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



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 September 30, 2017
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

aetnalogoa_02a08.jpg
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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth 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
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 326.1 million shares of the registrant’s voting common stock with a par value of $.01 per share outstanding at September 30, 2017.




Aetna Inc.
Form 10-Q
For the Quarterly Period Ended September 30, 2017

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), refer to Aetna Inc. (a Pennsylvania corporation) (“Aetna”) and its subsidiaries (collectively, the “Company”).






Part I.
Financial Information


Item 1.
Financial Statements
Index to Consolidated Financial Statements

 
 
 
Page
Consolidated Balance Sheets at September 30, 2017 and December 31, 2016
Consolidated Statements of Income for three and nine months ended September 30, 2017 and 2016
Consolidated Statements of Comprehensive Income for three and nine months ended September 30, 2017 and 2016
Consolidated Statements of Shareholders' Equity for the nine months ended September 30, 2017 and 2016
Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016
Condensed Notes to the Consolidated Financial Statements
Report of the Independent Registered Public Accounting Firm
 
 


Page 1


Consolidated Balance Sheets
 
 
 
 
(Unaudited)

 
 
(Millions)
 
 
 
September 30,
2017

 
December 31,
2016

Assets:
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
$
5,928

 
$
17,996

Investments
 
 
 
2,869

 
3,046

Premiums receivable, net
 
 
 
2,577

 
2,356

Other receivables, net
 
 
 
2,388

 
2,224

Accrued investment income
 
 
 
228

 
232

Income taxes receivable
 
 
 

 
44

Other current assets
 
 
 
2,444

 
2,551

Total current assets
 
 
 
16,434

 
28,449

Long-term investments
 
 
 
21,507

 
21,833

Reinsurance recoverables
 
 
 
705

 
727

Goodwill
 
 
 
10,683

 
10,637

Other acquired intangible assets, net
 
 
 
1,273

 
1,442

Property and equipment, net
 
 
 
581

 
587

Other long-term assets
 
 
 
1,865

 
1,480

Separate Accounts assets
 
 
 
4,335

 
3,991

Total assets
 
 
 
$
57,383

 
$
69,146

 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 
 
 

 
 

Current liabilities:
 
 
 
 

 
 

Health care costs payable
 
 
 
$
6,139

 
$
6,558

Future policy benefits
 
 
 
611

 
645

Unpaid claims
 
 
 
812

 
801

Unearned premiums
 
 
 
2,046

 
556

Policyholders’ funds
 
 
 
2,914

 
2,772

Current portion of long-term debt
 
 
 
1,998

 
1,634

Income taxes payable
 
 
 
79

 

Accrued expenses and other current liabilities
 
 
 
5,048

 
5,728

Total current liabilities
 
 
 
19,647

 
18,694

Future policy benefits
 
 
 
5,770

 
5,929

Unpaid claims
 
 
 
1,705

 
1,703

Policyholders’ funds
 
 
 
781

 
812

Long-term debt, less current portion
 
 
 
8,161

 
19,027

Deferred income taxes
 
 
 
72

 
4

Other long-term liabilities
 
 
 
1,094

 
1,043

Separate Accounts liabilities
 
 
 
4,335

 
3,991

Total liabilities
 
 
 
41,565

 
51,203

Commitments and contingencies (Note 15)
 
 
 


 


Shareholders’ equity:
 
 
 
 
 
 

Common stock ($.01 par value; 2.5 billion shares authorized and 326.1 million shares issued and outstanding in 2017; 2.5 billion shares authorized and 351.7 million shares issued and outstanding in 2016) and additional paid-in capital
 
 
 
4,707

 
4,716

Retained earnings
 
 
 
12,037

 
14,717

Accumulated other comprehensive loss
 
 
 
(1,161
)
 
(1,552
)
Total Aetna shareholders’ equity
 
 
 
15,583

 
17,881

Non-controlling interests
 
 
 
235

 
62

Total equity
 
 
 
15,818

 
17,943

Total liabilities and equity
 
 
 
$
57,383

 
$
69,146

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

Page 2


Consolidated Statements of Income
(Unaudited)
 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions, except per common share data)
 
2017

 
2016

 
2017

 
2016

Revenue:
 
 
 
 
 
 
 
 
 
 
Health care premiums
 
 
 
$
12,710

 
$
13,525

 
$
39,152

 
$
40,623

Other premiums
 
 
 
562

 
549

 
1,658

 
1,636

Fees and other revenue (1)
 
 
 
1,443

 
1,454

 
4,404

 
4,395

Net investment income
 
 
 
233

 
219

 
730

 
688

Net realized capital gains (losses)
 
 
 
46

 
34

 
(262
)
 
85

Total revenue
 
 
 
14,994

 
15,781

 
45,682

 
47,427

Benefits and expenses:
 
 
 
 
 
 
 
 
 
 
Health care costs (2)
 
 
 
10,412

 
11,092

 
31,905

 
33,172

Current and future benefits
 
 
 
548

 
535

 
1,632

 
1,589

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Selling expenses
 
 
 
401

 
408

 
1,224

 
1,245

General and administrative expenses
 
 
 
2,211

 
2,422

 
7,793

 
7,232

Total operating expenses
 
 
 
2,612

 
2,830

 
9,017

 
8,477

Interest expense
 
 
 
90

 
189

 
349

 
414

Amortization of other acquired intangible assets
 
 
 
58

 
61

 
176

 
187

Loss on early extinguishment of long-term debt
 
 
 

 

 
246

 

Reduction of reserve for anticipated future losses on discontinued products

 

 
(109
)
 
(128
)
Total benefits and expenses
 
 
 
13,720

 
14,707

 
43,216

 
43,711

Income before income taxes
 
 
 
1,274

 
1,074

 
2,466

 
3,716

Income taxes:
 
 
 
 
 
 
 
 
 
 
Current
 
 
 
470

 
580

 
955

 
1,697

Deferred
 
 
 
(44
)
 
(103
)
 
(140
)
 
(109
)
Total income tax expense
 
 
 
426

 
477

 
815

 
1,588

Net income including non-controlling interests
 
 
 
848

 
597

 
1,651

 
2,128

Less: Net income (loss) attributable to non-controlling interests
10

 
(7
)
 
(9
)
 
(4
)
Net income attributable to Aetna
 
 
 
$
838

 
$
604

 
$
1,660

 
$
2,132

Earnings per common share:
 
 
 
 
 
 
 
 
 
 
Basic
 
 
 
$
2.54

 
$
1.72

 
$
4.95

 
$
6.07

Diluted
 
 
 
$
2.52

 
$
1.70

 
$
4.92

 
$
6.02

 
 
 
 
 
 
 
 
 
 
 
(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 $31 million and $100 million (net of pharmaceutical and processing costs of $350 million and $1.0 billion) for the three and nine months ended September 30, 2017, respectively, and $34 million and $93 million (net of pharmaceutical and processing costs of $342 million and $983 million) for the three and nine months ended September 30, 2016, respectively.
(2) 
Health care costs have been reduced by Insured member co-payments related to our mail order and specialty pharmacy operations of $30 million and $96 million for the three and nine months ended September 30, 2017, respectively, and $27 million and $89 million for the three and nine months ended September 30, 2016, respectively.

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

Page 3


Consolidated Statements of Comprehensive Income
(Unaudited)


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions)
2017

 
2016

 
2017

 
2016

Net income including non-controlling interests
$
848

 
$
597

 
$
1,651

 
$
2,128

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
    Previously impaired debt securities
(1
)
 

 
(2
)
 
1

    All other securities
8

 
(2
)
 
132

 
384

    Derivatives and foreign currency
1

 
4

 
229

 
(165
)
Pension and other postretirement employee benefit (“OPEB”) plans
11

 
9

 
32

 
29

Other comprehensive income
19

 
11

 
391

 
249

Comprehensive income including non-controlling interests
867

 
608

 
2,042

 
2,377

Less: Comprehensive income (loss) attributable to non-controlling interests
10

 
(7
)
 
(9
)
 
(4
)
Comprehensive income attributable to Aetna
$
857

 
$
615

 
$
2,051

 
$
2,381

 
 
 
 
 
 
 
 



Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited), including Note 12 for further information about other comprehensive (loss) income.


Page 4


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

Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
351.7

 
$
4,716

 
$
14,717

 
$
(1,552
)
 
$
17,881

 
$
62

 
$
17,943

Net income (loss)

 

 
1,660

 

 
1,660

 
(9
)
 
1,651

Other increases in non-controlling interest

 

 

 

 

 
182

 
182

Other comprehensive income (Note 12)

 

 

 
391

 
391

 

 
391

Common shares issued for benefit plans, net of employee tax withholdings
1.4

 
(9
)
 

 

 
(9
)
 

 
(9
)
Repurchases of common shares
(27.0
)
 

 
(3,845
)
 

 
(3,845
)
 

 
(3,845
)
Dividends declared

 

 
(495
)
 

 
(495
)
 

 
(495
)
Balance at September 30, 2017
326.1

 
$
4,707

 
$
12,037

 
$
(1,161
)
 
$
15,583

 
$
235

 
$
15,818

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
349.5

 
$
4,647

 
$
12,797

 
$
(1,330
)
 
$
16,114

 
$
65

 
$
16,179

Net income (loss)

 

 
2,132

 

 
2,132

 
(4
)
 
2,128

Other comprehensive income (Note 12)

 

 

 
249

 
249

 

 
249

Common shares issued for benefit plans, net of employee tax withholdings
1.4

 
52

 

 

 
52

 

 
52

Dividends declared

 

 
(263
)
 

 
(263
)
 

 
(263
)
Balance at September 30, 2016
350.9

 
$
4,699

 
$
14,666

 
$
(1,081
)
 
$
18,284

 
$
61

 
$
18,345



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


Page 5


Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
 
Nine Months Ended
September 30,
(Millions)
 
2017

 
2016

Cash flows from operating activities:
 
 
 
 
 
 
Net income including non-controlling interests
 
 
 
$
1,651

 
$
2,128

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Net realized capital losses (gains)
 
 
 
262

 
(85
)
Depreciation and amortization
 
 
 
499

 
511

Debt fair value amortization
 
 
 
(14
)
 
(22
)
Equity in (earnings) losses of affiliates, net
 
 
 
(80
)
 
1

Stock-based compensation expense
 
 
 
135

 
147

Reduction of reserve for anticipated future losses on discontinued products
 
 
 
(109
)
 
(128
)
Amortization of net investment premium
 
 
 
54

 
62

Loss on early extinguishment of long-term debt
 
 
 
246

 

Changes in assets and liabilities:
 
 
 
 
 
 
Premiums due and other receivables
 
 
 
(184
)
 
(278
)
Income taxes
 
 
 
(15
)
 
387

Other assets and other liabilities
 
 
 
(1,196
)
 
57

Health care and insurance liabilities
 
 
 
931

 
1,841

Distributions from partnership investments
 
 
 
44

 

Net cash provided by operating activities
 
 
 
2,224

 
4,621

Cash flows from investing activities:
 
 
 
 

 
 

Proceeds from sales and maturities of investments
 
 
 
8,854

 
10,747

Cost of investments
 
 
 
(7,860
)
 
(10,876
)
Additions to property, equipment and software
 
 
 
(301
)
 
(197
)
Cash used for acquisitions, net of cash acquired
 
 
 
(24
)
 

Net cash provided by (used for) investing activities
 
 
 
669

 
(326
)
Cash flows from financing activities:
 
 
 
 

 
 

Issuance of long-term debt
 
 
 
988

 
12,886

Repayment of long-term debt
 
 
 
(11,734
)
 

Common shares issued under benefit plans, net
 
 
 
(132
)
 
(103
)
Common shares repurchased
 
 
 
(3,845
)
 

Dividends paid to shareholders
 
 
 
(420
)
 
(262
)
Net payment on interest rate derivatives
 
 
 

 
(274
)
Contributions, non-controlling interests
 
 
 
182

 

Net cash (used for) provided by financing activities
 
 
 
(14,961
)
 
12,247

Net (decrease) increase in cash and cash equivalents
 
 
 
(12,068
)
 
16,542

Cash and cash equivalents, beginning of period
 
 
 
17,996

 
2,524

Cash and cash equivalents, end of period
 
 
 
$
5,928

 
$
19,066

Supplemental cash flow information:
 
 
 
 

 
 

Interest paid
 
 
 
$
301

 
$
214

Income taxes paid
 
 
 
791

 
1,201

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

Page 6


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 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 for additional information).

2.
Summary of Significant Accounting Policies

Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. We have omitted certain footnote disclosures that would substantially duplicate the disclosures in our 2016 Annual Report on Form 10-K (our “2016 Annual Report”), unless the information contained in those disclosures materially changed or is required by GAAP. The accompanying unaudited consolidated financial statements and related condensed notes should be read in conjunction with the consolidated financial statements and related notes presented in our 2016 Annual Report.

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 Company has evaluated subsequent events that occurred after September 30, 2017 through the date the financial statements were issued and determined there were no subsequent events to disclose other than as disclosed in Notes 3 and 14.

Reclassifications
Certain reclassifications were made to 2016 financial information to conform with the 2017 presentation.

New Accounting Standards
Accounting for Financial Instruments - Hedge Accounting
During the third quarter of 2017, we elected to early adopt new accounting guidance which simplifies the application of hedge accounting. The new guidance expands our ability to hedge non-financial and financial risk components, eliminates the requirement to separately measure and report hedge ineffectiveness, requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item and simplifies certain documentation and assessment requirements. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Simplifying the Test for Goodwill Impairment
Effective January 1, 2017, we adopted, on a prospective basis, new accounting guidance which simplifies the accounting for goodwill impairment. The new guidance eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. A goodwill impairment charge would be recognized if the carrying amount of a reporting unit exceeds the estimated fair value of the reporting unit. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Page 7




Classification of Certain Cash Receipts and Cash Payments in the Statement of Cash Flows
Effective January 1, 2017, we adopted, on a retrospective basis, new accounting guidance which clarifies the classification of certain cash receipts and cash payments in our Consolidated Statements of Cash Flows. As a result, we classified $44 million of cash distributions received from our partnership investments as cash inflows from operating activities for the nine months ended September 30, 2017, that previously would have been classified as cash inflows from investing activities. There were no material reclassifications in our Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 as a result of the adoption of this new guidance.

Future Application of Accounting Standards
Revenue from Contracts with Customers
Effective January 1, 2018, we will adopt new accounting guidance related to revenue recognition from contracts with customers. While industry-specific guidance related to contracts with customers within the scope of Accounting Standards Codification (“ASC”) 944 Financial Services - Insurance remains unchanged, most other industry-specific revenue recognition requirements have been removed. The new guidance 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. We currently anticipate adopting the new guidance using the retrospective approach. We anticipate that any impact will only relate to contracts with customers outside the scope of ASC Topic 944. Adoption of this new guidance will result in reclassifications within our Consolidated Statements of Income; however, we do not anticipate any material changes in the timing of our recognition of revenue or net income.

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. While we are still evaluating the impact of adoption of this new guidance, we anticipate that we will be required to record an asset and corresponding liability related to our operating leases (as described in Note 17 in our 2016 Annual Report) on our Consolidated Balance Sheets.

Accounting for Interest Associated with the Purchase of Callable Debt Securities
Effective January 1, 2019, we will adopt new accounting guidance related to the amortization of purchased callable debt securities held at a premium. Under the new guidance, premiums on callable debt securities are amortized to the earliest call date rather than to the contractual maturity date.  Callable debt securities held at a discount will continue to be amortized to the contractual maturity date. We are still evaluating the impact of the adoption of this new guidance on our financial position and operating results.

Measurement of Credit Losses on Financial Instruments
Effective January 1, 2020, we will adopt new accounting guidance related to the measurement of credit losses on financial assets and certain other instruments. The new guidance requires the use of a new forward-looking expected loss impairment model for trade and other receivables, held-to-maturity debt securities, loans and other instruments. The new guidance also requires impairments and recoveries for available-for-sale debt securities to be recorded through an allowance account and revises certain disclosure requirements. We are still evaluating the impact of the adoption of this new guidance on our financial position and operating results.

3.
Divestiture, Terminated Acquisition and Terminated Divestiture

Divestiture of Group Life Insurance, Group Disability Insurance, and Absence Management Businesses
On October 22, 2017, we entered into a definitive agreement to sell a substantial portion of our Group Insurance business segment consisting of our domestic group life insurance, group disability insurance and absence management businesses to Hartford Life and Accident Insurance Company (“HLAIC”) for cash consideration of $1.45 billion. The transaction is being

Page 8



accomplished through an indemnity reinsurance arrangement, under which HLAIC will contractually assume certain of our policyholder liabilities and obligations, although we will remain directly obligated to policyholders. Assets related to and supporting the life and disability insurance policies will be transferred to a trust established by HLAIC for our benefit, and we will record a reinsurance receivable from HLAIC. The transaction is expected to result in an after-tax gain of approximately $900 million, a significant portion of which will be deferred and amortized into earnings as we recover amounts due from the reinsurer over a period estimated to be approximately 30 years. The amount of the gain will depend on the actual amount of assets transferred and liabilities contractually assumed from us at the closing date.

The transaction is expected to close in early November 2017, subject to customary closing conditions.

Terminated Acquisition of Humana
On July 2, 2015, we entered into a definitive agreement (the “Merger Agreement”) to acquire Humana Inc. (“Humana”). On July 21, 2016, the U.S. Department of Justice (the “DOJ”) and certain state attorneys general filed a civil complaint in the U.S. District Court for the District of Columbia (the “District Court”) against us and Humana charging that our acquisition of Humana (the “Humana Transaction”) would violate Section 7 of the Clayton Antitrust Act, and seeking a permanent injunction to prevent Aetna from acquiring Humana. On January 23, 2017, the District Court granted the DOJ’s request to enjoin the Humana Transaction.

On February 14, 2017, Aetna and Humana entered into a mutual termination agreement (the “Termination Agreement”) pursuant to which the parties thereto (collectively the “Parties”) agreed to terminate the Merger Agreement, including all schedules and exhibits thereto, and all ancillary agreements contemplated thereby, entered pursuant thereto or entered in connection therewith (other than certain confidentiality agreements) (collectively with the Merger Agreement, the “Transaction Documents”), effective immediately as of February 14, 2017 (the “Termination Date”). Under the Termination Agreement, Aetna agreed to pay Humana the Regulatory Termination Fee (as defined in the Merger Agreement) of $1.0 billion in cash in full satisfaction of any amounts required to be paid by Aetna under the Merger Agreement. The Parties also agreed to release each other from any and all liability, claims, rights, actions, causes of action, suits, liens, obligations, accounts, debts, demands, agreements, promises, liabilities, controversies, costs, charges, damages, expenses and fees, however arising, in connection with, arising out of or related to the Transaction Documents, the transactions contemplated therein or thereby or certain related matters. We paid Humana the Regulatory Termination Fee on February 16, 2017 and recorded the expense in general and administrative expenses. We funded that payment with the proceeds of the 2016 senior notes (as defined below).

In June 2016, we issued $13.0 billion of senior notes to partially fund the Humana Transaction (collectively, the “2016 senior notes”). In accordance with the terms of the 2016 senior notes, on February 14, 2017, we issued a notice of redemption for $10.2 billion aggregate principal amount of certain of the 2016 senior notes (collectively, the “Special Mandatory Redemption Notes”) at a redemption price equal to 101% of the aggregate principal amount of those notes plus accrued and unpaid interest. We redeemed the Special Mandatory Redemption Notes on March 16, 2017, and we funded the redemption with the proceeds of the 2016 senior notes. As a result of the redemption of the Special Mandatory Redemption Notes, we recognized certain costs in our net income during the nine months ended September 30, 2017. Refer to Note 9 for additional information.

Terminated Divestiture to Molina
In order to address the DOJ’s perceived competitive concerns regarding Medicare Advantage relating to the Humana Transaction, on August 2, 2016, we entered into a definitive agreement (the “Aetna APA”) to sell for cash to Molina Healthcare, Inc. (“Molina”) certain of our Medicare Advantage assets. On February 14, 2017, Aetna and Molina entered into a Termination Agreement (the “APA Termination Agreement”) pursuant to which Aetna terminated the Aetna APA, including all schedules and exhibits thereto, and all ancillary agreements contemplated thereby or entered pursuant thereto. Under the APA Termination Agreement, Aetna agreed to pay Molina in cash (a) a termination fee of $53 million and (b) approximately 70% of Molina’s transaction costs. We paid Molina the termination fee on February 16, 2017 and the applicable transaction costs of $7 million on February 27, 2017 and recorded the expense in general and administrative expenses. The payments were funded with the proceeds of the 2016 senior notes.


Page 9



4.    Investments

Total investments at September 30, 2017 and December 31, 2016 were as follows:
 
September 30, 2017
 
December 31, 2016
(Millions)
Current

 
Long-term

 
Total

 
Current

 
Long-term

 
Total

Debt and equity securities available for sale
$
2,714

 
$
18,606

 
$
21,320

 
$
2,876

 
$
18,866

 
$
21,742

Mortgage loans
155

 
1,342

 
1,497

 
170

 
1,341

 
1,511

Other investments

 
1,559

 
1,559

 

 
1,626

 
1,626

Total investments
$
2,869

 
$
21,507

 
$
24,376

 
$
3,046

 
$
21,833

 
$
24,879


Debt and Equity Securities
Debt and equity securities available for sale at September 30, 2017 and December 31, 2016 were as follows:
(Millions)
Amortized
Cost

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
Fair
Value

September 30, 2017
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,571

 
$
53

 
$

 
$
1,624

States, municipalities and political subdivisions
4,555

 
204

 
(13
)
 
4,746

U.S. corporate securities
8,217

 
440

 
(20
)
 
8,637

Foreign securities
3,011

 
208

 
(8
)
 
3,211

Residential mortgage-backed securities
733

 
9

 
(4
)
 
738

Commercial mortgage-backed securities
1,240

 
8

 
(20
)
 
1,228

Other asset-backed securities
1,040

 
8

 
(3
)
 
1,045

Redeemable preferred securities
26

 
5

 

 
31

Total debt securities
20,393

 
935

 
(68
)
 
21,260

Equity securities
54

 
9

 
(3
)
 
60

Total debt and equity securities (1)(2)
$
20,447

 
$
944

 
$
(71
)
 
$
21,320

December 31, 2016
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

U.S. government securities
$
1,643

 
$
51

 
$

 
$
1,694

States, municipalities and political subdivisions
5,047

 
152

 
(61
)
 
5,138

U.S. corporate securities
8,145

 
385

 
(55
)
 
8,475

Foreign securities
2,958

 
163

 
(33
)
 
3,088

Residential mortgage-backed securities
793

 
11

 
(9
)
 
795

Commercial mortgage-backed securities
1,382

 
5

 
(39
)
 
1,348

Other asset-backed securities
1,077

 
7

 
(9
)
 
1,075

Redeemable preferred securities
22

 
5

 

 
27

Total debt securities
21,067

 
779

 
(206
)
 
21,640

Equity securities
84

 
20

 
(2
)
 
102

Total debt and equity securities (1)(2)
$
21,151

 
$
799

 
$
(208
)
 
$
21,742

 
 
 
 
 
 
 
 
(1) 
At both September 30, 2017 and December 31, 2016, we held securities for which we previously recognized an immaterial amount of non-credit related impairments in accumulated other comprehensive loss. These securities each had an immaterial amount of net unrealized capital gains at both September 30, 2017 and December 31, 2016.
(2) 
Investment risks associated with our experience-rated and discontinued products generally do not impact our operating results (refer to Note 17 for additional information on our accounting for discontinued products).  At September 30, 2017, debt and equity securities with a fair value of approximately $2.9 billion, gross unrealized capital gains of $216 million and gross unrealized capital losses of $14 million and, at December 31, 2016, debt and equity securities with a fair value of approximately $2.9 billion, gross unrealized capital gains of $195 million and gross unrealized capital losses of $35 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 10




The fair value of debt securities at September 30, 2017 is shown below by contractual maturity.  Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid, or we intend to sell a security prior to maturity.
(Millions)
Amortized
Cost

 
Fair
Value

Due to mature:
 
 
 
Less than one year
$
1,298

 
$
1,310

One year through five years
6,697

 
6,872

After five years through ten years
4,553

 
4,737

Greater than ten years
4,832

 
5,330

Residential mortgage-backed securities
733

 
738

Commercial mortgage-backed securities
1,240

 
1,228

Other asset-backed securities
1,040

 
1,045

Total
$
20,393

 
$
21,260

 
Mortgage-Backed and Other Asset-Backed Securities
All of our residential mortgage-backed securities at September 30, 2017 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 September 30, 2017, our residential mortgage-backed securities had an average credit quality rating of AAA and a weighted average duration of 4.2 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 September 30, 2017, these securities had an average credit quality rating of AAA and a weighted average duration of 6.7 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 September 30, 2017, these securities had an average credit quality rating of AA- and a weighted average duration of 1.2 years.


Page 11



Summarized below are the debt and equity securities we held at September 30, 2017 and December 31, 2016 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, except number of securities)
Number of Securities

 
Fair
Value

 
Unrealized
Losses

 
Number of Securities

 
Fair
Value

 
Unrealized
Losses

 
Number of Securities

 
Fair
Value

 
Unrealized
Losses

September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
84

 
$
279

 
$

 
7

 
$
4

 
$

 
91

 
$
283

 
$

States, municipalities and political subdivisions
164

 
540

 
5

 
114

 
368

 
8

 
278

 
908

 
13

U.S. corporate securities
617

 
961

 
5

 
291

 
525

 
15

 
908

 
1,486

 
20

Foreign securities
192

 
344

 
2

 
110

 
230

 
6

 
302

 
574

 
8

Residential mortgage-backed securities
173

 
275

 
2

 
100

 
48

 
2

 
273

 
323

 
4

Commercial mortgage-backed securities
79

 
293

 
4

 
114

 
426

 
16

 
193

 
719

 
20

Other asset-backed securities
194

 
326

 
1

 
77

 
142

 
2

 
271

 
468

 
3

Total debt securities
1,503

 
3,018

 
19

 
813

 
1,743

 
49

 
2,316

 
4,761

 
68

Equity securities

 

 

 
9

 
7

 
3

 
9

 
7

 
3

Total debt and equity securities (1)
1,503

 
$
3,018

 
$
19

 
822

 
$
1,750

 
$
52

 
2,325

 
$
4,768

 
$
71

December 31, 2016
 
 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

Debt securities:
 
 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

U.S. government securities
26

 
$
39

 
$

 
1

 
$
1

 
$

 
27

 
$
40

 
$

States, municipalities and political subdivisions
865

 
2,228

 
58

 
37

 
75

 
3

 
902

 
2,303

 
61

U.S. corporate securities
1,428

 
2,277

 
44

 
114

 
101

 
11

 
1,542

 
2,378

 
55

Foreign securities
649

 
970

 
27

 
62

 
76

 
6

 
711

 
1,046

 
33

Residential mortgage-backed securities
188

 
455

 
8

 
104

 
17

 
1

 
292

 
472

 
9

Commercial mortgage-backed securities
285

 
1,038

 
39

 
3

 
3

 

 
288

 
1,041

 
39

Other asset-backed securities
226

 
403

 
4

 
208

 
177

 
5

 
434

 
580

 
9

Total debt securities
3,667

 
7,410

 
180

 
529

 
450

 
26

 
4,196

 
7,860

 
206

Equity securities
2

 
3

 

 
8

 
3

 
2

 
10

 
6

 
2

Total debt and equity securities (1)
3,669

 
$
7,413

 
$
180

 
537

 
$
453

 
$
28

 
4,206

 
$
7,866

 
$
208

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
At September 30, 2017 and December 31, 2016, debt and equity securities in an unrealized capital loss position of $14 million and $35 million, respectively, and with related fair value of $516 million and $890 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 September 30, 2017, 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 12



The maturity dates for debt securities in an unrealized capital loss position at September 30, 2017 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
$
7

 
$

 
$
232

 
$

 
$
239

 
$

One year through five years
50

 
1

 
1,423

 
12

 
1,473

 
13

After five years through ten years
139

 
2

 
637

 
9

 
776

 
11

Greater than ten years
140

 
5

 
623

 
12

 
763

 
17

Residential mortgage-backed securities
7

 

 
316

 
4

 
323

 
4

Commercial mortgage-backed securities
153

 
4

 
566

 
16

 
719

 
20

Other asset-backed securities
18

 

 
450

 
3

 
468

 
3

Total
$
514

 
$
12

 
$
4,247

 
$
56

 
$
4,761

 
$
68

 
 
 
 
 
 
 
 
 
 
 
 

Mortgage Loans
Our mortgage loans are collateralized by commercial real estate.  During the three and nine months ended September 30, 2017 and 2016 we had the following activity in our mortgage loan portfolio:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions)
2017

 
2016

 
2017

 
2016

New mortgage loans
$
27

 
$
66

 
$
209

 
$
155

Mortgage loans fully repaid
90

 
56

 
190

 
142

Mortgage loans foreclosed

 
8

 

 
8

 
 
 
 
 
 
 
 
 
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.  These indicators are based upon several factors, including current loan to value ratios, property condition, market trends, creditworthiness of the borrower and deal structure. The vast majority of our mortgage loans fall into categories 2 to 4.
Category 1 - Represents loans of superior quality.
Categories 2 to 4 - Represents loans where credit risk is minimal to acceptable; however, these loans may display some susceptibility to economic changes.
Categories 5 and 6 - Represents loans where credit risk is not substantial, but these loans warrant management’s close attention.
Category 7 - Represents loans where collections are potentially at risk and, if necessary, an impairment is recorded.
Based upon our most recent assessments at September 30, 2017 and December 31, 2016, our mortgage loans were given the following credit quality indicators:
(In Millions, except credit ratings indicator)
September 30, 2017

 
December 31, 2016

1
$
42

 
$
45

2 to 4
1,445

 
1,449

5 and 6
10

 
17

7

 

Total
$
1,497

 
$
1,511

 
 
 
 
 


Page 13



Net Investment Income
Sources of net investment income for the three and nine months ended September 30, 2017 and 2016 were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions)
2017

 
2016

 
2017

 
2016

Debt securities
$
184

 
$
187

 
$
564

 
$
578

Mortgage loans
22

 
24

 
65

 
74

Other investments
43

 
17

 
138

 
64

Gross investment income
249

 
228

 
767

 
716

Investment expenses
(16
)
 
(9
)
 
(37
)
 
(28
)
Net investment income (1)
$
233

 
$
219

 
$
730

 
$
688

 
 
 
 
 
 
 
 
(1) 
Net investment income includes $61 million and $186 million for the three and nine months ended September 30, 2017, respectively, and $48 million and $158 million for the three and nine months ended September 30, 2016, respectively, related to investments supporting our experience-rated and discontinued products.

Realized Capital Gains/Losses
Net realized capital gains and losses for the three and nine months ended September 30, 2017 and 2016, excluding amounts related to experience-rated contract holders and discontinued products, were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions)
2017

 
2016

 
2017

 
2016

Other-than-temporary impairment (“OTTI”) losses on debt securities recognized in earnings
$
(3
)
 
$

 
$
(5
)
 
$
(10
)
Other net realized capital gains (losses)
49

 
34

 
(257
)
 
95

Net realized capital gains (losses)
$
46

 
$
34

 
$
(262
)
 
$
85

 
The net realized capital gains for the three months ended September 30, 2017 were primarily attributable to gains from other investments and the sale of debt securities. The net realized capital losses for the nine months ended September 30, 2017 were primarily attributable to the recognition into earnings of the entire unamortized effective portion of the related hedge losses upon the mandatory redemption of $10.2 billion aggregate principal amount of the Special Mandatory Redemption Notes and the redemption of $750 million aggregate principal amount of senior notes due 2020. The net realized capital gains for the three and nine months ended September 30, 2016 were primarily attributable to gains from the sale of debt securities.

We had no individually material realized capital losses on debt or equity securities that impacted our operating results during the three or nine months ended September 30, 2017 or 2016.

Excluding amounts related to experience-rated and discontinued products, proceeds from the sale of available for sale debt and equity securities and the related gross realized capital gains and losses for the three and nine months ended September 30, 2017 and 2016 were as follows(1):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(Millions)
2017

 
2016

 
2017

 
2016

Proceeds on sales
$
1,205

 
$
1,481

 
$
3,877

 
$
4,796

Gross realized capital gains
23

 
31

 
74

 
131

Gross realized capital losses
6

 
3

 
33

 
38

 
 
 
 
 
 
 
 
(1) 
The proceeds on sales and gross realized capital gains and losses exclude the impact of the sales of short-term debt securities which primarily relate to our investments in mutual funds. These investments were excluded from the disclosed amounts because they represent an immaterial amount of aggregate gross realized capital gains or losses and have a high volume of sales activity.

Variable Interest Entities
We have investments in certain hedge fund and private equity investments and real estate partnerships that are considered Variable Interest Entities (“VIEs”). 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

Page 14



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
We have one majority owned hedge fund investment where we are the investment manager and have the power to direct the activities that most significantly impact the VIEs economic performance, including determining the hedge fund’s investment strategy. Accordingly, we are the primary beneficiary and consolidate the investment in our operating 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.

Substantially all of the assets of the VIE hedge fund are comprised of hedge fund investments reported as long-term investments on our Consolidated Balance Sheets. The VIE hedge fund had no material liabilities at September 30, 2017 or December 31, 2016. The total amount of the VIE hedge fund’s assets included in long-term investments on our Consolidated Balance Sheets at September 30, 2017 and December 31, 2016 were $436 million and $472 million, respectively.

Variable Interest Entities - Other Variable Interest Holder
Our involvement with VIEs where we are not determined to be the primary beneficiary consists 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 these 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 in these VIEs as long-term investments on our Consolidated Balance Sheets and recognize our share of each VIE’s income or losses in earnings.  Our maximum exposure to loss from these VIEs is limited to our investment balances as disclosed below and the risk of recapture of previously recognized tax credits related to the real estate partnerships, which we do not consider significant.

The total amount of other variable interest holder VIE assets included in long-term investments on our Consolidated Balance Sheets at September 30, 2017 and December 31, 2016 were as follows:
(Millions)
 
September 30, 2017

 
December 31, 2016

Hedge fund investments
 
$
347

 
$
384

Private equity investments
 
447

 
454

Real estate partnerships
 
248

 
278

Total
 
$
1,042

 
$
1,116



Page 15



The carrying value of the total assets and liabilities of our other variable interest holder VIE investments at September 30, 2017 and December 31, 2016 were as follows:
(Millions)
 
September 30, 2017

 
December 31, 2016

Assets:
 
 
 
 
Hedge fund investments
 
$
51,574

 
$
32,926

Private equity investments
 
29,640

 
25,368

Real estate partnerships
 
6,855

 
6,743

Total
 
$
88,069

 
$
65,037

 
 
 
 
 
Liabilities:
 
 
 
 
Hedge fund investments
 
$
10,579

 
$
2,819

Private equity investments
 
3,537

 
2,354

Real estate partnerships
 
5,038

 
4,938

Total
 
$
19,154

 
$
10,111


Non-controlling (Minority) Interests
At September 30, 2017 and December 31, 2016, continuing business non-controlling interests were $235 million and $62 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 $10 million for the three months ended September 30, 2017, and net loss attributable to non-controlling interests was $9 million for the nine months ended September 30, 2017. Net loss attributable to non-controlling interests was $7 million and $4 million for the three and nine months ended September 30, 2016, respectively. These non-controlling interests did not have a material impact on our financial position or operating results.


5.    Fair Value

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.

Financial Instruments Measured at Fair Value in our Balance Sheets
Certain of our financial instruments are measured at fair value in our Consolidated 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.


Page 16



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 September 30, 2017 or December 31, 2016.

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 September 30, 2017 or December 31, 2016.  The total fair value of our broker quoted debt securities was $68 million at September 30, 2017 and $80 million at December 31, 2016.  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 equity 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 17



There were no financial liabilities measured at fair value on a recurring basis in our Consolidated Balance Sheets at September 30, 2017 or December 31, 2016. Financial assets measured at fair value on a recurring basis in our Consolidated Balance Sheets at September 30, 2017 and December 31, 2016 were as follows:
 
 
 
 
 
 
 
 
(Millions)
Level 1

 
Level 2

 
Level 3

 
Total

September 30, 2017
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,499

 
$
125

 
$

 
$
1,624

States, municipalities and political subdivisions

 
4,745

 
1

 
4,746

U.S. corporate securities

 
8,553

 
84

 
8,637

Foreign securities

 
3,207

 
4

 
3,211

Residential mortgage-backed securities

 
738

 

 
738

Commercial mortgage-backed securities

 
1,228

 

 
1,228

Other asset-backed securities

 
1,045

 

 
1,045

Redeemable preferred securities

 
24

 
7

 
31

Total debt securities
1,499

 
19,665