10-Q 1 form10q.htm FORM 10-Q form10q.htm  

 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2010
or

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

For the transition period from _________ to_________

Commission File Number:  1-16095

 
 
Aetna Inc.
(Exact name of registrant as specified in its charter)


Pennsylvania
(State or other jurisdiction of incorporation or organization)
23-2229683
(I.R.S. Employer Identification No.)
151 Farmington Avenue, Hartford, CT
(Address of principal executive offices)
06156
(Zip Code)
Registrant’s telephone number, including area code:
(860) 273-0123

Former name, former address and former fiscal year, if changed since last report:                    N/A

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.
                                                                        þ Yes  ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
                                                                         þ Yes  ¨  No

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

Large accelerated filer  þ
 
Accelerated filer                   ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                   ¨ Yes  þ No

There were 417.4 million shares of the registrant’s voting common stock with a par value of $.01 per share outstanding at June 30, 2010.
 
 

 
 

 


 

Aetna Inc.
Form 10-Q
For the Quarterly Period Ended June 30, 2010

Unless the context otherwise requires, references to the terms “we,” “our” or “us” used throughout this Quarterly Report on Form 10-Q (except the Report of Independent Registered Public Accounting Firm on page 24), refer to Aetna Inc. (a Pennsylvania corporation) (“Aetna”) and its subsidiaries (collectively, the “Company”).

Table of Contents
Page

Part I
Financial Information
 
     
Item 1.
Financial Statements
1
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
42
Item 4.
Controls and Procedures
42
     
Part II
Other Information
 
     
Item 1.
Legal Proceedings
43
Item 1A.
Risk Factors
43
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
43
Item 6.
Exhibits
44
     
Signatures
 
46
Index to Exhibits
 
47

 
 

 



Part I
Financial Information

Item 1.
Financial Statements

Consolidated Statements of Income
(Unaudited)


 
For the Three Months
 
For the Six Months
 
 
Ended June 30,
 
Ended June 30,
 
(Millions, except per common share data)
2010
 
2009
 
2010
 
2009
 
Revenue:
               
  Health care premiums
$ 6,915.2   $ 7,030.5   $ 13,810.3   $ 14,022.7  
  Other premiums
  460.5     475.9     935.2     961.0  
  Fees and other revenue (1)
  873.0     892.4     1,772.8     1,785.4  
  Net investment income
  253.7     258.8     528.9     508.0  
  Net realized capital gains
  43.4     13.2     120.1     8.4  
Total revenue
  8,545.8     8,670.8     17,167.3     17,285.5  
Benefits and expenses:
                       
  Health care costs (2)
  5,658.6     6,102.4     11,349.6     11,906.6  
  Current and future benefits
  480.7     503.8     1,007.7     1,007.1  
  Operating expenses:
                       
    Selling expenses
  302.5     303.8     624.0     626.3  
    General and administrative expenses
  1,255.6     1,160.2     2,451.3     2,390.0  
  Total operating expenses
  1,558.1     1,464.0     3,075.3     3,016.3  
  Interest expense
  60.7     60.7     121.6     122.2  
  Amortization of other acquired intangible assets
  24.2     24.5     48.6     49.0  
Total benefits and expenses
  7,782.3     8,155.4     15,602.8     16,101.2  
Income before income taxes
  763.5     515.4     1,564.5     1,184.3  
Income taxes:
                       
  Current
  238.8     167.7     454.9     376.0  
  Deferred
  33.7     1.1     56.0     23.9  
Total income taxes
  272.5     168.8     510.9     399.9  
Net income
$ 491.0   $ 346.6   $ 1,053.6   $ 784.4  
Earnings per common share:
                       
  Basic
$ 1.16   $ .78   $ 2.47   $ 1.75  
  Diluted
$ 1.14   $ .77   $ 2.42   $ 1.72  
(1)
 
 
Fees and other revenue include administrative services contract member co-payments and plan sponsor reimbursements related to our mail order and specialty pharmacy operations of $17.8 million and $38.2 million (net of pharmaceutical and processing costs of $349.1 million and $702.7 million) for the three and six months ended June 30, 2010, respectively, and $22.3 million and $37.1 million (net of pharmaceutical and processing costs of $408.9 million and $806.8 million) for the three and six months ended June 30, 2009, respectively.
(2)
 
Health care costs have been reduced by Insured member co-payments related to our mail order and specialty pharmacy operations of $37.5 million and $77.5 million for the three and six months ended June 30, 2010, respectively, and $30.0 million and $60.0 million for the three and six months ended June 30, 2009, respectively.

Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).

 
Page 1

 

Consolidated Balance Sheets


(Millions)
(Unaudited) 
At June 30, 2010
 
At December 31, 2009
 
Assets:
       
Current assets:
       
  Cash and cash equivalents
$ 1,406.0   $ 1,203.6  
  Investments
  2,380.5     2,922.7  
  Premiums receivable, net
  847.6     630.4  
  Other receivables, net
  714.3     626.7  
  Accrued investment income
  212.5     209.2  
  Collateral received under securities loan agreements
  430.7     210.0  
  Income taxes receivable
  91.8     89.5  
  Deferred income taxes
  201.4     383.4  
  Other current assets
  629.2     551.4  
Total current assets
  6,914.0     6,826.9  
Long-term investments
  18,067.2     17,051.1  
Reinsurance recoverables
  968.7     986.9  
Goodwill
  5,145.7     5,146.2  
Other acquired intangible assets, net
  542.1     590.7  
Property and equipment, net
  550.9     551.0  
Deferred income taxes
  321.8     333.4  
Other long-term assets
  765.6     781.1  
Separate Accounts assets
  5,071.8     6,283.1  
Total assets
$ 38,347.8   $ 38,550.4  
Liabilities and shareholders' equity:
           
Current liabilities:
           
  Health care costs payable
$ 2,685.7   $ 2,895.3  
  Future policy benefits
  728.1     739.6  
  Unpaid claims
  559.5     559.5  
  Unearned premiums
  364.2     306.4  
  Policyholders' funds
  848.0     788.3  
  Collateral payable under securities loan agreements
  430.8     210.0  
  Short-term debt
  450.0     480.8  
  Current portion of long-term debt
  899.7     -  
  Accrued expenses and other current liabilities
  2,602.9     2,484.3  
Total current liabilities
  9,568.9     8,464.2  
Future policy benefits
  6,386.4     6,470.1  
Unpaid claims
  1,470.1     1,453.0  
Policyholders' funds
  1,330.8     1,294.1  
Long-term debt
  2,740.5     3,639.5  
Other long-term liabilities
  1,433.0     1,442.6  
Separate Accounts liabilities
  5,071.8     6,283.1  
Total liabilities
  28,001.5     29,046.6  
Commitments and contingencies (Note 12)
           
Shareholders' equity:
           
  Common stock ($.01 par value; 2.7 billion shares authorized; 417.4 million and 430.8 million
           
  shares issued and outstanding in 2010 and 2009, respectively) and additional paid-in capital
  542.4     470.1  
  Retained earnings
  10,829.5     10,256.7  
  Accumulated other comprehensive loss
  (1,025.6   (1,223.0 )
Total shareholders' equity
  10,346.3     9,503.8  
Total liabilities and shareholders' equity
$ 38,347.8   $ 38,550.4  


Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).


 
Page 2

 

Consolidated Statements of Shareholders’ Equity
(Unaudited)



       
Common
                         
 
Number of
   
Stock and
         
Accumulated
             
 
Common
   
Additional
         
Other
   
Total
       
 
Shares
   
Paid-in
   
Retained
   
Comprehensive
   
Shareholders'
   
Comprehensive
 
(Millions)
Outstanding
   
Capital
   
Earnings
   
Loss
   
Equity
   
Income
 
Six Months Ended June 30, 2010
                                 
Balance at December 31, 2009
  430.8     $ 470.1     $ 10,256.7     $ (1,223.0 )   $ 9,503.8        
Comprehensive income:
                                           
  Net income
              1,053.6             1,053.6     $ 1,053.6  
  Other comprehensive income (Note 6):
                                             
    Net unrealized gains on securities
                      165.7       165.7          
    Net foreign currency and derivative losses
               -        (33.2 )     (33.2 )        
    Pension and OPEB plans
         -              64.9       64.9          
  Other comprehensive income
             -              197.4       197.4       197.4  
Total comprehensive income
                                        $ 1,251.0  
Common shares issued for benefit plans,
                                             
  including tax benefits
  1.7       72.5                   72.5          
Repurchases of common shares
  (15.1 )     (.2 )     (480.8 )           (481.0 )        
Balance at June 30, 2010
  417.4     $ 542.4     $ 10,829.5     $ (1,025.6 )   $ 10,346.3          
                                               
Six Months Ended June 30, 2009
                                             
Balance at December 31, 2008
  456.3     $ 351.2     $ 9,716.5     $ (1,881.3 )   $ 8,186.4          
Cumulative effect of adopting new accounting
                                             
   standard at April 1, 2009 (Note 2)
  -       -       53.7       (53.7 )     -          
Comprehensive income:
                                             
  Net income
  -       -       784.4       -       784.4     $ 784.4  
  Other comprehensive income (Note 6):
                                             
    Net unrealized gains on securities
  -       -       -       290.7       290.7          
    Net foreign currency and derivative gains
  -       -       -       24.5       24.5          
    Pension and OPEB plans
  -       -       -       69.4       69.4          
  Other comprehensive income
  -       -       -       384.6       384.6       384.6  
Total comprehensive income
                                        $ 1,169.0  
Common shares issued for benefit plans,
                                             
  including tax benefits
  1.5       69.8       -       -       69.8          
Repurchases of common shares
  (21.3 )     (.2 )     (547.8 )     -       (548.0 )        
Balance at June 30, 2009
  436.5     $ 420.8     $ 10,006.8     $ (1,550.4 )   $ 8,877.2          

Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).



 
Page 3

 


   Consolidated Statements of Cash Flows
(Unaudited)


 
Six Months Ended
 
 
June 30,
 
(Millions)
2010
   
2009
 
Cash flows from operating activities:
         
Net income
$ 1,053.6     $ 784.4  
  Adjustments to reconcile net income to net cash provided by operating activities:
             
     Net realized capital gains
  (120.1 )     (8.4 )
     Depreciation and amortization
  206.3       200.9  
     Equity in earnings of affiliates, net
  (9.7 )     10.8  
     Stock-based compensation expense
  57.3       55.7  
     Accretion of net investment discount
  (14.4 )     (35.5 )
     Changes in assets and liabilities:
             
       Accrued investment income
  (3.3 )     (3.1 )
       Premiums due and other receivables
  (219.5 )     (294.0 )
       Income taxes
  56.9       (2.4 )
       Other assets and other liabilities
  27.2       (67.8 )
       Health care and insurance liabilities
  (278.9 )     287.5  
     Other, net
  (.6 )     (1.4 )
Net cash provided by operating activities
  754.8       926.7  
Cash flows from investing activities:
             
  Proceeds from sales and maturities of investments
  5,475.1       4,961.8  
  Cost of investments
  (5,356.3 )     (5,170.3 )
  Additions to property, equipment and software
  (144.5 )     (168.3 )
  Cash used for acquisition, net of cash acquired
  (.1 )     (6.1 )
Net cash used for investing activities
  (25.8 )     (382.9 )
Cash flows from financing activities:
             
  Net repayment of short-term debt
  (30.8 )     (20.1 )
  Deposits and interest credited for investment contracts
  3.1       3.4  
  Withdrawals of investment contracts
  (5.8 )     (7.1 )
  Common shares issued under benefit plans
  9.3       3.3  
  Stock-based compensation tax benefits
  3.1       4.7  
  Common shares repurchased
  (466.5 )     (533.0 )
  Collateral on interest rate swaps
  (39.0 )     33.0  
Net cash used for financing activities
  (526.6 )     (515.8 )
Net increase in cash and cash equivalents
  202.4       28.0  
Cash and cash equivalents, beginning of period
  1,203.6       1,179.5  
Cash and cash equivalents, end of period
$ 1,406.0     $ 1,207.5  
Supplemental cash flow information:
             
  Interest paid
$ 121.4     $ 123.2  
  Income taxes paid
  450.8       397.9  


Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).


 
Page 4

 

 
Condensed Notes to Consolidated Financial Statements
(Unaudited)

1.
Organization

We conduct our operations in three business segments:

·  
Health Care consists of medical, pharmacy benefits management, dental and vision plans offered on both an Insured basis (where we assume all or a majority of the risk for medical and dental care costs) and an employer-funded basis (where the plan sponsor under an administrative services contract (“ASC”) assumes all or a majority of this risk).  Medical products include point-of-service (“POS”), preferred provider organization (“PPO”), health maintenance organization (“HMO”) and indemnity benefit plans.  Medical products also include health savings accounts (“HSAs”) and Aetna HealthFund®, consumer-directed health plans that combine traditional POS or PPO and/or dental coverage, subject to a deductible, with an accumulating benefit account (which may be funded by the plan sponsor and/or the member in the case of HSAs).  We also offer Medicare and Medicaid products and services and specialty products, such as medical management and data analytics services, behavioral health plans and stop loss insurance, as well as products that provide access to our provider network in select markets.

·  
Group Insurance primarily includes group life insurance products offered on an Insured basis, including basic and supplemental group term life, group universal life, supplemental or voluntary programs and accidental death and dismemberment coverage.  Group Insurance also includes (i) group disability products offered to employers on both an Insured and an ASC basis which consist primarily of short-term and long-term disability insurance, (ii) absence management services offered to employers, which include short-term and long-term disability administration and leave management, and (iii) long-term care products that were offered primarily on an Insured basis, which provide benefits covering the cost of care in private home settings, adult day care, assisted living or nursing facilities.  We no longer solicit or accept new long-term care customers, and we are working with our customers on an orderly transition of this product to other carriers.

·  
Large Case Pensions manages a variety of retirement products (including pension and annuity products) primarily for tax qualified pension plans.  These products provide a variety of funding and benefit payment distribution options and other services.  Large Case Pensions also includes certain discontinued products (refer to Note 14 beginning on page 21 for additional information).


2.
Summary of Significant Accounting Policies

Interim Financial Statements
These interim financial statements necessarily rely on estimates, including assumptions as to annualized tax rates.  In the opinion of management, all adjustments necessary for a fair statement of results for the interim periods have been made.  All such adjustments are of a normal, recurring nature.  The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes presented in our 2009 Annual Report on Form 10-K (our “2009 Annual Report”).  Certain financial information that is normally included in annual financial statements prepared in accordance with U.S. generally- accepted accounting principles (“GAAP”), but that is not required for interim reporting purposes, has been condensed or omitted.  We have omitted certain footnote disclosures that would substantially duplicate the disclosures in our 2009 Annual Report, unless the information contained in those disclosures materially changed or is required by GAAP.  We have evaluated subsequent events from the balance sheet date through the date the financials were issued and determined there were no other items to disclose.

Principles of Consolidation
These unaudited consolidated financial statements have been prepared in accordance with GAAP and include the accounts of Aetna and the subsidiaries that we control.  All significant intercompany balances have been eliminated in consolidation.
 
 
Page 5

 
 
New Accounting Standards
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (“FASB”) released revised accounting guidance for variable interest entities (“VIEs”).  This accounting guidance removes the quantitative-based risks-and-rewards calculation previously used to assess whether a company must consolidate a VIE and, instead, requires a variable interest holder to qualitatively assess whether it has a controlling financial interest in the VIE.  This accounting guidance was effective on January 1, 2010.  The adoption of this new accounting guidance did not impact our financial position or results of operations.  Refer to Note 5 beginning on page 7 for additional information.

Recognition and Presentation of Other-Than-Temporary Impairments
Effective April 1, 2009, we adopted new accounting guidance issued by the FASB for other-than-temporary impairments (“OTTI”) of debt securities. This guidance establishes new criteria for the recognition of OTTI on debt securities and also requires additional financial statement disclosure. The new criteria require OTTI on debt securities to be recognized if either we determine a credit-related loss has occurred or we have the intention to sell a security that is in an unrealized capital loss position. Refer to Note 5 beginning on page 7 for additional information.


3.
Earnings Per Common Share

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the reporting period.  Diluted EPS is computed in a similar manner, except that the weighted average number of common shares outstanding is adjusted for the dilutive effects of our stock awards, but only if the effect is dilutive.

The computations of basic and diluted EPS for the three and six months ended June 30, 2010 and 2009 are as follows:

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(Millions, except per common share data)
 
2010
   
2009
   
2010
   
2009
 
Net income
  $ 491.0     $ 346.6     $ 1,053.6     $ 784.4  
Weighted average shares used to compute basic EPS
    423.0       442.8       427.2       447.7  
Dilutive effect of outstanding stock-based compensation awards (1)
    7.2       7.9       7.7       8.4  
Weighted average shares used to compute diluted EPS
    430.2       450.7       434.9       456.1  
Basic EPS
  $ 1.16     $ .78     $ 2.47     $ 1.75  
Diluted EPS
  $ 1.14     $ .77     $ 2.42     $ 1.72  
(1)
 
 
 
Approximately 18.7 million and 18.8 million stock appreciation rights ("SARs") (with exercise prices ranging from $32.11 to $59.76) respectively, and 5.8 million stock options (with exercise prices ranging from $33.38 to $42.35) were not included in the calculation of diluted EPS for the three and six months ended June 30, 2010, and approximately 19.4 million SARs (with exercise prices ranging from $25.94 to $59.76) and 6.2 million stock options (with exercise prices ranging from $33.38 to $42.35) were not included in the calculation of diluted EPS for the three and six months ended June 30, 2009, respectively, as their exercise prices were greater than the average market price of Aetna common shares during such periods.
 
 
4.
Operating Expenses

For the three and six months ended June 30, 2010 and 2009, selling expenses (which include broker commissions, the variable component of our internal sales force compensation and premium taxes) and general and administrative expenses were as follows:

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(Millions)
 
2010
   
2009
   
2010
   
2009
 
Selling expenses
  $ 302.5     $ 303.8     $ 624.0     $ 626.3  
General and administrative expenses:
                               
  Salaries and related benefits
    762.9       703.3       1,530.7       1,453.5  
  Other general and administrative expenses (1)
    492.7       456.9       920.6       936.5  
Total general and administrative expenses
    1,255.6       1,160.2       2,451.3       2,390.0  
Total operating expenses
  $ 1,558.1     $ 1,464.0     $ 3,075.3     $ 3,016.3  
(1)
 
Includes litigation-related insurance proceeds of $20.0 million and $90.0 million for the three and six months ended June 30, 2010, respectively, and $38.2 million for the three and six months ended June 30, 2009.  Refer to the reconciliation of operating earnings to net income in Note 13 beginning on page 20 for additional information.

 
 
Page 6

 

 
5.
Investments

Total investments at June 30, 2010 and December 31, 2009 were as follows:

   
June 30, 2010
   
December 31, 2009
 
(Millions)
 
Current
   
Long-term
   
Total
   
Current
   
Long-term
   
Total
 
Debt and equity securities available for sale
  $ 2,252.5     $ 15,481.2     $ 17,733.7     $ 2,834.8     $ 14,324.9     $ 17,159.7  
Mortgage loans
    114.1       1,406.3       1,520.4       86.1       1,507.9       1,594.0  
Other investments
    13.9       1,179.7       1,193.6       1.8       1,218.3       1,220.1  
Total investments
  $ 2,380.5     $ 18,067.2     $ 20,447.7     $ 2,922.7     $ 17,051.1     $ 19,973.8  

Debt and Equity Securities
Debt and equity securities available for sale at June 30, 2010 and December 31, 2009 were as follows:

       
Gross
 
Gross
         
   
Amortized
 
Unrealized
 
Unrealized
     
Fair
 
(Millions)
 
Cost
 
Gains
 
Losses
     
Value
 
June 30, 2010
                     
Debt securities:
                     
    U.S. government securities
  $ 1,708.4   $ 119.2   $ (.4 )     $ 1,827.2  
    States, municipalities and political subdivisions
    2,268.7     97.1     (16.9 )       2,348.9  
    U.S. corporate securities
    6,680.5     613.4     (28.4 )       7,265.5  
    Foreign securities
    2,676.9     239.0     (14.5 )       2,901.4  
    Residential mortgage-backed securities
    1,260.7     76.3     (.3 )  (1)     1,336.7  
    Commercial mortgage-backed securities
    1,197.6     73.3     (54.0 )  (1)     1,216.9  
    Other asset-backed securities
    531.2     31.3     (5.6 )  (1)     556.9  
    Redeemable preferred securities
    262.0     9.5     (25.9 )       245.6  
Total debt securities
    16,586.0     1,259.1     (146.0 )       17,699.1  
Equity securities
    35.4     3.0     (3.8 )       34.6  
Total debt and equity securities (2)
  $ 16,621.4   $ 1,262.1   $ (149.8 )     $ 17,733.7  
                               
December 31, 2009
                             
Debt securities:
                             
    U.S. government securities
  $ 1,801.3   $ 50.7   $ (5.2 )     $ 1,846.8  
    States, municipalities and political subdivisions
    2,022.2     80.7     (27.5 )       2,075.4  
    U.S. corporate securities
    6,741.9     497.1     (54.4 )       7,184.6  
    Foreign securities
    2,554.5     210.9     (20.9 )       2,744.5  
    Residential mortgage-backed securities
    1,375.8     49.4     (5.0 )  (1)     1,420.2  
    Commercial mortgage-backed securities
    1,109.8     37.6     (104.0 )  (1)     1,043.4  
    Other asset-backed securities
    419.6     25.0     (8.2 )  (1)     436.4  
    Redeemable preferred securities
    381.9     27.8     (41.0 )       368.7  
Total debt securities
    16,407.0     979.2     (266.2 )       17,120.0  
Equity securities
    35.3     7.9     (3.5 )       39.7  
Total debt and equity securities (2)
  $ 16,442.3   $ 987.1   $ (269.7 )     $ 17,159.7  
(1)
At June 30, 2010 and December 31, 2009, we held securities for which we had recognized a credit-related impairment in the past.  For the six months ended June 30, 2010 and 2009, we recognized $5.2 million and $38.1 million, respectively, of non-credit-related impairments in other comprehensive loss related to these securities (as of June 30, 2010 and December 31, 2009, these securities had a net unrealized capital loss of $6.6 million and $17.2 million, respectively.)
(2)
Investment risks associated with our experience-rated and discontinued products generally do not impact our results of operations (refer to Note 14 beginning on page 21 for additional information on our accounting for discontinued products).  At June 30, 2010, debt and equity securities with a fair value of $4.0 billion, gross unrealized capital gains of $394.6 million and gross unrealized capital losses of $47.3 million and, at December 31, 2009, debt and equity securities with a fair value of $4.0 billion, gross unrealized capital gains of $285.6 million and gross unrealized capital losses of $78.2 million were included in total debt and equity securities, but support our experience-rated and discontinued products.  Changes in net unrealized capital gains (losses) on these securities are not reflected in accumulated other comprehensive loss.

 
 
Page 7

 
 
The fair value of debt securities at June 30, 2010 is shown below by contractual maturity.  Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid.

   
Fair
 
(Millions)
 
Value
 
Due to mature:
     
  Less than one year
  $ 598.4  
  One year through five years
    3,964.1  
  After five years through ten years
    5,147.3  
  Greater than ten years
    4,878.8  
  Residential mortgage-backed securities
    1,336.7  
  Commercial mortgage-backed securities
    1,216.9  
  Other asset-backed securities
    556.9  
Total
  $ 17,699.1  

The maturity dates for debt securities in an unrealized capital loss position at June 30, 2010 were as follows:

   
Supporting discontinued
   
Supporting remaining
       
   
and experience-rated products
   
products
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(Millions)
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Due to mature:
                                   
  Less than one year
  $ 3.3     $ -     $ 22.0     $ 1.2     $ 25.3     $ 1.2  
  One year through five years
    36.3       .3       357.3       7.2       393.6       7.5  
  After five years through ten years
    69.9       2.1       384.4       7.6       454.3       9.7  
  Greater than ten years
    318.6       30.8       627.6       36.9       946.2       67.7  
  Residential mortgage-backed securities
                7.8       .3       7.8       .3  
  Commercial mortgage-backed securities
    40.6       10.1       204.2       43.9       244.8       54.0  
  Other asset-backed securities
    12.8       .4       46.8       5.2       59.6       5.6  
Total
  $ 481.5     $ 43.7     $ 1,650.1     $ 102.3     $ 2,131.6     $ 146.0  


Mortgage-Backed and Other Asset-Backed Securities
All of our residential mortgage-backed securities at June 30, 2010 were agency (e.g., Government National Mortgage Association, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation) issued and carry agency guarantees and explicit or implicit guarantees by the U.S. Government.  At June 30, 2010, our residential mortgage-backed securities had an average quality rating of AAA and a weighted average duration of 2.1 years.

Our commercial mortgage-backed securities have underlying loans that are dispersed throughout the United States.  Significant market observable inputs used to value these securities include probability of default and loss severity.  At June 30, 2010, these securities had an average quality rating of AA+ and a weighted average duration of 3.6 years.

Our other asset-backed securities have a variety of underlying collateral (e.g., automobile loans, credit card receivables and home equity loans).  Significant market observable inputs used to value these securities include the unemployment rate, loss severity and probability of default.  At June 30, 2010, these securities had an average quality rating of AA- and a weighted average duration of 2.5 years.

Unrealized and Net Realized Capital Gains (Losses)
When a debt or equity security is in an unrealized capital loss position, we monitor the duration and severity of the loss to determine if sufficient market recovery can occur within a reasonable period of time. As described in Note 2 beginning on page 5, effective April 1, 2009, we recognize an OTTI on debt securities when we intend to sell a security that is in an unrealized capital loss position or if we determine a credit-related loss has occurred. Prior to April 1, 2009, we recognized an OTTI on a security in an unrealized capital loss position if we could not assert our intention and ability to hold the security until it recovered its value.
 
 
 
Page 8

 
 
 
Summarized below are the debt and equity securities we held at June 30, 2010 and December 31, 2009 that were in an unrealized capital loss position, aggregated by the length of time the investments have been in that position:

   
Less than 12 months
   
Greater than 12 months
   
Total (1)
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(Millions)
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
June 30, 2010
                                   
Debt securities:
                                   
    U.S. government securities
  $     $ -     $ 20.6     $ .4     $ 20.6     $ .4  
    States, municipalities and political subdivisions
    292.9       5.9       174.6       11.0       467.5       16.9  
    U.S. corporate securities
    469.3       13.6       354.6       14.8       823.9       28.4  
    Foreign securities
    265.4       6.6       62.6       7.9       328.0       14.5  
    Residential mortgage-backed securites
                7.8       .3       7.8       .3  
    Commercial mortgage-backed securities
    49.8       2.1       195.0       51.9       244.8       54.0  
    Other asset-backed securities
    27.3       .2       32.3       5.4       59.6       5.6  
    Redeemable preferred securities
    16.7       .3       162.7       25.6       179.4       25.9  
Total debt securities
    1,121.4       28.7       1,010.2       117.3       2,131.6       146.0  
Equity securities
    .8       .3       22.5       3.5       23.3       3.8  
Total debt and equity securities (1)
  $ 1,122.2     $ 29.0     $ 1,032.7     $ 120.8     $ 2,154.9     $ 149.8  
                                                 
December 31, 2009
                                               
Debt securities:
                                               
    U.S. government securities
  $ 1,062.5     $ 4.8     $ 19.3     $ .4     $ 1,081.8     $ 5.2  
    States, municipalities and political subdivisions
    292.2       10.6       216.7       16.9       508.9       27.5  
    U.S. corporate securities
    730.2       16.8       681.4       37.6       1,411.6       54.4  
    Foreign securities
    418.1       9.0       110.4       11.9       528.5       20.9  
    Residential mortgage-backed securites
    383.0       4.7       8.2       .3       391.2       5.0  
    Commercial mortgage-backed securities
    129.7       3.1       401.6       100.9       531.3       104.0  
    Other asset-backed securities
    46.6       7.5       16.7       .7       63.3       8.2  
    Redeemable preferred securities
    49.1       8.8       198.5       32.2       247.6       41.0  
Total debt securities
    3,111.4       65.3       1,652.8       200.9       4,764.2       266.2  
Equity securities
    3.9       1.6       18.8       1.9       22.7       3.5  
Total debt and equity securities (1)
  $ 3,115.3     $ 66.9     $ 1,671.6     $ 202.8     $ 4,786.9     $ 269.7  
(1)
 
At June 30, 2010 and December 31, 2009, debt and equity securities in an unrealized capital loss position of $47.3 million and $78.2 million, respectively, and with related fair value of $504.2 million and $1.0 billion, respectively, related to experience-rated and discontinued products.

We reviewed the securities in the tables above and concluded that these are performing assets generating investment income to support the needs of our business.  In performing this review, we considered factors such as the quality of the investment security based on research performed by external rating agencies and our internal credit analysts and the prospects of realizing the carrying value of the security based on the investment’s current prospects for recovery.  Unrealized capital losses at June 30, 2010 and December 31, 2009 were generally caused by the widening of credit spreads on these particular securities relative to the interest rates on U.S. Treasury securities.  At June 30, 2010, we did not have an intention to sell the securities that were in an unrealized capital loss position.

Net realized capital gains for the three and six months ended June 30, 2010 and 2009, excluding amounts related to experience-rated contract holders and discontinued products, were as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Millions)
 
2010
   
2009
   
2010
   
2009
 
OTTI losses on securities
  $ (2.4 )   $ (18.5 )   $ (22.2 )   $ (61.4 )
Portion of OTTI losses recognized in other comprehensive income
    (.8 )     2.9       5.2       2.9  
Net OTTI losses on securities recognized in earnings
    (3.2 )     (15.6 )     (17.0 )     (58.5 )
Net realized capital gains, excluding OTTI losses on securities
    46.6       28.8       137.1       66.9  
Net realized capital gains
  $ 43.4     $ 13.2     $ 120.1     $ 8.4  
 

 
 
Page 9

 
 
Net realized capital gains, excluding OTTI losses on securities for the three and six months ended June 30, 2010 were primarily attributable to gains from the sale of debt securities partially offset by losses from derivative transactions.
 
Excluding amounts related to experience-rated and discontinued products, proceeds from the sale of debt securities and the related gross realized capital gains and losses for three and six months ended June 30, 2010 and 2009 were as follows:

   
For the Three Months Ended June 30,
   
For the Six Months Ended June 30,
 
(Millions)
 
2010
   
2009
   
2010
   
2009
 
Proceeds on sales
  $ 3,012.9     $ 2,379.6     $ 5,378.3      $ 4,810.5  
Gross realized capital gains
    86.7       35.3       195.4       89.9  
Gross realized capital losses
    (11.8 )     (16.7 )     (20.0 )     (35.6 )

Variable Interest Entities
We have relationships with certain real estate and hedge fund partnerships that are considered VIEs.  We record the amount of our investment in these partnerships as long-term investments on our balance sheets and recognize our share of partnership income or losses in earnings.  Our maximum exposure to loss as a result of our investment in these partnerships is our investment balance at June 30, 2010 and December 31, 2009 of approximately $114 million and $125 million, respectively, and the risk of recapture of tax credits related to the real estate partnerships previously recognized, which we do not consider significant.  We do not have a future obligation to fund losses or debt on behalf of these investments; however, we may voluntarily contribute funds.  The real estate partnerships construct, own and manage low-income housing developments and had total assets of approximately $4.9 billion and $5.1 billion at June 30, 2010 and December 31, 2009, respectively.  The hedge fund partnerships had total assets of approximately $6.6 billion and $5.7 billion at June 30, 2010 and December 31, 2009, respectively.

Non-controlling Interests
Certain of our investment holdings are partially-owned by third parties.  At June 30, 2010 and December 31, 2009, $77 million of our investment holdings were owned by third parties.  The non-controlling entities’ share of these investments was included in accrued expenses and other current liabilities.  Net income attributable to these interests was $1 million for each of the three and six months ended June 30, 2010 and 2009.  These non-controlling interests did not have a material impact on our financial position or results of operations.

Net Investment Income
Sources of net investment income for the three and six months ended June 30, 2010 and 2009 were as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Millions)
 
2010
   
2009
   
2010
   
2009
 
Debt securities
  $ 232.1     $ 226.8     $ 468.5     $ 450.4  
Mortgage loans
    26.3       29.1       53.0       58.3  
Other
    2.5       9.9       21.1       13.4  
Gross investment income
    260.9       265.8       542.6       522.1  
Less:  investment expenses
    (7.2 )     (7.0 )     (13.7 )     (14.1 )
Net investment income (1)
  $ 253.7     $ 258.8     $ 528.9     $ 508.0  
(1)
 
 
Investment risks associated with our experience-rated and discontinued products generally do not impact our results of operations (refer to Note 14 beginning on page 21 for additional information on our accounting for discontinued products).  Net investment income includes $78.9 million and $168.4 million for the three and six months ended June 30, 2010, respectively, and $88.2 million and $168.7 million for the three and six months ended June 30, 2009, respectively, related to investments supporting our experience-rated and discontinued products.

 
 
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6.
Other Comprehensive (Loss) Income

Shareholders’ equity included the following activity in accumulated other comprehensive loss (excluding amounts related to experience-rated contract holders and discontinued products) for the six months ended June 30, 2010 and 2009:

   
Net Unrealized Gains (Losses)
   
Pension and OPEB Plans
   
Total
 
   
Securities
   
Foreign
               
Accumulated
 
               
Currency
   
Unrecognized
   
Unrecognized
   
Other
 
   
Previously
         
and
   
Net Actuarial
   
Prior Service
   
Comprehensive
 
(Millions)
 
Impaired (1)
   
All Other
   
Derivatives
   
Losses
   
Cost
   
(Loss) Income
 
Six months ended June 30, 2010
                                   
Balance at December 31, 2009
  $ 100.3     $ 235.7     $ 25.3     $ (1,623.8 )   $ 39.5     $ (1,223.0 )
Net unrealized gains (losses) ($449.4 pretax)
    48.7       276.8       (33.4 )     -       -       292.1  
Reclassification to earnings ($72.8 pretax)
    (77.4 )     (82.4 )     .2       66.8       (1.9 )     (94.7 )
Other comprehensive (loss) income
    (28.7 )     194.4       (33.2 )     66.8       (1.9 )     197.4  
Balance at June 30, 2010
  $ 71.6     $ 430.1     $ (7.9 )   $ (1,557.0 )   $ 37.6     $ (1,025.6 )
                                                 
                                                 
Six months ended June 30, 2009
                                               
Balance at December 31, 2008
  $     $ (229.3 )   $ (8.7 )   $ (1,686.6 )   $ 43.3     $ (1,881.3 )
Cumulative effect of adopting a new accounting
                                               
     standard at April 1, 2009 ($83.0 pretax) (2)
    (5.3 )     (48.4 )                       (53.7 )
Net unrealized gains ($486.4 pretax)
    75.9       231.1       9.2                   316.2  
Reclassification to earnings ($100.8 pretax)
    4.3       (20.6 )     15.3       71.4       (2.0 )     68.4  
Other comprehensive income (loss)
    74.9       162.1       24.5       71.4       (2.0 )     330.9  
Balance at June 30, 2009
  $ 74.9     $ (67.2 )   $ 15.8     $ (1,615.2 )   $ 41.3     $ (1,550.4 )
(1)
Represents unrealized losses on the non-credit-related component of impaired debt securities that we do not intend to sell and subsequent appreciation in the fair value of those securities as well as those that we intend to sell.
(2)
Effective April 1, 2009, we adopted accounting guidance relating to the recognition and presentation of other-than-temporary impairments.  Refer to Note 2 beginning on page 5 for additional information on the cumulative effect adjustment required.

 
7.
Financial Instruments

The preparation of our consolidated financial statements in accordance with GAAP requires certain of our assets and liabilities to be reflected at their fair value, and others on another basis, such as adjusted historical cost.  In this note, we provide details on the fair values of financial assets and liabilities and how we determine those fair values.  We present this information for those instruments that are reported at fair value for which the change in fair value impacts net income or other comprehensive income separately from other financial assets and liabilities.

Financial Instruments Measured at Fair Value in our Balance Sheets
Certain of our financial instruments are measured at fair value in our balance sheet.  The fair values of these instruments are based on valuations that include inputs that can be classified within one of three levels of a hierarchy established by GAAP.  The following are the levels of the hierarchy and a brief description of the type of valuation information (“inputs”) that qualifies a financial asset or liability for each level:
 
o
Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets.
 
o
Level 2 – Inputs other than Level 1 that are based on observable market data.  These include: quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets, inputs that are observable that are not prices (such as interest rates, credit risks, etc.) and inputs that are derived from or corroborated by observable markets.
 
o
Level 3 – Developed from unobservable data, reflecting our own assumptions.

Financial assets and liabilities are classified based upon the lowest level of input that is significant to the valuation.  When quoted prices in active markets for identical assets and liabilities are available, we use these quoted market prices to determine the fair value of financial assets and liabilities and classify these assets and liabilities as Level 1.  In other cases where a quoted market price for identical assets and liabilities in an active market is either not available or not observable, we estimate fair value using valuation methodologies based on available and observable market information or by using a matrix pricing model.  These financial assets and liabilities would then be classified as Level 2.  If quoted market prices are not available, we determine fair value using broker
 
 
Page 11

 
 
quotes or an internal analysis of each investment’s financial performance and cash flow projections.  Thus, financial assets and liabilities may be classified in Level 3 even though there may be some significant inputs that may be observable.
 
The following is a description of the valuation methodologies used for our financial assets and liabilities that are measured at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Debt Securities – Where quoted prices are available in an active market, our debt securities are classified in Level 1 of the fair value hierarchy.  Our Level 1 debt securities are comprised primarily of U.S. Treasury securities.  If Level 1 valuations are not available, the fair value is determined using models such as matrix pricing, which uses quoted market prices of debt securities with similar characteristics or discounted cash flows to estimate fair value.  We obtained one price for each of our Level 2 debt securities and did not adjust any of these prices at June 30, 2010 or December 31, 2009.

We also value a certain amount of debt securities using Level 3 inputs.  For Level 3 debt securities, fair values are determined by outside brokers or, in the case of certain private placement securities, are priced by our internal staff.  Outside brokers determine the value of these debt securities through a combination of their knowledge of the current pricing environment and market flows.  We obtained one non-binding broker quote for each of these Level 3 debt securities and did not adjust any of these quotes at June 30, 2010 or December 31, 2009.  The total fair value of our broker quoted securities was approximately $196 million at June 30, 2010 and $364 million at December 31, 2009.  Examples of these Level 3 debt securities include certain U.S. and foreign corporate securities and certain of our residential and commercial mortgage-backed securities as well as other asset-backed securities.  For some of our private placement securities, our internal staff determine the value of these debt securities by analyzing spreads of corporate and sector indices as well as interest spreads of comparable public bonds.  Examples of these Level 3 debt securities include certain U.S. and foreign securities and certain tax-exempt municipal securities.

Equity Securities – We currently have two classifications of equity securities:  those that are publicly traded and those that are privately held.  Our publicly-traded securities are classified as Level 1 because quoted prices are available for these securities in an active market.  For privately-held equity securities, there is no active market; therefore, we classify these securities as Level 3 because we must price these securities through an internal analysis of each investment’s financial statements and cash flow projections.

Derivatives – Our derivative instruments are valued using models that primarily use market observable inputs and therefore are classified as Level 2 because they are traded in markets where quoted market prices are not readily available.
 
 

 
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Financial assets and liabilities with changes in fair value that are measured on a recurring basis in our balance sheets at June 30, 2010 and December 31, 2009 were as follows:
 


(Millions)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
June 30, 2010
                       
Assets:
                       
Debt securities:
                       
    U.S. government securities
  $ 1,503.3     $ 323.9     $ -     $ 1,827.2  
    States, municipalities and political subdivisions
          2,343.4       5.5       2,348.9  
    U.S. corporate securities
          7,180.4       85.1       7,265.5  
    Foreign securities
          2,850.5       50.9       2,901.4  
    Residential mortgage-backed securities
          1,336.7             1,336.7  
    Commercial mortgage-backed securities
          1,170.9       46.0       1,216.9  
    Other asset-backed securities
          490.9       66.0       556.9  
    Redeemable preferred securities
          227.2       18.4       245.6  
Total debt securities
    1,503.3       15,923.9       271.9       17,699.1  
Equity securities
    1.4             33.2       34.6  
Derivatives
          14.0             14.0  
Total investments
  $ 1,504.7     $ 15,937.9     $ 305.1     $ 17,747.7  
Liabilities:
                               
  Derivatives
  $     $ 4.9     $     $ 4.9  
                                 
December 31, 2009
                               
Assets:
                               
Debt securities:
                               
    U.S. government securities
  $ 1,529.4     $ 317.4     $     $ 1,846.8  
    States, municipalities and political subdivisions
          2,062.7       12.7       2,075.4  
    U.S. corporate securities
          7,056.5       128.1       7,184.6  
    Foreign securities
          2,545.5       199.0       2,744.5  
    Residential mortgage-backed securities
          1,420.2             1,420.2  
    Commercial mortgage-backed securities
          971.6       71.8       1,043.4  
    Other asset-backed securities
          425.4       11.0       436.4  
    Redeemable preferred securities
          345.8       22.9       368.7  
Total debt securities
    1,529.4       15,145.1       445.5       17,120.0  
Equity securities
    1.7             38.0       39.7  
Derivatives
          44.0             44.0  
Total investments
  $ 1,531.1     $ 15,189.1     $ 483.5     $ 17,203.7  

 
 
 
Page 13

 

The changes in the balances of Level 3 financial assets for the three and six months ended June 30, 2010 and 2009 were as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30, 2010
   
June 30, 2010
 
(Millions)
 
U.S.
Corporate 
Securities
   
Foreign 
Securities
   
Other
   
Total
   
U.S.
Corporate
Securities
   
Foreign
Securities
   
Other
   
Total
 
Beginning balance
  $ 69.5     $ 237.4     $ 205.1     $ 512.0     $ 75.3     $ 199.0     $ 209.2     $ 483.5  
Net realized and unrealized gains (losses):
                                                               
Included in earnings
    (.1 )     2.7       2.1       4.7       (.3 )     7.5       3.5       10.7  
Included in other comprehensive income
    1.6       (4.9 )     3.4       .1       .1       (2.8 )     12.3       9.6  
Other (1)
    .2       .3