantee" means the person named above to whom this Option has been granted. (l) "Interim Performance Period" means the period of time beginning on the Effective Date and ending on April 28, 1997. (m) "Option" means the option herein granted. (n) "Option Price" means the amount per share of Common Stock required to be paid upon the exercise of this Option, as set forth above, or such other amount per share of Common Stock as may result by operations of Article IV of this Agreement. (o) "Optioned Shares" means the number of shares of Common Stock represented by this Option, as set forth above, or such other amount as may result by operation of Article IV of this Agreement. (p) "Performance Target" means the performance objective measured by the price of the Common Stock as described in Article II. (q) "Performance Period" means the period of time beginning on the Effective Date and ending on April 28, 1998. (r) "Plan" means the Aetna Life and Casualty Company 1994 Stock Incentive Plan. (s) "Retirement" means the termination of employment of a Grantee from active service with the Company or a Subsidiary under circumstances which would entitle an employee of the Company or a Subsidiary to an immediate pension under one of the Company's approved retirement plans (such pension may be actuarially reduced for early commencement of benefits). (t) "Shares of Stock" or "Stock" means the Common Stock. (u) "Subsidiary" means any entity of which, at the time such subsidiary status is to be determined, at least 50% of the total combined voting power of all classes of stock in such entity is held by the Company and its Subsidiaries (exclusive of ownership by the entity whose subsidiary status is being determined). 24 25 (v) "Successor" means the legal representative of the estate of a deceased Grantee or the person or persons who shall acquire the right to exercise an Option by bequest or inheritance or by reason of the death of the Grantee. 25 26 ARTICLE II TERM OF OPTION AND VESTING (a) The Term of this Option shall commence on the Effective Date and shall terminate, unless sooner terminated by the terms of the Plan or this Agreement, at: (i) the close of the Company's business on the day preceding the tenth anniversary of the Effective Date, if the Company is open for business on such day: or (ii) the close of the Company's business on the next preceding day that the Company is open for business. (b) Except as provided in (c), (d) and (e) below, all or a portion of this Option will become vested and the Option will be exercisable on April 28, 1998 only to the extent the Fair Market Value of the Common Stock meets or exceeds the Performance Targets described below. A Performance Target shall be deemed to have been met only to the extent the Fair Market Value of the Common Stock meets or exceeds the Performance Target for at least five consecutive trading business days at any time during the Performance Period.
--------------------------------------------- Performance Target Amount Vested --------------------------------------------- Below $78 Option does not vest $78 33% $84 67% $91 or above 100% ---------------------------------------------
The portion of the Option which shall vest at performance levels between $62 and $73 shall be determined by mathematical interpolation between the respective measuring points. Notwithstanding anything else contained herein to the contrary, the portion of the Option which shall become vested under Section (b), if any, shall be reduced by the amount which has become vested pursuant to (c) below. (c) If the Performance Targets described above are met or exceeded during the Interim Performance Period, 50% of the amount which would have become vested in accordance with the above schedule will become vested on April 28, 1997. (d) This Option may become vested pursuant to (b) and (c) above only if the Grantee is an active employee of the Company or a Subsidiary as of the last day of the Performance Period or the Interim Performance Period, as the case may be; provided, however, if the Company involuntarily terminates the employment of the Grantee (other than "For Cause"), the Grantee dies or terminates employment for reason of Disability, or if the Grantee voluntarily terminates employment for "Good Reason," the Option may continue to vest for such Grantee if the Performance Targets are met during the Performance Period or Interim Performance Period. 26 27 (e) If the Performance Targets are not met as of the end of the Performance Period, the Options will become vested on April 28, 2002, provided the Grantee is an active employee of the Company or a Subsidiary on that date. ARTICLE III METHOD OF OPTION EXERCISE An option is exercisable only after it has become vested as provided in Article II above. In order to exercise this Option, Grantee must comply with procedures adopted by the Company from time to time. Under current procedures, the Grantee must deliver or mail to the Committee, Attention: Manager, Grantee Compensation, Aetna Human Resources, a properly executed exercise notification letter on the appropriate form along with payment of the Option Price. If Grantee is using the cashless exercise program offered by the Company, the exercise notice must be delivered to the participating broker. In addition, if the Grantee has been notified that he or she must consult with a member of the Company's Law and Regulatory Affairs Department prior to engaging in transactions in Aetna stock, Grantee must consult with the Law and Regulatory Affairs prior to exercising this Option. ARTICLE IV CAPITAL CHANGES Except as otherwise specifically provided in Article VI, in the event that the Committee shall determine that any Fundamental Corporate Event affects the Common Stock such that an adjustment is required to preserve, or to prevent enlargement of, the benefits or potential benefits made available under this Plan, then the Committee may, in such manner as the Committee may deem equitable, adjust the (i) the number and kind of shares subject to the Option (including substitution of shares or Options of another company), (ii) the Performance Targets, or (iii) the Option Price. Additionally, the Committee may make provision for a cash payment to a Grantee or the Successor of the Grantee. However, the number of Shares of Stock subject to the Option shall always be a whole number. ARTICLE V TERMINATION OF OPTION (a) Except as provided in (d) below, if the Grantee shall cease, for reason of death, Disability or Retirement, to be employed by the Company or its Subsidiaries during the Term of the Option, the Grantee or Successor of the Grantee may exercise a vested Option until the earlier of: (i) the expiration of the Term of the Option; or 27 28 (ii) a period not to exceed five years following such cessation of employment. (b) Except as provided in (a) above or (d) below, if the Grantee voluntarily ceases to be employed by the Company or its Subsidiaries (other than for "Good Reason") during the Term of the Option, the Grantee may exercise a vested Option until the earlier of: (i) the expiration of the Term of the Option; or (ii) a period not to exceed ninety days following such cessation of employment. (c) Except as provided in (a) above or (d) below, if the Grantee involuntarily ceases to be employed by the Company or its Subsidiaries other than for cause, or if Grantee voluntarily terminates employment for "Good Reason" during the Term of the Option, the Grantee may exercise a vested Option until the later of the expiration of four years from the Effective Date, or ninety days following such cessation of employment (but not following the expiration of the Term of the Option). (d) An Option that has not become vested as provided in Article II above at the time of cessation of employment (or after cessation of employment as provided in Article II(d)) may not be exercised thereafter. No Option may be exercised after the Company has terminated the employment of the Grantee For Cause, except that the Committee may, in its sole discretion, permit exercises for a period of up to ninety days in cases where the Committee shall determine such period is warranted under the particular circumstances. (e) If the Grantee has not entered into a written employment agreement satisfactory to the Company prior to February 16, 1996, this Option shall immediately terminate as of that date and shall have no further force or effect. In addition, if Grantee fails to comply with the term of any written employment agreement entered into with the Company, said failure shall cause this Option to immediately terminate, whether or not the Option has become vested. (f) Employment for purposes of determining eligibility for vesting post-employment exercise rights of the Grantee under this Agreement shall mean continuous full-time salaried employment with the Company or a Subsidiary and shall include periods during which the Grantee is on vacation, sick leave, or other approved absence, or in receipt of severance pay or other form of salary continuation benefit. (g) Except as otherwise herein provided, exercise of this Option, whether by the Grantee or the Successor of the Grantee, shall be subject to all terms and conditions of this Agreement. 28 29 ATICLE VI CHANGE-OF-CONTROL (a) For purposes of this Article VI, a "Change of Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act but excluding the Company and any subsidiary thereof and any employee benefit plan sponsored or maintained by the Company or any Subsidiary (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner", (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months after the Commencement Date, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof, provided that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Article VI(a)(ii); or (iii) The occurrence of a transaction requiring stockholder approval for the acquisition of the Company by an entity other than the Company or a subsidiary through purchase of assets, or by merger, or otherwise. (b) Unless the Board (or the Committee) shall otherwise determine in the manner set forth in Paragraph (c) below and notwithstanding anything in this Agreement to the contrary, this Option shall become fully exercisable upon the occurrence of a Change of Control (as defined in Paragraph (a) above) and shall remain exercisable for a period of at least one year thereafter regardless of whether Grantee continues to be employed by the Company or, if longer, for the period during which such Option would otherwise be exercisable in accordance with its terms. (c) Notwithstanding paragraph (b) above, no acceleration of exercisability shall occur with respect to any Option if the Board (or the Committee) reasonably determines in good faith, prior to the occurrence of a Change of Control, that such Option shall be honored or assumed, or new rights substituted therefor (such honored, assumed or substituted Option 29 30 being hereinafter referred to as an "Alternative Option") by the successor in interest to the Company, provided that any such Alternative Option must: (i) provide Grantee with rights and entitlements substantially equivalent to or better than the rights, terms and conditions applicable under the Option, including, but not limited to, an identical or better exercise and vesting schedule and identical or better timing and methods of payment; (ii) have substantially equivalent economic value to such Option (determined at the time of the Change of Control); and (iii) have terms and conditions which provide that, in the event that the Company involuntarily terminates employment of Grantee for any reason or if the Grantee terminates employment for Good Reason within two years following a Change of Control, any conditions on Grantee's rights under, or any restrictions on exercisability applicable to, each such Alternative Option shall be waived or shall lapse, as the case may be and the Alternative Option shall remain exercisable until the second anniversary of the Change of Control or, if longer, for the period during which such Alternative Option would otherwise be exercisable in accordance with its terms or the provisions of the plan under which it is granted that permit the longest post-termination exercise period for involuntary terminations (other than due to death, disability or retirement). ARTICLE VII OTHER TERMS (a) Grantee understands that the Grantee shall not have any rights as stockholder by virtue of the grant of an Option but only with respect to shares of Common Stock actually issued to the Grantee in accordance with the terms hereof. (b) Anything herein to the contrary notwithstanding, the Company may postpone the exercise of the Option for such time as the Committee in its discretion may deem necessary, in order to permit the Company with reasonable diligence (i) to effect or maintain registration under the Securities Act of 1933, as amended, of the Plan or the shares of Common Stock issuable upon the exercise of the Option, or (ii) to determine that the Plan and such shares are exempt from registration; and the Company shall not be obligated by virtue of this Option Agreement or any provision of the Plan to recognize the exercise of the Option or to sell or issue shares of Common Stock in violation of said Act or of the law of any government having jurisdiction thereof. Any such postponement shall not extend the Term of the Option; and neither the Company nor its Board shall have any obligation or liability to the Grantee, or to the Grantee's Successor, with respect to any shares of Common Stock as to which the Option shall lapse because of such postponement. 30 31 (c) The Option shall be nontransferable and nonassignable except by will and by the laws of descent and distribution. During the Grantee's lifetime, the Option may be exercised only by the Grantee. (d) This Option is not an incentive stock option as described in the Internal Revenue Code of 1986, as amended, Section 422A (b). (e) This Agreement is subject to the 1994 Stock Incentive Plan heretofore adopted by the Company and approved by its shareholders. The terms and provisions of the Plan (including any subsequent amendments thereto) are hereby incorporated herein by reference. In the event of a conflict between any term or provision contained herein and a term or provision of the Plan, the applicable terms and provisions of the Plan will govern and prevail. IN WITNESS WHEREOF, AETNA LIFE AND CASUALTY COMPANY has caused this Option Agreement to be executed as of the Effective Date, and Grantee has accepted the terms and provisions hereof. AETNA LIFE AND CASUALTY COMPANY By _____________________________________ Its Chairman Accepted: __________________________ (Signature) Name: ______________________________ Title: _____________________________ Social Security Number: ____________ Dated: _____________________________ 31 32 EXHIBIT B TO EMPLOYMENT AGREEMENT RELEASE AGREEMENT I, ________________ , acknowledge that this document accurately reflects an agreement entered into between me and Aetna Life and Casualty Company (the "Company") as of this __ day of ___________, 199__. In consideration for the benefits and consideration set forth in Paragraph 6 of the attached employment agreement (the "Agreement"), I hereby agree to the following: 1. DEFINITION. In this agreement the word "Company" means not only the Company by which I was employed, but also parent and subsidiary corporations, any affiliated entities whether or not incorporated, the employee, agents, officers, directors and shareholders of all such entities and any person or entity which may succeed to the rights and liabilities of such entities by assignment or otherwise. 2. RELEASE. I hereby release and hold harmless (on behalf of myself and my family, heirs, executors, successors and assigns) now and forever, the Company from and waive any claim that I have presently, may have or have had in the past, known or unknown, against the Company by reason of my employment by the Company including, without limitation, the termination thereof, other than claims I may have (i) to the payment of amounts due and payable in accordance with the terms of the Agreement, including without limitation the Severance Benefits and the Vested Benefits (as each such term is defined in the Agreement) and (ii) to be indemnified by the Company pursuant to its applicable policies and practices from and against any third party claims arising out of or relating to Executive's employment with or other services on behalf of the Company or any subsidiary of the Company. 3. EXTENT OF RELEASE. This agreement is valid whether any claim arises under any federal, state or local statute (including, without limitation, Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1991, the Age Discrimination in Employment Act of 1967, the Equal Pay Act, the Americans with Disabilities Act of 1990, the Employee Retirement Income Security Act of 1974 and all other statutes regulating the terms and conditions of my employment), regulation or ordinance, under the common law or in equity (including any claims for wrongful discharge or otherwise), or under any policy, agreement, understanding or promise, written or oral, formal or informal, between the Company and myself. 4. CONSIDERATION. The consideration hereby provided to me under the Agreement is not required under the Company's standard policies and I know of no circumstances other than my agreeing to the terms of this agreement which would require the Company to provide such consideration. 32 33 5. RESTRICTIONS. I have not filed, nor will I initiate or cause to be initiated on my behalf, any complaint, charge, claim or proceeding against the Company before any local, state or federal agency, court or other body relating to my employment or the termination thereof (each individually a "Proceeding"), nor will I participate in any Proceeding. I waive any right I may have to benefit in any manner from any relief (whether monetary or otherwise) arising out of any Proceeding, including any EEOC proceeding. I understand that by entering into this agreement, I will be limiting the availability of certain remedies that I may have against the Company and limiting also my ability to pursue certain claims against the Company. The foregoing will not be used to justify interfering with any right I may have to file a charge or participate in an investigation or proceeding conducted by the EEOC. 6. PENALTIES. If I initiate or participate in any legal actions, as described above, the Company shall have the right, but shall not be obligated, to deem this agreement void without effect and to require me to repay to the Company any amounts (other than Earned Salary and Vested Benefits) payment of which was conditioned on the execution of this agreement, plus interest thereon from the original date of payment at an annual rate, compounded semi-annually, equal to the prime rate as quoted in the Wall Street Journal on my date of termination, plus 2 percent and to terminate any benefit or payments (other than with respect to Vested Benefits) that are otherwise payable under the Agreement. 7. RIGHT TO COUNSEL. The Company advises me that I should consult with an attorney prior to execution of this agreement and the Agreement. I understand that it is in my best interest to have this document and the Agreement reviewed by an attorney of my own choosing and at my own expense, and I hereby acknowledge that I have been afforded a period of at least twenty-one days during which to consider this agreement and the Agreement and to have this agreement and the Agreement reviewed by my attorney. 8. SEVERABILITY CLAUSE. Should any provision or part of this agreement be found to be invalid or unenforceable, only that particular provision or part so found and not the entire agreement shall be inoperative. 9. EVIDENCE. This document may be used as evidence in any proceeding relating to my employment or the termination thereof. I waive all objections as to its form. 10. FREE WILL. I am entering into this agreement and the Agreement of my own free will. The Company has not exerted any undue pressure or influence on me in this regard. I have had reasonable time to determine whether entering into this agreement and the Agreement is in my best interest. I understand that if I request additional time to review the provisions of this agreement and the Agreement, a reasonable extension of time will be granted. 11. REVOCATION. This agreement may be revoked by me within seven days after the date on which I sign this agreement and I understand that this agreement and the Agreement are not binding or enforceable until such seven day period has expired. Any such revocation must be made in a signed letter executed by me and received by the Company at the following address no later than 5 p.m. Eastern Standard Time on the seventh day after I have executed this agreement 33 34 and the Agreement: _________________________________. I understand that if I revoke this agreement, the Agreement will not be effective or enforceable and I will not be entitled to any benefits thereunder. 12. NON-ADMISSION. Nothing contained in this agreement shall be deemed or construed as an admission of wrongdoing or liability on the part of the Company. 13. GOVERNING LAW. This agreement and the Agreement shall be construed in accordance with the laws of the State of Connecticut, applicable to contracts made and entirely to be performed therein. Date: ________________________ ______________________________ 34 35 [LOGO] Interoffice Communication Mary Ann Champlin Aetna Human Resources, RC3A (860) 273-8371 Fax: (860) 560-8721 To Frederick C. Copeland, Jr. Date July 22, 1996 Subject EMPLOYMENT AGREEMENT I am pleased to inform you that effective July 19, 1996, Aetna Inc. has assumed all of the obligations of Aetna Services, Inc. (formerly Aetna Life and Casualty Company) under your Employment Agreement with Aetna Services, Inc. All references to the "Company" in your Employment Agreement will hereinafter be deemed to mean both Aetna Services, Inc. and Aetna Inc. Among other things, this means that the Change in Control provisions of your Employment Agreement would be triggered by a change in control of either Aetna Services, Inc. or Aetna Inc. By way of background, Aetna Inc. became the ultimate parent within the Aetna holding company system as a result of the merger with U. S. Healthcare. Your Employment Agreement was entered into with Aetna Services, Inc., which is now a direct subsidiary of Aetna Inc. We felt it would be appropriate for the new ultimate parent, Aetna Inc., to assume these obligations to place you on an equivalent footing post-merger. The assumption of your Employment Agreement is self-executing. You do not need to take any action in response to this letter. If you have any questions or concerns, please let me know. /s/ Mary Ann Champlin 35 36 [LOGO] Interoffice Communication Richard L. Huber President and Chief Executive Officer A801 (860) 273-7851 Fax: (860) 273-6872 To Frederick C. Copeland, Jr. Date September 26, 1997 Subject Pension Credit This memorandum is to confirm that paragraph 7 of my letter to you dated June 6, 1995 regarding your pension benefits is amended in its entirety and replaced with the following: Your participation in the pension plan will begin after you have completed one year of service with Aetna. Under the terms of the plan currently in effect, you will receive credit for your actual years of service from your date of employment and your benefit will vest after five years of such service. We also will credit you under a supplemental plan with an additional eight years of service as follows: the first after two years of active service; the second after three years of active service; the third and fourth after four years of active service; the fifth after five years of active service; the sixth after six years of active service; the seventh after seven years of active service; and the eighth after eight years of active service. Under the regular plan, you will accumulate one year for each year you remain in the employ of the Company (but no more than 35 years of actual and credited service combined will accumulate under both plans) as long as the plans remain in effect. Your Employment Agreement with the Company dated as of December 21, 1995 remains in full force and effect. Please sign and return one copy of this memorandum to evidence your agreement. Aetna Inc. By: /s/ Richard L. Huber Date: 9/30/97 -------------------- ------- Richard L. Huber Agreed and Accepted: By: /s/ Frederick C. Copeland, Jr. ------------------------------ Frederick C. Copeland, Jr. 36 EX-10.2 3 EMPLOYMENT AGREEMENT - THOMAS MCINERNEY 1 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT, dated as of December 19, 1995, by and between Aetna Life and Casualty Company, a Connecticut corporation (the "Company"), and Thomas J. McInerney ("Executive"). W I T N E S S E T H: WHEREAS, the Company is considering certain restructuring alternatives that could result in significant changes in the structure of its business, including, without limitation, dividing the business of the Company into two or more separate publicly traded companies or otherwise transferring a portion of the business to a third party; WHEREAS, the Company believes that Executive is a key employee and that it is in the Company's best interests to retain the services of Executive for the period during which such restructuring alternatives are considered and, to the extent applicable, implemented; WHEREAS, the Company therefore desires to retain the services of Executive and to enter into an agreement embodying the terms of such employment (the "Agreement"); and WHEREAS, Executive desires to accept such employment and enter into such Agreement; NOW, THEREFORE, in consideration of the mutual covenants herein contained, the Company and Executive hereby agree as follows: 1. Employment. Except as provided in Paragraph 6(a), the Company shall continue to employ Executive and Executive agrees to remain employed by the Company under the terms of this Agreement for the period commencing on the date first written above and ending April 28, 1997. The period during which Executive is employed pursuant to this Agreement shall be referred to as the "Contract Employment Period". Upon the expiration of the Contract Employment Period, Executive's employment with the Company shall continue on an at-will basis. 2. Position and Duties. During the Contract Employment Period, Executive shall serve in Executive's current position and in such other comparable or better position or positions with the Company and its subsidiaries as the Chief Executive Officer or the Board of Directors of the Company (the "Board") shall specify from time to time. During the Contract Employment Period, Executive shall have the duties, responsibilities and obligations customarily assigned to individuals serving in the position or positions in which 1 2 Executive serves hereunder and such other duties, responsibilities and obligations as the Chief Executive Officer or the Board shall from time to time specify. Executive shall devote his full business time to the services required of him hereunder, except for vacation time and reasonable periods of absence due to sickness, personal injury or other disability, and shall use his best efforts, judgment, skill and energy to perform such services in a manner consistent with the duties of his position and to improve and advance the business and interests of the Company and its subsidiaries. Nothing contained herein shall preclude Executive from (i) serving on any corporate or governmental board of directors on which he currently serves or, if the Board consents to such service, on any other board of directors, (ii) serving on the board of, or working for, any charitable, not-for profit or community organization, (iii) pursuing any other activity to which the Board consents or (iv) pursuing his personal, financial and legal affairs, so long as such activities, individually or collectively, do not interfere with the performance of Executive's duties hereunder. 3. Cash Compensation. a. Base Salary. During the Contract Employment Period, the Company shall pay Executive a base salary at the annual rate of $225,000. The Board shall periodically review Executive's base salary and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above, is referred to herein as "Base Salary". Executive's Base Salary, as in effect from time to time, may not be reduced by the Company without Executive's consent, provided that the Base Salary payable under this paragraph shall be reduced to the extent Executive elects to defer or reduce such salary under the terms of any deferred compensation or savings plan or other employee benefit arrangement maintained or established by the Company. The Company shall pay Executive the portion of his Base Salary not deferred in accordance with its customary periodic payroll practices. b. Incentive Compensation. During the term of the Contract Employment Period, Executive shall remain eligible for participation in the Company's existing and future annual and long term incentive compensation programs at a level consistent with his position at the Company and the Company's then current policies and practices; provided that following any assignment of this Agreement in accordance with the provisions of Paragraph 9(c) or a Change in Control of the Company (as defined in Paragraph 7(e)), the calculation of the amount payable as annual incentive compensation and the conditions upon which such bonus shall be payable shall be no less favorable to the Executive (taking into account reasonable changes in the Company's goals and objectives) than the annual bonus opportunity that had been made available to the Executive for the fiscal year ended immediately prior to such assignment or Change in Control. Without limiting the generality of the foregoing, for each calendar year ending during the term hereof, Executive shall receive the opportunity to receive an annual bonus of at least 45% of his Base Salary (the "Minimum Bonus Percentage"), subject to satisfaction of such reasonable performance criteria as shall be established with respect to such year. 2 3 4. Stock Option Grant. Contingent upon the execution of this Agreement by the Executive, the Company has granted Executive an option, having a ten-year term, to purchase 25,000 shares of the Company's Common Stock at an exercise price per share equal to $57 a share (the "Option"). Except to the extent specified below, the terms of the Option shall be determined in accordance with the terms of the 1994 Stock Incentive Plan (the "1994 Plan") and shall be set forth in the separate agreement embodying the grant of such Option (the "Option Agreement"), the form of which is attached hereto as Exhibit A. 5. Benefits, Perquisites and Expenses. a. Benefits. During the Contract Employment Period, Executive shall be eligible to participate in (i) each welfare benefit plan sponsored or maintained by the Company, including, without limitation, each group life, hospitalization, medical, dental, health, accident or disability insurance or similar plan or program of the Company, and (ii) each pension, profit sharing, retirement, deferred compensation or savings plan sponsored or maintained by the Company, in each case, whether now existing or established hereafter, to the extent that Executive is eligible to participate in any such plan under the generally applicable provisions thereof. Nothing in this Paragraph 5(a) shall be construed to limit the ability of the Company to amend or terminate any particular plan, program or arrangements, provided that, following the occurrence of a Change in Control (as defined in Paragraph 7(e)) or the assignment of this Agreement to a New Entity (as defined in Paragraph 6(a)) pursuant to Paragraph 9(b), the benefits made available to the Executive thereafter shall be at least substantially comparable, in the aggregate, to the benefits made available to the Executive immediately prior to such Change in Control or assignment. With respect to the pension or retirement benefits payable to Executive, Executive's service credited for purposes of determining Executive's benefits and vesting shall be determined in accordance with the terms of the applicable plan or program or, if applicable, pursuant to any written agreement between Executive and the Company (whether now existing or hereafter adopted) that provides Executive a more favorable method of crediting service for any purpose thereunder. b. Perquisites. During the Contract Employment Period, Executive shall be entitled to receive such perquisites as are generally provided to other senior officers of the Company in accordance with the then current policies and practices of the Company. c. Business Expenses. During the Contract Employment Period, the Company shall pay or reimburse Executive for all reasonable expenses incurred or paid by Executive in the performance of Executive's duties hereunder, upon presentation of expense statements or vouchers and such other information as the Company may require and in accordance with the generally applicable policies and procedures of the Company. 3 4 6. Termination of Employment. a. Early Termination of the Contract Employment Period. Notwithstanding Paragraph 1, the Contract Employment Period shall end upon the earliest to occur of (i) a termination of Executive's employment on account of Executive's death, (ii) a Termination due to Disability, (iii) a Termination for Cause, (iv) a Termination Without Cause, (v) a Termination for Good Reason or (vi) a termination of Executive's employment by Executive other than a Termination for Good Reason. For purposes of this Agreement, a transfer of Executive's employment (i)to any other entity controlled by or under common control with the Company shall not be treated as a termination unless and until such entity ceases to be controlled by or under common control with the Company or (ii) as a result of the implementation of any restructuring of the Company (whether occurring by spin-off or otherwise) shall not be treated as a termination of employment, provided that, in either case, the successor employer (the "New Entity") expressly assumes and agrees to perform all of the Company's obligations under this Agreement. b. Benefits Payable Upon Termination. Following the end of the Contract Employment Period pursuant to Paragraph 6(a), Executive (or, in the event of his death, his surviving spouse, if any, or his estate) shall be paid the type or types of compensation determined to be payable in accordance with the following table at the times established pursuant to Paragraph 6(c):
Earned Vested Accrued Severance Salary Benefits Bonus Benefit ------ -------- ----- ------- Termination due Payable Payable Payable Not Payable to death Termination due to Payable Payable Payable Not Payable Disability Termination for Payable Payable Not Payable Not Payable Cause Termination Payable Payable Payable Payable Without Cause Termination for Payable Payable Payable Payable Good Reason Termination by Payable Payable Not Payable Not Payable Executive other than for Good Reason
4 5 c. Timing of Payments. Earned Salary and Accrued Bonus shall be paid in a single lump sum as soon as practicable, but in no event more than 30 days, following the end of the Contract Employment Period. Vested Benefits shall be payable in accordance with the terms of the plan, policy, practice, program, contract or agreement under which such benefits have accrued. Severance Benefits shall be paid in approximately equal installments, at the same intervals at which Executive was receiving his salary payments hereunder, for the greater of (i) one year, (ii) the period over which such benefits would be payable if paid to Executive under the Company's otherwise applicable plans, policies or procedures as currently in effect or (iii) the period over which such benefits would be payable if paid to Executive under the Company's otherwise applicable plans, policies or procedures, as in effect at the time of Executive's termination of employment. Notwithstanding the foregoing, Executive may elect, by written notice given to the Company prior to the first periodic payment and within ten business days after such termination, that, instead of periodic installments, Severance Benefits shall be paid in either a single lump sum, payable within ten business days of receipt by the Company of such election, or in two equal installments, the first payable within ten business days of receipt by the Company of such election, and the second payable on the first business day of the following calendar year. d. Definitions. For purposes of this Paragraph 6, capitalized terms have the following meanings: "Accrued Bonus" means a pro-rated amount equal to the product of (i) the annual incentive compensation Executive would have been entitled to receive under Paragraph 3(b) for the calendar year in which his active service for the Company terminates pursuant to Paragraph 6(a) had he remained employed for the entire year and assuming that all targets for such year had been met, multiplied by (ii) a fraction, the numerator of which is equal to the number of days in such calendar year occurring on or prior to the termination of Executive's active service for the Company (including any period of absence due to disability) and the denominator of which is 365. "Earned Salary" means any Base Salary earned, but unpaid, for services rendered to the Company on or prior to the date on which the Contract Employment Period ends (other than Base Salary deferred pursuant to Executive's election, as provided in Paragraph 3(a) hereof). "Severance Benefit" means an amount equal to the greater of: (i) the sum of (A) the annual Base Salary payable to Executive immediately prior to the end of the Contract Employment Period; and 5 6 (B) an amount (the "Bonus Severance Amount") equal to the product of Executive's Base Salary times the greater of (1) the Minimum Bonus Percentage and (2) the percentage of Base Salary that would have been payable to Executive for the year of such termination assuming achievement of target levels of performance and Executive's continued employment for the entire year, or (ii) the amount otherwise payable to Executive under the Company's otherwise applicable severance plans, policies or programs as in effect on the date hereof (or, if more favorable to Executive, as in effect on the date of Executive's termination), assuming for purposes of determining the amount payable thereunder that Executive's employment was terminated as a result of the elimination of his position, but calculated by including the Bonus Severance Amount as part of Executive's eligible compensation for purposes of calculating the benefits payable under such plans, policies or programs; except that, in the event that Executive becomes entitled to receive Severance Benefits hereunder following a Change in Control, the Severance Benefit payable to Executive shall be determined under Paragraph 7(c). Additionally, while Executive is receiving payment of Severance Benefits in periodic installments, Executive shall also be eligible to continue to participate in the welfare benefit plans and programs (excluding the long-term disability plan, the sick-pay plan and vacation accruals) generally made available to employees of the Company and in which he participated immediately prior to the termination of his employment on the same terms and conditions as would have applied had Executive continued to be employed. Upon an election to receive Severance Benefits in either a single lump sum payment or in two installments, Executive will forfeit any right to continue to receive any coverage under the Company's welfare benefit plans, other than COBRA coverage (determined from the original date of termination) at Executive's expense as required by applicable law; provided that, if Executive elects to receive Severance Benefits in two installments instead of periodic installments, the Company shall pay one-half of the cost of Executive's COBRA coverage from the date the first installment payment is made until the date the second installment payment is made. Notwithstanding the foregoing, receipt of a lump sum payment or two installment payments hereunder shall not cause Executive to cease to be eligible for any retiree benefit programs for which he is otherwise eligible under the terms of the Company's employee benefit plans, policies or programs. "Termination for Cause" means a termination of Executive's employment by the Company due to (i) the willful failure by Executive to perform substantially Executive's duties as an employee of the Company (other than due to physical or mental illness) after reasonable notice to Executive of such failure, (ii) Executive's engaging in misconduct that is materially injurious to the Company or any subsidiary or any affiliate of the Company, (iii) Executive's having been convicted of, or entered a plea of nolo contendere to, a crime that constitutes a felony, (iv) the material breach by Executive of any written covenant or agreement not to compete with the Company or any subsidiary or any affiliate or (v) the breach by Executive of his duty of loyalty to the Company which shall include, without 6 7 limitation, (A) the disclosure by Executive of any confidential information pertaining to the Company or any subsidiary or any affiliate of the Company, other than (x) in the ordinary course of the performance of his duties on behalf of the Company or (y) pursuant to a judicial or administrative subpoena from a court or governmental authority with jurisdiction over the matter in question, (B) the harmful interference by Executive in the business or operations of the Company or any subsidiary or any affiliate of the Company, (C) any attempt by Executive directly or indirectly to induce any employee, insurance agent, insurance broker or broker-dealer of the Company or any subsidiary or any affiliate to be employed or perform services elsewhere, other than actions taken by Executive that are intended to benefit the Company or any subsidiary or affiliate and do not benefit Executive financially other than as an employee or stockholder of the Company, (D) any attempt by Executive directly or indirectly to solicit the trade of any customer or supplier, or prospective customer or supplier, of the Company on behalf of any person other than the Company or a subsidiary thereof, other than actions taken by Executive that are intended to benefit the Company or any subsidiary or affiliate and do not benefit Executive financially other than as an employee or stockholder of the Company, provided, however, that this provision shall only apply to any product or service which is in competition with a product or service of the Company or any subsidiary or affiliate thereof or (E) any breach or violation of the Company's Code of Conduct, as amended from time to time sufficient to warrant a for cause termination consistent with the Company's past practice. Notwithstanding the foregoing, a breach of Executive's duty of loyalty to the Company as described in subclause (A) or a breach of the Company's Code of Conduct as described in subclause (E) of clause (v) of the preceding sentence shall not be grounds for a Termination for Cause unless such breach has had or could reasonably be expected to have a significant adverse effect on the business or reputation of the Company. "Termination due to Disability" means a termination of Executive's employment by the Company because Executive has been incapable, with or without reasonable accommodation, of substantially fulfilling the positions, essential duties, responsibilities and obligations of Executive's positions set forth in this Agreement because of physical, mental or emotional incapacity resulting from injury, sickness or disease for a period of (i) at least four consecutive months or (ii) more than six months in any twelve month period. Any question as to the existence, extent or potentiality of Executive's disability shall be made by a qualified, independent physician selected by the chief or assistant chief (or the equivalent position) of the department which treats the condition giving rise to Executive's absence at a nationally or regionally recognized teaching hospital chosen by the Company. The determination of any such physician shall be final and conclusive for all purposes of this Agreement. Notwithstanding the foregoing, (i) a Termination for Disability shall not affect Executive's right to receive any amount that would otherwise have been payable to Executive under the Company's plans, policies, practices or programs pertaining to short-term or long-term disability had Executive's employment continued and (ii) if it is determined, at the time Executive is first eligible to receive long-term disability benefits under the Company's plans, policies, practices or programs, that Executive is not entitled to receive such long-term disability benefits (other than due to Executive's failure to cooperate), Executive shall, for purposes of this Paragraph 6, be deemed to have been terminated as of the date of such 7 8 determination pursuant to a Termination Without Cause and to be entitled to receive any additional benefits payable hereunder in respect of a Termination Without Cause. "Termination for Good Reason" means a termination of Executive's employment by Executive within 90 days following actual knowledge of (i) a reduction in Executive's annual Base Salary or incentive compensation opportunity as provided under Paragraph 3(b), (ii) a material reduction in Executive's positions, duties and responsibilities from those described in Paragraph 2 hereof, (iii) the relocation of Executive's principal place of employment to a location more than 50 miles from the location at which he performed his principal duties on the date immediately prior to such relocation, (iv) a breach of the obligation to provide Executive with the benefits required to be provided in accordance with Paragraph 5(a), (v) a failure by the Company to pay any amounts due and owing to Executive within 10 days following written notice from Executive of such failure to pay, or (vi) any other material breach of the Company's obligations to Executive hereunder that materially affects the compensation or benefits payable to Executive or materially impairs Executive's ability to perform the duties and responsibilities of his position. Notwithstanding the foregoing, a termination shall not be treated as a Termination for Good Reason (i) if Executive shall have consented in writing to the occurrence of the event giving rise to the claim of Termination for Good Reason or (ii) unless Executive shall have delivered a written notice to the Chief Executive Officer of the Company within 60 days of his having actual knowledge of the occurrence of one of such events stating that he intends to terminate his employment for Good Reason and specifying the factual basis for such termination, and such event shall not have been cured within 30 days of the receipt of such notice. "Termination Without Cause" means any termination of Executive's employment by the Company other than (i) a Termination due to Disability or (ii) a Termination for Cause. Subject to the Company's obligations to make the payments, if any, required pursuant to this paragraph 6, nothing in this Agreement shall be construed to limit the right of the Company to terminate Executive's employment at any time for any reason or without reason. "Vested Benefits" means amounts payable under the terms of or in accordance with any plan, policy or practice or program of, or any contract or agreement with, the Company or any of its subsidiaries (including, without limitation, any supplemental pension plan, supplemental savings plan or other deferred compensation arrangement, the 1994 Plan and the Company's 1984 Stock Option Plan (the "1984 Plan") with respect to which Executive's rights to such amounts (i) have become vested and nonforfeitable on or before Executive's termination of employment or (ii) otherwise have or will become nonforfeitable at or subsequent to his termination of employment without regard to the performance by Executive of further services or the resolution of a contingency that is not satisfied at or after such termination, provided that, at any time during which Executive is entitled to receive the Severance Benefits hereunder, Executive shall not also be entitled to receive any benefits under the Company's generally applicable severance or other termination plans, policies or programs. 8 9 e. Full Discharge of Company Obligations. Except to the extent provided in this Paragraph 6, the amounts payable to Executive pursuant to this Paragraph 6 (including, without limitation, under Paragraph 6(f)) following termination of his employment shall be in full and complete satisfaction of Executive's rights under this Agreement and, except to the extent prohibited by law, any other claims he may have in respect of his employment by the Company or any of its subsidiaries. Such amounts shall constitute liquidated damages with respect to any and all such rights and claims and shall not be subject to any offset or mitigation. Notwithstanding anything else contained herein to the contrary, unless the Company shall waive its rights to any such release, the Company's obligations under this Paragraph 6 are expressly conditioned upon Executive's execution simultaneously with or immediately following such termination of employment, of a release and waiver, substantially in the form attached hereto as Exhibit B (subject to, in the event any change of law occurring after the date hereof, to such modifications as shall be necessary or appropriate to place the Company in a substantially the same position as though no change in law had occurred), of any claims he may have in connection with the termination of, or arising out of, his employment with the Company, provided that such release shall not be construed to waive, release or otherwise limit any amounts required to be paid hereunder or any benefits due and payable to Executive under the terms of any employee pension benefit plan, as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended, any other Vested Benefit or any right of Executive to be indemnified by the Company pursuant to its applicable policies and practices from and against any third party claims arising out of or relating to Executive's employment with or other services on behalf of the Company or any subsidiary of the Company. f. Special Continuation of Certain Protection for the Executive. Notwithstanding anything contained in this Agreement to the contrary, if, at the end of the Contract Employment Period, (i) Executive remains an at-will employee of the Company and (ii) within one year following the end of the Contract Employment Period, the Company effects a Termination Without Cause or takes actions which, if they had occurred within the Contract Employment Period, would have given Executive the right to terminate his employment pursuant to a Termination for Good Reason and Executive, after giving the Company timely written notice of the events permitting a Termination for Good Reason and the opportunity to cure described in the definition of a Termination for Good Reason, voluntarily terminates his employment within 90 days of the date of such actions by the Company, then in either case, Executive shall receive payment of the Severance Benefits that would otherwise have been payable to Executive hereunder had his termination of employment occurred during the Contract Employment Period. Notwithstanding the preceding sentence, this Section 6(f) shall not be applicable unless Executive executes the waiver and release referred to in Paragraph 6(e) above in connection with his termination of employment pursuant to this Paragraph 6(f). g. Outplacement Services. In addition to any other benefits described in this Paragraph 6, in the event Executive is eligible to receive Severance Benefits, the Company shall also provide to Executive, at its expense, individual outplacement services from a qualified outplacement firm selected by the Company. The outplacement services to 9 10 be provided to Executive shall be no less favorable to Executive than those made available to other executives prior to the date hereof under the Company's generally applicable policies, programs or arrangements. 7. Change in Control of the Company. a. Accelerated Vesting and Payment. Unless the Board (or the appropriate committee thereof) shall otherwise determine in the manner set forth in Paragraph 7(b), the Option shall become fully exercisable upon the occurrence of a Change in Control (as defined below) and shall remain exercisable for a period of one year thereafter regardless of whether Executive continues to be employed by the Company or, if longer, for the period during which such Option would otherwise be exercisable in accordance with its terms or the generally applicable provisions of the 1994 Plan. If no Alternative Option is provided as set forth in Section 7(b) below, and the Company does not survive as a publicly traded corporation following a Change in Control, the Company shall pay Executive, in full settlement of all rights with respect to the Option, an aggregate amount in cash equal to the product of (i) (A) the Fair Market Value of a Share of the Company's Common Stock on the date the Change in Control occurs minus (B) the per share exercise price for the Option times (ii) the number of shares as to which such Option has not been exercised at the time of the Change in Control. Any amount payable pursuant to the preceding sentence shall be paid within 30 days following such Change in Control. b. Alternative Options. Notwithstanding Paragraph 7(a), no acceleration of exercisability shall occur with respect to any Option if the Board (or the appropriate committee thereof) reasonably determines in good faith, prior to the occurrence of a Change in Control, that such Option shall be honored or assumed, or new rights substituted therefor (such honored, assumed or substituted Option being hereinafter referred to as an "Alternative Option") by the successor in interest to the Company, provided that any such Alternative Option must: (i) provide Executive with rights and entitlements substantially equivalent to or better than the rights, terms and conditions applicable under the Option, including, but not limited to, an identical or better exercise and vesting schedule and identical or better timing and methods of payment; (ii) have substantially equivalent economic value to such Option (determined at the time of the Change in Control); and (iii) have terms and conditions which provide that, in the event that Executive's employment is terminated by the Company for any reason or is terminated by Executive pursuant to a Termination for Good Reason within two years following a Change in Control, (A) any conditions on Executive's rights under, or any restrictions on exercisability applicable to, each such Alternative Option shall be waived or shall lapse, as the case may be and (B) the Alternative Option shall remain exercisable until the second anniversary of the Change in 10 11 Control or, if longer, for the period during which such Alternative Option would otherwise be exercisable in accordance with its terms or the provisions of the plan under which it is granted that permit the longest post-termination exercise period for involuntary terminations (other than due to death, disability or retirement). c. Enhanced Severance Payments. If Executive's employment is terminated following a Change in Control pursuant to a Termination for Good Reason or a Termination Without Cause, the Severance Benefit payable to Executive pursuant to Paragraph 6 shall be equal to two times the sum of Executive's annual Base Salary and the Bonus Severance Amount. d. Additional Payments by the Company. (i) Application of Paragraph 7(d). In the event that any amount or benefit paid or distributed to Executive pursuant to this Agreement, taken together with any amounts or benefits otherwise paid or distributed to Executive by the Company or any affiliated company (collectively, the "Covered Payments"), would be an "excess parachute payment" as defined in Section 280G of the Code and would thereby subject Executive to the tax (the "Excise Tax") imposed under Section 4999 of the Code (or any similar tax that may hereafter be imposed), the provisions of this Section 7(d) shall apply to determine the amounts payable to Executive pursuant to this Agreement. (ii) Calculation of Benefits. Immediately following delivery of any Notice of Termination, the Company shall notify Executive of the aggregate present value of all termination benefits to which he would be entitled under this Agreement and any other plan, program or arrangement as of the projected date of termination, together with the projected maximum payments, determined as of such projected date of termination that could be paid without Executive being subject to the Excise Tax. (iii) Imposition of Payment Cap. If the aggregate value of all compensation payments or benefits to be paid or provided to Executive under this Agreement and any other plan, agreement or arrangement with the Company exceeds the amount which can be paid to Executive without Executive incurring an Excise Tax by less than 105%, then the amounts payable to Executive under this Agreement may, in the discretion of the Company, be reduced (but not below zero) to the maximum amount which may be paid hereunder without Executive becoming subject to such an Excise Tax (such reduced payments to be referred to as the "Payment Cap"). In the event that Executive receives reduced payments and benefits hereunder, Executive shall have the right to designate which of the payments and benefits otherwise provided for in this Agreement that he will receive in connection with the application of the Payment Cap. 11 12 (iv) Further Payments by the Company. If the aggregate value of all compensation payments or benefits to be paid or provided to Executive under this Agreement and any other plan, agreement or arrangement with the Company exceeds the amount which can be paid to Executive without Executive incurring an Excise Tax by more than 105%, the Company shall pay to Executive immediately following Executive's termination of employment an additional amount (the "Tax Reimbursement Payment") such that the net amount retained by Executive with respect to such Covered Payments, after deduction of any Excise Tax on the Covered Payments and any Federal, state and local income tax and Excise Tax on the Tax Reimbursement Payment provided for by this Paragraph 7(d)(iv), but before deduction for any Federal, state or local income or employment tax withholding on such Covered Payments, shall be equal to the amount of the Covered Payments. (v) Application of Section 280G. For purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax, (A) such Covered Payments will be treated as "parachute payments" within the meaning of Section 280G of the Code, and all "parachute payments" in excess of the "base amount" (as defined under Section 280G(b)(3) of the Code) shall be treated as subject to the Excise Tax, unless, and except to the extent that, in the good faith judgment of the Company's independent certified public accountants appointed prior to the Effective Date or tax counsel selected by such Accountants (the "Accountants"), the Company has a reasonable basis to conclude that such Covered Payments (in whole or in part) either do not constitute "parachute payments" or represent reasonable compensation for personal services actually rendered (within the meaning of Section 280G(b)(4)(B) of the Code) in excess of the "base amount," or such "parachute payments" are otherwise not subject to such Excise Tax, and (B) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Accountants in accordance with the principles of Section 280G of the Code. (vi) Applicable Tax Rates. For purposes of determining whether Executive would receive a greater net after-tax benefit were the amounts payable under this Agreement reduced in accordance with Paragraph 7(d)(iii), Executive shall be deemed to pay: (A) Federal income taxes at the highest applicable marginal rate of Federal income taxation for the calendar year in which the first amounts are to be paid hereunder, and 12 13 (B) any applicable state and local income taxes at the highest applicable marginal rate of taxation for such calendar year, net of the maximum reduction in Federal incomes taxes which could be obtained from the deduction of such state or local taxes if paid in such year; provided, however, that Executive may request that such determination be made based on his individual tax circumstances, which shall govern such determination so long as Executive provides to the Accountants such information and documents as the Accountants shall reasonably request to determine such individual circumstances. (vii) Adjustments in Respect of the Payment Cap. If Executive receives reduced payments and benefits under this Paragraph 7(d) (or this Paragraph 7(d) is determined not to be applicable to Executive because the Accountants conclude that Executive is not subject to any Excise Tax) and it is established pursuant to a final determination of a court or an Internal Revenue Service proceeding (a "Final Determination") that, notwithstanding the good faith of Executive and the Company in applying the terms of this Agreement, the aggregate "parachute payments" within the meaning of Section 280G of the Code paid to Executive or for his benefit are in an amount that would result in Executive being subject an Excise Tax, then the amount equal to such excess parachute payments shall be deemed for all purposes to be a loan to Executive made on the date of receipt of such excess payments, which Executive shall have an obligation to repay to the Company on demand, together with interest on such amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the date of the payment hereunder to the date of repayment by Executive. If this Paragraph 7(d) is not applied to reduce Executive's entitlements under this Paragraph 7 because the Accountants determine that Executive would not receive a greater net-after tax benefit by applying this Paragraph 7(d) and it is established pursuant to a Final Determination that, notwithstanding the good faith of Executive and the Company in applying the terms of this Agreement, Executive would have received a greater net after tax benefit by subjecting his payments and benefits hereunder to the Payment Cap, then the aggregate "parachute payments" paid to Executive or for his benefit in excess of the Payment Cap shall be deemed for all purposes a loan to Executive made on the date of receipt of such excess payments, which Executive shall have an obligation to repay to the Company on demand, together with interest on such amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the date of the payment hereunder to the date of repayment by Executive. If Executive receives reduced payments and benefits by reason of this Paragraph 7(d) and it is established pursuant to a Final Determination that Executive could have received a greater amount without exceeding the Payment Cap, then the Company shall promptly thereafter pay Executive the aggregate additional amount which could have been paid without exceeding the Payment Cap, together with interest on such 13 14 amount at the applicable Federal rate (as defined in Section 1274(d) of the Code) from the original payment due date to the date of actual payment by the Company. (viii) Adjustments in Respect of the Tax Reimbursement Payments. In the event that the Excise Tax is subsequently determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to be less than the amount taken into account hereunder in calculating the Tax Reimbursement Payment made, Executive shall repay to the Company, at the time that the amount of such reduction in the Excise Tax is finally determined, the portion of such prior Tax Reimbursement Payment that would not have been paid if such Excise Tax had been applied in initially calculating such Tax Reimbursement Payment, plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. Notwithstanding the foregoing, in the event any portion of the Tax Reimbursement Payment to be refunded to the Company has been paid to any Federal, state or local tax authority, repayment thereof shall not be required until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed interest received or credited to Executive by such tax authority for the period it held such portion. Executive and the Company shall mutually agree upon the course of action to be pursued (and the method of allocating the expenses thereof) if Executive's good faith claim for refund or credit is denied. In the event that the Excise Tax is later determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including, but not limited to, by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalty payable with respect to such excess) at the time that the amount of such excess is finally determined. (ix) Timing of Payment. Any Tax Reimbursement Payment (or portion thereof) provided for in Paragraph 7(d)(iv) above shall be paid to Executive not later than 10 business days following the payment of the Covered Payments; provided, however, that if the amount of such Tax Reimbursement Payment (or portion thereof) cannot be finally determined on or before the date on which payment is due, the Company shall pay to Executive by such date an amount estimated in good faith by the Accountants to be the minimum amount of such Tax Reimbursement Payment and shall pay the remainder of such Tax Reimbursement Payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined, but in no event later than 45 calendar days after payment of the related 14 15 Covered Payment. In the event that the amount of the estimated Tax Reimbursement Payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to Executive, payable on the fifth business day after written demand by the Company for payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code). e. Definition of "Change in Control". For purposes of this Paragraph 7, a "Change in Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act but excluding the Company and any subsidiary thereof and any employee benefit plan sponsored or maintained by the Company or any Subsidiary (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months after the Commencement Date, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof, provided that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Paragraph 7(e)(ii); or (iii) The occurrence of a transaction requiring stockholder approval for the acquisition of the Company by an entity other than the Company or a subsidiary through purchase of assets, or by merger, or otherwise. 8. Noncompetition and Confidentiality. a. Noncompetition. During the Contract Employment Period and for a period of one year following Executive's termination of employment during the Contract Employment Period other than due to a Termination Without Cause or a Termination for Good Reason, Executive shall not become associated, whether as a principal, partner, employee, consultant or shareholder (other than as a holder of not in excess of 1% of the outstanding voting shares of any publicly traded company), with any entity that is actively engaged in any geographic area in any business which is in substantial and direct competition with the business or businesses of the Company for which Executive provides substantial 15 16 services or for which Executive has substantial responsibility, provided that nothing in this Paragraph 8(a) shall preclude Executive from performing services solely and exclusively for a division or subsidiary of such an entity that is engaged in a non-competitive business. b. Nondisclosure, Nonsolicitation and Cooperation. (i) Executive shall not (except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency) disclose to any third person, whether during or subsequent to the Executive's employment with the Company, any trade secrets; customer lists; product development and related information; marketing plans and related information; sales plans and related information; operating policies and manuals; business plans; financial records; or other financial, commercial, business or technical information related to the Company or any subsidiary or affiliate thereof unless such information has been previously disclosed to the public by the Company or has become public knowledge other than by a breach of this Agreement; provided, however, that this limitation shall not apply to any such disclosure made while Executive is employed by the Company, or any subsidiary or affiliate thereof in the ordinary course of the performance of Executive's duties; (ii) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to induce any employee or Insurance Agent (as defined below) of the Company, or any subsidiary or any affiliate thereof to be employed or perform services elsewhere provided that this covenant shall not preclude Executive from taking any actions during the Contract Employment Period that (x) are intended to benefit the Company or any subsidiary or affiliate and (y) do not benefit Executive financially other than as an employee or stockholder of the Company; (iii) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to induce any insurance agent or agency, insurance broker, broker-dealer or supplier of the Company, or any subsidiary or affiliate thereof to cease providing services to the Company, or any subsidiary or affiliate thereof provided that this covenant shall not preclude Executive from taking any actions during the Contract Employment Period that (x) are intended to benefit the Company or any subsidiary or affiliate and (y) do not benefit Executive financially other than as an employee or stockholder of the Company; (iv) during the Contract Employment Period and for two years after the termination of such Period, Executive shall not attempt, directly or indirectly, to solicit, on behalf of any person or entity other than the Company or any of its subsidiaries, the trade of any individual or entity which, at the time of the solicitation, is a customer of the Company, or any subsidiary or affiliate thereof, or which the Company, or any subsidiary or affiliate thereof is undertaking reasonable steps to 16 17 procure as a customer at the time of or immediately preceding termination of the Contract Employment Period; provided, however, that this limitation shall only apply to (x) any product or service which is in competition with a product or service of the Company or any subsidiary or affiliate thereof and (y) with respect to any customer or prospective customer with whom Executive has or had (by virtue of Executive's position or otherwise) a personal relationship; and (v) following the termination of the Contract Employment Period, Executive shall provide assistance to and shall cooperate with the Company or any subsidiary or affiliate thereof, upon its reasonable request, with respect to matters within the scope of Executive's duties and responsibilities during the Contract Employment Period. (The Company agrees and acknowledges that it shall, to the maximum extent possible under the then prevailing circumstances, coordinate (or cause a subsidiary or affiliate thereof to coordinate) any such request with Executive's other commitments and responsibilities to minimize the degree to which such request interferes with such commitments and responsibilities). The Company agrees that it will reimburse Executive for reasonable travel expenses (i.e., travel, meals and lodging) that Executive may incur in providing assistance to the Company hereunder. Solely for purposes of Paragraph 8(b)(ii) above, the term "Insurance Agent" shall mean those insurance agents or agencies representing the Company or any subsidiary or affiliate thereof, that are exclusive or career agents or agencies of the Company or any subsidiary or affiliate thereof, or any insurance agents or agencies which derive 50% or more of their business revenue from the Company or any subsidiary or affiliate thereof (calculated on an aggregate basis for the 12-month period prior to the date of determination or such other similar period for which such information is more readily available). c. Company Property. Promptly following Executive's termination of employment, Executive shall return to the Company all property of the Company, and all copies thereof in Executive's possession or under his control. d. Intention of the Parties. If any provision of Paragraph 8 is determined by an arbitrator (or a court of competent jurisdiction asked to enforce the decision of the arbitrator) not to be enforceable in the manner set forth in this Agreement, the Company and Executive agree that it is the intention of the parties that such provision should be enforceable to the maximum extent possible under applicable law and that such arbitrator (or court) shall reform such provision to make it enforceable in accordance with the intent of the parties. Executive acknowledges that a material part of the inducement for the Company to provide the salary and benefits evidenced hereby is Executive's covenants set forth in Paragraph 8(a), (b) and (c) and that the covenants and obligations of Executive with respect to nondisclosure and nonsolicitation relate to special, unique and extraordinary matters and that a violation of any of the terms of such covenants and obligations will cause the Company irreparable injury for which adequate remedies are not available at law. Therefore, Executive agrees that, if Executive shall materially breach any of those covenants following termination of employment, the Company shall have no further obligation to pay Executive any benefits 17 18 otherwise payable hereunder and the Company shall be entitled to an injunction, restraining order or such other equitable relief (without the requirement to post a bond) restraining Executive from committing any violation of the covenants and obligations contained in Paragraph 8(a), (b) and (c). The remedies in the preceding sentence are cumulative and are in addition to any other rights and remedies the Company may have at law or in equity as an arbitrator (or court) shall reasonably determine. e. Waiver. Without limiting the generality of the foregoing, upon request of Executive prior to engaging in any conduct otherwise prohibited by this Paragraph 8, the Company may, in its sole discretion, waive in writing, on such terms and conditions as it may deem appropriate, any violation of this Paragraph 8 which would otherwise occur due to such conduct. 9. Miscellaneous. a. Survival. Paragraph 7 (relating to a Change in Control), 8 (relating to noncompetition, nonsolicitation and confidentiality) and 9 (relating, among other things, to survival, assignment and governing law) shall survive the termination hereof, whether such termination shall be by expiration of the Contract Employment Period or an early termination pursuant to Paragraph 6 hereof. Paragraph 6((other than Paragraph 6(f)) (relating to early termination) shall survive the termination hereof to the extent that, prior thereto, or at the time of termination, Executive (or his beneficiary) has become or becomes entitled to receive any of the benefits payable thereunder. Paragraph 6(f) (and to the extent applicable to such Paragraph 6(f), 6(e)) shall survive for one year following the termination hereof. The option referred to in Paragraph 4 survives for the term specified in Attachment A. b. Binding Effect. This Agreement shall be binding on, and shall inure to the benefit of, the Company and any person or entity that succeeds to the interest of the Company (regardless of whether such succession does or does not occur by operation of law) by reason of the sale of all or a portion of the Company's stock, a merger, consolidation or reorganization involving the Company or, unless in the case of a sale involving less than all or substantially all of the Company's assets the Company otherwise elects in writing, a sale of the assets of the business of the Company (or portion thereof) in which Executive performs a majority of his services. Any successor in interest to the Company shall acknowledge in writing to Executive that it has assumed this Agreement and is responsible to Executive for the performance of the Company's obligations under this Agreement. Without limiting the generality of the foregoing, the Company shall have the right, without the consent of Executive, to assign this Agreement and its obligations hereunder to any New Entity or any subsidiary of any New Entity by which Executive becomes employed, at the discretion of the Company, by reason of the implementation of any restructuring of the Company, and, following any such assignment, such New Entity or subsidiary shall be treated as the Company for all purposes of this Agreement. This Agreement shall also enure to the benefit of Executive's heirs, executors, administrators and legal representatives. 18 19 c. Assignment. Except as provided under Paragraph 9(b), neither this Agreement nor any of the rights or obligations hereunder shall be assigned or delegated by any party hereto without the prior written consent of the other party. In the event the Company assigns this Agreement pursuant to Section 9(b), the Company shall guarantee payment to Executive of any amounts at any time due and payable hereunder in the event (and only to the extent) that the assignee has become a debtor in bankruptcy, is the subject of a receivership or similar preceding or has become insolvent, provided that Executive shall be required to assign his rights against the assignee through subrogation as a condition of receiving any payment under the Company's guarantee. In consideration of such guarantee, Executive agrees that following such assignment, the covenants of Executive in Paragraphs 8(b)(i) and (v) shall continue to inure to the benefit of the Company, as well as the assignee. The Company and Executive agree that following any assignment all other covenants described herein in favor of the Company shall, from and after the date of such assignment, inure solely to the benefit of the assignee. d. Entire Agreement. Except as expressly provided below, this Agreement, the Option Agreement and the portion, if any, of any other agreement relating to pension service or credits referred to in Paragraph 5(a) shall constitute the entire agreement between the parties hereto with respect to the matters referred to herein and any other agreement or any portion of any such other agreement not expressly preserved hereby shall cease to be effective upon the execution hereof and shall not become reinstated upon the expiration or other termination of this Agreement. There are no promises, representations, inducements or statements between the parties other than those that are expressly contained herein. Executive acknowledges that he is entering into this Agreement of his own free will and accord, and with no duress, that he has read this Agreement and that he understands it and its legal consequences. Other than the provisions of Paragraph 6 which limit Executive's eligibility to receive severance benefits under the Company's generally applicable plans, programs or agreements, nothing in this Agreement shall be construed to limit or otherwise supersede Executive's rights or entitlements under any compensatory plan, program or arrangement made available generally to all employees or all officers of the Company or under the 1994 Plan or the 1984 Plan and this Paragraph 9(d) shall not preclude reference to the documents governing any such plan, program or arrangement to determine such rights and entitlements. e. Severability; Reformation. In the event that one or more of the provisions of this Agreement shall become invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not be affected thereby. In the event any of Paragraph 8(a), (b) or (c) is not enforceable in accordance with its terms, Executive and the Company agree that such Paragraph shall be reformed to make such Paragraph enforceable in a manner which provides the Company the maximum rights permitted at law. f. Waiver. Waiver by any party hereto of any breach or default by the other party of any of the terms of this Agreement shall not operate as a waiver of any other breach or default, whether similar to or different from the breach or default waived. No 19 20 waiver of any provision of this Agreement shall be implied from any course of dealing between the parties hereto or from any failure by either party hereto to assert its or his rights hereunder on any occasion or series of occasions. g. Notices. Any notice required or desired to be delivered under this Agreement shall be in writing and shall be delivered personally, by courier service, by registered mail, return receipt requested, or by telecopy and shall be effective upon actual receipt by the party to which such notice shall be directed, and shall be addressed as follows (or to such other address as the party entitled to notice shall hereafter designate in accordance with the terms hereof): If to the Company: Aetna Life and Casualty Company 151 Farmington Avenue Hartford, Connecticut Attention: Corporate Secretary If to Executive: Thomas J. McInerney 110 Mountain Terrace Road West Hartford, Connecticut 06107 h. Arbitration. The Company and Executive agree that any claim, dispute or controversy arising under or in connection with this Agreement, or otherwise in connection with Executive's employment by the Company (including, without limitation, any such claim, dispute or controversy arising under any federal, state or local statute, regulation or ordinance or any of the Company's employee benefit plans, policies or programs) shall be resolved solely and exclusively by binding arbitration. The arbitration shall be held in the city of Hartford, Connecticut (or at such other location as shall be mutually agreed by the parties). The arbitration shall be conducted in accordance with the Expedited Employment Arbitration Rules (the "Rules") of the American Arbitration Association (the "AAA") in effect at the time of the arbitration, except that the arbitrator shall be selected by alternatively striking from a list of five arbitrators supplied by the AAA. All fees and expenses of the arbitration, including a transcript if either requests, shall be borne equally by the parties. If Executive prevails as to any material issue presented to the arbitrator, the entire cost of such proceedings (including, without limitation, Executive's reasonable attorneys fees) shall be borne by the Company. If Executive does not prevail as to any material issue, each party will pay for the fees and expenses of its own attorneys, experts, witnesses, and preparation and presentation of proofs and post-hearing briefs (unless the party prevails on a claim for which attorney's fees are recoverable under the Rules). Any action to enforce or vacate the arbitrator's award shall be governed by the Federal Arbitration Act, if applicable, and otherwise by applicable state law. If either the Company or Executive pursues any claim, dispute or controversy against the other in a proceeding other than the arbitration provided for herein, the responding party shall 20 21 be entitled to dismissal or injunctive relief regarding such action and recovery of all costs, losses and attorney's fees related to such action. i. Amendments. This Agreement may not be altered, modified or amended except by a written instrument signed by each of the parties hereto. j. Headings. Headings to paragraphs in this Agreement are for the convenience of the parties only and are not intended to be part of or to affect the meaning or interpretation hereof. k. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. l. Withholding. Any payments provided for herein shall be reduced by any amounts required to be withheld by the Company from time to time under applicable Federal, State or local income or employment tax laws or similar statutes or other provisions of law then in effect. m. Governing Law. This Agreement shall be governed by the laws of the State of Connecticut, without reference to principles of conflicts or choice of law under which the law of any other jurisdiction would apply. IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer and Executive has hereunto set his hand as of the day and year first above written. Aetna Life and Casualty Company /s/ Ronald E. Compton ------------------------------- Ronald E. Compton Chairman /s/ Thomas J. McInerney ------------------------------- Thomas J. McInerney 21 22 EXHIBIT A TO EMPLOYMENT AGREEMENT AETNA LIFE AND CASUALTY COMPANY 1994 STOCK INCENTIVE PLAN PERFORMANCE VESTED NONSTATUTORY STOCK OPTION AGREEMENT Pursuant to its 1994 Stock Incentive Plan, Aetna Life and Casualty Company hereby grants to the person named below the right and option to purchase the stated number of shares of Common Stock on the terms and conditions hereinafter set forth.
- -------------------------------------------------------------------------------- Effective Date Aetna No. Grantee Total Optioned Shares Option Price - --------------------------------------------------------------------------------
ARTICLE I DEFINITIONS (a) "Board" means the Board of Directors of Aetna Life and Casualty Company. (b) "Committee" means the Board's Committee on Compensation and Organization or any successor thereto. (c) "Common Stock" means shares of the Company's Common Capital Stock, without par value. (d) "Company" means Aetna Life and Casualty Company. (e) "Disability" means long-term disability as defined under the terms of the Company's applicable long-term disability plans or policies. (f) "Effective Date" means the date of grant of this Option, as set forth above. (g) "Fair Market Value" means the closing price of the Common Stock as reported by the Consolidated Tape of the New York Stock Exchange Listed Shares on the date such value is to be determined, or, if no shares were traded on such day, on the next preceding day on which the Common Stock was traded. (h) "For Cause" means a termination of Grantee's employment by the Company due to (i) the willful failure by Grantee to perform substantially Grantee's duties as an employee of the Company (other than due to physical or mental illness) after reasonable notice to Grantee of such failure, (ii) Grantee's engaging in serious misconduct that is injurious to the Company or any subsidiary or any affiliate of the Company, (iii) Grantee's having been convicted of, or entered a plea of nolo 22 23 contendere to, a crime involving an act that is immoral or wrong in and of itself (e.g., burglary, larceny, murder or arson) or a crime involving deceit, fraud, perjury or embezzlement, (iv) the breach by Grantee of any written covenant or agreement not to compete with the Company or any subsidiary or any affiliate or (v) the breach by Grantee of his duty of loyalty to the Company which shall include, without limitation, (A) the disclosure by Grantee of any confidential information pertaining to the Company or any Subsidiary or any affiliate of the Company, other than (x) in the, ordinary course of the performance of his duties on behalf of the Company or (y) pursuant to a judicial or administrative subpoena from a court or governmental authority with jurisdiction over the matter in question, (B) the harmful interference by Grantee in the business or operations of the Company or any Subsidiary or any affiliate of the Company, (C) any attempt by Grantee directly or indirectly to induce any employee, insurance agent, insurance broker or broker-dealer of the Company or any Subsidiary or any affiliate to be employed or perform services elsewhere, (D) any attempt by Grantee directly or indirectly to solicit the trade of any customer or supplier, or prospective customer or supplier, of the Company on behalf of any person other than the Company or a Subsidiary thereof or (E) any breach or violation of the Company's Code of Conduct, as amended from time to time. Notwithstanding the foregoing, a breach of Grantee's duty of loyalty to the Company as described in subclause (A) or (E) of clause (v) of the preceding sentence shall not be grounds for a termination For Cause unless such breach has had or could reasonably be expected to have a significant adverse effect on the business or reputation of the Company. (i) "Fundamental Corporate Event" shall mean any stock dividend, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below fair market value, or similar event. (j) "Good Reason" means a termination of Grantee's employment by Grantee within 90 days following (i) a reduction in Grantee's annual Base Salary or incentive compensation opportunity as provided under Paragraph 3(b) of the employment agreement signed by Grantee and the Company dated as of December 8, 1995 (the "Employment Agreement"), (ii) a material reduction in Grantee's positions, duties and responsibilities from those described in Paragraph 2 of the Employment Agreement, (iii) the relocation of Grantee's principal place of employment to a location more than 50 miles from the location at which he performed his principal dudes on the date immediately prior to such relocation, (iv) a breach of the obligation to provide Grantee with the benefits required to be provided in accordance with Paragraph 5(a) of the Employment Agreement, (v) a failure by the Company to pay any amounts due and owing to Grantee within 10 days following written notice from Grantee of such failure to pay, or (vi) any other material breach of the Company's obligations to Grantee under the Employment Agreement that significantly affects the compensation or benefits payable to Grantee or materially impairs Grantee's ability to perform the duties and responsibilities of his position. Notwithstanding the foregoing, a termination shall not be treated as a termination for Good Reason (i) if Grantee shall 23 24 have consented in writing to the occurrence of the event giving rise to the claim of termination for Good Reason or (ii) unless Grantee shall have delivered a written notice to the Chief Executive Officer of the Company within 60 days of his having actual knowledge of the occurrence of one or such events stating that he intends to terminate his employment for Good Reason and specifying the factual basis for such termination, and such event shall not have been cured within 30 days of the receipt of such notice. (k) "Grantee" means the person named above to whom this Option has been granted. (l) "Interim Performance Period" means the period of time beginning on the Effective Date and ending on April 28, 1997. (m) "Option" means the option herein granted. (n) "Option Price" means the amount per share of Common Stock required to be paid upon the exercise of this Option, as set forth above, or such other amount per share of Common Stock as may result by operations of Article IV of this Agreement. (o) "Optioned Shares" means the number of shares of Common Stock represented by this Option, as set forth above, or such other amount as may result by operation of Article IV of this Agreement. (p) "Performance Target" means the performance objective measured by the price of the Common Stock as described in Article II. (q) "Performance Period" means the period of time beginning on the Effective Date and ending on April 28, 1998. (r) "Plan" means the Aetna Life and Casualty Company 1994 Stock Incentive Plan. (s) "Retirement" means the termination of employment of a Grantee from active service with the Company or a Subsidiary under circumstances which would entitle an employee of the Company or a Subsidiary to an immediate pension under one of the Company's approved retirement plans (such pension may be actuarially reduced for early commencement of benefits). (t) "Shares of Stock" or "Stock" means the Common Stock. (u) "Subsidiary" means any entity of which, at the time such subsidiary status is to be determined, at least 50% of the total combined voting power of all classes of stock in such entity is held by the Company and its Subsidiaries (exclusive of ownership by the entity whose subsidiary status is being determined). 24 25 (v) "Successor" means the legal representative of the estate of a deceased Grantee or the person or persons who shall acquire the right to exercise an Option by bequest or inheritance or by reason of the death of the Grantee. 25 26 ARTICLE II TERM OF OPTION AND VESTING (a) The Term of this Option shall commence on the Effective Date and shall terminate, unless sooner terminated by the terms of the Plan or this Agreement, at: (i) the close of the Company's business on the day preceding the tenth anniversary of the Effective Date, if the Company is open for business on such day; or (ii) the close of the Company's business on the next preceding day that the Company is open for business. (b) Except as provided in (c), (d) and (e) below, all or a portion of this Option will become vested and the Option will be exercisable on April 28, 1998 only to the extent the Fair Market Value of the Common Stock meets or exceeds the Performance Targets described below. A Performance Target shall be deemed to have been met only to the extent the Fair Market Value of the Common Stock meets or exceeds the Performance Target for at least five consecutive trading business days at any time during the Performance Period.
------------------------------------------------- Performance Target Amount Vested ------------------------------------------------- Below $62 Option does not vest $62 33% $67 67% $73 or above 100% -------------------------------------------------
The portion of the Option which shall vest at performance levels between $62 and $73 shall be determined by mathematical interpolation between the respective measuring points. Notwithstanding anything else contained herein to the contrary, the portion of the Option which has become vested under Section (b), if any, shall be reduced by the amount which has become vested pursuant to (c) below. (c) If the Performance Targets described above are met or exceeded during the Interim Performance Period, 50% of the amount which would have become vested in accordance with the above schedule will become vested on April 28, 1997. (d) This Option may become vested pursuant to (b) and (c) above only if the Grantee is an active employee of the Company or a Subsidiary as of the last day of the Performance Period or the Interim Performance Period, as the case may be; provided, however, if the Company involuntarily terminates the employment of the Grantee (other than "For Cause"), the Grantee dies or terminates employment for reason of Disability, or if the Grantee voluntarily terminates employment for "Good Reason," the Option may 26 27 continue to vest for such Grantee if the Performance Targets are met during the Performance Period or Interim Performance Period. (e) If the Performance Targets are not met as of the end of the Performance Period, the Options will become vested on April 28, 2002, provided the Grantee is an active employee of the Company or a Subsidiary on that date. ARTICLE III METHOD OF OPTION EXERCISE An option is exercisable only after it has become vested as provided in Article II above. In order to exercise this Option, Grantee must comply with procedures adopted by the Company from time to time. Under current procedures, the Grantee must deliver or mail to the Committee, Attention: Manager, Grantee Compensation, Aetna Human Resources, a properly executed exercise notification letter on the appropriate form along with payment of the Option Price. If Grantee is using the cashless exercise program offered by the Company, the exercise notice must be delivered to the participating broker. In addition, if the Grantee has been notified that he or she must consult with a member of the Company's Law and Regulatory Affairs Department prior to engaging in transactions in Aetna stock, Grantee must consult with the Law and Regulatory Affairs prior to exercising this Option. ARTICLE IV CAPITAL CHANGES Except as otherwise specifically provided in Article VI, in the event that the Committee shall determine that any Fundamental Corporate Event affects the Common Stock such that an adjustment is required to preserve, or to prevent enlargement of, the benefits or potential benefits made available under this Plan, then the Committee may, in such manner as the Committee may deem equitable, adjust the (i) the number and kind of shares subject to the Option (including substitution of shares or Options of another company), (ii) the Performance Targets, or (iii) the Option Price. Additionally, the Committee may make provision for a cash payment to a Grantee or the Successor of the Grantee. However, the number of Shares of Stock subject to the Option shall always be a whole number. ARTICLE V TERMINATION OF OPTION (a) Except as provided in (d) below, if the Grantee shall cease, for reason of death, Disability or Retirement, to be employed by the Company or its Subsidiaries during 27 28 the Term of the Option, the Grantee or Successor of the Grantee may exercise a vested Option until the earlier of: (i) the expiration of the Term of the Option; or (ii) a period not to exceed five years following such cessation of employment. (b) Except as provided in (a) above or (d) below, if the Grantee voluntarily ceases to be employed by the Company or its Subsidiaries (other than for "Good Reason") during the Term of the Option, the Grantee may exercise a vested Option until the earlier of: (i) the expiration of the Term of the Option; or (ii) a period not to exceed ninety days following such cessation of employment; (c) Except as provided in (a) above or (d) below, if the Grantee involuntarily ceases to be employed by the Company or its Subsidiaries other than for cause, or if Grantee voluntarily terminates employment for "Good Reason" during the Term of the Option, the Grantee may exercise a vested Option under the later of the expiration of four years from the Effective Date, or ninety days following such cessation of employment (but not following the expiration of the Term of the Option). (d) An Option that has not become vested as provided in Article II above at the time of cessation of employment (or after cessation of employment as provided in Article II(d)) may not be exercised thereafter. No Option may be exercised after the Company has terminated the employment of the Grantee For Cause, except that the Committee may, in its sole discretion, permit exercises for a period of up to ninety days in cases where the Committee shall determine such period is warranted under the particular circumstances. (e) If the Grantee has not entered into a written employment agreement satisfactory to the Company prior to February 16, 1996, this Option shall immediately terminate as of that date and shall have no further force or effect. In addition, if Grantee fails to comply with the terms of any written employment agreement entered into with the Company, said failure shall cause this Option to immediately terminate, whether or not the Option has become vested. (f) Employment for purposes of determining eligibility for vesting post-employment exercise rights of the Grantee under this Agreement shall mean continuous full-time salaried employment with the Company or a Subsidiary and shall include periods during which the Grantee is on vacation, sick leave, or other approved absence, or in receipt of severance pay or other form of salary continuation benefit. 28 29 (g) Except as otherwise herein provided, exercise of this Option, whether by the Grantee or the Successor of the Grantee, shall be subject to all terms and conditions of this Agreement. 29 30 ARTICLE VI CHANGE-OF-CONTROL (a) For purposes of this Article VI, a "Change of Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act but excluding the Company and any subsidiary thereof and any employee benefit plan sponsored or maintained by the Company or any Subsidiary (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months after the Commencement Date, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof, provided that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Article VI(a)(ii); or (iii) The occurrence of a transaction requiring stockholder approval for the acquisition of the Company by an entity other than the Company or a subsidiary through purchase of assets, or by merger, or otherwise. (b) Unless the Board (or the Committee) shall otherwise determine in the manner set forth in Paragraph (c) below and notwithstanding anything in this Agreement to the contrary, this Option shall become fully exercisable upon the occurrence of a Change of Control (as defined in Paragraph (a) above) and shall remain exercisable for a period of at least one year thereafter regardless of whether Grantee continues to be employed by the Company or, if longer, for the period during which such Option would otherwise by exercisable in accordance with its terms. (c) Notwithstanding paragraph (b) above, no acceleration of exercisability shall occur with respect to any Option if the Board (or the Committee) reasonably determines in good faith, prior to the occurrence of a Change of Control, that such Option shall be honored or assumed, or new rights substituted therefor (such honored, assumed or 30 31 substituted Option being hereinafter referred to as an "Alternative Option") by the successor in interest to the Company, provided that any such Alternative Option must: (i) provide Grantee with rights and entitlements substantially equivalent to or better than the rights, terms and conditions applicable under the Option, including, but not limited to, an identical or better exercise and vesting schedule and identical or better timing and methods of payment; (ii) have substantially equivalent economic value to such Option (determined at the time of the Change of Control); and (iii) have terms and conditions which provide that, in the event that the Company involuntarily terminates employment of Grantee for any reason or if the Grantee terminates employment for Good Reason within two years following a Change of Control, any conditions on Grantee's rights under, or any restrictions on exercisability applicable to, each such Alternative Option shall be waived or shall lapse, as the case may be and the Alternative Option shall remain exercisable until the second anniversary of the Change of Control or, if longer, for the period during which such Alternative Option would otherwise be exercisable in accordance with its terms or the provisions of the plan under which it is granted that permit the longest post-termination exercise period for involuntary terminations (other than due to death, disability or retirement). ARTICLE VII OTHER TERMS (a) Grantee understands that the Grantee shall not have any rights as stockholder by virtue of the grant of an Option but only with respect to shares of Common Stock actually issued to the Grantee in accordance with the terms hereof. (b) Anything herein to the contrary notwithstanding, the Company may postpone the exercise of the Option for such time as the Committee in its discretion may deem necessary, in order to permit the Company with reasonable diligence (i) to effect or maintain registration under the Securities Act of 1933, as amended, of the Plan or the shares of Common Stock issuable upon the exercise of the Option, or (ii) to determine that the Plan and such shares are exempt from registration; and the Company shall not be obligated by virtue of this Option Agreement or any provision of the Plan to recognize the exercise of the Option or to sell or issue shares of Common Stock in violation of said Act or of the law of any government having jurisdiction thereof. Any such postponement shall not extend the Term of the Option; and neither the Company nor its Board shall have any obligation or liability to the Grantee, or to the Grantee's Successor, with respect to any shares of Common Stock as to which the Option shall lapse because of such postponement. 31 32 (c) The Option shall be nontransferable and nonassignable except by will and by the laws of descent and distribution. During the Grantee's lifetime, the Option may be exercised only by the Grantee. (d) This Option is not an incentive stock option as described in the Internal Revenue Code of 1986, as amended, Section 422A(b). (e) This Agreement is subject to the 1994 Stock Incentive Plan heretofore adopted by the Company and approved by its shareholders. The terms and provisions of the Plan (including any subsequent amendments thereto) are hereby incorporated herein by reference. In the event of a conflict between any term or provision contained herein and a term or provision of the Plan, the applicable terms and provisions of the Plan will govern and prevail. IN WITNESS WHEREOF, AETNA LIFE AND CASUALTY COMPANY has caused this Option Agreement to be executed as of the Effective Date, and Grantee has accepted the terms and provisions hereof. AETNA LIFE AND CASUALTY COMPANY By:_________________________________ Its Chairman Accepted:________________________ (Signature) Name: ________________________ Title: ________________________ Social Security Number:__________ Dated: ________________________ 32 33 EXHIBIT B TO EMPLOYMENT AGREEMENT RELEASE AGREEMENT I,____________________ acknowledge that this document accurately reflects an agreement entered into between me and Aetna Life and Casualty Company (the "Company") as of this ______ day of __________, 199__. In consideration for the benefits and consideration set forth in Paragraph 6 of the attached employment agreement (the "Agreement"), I hereby agree to the following: 1. DEFINITION. In this agreement the word "Company" means not only the Company by which I was employed, but also parent and subsidiary corporations, any affiliated entities whether or not incorporated, the employee, agents, officers, directors and shareholders of all such entities and any person or entity which may succeed to the rights and liabilities of such entities by assignment or otherwise. 2. RELEASE. I hereby release and hold harmless (on behalf of myself and my family, heirs, executors, successors and assigns) now and forever, the Company from and waive any claim that I have presently, may have or have had in the past, known or unknown, against the Company by reason of my employment by the Company including, without limitation, the termination thereof, other than claims I may have (i) to the payment of amounts due and payable in accordance with the terms of the Agreement, including without limitation the Severance Benefits and the Vested Benefits (as each such term is defined in the Agreement) and (ii) to be indemnified by the Company pursuant to its applicable policies and practices from and against any third party claims arising out of or relating to Executive's employment with or other services on behalf of the Company or any subsidiary of the Company. 3. EXTENT OF RELEASE. This agreement is valid whether any claim arises under any federal, state or local statute (including, without limitation, Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1991, the Age Discrimination in Employment Act of 1967, the Equal Pay Act, the Americans with Disabilities Act of 1990, the Employee Retirement Income Security Act of 1974 and all other statutes regulating the terms and conditions of my employment), regulation or ordinance, under the common law or in equity (including any claims for wrongful discharge or otherwise), or under any policy, agreement, understanding or promise, written or oral, formal or informal, between the Company and myself. 4. CONSIDERATION. The consideration hereby provided to me under the Agreement is not required under the Company's standard policies and I know of no circumstances other than my agreeing to the terms of this agreement which would require the Company to provide such consideration. 33 34 5. RESTRICTIONS. I have not filed, nor will I initiate or cause to be initiated on my behalf, any complaint, charge, claim or proceeding against the Company before any local, state or federal agency, court or other body relating to my employment or the termination thereof (each individually a "Proceeding"), nor will I participate in any Proceeding. I waive any right I may have to benefit in any manner from any relief (whether monetary or otherwise) arising out of any Proceeding, including any EEOC proceeding. I understand that by entering into this agreement, I will be limiting the availability of certain remedies that I may have against the Company and limiting also my ability to pursue certain claims against the Company. The foregoing will not be used to justify interfering with any right I may have to file a charge or participate in an investigation or proceeding conducted by the EEOC. 6. PENALTIES. If I initiate or participate in any legal actions, as described above, the Company shall have the right, but shall not be obligated, to deem this agreement void without effect and to require me to repay to the Company any amounts (other than Earned Salary and Vested Benefits) payment of which was conditioned on the execution of this agreement, plus interest thereon from the original date of payment at an annual rate, compounded semi-annually, equal to the prime rate as quoted in the Wall Street Journal on my date of termination, plus 2 percent and to terminate any benefit or payments (other than with respect to Vested Benefits) that are otherwise payable under the Agreement. 7. RIGHT TO COUNSEL. The Company advises me that I should consult with an attorney prior to execution of this agreement and the Agreement. I understand that it is in my best interest to have this document and the Agreement reviewed by an attorney of my own choosing and at my own expense, and I hereby acknowledge that I have been afforded a period of at least twenty-one days during which to consider this agreement and the Agreement and to have this agreement and the Agreement reviewed by my attorney. 8. SEVERABILITY CLAUSE. Should any provision or part of this agreement be found to be invalid or unenforceable, only that particular provision or part so found and not the entire agreement shall be inoperative. 9. EVIDENCE. This document may be used as evidence in any proceeding relating to my employment or the termination thereof. I waive all objections as to its form. 10. FREE WILL. I am entering into this agreement and the Agreement of my own free will. The Company has not exerted any undue pressure or influence on me in this regard. I have had reasonable time to determine whether entering into this agreement and the Agreement is in my best interest. I understand that if I request additional time to review the provisions of this agreement and the Agreement, a reasonable extension of time will be granted. 11. REVOCATION. This agreement may be revoked by me within seven days after the date on which I sign this agreement and I understand that this agreement and the Agreement are not binding or enforceable until such seven day period has expired. Any such revocation must be made in a signed letter executed by me and received by the Company at 34 35 the following address no later than 5 p.m. Eastern Standard Time on the seventh day after I have executed this agreement and the Agreement: _____________. I understand that if I revoke this agreement, the Agreement will not be effective or enforceable and I will not be entitled to any benefits thereunder. 12. NON-ADMISSION. Nothing contained in this agreement shall be deemed or construed as an admission of wrongdoing or liability on the part of the Company. 13. GOVERNING LAW. This agreement and the Agreement shall be construed in accordance with the laws of the State of Connecticut, applicable to contracts made and entirely to be performed therein. Date: ________________________ ____________________________________ 35 36 [LOGO] Interoffice Mary Ann Champlin Communication Senior Vice President Aetna Human Resources, RC3A (203) 273-8371 Fax: (203) 560-8721 To... Thomas J. McInerney Date... May 2, 1996 Subject... Employment Agreement This memorandum is intended to amend that certain Employment Agreement dated as of December 19, 1995 by and between Aetna Life and Casualty Company and you. 1. Paragraph 1 shall be amended and restated as follows: Employment. Except as provided in Paragraph 6(a), the Company shall continue to employ Executive and Executive agrees to remain employed by the Company under the terms of this Agreement for the period commencing on the date first written above and ending December 31, 1998. The period during which Executive is employed pursuant to this Agreement shall be referred to as the "Contract Employment Period". The Contract Employment Period shall automatically be extended for one additional year unless, not later than 180 days prior to the end of the Contract Employment Period, the Company or Executive shall have given notice not to extend the Contract Employment Period. The giving by the Company of a notice not to extend the Contract Employment Period shall not constitute a Termination Without Cause or a Termination for Good Reason (as defined below). Upon the expiration of the Contract Employment Period, Executive's employment with the Company shall continue on an at-will basis. 2. Paragraph 3 shall be amended and restated as follows: Compensation a. Base Salary. During the Contract Employment Period, the Company shall pay Executive a base salary at the annual rate of $450,000 effective April 29, 1996. The Board shall periodically review Executive's base salary and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above, is referred to herein as "Base Salary". Executive's Base Salary, as in effect from time to time, may not be reduced by the Company without Executive's consent, provided that the Base Salary payable under this paragraph shall be reduced to the extent Executive elects to defer or reduce such salary under the terms of any deferred compensation or savings plan or other employee benefit arrangement maintained or established by the Company. The Company shall pay Executive the portion of his Base Salary not deferred in accordance with its customary periodic payroll practices. b. Incentive Compensation. During the term of the Contract Employment Period, Executive shall remain eligible for participation in the Company's existing and future annual and long term 36 37 incentive compensation programs at a level consistent with his position at the Company and the Company's then current policies and practices; provided that following any assignment of this Agreement in accordance with the provisions of Paragraph 9(c) or a Change in Control of the Company (as defined in Paragraph 7(e)), the calculation of the amount payable as annual incentive compensation and the conditions upon which such bonus shall be payable shall be no less favorable to the Executive (taking into account reasonable changes in the Company's goals and objectives) than the annual bonus opportunity that had been made available to the Executive for the fiscal year ended immediately prior to such assignment or Change in Control. Without limiting the generality of the foregoing, beginning with the performance year 1997, for each performance year ending during the term hereof, Executive shall receive the opportunity to receive an annual bonus of at least 80% of his Base Salary (the "Minimum Bonus Percentage"), subject to satisfaction of such reasonable performance criteria as shall be established with respect to such year. 3. Paragraph 4 shall be amended and restated as follows: Options. a. Stock Option Grant. Contingent upon the execution of this Agreement by the Executive, the Company has granted Executive an option, having a ten-year term, to purchase 25,000 shares of the Company's Common Stock at an exercise price per share equal to $57 a share (the "Option"). Except to the extent specified below, the terms of the Option shall be determined in accordance with the terms of the 1994 Stock Incentive Plan (the "1994 Plan") and shall be set forth in the separate agreement embodying the grant of such Option (the "Option Agreement"), the form of which is attached hereto as Exhibit A. b. Performance Vested Stock Option Grant. Contingent upon the execution of this amendment to the Agreement by the Executive, the Company has granted Executive an option, having a ten-year term, to purchase 44,400 shares of the Company's Common Stock at an exercise price per share equal to $71 a share (also referred to as the "Option"). Except to the extent specified below, the terms of the Option shall be determined in accordance with the terms of the 1994 Stock Incentive Plan (the "1994 Plan") and shall be set forth in the separate agreement embodying the grant of such Option (also referred to as the "Option Agreement"). Except as amended herein, the Employment Agreement shall remain in full force and effect. Aetna Life and Casualty Company By: /s/ Mary Ann Champlin /s/ Thomas J. McInerney --------------------------------- ------------------------------- Thomas J. McInerney Date: May 2, 1996 Date: May 7, 1996 - ------------------------- ------------------------------- 37 38 [LOGO] Interoffice Communication Mary Ann Champlin Aetna Human Resources, RC3A (860) 273-8371 Fax: (860) 560-8721 To Thomas McInerney Date July 22, 1996 Subject Employment Agreement I am pleased to inform you that effective July 19, 1996, Aetna Inc. has assumed all of the obligations of Aetna Services, Inc. (formerly Aetna Life and Casualty Company) under your Employment Agreement with Aetna Services, Inc. All references to the "Company" in your Employment Agreement will hereinafter be deemed to mean both Aetna Services, Inc. and Aetna Inc. Among other things, this means that the Change in Control provisions of your Employment Agreement would be triggered by a change in control of either Aetna Services, Inc. or Aetna Inc. By way of background, Aetna Inc. became the ultimate parent within the Aetna holding company system as a result of the merger with U.S. Healthcare. Your Employment Agreement was entered into with Aetna Services, Inc., which is now a direct subsidiary of Aetna Inc. We felt it would be appropriate for the new ultimate parent, Aetna Inc., to assume these obligations to place you on an equivalent footing post-merger. The assumption of your Employment Agreement is self-executing. You do not need to take any action in response to this letter. If you have any questions or concerns, please let me know. /s/ Mary Ann Champlin 38 EX-12 4 STATEMENT RE COMPUTATION OF RATIOS 1 Page 1 EXHIBIT 12 AETNA INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(Millions) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Pretax income (loss) from continuing operations $1,511.2 $338.7 $726.2 $627.5 $(1,014.7) Add back fixed charges 321.9 245.1 187.0 170.8 154.7 Minority interest 14.7 16.4 16.1 11.4 7.0 -------- ------ ------ ------ --------- Income (loss) as adjusted $1,847.8 $600.2 $929.3 $809.7 $ (853.0) ======== ====== ====== ====== ========= Fixed charge Interest on indebtedness $ 235.8(1) $168.3(1) $115.9(1) $ 98.6(1) $ 77.4 Portion of rents representative of interest factor 86.1 76.8 71.1 72.2 77.3 -------- ------ ------ ------ --------- Total fixed charges $ 321.9 $245.1 $187.0 $170.8 $ 154.7 ======== ====== ====== ====== ========= Preferred stock dividend requirements 92.4 41.1 -- -- -- -------- ------ ------ ------ --------- Total combined fixed charges and preferred stock dividend requirements $ 414.3 $286.2 $187.0 $170.8 $ 154.7 ======== ====== ====== ====== ========= Ratio of earnings to fixed charges 5.74 2.45 4.97 4.74 (5.51) ======== ====== ====== ====== ========= Ratio of earnings to combined fixed charges and preferred stock dividends 4.46 2.10 4.97 4.74 (5.51) ======== ====== ====== ====== =========
(1) Includes the dividends paid to preferred shareholders of a subsidiary. (See Note 14 of Notes to Financial Statements in the 1997 Annual Report.) 2 Page 2 EXHIBIT 12 AETNA SERVICES, INC. (1) COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(Millions) 1997 1996 ---- ---- Pretax income from continuing operations $ 1,505.2 $ 335.0 Add back fixed charges 318.1 243.8 Minority interest 15.7 16.4 --------- --------- Income as adjusted $ 1,839.0 $ 595.2 ========= ========= Fixed charges: Interest on indebtedness $ 234.0(2) $ 168.3(2) Portion of rents representative of interest factor 84.1 75.5 --------- --------- Total fixed charges $ 318.1 $ 243.8 ========= ========= Preferred stock dividend requirements -- -- --------- --------- Total combined fixed charges and preferred stock dividend requirements $ 318.1 $ 243.8 ========= ========= Ratio of earnings to fixed charges 5.78 2.44 ========= ========= Ratio of earnings to combined fixed charges and preferred stock dividends 5.78 2.44 ========= =========
(1) Aetna Inc. has fully and unconditionally guaranteed the payment of all principal, premium, if any, and interest on all outstanding debt securities of Aetna Services, Inc. (See Note 13 of Notes to Financial Statements in the 1997 Annual Report.) (2) Includes the dividends paid to preferred shareholders of a subsidiary. (See Note 14 of Notes to Financial Statements in the 1997 Annual Report.) EX-13 5 ANNUAL REPORT TO SECURITY HOLDERS 1 Page 1 EXHIBIT 13 Selected Financial Data
(Millions, except per common share data) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Premiums: Aetna U.S. Healthcare $ 10,844.6 $ 7,765.2 $ 5,949.7 $ 5,611.5 $ 4,700.6 Aetna Retirement Services 158.5 180.7 260.2 235.7 189.8 International 1,434.1 1,166.1 1,038.5 887.1 909.5 Large Case Pensions 155.0 214.1 244.4 123.5 90.8 ---------------------------------------------------------- Total Premiums 12,592.2 9,326.1 7,492.8 6,857.8 5,890.7 - ------------------------------------------------------------------------------------------------------ Net Investment Income, Fees and Other Income, and Net Realized Capital Gains (Losses): Aetna U.S. Healthcare 2,056.8 1,968.5 1,665.7 1,527.6 1,405.4 Aetna Retirement Services 1,744.0 1,581.5 1,445.9 1,269.1 1,269.6 International 541.4 464.9 421.3 409.9 369.8 Large Case Pensions 1,467.5 1,761.5 2,004.0 2,120.8 2,380.1 Corporate: Other 138.3 98.0 9.7 (9.7) (6.9) ---------------------------------------------------------- Total Net Investment Income, Fees and Other Income, and Net Realized Capital Gains (Losses) 5,948.0 5,874.4 5,546.6 5,317.7 5,418.0 - ------------------------------------------------------------------------------------------------------ Total Revenue $ 18,540.2 $ 15,200.5 $ 13,039.4 $ 12,175.5 $ 11,308.7 - --------------------------------------------========================================================== Income (Loss) from Continuing Operations before Extraordinary Item and Cumulative Effect Adjustments: Aetna U.S. Healthcare $ 453.8 $ 58.7 $ 286.0 $ 341.7 $ 272.2 Aetna Retirement Services 257.1 186.2 198.0 159.1 111.4 International 142.4 109.9 86.6 71.2 55.0 Large Case Pensions 234.2 258.4 89.2 54.4 (822.3) Corporate: Interest (147.5) (103.9) (70.4) (60.5) (44.7) Other (38.9) (304.2) (115.5) (156.5) (173.9) - ------------------------------------------------------------------------------------------------------ Income (Loss) from Continuing Operations before Extraordinary Item and Cumulative Effect Adjustments 901.1 205.1 473.9 409.4 (602.3) - ------------------------------------------------------------------------------------------------------ Net Income (Loss) 901.1 651.0 251.7 467.5 (365.9) - ------------------------------------------------------------------------------------------------------ Net Realized Capital Gains (Losses), Net of Tax (included above) 198.4 85.9 29.5 (41.2) (42.0) - ------------------------------------------------------------------------------------------------------ Total Assets 96,000.6 92,912.9 84,323.7 75,486.7 81,572.8 - ------------------------------------------------------------------------------------------------------ Total Long-Term Debt 2,346.2 2,380.0 989.1 1,079.2 1,112.2 - ------------------------------------------------------------------------------------------------------ Aetna-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Limited Liability Company Holding Primarily Debentures Guaranteed by Aetna 275.0 275.0 275.0 275.0 - - ------------------------------------------------------------------------------------------------------ Shareholders' Equity 11,195.4 10,889.7 7,272.8 5,503.0 7,043.1 - ------------------------------------------------------------------------------------------------------ Per Common Share Data: Income (Loss) from Continuing Operations before Extraordinary Item and Cumulative Effect Adjustments Basic $ 5.67 $ 1.37 $ 4.18 $ 3.64 $ (5.43) Diluted 5.60 1.36 4.14 3.62 (5.43) Net Income (Loss) Basic 5.67 4.77 2.22 4.15 (3.30) Diluted 5.60 4.72 2.20 4.14 (3.30) Dividends Declared .80 1.29 2.76 2.76 2.76 Shareholders' Equity 70.85 66.79 63.39 48.85 62.77 Market Price at Year End 70.56 80.00 69.25 47.13 60.38 - ------------------------------------------------------------------------------------------------------
See Notes to Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations for significant events affecting the comparability of current year results with 1996 and 1995 results. 2 Page 2 Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of Aetna Inc. and its subsidiaries (collectively, the "Company") as of December 31, 1997 and 1996, and its results of operations for 1997, 1996 and 1995. Overview General The Company's current operations include three core businesses - Aetna U.S. Healthcare, Aetna Retirement Services and Aetna International. Aetna U.S. Healthcare provides a full spectrum of managed care, indemnity, and group life and disability insurance products. Aetna Retirement Services offers a range of financial services and individual life insurance products. Aetna International, through subsidiaries and joint venture operations, sells primarily life insurance, health insurance and financial services products in non-U.S. markets. The Company also has a Large Case Pensions business which manages a variety of retirement products for defined benefit and defined contribution plans. Aetna Inc. became the parent corporation of Aetna Services, Inc. ("Aetna Services")(formerly Aetna Life and Casualty Company) and Aetna U.S. Healthcare Inc. (formerly U.S. Healthcare, Inc.) as a result of a merger transaction on July 19, 1996. The merger was accounted for as a purchase of U.S. Healthcare. (See Note 2 of Notes to Financial Statements for a discussion of the merger and related matters, including the issuance of additional common stock and preferred stock, which affects the year to year comparability of per common share amounts.) The Company also sold its property-casualty operations on April 2, 1996. (See Note 3 of Notes to Financial Statements for a discussion of certain indemnifications and other information related to the property-casualty sale.) Consolidated Results The Company reported income from continuing operations of $901 million in 1997, $205 million in 1996 and $474 million in 1995. These results include severance and facilities actions in 1997 and 1996, reductions of the reserve for loss on discontinued products for Large Case Pensions in 1997 and 1996 and net realized capital gains in all three years. Excluding these factors, income from continuing operations would have been $565 million in 1997, $550 million in 1996 and $444 million in 1995. Aetna U.S. Healthcare's 1997 results were comparable to 1996, although down from 1996 pro forma levels. Aetna Retirement Services and Aetna International both increased earnings during 1997. The 1996 results reflect earnings growth in each of the Company's core businesses. The 1997 and 1996 results include higher interest expense primarily due to additional debt incurred in 1996 in connection with the financing of the U.S. Healthcare merger. See "Aetna U.S. Healthcare" for a comparison of pro forma results as though the merger had occurred on January 1, 1995. 3 Page 3 Aetna U.S. Healthcare
Operating Summary (Millions) 1997 1996 1995 - --------------------------------------------------------------------------- Premiums $10,844.6 $ 7,765.2 $ 5,949.7 Net investment income 451.2 414.6 364.0 Fees and other income 1,463.9 1,495.9 1,312.3 Net realized capital gains (losses) 141.7 58.0 (10.6) -------------------------------- Total revenue 12,901.4 9,733.7 7,615.4 -------------------------------- Current and future benefits 9,239.2 6,622.4 5,100.4 Operating expenses 2,479.2 2,351.5 2,023.2 Amortization of goodwill and other acquired intangible assets 362.9 169.4 15.2 Amortization of deferred policy acquisition costs 20.3 11.9 22.2 Severance and facilities charges(reserve reductions) (45.0) 453.0 - -------------------------------- Income before income taxes 844.8 125.5 454.4 Income taxes 391.0 66.8 168.4 -------------------------------- Net income $ 453.8 $ 58.7 $ 286.0 - -------------------------------------------================================= Net realized capital gains (losses), net of tax (included above) $ 69.9 $ 37.9 $ (7.1) - -------------------------------------------=================================
Aetna U.S. Healthcare consists of the Health Risk business and the Group Insurance and Other Health business. Health products include health maintenance organization (HMO), point-of-service (POS), preferred provider organization (PPO) and indemnity products. The Health Risk business includes health products offered on an insured basis. The Group Insurance and Other Health business includes group life and disability insurance and long-term care insurance, offered on both an insured and employer-funded basis, and all health products offered on an employer-funded basis. Under insured plans, the Company assumes all or a majority of health care cost, utilization, mortality, morbidity or other risk depending on the product. Under employer-funded plans, the customer, and not the Company, assumes all or a majority of these risks. HMO results include POS members who access primary care physicians and referred care through an HMO network. Actual Results Aetna U.S. Healthcare's net income increased $395 million in 1997 following a decline of $227 million in 1996. These results reflect unusual items including benefits of $29 million in 1997 and expenses of $321 million in 1996, primarily related to severance and facilities actions (see "Severance and Facilities Charges"), and net realized capital gains or losses in all three years. Excluding these items, 1997 results were comparable to 1996. When compared to 1995, the 1996 results increased $48 million. These results reflect the inclusion of U.S. Healthcare for a full year in 1997 and approximately five and one-half months in 1996. For a discussion of underlying results, see the discussion of Aetna U.S. Healthcare pro forma results below. During 1997, the Company sold certain subsidiaries primarily to more effectively focus its health business resources. On December 5, 1997, the Company sold Human Affairs International ("HAI"), a behavioral health management business, and recognized a gain of $55 million after tax. On August 3, 1997, the Company sold Healthcare Data Interchange Corporation ("HDIC"), a provider of health care electronic data interchange services, and recognized a gain of $21 million after tax. Net realized capital gains for 1997 also include after-tax losses of $44 million related to the disposition of Aetna Professional Management Corporation ("APMC"), a physician practice management business. Net realized capital gains for 1996 include a $15 million after-tax gain from the sale of an HMO subsidiary. The earnings of HAI, HDIC, APMC and the HMO subsidiary were not material to the results of Aetna U.S. Healthcare. 4 Page 4 Aetna U.S. Healthcare (Continued) Aetna U.S. Healthcare's effective tax rates were 46% for 1997, 53% for 1996 and 37% for 1995. The higher effective tax rates for 1997 and 1996 are primarily the result of merger-related goodwill amortization (which is nondeductible for income tax purposes) and for 1997, the tax treatment of the dispositions of APMC and HAI. Pro Forma Results The remainder of the discussion related to Aetna U.S. Healthcare compares 1997 actual results to 1996 and 1995 results on a pro forma basis as if the merger had occurred at the beginning of 1995.
Pro forma (1) ------------------------- Operating Summary (Millions) 1997 1996 1995 - ---------------------------------------------------------------------------------- Premiums $10,844.6 $10,096.6 $ 9,436.1 Net investment income 451.2 441.3 408.2 Fees and other income 1,463.9 1,549.2 1,368.0 Net realized capital gains 141.7 52.5 4.5 ------------------------------------- Total revenue 12,901.4 12,139.6 11,216.8 ------------------------------------- Current and future benefits 9,239.2 8,387.0 7,627.9 Operating expenses 2,479.2 2,683.3 2,517.6 Amortization of goodwill and other acquired intangible assets 362.9 364.6 371.2 Amortization of deferred policy acquisition costs 20.3 11.9 22.2 Severance and facilities charges (reserve reductions) (45.0) 453.0 - ------------------------------------- Income before income taxes 844.8 239.8 677.9 Income taxes 391.0 146.7 332.7 ------------------------------------- Net income $ 453.8 $ 93.1 $ 345.2 - --------------------------------------------====================================== Net realized capital gains, net of tax (included above) $ 69.9 $ 34.4 $ 2.1 - --------------------------------------------======================================
(1) Represents financial information as though the merger with U.S. Healthcare occurred on January 1, 1995, reflecting adjustments which include: (a) amortization of goodwill and other acquired intangible assets; (b) interest income foregone related to a $500 million dividend paid by U.S. Healthcare to the Company; and (c) adjustments to conform U.S. Healthcare's accounting policies with Aetna Services' and to remove the effect of merger-related costs incurred by U.S. Healthcare prior to the merger. The 1996 and 1995 pro forma operating summaries and information derived from the summaries are not necessarily indicative of the results of operations of the Aetna U.S. Healthcare segment had the merger occurred at the beginning of 1995, nor is it necessarily indicative of future results. The 1996 and 1995 pro forma operating summaries do not give effect to the costs of financing the merger (See "Corporate"). In order to provide a comparison that management believes better reflects the underlying performance of Aetna U.S. Healthcare, the earnings discussion that follows excludes amortization of goodwill and other acquired intangible assets; unusual items, primarily severance and facilities actions; and net realized capital gains.
(Millions) 1997 1996 1995 - --------------------------------------------------------------------------------- Health Risk $ 312.9 $ 461.9 $ 499.1 Group Insurance and Other Health 340.7 218.2 151.6 ------ ------ ------ Total Aetna U.S. Healthcare $ 653.6 $ 680.1 $ 650.7 ======= ======= ======= Health Risk Medical Loss Ratio 85.1% 81.5% 78.5% ======== ======== ======== Commercial HMO Medical Loss Ratio 84.2% 79.3% 73.5% ======== ======== ======== Medicare HMO Medical Loss Ratio 93.4% 89.7% 86.7% ======== ======== ======== Health Risk SG&A Ratio 12.4% 14.5% 14.9% ======== ======== ========
5 Page 5 Aetna U.S. Healthcare (Continued) Aetna U.S. Healthcare's earnings decreased $27 million in 1997 and increased $29 million in 1996. The segment's results reflect decreased Health Risk earnings and improved Group Insurance and Other Health earnings in both 1997 and 1996. Health Risk Health Risk earnings for 1997 were affected by several factors, primarily consisting of significantly increased HMO medical costs which more than offset the benefit of increased HMO membership and HMO premium rate increases. Commercial and Medicare HMO medical costs per member per month (PMPM) increased by 8% and 10%, when compared to 1996, primarily because of higher inpatient facility and physician costs. The increase in Medicare HMO medical costs PMPM also reflects higher pharmacy costs. Partially offsetting this increase in HMO medical costs were benefits resulting from increased HMO enrollment and increased Commercial and Medicare HMO premiums PMPM of 1% and 5%, when compared to 1996. Commercial HMO premiums PMPM for 1997 increased because of premium rate increases instituted primarily at the beginning of 1997, the effect of which was partially offset by customers selecting lower premium plans and a shift in geographic mix. For 1997, Health Risk results also benefited from improved operating expenses as a percentage of premiums because of continuing cost reduction efforts. For the Health Risk business, medical claims payable reflects estimates of the ultimate cost of claims that have been incurred but not yet reported and reported but not yet paid. Medical claims payable are based on a number of factors including those derived from historical claim experience. Medical claims payable are estimated periodically, and any resulting adjustments are reflected in current period results. The 1997 HMO medical cost increases include a $103 million after-tax charge in the third quarter of 1997 for the reestimation of HMO medical claims reserves, a majority of which relate to 1997 claims. Health Risk earnings for 1996 were significantly impacted by 4% lower Commercial HMO premiums PMPM combined with 4% higher Commercial HMO and 13% higher Medicare HMO medical costs PMPM. Partially offsetting these negative factors were material benefits from increased HMO enrollment, favorable adjustments to claim benefit reserve estimates for indemnity and PPO products, favorable tax reserve developments, increased net investment income and slower growth in operating expenses relative to premiums. The decrease in Commercial HMO premiums PMPM resulted from competitive pricing pressures and customers selecting lower premium plans. The increase in Commercial HMO medical costs PMPM resulted primarily from increased outpatient facility and pharmacy costs. The increase in Medicare HMO medical costs PMPM resulted primarily from increased inpatient facility and pharmacy costs. Group Insurance and Other Health Group Insurance and Other Health results for 1997 reflect higher earnings in both Group Insurance products and Other Health products. The increase from Group Insurance products is primarily due to favorable developments in claim benefit reserve estimates for life and disability products, as well as increased product sales. The increase in earnings from Other Health products reflects higher administrative service contract fees resulting from rate increases and changes in product mix, and lower operating expenses as a percentage of revenue due to continued cost reduction efforts. Results for 1996 primarily reflect favorable group life mortality experience, as well as increased Group Insurance sales and enrollment in nonrisk health products, partially offset by increased costs resulting from higher disability claim volume. 6 Page 6 Aetna U.S. Healthcare (Continued) Membership Aetna U.S. Healthcare's membership was as follows:
December 31, 1997 (1)(2) December 31, 1996 (1)(2) -------------------------------- ---------------------------- (Thousands) Risk Nonrisk Total Risk Nonrisk Total - -------------------------------------------------------------- ---------------------------- HMO Commercial (3) 3,642 584 4,226 3,316 531 3,847 Medicare 382 19 401 303 19 322 Medicaid 98 - 98 134 - 134 ----- ----- ------ ----- ----- ------ Total HMO 4,122 603 4,725 3,753 550 4,303 POS 310 2,473 2,783 325 2,332 2,657 PPO 609 3,012 3,621 761 2,956 3,717 Indemnity 294 2,311 2,605 466 2,595 3,061 ----- ----- ------ ----- ----- ------ Total Health Membership 5,335 8,399 13,734 5,305 8,433 13,738 ===== ===== ====== ===== ===== ====== Group Insurance (4): Group Life 9,890 9,624 ====== ====== Disability 2,598 2,357 ====== ====== Long-Term Care 97 104 ====== ======
(1) Health membership as of December 31, 1997 reflects system and plan conversions. The conversions predominantly affect Indemnity and PPO membership and have an immaterial impact on all other Health products. December 31, 1996 reflects adjustments based on known corrected data from the conversions, as applied to December 31, 1996 membership previously reported. (2) Group Insurance membership as of December 31, 1997 reflects the conversion to a new membership reporting system. December 31, 1996 reflects adjustments as applied to membership previously reported. (3) Includes 885 thousand POS members who access primary care physicians and referred care through an HMO network at December 31, 1997 and 806 thousand at December 31, 1996. (4) Many Group Insurance members participate in more than one type of Aetna U.S. Healthcare coverage and are counted in each. Total Health membership as of December 31, 1997 decreased by 4 thousand members when compared to December 31, 1996. Membership increases in Commercial HMO, Medicare HMO and POS were offset by declines in Indemnity, PPO and Medicaid enrollment. The decline in Indemnity enrollment reflects, among other factors, the continued migration of Indemnity members to managed care products. Total HMO membership as of December 31, 1997 increased by 422 thousand members, or 10% when compared to December 31, 1996. Total Revenue and Expense Aetna U.S. Healthcare's revenues increased by $1.0 billion in 1997 and $1.3 billion in 1996, excluding income in 1996 and 1995 not present in 1997 associated with investments in primary care physician practices, as well as premiums related to the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") contract, which was not renewed, and income related to certain Medicare administrative services no longer provided by the Company, and excluding net realized capital gains. This revenue growth was primarily due to membership growth in Commercial and Medicare HMO and POS products, partially offset by lower Indemnity and PPO membership, as well as, for 1997, premium rate increases primarily instituted at the beginning of the year. 7 Page 7 Aetna U.S. Healthcare (Continued) Aetna U.S. Healthcare's operating expenses decreased by $14 million, or .6%, in 1997 and increased by $179 million, or 8%, in 1996, excluding operating expenses in 1996 and 1995 not present in 1997 associated with investments in primary care physician practices, as well as operating expenses related to CHAMPUS and certain Medicare administrative services no longer provided by the Company. The decrease in 1997 reflects the impact of continuing cost reduction efforts which also resulted in a reduction in operating expenses as a percentage of revenue. The increase in 1996 is due primarily to the continued migration of members from the Indemnity product to more resource-intensive POS and HMO products, partially offset by continuing cost reduction efforts. Operating expenses as a percentage of revenue, however, declined. Outlook The Company intends to continue to enter new geographic markets and expand its presence in the Medicare and Commercial risk business. In doing so, the Company may seek acquisitions in order to strengthen its market position. With the market shift from traditional indemnity plans toward managed care products and the increased importance of managed care to the Company, the ability to profitably grow the managed care risk business and obtain adequate pricing in an increasingly competitive environment while effectively managing medical costs and operating expenses is of increasing importance. Premiums in the Health Risk business are generally fixed by contract for one-year periods and, accordingly, costs in excess of those reflected in pricing, such as those experienced in 1997, cannot be recovered in the year through higher premiums. Results in 1998 will be affected because a significant portion of the Company's Commercial risk contracts for 1998 were priced prior to the Company's receipt of information in the third quarter of 1997 regarding increased medical cost levels, and these contracts cannot be repriced to factor in the higher medical costs. For remaining 1998 Commercial risk contracts and for Medicare products, the Company has targeted further premium increases in an attempt to improve Health Risk profitability. The Company also attempts to improve profitability by addressing cost increases in its contracting with providers and through other cost management techniques. Also, the premium rate increases set by the federal government in 1998 for Medicare risk products averaged just under 3%, which the Company believes will be below the rate of medical cost inflation. In an effort to help stem any medical loss ratio deterioration, the Company has made plan benefit changes, added premiums for supplemental benefits and made copayment modifications. There can be no assurances, however, that any premium increases, benefit changes, or cost savings achieved through recontracting will be sufficient to offset the increases in medical costs as well as any increases in other operating costs, due to potential governmental action (including rate decreases or reduction of rate increases), business conditions (including intensification of competition) and other factors. Results for the Group Insurance and Other Health businesses are not expected to increase at the same rate they have from 1995 through 1997. See "Liquidity and Capital Resources - Health Legislation and Regulation" and "Forward-Looking Information/Risk Factors" for information regarding other important factors that may materially affect Aetna U.S. Healthcare. 8 Page 8 Aetna Retirement Services
Operating Summary (Millions) 1997 1996 1995 - -------------------------------------------------------------------------------- Premiums (1) $ 158.5 $ 180.7 $ 260.2 Net investment income 1,114.7 1,086.7 1,044.1 Fees and other income 591.7 467.7 359.1 Net realized capital gains 37.6 27.1 42.7 ----------------------------------- Total revenue 1,902.5 1,762.2 1,706.1 ----------------------------------- Current and future benefits (1) 1,034.1 1,035.9 1,061.4 Operating expenses 385.6 337.5 303.8 Amortization of deferred policy acquisition costs 110.6 74.3 46.1 Severance and facilities charge - 49.0 - ----------------------------------- Income before income taxes 372.2 265.5 294.8 Income taxes 115.1 79.3 96.8 ----------------------------------- Net income $ 257.1 $ 186.2 $ 198.0 - --------------------------------------------==================================== Net realized capital gains, net of tax (included above) $ 24.2 $ 17.8 $ 27.0 - --------------------------------------------==================================== Deposits not included in premiums above: Annuities - fixed options $ 1,191.4 $ 1,362.3 $ 1,306.8 Annuities - variable options 3,291.2 2,759.3 1,939.2 Individual life insurance 486.4 443.2 539.1 ----------------------------------- Total $ 4,969.0 $ 4,564.8 $ 3,785.1 - --------------------------------------------==================================== Assets under management:(2) Annuities - fixed options $ 12,056.3 $ 11,692.4 $ 11,076.8 Annuities - variable options (3) 20,076.9 14,468.1 10,489.0 Other investment advisory (4)(5) 9,716.6 3,064.9 968.6 ----------------------------------- Financial services 41,849.8 29,225.4 22,534.4 Individual life insurance 3,102.3 2,837.3 2,599.7 ----------------------------------- Total $ 44,952.1 $ 32,062.7 $ 25,134.1 - --------------------------------------------==================================== Individual life insurance coverage issued $ 5,029.9 $ 5,740.3 $ 6,200.6 - --------------------------------------------==================================== Individual life insurance coverage in force $ 49,794.7 $ 48,983.4 $ 47,173.5 - --------------------------------------------====================================
(1) Includes $59.1 million for 1997, $71.8 million for 1996 and $81.9 million for 1995, for annuity premiums on contracts converting from the accumulation phase to payout options with life contingencies. (2) Excludes net unrealized capital gains of $551.6 million, $366.0 million and $797.1 million at December 31, 1997, 1996 and 1995. (3) Includes $5,178.6 million, $4,724.8 million and $2,604.2 million at December 31, 1997, 1996 and 1995, related to assets invested through ARS' products in unaffiliated mutual funds. (4) The December 31, 1997 balance includes the transfer of $4,078.5 million of assets under management that were previously reported in the Large Case Pensions segment, reflecting the consolidation of the Company's investment advisory services and migration of certain other pension products which complement ARS' business strategy. (5) The December 31, 1996 balance includes $1,957.3 million of assets under management that were previously reported in the Large Case Pensions segment, reflecting the consolidation of the Company's investment advisory services. ARS offers financial services and individual life insurance products. Financial services include fixed and variable annuity contracts, investment advisory services, financial planning services and pension plan administrative services. Individual life insurance products include universal life, variable universal life, traditional whole life and term insurance. ARS' net income increased $71 million in 1997 and decreased $12 million in 1996. ARS' 1996 net income includes an after-tax severance and facilities charge of $32 million (see "Severance and Facilities Charges"). Excluding this charge and net realized capital gains, ARS' results, as shown below, increased $33 million in 1997 and $29 million in 1996. The 1997 results reflect improved earnings from financial services offset by a decrease in earnings from individual life insurance products. The 1996 results reflect improved earnings from both financial services and individual life products. 9 Page 9 Aetna Retirement Services (Continued)
(Millions) 1997 1996 1995 - -------------------------------------------------------------------------------- Financial services $ 157.8 $ 120.7 $ 99.8 Individual life insurance 75.1 79.5 71.2 ------ ------ ------ Total $ 232.9 $ 200.2 $ 171.0 ======= ======= =======
The increases in 1997 and 1996 earnings for financial services reflect increased fee income primarily from increased assets under management in annuity products. Assets under management (excluding assets under management that were previously reported in the Large Case Pensions segment) increased by 27% in 1997 and 20% in 1996. Assets under management grew primarily because of appreciation in the stock market and additional net deposits (i.e., deposits less surrenders) and, in 1997, the inclusion of assets from the acquisition of Financial Network Investment Corporation ("FNIC") (discussed below). Partially offsetting 1997 increases in fee income were increased operating expenses as well as the expenses of FNIC. Both 1997 and 1996 reflect increased expenses due to business growth and continued strategic investments. However, operating expenses as a percentage of assets under management declined in both years. Premiums relate to traditional life insurance and annuity products containing life contingencies. Premiums decreased by $22 million in 1997 following a decrease of $80 million in 1996. The decrease in 1997 was due to a shift from annuity products containing life contingencies to annuity products not involving life contingencies, and in part, from ceasing to write structured settlement business. The decrease in 1996 was primarily from ARS ceasing to write structured settlement annuities in the fourth quarter of 1995. Deposits relate to annuity contracts not involving life contingencies and to universal life contracts. Deposits increased 9% in 1997 and 21% in 1996, reflecting continued business growth. Of the $12.1 billion, $11.7 billion and $11.1 billion of fixed annuity assets under management at December 31, 1997, 1996 and 1995, respectively, 25%, 25% and 23%, respectively, were fully guaranteed and 75%, 75% and 77%, respectively, were experience rated. The average earned rate on investments supporting fully guaranteed investment contracts was 7.8%, 7.9% and 8.2%, and the average earned rate on investments supporting experience rated investment contracts was 7.9%, 8.0% and 8.1% for the years ended December 31, 1997, 1996 and 1995, respectively. The average credited rate on fully guaranteed investment contracts was 6.6%, 6.7% and 6.9%, and the average credited rate on experience rated investment contracts was 5.9%, 6.0% and 6.2% for the years ended December 31, 1997, 1996 and 1995, respectively. The resulting interest margins on fully guaranteed investment contracts were 1.2%, 1.2% and 1.3% and on experience rated investment contracts were 2.0%, 2.0% and 1.9% for the years ended December 31, 1997, 1996 and 1995, respectively. 10 Page 10 Aetna Retirement Services (Continued) The duration of the investment portfolios supporting ARS' liabilities is regularly monitored and adjusted in order to maintain an aggregate duration that is within 0.5 years of the estimated duration of the underlying liabilities (see "General Account Investments"). In 1997, in connection with the Company's efforts to expand its financial planning business, the Company acquired FNIC. FNIC is a broker/dealer licensed in all fifty states and includes more than 2,400 registered representatives and 177 branch offices in 35 states. The purchase price was not material to the Company. Outlook ARS' strategy is to increase assets under management and improve profitability by focusing on strategic markets and products in the financial services business. In doing so, ARS may take a variety of actions intended to improve its investment and product management, marketing, distribution and customer service, including increased sales of proprietary fund options within its variable products. ARS also may seek divestitures or acquisitions of lines of business or in selected markets in order to align its businesses with strategic and financial targets or build scale. See "Forward-Looking Information/Risk Factors" for information regarding other important factors that may materially affect ARS. 11 Page 11 Aetna International
Operating Summary (Millions) 1997 1996 1995 - -------------------------------------------------------------------------------- Premiums $1,434.1 $1,166.1 $1,038.5 Net investment income 384.4 334.2 308.7 Fees and other income (1) 140.3 124.2 115.0 Net realized capital gains (losses) 16.7 6.5 (2.4) ------------------------------- Total revenue 1,975.5 1,631.0 1,459.8 ------------------------------- Current and future benefits 1,206.3 996.8 911.2 Operating expenses 462.0 377.2 340.6 Interest expense 7.8 8.2 7.4 Amortization of goodwill and other acquired intangible assets 16.3 3.0 2.5 Amortization of deferred policy acquisition costs 86.6 73.9 70.8 ------------------------------- Income before income taxes 196.5 171.9 127.3 Income taxes 54.1 62.0 40.7 ------------------------------- Net income $ 142.4 $ 109.9 $ 86.6 - --------------------------------------------================================ Net realized capital gains (losses), net of tax (included above) $ 13.7 $ 4.4 $ (2.1) - --------------------------------------------=================================
(1) Includes $51.5 million in 1997, $16.8 million in 1996 and $29.7 million in 1995, of earnings from Aetna International subsidiaries, that are carried on the equity basis. Aetna International's business, through subsidiaries and joint venture operations, sells primarily life insurance, health insurance and financial services products in non-U.S. markets including Brazil, Taiwan, Mexico, Canada, Chile, Malaysia, Hong Kong, New Zealand, Peru, Argentina, the Philippines and Indonesia. Earnings by major geographic location, excluding net realized capital gains and losses, are as follows:
(Millions) 1997 1996 1995 - ----------------------------------------------------------------------------- Asia Pacific $ 60.1 $ 54.3 $ 46.0 Latin America 76.7 56.0 47.9 Start-ups and other (8.1) (4.8) (5.2) -------------------------------- Total $ 128.7 $ 105.5 $ 88.7 =================================
Aetna International's net income increased $33 million in 1997, following a $23 million increase in 1996. Excluding net realized capital gains or losses, earnings increased $23 million in 1997, following a $17 million increase in 1996. Results in 1997 primarily reflect the Company's operations in Brazil, which were acquired in April 1997, earnings growth in Taiwan and Canada (included above in other) and favorable investment performance in certain Asia Pacific and Latin American operations. This earnings growth was partially offset by increased losses related to start-up operations, primarily those in the Philippines and Argentina, and fourth quarter currency devaluations in Asia. Results in 1996 reflect earnings growth in Chile and decreased earnings in Mexico due to a decline in interest rates. Premiums in 1997 were 23% higher than in 1996, following a 12% increase in 1996 premiums as compared with 1995. The increases in premiums were primarily due to increased insurance product sales in Taiwan and Chile. The lower premium growth rate in 1996 was primarily due to strategic decisions to exit low margin product businesses in Canada and Latin America. 12 Page 12 Aetna International (Continued) Outlook Aetna International seeks to invest in new emerging markets outside the U.S. that have the potential for attractive long-term returns. The Company also explores opportunities for additional investments, or divestitures where appropriate, in markets where it currently has a presence. These investments are generally made through the acquisition of part or all of an existing company or an investment in a start-up operation. Acquisitions of existing companies generally require larger initial capital expenditures and may result in immediate earnings. These earnings may, however, be offset in whole or in part, by the amortization of goodwill and intangible assets related to the acquisition. Investments in start-up operations generally require less initial capital, but generally do not generate earnings for a number of years. Currency devaluation, such as recently experienced in Southeast Asia, could adversely affect Aetna International's results when translated into U.S. dollars. Aetna International has established operations in Brazil, Taiwan, Mexico, Canada, Chile, Malaysia, Hong Kong and Peru whose results could be adversely affected by devaluation of those currencies. Smaller, or start-up operations are also subject to currency devaluations which could reduce start-up losses when translated into U.S. dollars. See "Forward-Looking Information/Risk Factors" for information regarding important factors that may materially affect Aetna International. 13 Page 13 Large Case Pensions
Operating Summary (Millions) 1997 1996 1995 - -------------------------------------------------------------------------------- Premiums $ 155.0 $ 214.1 $ 244.4 Net investment income 1,408.7 1,649.2 1,850.6 Fees and other income (1) 28.1 81.4 135.3 Net realized capital gains 30.7 30.9 18.1 ----------------------------------- Total revenue 1,622.5 1,975.6 2,248.4 ----------------------------------- Current and future benefits 1,372.4 1,723.6 2,015.6 Operating expenses (1) 34.8 58.6 100.1 Reductions of loss on discontinued products (172.5) (202.3) - ----------------------------------- Income before income taxes 387.8 395.7 132.7 Income taxes 153.6 137.3 43.5 ----------------------------------- Net income $ 234.2 $ 258.4 $ 89.2 - -------------------------------------------==================================== Net realized capital gains, net of tax (included above) $ 20.8 $ 20.8 $ 11.0 - -------------------------------------------==================================== Deposits not included in premiums above: Fully guaranteed discontinued products $ 14.0 $ 17.7 $ 31.5 Experience rated 735.4 789.0 719.9 Nonguaranteed 849.2 975.1 848.8 ----------------------------------- Total $ 1,598.6 $ 1,781.8 $ 1,600.2 - -------------------------------------------==================================== Assets under management: (1)(2) Fully guaranteed discontinued products $ 7,548.9 $ 8,477.1 $ 9,903.6 Experience rated 11,114.7 16,103.2 17,078.6 Nonguaranteed 11,070.2 10,749.3 18,634.1 ----------------------------------- Total $ 29,733.8 $ 35,329.6 $ 45,616.3 - -------------------------------------------====================================
(1) 1996 includes $15.7 million of fees and other income and $12.7 million of operating expenses and, at December 31, 1996, assets of $3,608.0 million which are currently reported in the ARS segment, reflecting the consolidation of the Company's investment advisory services and certain other pension products which complement ARS' business strategy. (2) Excludes net unrealized capital gains of $645.4 million, $321.4 million and $788.8 million at December 31, 1997, 1996 and 1995, respectively. The Large Case Pensions segment manages a variety of retirement products (including pension and annuity products) for primarily defined benefit and defined contribution plans. These products provide a variety of funding and benefit payment distribution options and other services. Certain products provide investment guarantees. Large Case Pensions' net income decreased $24 million in 1997, following a $169 million increase in 1996. Large Case Pensions' earnings, excluding the reductions of the reserve for loss on discontinued products (discussed below) and net realized capital gains, decreased slightly in 1997, following a $28 million increase in 1996. The 1997 earnings reflect decreased income as a result of redeploying capital supporting the Large Case Pensions segment, as obligations mature, to other businesses of the Company, partially offset by lower expenses. Earnings in 1996 include a $10 million increase in investment income from distributions from leveraged buyout and venture capital limited partnership investments supporting Large Case Pensions' capital and an increase in net interest margins. Results in 1996 were partially offset by the effect of reduced net investment income on the declining capital in the business. After-tax net realized capital gains in 1996 include a gain of $25 million related to the sale of Aetna Realty Investors ("ARI"), which was partially offset by net realized capital losses on bond sales. The earnings of ARI were not material to Large Case Pensions' net income. 14 Page 14 Large Case Pensions (Continued) Assets under management decreased during 1997 and 1996. The 1997 decrease primarily resulted from the continuing runoff of the segment's underlying liabilities as well as the consolidation of investment advisory services and certain other pension products into the ARS segment. The 1996 decrease resulted primarily from the sale of Insurance Company Investment Management("ICIM"), a specialized asset manager. ICIM was not a significant contributor to Large Case Pensions' earnings. General account assets supporting experience rated products (where the customer, not the Company, assumes investment and other risks) may be subject to participant or contractholder withdrawal. Participant withdrawals are generally subject to significant tax and plan constraints. Experience rated contractholder and participant withdrawals and transfers were as follows (excluding contractholder transfers to other Company products):
(Millions) 1997 1996 1995 - ----------------------------------------------------------------------------------- Scheduled contract maturities and benefit payments (1) $ 905.0 $1,089.1 $1,012.3 Contractholder withdrawals other than scheduled contract maturities and benefit payments (2) 358.1 506.2 (3) 381.3 Participant withdrawals (2) 130.0 170.8 182.2
(1) Includes payments made upon contract maturity and other amounts distributed in accordance with contract schedules. (2) At December 31, 1997, approximately $1.7 billion of experience rated pension contracts allowed for unscheduled contractholder withdrawals, subject to timing restrictions and formula-based market value adjustments. Further, approximately $3.2 billion of such contracts supported by general account assets could be withdrawn or transferred to other plan investment options at the direction of plan participants without market value adjustment. (3) Increase primarily relates to an unscheduled withdrawal by one contractholder in 1996. Outlook Large Case Pensions' earnings are expected to materially decline in 1998 due to reductions in investment income, as capital supporting Large Case Pensions is redeployed, as obligations mature, to other businesses and certain products of Large Case Pensions are consolidated into ARS. See "Forward-Looking Information/Risk Factors" for information regarding other important factors that may materially affect Large Case Pensions. Discontinued Products The Company discontinued the sale of its fully guaranteed large case pension products (single-premium annuities ("SPAs")and guaranteed investment contracts ("GICs"))in 1993. The Company established a reserve for anticipated future losses on these products based on the present value of the difference between (a) the expected cash flows from the assets supporting these products and (b) the cash flows expected to be required to meet the product obligations. 15 Page 15 Large Case Pensions (Continued) Results of operations of discontinued products, including net realized capital gains or losses, are credited or charged to the reserve. To the extent that aggregate future losses on the products are greater than anticipated, the Company's results of operations would be adversely affected, and positively affected to the extent future losses are less than anticipated. Management reviews the adequacy of the discontinued products reserve quarterly. As a result of continued favorable developments in real estate markets, the Company reduced $173 million (pretax) in 1997 and $202 million (pretax) in 1996 of the reserve related to GICs. The current reserve reflects management's best estimate of anticipated future losses. The discussion below presents information for SPA and GIC products on a combined basis. The results of discontinued products were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------------------------ Interest margin $ 15.1 $ 26.3 $ (58.6) Net realized capital gains (losses)(1) 175.4 79.2 (8.6) Interest earned on receivable from continuing products 21.5 29.7 33.0 Other, net 2.8 16.3 8.0 ------- ------ ------- Results of discontinued products, after tax $ 214.8 $ 151.5 $ (26.2) ======== ======= ======== Results of discontinued products, pretax $ 337.4 $ 230.3 $ (38.2) ======== ======= ======== Net realized capital gains from sales of bonds, after tax, included above $ 36.6 $ 7.7 $ 39.9 ======== ======= ========
(1) 1997 includes net realized capital gains of $100.4 million related to continued favorable developments in real estate markets (including gains of $24.3 million related to the securitization of commercial mortgage loans) as well as $37.3 million resulting from the sale of investments in order to meet liquidity needs. 1996 includes $72.7 million related to favorable developments in real estate markets. The interest margin is the difference between earnings on invested assets and interest credited to contractholders. The interest margin for 1996 and 1995 includes losses (pretax) of $4 million and $50 million, respectively, due to the early retirement of $183 million of contract liabilities in 1996 and $728 million in 1995. These losses improve interest margins in future periods. Total assets supporting discontinued products and the reserve include a receivable from continuing products of $515 million (after tax) at December 31, 1997. Interest income accrues on this receivable at the discount rate used to calculate the reserve. The activity in the reserve for anticipated future losses on discontinued products was as follows (pretax):
(Millions) - --------------------------------------------- Reserve at December 31, 1994 $ 997.0 Results of discontinued products (38.2) -------- Reserve at December 31, 1995 958.8 Results of discontinued products 230.3 Reserve reduction (202.3) -------- Reserve at December 31, 1996 986.8 Results of discontinued products 337.4 Reserve reduction (172.5) -------- Reserve at December 31, 1997 $1,151.7 ========
16 Page 16 Large Case Pensions (Continued) Distributions on discontinued products were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------------ Scheduled contract maturities, settlements and benefit payments (1) $1,683.1 $2,609.0 $3,208.5 Participant directed withdrawals 36.4 52.0 92.8
(1) Includes early retirement of GIC liabilities of $183.3 million in 1996 and $728.0 million in 1995. There were no such retirements in 1997. Cash required to fund these distributions was provided by earnings and scheduled payments on and sales of invested assets and the funding of a portion of the receivable from continuing products. At December 31, 1997, contractholder liabilities were $7.1 billion. Scheduled maturities, future benefit payments, and other expected payments, including future interest, were as follows:
(Millions) - --------- 1998 $1,443.8 1999 1,256.2 2000 896.5 2001 813.6 2002 674.8 2003-2007 2,367.3 2008-2012 2,039.3 2013-2017 1,663.2 2018-2022 1,260.8 Thereafter 2,296.2
See Note 9 of Notes to Financial Statements and "General Account Investments" for additional information. 17 Page 17 Corporate
Operating Summary (Millions, after tax) 1997 1996 1995 - ---------------------------------------------------------------------------- Interest expense $ 147.5 $ 103.9 $ 70.4 -------------------------------- Other expense: Severance and facilities charges (1) $ - $ 235.5 $ - Other operating expenses, net 108.7 110.5 116.2 Interest on property-casualty proceeds - (36.8) - Net realized capital gains (2) (69.8) (5.0) (.7) ------------------------------- Total other expense $ 38.9 $ 304.2 $ 115.5 ================================
(1) See Note 8 of Notes to Financial Statements for additional information. (2) After-tax net realized capital gains in 1997 include gains of $98.1 million related to sales of portions of the Company's investment in Travelers Property Casualty Corp. offset by an after-tax realized capital loss of $28.6 million related to the write-down of certain properties that the Company has classified as held for sale. The Corporate segment includes interest expense and other expenses which are not directly related to the Company's business segments. "Other expense" includes corporate expenses such as staff area expenses, advertising and contributions, which are partially offset by net investment income. The 1997 and 1996 increase in interest expense primarily results from additional debt incurred in connection with the financing of the U.S. Healthcare merger. Other operating expenses were comparable in 1997 and 1996. Severance and Facilities Charges During 1996, the Company established severance and facilities reserves of $865 million (pretax)in the Aetna U.S. Healthcare, ARS and Corporate segments to reflect the integration of the health businesses and certain other actions taken or to be taken in order to make its businesses more competitive. During 1997, the Company charged costs of $275 million ($140 million in 1996)(pretax) against the reserves. In addition, the Company also reduced the Aetna U.S. Healthcare severance and facilities reserve by $45 million (pretax) during 1997 due to higher attrition than was contemplated in the establishment of the reserve. Of the approximately 9,400 positions originally expected to be eliminated by the Company in the aggregate, 6,423 had been eliminated through severance actions and the effects of higher attrition by December 31, 1997 and the related severance benefits were charged against the reserve. See Note 8 of Notes to Financial Statements for additional information. 18 Page 18 General Account Investments Overview Investments disclosed in this section relate to the Company's total general account portfolio (including assets supporting discontinued products and experience rated products).
December 31, ------------------------ (Millions) 1997 1996 - ---------------------------------------------------------------------------- Invested Assets: Fully Guaranteed $10,588.4 $11,075.5 Experience Rated 18,663.3 18,810.2 Other 13,310.2 13,600.5 -------- -------- Total Invested Assets, net of impairment reserves $42,561.9 $43,486.2 - ----------------------------------------------------======================== Net investment income $ 3,377.5 $ 3,565.2 - ----------------------------------------------------========================
The Company's investment objective is to fund policyholder and other liabilities in a manner that enhances shareholder and contractholder value, subject to appropriate risk constraints. The Company seeks to meet this investment objective through a mix of investments that reflect the characteristics of the liabilities they support, diversify the types of investment risks by interest rate, liquidity, credit and equity price risk, and achieve asset diversification by investment type, industry, issuer and geographic location. The Company regularly projects duration and cash flow characteristics of its liabilities and makes appropriate adjustments in its investment portfolios. Risk Management and Market Sensitive Instruments Interest rate risk is managed within a tight duration band, and credit risk is managed by maintaining high average quality ratings and diversified sector exposure within the debt securities portfolio. In connection with its investment and risk management objectives, the Company also uses financial instruments whose market value is at least partially determined by, among other things, levels of or changes in domestic and/or foreign interest rate (short-term or long-term), exchange rates, prepayment rates, equity markets or credit ratings/spreads. Using financial modeling and other techniques, the Company regularly evaluates the appropriateness of investments relative to its management-approved investment guidelines and the business objective of the portfolios. The Company operates within these investment guidelines by maintaining a mix of investments that diversifies its assets and reflects the characteristics of the liabilities that they support. The Company's use of derivatives is generally limited to hedging purposes and has principally consisted of using foreign exchange forward contracts, futures contracts, interest rate swap agreements and warrants to hedge interest rate, equity price and foreign exchange risks (collectively, market risk). These instruments, viewed separately, subject the Company to varying degrees of market and credit risk. However, when used for hedging, the expectation is that these instruments would reduce overall market risk. Credit risk arises from the possibility that counterparties may fail to perform under the terms of the contracts. (See Note 5 of Notes to Financial Statements for additional information.) 19 Page 19 General Account Investments (Continued) The risks associated with investments supporting experience rated pension, annuity and life products are assumed by those contractholders, and not by the Company (subject to, among other things, certain minimum guarantees). Anticipated future losses associated with investments supporting discontinued fully guaranteed large case pension products are provided for in the reserve for anticipated future losses (see "Large Case Pensions - Discontinued Products"). Risks associated with the investments and liabilities related to experience rated pension, annuity and life products and discontinued fully guaranteed large case pension products are not included in the analysis presented below. The following discussion about the Company's risk management activities includes forward-looking statements that involve risk and uncertainties. Set forth below are management's projections of hypothetical net losses in fair value of shareholders' equity of the Company's market sensitive instruments if certain assumed changes in market rates and prices were to occur (sensitivity analysis). These instruments are not leveraged and are held for purposes other than trading. While the Company believes that the assumed market rate changes are reasonably possible in the near term, actual results may differ, particularly as a result of any management actions that would be taken to mitigate such hypothetical losses in fair value of shareholders' equity. Based on the Company's overall exposure to interest rate risk, equity price risk and foreign exchange risk, the Company believes that these changes in market rates and prices would not materially affect the consolidated near-term financial position, results of operations or cash flows of the Company. Interest Rate Risk Assuming an immediate increase of 100 basis points in interest rates (decrease for long-term debt) the net hypothetical loss in fair value of shareholders' equity related to financial and derivative instruments is estimated to be $323 million (after tax), (2.9% of total shareholders' equity at December 31, 1997). Included in this hypothetical loss in fair value of shareholders' equity at December 31, 1997 is $122 million (after tax) related to fixed rate long-term debt (which is recorded at historical cost), which would not affect the Company's shareholders' equity or results of operations in a decreasing interest rate environment. The Company believes that an interest rate shift of this magnitude represents a moderately adverse scenario, and is approximately equal to the historical annual volatility of interest rate movements for the Company's intermediate term available for sale debt securities. The Company has included corresponding changes in certain insurance liabilities in this sensitivity analysis. The effect of interest rate risk on potential near-term net income, cash flow and fair value was determined based on commonly used models. The models project the impact of interest rate changes on a wide range of factors, including duration, prepayment, put options and call options. Fair value was estimated based on the net present value of cash flows or duration estimates, using a representative set of likely future interest rate scenarios. 20 Page 20 General Account Investments (Continued) Equity Price Risk The Company's available for sale equity securities are comprised primarily of domestic stocks, as well as certain foreign holdings. Assuming an immediate decrease of 10% in equity prices for domestic and foreign equity securities generally, and 25% for Southeast Asian and Latin American emerging market equity securities, the hypothetical loss in fair value of shareholders' equity related to financial and derivative instruments is estimated to be $92 million (after tax), (.8% of total shareholders' equity at December 31, 1997). Foreign Exchange Risk The Company selectively hedges to manage its foreign exchange risk. The Company generally utilizes short-term foreign exchange forward contracts to hedge its foreign exchange risk arising from certain nondollar denominated investment securities and investments in foreign affiliates. Assuming a foreign exchange rate volatility of 10% generally, and 25% for certain Southeast Asian and Latin American emerging market currencies, the net hypothetical loss in fair value of shareholders' equity related to financial and derivative instruments is estimated to be $168 million (after tax), (1.5% of total shareholders' equity at December 31, 1997). Approximately 75% of total foreign exchange risk is comprised of Brazil, Mexico, Taiwan, Chile, Malaysia and Canada. Included in the calculation of net hypothetical loss above is $77 million (after tax) related to equity investments in foreign affiliates, primarily Brazil and Mexico. Foreign exchange exposure was calculated by: (1) translating the local reporting currency into U.S. dollars using foreign exchange rates at December 31, 1997 and (2) applying the market volatility rate to the translated amount. Debt Securities Available for sale debt securities represented 80% of the Company's total general account invested assets at December 31, 1997 and 74% at December 31, 1996, and were as follows:
(Millions) 1997 1996 - ---------------------------------------------------------------------------- Supporting discontinued products $ 6,471.4 $ 5,189.3 Supporting experience rated products 15,322.8 14,888.9 Supporting remaining products 12,450.8 12,258.1 - ---------------------------------------------------------------------------- Total debt securities $34,245.0 $32,336.3 - ------------------------------------------------============================
Debt securities reflect net unrealized capital gains of $1.6 billion at December 31, 1997 compared with $895 million at December 31, 1996. Of the net unrealized capital gains at December 31, 1997, $388 million relate to assets supporting discontinued products and $678 million relate to experience rated pension contractholders. 21 Page 21 General Account Investments (Continued) The debt securities in the Company's portfolio are generally rated by external rating agencies, and, if not externally rated, are rated by the Company on a basis believed to be similar to that used by the rating agencies. As of December 31, 1997 and 1996, the Company's investments in debt securities had average quality ratings of AA-, (36% were AAA at December 31, 1997 and 38% were AAA at December 31, 1996). "Below investment grade" debt securities carry a rating of below BBB-/Baa3 and represent 6% of the portfolio at December 31, 1997 and 5% at December 31, 1996. (See Note 4 of Notes to Financial Statements for disclosures related to debt securities by market sector.) Residential Collateralized Mortgage Obligations Included in the Company's debt securities were residential collateralized mortgage obligations ("CMOs") supporting the following:
(Millions) 1997 1996 - ------------------------------------------------------------------------------------- Fair Amortized Fair Amortized Value Cost Value Cost --------- --------- --------- --------- Total residential CMOs (1) $ 2,710.4 $ 2,549.6 $ 2,764.7 $ 2,665.8 ========= ========= ========= ========= Percentage of total: Supporting discontinued products 3.9% 8.0% Supporting experience rated products 76.0 77.3 Supporting remaining products 20.1 14.7 ----- ----- 100.0% 100.0% ====== =====
(1) Approximately 76% of the Company's residential CMO holdings were backed by government agencies such as GNMA, FNMA and FHLMC at December 31, 1997 and 66% at December 31, 1996. There are various categories of CMOs which are subject to different degrees of risk from changes in interest rates and, for nonagency-backed CMOs, defaults. The principal risks inherent in holding CMOs are prepayment and extension risks related to dramatic decreases and increases in interest rates resulting in the repayment of principal from the underlying mortgages either earlier or later than originally anticipated. At December 31, 1997 and 1996, approximately 3% of the Company's CMO holdings were invested in amounts which are subject to more prepayment and extension risk than traditional CMOs (such as interest- or principal-only strips). Mortgage Loans At December 31, 1997 and 1996, the Company's mortgage loan investments, net of impairment reserves, supported the following types of business:
(Millions) 1997 1996 - ---------------------------------------------------------------------- Supporting discontinued products $ 976.9 $ 2,730.7 Supporting experience rated products 1,671.9 2,370.5 Supporting remaining products 1,559.0 1,599.7 - ---------------------------------------------------------------------- Total mortgage loans $ 4,207.8 $ 6,700.9 - -------------------------------------------===========================
22 Page 22 General Account Investments (Continued) During 1997, the Company continued to manage its mortgage loan portfolio to reduce the balance in absolute terms and relative to invested assets, and to reduce its overall risk. The $2.5 billion decrease in the total mortgage loan portfolio primarily reflects the effect of loan prepayments and repayments of maturing loans. In addition, in December 1997, the Company completed the sale and securitization of approximately $803 million of commercial mortgage loans primarily supporting discontinued fully guaranteed large case pension products. Concurrent with the sale, the Company retained approximately $210 million of subordinate and residual certificates which were classified as available for sale debt securities at December 31, 1997. The net proceeds from the sale were approximately $635 million. Realized capital gains on the sale and securitization were approximately $42 million (pretax), of which $37 million (pretax) was recorded as part of the reserve for anticipated future losses on discontinued products. Problem, Restructured and Potential Problem Loans Included in the Company's mortgage loan balances were the following categories of mortgage loans:
(Millions) December 31, - ------------------------------------------------------------------- 1997 1996 Problem loans (1) $ 101.6 $ 183.6 Restructured loans (2) 125.6 377.6 Potential problem loans (3) 160.3 239.9 ------- ------- Total (4) $ 387.5 $ 801.1 ======== ======== Specific impairment reserves on loans (5) $ 51.2 $ 144.1 ======== ========
(1) Represent loans with payments over 60 days past due, properties in the process of foreclosure, properties involved in bankruptcy proceedings and properties subject to redemption. (2) Represent loans where the Company modified the original contract terms to grant concessions to the borrower and are currently performing pursuant to the modified terms. Restructured loans yielded cash returns of approximately 9% during 1997 and 7% during 1996. (3) Represent loans which are performing pursuant to existing terms, but the Company considers likely to become classified as problem or restructured loans. (4) Total problem, restructured and potential problem loans at December 31, 1997 include 55% supporting discontinued products and 29% supporting experienced rated products; 48% supporting discontinued products and 32% supporting experience rated products at December 31, 1996. (5) See Note 4 of Notes to Financial Statements for additional information. The Company has a comprehensive process for assessing individual mortgage loans which includes an ongoing evaluation of key attributes of the mortgage investment, specifically, debt service coverage, cash flow sustainability, property condition, loan to value, market/economic trends, deal structure, borrower strength and ability to refinance. Management establishes action plans intended to reduce potential risk and maximize return on the investment. Real Estate The Company's real estate balances, net of write-downs and reserves, were $370 million at December 31, 1997 and $850 million at December 31, 1996. 23 Page 23 General Account Investments (Continued) The Company sold real estate with a carrying value of $540 million during 1997, $666 million during 1996 and $262 million during 1995, (including real estate supporting discontinued and experience rated products). These sales generated after-tax net realized capital gains of $80 million in 1997, $113 million in 1996 (substantially all of which was allocable to discontinued and experience rated products) and $18 million in 1995. Losses from real estate write-downs and changes in the valuation reserves were immaterial in 1997, 1996 and 1995. The Company intends to sell a significant amount of its real estate investment properties held for sale over the next year, real estate and capital market conditions permitting. 24 Page 24 Liquidity and Capital Resources Cash Flows The liquidity needs of the Company's businesses are generally met from cash provided by investing activities (asset maturities and sales), premiums, deposits and income received on investments. The Company's businesses use cash primarily for claim and benefit payments, contract withdrawals and operating expenses. The Company's current liquidity objectives are to maximize the use of available cash to fund ongoing operating needs, pay shareholder dividends, strategically invest in core businesses and repurchase shares of common stock. During 1997, net cash generated from investing, financing and operating activities was used to make approximately $500 million of investments in core businesses, repurchase approximately $523 million of common stock and pay approximately $175 million of dividends to shareholders. In 1996, net cash used by investing, financing and operating activities was used to make approximately $250 million of investments in core businesses, repurchase approximately $83 million of common stock and pay approximately $237 million of dividends to shareholders. Dividend payments decreased in 1997, reflecting lower dividends declared per common share, partially offset by increased common shares outstanding following the U.S. Healthcare merger. See "Consolidated Statements of Cash Flows" for additional information. The Company monitors the duration of its debt securities portfolio (which is highly marketable) and mortgage loans, and executes its purchases and sales with the objective of having adequate funds available to satisfy the Company's maturing liabilities. At December 31, 1997 scheduled mortgage loan principal repayments were as follows:
(Millions) - ---------------------------------------- 1998 $ 502.2 1999 467.6 2000 669.4 2001 211.2 2002 193.8 Thereafter 2,282.4
Dividends The Board of Directors (the "Board") reviews Aetna Inc.'s common stock dividend each quarter. Among the factors considered by the Board in determining the dividend are the Company's results of operations, the capital requirements, growth and other characteristics of its businesses. Financings, Financing Capacity and Capitalization Substantially all of the Company's borrowings and financings are conducted through Aetna Services and are fully and unconditionally guaranteed by Aetna Inc. (See Note 13 of Notes to Financial Statements for additional information.) 25 Page 25 Liquidity and Capital Resources (Continued) The Company has significant short-term liquidity supporting its businesses. The Company uses short-term borrowings from time to time to address timing differences between cash receipts and disbursements. Average short-term debt outstanding totaled $586.3 million in 1997, $427.4 million in 1996 and $96.0 million in 1995. In 1996, the Company used funds made available from the issuance of $1.4 billion of commercial paper to fund a portion of the consideration paid in connection with the U.S. Healthcare merger. Aetna Services also has a revolving credit facility in an aggregate amount of $1.5 billion with a worldwide group of banks. The facility terminates in June 2001. (See Note 13 of Notes to Financial Statements for additional information.) The Company's total debt to capital ratio (total debt divided by total debt and shareholders' equity, adjusted for unrealized gains or losses on available-for-sale investment securities and redeemable preferred securities) was 19.1%, 19.9% and 16.9% at the end of 1997, 1996 and 1995, respectively. The increase in this ratio from 1995 to 1996 reflects additional long-term debt incurred to refinance outstanding short term borrowings used to partially fund a portion of the consideration paid in connection with the U.S. Healthcare merger. The Company continually monitors existing and alternative financing sources to support the Company's capital and liquidity needs, including, but not limited to, debt issuance, preferred or common stock issuance, intercompany borrowings and pledging or selling of assets. Common Stock Transactions The Company issued 34,988,615 shares of common stock on July 19, 1996 in connection with the U.S. Healthcare merger. The Company issued 1,883,945 shares in 1997, 1,563,491 shares in 1996 and 2,069,335 shares in 1995 of treasury stock or previously unissued shares for benefit plans. In October 1996, the Board authorized Aetna Inc. to repurchase up to 5 million shares of its common stock from time to time. In September, 1997, the Board authorized the repurchase of up to an additional 7.5 million shares of its common stock from time to time. As of December 31, 1997, 7,368,300 shares of common stock had been repurchased pursuant to this authority at a cost of $606 million, of which 6,173,900 shares at a cost of $523 million were repurchased during 1997. Restrictions on Certain Payments by the Company The Company's business operations are conducted through Aetna Services and Aetna U.S. Healthcare and their respective subsidiaries (which principally consist of HMOs and insurance companies). In addition to general state law restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, HMOs and insurance companies are subject to further state regulations that, among other things, may require those companies to maintain certain levels of equity, and restrict the amount of dividends and other distributions that may be paid to their parent corporations. These regulations are not directly applicable to Aetna Services, Aetna U.S. Healthcare, or Aetna Inc., as none is an HMO or insurance company. The additional regulations applicable to the Company's indirect HMO and insurance company subsidiaries are not expected to affect the ability of Aetna Inc. to pay dividends, or the ability of any of the Company's subsidiaries to service their outstanding debt or preferred stock obligations. 26 Page 26 Liquidity and Capital Resources (Continued) Solvency Regulation In recent years, state insurance regulators have been considering changes in statutory accounting practices and other initiatives to strengthen solvency regulation. The National Association of Insurance Commissioners ("NAIC") adopted risk-based capital ("RBC") standards for life insurers which are designed to identify weakly capitalized companies by comparing the adjusted surplus to the required surplus, which reflects the risk profile of the company ("RBC ratio"). Within certain ratio ranges, regulators have increasing authority to take action as the RBC ratio decreases. There are four levels of regulatory action ranging from requiring insurers to submit a comprehensive plan to the state insurance commissioner to when the state insurance commissioner places the insurer under regulatory control. The RBC ratio for each of the Company's primary life insurance subsidiaries as measured at December 31, 1997 was significantly above the levels which would require regulatory action. Rating agencies use their own RBC standards as part of determining a company's rating. The NAIC has developed two model investment laws, one providing for limits on the types and amounts of investments by insurance companies, and an alternative version which defines standards for insurance company investing. Management believes that these model laws, if adopted by states regulating the Company, will not materially affect the Company. The NAIC also is considering several other solvency-related laws or regulations, such as RBC standards for health plans, including HMOs. Because these other initiatives are in a preliminary stage, management cannot assess the potential impact of their adoption on the Company. Year 2000 As a health care and financial services enterprise operating multiproduct businesses in 15 countries, the Company is dependent on computer systems and applications to conduct its business. The Company has developed and is currently executing a comprehensive risk-based plan designed to make its computer systems, applications and facilities Year 2000 ready. The plan covers four stages including (i) inventory, (ii) assessment, (iii) remediation, and (iv) testing and certification. At year end 1997, the Company had substantially completed the inventory stage for its Company-owned systems and applications. The assessment and remediation processes are currently underway and the Company is utilizing both internal and external resources to reprogram, or replace where necessary, and test the software for Year 2000 modifications. The remediation process is targeted to be largely completed by December 31, 1998. Testing and certification of these systems and applications are targeted for completion by mid-1999. Year 2000 compliance is critical to the Company. However, because of the importance of computer systems and applications to its business, management has made a strategic decision to continue other planned systems enhancements and not redeploy significant internal resources to become Year 2000 ready. As a result, a large majority of these costs are currently believed to be incremental expenses that will not recur in the Year 2000 or thereafter. Total Year 2000 costs for the Company-owned systems and applications are currently estimated to be approximately $95 million (after tax) in 1998 and approximately $44 million (after tax) in 1999, which are expected to be funded through operating cash flows. 27 Page 27 Year 2000 (Continued) The Company is initiating communications with its critical external relationships to determine the extent to which the Company may be vulnerable to such parties' failure to resolve their own Year 2000 issues. Where practicable, the Company will assess and attempt to mitigate its risks with respect to the failure of these entities to be Year 2000 ready. The effect, if any, on the Company's results of operations from the failure of such parties to be Year 2000 ready, is not reasonably estimable. Regulatory Environment A variety of legislative and regulatory proposals have been made at both the federal and state government levels to address various aspects of the health care system. Legislation to reform the federal Medicare program was passed by Congress on July 31, 1997 and was signed into law. Certain provisions of this legislation will phase in, beginning in 1998, changes to the Medicare risk HMO premium determination methodology that will generally reduce the premiums payable to the Company as compared with the methodology previously used. The level and extent of any reductions will vary by geographic market and other factors. While the phase-in provisions have provided the Company with an opportunity to offset some of such premium reductions by adjusting the supplemental premiums payable by members and the benefits included in the Company's products, competition and other factors may result in such adjustments not fully offsetting such premium reductions. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), was enacted to (i) ensure portability of coverage to individuals changing jobs or moving to individual coverage by limiting preexisting condition exclusions, (ii) guarantee availability of coverage to employees in the small group market, and (iii) prevent exclusion of individuals from coverage under group plans based on health status. This legislation was effective on July 1, 1997. Other federal legislation, effective January 1, 1998, mandates minimum hospital stays after childbirth and parity applying lifetime limits to mental health benefits. In New York, the Health Care Reform Act of 1996 ("the Act"), effective January 1, 1997, allowed all private health care payors to negotiate payment rates for inpatient hospital services; previously only HMOs were permitted to negotiate such rates. The Act also provides for direct funding by private payors of hospital bad debt and charity care and graduate medical education by payments to state funding pools rather than through surcharges on payments for hospital services. The Company has negotiated arrangements with hospitals in its New York network to adjust the payments it makes to network hospitals to partially offset the direct payments from the Company required by the Act. 28 Page 28 Regulatory Environment (Continued) Several other states, including states in which the Company has substantial managed care membership, have enacted or are considering legislation or regulation related to the operation of health plans. Such legislation or regulation varies, but includes, among other things,(i) mandatory maternity and other lengths of stay, (ii) regulation of utilization review, (iii) mandated expanded consumer disclosures, (iv) mandatory direct access to specialists including OB/GYNs and chiropractors, (v) mandatory point-of-service benefits, (vi) mandatory or expanded coverage of experimental procedures and drugs, (vii) third party review of denials of benefits, (viii) liability for negligent denials of benefits, (ix) assessments, surcharges or taxes on premiums or provider payments to fund uncompensated care, graduate medical education or government programs, (x) extension of malpractice and other liability for medical decisions from providers to health plans, (xi) required payment for emergency services, (xii) mandated grievance and appeal procedures, (xiii) hearings on termination of physicians from networks, (xiv) prohibition of so-called "gag" clauses, and (xv) provisions similar to those in HIPAA. There can be no assurance that the Company can recoup, through higher premiums or other measures, the increased costs of mandated benefits, or the other increased costs caused by such legislation or regulation. Other potential legislative and regulatory changes related to health plans that are receiving a high level of attention at both the state and federal levels include, but are not limited to, eliminating or reducing the scope of ERISA preemption of state laws, required payment levels for out of network care, prohibition or limitation of arrangements designed to manage medical costs and improve quality of care, such as capitated arrangements with providers or provider financial incentives, limitations on utilization management methods, regulation of the composition of the Company's provider networks, such as any willing provider or pharmacy laws, and changes to licensure or certification requirements. At this time, the Company is unable to predict the impact of the foregoing federal or state legislation or regulation, or of any future legislation or regulatory changes that may be enacted, although it can be anticipated that certain of these measures, if enacted, would adversely affect the Company. For other important information regarding regulation of the Company's health and other businesses, see the Company's 1997 Annual Report on Form 10-K. New Accounting Standards See Note 1 of Notes to Financial Statements for a discussion of recently issued accounting standards. Forward-Looking Information/Risk Factors The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a "safe harbor" for forward-looking statements, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. The Company desires to take advantage of these safe harbor provisions. 29 Page 29 Forward-Looking Information/Risk Factors (Continued) Certain information contained in this management's discussion and analysis is forward-looking within the meaning of the 1995 Act or Securities and Exchange Commission rules including, but not limited to, the information that appears under the headings "Outlook" in the discussion of results of operations of each of the Company's businesses and "General Account Investments - Risk Management and Market Sensitive Instruments". Words such as expects, projects, anticipates, intends, plans, believes, seeks or estimates, or variations of such words and similar expressions are also intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties and contingencies, many of which are beyond the control of the Company. Set forth below are certain important factors that, in addition to general economic conditions and other factors, some of which are discussed elsewhere in this Annual Report or the Company's 1997 Annual Report on Form 10-K, may affect these forward-looking statements and the Company's businesses generally. Certain Factors Particular to Health Operations Premiums; Medical Cost Increases. Premiums in the Company's Health Risk business are generally fixed by contract for one-year periods and actual costs in excess of those estimated and reflected in pricing cannot be recovered in the contract year through higher premiums from customers. Increased utilization, increases in provider contract rates, changes in legislation or regulation, changes in health practices and medical technologies and price increases in pharmaceuticals and durable medical equipment and other factors may increase medical costs. Reserves. For the Health risk business, medical claims payable reflect estimates of the ultimate cost of claims that have been incurred but not yet reported and reported but not yet paid. Medical claims payable are based on a number of factors including those derived from historical claim experience. Medical claims payable are estimated periodically, and any resulting adjustments are reflected in current period results. As a result, there can be no assurances that the unfavorable reserve developments that occurred in 1997 will not recur. For Group Insurance products, reserves are established as premiums become due to reflect the present value of expected future obligations net of the present value of expected future premiums. Policy reserves for group paid-up life insurance generally reflect long-term fixed obligations and are computed on the basis of assumed or guaranteed yield and benefit payments. Assumptions are based on the Company's historical claim experience. For long-term disability products, reserves are established for (i) lives currently in payment status (using both standard industry, as well as the Company's own morbidity and interest rate assumptions), (ii) lives who have not yet satisfied the waiting period, but are expected to do so, and (iii) claims that have been incurred but not reported. Long-term care reserves are a long-term obligation calculated using industry data for morbidity and mortality assumptions. As a result, there can be no assurances that the favorable reserve developments that occurred in 1997 and 1996 will recur. 30 Page 30 Forward-Looking Information/Risk Factors (Continued) Health Business Legislative and Regulatory Environment. As discussed above (see "Regulatory Environment"), certain legislative and regulatory changes related to health products have recently been enacted or proposed, and a variety of other potential legislative and regulatory changes are receiving a high level of attention at both the state and federal levels. At this time the Company is unable to predict the impact of these changes, although it can be anticipated that certain of these measures, if enacted, would adversely affect health operations through (i) reducing premiums, (ii) reducing the ability to manage medical costs, (iii) increasing medical costs and operating expenses, (iv) regulating levels and permitted lines of business, (v) imposing financial assessments, and (vi) regulating other business practices. Integration of Health Operations. Growth in the Company's profitability is dependent, in part, on its ability to successfully integrate its health operations with other health operations acquired, including those of U.S. Healthcare. Factors affecting successful integration include, but are not limited to, timely integration of management and information systems, the application of managed care expertise throughout the Company's broader membership base, and the timely elimination of duplicative administrative and customer service functions. Business Mix. The selection by employers and individuals of plans with higher copayments, deductibles, or coinsurance may lower certain medical costs, but generally results in lower premiums to the Company. In addition, continued migration of employers to self-funded coverage, or increased membership in Medicare risk plans (plans which the Company intends to expand), or the selection by plan participants of other health products with higher medical loss ratios may make the Company's margins more sensitive to changes in medical costs and premiums. Adverse publicity regarding managed care may negatively influence the selection of managed care plans generally, and the Company's health plans, specifically. Government Payors. In government-funded health programs such as Medicare and Medicaid, premium levels are determined by the government payor. Reduction of premium levels would adversely affect these lines of business. In addition, for plans covering government employees, the Company may be subject to retroactive reductions of premium rates by the government payor. Accreditation. For certain of the Company's health plans, accreditation by independent quality accrediting agencies such as the National Committee for Quality Assurance is an important competitive factor. Any loss of or denial of accreditation may adversely affect customer selection of health products, and, in some jurisdictions may affect licensure status. 31 Page 31 Forward-Looking Information/Risk Factors (Continued) Certain Factors Particular to Financial Services Operations Significant Changes in Financial Markets. Significant changes in financial markets could impact the level of assets under management in the Company's Aetna Retirement Services, Large Case Pensions and Aetna International businesses, and, in turn, the Company's level of asset-based fees in those businesses. For example, significant increases in interest rates or decreases in equity markets, in addition to directly affecting the level of assets under management, may increase the level of withdrawals and decrease the level of deposits by customers. Customers under those circumstances may seek to diversify among asset managers or seek investment alternatives not offered by the Company. Significant declines in the value of investments may also affect the Company's ability to pass through investment losses to certain experience rated customers, whether due to triggering minimum guarantees or other business reasons. Ratings. Adverse changes in the claims-paying ratings of the Company's financial services subsidiaries could have the effect of decreasing new sales and deposits and increasing withdrawals and surrenders in the Company's Aetna Retirement Services and Large Case Pensions businesses, which would adversely affect the level of asset-based fees of those businesses. Product Retention. The Company incurs up-front costs, such as commissions, in sales of its annuity, life insurance and other financial services products, including international financial services products. These costs are generally deferred and recognized by the Company over time, and the retention of assets under those products is an important component of profitability. The Company generally seeks to structure its products and sales to encourage retention of assets under management or recover costs, through surrender charges, more favorable credited rates to customers on assets the Company retains for longer periods, renewal commissions, service fees or other terms. However, customer withdrawal of assets earlier than anticipated by the Company in pricing its products would adversely affect profitability. To retain asset levels, also the Company may experience competitive pressure to lower margins. Certain Factors Particular to International Operations Currency Devaluation. The Company selectively hedges to manage its foreign exchange risk, although it generally does not hedge the currency exposure of investments in its foreign affiliates since it views these investments as long term. In preparing its consolidated financial statements, the Company translates its results from the foreign currency in which it operates in a particular country into U.S. dollars. Devaluation of a country's currency, however, would adversely affect results of operations when translated into U.S. dollars. Also, when economies, such as Mexico, are considered highly inflationary (generally, cumulative inflation levels in excess of 100% over a three-year period), changes in the value of net monetary assets or liabilities would be recognized currently in earnings, rather than through shareholders' equity, making reported earnings potentially more volatile. In addition, although the Company considers foreign exchange trends when deciding to invest in particular countries, currency devaluation may also affect the value of international investments when translated to U.S. dollars. 32 Page 32 Forward-Looking Information/Risk Factors (Continued) International Market Factors. The Company's International operations involve certain other risks not typically associated with doing business in the United States. These risks include investment and other controls that may be imposed by governments, such as permitted levels of equity ownership of companies by foreign persons, remittances of foreign earnings or repatriation of capital, currency exchange controls, restrictions on entry into new lines of business, requirements that portions of business be reinsured through state-affiliated institutions and other requirements affecting the conduct of business. Additionally, interest rate risk management may be more difficult due to the relatively short durations of investments available in currencies that match long-term liabilities for international fixed-rate products. Foreign economies may also experience increased volatility of equity markets and high rates of inflation and be subject to other political and economic factors such as more rapid change of regulatory policy. The Company generally does not insure against foreign political risks. Other Factors Affecting All of the Company's Businesses Retention of Key Senior Executives. The Company's success is dependent, in part, on its ability to attract and retain key senior executives. The Company has entered into employment agreements with certain of these executives, although an employment agreement does not guarantee that an executive's services with the Company will continue. Other Adverse Changes in Regulation. In addition to its health business, each of Aetna's other businesses is subject to comprehensive regulation. These businesses could be adversely affected by (i) increases in minimum capital and other financial viability requirements for health and other insurance operations, (ii) removal of barriers preventing banks from engaging in insurance and mutual fund businesses, (iii) the taxation of insurance companies, and (iv) changes in the tax treatment of annuity and other insurance products, such as those suggested in the President of the United States' recent Federal budget proposal. Litigation and Year 2000. Litigation could also adversely affect the Company. See Note 18 of Notes to Financial Statements and the Company's Annual Report on Form 10-K for information regarding litigation, including current shareholder litigation. The Company could also be adversely affected by Year 2000 issues. See "Year 2000". 33 Page 33 Consolidated Statements of Income For the years ended December 31,
(Millions, except per common share data) 1997 1996 1995 - ----------------------------------------------------------------------------------------------------- Revenue: Premiums $ 12,592.2 $ 9,326.1 $ 7,492.8 Net investment income 3,377.5 3,565.2 3,575.1 Fees and other income 2,236.3 2,174.8 1,924.3 Net realized capital gains 334.2 134.4 47.2 ---------------------------------------------- Total revenue 18,540.2 15,200.5 13,039.4 - ----------------------------------------------------------------------------------------------------- Benefits and Expenses: Current and future benefits 12,852.0 10,378.7 9,088.6 Operating expenses 3,561.2 3,319.8 2,951.8 Interest expense 235.8 168.3 115.9 Amortization of goodwill and other acquired intangible assets 380.0 172.5 17.8 Amortization of deferred policy acquisition costs 217.5 160.1 139.1 Reductions of loss on discontinued products (172.5) (202.3) - Severance and facilities charges (reserve reductions) (45.0) 864.7 - ---------------------------------------------- Total benefits and expenses 17,029.0 14,861.8 12,313.2 - ----------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes 1,511.2 338.7 726.2 Income taxes 610.1 133.6 252.3 ---------------------------------------------- Income from continuing operations 901.1 205.1 473.9 Discontinued Operations, net of tax: Income (Loss) from operations - 182.2 (222.2) Gain on sale - 263.7 - ---------------------------------------------- Net income $ 901.1 $ 651.0 $ 251.7 ============================================== Net income applicable to common ownership $ 845.6 $ 625.9 $ 251.7 - -------------------------------------------------------============================================== Results Per Common Share: Income from continuing operations: Basic $ 5.67 $ 1.37 $ 4.18 Diluted 5.60 1.36 4.14 Net income: Basic $ 5.67 $ 4.77 $ 2.22 Diluted 5.60 4.72 2.20 - -----------------------------------------------------------------------------------------------------
See Notes to Financial Statements. 34 Page 34 Consolidated Balance Sheets As of December 31,
(Millions, except share and per common share data) 1997 1996 - ---------------------------------------------------------------------------------- Assets: Investments: Debt securities available for sale, at fair value (amortized cost $32,694.0 and $31,441.4) $ 34,245.0 $ 32,336.3 Equity securities, at fair value (cost $824.4 and $963.4) 1,041.4 1,332.8 Short-term investments 1,003.9 723.2 Mortgage loans 4,207.8 6,700.9 Real estate 369.5 850.2 Policy loans 746.9 707.3 Other 947.4 835.5 ---------------------------- Total investments 42,561.9 43,486.2 - ---------------------------------------------------------------------------------- Cash and cash equivalents 1,805.8 1,462.6 Accrued investment income 545.8 598.6 Premiums due and other receivables 1,381.0 1,190.4 Deferred policy acquisition costs 2,367.3 2,226.9 Goodwill and other acquired intangible assets 8,506.3 8,432.6 Other assets 875.1 1,070.1 Separate Accounts assets 37,957.4 34,445.5 ---------------------------- Total assets $ 96,000.6 $ 92,912.9 ================================================================================== Liabilities: Future policy benefits $ 17,837.1 $ 17,783.4 Unpaid claims 3,294.4 3,029.2 Unearned premiums 359.2 333.6 Policyholders' funds left with the Company 18,761.2 19,901.7 ---------------------------- Total insurance liabilities 40,251.9 41,047.9 Dividends payable to shareholders 36.1 36.9 Short-term debt 252.1 282.8 Long-term debt 2,346.2 2,380.0 Current income taxes 320.5 164.3 Deferred income taxes 223.3 31.7 Other liabilities 2,931.9 3,202.3 Minority and participating policyholders' interests 237.7 221.7 Separate Accounts liabilities 37,930.5 34,380.6 ---------------------------- Total liabilities 84,530.2 81,748.2 - ---------------------------------------------------------------------------------- Aetna-obligated mandatorily redeemable preferred securities of subsidiary limited liability company holding primarily debentures guaranteed by Aetna 275.0 275.0 - ---------------------------------------------------------------------------------- Commitments and Contingent Liabilities (Notes 3, 5 and 18) Shareholders' Equity: Class C voting mandatorily convertible preferred stock ($.01 par value; 15,000,000 shares authorized; 11,655,206 in 1997 and 11,655,546 in 1996 issued and outstanding) 865.4 865.4 Common stock ($.01 par value; 500,000,000 shares authorized; 145,794,844 in 1997 and 150,084,799 in 1996 issued and outstanding) 3,644.4 4,032.8 Accumulated other comprehensive income 307.1 340.0 Retained earnings 6,378.5 5,651.5 ---------------------------- Total shareholders' equity 11,195.4 10,889.7 - ---------------------------------------------------------------------------------- Total liabilities, redeemable preferred securities and shareholders' equity $ 96,000.6 $ 92,912.9 ================================================================================== Shareholders' equity per common share $ 70.85 $ 66.79 ==================================================================================
See Notes to Financial Statements. 35 Page 35 Consolidated Statements of Shareholders' Equity
Three years ended December 31, 1997 Accumulated Other Comprehensive Income -------------------- Unrealized Class C Voting Gains Mandatorily Retained (Losses) on Foreign Convertible Common (Millions, except share data) Total Earnings Securities Currency Preferred Stock Stock - -------------------------------------------------------------------------------------------------------------- Balances at December 31, 1994 $ 5,503.0 $ 5,259.6 $ (941.5) $ (130.0) $ - $ 1,314.9 - -------------------------------------------------------------------------------------------------------------- Comprehensive income: Net income 251.7 251.7 Other comprehensive income, net of tax: Unrealized gains on securities ($2,697.9 pretax)(1) 1,738.5 1,738.5 Foreign currency (($39.8) pretax) (25.9) (25.9) --------- Other comprehensive income 1,712.6 --------- Total comprehensive income 1,964.3 ========= Common stock issued for benefit plans (74,400 shares) 5.2 5.2 Treasury stock issued for benefit plans (1,994,935 shares) 92.2 92.2 Common stock dividends (315.7) (315.7) Gain on issuance of treasury stock 23.8 23.8 ------------------------------------------------------------------------ Balances at December 31, 1995 7,272.8 5,195.6 797.0 (155.9) - 1,436.1 - --------------------------------------======================================================================== Comprehensive income: Net income 651.0 651.0 Other comprehensive loss, net of tax: Unrealized losses on securities (($527.6) pretax)(1) (342.8) (342.8) Foreign currency ($64.2 pretax) 41.7 41.7 --------- Other comprehensive loss (301.1) --------- Total comprehensive income 349.9 ========= Issued for U.S. Healthcare merger: Class C Voting mandatorily convertible preferred stock (11,655,546 shares) 865.4 865.4 Common shares (34,988,615 shares) 2,580.1 2,580.1 Stock options 24.8 24.8 Common stock issued for benefit plans (1,563,491 shares) 75.1 75.1 Repurchase of common shares (1,194,400 shares) (83.3) (83.3) Common stock dividends (170.0) (170.0) Preferred stock dividends (25.1) (25.1) ------------------------------------------------------------------------ Balances at December 31, 1996 10,889.7 5,651.5 454.2 (114.2) 865.4 4,032.8 - --------------------------------------======================================================================== Comprehensive income: Net income 901.1 901.1 Other comprehensive loss, net of tax: Unrealized gains on securities ($81.8 pretax)(1) 49.9 49.9 Foreign currency (($127.3) pretax) (82.8) (82.8) --------- Other comprehensive loss (32.9) --------- Total comprehensive income 868.2 ========= Common stock issued for benefit plans (1,883,945 shares) 134.7 134.7 Repurchase of common shares (6,173,900 Shares) (523.1) (523.1) Common stock dividends (118.6) (118.6) Preferred stock dividends (55.5) (55.5) ------------------------------------------------------------------------ Balances at December 31, 1997 $11,195.4 $ 6,378.5 $ 504.1 $ (197.0) $ 865.4 $ 3,644.4 - --------------------------------------========================================================================
(1) Net of reclassification adjustments. See Notes to Financial Statements. 36 Page 36 Consolidated Statements of Cash Flows For the years ended December 31,
(Millions) 1997 1996 1995 - ----------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income $ 901.1 $ 651.0 $ 251.7 Adjustments to reconcile net income to net cash provided by (used for) operating activities: (Income) Loss from Discontinued Operations - (182.2) 222.2 Decrease (Increase) in accrued investment income 46.0 24.9 (21.0) (Increase) Decrease in premiums due and other receivables (245.8) 12.0 (250.7) Increase in deferred policy acquisition costs (302.4) (275.1) (267.1) Depreciation and amortization 523.7 338.9 175.8 Increase(Decrease) in income taxes 323.3 (155.8) 263.0 Net (increase) decrease in other assets and other liabilities (193.0) 184.0 (55.5) (Decrease) Increase in other insurance liabilities (288.8) (956.8) 522.4 Net realized capital gains (334.2) (134.4) (47.2) Gain on sale of Discontinued Operations - (263.7) - Amortization of net investment discounts (149.5) (131.5) (123.7) Other, net 4.9 5.5 (22.2) ------------------------------------------- Net cash provided by (used for) operating activities 285.3 (883.2) 647.7 ------------------------------------------- Cash Flows from Investing Activities: Proceeds from sales of: Debt securities available for sale 16,247.8 13,625.6 13,747.2 Equity securities 961.4 565.6 355.9 Mortgage loans 1,078.8 154.9 668.4 Real estate 626.8 689.5 317.1 Other investments 924.7 838.6 761.4 Short-term investments 19,957.0 34,679.2 48,763.1 Discontinued Operations - 4,134.1 - Investment maturities and repayments of: Debt securities available for sale 3,913.9 3,567.0 2,190.9 Mortgage loans 1,726.5 1,569.7 1,404.2 Cost of investments in: Debt securities available for sale (21,310.1) (16,922.5) (16,842.1) Equity securities (626.1) (859.5) (353.2) Mortgage loans (255.3) (360.5) (244.9) Real estate (66.8) (116.4) (96.9) Other investments (1,544.6) (1,064.9) (841.1) Short-term investments (20,291.7) (34,703.0) (49,024.1) U.S. Healthcare - (5,243.9) - Increase in property and equipment (92.4) (78.2) (155.3) Decrease (Increase) in Separate Accounts 38.1 (3.2) 57.3 Other, net 83.0 (46.7) (585.7) ------------------------------------------- Net cash provided by investing activities 1,371.0 425.4 122.2 ------------------------------------------- Cash Flows from Financing Activities: Deposits and interest credited for investment contracts 1,872.5 1,968.1 2,017.1 Withdrawals of investment contracts (2,535.9) (3,561.1) (3,442.3) Issuance of long-term debt 4.7 1,389.3 52.4 Repayment of long-term debt (34.3) - (144.6) Net (decrease) increase in short-term debt (46.7) (109.4) 375.5 Common stock issued under benefit plans 134.7 75.1 121.2 Common stock acquired (523.1) (83.3) - Dividends paid to shareholders (174.9) (237.3) (315.7) ------------------------------------------- Net cash used for financing activities (1,303.0) (558.6) (1,336.4) - ----------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents (10.1) (0.3) 2.0 - ----------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 343.2 (1,016.7) (564.5) Cash acquired from U.S. Healthcare - 766.6 - Cash and cash equivalents, beginning of year 1,462.6 1,712.7 2,277.2 ------------------------------------------- Cash and cash equivalents, end of year $ 1,805.8 $ 1,462.6 $ 1,712.7 =====================================================================================================
See Notes to Financial Statements. 37 Page 37 Notes to Financial Statements 1. Summary of Significant Accounting Policies Aetna Inc., through its subsidiaries, provides health care benefits, group insurance, financial services and individual life insurance. Aetna U.S. Healthcare provides a full spectrum of managed care, indemnity, other health and group insurance products. Aetna Retirement Services offers a range of financial services and individual life insurance products. Aetna International, through subsidiaries and joint venture operations, sells primarily life insurance, health insurance and financial services products in non-U.S. markets. The Company also has a Large Case Pensions business which manages a variety of retirement products for defined benefit and defined contribution plans. All footnote disclosures reflect continuing operations unless otherwise noted. Principles of Consolidation The consolidated financial statements include Aetna Inc. and its majority-owned subsidiaries (collectively, the "Company"), including Aetna Services, Inc. (formerly Aetna Life and Casualty Company) and, from July 19, 1996, Aetna U.S. Healthcare, Inc. (Refer to Note 2.) Less than majority-owned entities in which the Company has at least a 20% interest are reported on the equity basis. These consolidated financial statements have been prepared in accordance with generally accepted accounting principles. Certain reclassifications have been made to 1996 and 1995 financial information to conform to the 1997 presentation. New Accounting Standards Reporting Comprehensive Income As of December 31, 1997 the Company adopted Financial Accounting Standard ("FAS")No. 130, Reporting Comprehensive Income. This statement establishes standards for the reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income encompasses all changes in shareholders' equity (except those arising from transactions with shareholders) and includes net income, net unrealized capital gains or losses on available-for-sale securities and foreign currency translation adjustments. As this new standard only requires additional information in the financial statements, it does not affect the Company's financial position or results of operations. Earnings Per Share As of December 31, 1997, the Company adopted FAS No. 128, Earnings Per Share. This statement provides new accounting and reporting standards for earnings per share. It replaces the previously used primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share represents the potential dilution that could occur if all stock options and other stock-based awards, as well as convertible securities, were exercised and converted into common stock if their effect is dilutive. Prior period earnings per common share data have been restated. 38 Page 38 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of As of January 1, 1996, the Company adopted FAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement requires long-lived assets to be held and used to be written down to fair value when they are considered impaired. Long-lived assets to be disposed of (e.g., real estate held for sale) are to be carried at the lower of cost or fair value less estimated selling costs. The adoption of FAS No. 121 did not materially impact the Company's results of operations. Future Application of Accounting Standards Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities FAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, was issued in June 1996 and provides accounting and reporting standards for transfers of financial assets and extinguishments of liabilities. FAS No. 125 is effective for 1997 financial statements; however, certain provisions relating to accounting for repurchase agreements and securities lending are not effective until January 1, 1998. Provisions effective in 1997 did not have a material effect on the Company's financial position or results of operations. The Company does not expect adoption of this statement for provisions effective in 1998 to have a material effect on its financial position or results of operations. Accounting by Insurance and Other Enterprises for Insurance-Related Assessments In December 1997, the American Institute of Certified Public Accountants issued Statement of Position 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments, which provides guidance for determining when an insurance or other enterprise should recognize a liability for guaranty-fund and other insurance-related assessments and guidance for measuring the liability. This statement is effective for 1999 financial statements with early adoption permitted. The Company does not expect adoption of this statement to have a material effect on its financial position or results of operations. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from reported results using those estimates. 39 Page 39 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Cash and Cash Equivalents Cash and cash equivalents include cash on hand, money market instruments and other debt issues with a maturity of 90 days or less when purchased. Investments Debt and equity securities are classified as available for sale and carried at fair value. These securities are written down (as realized capital losses) for other than temporary declines in value. Unrealized capital gains and losses related to available for sale investments, other than amounts allocable to experience rated contractholders and discontinued products, are reflected in shareholders' equity, net of related income taxes. Fair values for debt and equity securities are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, fair values are measured utilizing quoted market prices for similar securities or by using discounted cash flow methods. Cost for mortgage-backed securities is adjusted for unamortized premiums and discounts, which are amortized using the interest method over the estimated remaining term of the securities, adjusted for anticipated prepayments. The Company does not accrue interest on problem debt securities when management believes the likelihood of collection of interest is doubtful. The Company engages in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. Initial collateral, primarily cash, is required at a rate of 102% of the market value of a loaned domestic security and 105% of the market value of a loaned foreign security. The collateral is deposited by the borrower with a lending agent, and retained and invested by the lending agent according to the Company's guidelines to generate additional income. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value of the loaned securities fluctuates. Purchases and sales of debt and equity securities are recorded on the trade date. Sales of mortgage loans and real estate are recorded on the closing date. 40 Page 40 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Investments (Continued) Mortgage loans and policy loans are carried at unpaid principal balances, net of impairment reserves. A mortgage loan is considered impaired when it is probable that the Company will be unable to collect amounts due according to the contractual terms of the loan agreement (delays of up to 60 days may not result in a loan being considered impaired). For impaired loans, a specific impairment reserve is established for the difference between the recorded investment in the loan and the estimated fair value of the collateral. The Company applies this loan impairment policy individually to all loans in the portfolio and does not aggregate loans for the purpose of applying such provisions. The Company records full or partial charge-offs of loans at the time an event occurs affecting the legal status of the loan, typically at the time of foreclosure (actual or in-substance) or upon a loan modification giving rise to forgiveness of debt. A general reserve is established for losses management believes are likely to arise from loans in the portfolio, other than for those losses which have been specifically reserved. The Company does not accrue interest on impaired loans when management believes the collection of interest is unlikely. Investment real estate, which the Company has the intent to hold for the production of income, is carried at depreciated cost, including capital additions, net of write-downs for other than temporary declines in fair value. Properties held for sale (primarily acquired through foreclosure) are carried at the lower of cost or fair value less estimated selling costs. Adjustments to the carrying value of properties held for sale are recorded in a valuation reserve when the fair value less estimated selling costs is below cost. Fair value is generally estimated using a discounted future cash flow analysis in conjunction with comparable sales information. Property valuations are reviewed regularly by investment management. Short-term investments, consisting primarily of money market instruments and other debt purchased with a maturity of 91 days to one year, are considered available for sale and are carried at fair value, which approximates amortized cost. Other invested assets consist primarily of partnerships and equity subsidiaries. Partnerships and equity subsidiaries are carried on an equity basis. The Company utilizes foreign exchange forward contracts, futures contracts, swap agreements and warrants for other than trading purposes in order to hedge interest rate, equity price and foreign exchange risks (collectively, market risk). (Refer to Note 5.) 41 Page 41 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Investments (Continued) Foreign exchange forward contracts which are designated at inception and are effective as hedges of foreign translation and transaction exposures related to investments classified as available for sale are accounted for using the deferral method. Accordingly, realized and unrealized gains and losses from these foreign exchange forward contracts are deferred on the Consolidated Balance Sheets, net of tax, in accumulated other comprehensive income. Upon disposal of the hedged item, deferred gains and losses are recognized in net realized capital gains or losses. Excess realized or unrealized gain or loss, if any, from the foreign exchange forward contract compared to the foreign investment being hedged, is reported as a net realized capital gain or loss. Futures contracts are carried at fair value and require daily cash settlement. Changes in the fair value of futures contracts that qualify as hedges are deferred and recognized as an adjustment to the hedged asset or liability. Deferred gains or losses on such futures contracts are amortized over the life of the acquired asset or liability as a yield adjustment or through net realized capital gains or losses upon disposal of an asset. Changes in the fair value of futures contracts that do not qualify as hedges are recorded in net realized capital gains or losses. Hedge designation requires specific asset or liability identification, a probability at inception of high correlation with the position underlying the hedge, and that high correlation be maintained throughout the hedge period. If a hedging instrument ceases to be highly correlated with the position underlying the hedge, hedge accounting ceases at that date and excess gains and losses on the hedging instrument are reflected in net realized capital gains or losses. Warrants represent the right to purchase specific securities and are accounted for as hedges. Upon exercise, the cost of the warrants are added to the basis of the securities purchased. Interest rate swap agreements which are designated as interest rate risk management instruments at inception are accounted for using the accrual method. Accordingly, the difference between amounts paid and received on such agreements is reported in net investment income. There is no recognition in the Consolidated Balance Sheets of changes in the fair value of these agreements. 42 Page 42 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Foreign Currency Translation The financial statements of the Company's foreign subsidiaries, where the local currency is the functional currency, are translated into U.S. dollars at the exchange rate in effect at each year end for assets and liabilities and average exchange rates during the year for results of operations. The related unrealized gains or losses resulting from translation of the net assets are included in shareholders' equity. If the economy of the country where a foreign subsidiary is located is considered highly inflationary (generally, cumulative inflation levels in excess of 100% over a three-year period), changes in the value of net monetary assets or liabilities would be recognized currently in earnings. Goodwill and Other Acquired Intangible Assets Goodwill, which represents the excess of cost over the fair value of net assets acquired, is amortized on a straight-line basis over periods not exceeding 40 years. Other acquired intangible assets, which are primarily customer lists, health provider networks and computer systems, are amortized on a straight-line basis over various periods not exceeding 25 years. The Company regularly evaluates the recoverability of goodwill and other acquired intangible assets. The carrying value of such assets would be reduced through a direct write-off if, in management's judgment, it was probable that projected future operating income (before amortization of goodwill and other acquired intangible assets) would not be sufficient on an undiscounted basis to recover the carrying value. Operating earnings considered in such an analysis are those of the entity acquired, if separately identifiable, or the business segment that acquired the entity if the entity's earnings are not separately identifiable. Deferred Policy Acquisition Costs Certain costs of acquiring insurance business are deferred. These costs, all of which vary with and are primarily related to the production of new and renewal business, consist principally of commissions, certain expenses of underwriting and issuing contracts, and certain agency expenses. For fixed ordinary life contracts, such costs are amortized over expected premium-paying periods (up to 20 years). For universal life and certain annuity and pension contracts, such costs are amortized in proportion to estimated gross profits and adjusted to reflect actual gross profits over the life of the contracts (up to 20 years for annuity and pension contracts). Deferred policy acquisition costs are written off to the extent that it is determined that future policy premiums and investment income or gross profits are not adequate to cover related losses and expenses. 43 Page 43 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Separate Accounts Separate Accounts assets and liabilities generally represent funds maintained to meet specific investment objectives of contractholders who bear the investment risk, subject, in some cases, to minimum guaranteed rates. Investment income and investment gains and losses generally accrue directly to such contractholders. The assets of each account are legally segregated and are not subject to claims that arise out of any other business of the Company. The assets and liabilities are carried at market value. Deposits, net investment income and realized capital gains and losses on Separate Accounts assets are not reflected in the Consolidated Statements of Income. Management fees charged to contractholders are included in fees and other income. Insurance Liabilities Future policy benefits include reserves for universal life, limited payment and traditional life insurance contracts. Reserves for universal life contracts are equal to cumulative premiums less charges plus credited interest thereon. Reserves for limited payment and traditional life insurance contracts are computed on the basis of assumed investment yield, mortality, morbidity and expenses, including a margin for adverse deviation. Such assumptions generally vary by plan, year of issue and policy duration. Reserve interest rates range from 2.25% to 13.04% for all years presented. Investment yield is based on the Company's experience. Mortality, morbidity and withdrawal rate assumptions are based on the experience of the Company and are periodically reviewed against both industry standards and experience. Policyholders' funds left with the Company include reserves for pension and annuity investment contracts. Reserves on such contracts are equal to cumulative deposits less charges plus credited interest thereon (rates range from 2.50% to 17.80% for all years presented), net of adjustments for investment experience that the Company is entitled to reflect in future credited interest. Reserves on contracts subject to experience rating reflect the rights of contractholders, plan participants and the Company. 44 Page 44 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Insurance Liabilities (Continued) Unpaid claims related to the Company's prepaid health care services (primarily health maintenance organizations) consist principally of medical claims and capitation costs. Medical claims include estimates of payments to be made on claims reported and estimates of health care services rendered but not reported to the Company as of the balance sheet date. Such estimates include the cost of services which will continue to be rendered after the balance sheet date if the Company is obligated to pay for such services in accordance with contract provisions or regulatory requirements. Medical claims payable are estimated periodically and any resulting adjustments are included in current operations. Unpaid claim reserves for other group health products and medical claims payable reflect estimates, derived from past experience, of the ultimate cost of incurred claims, including claims that have been incurred but not reported, and claims that have been reported, but not settled. Revenue Recognition For universal life and certain annuity contracts, charges assessed against policyholders' funds for the cost of insurance, surrender charges, actuarial margin and other fees are recorded as revenue in fees and other income. Other amounts received for these contracts are reflected as deposits and are not recorded as revenue. Life insurance premiums, other than premiums for universal life and certain annuity contracts, are recorded as premium revenue when due. Related policy benefits are recorded in relation to the associated premiums or gross profit so that profits are recognized over the expected lives of the contracts. When annuity payments with life contingencies begin under contracts that were initially investment contracts, the accumulated balance in the account is treated as a single premium for the purchase of an annuity, reflected as an offsetting amount in both premiums and current and future benefits in the Consolidated Statements of Income. Group health and group insurance premiums are generally recorded as premium revenue over the term of the coverage. Some group contracts allow for premiums to be adjusted to reflect actual experience. Such premiums are recognized as the experience emerges. Fees and other income are derived primarily from contracts for claim processing or other administrative services and are recorded over the period the service is provided. 45 Page 45 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Income Taxes The Company is taxed at regular corporate rates after adjusting income reported for financial statement purposes for certain items. The Company files a consolidated federal income tax return. Foreign subsidiaries and U.S. subsidiaries operating outside of the United States are taxed under applicable foreign statutes. Deferred income tax expenses/benefits result from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities. Reinsurance The Company utilizes reinsurance agreements to reduce exposure to large losses in certain aspects of its insurance business. Reinsurance permits recovery of a portion of losses from reinsurers, although it does not discharge the primary liability of the Company as direct insurer of the risks reinsured. Only those reinsurance recoverables deemed probable of recovery are reflected as assets. 46 Page 46 Notes to Financial Statements (Continued) 1. Summary of Significant Accounting Policies (Continued) Earnings Per Common Share A reconciliation of the numerator and denominator of the basic and diluted earnings per common share ("EPS") is as follows:
Per Common Income Shares Share (Millions, except per common share data) (Numerator) (Denominator) Amount - ------------------------------------------------------------------------------------------- 1997 - ------------------------------------------------------------------------------------------- Net income $ 901.1 Less: Preferred stock dividends 55.5 --------- Basic EPS Income applicable to common ownership 845.6 149.2 $ 5.67 ========= Effect of dilutive securities: Stock options and other(1) 1.5 Convertible preferred stock 55.5 10.2 --------- -------- Diluted EPS Income applicable to common ownership and assumed conversions $ 901.1 160.9 $ 5.60 - ----------------------------------------------------======================================= 1996(2)(3) - ------------------------------------------------------------------------------------------- Income from continuing operations $ 205.1 Less: Preferred stock dividends 25.1 --------- Basic EPS Income applicable to common ownership $ 180.0 131.3 $ 1.37 ========= ========= Effect of dilutive securities: Stock options and other(1) 1.2 -------- Diluted EPS Income applicable to common ownership and assumed conversions $ 180.0 132.5 $ 1.36 - ----------------------------------------------------======================================= 1995(2)(3) - ------------------------------------------------------------------------------------------- Basic EPS Income applicable to common ownership $ 473.9 113.5 $ 4.18 ========= ========= Effect of dilutive securities: Stock options and other(1) .8 -------- Diluted EPS Income applicable to common ownership and assumed conversions $ 473.9 114.3 $ 4.14 - ----------------------------------------------------=======================================
(1) Options to purchase shares of common stock in 1997, 1996 and 1995 of .2 million shares, 1.2 million shares and .3 million shares, respectively, (with exercise prices ranging from $62.63 - $112.63) were not included in the calculation of diluted earnings per common share because the options' exercise price was greater than the average market price of common shares. (2) The common stock issuable related to Class C Voting Mandatorily Convertible Preferred Stock (5.3 million weighted average shares) was not included in the computation of diluted earnings per common share in 1996 because to do so would be antidilutive. No preferred securities were outstanding in 1995. (3) Basic earnings (losses) per common share related to Discontinued Operations were $3.40 and $(1.96) for 1996 and 1995, respectively. Diluted earnings (losses) per common share related to Discontinued Operations were $3.36 and $(1.94) for 1996 and 1995, respectively. 47 Page 47 Notes to Financial Statements (Continued) 2. Merger with U.S. Healthcare The merger with U.S. Healthcare was consummated on July 19, 1996. As a result of the merger, each outstanding share of Aetna Services common stock became a share of common stock of Aetna Inc. Each outstanding share of U.S. Healthcare common stock and Class B Stock became a right to receive $34.20 in cash, 0.2246 shares of Aetna Inc. common stock and 0.0749 shares of Aetna Inc. Class C Stock. The Company's consolidated results of operations include U.S. Healthcare from July 19, 1996. The merger was accounted for as a purchase. Total consideration of approximately $8.9 billion resulted in $7.9 billion, net of related deferred taxes, representing the excess of the purchase price over the fair values of the net assets acquired, being allocated to goodwill and other acquired intangible assets and is being amortized over a 40-year period for goodwill and over a range of five to 25 years for other acquired intangible assets. 3. Other Acquisitions and Dispositions During 1997, the Company's health business sold subsidiaries that were involved in physician practice management, health electronic data interchange services and behavioral health management. The sale of these entities resulted in a net after-tax realized capital gain of $31 million ($82 million pretax). In addition to the sale of the behavioral health management business, Human Affairs International ("HAI"), the Company entered into a long-term strategic provider relationship that will provide its health members continued access to HAI's, as well as the purchaser's, participating behavioral health professionals. Under the terms of this long-term strategic relationship, the Company may receive incentive-related compensation payments of up to $300 million over a period of up to seven years. In April 1997, the Company acquired a 49% stake for approximately $300 million in a Brazilian joint venture which provides health and life insurance, as well as private pension plan products. The joint venture is being accounted for on the equity basis. In late 1996, the Company acquired certain interests in two similar joint ventures with its Mexican partner, in addition to increasing its existing equity ownership in Mexico. The total amount of these investments was $171 million. Additional investments in the pension products joint venture totaled $50 million in 1997. The Company also acquired the following entities during 1997: Financial Network Investment Corporation, Virginia Mason Health Plan, Inc., Frontier Health Holdings, Inc. and Financial Life Assurance Company of Canada. The purchase price of these acquisitions, both individually and in the aggregate, were not material. On April 2, 1996, the Company sold its property-casualty operations to an affiliate of The Travelers Insurance Group Inc. ("Travelers") for approximately $4.1 billion in cash. The sale resulted in an after-tax gain of $264 million ($218 million pretax). 48 Page 48 Notes to Financial Statements (Continued) 3. Other Acquisitions and Dispositions (Continued) The operating results of the property-casualty operations were presented as Discontinued Operations through the sale date. Operating results for the period from January 1 to April 2, 1996 and for the year ended December 31, 1995 were as follows:
(Millions) 1996 1995 - ------------------------------------------------------------------------- Total revenue $ 1,539.3 $ 5,258.2 ========= ========= Income (Loss) before income taxes $ 262.7 $ (384.3) Income taxes (benefits) 80.5 (162.1) --------- --------- Income (Loss) $ 182.2 $ (222.2) - ----------------------------------------------------=====================
As a result of the sale, the Company retained no property-casualty liabilities other than those associated with indemnifying Travelers for a portion of certain potential liability exposures. While there can be no assurances, management currently does not believe that the aggregate ultimate loss arising from these indemnifications, if any, will be material to the annual net income, liquidity or financial condition of the Company, although it is reasonably possible. 49 Page 49 Notes to Financial Statements (Continued) 4. Investments Debt securities available for sale at December 31 were as follows:
Gross Gross (Millions) Amortized Unrealized Unrealized Fair 1997 Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------- Bonds: U.S. government and government agencies and authorities $ 3,762.3 $ 168.0 $ 1.7 $ 3,928.6 States, municipalities and political subdivisions 190.7 16.1 .2 206.6 U.S. corporate securities: Utilities 2,382.6 125.1 2.2 2,505.5 Financial 5,049.4 169.8 2.4 5,216.8 Transportation/capital goods 2,417.7 174.7 3.0 2,589.4 Health care/consumer products 1,641.5 97.7 3.9 1,735.3 Natural resources 1,467.1 93.5 .7 1,559.9 Other corporate securities 1,418.9 88.2 .9 1,506.2 ---------------------------------------------------- Total U.S. corporate securities 14,377.2 749.0 13.1 15,113.1 Foreign: Government, including political subdivisions 2,514.7 161.6 46.5 2,629.8 Utilities 612.4 76.9 .2 689.1 Other 3,714.8 188.5 72.9 3,830.4 ---------------------------------------------------- Total foreign securities 6,841.9 427.0 119.6 7,149.3 Residential mortgage-backed securities: Pass-throughs 1,707.5 107.3 2.3 1,812.5 Collateralized mortgage obligations 2,549.6 162.8 2.0 2,710.4 ---------------------------------------------------- Total residential mortgage-backed securities 4,257.1 270.1 4.3 4,522.9 Commercial/Multifamily mortgage-backed securities(1) 1,586.2 42.0 6.2 1,622.0 Other asset-backed securities (2) 1,612.9 23.0 .8 1,635.1 ---------------------------------------------------- Total Bonds 32,628.3 1,695.2 145.9 34,177.6 Redeemable Preferred Stocks 65.7 1.7 - 67.4 ---------------------------------------------------- Total Debt Securities $ 32,694.0 $ 1,696.9 $ 145.9 $ 34,245.0 - -----------------------------------------------------==================================================== Gross Gross (Millions) Amortized Unrealized Unrealized Fair 1996 Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------- Bonds: U.S. government and government agencies and authorities $ 3,723.0 $ 82.9 $ 32.8 $ 3,773.1 States, municipalities and political subdivisions 348.4 7.3 .4 355.3 U.S. corporate securities: Utilities 2,355.3 85.8 20.8 2,420.3 Financial 4,486.0 82.5 22.0 4,546.5 Transportation/capital goods 2,373.7 136.6 17.5 2,492.8 Health care/consumer products 1,754.0 64.6 14.9 1,803.7 Natural resources 1,287.7 44.1 13.9 1,317.9 Other corporate securities 1,488.1 46.4 14.7 1,519.8 ---------------------------------------------------- Total U.S. corporate securities 13,744.8 460.0 103.8 14,101.0 Foreign: Government, including political subdivisions 2,407.5 111.2 13.3 2,505.4 Utilities 740.3 55.0 5.1 790.2 Other 3,376.3 148.3 11.5 3,513.1 ---------------------------------------------------- Total foreign securities 6,524.1 314.5 29.9 6,808.7 Residential mortgage-backed securities: Pass-throughs 1,771.5 88.6 11.7 1,848.4 Collateralized mortgage obligations 2,665.8 117.6 18.7 2,764.7 ---------------------------------------------------- Total residential mortgage-backed securities 4,437.3 206.2 30.4 4,613.1 Commercial/Multifamily mortgage-backed securities 1,131.5 27.8 15.0 1,144.3 Other asset-backed securities (2) 1,458.0 10.3 3.7 1,464.6 ---------------------------------------------------- Total Bonds 31,367.1 1,109.0 216.0 32,260.1 Redeemable Preferred Stocks 74.3 1.9 - 76.2 ---------------------------------------------------- Total Debt Securities $ 31,441.4 $ 1,110.9 $ 216.0 $ 32,336.3 - -----------------------------------------------------====================================================
(1) Includes approximately $209.6 million of subordinate and residual certificates from a securitization of approximately $802.7 million of commercial mortgage loans in 1997 (proceeds of approximately $635.1 million) which were retained by the Company. (2) Includes approximately $97.9 million and $108.0 million of subordinate and residual certificates at December 31, 1997 and 1996, respectively, from a 1995 mortgage loan securitization which were retained by the Company. 50 Page 50 Notes to Financial Statements (Continued) 4. Investments (Continued) At December 31, 1997 and 1996, net unrealized appreciation on available for sale debt securities included $678 million and $399 million, respectively, related to experience rated contracts and $388 million and $205 million, respectively, related to discontinued products (refer to Note 9), which were not reflected in shareholders' equity. The carrying and fair value of debt securities are shown below by contractual maturity. Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid.
1997 Amortized Fair (Millions) Cost Value - ------------------------------------------------------------------ Due to mature: One year or less $ 2,058.9 $ 2,097.8 After one year through five years 6,689.3 6,812.1 After five years through ten years 7,753.5 7,984.1 After ten years 8,736.1 9,571.0 Mortgage-backed securities 5,843.3 6,144.9 Other asset-backed securities 1,612.9 1,635.1 - ------------------------------------------------------------------ Total $32,694.0 $34,245.0 - ------------------------------------------========================
Investments in equity securities were as follows:
Gross Gross Unrealized Unrealized Fair (Millions) Cost Gains Losses Value - -------------------------------------------------------------------------------- 1997 - -------------------------------------------------------------------------------- Equity securities $ 824.4 $ 287.6 $ 70.6 $ 1,041.4 - -----------------------------=================================================== 1996 - -------------------------------------------------------------------------------- Equity securities $ 963.4 $ 397.9 $ 28.5 $ 1,332.8 - -----------------------------===================================================
Real estate holdings at December 31 were as follows:
(Millions) 1997 1996 - -------------------------------------------------------------- Properties held for sale $ 328.3 $ 771.7 Investment real estate 142.5 220.6 -------------------- 470.8 992.3 Valuation reserve 101.3 142.1 -------------------- Net carrying value of real estate $ 369.5 $ 850.2 - ------------------------------------------====================
Accumulated depreciation for investment real estate was $12 million and $21 million at December 31, 1997 and 1996, respectively. 51 Page 51 Notes to Financial Statements (Continued) 4. Investments (Continued) Total real estate write-downs included in the net carrying value of the Company's real estate holdings at December 31, 1997 and 1996 were $160 million and $347 million, respectively, (including $116 million and $224 million, respectively, attributable to assets of discontinued products). At December 31, 1997 and 1996, the total recorded investment in mortgage loans that are considered to be impaired (including problem loans, restructured loans and potential problem loans) and related specific reserves were as follows:
1997 1996 --------------------------------------------------- Total Total Recorded Specific Recorded Specific (Millions) Investment Reserves Investment Reserves - ------------------------------------------------------------------------------------------------- Supporting discontinued products $ 206.5 $ 25.8 $ 387.3 $ 86.9 Supporting experience rated products 110.8 16.7 258.3 40.0 Supporting remaining products 65.6 8.7 160.1 17.2 --------------------------------------------------- Total Impaired Loans $ 382.9(1) $ 51.2 $ 805.7(1) $ 144.1 - ----------------------------------------------===================================================
(1) Includes impaired loans of $127.7 million and $227.0 million, respectively, for which no specific reserves are considered necessary. The activity in the specific and general mortgage loan impairment reserves as of December 31 is summarized below:
Supporting Supporting Experience Supporting Discontinued Rated Remaining (Millions) Products Products Products Total - ------------------------------------------------------------------------------------ Balance at December 31, 1995 $ 287.5 $ 228.3 $ 89.1 $ 604.9 - -------------------------------===================================================== Credited to net realized capital gains - - (33.0) (33.0) Credited to other accounts (1) (10.0) (57.6) - (67.6) Principal write-offs (140.8) (96.0) (20.5) (257.3) ----------------------------------------------------- Balance at December 31, 1996 (2) 136.7 74.7 35.6 247.0 - -------------------------------===================================================== Credited to net realized capital gains - - (10.6) (10.6) Credited to other accounts (1) (25.0) (20.0) - (45.0) Principal write-offs (43.0) (23.1) (10.8) (76.9) ----------------------------------------------------- Balance at December 31, 1997 (2) $ 68.7 $ 31.6 $ 14.2 $ 114.5 - -------------------------------=====================================================
(1) Reflects adjustments to reserves related to assets supporting experience rated products and discontinued products which do not affect the Company's results of operations. (2) Total reserves at December 31, 1997 and 1996 include $51.2 million and $144.1 million of specific reserves and $63.3 million and $102.9 million of general reserves, respectively. 52 Page 52 Notes to Financial Statements (Continued) 4. Investments (Continued) The Company accrues interest income on impaired loans to the extent it is deemed collectible and the loan continues to perform under its original or restructured terms. Interest income on problem loans is generally recognized on a cash basis. Cash payments on loans in the process of foreclosure are generally treated as a return of principal. Income earned (pretax) and cash received on the average recorded investment in impaired loans for the twelve months ended December 31 was as follows:
1997 1996 ---------------------------------------------------------------- Average Average Impaired Income Cash Impaired Income Cash (Millions) Loans Earned Received Loans Earned Received - ------------------------------------------------------------------------------------------------------ Supporting discontinued products $ 343.1 $ 36.9 $ 30.2 $ 675.0 $ 54.6 $ 55.8 Supporting experience rated products 195.3 17.6 14.5 474.7 33.1 33.2 Supporting remaining products 112.2 12.5 10.3 211.6 16.6 16.8 ---------------------------------------------------------------- Total $ 650.6 $ 67.0 $ 55.0 $ 1,361.3 $ 104.3 $ 105.8 - --------------------------------------================================================================
Significant noncash investing and financing activities include acquisition of real estate through foreclosures (including in-substance foreclosures) of mortgage loans amounting to $33 million and $139 million for 1997 and 1996, respectively. At December 31, 1997 and 1996, the Company's mortgage loan balances, net of specific impairment reserves, by geographic region and property type were as follows:
(Millions) 1997 1996 (Millions) 1997 1996 - ------------------------------------------ ---------------------------------------- South Atlantic $ 790.0 $ 1,311.6 Office $ 2,009.2 $ 3,056.4 Middle Atlantic 948.4 1,592.9 Retail 901.9 1,369.3 New England 417.9 745.1 Apartment 140.0 428.8 South Central 116.0 334.5 Hotel/Motel 239.6 572.0 North Central 522.8 749.4 Industrial 325.1 584.7 Pacific and Mountain 886.6 1,412.4 Mixed Use 263.8 430.0 Other 589.4 657.9 Other 391.5 362.6 -------------------- -------------------- Total 4,271.1 6,803.8 Total 4,271.1 6,803.8 Less general Less general impairment reserve 63.3 102.9 impairment reserve 63.3 102.9 -------------------- -------------------- Net mortgage Net mortgage loan balance $ 4,207.8 $ 6,700.9 loan balance $ 4,207.8 $ 6,700.9 - ----------------------==================== --------------------====================
53 Page 53 Notes to Financial Statements (Continued) 5. Financial Instruments Estimated Fair Value The carrying values and estimated fair values of certain of the Company's financial instruments at December 31, 1997 and 1996 were as follows:
(Millions) 1997 1996 - --------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- ----- Assets: Mortgage loans $ 4,207.8 $ 4,327.0 $ 6,700.9 $ 6,705.0 Liabilities: Investment contract liabilities: With a fixed maturity $ 5,897.1 $ 6,022.6 $ 7,167.2 $ 7,175.0 Without a fixed maturity 11,932.0 11,438.8 11,633.5 11,538.9 Long-term debt 2,346.2 2,390.6 2,380.0 2,374.6 - ---------------------------------------------------------------------------------------
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, such as estimates of timing and amount of future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized capital gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument. In evaluating the Company's management of interest rate, equity price, liquidity, and foreign exchange risks, the fair values of all assets and liabilities should be taken into consideration, not only those presented above. The following valuation methods and assumptions were used by the Company in estimating the fair value of the above financial instruments: Mortgage loans: Fair values are estimated by discounting expected mortgage loan cash flows at market rates which reflect the rates at which similar loans would be made to similar borrowers. The rates reflect management's assessment of the credit quality and the remaining duration of the loans. The fair value estimates of mortgage loans of lower credit quality, including problem and restructured loans, are based on the estimated fair value of the underlying collateral. Investment contract liabilities (included in policyholders' funds left with the Company): With a fixed maturity: Fair value is estimated by discounting cash flows at interest rates currently being offered by, or available to, the Company for similar contracts. Without a fixed maturity: Fair value is estimated as the amount payable to the contractholder upon demand. However, the Company has the right under such contracts to delay payment of withdrawals which may ultimately result in paying an amount different than that determined to be payable on demand. 54 Page 54 Notes to Financial Statements (Continued) 5. Financial Instruments (Continued) Estimated Fair Value (Continued) Long-term debt: Fair value is based on quoted market prices for the same or similar issued debt or, if no quoted market prices are available, on the current rates estimated to be available to the Company for debt of similar terms and remaining maturities. Off-Balance-Sheet and Other Financial Instruments The notional amounts, carrying values and estimated fair values of the Company's off-balance-sheet and other financial instruments at December 31 were as follows:
1997 1996 ----------------------------- ------------------------------ Carrying Carrying Value Value Notional Asset Fair Notional Asset Fair (Millions) Amount (Liability) Value Amount (Liability) Value - ------------------------------------------------------------------------------------------------ Foreign exchange forward contracts - sell: Related to net investments in foreign affiliates $ 157.8 $ .8 $ 1.0 $ 178.9 $ 3.1 $ 3.5 Related to investments in nondollar denominated assets 42.7 .6 .6 63.9 (.7) (.7) Foreign exchange forward contracts - buy: Related to net investments in foreign affiliates 11.9 - - 25.3 - - Related to investments in nondollar denominated assets 25.0 1.5 1.5 23.5 .5 .5 Futures contracts to purchase securities 8.5 .1 .1 100.0 (1.2) (1.2) Futures contracts to sell securities 10.0 .2 .2 - - - Interest rate swaps 43.0 - 7.2 43.0 - 6.4 Warrants to purchase securities 19.6 6.7 6.7 19.0 3.9 3.9 - ------------------------------------------------------------------------------------------------
The notional amounts of these instruments do not represent the Company's risk of loss. The fair value of these instruments was estimated based on quoted market prices, dealer quotations or internal price estimates believed to be comparable to dealer quotations. These fair value amounts reflect the estimated amounts that the Company would have to pay or would receive if the contracts were terminated. 55 Page 55 Notes to Financial Statements (Continued) 5. Financial Instruments (Continued) Off-Balance-Sheet and Other Financial Instruments (Continued) The Company engages in hedging activities to manage interest rate, equity price and foreign exchange risks. Such hedging activities have principally consisted of using off-balance-sheet instruments which involve, to varying degrees, elements of market risk and credit risk in excess of the amounts recognized in the Consolidated Balance Sheets. The Company evaluates the risks associated with these instruments in a manner similar to that used to evaluate the risks associated with on-balance-sheet financial instruments. Unlike on-balance-sheet financial instruments, where credit risk is generally represented by the notional or principal amount, the off-balance-sheet financial instruments' risk of credit loss generally is significantly less than the notional value of the instrument and is represented by the positive fair value of the instrument. The Company generally does not require collateral or other security to support the financial instruments discussed below. However, the Company controls its credit risk exposure through credit approvals, credit limits and regular monitoring procedures. There were no material concentrations of off-balance-sheet financial instruments at December 31, 1997. Foreign Exchange Forward Contracts: Foreign exchange forward contracts are agreements to exchange fixed amounts of two different currencies at a specified future date and at a specified price. The Company selectively hedges to manage its foreign exchange risk. The Company generally utilizes short-term foreign exchange forward contracts to hedge its foreign exchange exposure arising from certain investments in foreign affiliates and nondollar denominated investment securities. Futures Contracts: Futures contracts represent commitments to either purchase or sell securities at a specified future date and at a specified price or yield. Futures contracts trade on organized exchanges and, therefore, have minimal credit risk. Interest Rate Swaps: The Company utilizes interest rate swaps to manage certain exposures related to changes in interest rates primarily by exchanging variable rate returns for fixed rate returns. Warrants: Warrants are instruments giving the Company the right, but not the obligation to buy a security at a given price during a specified period. 56 Page 56 Notes to Financial Statements (Continued) 6. Net Investment Income Sources of net investment income were as follows:
(Millions) 1997 1996 1995 - --------------------------------------------------------------- Debt securities $ 2,364.9 $ 2,312.1 $ 2,275.9 Equity securities 42.1 34.0 22.0 Short-term investments 25.2 29.0 25.1 Mortgage loans 610.1 761.8 962.6 Real estate 182.6 300.2 306.4 Policy loans 39.9 37.2 30.6 Other 175.5 155.2 133.2 Cash equivalents 141.9 168.6 151.8 ----------------------------------- Gross investment income 3,582.2 3,798.1 3,907.6 Less: investment expenses 204.7 232.9 332.5 ----------------------------------- Net investment income (1)(2) $ 3,377.5 $ 3,565.2 $ 3,575.1 - ----------------------------===================================
(1) Includes $15.6 million, $67.1 million and $76.2 million from real estate held for sale during 1997, 1996 and 1995, respectively. (2) Includes amounts allocable to experience rated contractholders of $1.3 billion, $1.4 billion and $1.5 billion during 1997, 1996 and 1995, respectively. Interest credited to contractholders is included in current and future benefits. 7. Capital Gains and Losses on Investment Operations and Other Realized capital gains or losses are the difference between the carrying value and sale proceeds of specific investments sold. Provisions for impairments and changes in the fair value of real estate held for sale are also included in net realized capital gains or losses. Net realized capital gains (losses), excluding amounts allocable to experience rated contractholders and discontinued products, on investments were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------ Debt securities $ 49.8 $ (11.8) $ 34.4 Equity securities (1) 231.2 46.3 18.2 Mortgage loans 19.2 33.9 (9.4) Real estate 13.5 4.7 3.5 Sales of subsidiaries (2) 82.3 60.1 - Other (3) (61.8) 1.2 .5 -------------------------------- Pretax realized capital gains $ 334.2 $ 134.4 $ 47.2 - ----------------------------================================ After-tax realized capital gains $ 198.4 $ 85.9 $ 29.5 - ----------------------------================================
(1) Includes pretax realized capital gains of $151.0 million in 1997 related to the sale of the Company's investment in Travelers Property Casualty Corp. (2) Realized capital gains in 1997 include net pretax gains associated with the sale of certain health subsidiaries. (Refer to Note 3.) Realized capital gains in 1996 include pretax gains of $39.3 million from the sale of Aetna Realty Investors and $20.8 million from the sale of Aetna Health Plans of Western Pennsylvania. (3) Includes a pretax realized capital loss of $44.0 million in 1997 related to the write-down of certain properties that the Company has classified as held for sale. 57 Page 57 Notes to Financial Statements (Continued) 7. Capital Gains and Losses on Investment Operations and Other (Continued) Net realized capital gains of $221 million, $199 million and $97 million for 1997, 1996 and 1995, respectively, allocable to experience rated contractholders were deducted from net realized capital gains and an offsetting amount was reflected in policyholders' funds left with the Company. Proceeds from the sale of available-for-sale debt securities and the related gross gains and losses were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------- Proceeds on sales $16,247.8 $13,625.6 $13,747.2 Gross gains 90.2 77.6 124.0 Gross losses 40.4 89.4 89.6 - -------------------------------------------------------------
Changes in shareholders' equity related to changes in accumulated other comprehensive income (unrealized capital gains and losses on securities and foreign currency) (excluding those related to experience rated contractholders and discontinued products) were as follows:
(Millions) 1997 1996 1995 - -------------------------------------------------------------------------------------- Continuing Operations: Debt securities $ 194.5 $ (225.8) $ 984.8 Equity securities (152.4) 307.5 41.3 Foreign exchange and other, net (92.8) (70.9) (23.3) Discontinued Operations - (474.0) 900.9 ---------------------------------------- Subtotal (50.7) (463.2) 1,903.7 (Decrease) Increase in deferred income taxes (17.8) (162.1) 191.1 ---------------------------------------- Net changes in accumulated other comprehensive income $ (32.9) $ (301.1) $ 1,712.6 - ----------------------------------------------========================================
Shareholders' equity included the following accumulated other comprehensive income, which are net of amounts allocable to experience rated contractholders and discontinued products, at December 31:
(Millions) 1997 1996 - -------------------------------------------------------------------- Debt securities available for sale: Gross unrealized capital gains $ 563.0 $ 378.5 Gross unrealized capital losses (77.6) (87.6) ---------------------- 485.4 290.9 Equity securities: Gross unrealized capital gains 287.6 397.9 Gross unrealized capital losses (70.6) (28.5) ---------------------- 217.0 369.4 Foreign exchange and other, net (230.0) (137.2) Deferred income taxes 165.3 183.1 ---------------------- Net accumulated other comprehensive income $ 307.1 $ 340.0 - ----------------------------------------------======================
58 Page 58 Notes to Financial Statements (Continued) 7. Capital Gains and Losses on Investment Operations and Other (Continued) Additional Information - Accumulated Other Comprehensive Income Changes in accumulated other comprehensive income related to changes in unrealized gains (losses) on securities (excluding those related to experience rated contractholders and discontinued products) were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------------------------------- Unrealized holding gains (losses) arising during the period (1) $ 385.3 $ (189.0) $ 1,911.5 Less: reclassification adjustment for gains and other items included in net income (2) 335.4 153.8 173.0 --------------------------------------- Net unrealized gains (losses) on securities $ 49.9 $ (342.8) $ 1,738.5 - ----------------------------------------------=======================================
(1) Pretax unrealized holding gains (losses) arising during the period were $592.8 million, $(290.8) million and $2,940.8 million for 1997, 1996 and 1995, respectively. (2) Pretax reclassification adjustments for gains and other items included in net income were $511.0 million, $236.8 million and $242.9 million for 1997, 1996 and 1995, respectively. 8. Severance and Facilities Charges In 1996, the Company recorded severance and facilities reserves in connection with the integration of the health businesses and certain other actions taken or to be taken in order to make its businesses more competitive. The 1996 severance and facilities charges included the following (pretax):
Vacated Asset Leased (Millions) Severance Write-Off Property Other Total - -------------------------------------------------------------------------------------- Aetna U.S. Healthcare $ 277.9 $ 84.9 $ 64.5 $ 25.7 $ 453.0 Aetna Retirement Services 42.8 1.5 1.9 2.8 49.0 Corporate: Other 28.5 18.0 313.2 (1) 3.0 362.7 ------------------------------------------------------- Total Company $ 349.2 $ 104.4 $ 379.6 $ 31.5 $ 864.7 - -------------------------------=======================================================
(1) Includes $292.2 million related to the CityPlace lease. Activity for 1997 and 1996 within the severance and facilities reserves (pretax) and positions eliminated related to such actions were as follows:
(Millions) Reserve Positions - --------------------------------------------------------------- Balance at December 31, 1995 $ - - Severance and facilities charges 864.7 9,373 Actions taken (1) (139.5) (2,421) ------------------- Balance at December 31, 1996 725.2 6,952 Actions taken (1) (274.8) (2,802) Adjustments (2) (45.0) (1,200) ------------------- Balance at December 31, 1997 $ 405.4 2,950 - --------------------------------------------===================
(1) Includes $120.8 million and $84.6 million in 1997 and 1996, respectively, of severance-related actions. Other actions include asset write-offs, vacated leased property payments and other exit costs. (2) Reflects reductions in anticipated severance actions resulting from higher attrition than was contemplated in the establishment of the reserve in the Aetna U.S. Healthcare segment recorded as severance and facilities reserve reductions in the Consolidated Statements of Income. 59 Page 59 Notes to Financial Statements (Continued) 8. Severance and Facilities Charges (Continued) The 2,802 positions eliminated during 1997 related to the following segments: 89.3% - Aetna U.S. Healthcare, 5.8% - Aetna Retirement Services and 4.9% - Corporate. The Aetna U.S. Healthcare severance actions are expected to be substantially completed by the end of 1998. The Aetna Retirement Services severance actions are expected to be substantially completed by September 30, 1998. The Corporate severance actions and vacating of certain leased office space were substantially completed in 1997. In connection with the sale of the Company's property-casualty operations, the Company vacated, and the purchaser subleased, at market rates for a period of eight years, the space that the Company occupied in the CityPlace office facility in Hartford. The remaining lease payments (net of expected subrentals) on the facilities (other than the CityPlace office facility) are payable over approximately the next two years. 9. Discontinued Products The Company discontinued the sale of its fully guaranteed large case pension products (single-premium annuities ("SPAs") and guaranteed investment contracts ("GICs")) in 1993. Under the Company's accounting for these discontinued products, a reserve for anticipated future losses from these products was established, and the reserve is reviewed by management quarterly. As long as the reserve continues to represent management's then best estimate of expected future losses, results of operations of the discontinued products, including net realized capital gains and losses, are credited/charged to the reserve and do not affect the Company's results of operations. As a result of continued favorable developments in real estate markets, the Company released $173 million (pretax) in 1997, and $202 million (pretax) in 1996, respectively, of the reserve related to GICs. The current reserve reflects management's best estimate of anticipated future losses. To the extent that aggregate future losses on GICs and SPAs are greater or less than anticipated, the Company's results of operations would be adversely or positively affected, respectively. The discussion below presents information for the discontinued SPAs and GICs on a combined basis. 60 Page 60 Notes to Financial Statements (Continued) 9. Discontinued Products (Continued) At the time of discontinuance, a receivable from Large Case Pensions' continuing products equivalent to the net present value of the anticipated cash flow shortfalls was established for the discontinued products. Interest on the receivable is accrued at the discount rate which was used to calculate the loss on discontinuance. The offsetting payable, on which interest is similarly accrued, is reflected in continuing products. Interest on the payable generally offsets the investment income on the assets available to fund the shortfall. At December 31, 1997, the receivable from continuing products, net of related deferred taxes payable of $43 million on the accrued interest income, was $515 million. During 1996, $315 million of the receivable, net of the related deferred taxes payable on the accrued interest income of $19 million, was funded from continuing products to meet liquidity needs from maturing GICs. As of December 31, 1997, no additional funding of the receivable had taken place. This amount is eliminated in consolidation. 61 Page 61 Notes to Financial Statements (Continued) 9. Discontinued Products (Continued) Results of discontinued products were as follows (pretax):
Charged (Credited) to Reserve for (Millions) Results Future Losses Net(1) - ---------------------------------------------------------------------------------------- 1997 Net investment income $ 675.5 $ - $ 675.5 Net realized capital gains(2) 269.9 (269.9) - Interest earned on receivable from continuing products 33.1 - 33.1 Other income 25.3 - 25.3 ---------------------------------------- Total revenue 1,003.8 (269.9) 733.9 ---------------------------------------- Current and future benefits (3) 652.3 67.5 719.8 Operating expenses 14.1 - 14.1 ---------------------------------------- Total benefits and expenses 666.4 67.5 733.9 ---------------------------------------- Results of discontinued products $ 337.4 $ (337.4) $ - ======================================================================================== 1996 Net investment income $ 818.3 $ - $ 818.3 Net realized capital gains 121.8 (121.8) - Interest earned on receivable from continuing products 45.7 - 45.7 Change in Accounting Policy -FAS No. 121 (4) 8.3 - 8.3 Other income 31.5 - 31.5 ---------------------------------------- Total revenue 1,025.6 (121.8) 903.8 ---------------------------------------- Current and future benefits (3) 777.8 108.5 886.3 Operating expenses 17.5 - 17.5 ---------------------------------------- Total benefits and expenses 795.3 108.5 903.8 ---------------------------------------- Results of discontinued products $ 230.3 $ (230.3) $ - ======================================================================================== 1995 Net investment income $ 962.9 $ - $ 962.9 Net realized capital losses (7.1) 7.1 - Interest earned on receivable from continuing products 50.8 - 50.8 Other income 20.7 - 20.7 ---------------------------------------- Total revenue 1,027.3 7.1 1,034.4 ---------------------------------------- Current and future benefits (3) 1,053.1 (31.1) 1,022.0 Operating expenses 12.4 - 12.4 ---------------------------------------- Total benefits and expenses 1,065.5 (31.1) 1,034.4 ---------------------------------------- Results of discontinued products $ (38.2) $ 38.2 $ - ========================================================================================
(1) Amounts are reflected in the 1997, 1996 and 1995 Consolidated Statements of Income, except for interest earned on the receivable from continuing products which is eliminated in consolidation. (2) Includes net realized capital gains of $154.4 million (pretax) related to continued favorable developments in real estate markets (including gains of $37.4 million (pretax) related to the securitization of commercial mortgage loans) as well as $57.4 million (pretax) resulting from the sale of investments in order to meet liquidity needs. (3) 1995 current and future benefits include losses of $49.5 million (pretax) due to early retirement of GICs. There were no such losses in 1997 and such losses were immaterial in 1996. (4) Refer to Note 1 for a discussion of FAS No. 121. Deposits of $14 million, $18 million and $32 million were received during 1997, 1996 and 1995, respectively, under preexisting GICs. 62 Page 62 Notes to Financial Statements (Continued) 9. Discontinued Products (Continued) Net realized capital gains from the sale of bonds supporting discontinued products were $56 million, $12 million and $61 million (pretax) for 1997, 1996 and 1995, respectively. Assets and liabilities of discontinued products at December 31 were as follows:(1)
(Millions) 1997 1996 - ------------------------------------------------------------------------- Debt securities available for sale $ 6,471.4 $ 5,189.3 Mortgage loans 976.9 2,730.7 Real estate 116.9 367.7 Short-term and other investments 371.3 394.5 ------------------------ Total investments 7,936.5 8,682.2 Current and deferred income taxes 165.6 166.0 Receivable from continuing products (2) 557.8 524.7 - ------------------------------------------------------------------------- Total assets $ 8,659.9 $ 9,372.9 ========================================================================= Future policy benefits $ 4,763.0 $ 4,793.7 Policyholders' funds left with the Company 2,321.4 3,288.7 Reserve for anticipated future losses on discontinued products 1,151.7 986.8 Other 423.8 303.7 - ------------------------------------------------------------------------- Total liabilities $ 8,659.9 $ 9,372.9 =========================================================================
(1) Assets supporting the discontinued products are distinguished from other continuing operations assets. (2) The receivable from continuing products is eliminated in consolidation. Net unrealized capital gains on available for sale debt securities are included above in other liabilities and are not reflected in consolidated shareholders' equity. The reserve for anticipated future losses is included in future policy benefits on the Consolidated Balance Sheets. 63 Page 63 Notes to Financial Statements (Continued) 9. Discontinued Products (Continued) The reserve for anticipated future losses on discontinued products represents the present value (at the risk-free rate at the time of discontinuance, consistent with the duration of the liabilities) of the difference between (a) the expected cash flows from the assets supporting discontinued products, and (b) the cash flows expected to be required to meet the obligations of the outstanding contracts. Calculation of the reserve for anticipated future losses requires projection of both the amount and the timing of cash flows over approximately the next 30 years, including consideration of, among other things, future investment results, participant withdrawal and mortality rates, and cost of asset management and customer service. Projections of future investment results consider both industry and Company data and are based on performance of mortgage loan and real estate assets, projections regarding levels of future defaults and prepayments, and assumptions regarding future real estate market conditions, which assumptions management believes are reasonable. Management believes that the reserve for anticipated future losses is adequate to provide for the future losses associated with the runoff of the liabilities. At December 31, 1997 and 1996, estimated future net realized capital losses attributable to mortgage loans and real estate expected to be charged to the reserve for anticipated future losses were $68.7 million and $180.8 million (pretax), respectively. The activity in the reserve for anticipated future losses on discontinued products was as follows (pretax):
(Millions) - ------------------------------------------------ Reserve at December 31, 1994 $ 997.0 Results of discontinued products (38.2) -------- Reserve at December 31, 1995 958.8 Results of discontinued products 230.3 Reserve reduction (202.3) -------- Reserve at December 31, 1996 986.8 Results of discontinued products 337.4 Reserve reduction (172.5) -------- Reserve at December 31, 1997 $1,151.7 ================================================
64 Page 64 Notes to Financial Statements (Continued) 10. Income Taxes Income taxes (benefits) for continuing operations consist of the following:
(Millions) 1997 1996 1995 ---- ---- ---- Current taxes: Federal $ 407.1 $ 231.9 $ 260.1 State (1) 34.6 15.6 - Foreign 25.1 10.4 8.0 ------------------------------------ 466.8 257.9 268.1 ------------------------------------ Deferred taxes (benefits): Federal 141.2 (139.9) (25.7) State (1) 4.4 2.4 - Foreign (2.3) 13.2 9.9 ------------------------------------ 143.3 (124.3) (15.8) ------------------------------------ Total $ 610.1 $ 133.6 $ 252.3 - -------------------------------------------====================================
(1) Prior to the merger with U.S. Healthcare, state income taxes were immaterial and were included in operating expenses. Income taxes were different from the amount computed by applying the federal income tax rate to income from continuing operations before income taxes, as follows:
(Millions) 1997 1996 1995 ---- ---- ---- Income from U.S. operations $ 1,271.9 $ 162.5 $ 544.8 Income from non-U.S. operations 239.3 176.2 181.4 ------------------------------------ Income before income taxes 1,511.2 338.7 726.2 Tax rate 35% 35% 35% ------------------------------------ Application of the tax rate 528.9 118.5 254.2 Tax effect of: Tax-exempt interest (2.6) (4.4) (4.3) Foreign operations (18.3) (4.9) 10.1 Excludable dividends (10.1) (10.5) (9.8) Goodwill amortization 66.5 30.7 5.5 State income taxes (1) 25.4 11.7 - Other, net 20.3 (7.5) (3.4) ------------------------------------ Income taxes $ 610.1 $ 133.6 $ 252.3 - -------------------------------------------====================================
(1) Prior to the merger with U.S. Healthcare, state income taxes were immaterial and were included in operating expenses. 65 Page 65 Notes to Financial Statements (Continued) 10. Income Taxes (Continued) The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities at December 31, are as follows:
(Millions) 1997 1996 - ----------------------------------------------------------------- Deferred tax assets: Insurance reserves $ 325.4 $ 391.5 Reserve for anticipated future losses on discontinued products 392.3 335.6 Reserve for severance and facilities charges 167.4 308.9 Impairment reserves 38.0 42.4 Other postretirement benefits 191.3 224.1 Net operating loss carry forward 27.7 59.1 Deferred compensation and other 64.3 86.9 Other 24.1 14.8 ---------------------- Total gross assets 1,230.5 1,463.3 Less valuation allowance 20.2 23.0 ---------------------- Assets, net of valuation allowance 1,210.3 1,440.3 Deferred tax liabilities: Deferred policy acquisition costs 651.5 645.5 Acquired intangibles other than goodwill 432.8 496.1 Accumulated other comprehensive income 132.2 175.8 Market discount 56.3 57.3 Other 160.8 97.3 ---------------------- Total gross liabilities 1,433.6 1,472.0 ---------------------- Net deferred tax liability $ 223.3 $ 31.7 - -------------------------------------------======================
Valuation allowances are provided when it is considered unlikely that deferred tax assets will be realized. The valuation allowance relates to future tax benefits on certain purchased domestic and foreign net operating losses. The Company has not recognized U.S. deferred taxes related to the estimated cumulative amount of undistributed earnings of approximately $385 million on its foreign corporations because the Company does not expect to repatriate these earnings. A U.S. deferred tax liability will be recognized when the Company expects that it will recover these undistributed earnings in a taxable manner, such as through a receipt of dividends or a sale of the investment. The "Policyholders' Surplus Account," which arose under prior tax law, is generally that portion of a life insurance company's statutory income that has not been subject to taxation. As of December 31, 1983, no further additions could be made to the Policyholders' Surplus Account for tax return purposes under the Deficit Reduction Act of 1984. The balance in such account was $935 million at December 31, 1997 adjusted for Internal Revenue Service (the "Service") audits finalized to date. This amount would be taxed only under certain conditions. No income taxes have been provided on this amount since management believes the conditions under which such taxes would become payable are remote. 66 Page 66 Notes to Financial Statements (Continued) 10. Income Taxes (Continued) The Service has completed its examination of the consolidated federal income tax returns of Aetna Services and affiliated companies through 1990 and U.S. Healthcare through 1994. Discussions are being held with the Service with respect to proposed adjustments. Management believes there are adequate defenses against, or sufficient reserves to provide for, any such adjustments. The Service is continuing its examination for the years 1991 through 1994 for Aetna Services. The Company paid net income taxes of $378 million, $249 million and $135 million in 1997, 1996 and 1995, respectively. 11. Benefit Plans Pension Plans - The Company has noncontributory defined benefit pension plans covering substantially all Aetna Services employees and certain agents. The plans provide pension benefits based on years of service and average annual compensation (measured over 60 consecutive months of highest earnings in a 120-month period). Contributions are determined by using the Projected Unit Credit Method and, for qualified plans subject to ERISA requirements, are limited to amounts that are tax deductible. Components of the net periodic pension cost in continuing operations were as follows:
(Millions) 1997 1996 1995 - --------------------------------------------------------------------------------- Return on plan assets $ 731.4 $ 373.1 $ 427.5 Service cost - benefits earned during the period (74.9) (77.7) (86.7) Interest cost on projected benefit obligation (231.4) (217.0) (192.9) Net amortization and deferral (476.1) (128.8) (222.0) - --------------------------------------------------------------------------------- Net periodic cost (1) $ (51.0) $ (50.4) $ (74.1) - ----------------------------------------------===================================
(1) A curtailment loss of $95.6 million (pretax) is included in the gain on the sale of Discontinued Operations in 1996. 67 Page 67 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) As of the measurement date (September 30), the funded status of plans for which assets exceeded accumulated benefits was as follows:
(Millions) 1997 1996 - -------------------------------------------------------------------- Actuarial present value of vested benefit obligation $ 2,985.6 $ 2,820.8 - -------------------------------------------------------------------- Actuarial present value of accumulated benefit obligation $ 3,008.6 $ 2,840.2 - -------------------------------------------------------------------- Plan assets at fair value $ 3,587.5 $ 2,932.3 Actuarial present value of projected benefit obligation 3,097.3 3,006.9 ---------------------- Plan assets greater (less) than projected benefit obligation 490.2 (74.6) Unrecognized net (gain) loss (447.4) 86.7 Unrecognized prior service cost 2.4 3.4 Unrecognized net asset at date of adoption of FAS No. 87 (1.5) (2.0) ---------------------- Prepaid pension cost $ 43.7 $ 13.5 - ----------------------------------------------======================
Nonfunded plans had projected benefit obligations of $176 million and $143 million for 1997 and 1996, respectively. The 1997 and 1996 accumulated benefit obligations for these plans were $148 million and $126 million, respectively, and the related accrued pension cost was $138 million and $132 million, respectively. The weighted average discount rate was 7.5% for 1997, 1996 and 1995. The expected long-term rate of return on plan assets was 9.0% for 1997 and 8.5% for 1996 and 1995. The rate of increase in future compensation was 4.5% for 1997, 1996 and 1995. The future annual cost-of-living adjustment was 2.8% for 1997 and 1996 and 3.0% for 1995. Plan assets, primarily investments in domestic equities and fixed-income instruments, are held in trust, and benefit payments are administered by Aetna Life Insurance Company and affiliates. Approximately 10% of the plan assets at December 31, 1997 are held in the general account of Aetna Life Insurance Company. The Company also has a defined contribution pension plan which covers substantially all of its former U.S. Healthcare employees, subject to certain age and service requirements. The Company's contribution for each eligible employee is a percentage of the employee's compensation, as defined. Pretax charges for this defined contribution pension plan were $16 million in 1997 and $7 million for the period from July 19, 1996 through December 31, 1996. 68 Page 68 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) Postretirement Benefits - In addition to providing pension benefits, the Company currently provides certain health care and life insurance benefits for retired employees of Aetna Services. A comprehensive medical and dental plan is offered to all full-time employees retiring at age 50 with 15 years of service or at age 65 with 10 years of service. There is a cap on the portion of the cost paid by the Company relating to medical and dental benefits. Retirees are generally required to contribute to the plans based on their years of service with the Company. Components of the net periodic postretirement benefit cost in continuing operations were as follows:
(Millions) 1997 1996 1995 - --------------------------------------------------------------------------------- Service cost - benefits earned during the year $ (5.9) $ (7.3) $ (8.3) Interest cost (30.2) (34.7) (34.7) Net amortization 24.9 26.4 28.3 Return on plan assets 2.4 1.4 2.0 ----------------------------------- Net periodic cost (1) $ (8.8) $ (14.2) $ (12.7) - ----------------------------------------------===================================
(1) A curtailment gain of $77.4 million (pretax) is included in the gain on the sale of Discontinued Operations in 1996. As of the measurement date (September 30), the funded status of the postretirement benefit plans (other than pensions) was as follows:
(Millions) 1997 1996 - -------------------------------------------------------------------- Actuarial present value of accumulated postretirement benefit obligation: Retirees $ 342.5 $ 329.1 Fully eligible active employees 17.0 17.9 Active employees not eligible to retire 67.0 70.2 ---------------------- Total 426.5 417.2 Plan assets at fair value 55.7 54.0 ---------------------- Accumulated postretirement benefit obligation in excess of plan assets 370.8 363.2 Unrecognized net gain 78.8 84.0 Prior service cost 78.5 100.0 - -------------------------------------------------------------------- Accrued postretirement benefit cost $ 528.1 $ 547.2 - ----------------------------------------------======================
69 Page 69 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) The weighted average discount rate was 7.5% for 1997, 1996 and 1995. The health care cost trend rate for the 1997 valuation decreased gradually from 9.0% for 1998 to 5.5% by the year 2005. For the 1996 valuation, the rates decreased gradually from 10.5% for 1997 to 5.5% by the year 2005. Increasing the health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation at December 31, 1997 by $24 million and would increase the net periodic cost for 1997 by $2 million (pretax). It is the Company's practice to fund amounts for postretirement life insurance benefits to the extent the contribution is deductible for federal income taxes. The plan assets are held in trust and administered by Aetna Life Insurance Company. The assets are in the general account of Aetna Life Insurance Company, and the expected rate of return on the plan assets was 7% for 1997, 1996 and 1995. The Company's retiree health benefit plan for former U.S. Healthcare employees is a defined contribution plan which covers substantially all such employees, subject to certain age and service requirements. Contributions are at the Company's sole discretion. Accumulated contributions and interest thereon are used to fund all or a portion of the premiums for health care benefit coverage for eligible retired employees and their eligible spouses. When funds are exhausted, the Company has no obligation to make any further contributions or payments. No contributions have been made to this retiree health benefit plan since July 19, 1996. Incentive Savings Plans - Substantially all Aetna Services employees are eligible to participate in a savings plan under which designated contributions, which may be invested in common stock of Aetna Inc. or certain other investments, are matched, up to 5% of compensation, by the Company. The former U.S. Healthcare savings plan, which has not been merged into the Company's incentive savings plan, provides for a match of up to 2% of compensation in common stock of Aetna Inc. Pretax charges to operations (including continuing and Discontinued Operations in 1996 and 1995) for the incentive savings plans were $42 million, $50 million and $60 million for 1997, 1996 and 1995, respectively. Plan trustees held 4,177,786 shares, 4,514,258 shares and 5,015,075 shares of the Company's common stock for plan participants at the end of 1997, 1996 and 1995, respectively. 70 Page 70 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) 1996 Stock Incentive Plan - The Company's 1996 Stock Incentive Plan (the "1996 Plan") replaced the Company's and U.S. Healthcare's previous stock incentive plans. Effective with the merger, stock options of Aetna Inc. were substituted for options outstanding under the previous Aetna Services plans and for that portion of options outstanding under the previous U.S. Healthcare plans that were not satisfied for cash in the merger. The 1996 Plan provides for stock options (see "Stock Options" below), deferred contingent common stock or equivalent cash awards (see "Incentive Units" below) or restricted stock to certain key employees. The maximum number of shares of common stock initially issuable under the 1996 Plan (including shares issuable in respect of options and units granted under predecessor plans that were outstanding prior to the merger) is 13,270,000. At December 31, 1997, 6,753,386 shares were available for grant under the 1996 Plan. The compensation expense charged to operations related to the Incentive Units was $22 million, $27 million and $36 million, pretax, for 1997, 1996 and 1995, respectively. The Company does not recognize compensation expense for stock options granted at or above the market price on the date of grant under its stock incentive plans. FAS No. 123, Accounting for Stock-Based Compensation, requires disclosure of pro forma net income as if the fair value method of valuing stock option grants were applied to such grants (disclosure alternative). The Company's net income and earnings per common share, on a pro forma basis, which may not be indicative of pro forma effects in future years, would have been as follows:
(Millions) 1997 1996 1995 - --------------------------------------------------------------------------------- Net income: As reported $ 901.1 $ 651.0 $ 251.7 Pro forma $ 886.3 $ 643.1 $ 249.1 Basic earnings per common share: As reported $ 5.67 $ 4.77 $ 2.22 Pro forma $ 5.57 $ 4.71 $ 2.20 Diluted earnings per common share: As reported $ 5.60 $ 4.72 $ 2.20 Pro forma $ 5.51 $ 4.67 $ 2.18 - ---------------------------------------------------------------------------------
The fair value of the stock options included in the pro forma amounts shown above was estimated as of the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions:
1997 1996 1995 - ---------------------------------------------------------------------------------- Dividend yield 1% 2% 5% Expected volatility 30% 26% 22% Risk-free interest rate 7% 6% 7% Expected life 4 years 4 years 4 years - ----------------------------------------------------------------------------------
71 Page 71 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) The weighted-average grant date fair values for options granted in 1997, 1996 and 1995 were $29.17, $17.00, and $9.22, respectively. Stock Options - Executive and middle management employees may be granted options to purchase common stock of the Company at or above the market price on the date of grant. Options generally become 100% vested three years after the grant is made, with one-third of the options vesting each year. From time to time, the Company has issued options with different vesting provisions. Vested options may be exercised at any time during the 10 years after grant, except in certain circumstances generally related to employment termination or retirement. At the end of the 10-year period, any unexercised options expire. Stock option transactions for 1997, 1996 and 1995 were as follows:
1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Number Average Number Average Number Average of Exercise of Exercise of Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------- Outstanding, beginning of year 7,228,550 $ 58.99 4,883,661 $ 53.72 5,072,958 $ 52.44 Granted 385,025 $ 94.22 3,185,180 $ 70.78 2,131,100 $ 55.61 Exchanged for U.S. Healthcare options (1) - $ - 800,610 $ 32.72 - $ - Exercised (1,821,113) $ 51.94 (1,438,730) $ 51.94 (2,198,219) $ 52.46 Expired or forfeited (525,168) $ 68.55 (202,171) $ 62.02 (122,178) $ 56.19 ---------- ---------- ---------- Outstanding, end of year 5,267,294 $ 63.12 7,228,550 $ 58.99 4,883,661 $ 53.72 - ----------------------------------====================================================================== Options exercisable at year end 2,614,399 $ 54.90 2,749,017 $ 47.47 2,110,474 $ 51.43 - ----------------------------------======================================================================
(1) Effective with the merger, stock options of Aetna Inc. were substituted for that portion of options outstanding under the previous U.S. Healthcare plans that were not satisfied in cash in the merger. The following is a summary of information regarding options outstanding and options exercisable at December 31, 1997:
Options Outstanding Options Exercisable ----------------------------------------------------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life (Years) Price Exercisable Price - ------------------------------------------------------------------------------------- $14.87 - $ 38.72 469,476 8 $ 34.18 469,476 $ 34.18 $41.50 - $ 46.75 292,221 5 $ 44.88 292,221 $ 44.88 $50.50 - $ 57.00 1,450,495 7 $ 54.72 1,000,608 $ 54.78 $61.63 - $ 75.50 2,687,277 9 $ 70.37 852,094 $ 69.90 $80.25 - $112.63 367,825 10 $ 94.70 - $ - ----------- ----------- 5,267,294 2,614,399 - --------------------===========-----------------------------===========--------------
72 Page 72 Notes to Financial Statements (Continued) 11. Benefit Plans (Continued) Incentive Units - Executives may be granted incentive units which are rights to receive common stock or an equivalent value in cash. Of the two cycles of incentive unit grants outstanding, each vests at the end of a four-year vesting period (currently 1998 and 2000) conditioned upon the employee's continued employment during that period and achievement of specified Company performance goals related to the Company's total return to shareholders over the four-year measurement period. The incentive units may vest within a range from 0% to 175% at the end of the four-year period based on the attainment of these performance goals. The incentive unit holders are not entitled to dividends during the vesting period. Incentive unit transactions related to the 1996 Plan under which holders may be entitled to receive common stock, are as follows:
Number of Incentive Units - ----------------------------------------------------------------------- 1997 1996 1995 --------- -------- ------- Outstanding, beginning of year 368,217 564,920 345,800 Granted 433,500 3,425 243,440 Vested (202,852) (191,928) (24,320) Expired or forfeited (23,720) (8,200) - --------- -------- ------- Outstanding, end of year 575,145 368,217 564,920 - --------------------------------------=================================
The weighted-average grant date fair values for incentive units granted in 1997, 1996 and 1995 were $85.17, $71.88 and $54.33, respectively. 12. Participating Policyholders' Interests Under participating life insurance contracts issued by the Company, the policyholder is entitled to share in the earnings of such contracts. This business is accounted for in the Company's consolidated financial statements on a statutory basis since any adjustments to policy acquisition costs and reserves on this business would have no effect on the Company's net income or shareholders' equity. Statutory premiums, assets and liabilities allocable to the participating policyholders were as follows:
(Millions) 1997 1996 1995 - ------------------------------------------------------------------------------ Premiums $ 63.8 $ 48.4 $ 50.1 - ------------------------------------------------------------------------------ Assets $ 733.5 $ 702.1 $ 688.3 - ------------------------------------------------------------------------------ Liabilities $ 640.3 $ 613.3 $ 614.9 - ------------------------------------------------------------------------------
73 Page 73 Notes to Financial Statements (Continued) 13. Debt and Guarantee of Debt Securities
(Millions) 1997 1996 - ---------------------------------------------------------------------------- Long-term debt: Domestic: Notes, 8.625% due 1998 $ 99.9 $ 99.9 Notes, 6.75% due 2001 299.7 299.6 Notes, 6.375% due 2003 199.2 199.1 Notes, 7.125% due 2006 347.8 347.5 Debentures, 6.75% due 2013 199.8 199.8 Eurodollar Notes, 7.75% due 2016 63.6 63.6 Debentures, 8% due 2017 (1) 170.0 200.0 Mortgage Notes and Other Notes, 3% due in varying amounts to 2009 5.6 6.0 Debentures, 7.25% due 2023 200.0 200.0 Debentures, 7.625% due 2026 446.0 445.9 Debentures, 6.97% due 2036 (putable at par in 2004) 300.0 300.0 International: Mortgage Notes, 6.5%-11.875% due in varying amounts to 2006 14.6 18.6 ---------------------- Total $ 2,346.2 $ 2,380.0 - ------------------------------------------------------======================
(1) Subject to various redemption options which began on January 15, 1997. On August 19, 1996, Aetna Services issued the following debt: $300 million 6.75% Notes due 2001; $350 million 7.125% Notes due 2006; $450 million 7.625% Debentures due 2026; and $300 million 6.97% Debentures due 2036 (putable at par in 2004). Aetna Inc. has fully and unconditionally guaranteed the payment of all principal, premium, if any, and interest on all outstanding debt securities of Aetna Services, including the $348 million 9.5% Subordinated Debentures due 2024 (the "Subordinated Debentures") issued to Aetna Capital L.L.C., a wholly owned subsidiary of Aetna Services (refer to Note 14) (collectively the "Aetna Services Debt"). At December 31, 1997, $252.1 million of short-term borrowings were outstanding. In addition, Aetna Services has a revolving credit facility in an aggregate amount of $1.5 billion with a worldwide group of banks that terminates in June 2001. Various interest rate options are available under the facility and any borrowings mature on the expiration date of the applicable credit commitment. Aetna Services pays facility fees ranging from .065% to .20% per annum, depending upon its long-term senior unsecured debt rating. The facility fee at December 31, 1997 is at an annual rate of .08%. The facility also supports Aetna Services' commercial paper borrowing program. As a guarantor to the credit facility, Aetna Inc. is required to maintain shareholders' equity, excluding net unrealized capital gains and losses, of at least $7.5 billion. 74 Page 74 Notes to Financial Statements (Continued) 13. Debt and Guarantee of Debt Securities (Continued) Aggregate maturities of long-term debt and sinking fund requirements for 1998 through 2001 are $106 million, $2 million, $4 million, $305 million, respectively, no maturities in 2002 and $1,929 million thereafter. Total interest paid by the Company was $239 million, $130 million and $122 million in 1997, 1996 and 1995, respectively. Consolidated financial statements of Aetna Services have not been presented herein or in any separate reports filed with the Securities and Exchange Commission because management has determined that such financial statements would not be material to holders of the Aetna Services Debt. Summarized consolidated financial information for Aetna Services at December 31 and for the year then ended, is as follows (in millions):
Balance Sheets Information: 1997 1996 ---------- ---------- Total investments (excluding Separate Accounts) $ 41,020.9 $ 42,555.0 ---------- ---------- Total assets $ 85,138.9 $ 83,171.6 ---------- ---------- Total insurance liabilities $ 38,620.0 $ 40,357.4 ---------- ---------- Total liabilities $ 82,160.2 $ 80,352.8 ---------- ---------- Total redeemable preferred stock $ 275.0 $ 275.0 ---------- ---------- Total shareholder's equity $ 2,703.7 $ 2,543.8 ---------- ---------- Statements of Income Information: Total revenue $ 10,390.7 $ 13,048.7 ---------- ---------- Total benefits and expenses $ 8,885.5 $ 12,713.7 ---------- ---------- Income from continuing operations before income taxes $ 1,505.2 $ 335.0 ---------- ---------- Income from continuing operations $ 975.9 $ 233.9 ---------- ---------- Net income $ 975.9 $ 679.8 ---------- ----------
75 Page 75 Notes to Financial Statements (Continued) 14. Aetna-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Limited Liability Company Holding Primarily Debentures Guaranteed by Aetna On November 22, 1994, Aetna Capital L.L.C. ("ACLLC"), a wholly owned subsidiary of Aetna Services, issued $275 million (11,000,000 shares) of 9.5% Cumulative Monthly Income Preferred Securities, Series A. The securities are redeemable, at the option of ACLLC with Aetna Services' consent, in whole or in part, from time to time, on or after November 30, 1999, or at any time under certain limited circumstances related to tax events, at a redemption price of $25 per security plus accumulated and unpaid dividends to the redemption date. The securities are scheduled to become due and payable in 2024. The maturity date may be changed under certain circumstances. ACLLC loaned the proceeds from the preferred stock issuance and the common capital contributions to Aetna Services. In return, Aetna Services issued to ACLLC approximately $348 million principal amount of 9.5% Subordinated Debentures due in 2024 which are fully and unconditionally guaranteed by Aetna Inc. on a subordinated basis. (Refer to Note 13.) These Subordinated Debentures represent substantially all of the assets of ACLLC. Interest on these debentures is payable monthly, and under certain circumstances, principal may be due prior to or later than the original maturity date. This loan is eliminated in the Consolidated Balance Sheets. The interest and other payment dates on the debentures correspond to the distribution and other payment dates on the preferred and common securities of ACLLC. Aetna Inc.'s obligations under the debentures and related agreements, taken together, constitute a full and unconditional guarantee of payments due on the preferred securities of ACLLC. 15. Capital Stock In addition to the capital stock disclosed on the Consolidated Balance Sheets, Aetna Inc. has the following authorized capital stock: 15,000,000 shares of Class A Voting Preferred Stock, $.01 par value per share; 15,000,000 shares of Class B Voting Preferred Stock, $.01 par value per share; and 15,000,000 shares of Class D Non-Voting Preferred Stock, par value $.01 per share. 76 Page 76 Notes to Financial Statements (Continued) 15. Capital Stock (Continued) Each share of Class C Stock is mandatorily convertible into one share of common stock on July 19, 2000. Dividends accrue on a daily basis at an annual rate of $4.7578 per share and are payable upon declaration by Aetna Inc.'s Board of Directors (the "Board"). Aetna Inc. may, at its option, redeem the Class C Stock during the period July 19, 1999 to July 18, 2000 for shares of Aetna Inc. common stock based on specified formulas. The number of shares of common stock to be issued for each share of Class C Stock pursuant to an optional redemption will be based on a ratio, calculated as the greater of: (a) $76.125 (plus any accrued but unpaid dividends) divided by the then current market price of the common stock determined two trading days prior to the notice date of the intent to redeem; or (b) .8197 of a share of common stock. Each share of Class C Stock is also convertible, prior to the mandatory redemption date in whole or part, at the option of the holder, into .8197 of a share of common stock. At December 31, 1997 and 1996, 12,585,929 and 13,204,381 common shares, respectively, were reserved for Aetna Inc.'s stock option plans. Pursuant to Aetna Inc.'s Rights Agreement, one share purchase right (a "Right") is attached to each share of outstanding common stock and common stock subsequently issued, prior to the time at which the Rights become exercisable, expire or are redeemed. The Rights trade with the common stock until they become exercisable. The Rights become exercisable 10 days after: (i) a public announcement that a person or group ("person") has acquired 15% or more of the outstanding shares of common stock or, 10% or more of the outstanding shares of common stock if such person is declared by the Board to be an "adverse person" ("triggering acquisition"); or (ii) a person commences a tender offer or exchange offer, the consummation of which could result in such person owning 15% or more of the common stock; or (iii), in either event, such later date as the Board may determine. Upon becoming exercisable, each Right will entitle the holder thereof (the "Holder") to purchase one one-hundredth of a share of Aetna Inc.'s Class B Voting Preferred Stock, Series A (a "Fractional Preferred Share") at a price of $200 (the "Exercise Price"). Each Fractional Preferred Share has dividend, voting and liquidation rights designed to make it approximately equal in value to one share of common stock. Under certain circumstances, including a triggering acquisition, each Right (other than Rights that were or are owned by the acquirer, which are void) thereafter will entitle the Holder to purchase common stock (or economically equivalent securities, under certain circumstances) worth twice the Exercise Price. Under certain circumstances, including certain acquisitions of Aetna Inc. in a merger or sale of its assets, each Right thereafter will entitle the Holder to purchase equity securities of the acquirer at a 50% discount. 77 Page 77 Notes to Financial Statements (Continued) 15. Capital Stock (Continued) Under certain circumstances, Aetna Inc. may redeem all of the Rights at a price of $.01 per Right. The Rights will expire on November 7, 1999, unless earlier redeemed. The Rights have no dilutive effect on earnings per share until exercised. 16. Dividend Restrictions and Shareholders' Equity The Company's business operations are conducted through Aetna Services and Aetna U.S. Healthcare and their respective subsidiaries (which principally consist of HMOs and insurance companies). In addition to general state law restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, HMOs and insurance companies are subject to further state regulations that, among other things, may require such companies to maintain certain levels of equity, and restrict the amount of dividends and other distributions that may be paid to their parent corporations. These regulations are not directly applicable to Aetna Services, Aetna U.S. Healthcare, or Aetna Inc., as none are an HMO or insurance company. The additional regulations applicable to the Company's indirect HMO and insurance company subsidiaries are not expected to affect the ability of Aetna Inc. to pay dividends, or the ability of any of the Company's subsidiaries to service their outstanding debt or preferred stock obligations. The amount of dividends that may be paid to Aetna Services or Aetna U.S. Healthcare by their domestic insurance and HMO subsidiaries at December 31, 1997 without prior approval by state regulatory authorities is limited to approximately $634 million in the aggregate. There are no such restrictions on distributions from Aetna Services or Aetna U.S. Healthcare to Aetna Inc. or on distributions from Aetna Inc. to its shareholders. The combined statutory net income for the years ended and statutory surplus as of December 31 for the domestic insurance and HMO subsidiaries of the Company, reflecting intercompany eliminations, were as follows:
(Millions) 1997 1996 - -------------------------------------------------------- Statutory net income (1) $ 759.5 $ 418.5 Statutory surplus $ 3,361.3 $ 3,512.7 - --------------------------------------------------------
(1) Statutory net income includes results for Aetna U.S. Healthcare from July 19, 1996. As of December 31, 1997, the Company does not utilize any statutory accounting practices which are not prescribed by state regulatory authorities that, individually or in the aggregate, materially affect statutory surplus. 78 Page 78 Notes to Financial Statements (Continued) 17. Segment Information (1)(2) Summarized financial information for the Company's principal operations was as follows:
(Millions) 1997 1996 1995 - ----------------------------------------------------------------------------------- Revenue: Aetna U.S. Healthcare (3) $ 12,901.4 $ 9,733.7 $ 7,615.4 Aetna Retirement Services 1,902.5 1,762.2 1,706.1 International 1,975.5 1,631.0 1,459.8 Large Case Pensions 1,622.5 1,975.6 2,248.4 Corporate: Other 138.3 98.0 9.7 ---------------------------------- Total revenue $ 18,540.2 $ 15,200.5 $13,039.4 - -------------------------------------------------================================== Income from continuing operations before income taxes: Aetna U.S. Healthcare $ 844.8 $ 125.5 $ 454.4 Aetna Retirement Services 372.2 265.5 294.8 International 196.5 171.9 127.3 Large Case Pensions 387.8 395.7 132.7 Corporate: Interest (226.9) (159.9) (108.3) Other (63.2) (460.0) (174.7) ---------------------------------- Total income from continuing operations before income taxes $ 1,511.2 $ 338.7 $ 726.2 - -------------------------------------------------================================== Net income: Aetna U.S. Healthcare $ 453.8 $ 58.7 $ 286.0 Aetna Retirement Services 257.1 186.2 198.0 International 142.4 109.9 86.6 Large Case Pensions 234.2 258.4 89.2 Corporate: Interest (147.5) (103.9) (70.4) Other (38.9) (304.2) (115.5) ---------------------------------- Income from continuing operations 901.1 205.1 473.9 Discontinued Operations, net of tax - 445.9 (222.2) ---------------------------------- Net income $ 901.1 $ 651.0 $ 251.7 - -------------------------------------------------==================================
(Millions) 1997 1996 - ----------------------------------------------------------------------- Assets: Aetna U.S. Healthcare $ 15,938.5 $ 15,831.0 Aetna Retirement Services 40,916.6 32,402.1 International 6,521.5 5,999.6 Large Case Pensions (4) 32,325.2 38,146.1 Corporate 298.8 534.1 ---------------------- Total assets $ 96,000.6 $ 92,912.9 - -------------------------------------------------======================
(1) The 1997 and 1996 results include benefits of $108.4 million and $131.5 million, after tax, respectively, from reductions of the loss on discontinued products in Large Case Pensions. (2) The 1996 results include severance and facilities charges of $561.8 million, after tax. Of this charge $294.5 million related to Aetna U.S. Healthcare, $31.8 million related to Aetna Retirement Services and $235.5 million related to Corporate. (3) Premiums and fees from the federal government accounted for 19.1% and 13.4% of Aetna U.S. Healthcare's and the Company's consolidated revenue, respectively in 1997. For 1996, such amounts were 18.0% of Aetna U.S. Healthcare's revenue, as determined on a pro forma basis for the U.S. Healthcare acquisitions and less than 10.0% of the Company's consolidated revenue. Contracts with the Health Care Financing Administration accounted for 82.4% and 70.0% of these premiums and fees, with the balance from other federal employee benefit programs in 1997 and 1996, respectively. (4) Assets at December 31, 1997 and 1996 include $7.9 billion and $8.7 billion, respectively, of assets attributable to discontinued products. 79 Page 79 Notes to Financial Statements (Continued) 18. Commitments and Contingent Liabilities Commitments The Company has agreed with its Mexican partner to invest up to an additional $63 million in a joint venture that offers insurance products through the partner's bank subsidiary based on the performance of the new company over the first five years of operations. In addition, the Company has agreed with its Brazilian partner to invest up to an additional $90 million in a joint venture that provides health and life insurance, as well as private pension products, based on future performance of the new company. The Company also agreed to invest approximately $75 million in a number of other international joint ventures, expected to be funded in 1998. Leases The Company has entered into operating leases for office space and certain computer and other equipment. Rental expenses for these items were $192 million, $179 million and $203 million for 1997, 1996 and 1995, respectively. The future net minimum payments under noncancelable leases for 1998 through 2002 are estimated to be $172 million, $137 million, $96 million, $71 million and $62 million, respectively, and $270 million thereafter. In connection with the property-casualty sale the Company vacated, and the purchaser subleased, at market rates for a period of eight years, the space that the Company occupied in the CityPlace office facility in Hartford. In 1996, the Company recorded a charge of $292 million pretax ($190 million after tax) which represents the present value of the difference between rent required to be paid by the Company under the lease and future rentals expected to be received by the Company. Future payments under the lease, net of expected subrentals (which are to be applied against the reserve and are not included in the future net minimum payments above), are $160 million and $235 million, attributable to the next five and subsequent six years, respectively. 80 Page 80 Notes to Financial Statements (Continued) 18. Commitments and Contingent Liabilities (Continued) Litigation Purported Class Action Complaints were filed in the United States District Court for the Eastern District of Pennsylvania on November 5, 1997 by Eileen Herskowitz and Michael Wolin, and on December 2, 1997 by Pamela Goodman and Michael J. Oring. Other purported Class Action Complaints were filed in the United States District Court for the District of Connecticut on November 25, 1997 by Evelyn Silvert, on November 26, 1997 by The Rainbow Fund, Inc., and on December 24, 1997 by Terry B. Cohen. The Complaints seek, among other remedies, unspecified damages resulting from defendants' alleged violations of federal securities laws. The Complaints allege that the Company and three of its officers or directors, Ronald E. Compton, Richard L. Huber, and Leonard Abramson, are liable for certain misrepresentations and omissions regarding, among other matters, the integration of the merger with U.S. Healthcare and the Company's medical claim reserves. The litigation is still in the preliminary stages, and the Company is defending the actions vigorously. The Company also is involved in numerous other lawsuits arising, for the most part, in the ordinary course of its business operations, including litigation in its health business concerning benefit plan coverage and other decisions made by the Company, and alleged medical malpractice by participating providers. While the ultimate outcome of these other lawsuits cannot be determined at this time, after consideration of the defenses available to the Company and any related reserves established, they are not expected to result in liability for amounts material to the financial condition of the Company, although they may adversely affect results of operations in future periods. 81 Page 81 Management's Responsibility for Financial Statements Management is responsible for the financial statements of Aetna Inc., which have been prepared in accordance with generally accepted accounting principles. The financial statements are the product of a number of processes that include the gathering of financial data developed from the records of the Company's day-to-day business transactions. Informed judgments and estimates are used for those transactions not yet complete or for which the ultimate effects cannot be measured precisely. The Company emphasizes the selection and training of personnel who are qualified to perform these functions. In addition, Company personnel are subject to rigorous standards of ethical conduct that are widely communicated throughout the organization. The Company's internal controls are designed to reasonably assure that Company assets are safeguarded from unauthorized use or disposition and that Company transactions are authorized, executed and recorded properly. Company personnel maintain and monitor these internal controls on an ongoing basis. In addition, the Company's internal auditors review and report upon the functioning of these controls with the right of full access to all Company personnel. The Company engages KPMG Peat Marwick LLP as independent auditors to audit its financial statements and express their opinion thereon. Their audits include reviews and tests of the Company's internal controls to the extent they believe necessary to determine and conduct the audit procedures that support their opinion. Members of that firm also have the right of full access to each member of management in conducting their audits. The report of KPMG Peat Marwick LLP appears below. Aetna's Board of Directors has an Audit Committee composed solely of independent directors. The Committee meets periodically with management, the internal auditors and KPMG Peat Marwick LLP to oversee and monitor the work of each and to inquire of each as to their assessment of the performance of the others in their work relating to the Company's financial statements. Both the independent and internal auditors have, at all times, the right of full access to the Audit Committee, without management present, to discuss any matter they believe should be brought to the attention of the Committee. 82 Page 82 Independent Auditors' Report The Shareholders and Board of Directors Aetna Inc.: We have audited the accompanying consolidated balance sheets of Aetna Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the aforementioned consolidated financial statements present fairly, in all material respects, the financial position of Aetna Inc. and Subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Hartford, Connecticut February 3, 1998 83 Page 83 Quarterly Data (Unaudited)
(Millions, except per common share data) - ------------------------------------------------------------------------------------------------ 1997 (1)(2)(3) First Second Third Fourth - ------------------------------------------------------------------------------------------------ Total revenue $ 4,486.7 $ 4,628.3 $ 4,632.3 $ 4,792.9 - ------------------------------------------------------------------------------------------------ Income before income taxes $ 487.9 $ 370.1 $ 211.2 $ 442.0 Income taxes 208.6 140.0 93.4 168.1 ------------------------------------------------------ Net income $ 279.3 $ 230.1 $ 117.8 $ 273.9 - ------------------------------------------====================================================== Net income applicable to common shareholders $ 265.4 $ 216.2 $ 104.0 $ 260.0 - ------------------------------------------====================================================== Per Common Share Results: (4) Net income Basic $ 1.77 $ 1.44 $ .70 $ 1.76 Diluted 1.72 1.43 .69 1.71 - ------------------------------------------------------------------------------------------------ Common Stock Data: Dividends declared $ .20 $ .20 $ .20 $ .20 Common stock prices, high 92.88 112.75 117.00 80.38 Common stock prices, low 74.00 83.63 81.00 67.00 - ------------------------------------------------------------------------------------------------
(1) First quarter includes a benefit of $108.4 million after tax ($172.5 million pretax) from a reduction of the loss on discontinued products. (2) First and second quarters include after-tax reductions of the severance and facilities reserves of $9.1 million and $20.2 million, respectively. (3) The third quarter includes an increase in the reserve for HMO medical claims of $103.0 million after tax ($161.0 million pretax), the majority of which relates to the first two quarters of 1997. (4) Calculation of the earnings per share is based on weighted average shares outstanding during each quarter and, accordingly, the sum may not equal the total for the year. 84 Page 84 Quarterly Data (Unaudited)
(Millions, except per common share data) - -------------------------------------------------------------------------------------------------- 1996 (1)(2) First Second Third Fourth - -------------------------------------------------------------------------------------------------- Total revenue $ 3,344.9 $ 3,173.9 $ 4,185.9 $ 4,495.8 - -------------------------------------------------------------------------------------------------- Income (Loss) from continuing operations before income taxes (benefits) $ 246.3 $ 35.9 $ 205.4 $ (148.9) Income taxes (benefits) 80.8 11.6 83.0 (41.8) --------------------------------------------------------- Income (Loss) from continuing operations 165.5 24.3 122.4 (107.1) Income from Discontinued Operations, net of tax 182.2 - - - Gain on sale of Discontinued Operations, net of tax - 263.7 - - -------------------------------------------------------- Net income (loss) $ 347.7 $ 288.0 $ 122.4 $ (107.1) - ------------------------------------------======================================================== Net income (loss) applicable to common shareholders $ 347.7 $ 288.0 $ 111.2 $ (121.0) - ------------------------------------------======================================================== Per Common Share Results: (3) Income (Loss) from continuing operations Basic $ 1.44 $ .21 $ .77 $ (.80) Diluted 1.43 .21 .77 (.80) Net income (loss) Basic 3.03 2.49 .77 (.80) Diluted 2.99 2.47 .77 (.80) - -------------------------------------------------------------------------------------------------- Common Stock Data: (4) Dividends declared $ .69 $ - $ .40 $ .20 Common stock prices, high 78.50 75.13 73.63 81.63 Common stock prices, low 67.13 67.13 58.00 60.13 - --------------------------------------------------------------------------------------------------
(1) Second, third and fourth quarters include after-tax severance and facilities charges of $255.0 million, $31.8 million and $275.0 million, respectively. (2) Second and fourth quarters include benefits of $110.5 million and $21.0 million, respectively, after tax, from reductions of the loss on discontinued products. (3) Calculation of the earnings per common share is based on weighted average shares outstanding during each quarter and, accordingly, the sum may not equal the total for the year. (4) Aetna Life and Casualty Company common shares through the date of the merger with U.S. Healthcare, Aetna Inc. common shares thereafter. EX-21 6 SUBSIDIARIES OF THE REGISTRANT 1 Page 1 EXHIBIT 21
State of Subsidiary Incorporation Ownership(1) - --------------------------------------- -------------- ---------------------------------------------- Aetna Inc. CT - Aetna Services, Inc. CT 100% owned by Aetna Inc. Aetna U.S. Healthcare Inc. PA 100% owned by Aetna Inc. Aetna Risk Indemnity Company Limited Bermuda 100% owned by Aetna Inc. Aetna Life Insurance Company CT 100% owned by Aetna Services, Inc. Aetna Retirement Services, Inc. CT 100% owned by Aetna Services, Inc. Aetna Health and Life Insurance Company CT 100% owned by Aetna Services, Inc. Aetna Capital L.L.C. DE 95% owned by Aetna Services, Inc.(2) Imperial Fire & Marine Re-Insurance Company Limited United Kingdom 10% owned by Aetna Services, Inc. Aetna International, Inc. CT 100% owned by Aetna Services, Inc. AUSHC Holdings, Inc. CT 100% owned by Aetna Services, Inc. U.S. Healthcare Dental Plan, Inc. PA 100% owned by Aetna U.S. Healthcare Inc. U.S. Healthcare Dental Plan, Inc. NJ 100% owned by Aetna U.S. Healthcare Inc. U.S. Healthcare Dental Plan, Inc. DE 100% owned by Aetna U.S. Healthcare Inc. U.S. Health Insurance Company NY 100% owned by Aetna U.S. Healthcare Inc. Primary Holdings, Inc. DE 100% owned by Aetna U.S. Healthcare Inc. Corporate Health Insurance Company PA 100% owned by Aetna U.S. Healthcare Inc. Aetna U.S. Healthcare Inc. NJ 100% owned by Aetna U.S. Healthcare Inc. U.S. Healthcare, Inc. NY 100% owned by Aetna U.S. Healthcare Inc. Aetna U.S. Healthcare Inc. CT 100% owned by Aetna U.S. Healthcare Inc. Aetna U.S. Healthcare Inc. MA 100% owned by Aetna U.S. Healthcare Inc. Aetna U.S. Healthcare Inc. DE 100% owned by Aetna U.S. Healthcare Inc. Aetna U.S. Healthcare Inc. NH 100% owned by Aetna U.S. Healthcare Inc. U.S. Healthcare Financial Services, Inc. DE 100% owned by Aetna U.S. Healthcare Inc. Aetna Health Management, Inc. DE 100% owned by Aetna U.S. Healthcare Inc. CMBS Holdings, Inc. TX 100% owned by Aetna Life Insurance Company CDI Equity, Inc. DE 100% owned by Aetna Life Insurance Company AHP Holdings, Inc. CT 100% owned by Aetna Life Insurance Company CMBS Holdings, Inc. - II CT 100% owned by Aetna Life Insurance Company CMBS Holdings, L.L.C. CT 99% owned by Aetna Life Insurance Company(3) Southeast Second Avenue, Inc. DE 100% owned by Aetna Life Insurance Company Bay Area Mall, Inc. DE 100% owned by Aetna Life Insurance Company Aetna Affordable Housing, Inc. CT 100% owned by Aetna Life Insurance Company PHPSNE Parent Corporation DE 55% owned by AUSHC Holdings Inc. Aetna Retirement Holdings, Inc. CT 100% owned by Aetna Retirement Services, Inc. Aetna Canada Holdings Limited Canada 100% owned by Aetna International, Inc. Aetna Life Insurance Company of America CT 100% owned by Aetna International, Inc. Aetna Capital Holdings, Inc. CT 100% owned by Aetna International, Inc. Aetna Life & Casualty (Bermuda) Ltd. Bermuda 100% owned by Aetna International, Inc. Primary Investments, Inc. DE 100% owned by Primary Holdings, Inc. Aetna U.S. Healthcare Inc. OH 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare Inc. VA 74% owned by Aetna Health Management, Inc.(4) Aetna U.S. Healthcare Inc. FL 100% owned by Aetna Health Management, Inc. Aetna Health Plans of the Carolinas, Inc. NC 100% owned by Aetna Health Management, Inc. Aetna Dental Care of Kentucky, Inc. KY 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare of California, Inc. CA 100% owned by Aetna Health Management, Inc. Aetna Health Plans of Central and Eastern Pennsylvania, Inc. DE 100% owned by Aetna Health Management, Inc. AUSHC Holdings, Inc. DE 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare Inc. LA 100% owned by Aetna Health Management, Inc. Aetna Government Health Plans, Inc. CA 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare Inc. AZ 100% owned by Aetna Health Management, Inc. Med Southwest, Inc. TX 55% owned by Aetna Health Management, Inc. Informed Health, Inc. DE 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare of Georgia, Inc. GA 37% owned by Aetna Health Management, Inc.(5) Aetna U.S. Healthcare Dental Care of California Inc. CA 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare of Illinois, Inc. IL 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare Inc. TX 100% owned by Aetna Health Management, Inc. Aetna U.S. Healthcare Inc. TN 100% owned by Aetna Health Management, Inc. Aetna Dental Care of Texas, Inc. TX 100% owned by Aetna Health Management, Inc. Aetna Life Insurance and Annuity Company CT 100% owned by Aetna Retirement Holdings, Inc. Aeltus Investment Management, Inc. CT 100% owned by Aetna Retirement Holdings, Inc.
2 PAGE 2 EXHIBIT 21 (Continued)
State of Subsidiary Incorporation Ownership(1) - --------------------------------------- -------------- ---------------------------------------------- Aetna Life Insurance Company of Canada Canada 100% owned by Aetna Canada Holdings Limited Aetna Health Plans of Southern New England, Inc. CT 100% owned by PHPSNE Parent Corporation United States Health Care Systems of Pennsylvania, Inc. PA 100% owned by Primary Investments, Inc. Aetna U.S. Healthcare, Inc. VA 26% owned by Primary Investments, Inc.(4) U.S. Healthcare, Inc. OH 100% owned by Primary Investments, Inc. U.S. Healthcare of the Carolinas, Inc. NC 100% owned by Primary Investments, Inc. Aetna U.S. Healthcare of Georgia, Inc. GA 63% owned by Primary Investments, Inc.(5) U.S. Health Insurance Company CT 100% owned by Primary Investments, Inc. Aetna U.S. Healthcare Holdings, Inc. DE 100% owned by Primary Investments, Inc. Aetna U.S. Healthcare Inc. WA 100% owned by Primary Investments, Inc. Aetna Insurance Company of Connecticut CT 100% owned by AHP Holdings, Inc. Aetna Health Plans of New York, Inc. NY 100% owned by AUSHC Holdings, Inc. Aetna Health Plans of New Jersey, Inc. NJ 100% owned by AUSHC Holdings, Inc. Southwest Physicians Life Insurance Company TX 100% owned by Med Southwest, Inc. Aetna U.S. Healthcare of North Texas Inc. TX 100% owned by Med Southwest, Inc. Aetna Get Fund MA 100% owned by Aetna Life Insurance and Annuity Company Aetna Variable Encore Fund MA 100% owned by Aetna Life Insurance and Annuity Company Aetna Variable Fund MA 98% owned by Aetna Life Insurance and Annuity Company Aetna Income Shares MA 99% owned by Aetna Life Insurance and Annuity Company Aetna Insurance Company of America CT 100% owned by Aetna Life Insurance and Annuity Company Aetna Series Fund, Inc. MD 13% owned by Aetna Life Insurance and Annuity Company Aetna Investment Advisers Fund, Inc. MD 100% owned by Aetna Life Insurance and Annuity Company Aetna Variable Portfolios, Inc. MD 100% owned by Aetna Life Insurance and Annuity Company Aetna Generation Portfolios, Inc. MD 100% owned by Aetna Life Insurance and Annuity Company Portfolio Partners, Inc. MD 100% owned by Aetna Life Insurance and Annuity Company Financial Life Assurance Company of Canada Canada 100% owned by Aetna Life Insurance Company of Canada Aetna U.S. Healthcare of Colorado, Inc. CO 100% owned by Aetna U.S. Healthcare Holdings, Inc. Aeltus Capital, Inc. CT 100% owned by Aeltus Investment Management, Inc. Aeltus Trust Company CT 100% owned by Aeltus Investment Management, Inc.
(1) Percentages are rounded to the nearest whole percent and are based on ownership of voting rights. (2) Aetna Capital Holdings, Inc. owns 5% of Aetna Capital L.L.C. (3) CMBS Holdings, Inc. - II owns 1% of CMBS Holdings, L.L.C. (4) Aetna Health Management, Inc. owns 74% and Primary Investments, Inc. owns 26% of Aetna U. S. Healthcare Inc. (VA) (5) Primary Investments, Inc. owns 63% and Aetna Health Management, Inc. owns 37% of Aetna U.S. Healthcare of Georgia, Inc. EX-23 7 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23 Consent of Independent Auditors The Board of Directors Aetna Inc.: We consent to incorporation by reference in the Registration Statements (No. 33-52819 on Form S-3, No. 33-52819-01 on Form S-3, No. 333-07167 on Form S-3, No. 333-07169 on Form S-3, No. 333-08427 on Form S-8, No. 333-08429 on Form S-8 and No. 333-08431 on Form S-8) of Aetna Inc. of our reports dated February 3, 1998, relating to the consolidated balance sheets of Aetna Inc. and Subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of income, shareholders' equity, and cash flows and related schedules for each of the years in the three-year period ended December 31, 1997, which reports appear in or are incorporated by reference in the December 31, 1997 annual report on Form 10-K of Aetna Inc. /s/ KPMG Peat Marwick LLP Hartford, Connecticut March 2, 1998 EX-24 8 POWERS OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY We, the undersigned directors and officers of Aetna Inc. (the "Company"), hereby severally constitute and appoint Thomas J. Calvocoressi and Robert J. Price, and each of them individually, our true and lawful attorneys, with full power to them and each of them to sign for us, and in our names and in the capacities indicated below, the Company's 1997 Form 10-K and any and all amendments thereto to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, hereby ratifying and confirming our signatures as they may be signed by our said attorneys to the Form 10-K and to any and all amendments thereto. Dated as of March 2, 1998. /s/ Richard L. Huber /s/ Gerald Greenwald - ------------------------------------- ------------------------------------- Richard L. Huber Gerald Greenwald Chairman, Chief Executive Officer, Director President and Director (Principal Executive Officer and Principal Financial Officer) /s/ Leonard Abramson /s/ Ellen M. Hancock - ------------------------------------- ------------------------------------- Leonard Abramson Ellen M. Hancock Director Director /s/ Betsy Z. Cohen /s/ Michael H. Jordan - ------------------------------------- ------------------------------------- Betsy Z. Cohen Michael H. Jordan Director Director /s/ William H. Donaldson /s/ Jack D. Kuehler - ------------------------------------- ------------------------------------- William H. Donaldson Jack D. Kuehler Director Director /s/ Barbara Hackman Franklin /s/ Frank R. O'Keefe, Jr. - ------------------------------------- ------------------------------------- Barbara Hackman Franklin Frank R. O'Keefe, Jr. Director Director /s/ Jerome S. Goodman /s/ Judith Rodin - ------------------------------------- ------------------------------------- Jerome S. Goodman Judith Rodin Director Director /s/ Earl G. Graves - ------------------------------------- Earl G. Graves Director EX-27.1 9 FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained in the Form 10-K for the fiscal year ended December 31, 1997 for Aetna Inc. and is qualified in its entirety by reference to such statements. 1,000,000 YEAR DEC-31-1997 DEC-31-1997 34,245 0 0 1,041 4,208 370 42,562 1,806 0 2,367 96,001 17,837 359 3,294 18,761 2,346 865 0 3,644 6,686 96,001 12,592 3,378 334 2,236 12,852 218 0 1,511 610 901 0 0 0 901 5.67 5.60 0 0 0 0 0 0 0 The EPS-Primary tag represents basic EPS under SFAS 128. The EPS-Diluted tag represents diluted EPS under SFAS 128.
EX-27.2 10 FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained in the Form 10-K for the fiscal year ended December 31, 1997 for Aetna Inc. and is qualified in its entiresty by reference to such statements. 1,000,000 9-MOS 6-MOS 3-MOS YEAR DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1996 SEP-30-1997 JUN-30-1997 MAR-31-1997 DEC-31-1996 32,612 31,634 31,111 32,336 0 0 0 0 0 0 0 0 1,402 1,393 1,327 1,333 6,014 6,322 6,468 6,701 533 637 679 850 43,314 42,553 41,991 43,486 1,333 1,617 1,606 1,463 0 0 0 0 2,373 2,373 2,305 2,227 99,147 95,700 91,813 92,913 18,115 18,041 17,865 17,783 199 188 191 334 3,263 3,100 3,055 3,029 18,939 19,033 19,064 19,902 2,374 2,376 2,376 2,380 865 865 865 865 0 0 0 0 3,862 3,997 4,012 4,033 6,636 6,426 6,031 5,992 99,147 95,700 91,813 92,913 9,418 6,266 3,087 9,326 2,506 1,687 840 3,565 130 36 2 134 1,694 1,126 558 2,175 9,684 6,366 3,157 10,379 159 101 45 160 0 0 0 0 1,069 858 488 339 442 349 209 134 627 509 279 205 0 0 0 446 0 0 0 0 0 0 0 0 627 509 279 651 3.91 3.21 1.77 4.77 3.86 3.15 1.72 4.72 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 The EPS-Primary tag represents basic EPS under SFAS 128. The EPS-Diluted tag represents diluted EPS under SFAS 128.
EX-27.3 11 FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained in the Form 10-K for the fiscal year ended December 31, 1997 for Aetna Inc. and is qualified in its entirety by reference to such statements. 1,000,000 9-MOS 6-MOS 3-MOS YEAR DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1995 SEP-30-1996 JUN-30-1996 MAR-31-1996 DEC-31-1995 30,956 29,828 30,345 31,860 0 0 0 0 0 0 0 0 1,235 1,225 929 660 7,172 7,493 7,948 8,327 1,101 1,211 1,302 1,277 42,435 42,845 42,490 44,050 2,159 4,254 1,559 1,713 0 0 0 0 2,141 2,078 2,007 1,953 91,540 84,717 84,102 84,324 17,150 17,152 17,293 17,232 217 245 159 142 3,136 2,583 2,646 2,704 20,483 20,711 21,703 22,899 2,382 987 986 989 865 0 0 0 0 0 0 0 4,104 1,500 1,474 1,448 5,943 5,842 5,554 5,825 91,540 84,717 84,102 84,324 6,328 3,606 1,878 7,493 2,678 1,780 886 3,575 74 66 62 47 1,625 1,066 518 1,924 7,242 4,348 2,271 9,089 124 75 37 139 0 0 0 0 487 282 246 726 175 92 81 252 312 190 166 474 446 446 182 (222) 0 0 0 0 0 0 0 0 758 636 348 252 5.98 5.52 3.03 2.22 5.91 5.47 2.99 2.20 0 0 0 11,144 0 0 0 3,099 0 0 0 1,134 0 0 0 1,092 0 0 0 2,540 0 0 0 11,745 0 0 0 (1,134) The EPS-Primary tag represents basic EPS under SFAS 128. The EPS-Diluted tag represents diluted EPS under SFAS 128.
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