10-Q 1 form10-q.htm FORM 10-Q 10-Q



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 March 31, 2016
or

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

For the transition period from _________ to_________

Commission File Number: 1-16095

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 o 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 o 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 o
Non-accelerated filer o  (Do not check if a smaller reporting company)
Smaller reporting company o
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

There were 350.6 million shares of the registrant’s voting common stock with a par value of $.01 per share outstanding at March 31, 2016.




Aetna Inc.
Form 10-Q
For the Quarterly Period Ended March 31, 2016

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 39), 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
40
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
53
Item 4.
Controls and Procedures
53
 
 
 
Part II
Other Information
 
 
 
 
Item 1.
Legal Proceedings
54
Item 1A.
Risk Factors
54
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
54
Item 4.
Mine Safety Disclosures
54
Item 6.
Exhibits
55
 
 
 
Signatures
56
Index to Exhibits
57






Part I.
Financial Information

Item 1.
Financial Statements

Consolidated Statements of Income
(Unaudited)
 
 
 
 
For the Three Months
 
 
 
 
Ended March 31,
(Millions, except per common share data)
 
2016

 
2015

Revenue:
 
 
 
 
 
 
Health care premiums
 
 
 
$
13,469.0

 
$
12,940.1

Other premiums
 
 
 
540.1

 
538.0

Fees and other revenue (1)
 
 
 
1,467.0

 
1,375.0

Net investment income
 
 
 
217.7

 
232.9

Net realized capital (losses) gains
 
 
 
(.4
)
 
8.1

Total revenue
 
 
 
15,693.4

 
15,094.1

Benefits and expenses:
 
 
 
 
 
 
Health care costs (2)
 
 
 
10,847.7

 
10,240.5

Current and future benefits
 
 
 
528.9

 
528.1

Operating expenses:
 
 
 
 
 
 
Selling expenses
 
 
 
421.1

 
414.9

General and administrative expenses
 
 
 
2,442.5

 
2,400.6

Total operating expenses
 
 
 
2,863.6

 
2,815.5

Interest expense
 
 
 
101.8

 
80.2

Amortization of other acquired intangible assets
 
 
 
62.8

 
63.2

Total benefits and expenses
 
 
 
14,404.8

 
13,727.5

Income before income taxes
 
 
 
1,288.6

 
1,366.6

Income taxes:
 
 
 
 
 
 
Current
 
 
 
573.1

 
647.0

Deferred
 
 
 
(12.4
)
 
(56.7
)
Total income taxes
 
 
 
560.7

 
590.3

Net income including non-controlling interests
 
 
 
727.9

 
776.3

Less: Net income (loss) attributable to non-controlling interests
1.3

 
(1.2
)
Net income attributable to Aetna
 
 
 
$
726.6

 
$
777.5

Earnings per common share:
 
 
 
 
 
 
Basic
 
 
 
$
2.07

 
$
2.22

Diluted
 
 
 
$
2.06

 
$
2.20

 
 
 
 
 
 
 
(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 $24.4 million and $24.1 million (net of pharmaceutical and processing costs of $308.4 million and $299.3 million) for the three months ended March 31, 2016 and 2015, respectively.
(2) 
Health care costs have been reduced by Insured member co-payments related to our mail order and specialty pharmacy operations of $34.0 million and $33.4 million for the three months ended March 31, 2016 and 2015, respectively.

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

Page 1



Consolidated Statements of Comprehensive Income
(Unaudited)

 
For the Three Months
 
Ended March 31,
(Millions)
2016

 
2015

Net income including non-controlling interests
$
727.9

 
$
776.3

Other comprehensive (loss) income, net of tax:
 
 
 
    Previously impaired debt securities: (1)
 
 
 
Net unrealized losses
 
 
 
($(4.2) and $(3.4) pretax)
(2.7
)
 
(2.2
)
Less: reclassification of (losses) gains to earnings
 
 
 
($(5.3) and $2.4 pretax)
(3.4
)
 
1.6

    Total previously impaired debt securities (1)
.7

 
(3.8
)
    All other securities:
 
 
 
Net unrealized gains
 
 
 
($317.4 and $119.9 pretax)
206.3

 
77.9

Less: reclassification of losses to earnings
 
 
 
($(23.4) and $(11.0) pretax)

(15.2
)
 
(7.2
)
    Total all other securities
221.5

 
85.1

    Foreign currency and derivatives:
 
 
 
Net unrealized losses
 
 
 
($(246.3) and $(21.4) pretax)
(160.1
)
 
(13.9
)
Less: reclassification of losses to earnings
 
 
 
($(5.5) and $(1.5) pretax)
(3.6
)
 
(1.0
)
    Total foreign currency and derivatives
(156.5
)
 
(12.9
)
    Pension and other postretirement employee benefit (“OPEB”) plans:
 
 
 
Less: amortization of net actuarial losses
 
 
 
($(16.0) and $(16.1) pretax)
(10.4
)
 
(10.5
)
Less: amortization of prior service credit
 
 
 
($1.0 and $1.0 pretax)
.7

 
.7

Total pension and OPEB plans
9.7

 
9.8

Other comprehensive income
75.4

 
78.2

Comprehensive income including non-controlling interests
803.3

 
854.5

Less: Comprehensive income (loss) attributable to non-controlling interests
1.3

 
(1.2
)
Comprehensive income attributable to Aetna
$
802.0

 
$
855.7

 
 
 
 
(1) 
Represents unrealized (losses) gains on the non-credit related component of impaired debt securities that we do not intend to sell and subsequent changes in the fair value of any previously impaired security.


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


Page 2



Consolidated Balance Sheets
 
 
 
 
(Unaudited)

 
 
(Millions)
 
 
 
At March 31, 2016

 
At December 31,
2015

Assets:
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
$
3,766.4

 
$
2,524.3

Investments
 
 
 
3,127.8

 
3,014.8

Premiums receivable, net
 
 
 
2,206.7

 
1,753.1

Other receivables, net
 
 
 
2,673.7

 
2,443.2

Accrued investment income
 
 
 
227.6

 
227.7

Income taxes receivable
 
 
 

 
260.4

Other current assets
 
 
 
3,391.4

 
2,509.5

Total current assets
 
 
 
15,393.6

 
12,733.0

Long-term investments
 
 
 
22,112.2

 
21,664.8

Reinsurance recoverables
 
 
 
730.9

 
723.9

Goodwill
 
 
 
10,636.8

 
10,636.8

Other acquired intangible assets, net
 
 
 
1,626.4

 
1,688.3

Property and equipment, net
 
 
 
616.1

 
629.7

Other long-term assets
 
 
 
1,289.8

 
1,269.9

Separate Accounts assets
 
 
 
4,017.9

 
4,035.1

Total assets
 
 
 
$
56,423.7

 
$
53,381.5

 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 
 
 

 
 

Current liabilities:
 
 
 
 

 
 

Health care costs payable
 
 
 
$
6,824.8

 
$
6,305.7

Future policy benefits
 
 
 
666.3

 
671.8

Unpaid claims
 
 
 
775.7

 
772.3

Unearned premiums
 
 
 
716.3

 
549.2

Policyholders’ funds
 
 
 
2,444.7

 
2,262.5

Current portion of long-term debt
 
 
 
398.4

 

Income taxes payable
 
 
 
274.9

 

Accrued expenses and other current liabilities
 
 
 
5,814.1

 
4,920.0

Total current liabilities
 
 
 
17,915.2

 
15,481.5

Future policy benefits
 
 
 
6,209.1

 
6,268.2

Unpaid claims
 
 
 
1,670.7

 
1,655.6

Policyholders’ funds
 
 
 
921.0

 
885.6

Long-term debt, less current portion
 
 
 
7,382.5

 
7,785.4

Deferred income taxes
 
 
 
234.0

 
177.4

Other long-term liabilities
 
 
 
1,194.6

 
914.1

Separate Accounts liabilities
 
 
 
4,017.9

 
4,035.1

Total liabilities
 
 
 
39,545.0

 
37,202.9

Commitments and contingencies (Note 14)
 
 
 


 


Shareholders’ equity:
 
 
 
 
 
 

Common stock ($.01 par value; 2.5 billion shares authorized and 350.6 million shares issued
 
 

and outstanding in 2016; 2.5 billion shares authorized and 349.5 million shares issued and
 
 
 
 

outstanding in 2015) and additional paid-in capital
 
 
 
4,632.0

 
4,647.2

Retained earnings
 
 
 
13,436.4

 
12,797.4

Accumulated other comprehensive loss
 
 
 
(1,254.9
)
 
(1,330.3
)
Total Aetna shareholders’ equity
 
 
 
16,813.5

 
16,114.3

Non-controlling interests
 
 
 
65.2

 
64.3

Total equity
 
 
 
16,878.7

 
16,178.6

Total liabilities and equity
 
 
 
$
56,423.7

 
$
53,381.5

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

Page 3



Consolidated Statements of Shareholders’ Equity
(Unaudited)

 
 
 
Attributable to Aetna
 
 
 
 
(Millions)
Number of
Common
Shares
Outstanding

 
Common
Stock and
Additional
Paid-in
Capital

 
Retained
Earnings

Accumulated
Other
Comprehensive
Loss
 
 
Total Aetna
Shareholders’
Equity

 
Non-Controlling Interests

Total
Equity
 
Three Months Ended March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
349.5

 
$
4,647.2

 
$
12,797.4

 
$
(1,330.3
)
 
$
16,114.3

 
$
64.3

 
$
16,178.6

Net income

 

 
726.6

 

 
726.6

 
1.3

 
727.9

Other decreases in non-
 
 
 
 
 
 
 
 
 
 
 
 
 
  controlling interest

 

 

 

 

 
(.4
)
 
(.4
)
Other comprehensive income (Note 8)

 

 

 
75.4

 
75.4

 

 
75.4

Common shares issued for benefit
 
 
 
 
 
 
 
 
 
 
 
 
 
  plans, including tax benefits, net of
 
 
 
 
 
 
 
 
 
 
 
 
 
  employee tax withholdings
1.1

 
(15.2
)
 

 

 
(15.2
)
 

 
(15.2
)
Dividends declared

 

 
(87.6
)
 

 
(87.6
)
 

 
(87.6
)
Balance at March 31, 2016
350.6

 
$
4,632.0

 
$
13,436.4

 
$
(1,254.9
)
 
$
16,813.5

 
$
65.2

 
$
16,878.7

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2014
349.8

 
$
4,542.2

 
$
11,051.7

 
$
(1,111.3
)
 
$
14,482.6

 
$
69.2

 
$
14,551.8

Net income (loss)

 

 
777.5

 

 
777.5

 
(1.2
)
 
776.3

Other decreases in non-
 
 
 
 
 
 
 
 
 
 
 
 
 
  controlling interest

 

 

 

 

 
(1.7
)
 
(1.7
)
Other comprehensive income (Note 8)

 

 

 
78.2

 
78.2

 

 
78.2

Common shares issued for benefit
 
 
 
 
 
 
 
 
 
 
 
 
 
  plans, including tax benefits, net of
 
 
 
 
 
 
 
 
 
 
 
 
 
  employee tax withholdings
1.5

 
(2.4
)
 

 

 
(2.4
)
 

 
(2.4
)
Repurchases of common shares
(2.1
)
 
(.1
)
 
(196.2
)
 

 
(196.3
)
 

 
(196.3
)
Dividends declared

 

 
(87.0
)
 

 
(87.0
)
 

 
(87.0
)
Balance at March 31, 2015
349.2

 
$
4,539.7

 
$
11,546.0

 
$
(1,033.1
)
 
$
15,052.6

 
$
66.3

 
$
15,118.9



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


Page 4



Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
 
Three Months Ended
 
 
 
 
March 31,
(Millions)
 
 
 
2016

 
2015

Cash flows from operating activities:
 
 
 
 
 
 
Net income including non-controlling interests
 
 
 
$
727.9

 
$
776.3

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Net realized capital losses (gains)
 
 
 
.4

 
(8.1
)
Depreciation and amortization
 
 
 
169.2

 
164.0

Debt fair value amortization
 
 
 
(7.4
)
 
(7.8
)
Equity in losses (earnings) of affiliates, net
 
 
 
14.8

 
(9.7
)
Stock-based compensation expense
 
 
 
53.6

 
49.8

Amortization of net investment premium
 
 
 
20.6

 
22.3

Changes in assets and liabilities:
 
 
 
 
 
 
Accrued investment income
 
 
 
.1

 
(.5
)
Premiums due and other receivables
 
 
 
(495.9
)
 
(830.4
)
Income taxes
 
 
 
519.3

 
629.5

Other assets and other liabilities
 
 
 
64.9

 
123.5

Health care and insurance liabilities
 
 
 
713.4

 
564.5

Net cash provided by operating activities
 
 
 
1,780.9

 
1,473.4

Cash flows from investing activities:
 
 
 
 

 
 

Proceeds from sales and maturities of investments
 
 
 
2,938.3

 
2,608.9

Cost of investments
 
 
 
(3,060.4
)
 
(2,493.9
)
Additions to property, equipment and software
 
 
 
(54.6
)
 
(82.3
)
Cash used for acquisitions, net of cash acquired
 
 
 

 
(10.9
)
Net cash (used for) provided by investing activities
 
 
 
(176.7
)
 
21.8

Cash flows from financing activities:
 
 
 
 

 
 

Repayment of long-term debt
 
 
 

 
(228.8
)
Net repayment of short-term debt
 
 
 

 
(203.0
)
Deposits net of (withdrawals) and interest credited to investment contracts
 
 
 
.1

 
(7.6
)
Common shares issued under benefit plans, net
 
 
 
(79.1
)
 
(79.9
)
Stock-based compensation tax benefits
 
 
 
10.3

 
27.7

Settlements from repurchase agreements
 
 
 

 
(201.7
)
Common shares repurchased
 
 
 

 
(196.3
)
Dividends paid to shareholders
 
 
 
(87.4
)
 
(87.1
)
Collateral on interest rate hedges
 
 
 
(205.6
)
 
(21.4
)
Distributions, non-controlling interests
 
 
 
(.4
)
 
(1.7
)
Net cash used for financing activities
 
 
 
(362.1
)
 
(999.8
)
Net increase in cash and cash equivalents
 
 
 
1,242.1

 
495.4

Cash and cash equivalents, beginning of period
 
 
 
2,524.3

 
1,420.4

Cash and cash equivalents, end of period
 
 
 
$
3,766.4

 
$
1,915.8

Supplemental cash flow information:
 
 
 
 

 
 

Interest paid
 
 
 
$
43.7

 
$
47.6

Income taxes paid (refunded)
 
 
 
31.1

 
(66.8
)
 
 
 
 
 
 
 
 
 Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).

Page 5



Condensed Notes to Consolidated Financial Statements
(Unaudited)

1.
Organization

We conduct our operations in three business segments:

Health Care consists of medical, pharmacy benefit management services, dental, behavioral health 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) and emerging business products and services, such as Accountable Care Solutions, that complement and enhance our medical products. We also offer Medicare and Medicaid products and services and other medical products, such as medical management and data analytics services, medical stop loss insurance, workers’ compensation administrative services and products that provide access to our provider networks in select geographies.

Group Insurance primarily includes group life insurance and group disability products. Group life insurance products are offered on an Insured basis. Group disability products are offered to employers on both an Insured and an ASC basis. Group Insurance also includes long-term care products that were offered primarily on an Insured basis. We no longer solicit or accept new long-term care customers.

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 17 beginning on page 36 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 2015 Annual Report on Form 10-K (our “2015 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 2015 Annual Report, unless the information contained in those disclosures materially changed and is required by GAAP.  The Company has evaluated subsequent events that occurred after March 31, 2016 through the date the financial statements were issued and determined there were no subsequent events to disclose other than as disclosed in Note 11 beginning on page 26.

Reclassifications
Certain reclassifications were made to 2015 financial information to conform with the 2016 presentation.

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


Page 6



New Accounting Standards
Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
Effective January 1, 2016, we adopted new accounting guidance related to the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This guidance clarifies that awards with these provisions should be treated as performance conditions that affect vesting, and do not impact the award’s estimated grant-date fair value. The adoption of this new guidance did not have an impact on our financial position or operating results.

Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity
Effective January 1, 2016, we adopted new accounting guidance related to the approach used in determining whether the host contract in a hybrid financial instrument issued in the form of a share is more akin to debt or equity. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items
Effective January 1, 2016, we adopted new accounting guidance related to the presentation of extraordinary items. The amendment eliminates the concept of extraordinary items, which are events that are both unusual and infrequent. Presentation and disclosure of items that are unusual or infrequent will be retained, and will be expanded to include items that are both unusual and infrequent. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Amendments to the Consolidation Analysis
Effective January 1, 2016, we adopted new accounting guidance related to the evaluation of consolidation for certain legal entities. The amendment changes how a reporting entity assesses consolidation, including whether an entity is considered a variable interest entity, determination of the primary beneficiary and how related parties are considered in the analysis. The adoption of this new guidance required more of our other investments to be considered variable interest entities; however, it did not require additional investments to be consolidated or de-consolidated or have a material impact on our financial position or operating results. Our variable interest entity disclosures as of December 31, 2015 were retrospectively adjusted to conform with the new accounting guidance. Refer to Note 6 beginning on page 11 for further discussion.

Simplifying the Presentation of Debt Issuance Costs
Effective January 1, 2016, we adopted new accounting guidance related to the financial statement presentation of all debt issuance costs, including those related to line-of-credit arrangements. The amendment requires debt issuance costs to be presented as a direct deduction from the carrying amount of our debt liability, consistent with the approach used for debt premiums or discounts. We also elected to report debt issuance costs associated with any line-of-credit arrangements as a direct deduction from the carrying amount of our debt liability. Amortization of debt issuance costs also will be reported in our statements of income in interest expense, as opposed to general and administrative expenses. We are applying this new guidance on a full retrospective basis, with all prior periods restated for the new presentation. The adoption of this new guidance requires certain reclassifications in our financial statements and did not have a material impact on our financial position or operating results. As a result of adopting this guidance, we reclassified $41 million and $43 million of other current and long-term assets as a reduction of long-term debt on our balance sheets at March 31, 2016 and December 31, 2015, respectively. Additionally, we reclassified an immaterial amount of general and administrative expenses into interest expense for the three months ended March 31, 2016 and 2015.

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
Effective January 1, 2016, we adopted new accounting guidance related to the evaluation of fees paid by a customer in a cloud computing arrangement. The amendment provides additional guidance that aids in determining whether a cloud computing arrangement contains a software license. Arrangements that do not contain a software license must be accounted for as a service contract. If a software license is included in the cloud computing arrangement, the

Page 7



license element must be accounted for consistent with the acquisition of a software license. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)
Effective January 1, 2016, we adopted new accounting guidance related to the presentation of investments in certain entities that calculate net asset value per share (or its equivalent). The amendment removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. This new guidance is applicable to certain of our investments that reside in our separate accounts and employee benefit plans. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Simplifying the Accounting for Measurement-Period Adjustments
Effective January 1, 2016, we adopted new accounting guidance related to the recognition of adjustments to provisional amounts that are identified during the measurement period in a business combination. The new guidance eliminates the requirement to retrospectively account for measurement-period adjustments as part of a business combination and permits such adjustments to be recognized in the period in which the adjustment was determined. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Future Application of Accounting Standards
Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern
Effective December 31, 2016, we will adopt new accounting guidance related to management’s evaluation of whether there is substantial doubt about an entity’s ability to continue as a going concern and the related disclosures. The adoption of this new guidance will not have a material impact on our financial position or operating results.

Disclosures about Short-Duration Insurance Contracts
Effective December 31, 2016, we will adopt new accounting guidance related to the disclosure of short-duration insurance contracts. The amendment requires insurance companies that issue short-duration contracts to include additional disclosures about those insurance liabilities, including disaggregation of certain disclosures, as appropriate. The adoption of this new guidance will not have a material impact on our financial position or operating results, however, the new guidance will require additional disclosure for our short-duration insurance liabilities that reside in our Health Care and Group Insurance segments.

Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships
Effective January 1, 2017, we will adopt new accounting guidance clarifying that the novation of a derivative contract in a hedge accounting relationship does not, in and of itself, require dedesignation of the hedge accounting relationship. The adoption of this new guidance is not expected to have a material impact on our financial position or operating results.

Contingent Put and Call Options in Debt Instruments
Effective January 1, 2017, we will adopt new accounting guidance related to the assessment of embedded contingent put or call options in debt instruments. The new guidance clarifies that assessment of whether an embedded contingent put or call option is clearly and closely related to the debt host requires only an analysis of the four-step decision sequence. The adoption of this new guidance is not expected to have a material impact on our financial position or operating results.

Simplifying the Transition to the Equity Method of Accounting
Effective January 1, 2017, we will adopt new accounting guidance related to the accounting for investments that subsequently qualify for the equity method of accounting. The new accounting guidance eliminates the requirement that an entity retrospectively apply the equity method of accounting to an investment previously accounted for by another method when we subsequently obtain significant influence. The adoption of this new guidance is not expected to have a material impact on our financial position or operating results.

Page 8




Improvements to Employee Share-Based Payment Accounting
We will adopt new accounting guidance related to the accounting for and financial statement presentation of employee share-based payments. Under the new guidance, entities will be required to recognize all excess tax benefits and tax deficiencies as income tax benefit or expense in the income statement instead of in additional paid-in capital. The new guidance also revises the allowable number of shares an employer can withhold to satisfy the employer’s statutory income tax obligation and still qualify for equity classification on its balance sheets, permits an accounting policy election to recognize the forfeiture of share-based payment awards as they occur and provides clarification on certain statement of cash flow presentation requirements. The new guidance is effective January 1, 2017 with early adoption permitted during 2016, with any adjustments reflected as of January 1, 2016. We are currently assessing the impact of this new guidance on our financial position and operating results.

Revenue from Contracts with Customers
Effective January 1, 2018, we will adopt new accounting guidance related to revenue recognition from contracts with customers. This new guidance removes most industry-specific revenue recognition requirements (insurance contracts are not covered by this guidance) and requires that an entity recognize revenue for the transfer of goods or services to a customer at an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The new guidance also requires additional disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. The new guidance allows an entity to adopt the standard either through a full retrospective approach or a modified retrospective approach with a cumulative effect adjustment to retained earnings. Early adoption of this new guidance is permitted as of January 1, 2017. We are still assessing the impact of this new guidance on our financial position and operating results in addition to evaluating the transition method we will use when we adopt this new guidance.

Recognition and Measurement of Financial Assets and Financial Liabilities
Effective January 1, 2018, we will adopt new accounting guidance related to the recognition and measurement of financial assets and financial liabilities. Under the new guidance, all equity investments in unconsolidated entities will be measured at fair value with changes in fair value recognized in net income. A reporting entity may elect to report equity investments without a readily determinable fair value at cost. The new guidance also revises certain disclosures regarding financial assets and liabilities. The adoption of this new guidance is not expected to have a material impact on our financial position or operating results.

Leases
Effective January 1, 2019, we will adopt new accounting guidance related to the recognition, measurement and disclosure requirements for leases. Under the new guidance, lessees will be required to recognize a right-of-use asset and corresponding lease liability on their balance sheets for all leases other than those that meet the definition of a short-term lease. The new guidance also revises certain disclosure requirements regarding leases. We are still assessing the impact of this new guidance on our financial position and operating results.

3.
Proposed Acquisition of Humana

On July 2, 2015, we entered into a definitive agreement (as it may be amended, the "Merger Agreement") to acquire Humana Inc. ("Humana") in a transaction valued at approximately $37 billion, based on the closing price of Aetna common shares on July 2, 2015, including the assumption of Humana debt and Humana cash and cash equivalents. Under the terms of the Merger Agreement, Humana stockholders will receive $125.00 in cash and 0.8375 Aetna common shares for each Humana share.

On October 19, 2015, Aetna and Humana each obtained the approval of their respective shareholders necessary for our proposed acquisition of Humana (the “Humana Acquisition”).

The Humana Acquisition remains subject to customary closing conditions, including the expiration of the federal Hart-Scott-Rodino Antitrust Improvements Act of 1976 waiting period and approvals of state departments of insurance and other regulators, and therefore has not been reflected in these financial statements.

Page 9




4.
Earnings Per Common Share

Basic earnings per share (“EPS”) is computed by dividing net income attributable to Aetna 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 outstanding stock-based compensation awards, but only if the effect is dilutive.

The computations of basic and diluted EPS for the three months ended March 31, 2016 and 2015 are as follows:
 
Three Months Ended
 
March 31,
(Millions, except per common share data)
2016

 
2015

Net income attributable to Aetna
$
726.6

 
$
777.5

Weighted average shares used to compute basic EPS
350.7

 
349.5

Dilutive effect of outstanding stock-based compensation awards
2.4

 
3.2

Weighted average shares used to compute diluted EPS
353.1

 
352.7

Basic EPS
$
2.07

 
$
2.22

Diluted EPS
$
2.06

 
$
2.20

 
 
 
 

The stock-based compensation awards excluded from the calculation of diluted EPS for the three months ended March 31, 2016 and 2015 are as follows:
 
Three Months Ended
 
March 31,
(Millions)
2016

 
2015

Stock appreciation rights (“SARs”) (1)
.2

 
1.9

Other stock-based compensation awards (2)
.8

 
1.1

 
 
 
 
(1) 
SARs are excluded from the calculation of diluted EPS if the exercise price is greater than the average market price of Aetna common shares during the period (i.e., the awards are anti-dilutive).
(2) 
Performance stock units ("PSUs"), certain market stock units ("MSUs") with performance conditions, and performance stock appreciation rights ("PSARs") are excluded from the calculation of diluted EPS if all necessary performance conditions have not been satisfied at the end of the reporting period.

5.     Operating Expenses

For the three months ended March 31, 2016 and 2015, 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
 
March 31,
(Millions)
2016

 
2015

Selling expenses
$
421.1

 
$
414.9

General and administrative expenses:
 
 
 
Salaries and related benefits
1,252.4

 
1,206.6

  Other general and administrative expenses  (1)
1,190.1

 
1,194.0

Total general and administrative expenses
2,442.5

 
2,400.6

Total operating expenses
$
2,863.6

 
$
2,815.5

 
 
 
 
(1) 
The three months ended March 31, 2016 and 2015 include estimated fees mandated by the ACA comprised primarily of the health insurer fee of $213.8 million and $218.7 million, respectively, and our estimated contribution to the funding of the ACA’s reinsurance program of $29.4 million and $53.6 million, respectively.


Page 10



6.     Investments

Total investments at March 31, 2016 and December 31, 2015 were as follows:
 
March 31, 2016
 
December 31, 2015
(Millions)
Current

 
Long-term

 
Total

 
Current

 
Long-term

 
Total

Debt and equity securities available for sale
$
2,987.0

 
$
19,120.6

 
$
22,107.6

 
$
2,877.1

 
$
18,445.9

 
$
21,323.0

Mortgage loans
138.5

 
1,367.7

 
1,506.2

 
126.9

 
1,426.8

 
1,553.7

Other investments
2.3

 
1,623.9

 
1,626.2

 
10.8

 
1,792.1

 
1,802.9

Total investments
$
3,127.8

 
$
22,112.2

 
$
25,240.0

 
$
3,014.8

 
$
21,664.8

 
$
24,679.6



Page 11



Debt and Equity Securities
Debt and equity securities available for sale at March 31, 2016 and December 31, 2015 were as follows:
(Millions)
Amortized
Cost

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
 
Fair
Value

March 31, 2016
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
U.S. government securities
$
1,769.9

 
$
105.2

 
$
(.4
)
 
 
$
1,874.7

States, municipalities and political subdivisions
4,960.2

 
290.9

 
(5.2
)
 
 
5,245.9

U.S. corporate securities
8,222.4

 
501.3

 
(50.7
)
 
 
8,673.0

Foreign securities
2,853.1

 
194.4

 
(28.3
)
 
 
3,019.2

Residential mortgage-backed securities
934.2

 
23.7

 
(1.7
)
 
 
956.2

Commercial mortgage-backed securities
1,275.2

 
27.7

 
(1.3
)
(1) 
 
1,301.6

Other asset-backed securities
910.8

 
6.3

 
(29.0
)
(1) 
 
888.1

Redeemable preferred securities
32.8

 
8.7

 

 
 
41.5

Total debt securities
20,958.6

 
1,158.2

 
(116.6
)
 
 
22,000.2

Equity securities
96.4

 
14.4

 
(3.4
)
 
 
107.4

Total debt and equity securities (2)
$
21,055.0

 
$
1,172.6

 
$
(120.0
)
 
 
$
22,107.6

December 31, 2015
 

 
 

 
 

 
 
 

Debt securities:
 

 
 

 
 

 
 
 

U.S. government securities
$
1,803.5

 
$
68.8

 
$
(.6
)
 
 
$
1,871.7

States, municipalities and political subdivisions
4,889.5

 
244.3

 
(9.3
)
 
 
5,124.5

U.S. corporate securities
7,981.5

 
339.5

 
(146.6
)
 
 
8,174.4

Foreign securities
2,910.2

 
148.3

 
(61.4
)
 
 
2,997.1

Residential mortgage-backed securities
914.6

 
16.6

 
(6.3
)
 
 
924.9

Commercial mortgage-backed securities
1,262.4

 
17.2

 
(9.0
)
(1) 
 
1,270.6

Other asset-backed securities
910.4

 
3.1

 
(19.2
)
(1) 
 
894.3

Redeemable preferred securities
33.0

 
11.5

 

 
 
44.5

Total debt securities
20,705.1

 
849.3

 
(252.4
)
 
 
21,302.0

Equity securities
22.8

 
4.1

 
(5.9
)
 
 
21.0

Total debt and equity securities (2)
$
20,727.9

 
$
853.4

 
$
(258.3
)
 
 
$
21,323.0

 
 
 
 
 
 
 
 
 
(1) 
At March 31, 2016 and December 31, 2015, we held securities for which we previously recognized $4.9 million and $5.4 million, respectively, of non-credit related impairments in accumulated other comprehensive loss. These securities had a net unrealized capital gain at March 31, 2016 and December 31, 2015 of $1.5 million and $1.9 million, respectively.
(2) 
Investment risks associated with our experience-rated and discontinued products generally do not impact our operating results (refer to Note 17 beginning on page 36 for additional information on our accounting for discontinued products).  At March 31, 2016, debt and equity securities with a fair value of approximately $3.1 billion, gross unrealized capital gains of $274.6 million and gross unrealized capital losses of $27.1 million and, at December 31, 2015, debt and equity securities with a fair value of approximately $3.0 billion, gross unrealized capital gains of $208.7 million and gross unrealized capital losses of $68.0 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 income.


Page 12



The fair value of debt securities at March 31, 2016 is shown below by contractual maturity.  Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid.
(Millions)
Fair
Value

Due to mature:
 
Less than one year
$
1,277.2

One year through five years
6,411.3

After five years through ten years
5,295.3

Greater than ten years
5,870.5

Residential mortgage-backed securities
956.2

Commercial mortgage-backed securities
1,301.6

Other asset-backed securities
888.1

Total
$
22,000.2

 
Mortgage-Backed and Other Asset-Backed Securities
All of our residential mortgage-backed securities at March 31, 2016 were issued by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation and carry agency guarantees and explicit or implicit guarantees by the U.S. Government.  At March 31, 2016, our residential mortgage-backed securities had an average credit quality rating of AAA and a weighted average duration of 3.9 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 loss severity and probability of default.  At March 31, 2016, these securities had an average credit quality rating of AA+ and a weighted average duration of 3.5 years.

Our other asset-backed securities have a variety of underlying collateral (e.g., automobile loans, credit card receivables, home equity loans and commercial loans).  Significant market observable inputs used to value these securities include the unemployment rate, loss severity and probability of default.  At March 31, 2016, these securities had an average credit quality rating of AA- and a weighted average duration of 1.2 years.

Unrealized Capital Losses 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.  We recognize an other-than-temporary impairment (“OTTI”) when we intend to sell a debt security that is in an unrealized capital loss position or if we determine a credit-related loss on a debt or equity security has occurred.


Page 13



Summarized below are the debt and equity securities we held at March 31, 2016 and December 31, 2015 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)
(Millions)
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
$
5.5

 
$
.1

 
$
10.5

 
$
.3

 
$
16.0

 
$
.4

States, municipalities and political subdivisions
385.5

 
2.1

 
121.4

 
3.1

 
506.9

 
5.2

U.S. corporate securities
779.1

 
27.5

 
406.4

 
23.2

 
1,185.5

 
50.7

Foreign securities
376.7

 
14.2

 
211.3

 
14.1

 
588.0

 
28.3

Residential mortgage-backed securities
43.2

 
.1

 
124.4

 
1.6

 
167.6

 
1.7

Commercial mortgage-backed securities
198.8

 
1.0

 
48.5

 
.3

 
247.3

 
1.3

Other asset-backed securities
429.3

 
22.8

 
63.6

 
6.2

 
492.9

 
29.0

Redeemable preferred securities
1.4

 

 

 

 
1.4

 

Total debt securities
2,219.5

 
67.8

 
986.1

 
48.8

 
3,205.6

 
116.6

Equity securities
16.5

 
2.6

 
1.5

 
.8

 
18.0

 
3.4

Total debt and equity securities (1)
$
2,236.0

 
$
70.4

 
$
987.6

 
$
49.6

 
$
3,223.6

 
$
120.0

December 31, 2015
 

 
 

 
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

 
 

 
 

U.S. government securities
$
66.8

 
$
.2

 
$
12.6

 
$
.4

 
$
79.4

 
$
.6

States, municipalities and political subdivisions
714.2

 
6.1

 
91.6

 
3.2

 
805.8

 
9.3

U.S. corporate securities
3,168.7

 
130.8

 
144.3

 
15.8

 
3,313.0

 
146.6

Foreign securities
1,102.4

 
50.4

 
89.2

 
11.0

 
1,191.6

 
61.4

Residential mortgage-backed securities
328.7

 
2.9

 
89.5

 
3.4

 
418.2

 
6.3

Commercial mortgage-backed securities
562.0

 
8.6

 
23.8

 
.4

 
585.8

 
9.0

Other asset-backed securities
653.5

 
15.6

 
67.1

 
3.6

 
720.6

 
19.2

Total debt securities
6,596.3

 
214.6

 
518.1

 
37.8

 
7,114.4

 
252.4

Equity securities

 
5.0

 
1.3

 
.9

 
1.3

 
5.9

Total debt and equity securities (1)
$
6,596.3

 
$
219.6

 
$
519.4

 
$
38.7

 
$
7,115.7

 
$
258.3

 
 
 
 
 
 
 
 
 
 
 
 
(1) 
At March 31, 2016 and December 31, 2015, debt and equity securities in an unrealized capital loss position of $27.1 million and $68.0 million, respectively, and with related fair value of $426.4 million and $966.2 million, 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 our internal credit analysts and external rating agencies and the prospects of realizing the carrying value of the security based on the investment’s current prospects for recovery.  At March 31, 2016, we did not intend to sell these securities, and we did not believe it was more likely than not that we would be required to sell these securities prior to anticipated recovery of their amortized cost basis.


Page 14



The maturity dates for debt securities in an unrealized capital loss position at March 31, 2016 were as follows:
 
Supporting discontinued and
experience-rated products
 
Supporting remaining
products
 
Total
(Millions)
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

Due to mature:
 
 
 
 
 
 
 
 
 
 
 
Less than one year
$

 
$

 
$
166.9

 
$
.6

 
$
166.9

 
$
.6

One year through five years
26.6

 
.5

 
647.1

 
9.0

 
673.7

 
9.5

After five years through ten years
148.9

 
5.9

 
557.2

 
20.3

 
706.1

 
26.2

Greater than ten years
223.8

 
18.5

 
527.3

 
29.8

 
751.1

 
48.3

Residential mortgage-backed securities

 

 
167.6

 
1.7

 
167.6

 
1.7

Commercial mortgage-backed securities
19.9

 

 
227.4

 
1.3

 
247.3

 
1.3

Other asset-backed securities
3.0

 

 
489.9

 
29.0

 
492.9

 
29.0

Total
$
422.2

 
$
24.9

 
$
2,783.4

 
$
91.7

 
$
3,205.6

 
$
116.6

 
 
 
 
 
 
 
 
 
 
 
 

Net realized capital (losses) gains for the three months ended March 31, 2016 and 2015, excluding amounts related to experience-rated contract holders and discontinued products, were as follows:
 
Three Months Ended
 
March 31,
(Millions)
2016

 
2015

OTTI losses on debt securities recognized in earnings
$
(9.1
)
 
$
(2.4
)
Other net realized capital gains
8.7

 
10.5

Net realized capital (losses) gains
$
(.4
)
 
$
8.1

 
The net realized capital losses for the three months ended March 31, 2016 were primarily attributable to yield-related OTTI on debt securities, substantially offset by gains from the sales of other investments. The net realized capital gains for the three months ended March 31, 2015 were primarily attributable to gains from the sales of debt securities.

We had no individually material realized capital losses on debt or equity securities that impacted our operating results during three months ended March 31, 2016 or 2015.

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 the three months ended March 31, 2016 and 2015 were as follows:
 
Three Months Ended
 
March 31,
(Millions)
2016

 
2015

Proceeds on sales
$
1,582.4

 
$
945.9

Gross realized capital gains
32.3

 
24.9

Gross realized capital losses
31.3

 
8.8

 
 
 
 


Page 15



Mortgage Loans
Our mortgage loans are collateralized by commercial real estate.  During the three months ended March 31, 2016 and 2015 we had the following activity in our mortgage loan portfolio:
 
Three Months Ended
 
March 31,
(Millions)
2016

 
2015

New mortgage loans
$
12.2

 
$
12.7

Mortgage loans fully repaid
48.3

 
39.5

Mortgage loans foreclosed

 
9.0

 
 
 
 

At March 31, 2016 and December 31, 2015, we had no material problem, restructured or potential problem mortgage loans. We also had no material impairment reserves on these loans at March 31, 2016 or December 31, 2015.
 
We assess our mortgage loans on a regular basis for credit impairments, and annually assign a credit quality indicator to each loan.  Our credit quality indicator is internally developed and categorizes our portfolio on a scale from 1 to 7.  Category 1 represents loans of superior quality, and Category 7 represents loans where collections are potentially at risk.  The vast majority of our mortgage loans fall into the Category 2 to 4 ratings.  These ratings represent loans where credit risk is minimal to acceptable; however, these loans may display some susceptibility to economic changes.  Categories 5 and 6 represent loans where credit risk is not substantial, but these loans warrant management’s close attention.  These indicators are based upon several factors, including current loan to value ratios, property condition, market trends, creditworthiness of the borrower and deal structure. At both March 31, 2016 and December 31, 2015 we did not have any loans in Category 7. Based upon our most recent assessments at March 31, 2016 and December 31, 2015, our mortgage loans were given the following credit quality indicators:
(In Millions, except credit ratings indicator)
March 31,
2016

 
December 31,
2015

1
$
50.7

 
$
65.8

2 to 4
1,434.7

 
1,466.9

5 and 6
20.8

 
21.0

Total
$
1,506.2

 
$
1,553.7

 
 
 
 
 

Variable Interest Entities
As discussed in Note 2 beginning on page 6, we adopted the guidance of Accounting Standards Update (ASU) No. 2015-02, Amendments to the Consolidation Analysis (Topic 810) effective January 1, 2016. As a result of adopting the new guidance, we have investments in certain hedge fund and private equity investments and real estate partnerships that are considered Variable Interest Entities (“VIE’s”). We do not have a future obligation to fund losses or debts on behalf of these investments; however, we may voluntarily contribute funds.

In evaluating whether we are the primary beneficiary of a VIE, we considered several factors, including whether we (a) have the power to direct the activities that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses and the right to receive benefits that could potentially be significant to the VIE.

Variable Interest Entities - Primary Beneficiary
Upon adoption of the new guidance, we identified one hedge fund investment previously consolidated as a Voting Interest Entity in our statement of financial position and operating results that is determined to be a VIE under the new guidance. The investment represents a majority owned hedge fund where we are the investment manager and have the power to direct the activities that most significantly impact the VIE’s economic performance, including determining the hedge fund’s investment strategy. Accordingly, we are the primary beneficiary and will continue to consolidate the investment in our financial results. The fund invests in additional hedge funds that are VIEs; however, we are not the primary beneficiary of these underlying funds as discussed in further detail below.


Page 16



Substantially all of the assets of the VIE hedge fund are comprised of hedge fund investments reported as long-term investments on our balance sheets. The VIE hedge fund had no material liabilities at March 31, 2016 or December 31, 2015. The total amount of the VIE hedge fund’s assets included in long term investments on our balance sheets at March 31, 2016 and December 31, 2015 were $494 million and $477 million, respectively.

Variable Interest Entities - Other Variable Interest Holder
Our involvement with VIEs where we are not determined to be the primary beneficiary consist of the following:

Hedge fund and private equity investments - We invest in hedge fund and private equity investments in order to generate investment returns for our investment portfolio supporting our businesses.

Real estate partnerships - We invest in various real estate partnerships including those that construct, own and manage low-income housing developments. For the low income housing development investments, substantially all of the projected benefits to us are from tax credits and other tax benefits.

We are not the primary beneficiary of these investments because the nature of our involvement with the activities of the VIEs does not give us the power to direct the activities that most significantly impact their economic performance. We record the amount of our investment as long-term investments on our balance sheets and recognize our share of each VIE’s income or losses in earnings.  Our maximum exposure to loss is limited to our investment balances as disclosed below and the risk of recapture of tax credits related to real estate partnerships previously recognized, which we do not consider significant.

The total amount of other variable interest holder VIE assets included in long term investments on our balance sheets at March 31, 2016 and December 31, 2015 were as follows:
(Millions)
 
March 31, 2016

 
December 31, 2015

Hedge fund investments
 
$
425.1

 
$
418.1

Private equity investments
 
438.8

 
443.3

Real estate partnerships
 
264.5

 
253.3

Total
 
$
1,128.4

 
$
1,114.7


The carrying value of the total assets and liabilities of our other variable interest holder VIE investments at March 31, 2016 and December 31, 2015 were as follows:
(Millions)
 
March 31, 2016

 
December 31, 2015

Assets:
 
 
 
 
Hedge fund investments
 
$
34,375.0

 
$
33,065.7

Private equity investments
 
28,075.4

 
28,552.5

Real estate partnerships
 
6,699.3

 
6,808.7

Total
 
$
69,149.7

 
$
68,426.9

 
 
 
 
 
Liabilities:
 
 
 
 
Hedge fund investments
 
$
4,048.4

 
$
3,535.3

Private equity investments
 
3,236.0

 
3,235.7

Real estate partnerships
 
5,005.1

 
5,044.5

Total
 
$
12,289.5

 
$
11,815.5



Page 17



Non-controlling (Minority) Interests
At March 31, 2016 and December 31, 2015, continuing business non-controlling interests were $65 million and $64 million, respectively, primarily related to third party interests in our investment holdings as well as third party interests in certain of our operating entities. The non-controlling entities’ share was included in total equity. Net income attributable to non-controlling interests was $1.3 million for the three months ended March 31, 2016. Net loss attributable to non-controlling interests was $1.2 million for the three months ended March 31, 2015. These non-controlling interests did not have a material impact on our financial position or operating results.

Net Investment Income
Sources of net investment income for the three months ended March 31, 2016 and 2015 were as follows:
 
Three Months Ended
 
March 31,
(Millions)
2016

 
2015

Debt securities
$
194.9

 
$
196.4

Mortgage loans
29.1

 
21.9

Other investments
3.8

 
23.9

Gross investment income
227.8

 
242.2

Investment expenses
(10.1
)
 
(9.3
)
Net investment income (1)
$
217.7

 
$
232.9

 
 
 
 
(1) 
Net investment income includes $44.7 million and $66.6 million for the three months ended March 31, 2016 and 2015, respectively, related to investments supporting our experience-rated and discontinued products.

7.    Health Care Reform’s Reinsurance, Risk Adjustment and Risk Corridor (the “3Rs”)

We participate in certain public health insurance exchanges (“Public Exchanges”) established pursuant to the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (as amended, collectively, “Health Care Reform” or the “ACA”). Under regulations established by the U.S. Department of Health and Human Services (“HHS”), HHS pays us a portion of the premium (“Premium Subsidy”) and a portion of the health care costs (“Cost Sharing Subsidy”) for low-income individual Public Exchange members. In addition, HHS administers the 3Rs risk management programs.

Our net receivable (payable) related to the 3Rs risk management programs at March 31, 2016 and December 31, 2015 were as follows:
 
 
As of March 31, 2016
 
As of December 31, 2015
(Millions)
 
Reinsurance
 
Risk Adjustment
 
Risk Corridor
 
Reinsurance
 
Risk Adjustment
 
Risk Corridor
Current
 
$
291.9

 
$
(698.9
)
 
$
(.7
)
 
$
394.5

 
$
(710.2
)
 
$
(8.1
)
Long-term
 
1.9

 
(177.7
)
 

 

 

 

Total net receivable (payable)
$
293.8

 
$
(876.6
)
 
$
(.7
)
 
$
394.5

 
$
(710.2
)
 
$
(8.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 

At March 31, 2016, we did not record any ACA risk corridor receivables related to the 2016 or 2015 program years or any amount in excess of the prorated 12.6% HHS funding amount received for the 2014 program year, because payments from HHS are uncertain.

We expect to perform an annual final reconciliation and settlement with HHS of the Cost Sharing Subsidy and the 3Rs in each subsequent year.


Page 18



8.    Other Comprehensive (Loss) Income

Shareholders’ equity included the following activity in accumulated other comprehensive loss for the three months ended March 31, 2016 and 2015:
 
Net Unrealized Gains (Losses)
 
Pension and OPEB Plans
 
Total
Accumulated
Other
Comprehensive
(Loss) Income

 
Securities
 
Foreign
Currency
and
Derivatives

 
 
 
 
 
(Millions)
Previously
Impaired (1)

 
All Other

 
Unrecognized
Net Actuarial
Losses
 
Unrecognized
Prior Service
Credit
 
 
Three months ended March 31, 2016
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
$
18.7

 
$
312.4

 
$
(74.0
)
 
$
(1,602.3
)
 
$
14.9

 
$
(1,330.3
)
Other comprehensive (loss) income
 
 
 
 
 
 
 
 
 
 
 
  before reclassifications
(2.7
)
 
206.3

 
(160.1
)
 

 

 
43.5

Amounts reclassified from accumulated
 
 
 
 
 
 
 
 
 
 
  other comprehensive income
3.4

(2 
) 
15.2

(2 
) 
3.6

(3 
) 
10.4

(4 
) 
(.7
)
(4 
) 
31.9

Other comprehensive income (loss)
.7

 
221.5

 
(156.5
)
 
10.4

 
(.7
)
 
75.4

Balance at March 31, 2016
$
19.4

 
$
533.9

 
$
(230.5
)
 
$
(1,591.9
)
 
$
14.2

 
$
(1,254.9
)
Three months ended March 31, 2015
 
 

 
 

 
 

 
 

 
 

Balance at December 31, 2014
$
34.9

 
$
568.0

 
$
(60.9
)
 
$
(1,670.9
)
 
$
17.6

 
$
(1,111.3
)
Other comprehensive (loss) income
 
 
 
 
 
 
 
 
 
 
 
  before reclassifications
(2.2
)
 
77.9

 
(13.9
)
 

 

 
61.8

Amounts reclassified from accumulated
 
 
 
 
 
 
 
 
 
 
  other comprehensive income
(1.6
)
(2 
) 
7.2

(2 
) 
1.0

(3 
) 
10.5

(4 
) 
(.7
)
(4 
) 
16.4

Other comprehensive (loss) income
(3.8
)
 
85.1

 
(12.9
)
 
10.5

 
(.7
)
 
78.2

Balance at March 31, 2015
$
31.1

 
$
653.1

 
$
(73.8
)
 
$
(1,660.4
)
 
$
16.9

 
$
(1,033.1
)
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
Represents unrealized gains on the non-credit related component of impaired debt securities that we do not intend to sell and subsequent changes in the fair value of any previously impaired security.
(2) 
Reclassifications out of accumulated other comprehensive income for previously impaired debt securities and all other securities are reflected in net realized capital gains (losses) within the Consolidated Statements of Income.
(3) 
Reclassifications out of accumulated other comprehensive income for foreign currency gains (losses) and derivatives are reflected in net realized capital gains (losses) within the Consolidated Statements of Income, except for the effective portion of derivatives related to interest rate swaps which are reflected in interest expense and were not material during the three months ended March 31, 2016 or 2015. Refer to Note 11 beginning on page 26 for additional information.
(4) 
Reclassifications out of accumulated other comprehensive income for pension and OPEB plan expenses are reflected in general and administrative expenses within the Consolidated Statements of Income. Refer to Note 10 beginning on page 26 for additional information.

Refer to the Consolidated Statements of Comprehensive Income on page 2 for additional information regarding reclassifications out of accumulated other comprehensive income on a pretax basis.

9.    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 an adjusted historical cost basis.  In this note, we provide details on the fair value of financial assets and liabilities and how we determine those fair values.  We present this information for those financial instruments that are measured at fair value for which the change in fair value impacts net income attributable to Aetna or other comprehensive income separately from other financial assets and liabilities.


Page 19



Financial Instruments Measured at Fair Value in our Balance Sheets
Certain of our financial instruments are measured at fair value in our balance sheets.  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:
Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets.
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 and credit risks) and inputs that are derived from or corroborated by observable markets.
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 in 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 in Level 2.  If quoted market prices are not available, we determine fair value using broker 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.

The fair values of our Level 2 debt securities are obtained using models such as matrix pricing, which use quoted market prices of debt securities with similar characteristics, or discounted cash flows to estimate fair value. We review these prices to ensure they are based on observable market inputs that include, but are not limited to, quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets and inputs that are observable but not prices (for example, interest rates and credit risks). We also review the methodologies and the assumptions used to calculate prices from these observable inputs. On a quarterly basis, we select a sample of our Level 2 debt securities’ prices and compare them to prices provided by a secondary source. Variances over a specified threshold are identified and reviewed to confirm the price provided by the primary source represents an appropriate estimate of fair value. In addition, our internal investment team consistently compares the prices obtained for select Level 2 debt securities to the team’s own independent estimates of fair value for those securities. We obtained one price for each of our Level 2 debt securities and did not adjust any of these prices at March 31, 2016 or December 31, 2015.


Page 20



We also value certain 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 internally.  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 March 31, 2016 or December 31, 2015.  The total fair value of our broker quoted debt securities was $79 million at March 31, 2016 and $78 million at December 31, 2015.  Examples of these broker quoted Level 3 debt securities include certain U.S. and foreign corporate securities and certain of our commercial mortgage-backed securities as well as other asset-backed securities.  For some of our private placement securities, our internal staff determines 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 private placement 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 placed.  Our publicly-traded securities are classified in Level 1 because quoted prices are available for these securities in an active market. For privately-placed equity securities, there is no active market; therefore, we classify these securities in Level 3 because we price these securities through an internal analysis of each investment’s financial statements and cash flow projections. Significant unobservable inputs consist of earnings and revenue multiples, discount for lack of marketability and comparability adjustments. An increase or decrease in any of these unobservable inputs would result in a change in the fair value measurement, which may be significant.

Derivatives – Where quoted prices are available in an active market, our derivatives are classified in Level 1.  Certain of our derivative instruments are valued using models that primarily use market observable inputs and therefore are classified in Level 2 because they are traded in markets where quoted market prices are not readily available.


Page 21



Financial assets and liabilities measured at fair value on a recurring basis in our balance sheets at March 31, 2016 and December 31, 2015 were as follows:
 
 
 
 
 
 
 
 
(Millions)
Level 1