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 March 31, 2018
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_02a10.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 327.1 million shares of the registrant’s voting common stock with a par value of $.01 per share outstanding at March 31, 2018.




Aetna Inc.
Form 10-Q
For the Quarterly Period Ended March 31, 2018

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 March 31, 2018 and December 31, 2017
Consolidated Statements of Income for the three months ended March 31, 2018 and 2017
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017
Consolidated Statements of Shareholders' Equity for the three months ended March 31, 2018 and 2017
Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017
Condensed Notes to the Consolidated Financial Statements
Report of the Independent Registered Public Accounting Firm
 
 


Page 1


Consolidated Balance Sheets
 
 
 
 
(Unaudited)

 
 
(Millions)
 
 
 
March 31,
2018

 
December 31,
2017

Assets:
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
$
7,875

 
$
4,076

Investments
 
 
 
2,521

 
2,280

Premiums receivable, net
 
 
 
2,384

 
2,240

Other receivables, net
 
 
 
3,266

 
2,831

Reinsurance recoverables
 
 
 
1,103

 
1,050

Income taxes receivable
 
 
 
49

 
365

Other current assets
 
 
 
3,503

 
2,681

Total current assets
 
 
 
20,701

 
15,523

Long-term investments
 
 
 
16,409

 
17,793

Reinsurance recoverables
 
 
 
3,176

 
3,323

Goodwill
 
 
 
10,576

 
10,571

Other acquired intangible assets, net
 
 
 
1,152

 
1,180

Property and equipment, net
 
 
 
577

 
586

Deferred income taxes
 
 
 
351

 
195

Other long-term assets
 
 
 
1,948

 
1,684

Separate Accounts assets
 
 
 
4,307

 
4,296

Total assets
 
 
 
$
59,197

 
$
55,151

 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 

 
 

 
 

Current liabilities:
 
 
 
 

 
 

Health care costs payable
 
 
 
$
5,783

 
$
5,815

Future policy benefits
 
 
 
581

 
604

Unpaid claims
 
 
 
849

 
850

Unearned premiums
 
 
 
2,528

 
654

Policyholders’ funds
 
 
 
3,060

 
2,918

Current portion of long-term debt
 
 
 
1,374

 
999

Accrued expenses and other current liabilities
 
 
 
5,518

 
4,997

Total current liabilities
 
 
 
19,693

 
16,837

Future policy benefits
 
 
 
5,741

 
5,763

Unpaid claims
 
 
 
1,901

 
1,922

Policyholders’ funds
 
 
 
709

 
739

Long-term debt, less current portion
 
 
 
7,785

 
8,160

Other long-term liabilities
 
 
 
2,396

 
1,597

Separate Accounts liabilities
 
 
 
4,307

 
4,296

Total liabilities
 
 
 
42,532

 
39,314

Commitments and contingencies (Note 13)
 
 
 


 


Shareholders’ equity:
 
 
 
 
 
 

Common stock ($.01 par value; 2.5 billion shares authorized and 327.1 million shares issued and outstanding in 2018; 2.5 billion shares authorized and 326.8 million shares issued and outstanding in 2017) and additional paid-in capital
 
 
 
4,687

 
4,706

Retained earnings
 
 
 
13,440

 
12,118

Accumulated other comprehensive loss
 
 
 
(1,729
)
 
(1,244
)
Total Aetna shareholders’ equity
 
 
 
16,398

 
15,580

Non-controlling interests
 
 
 
267

 
257

Total equity
 
 
 
16,665

 
15,837

Total liabilities and equity
 
 
 
$
59,197

 
$
55,151

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

Page 2


Consolidated Statements of Income
(Unaudited)
 
 
 
 
Three Months Ended
March 31,
(Millions, except per common share data)
 
2018

 
2017

Revenue:
 
 
 
 
 
 
Premiums
 
 
 
$
13,070

 
$
13,763

Fees and other revenue (1)
 
 
 
2,062

 
1,475

Net investment income
 
 
 
197

 
260

Net realized capital gains (losses)
 
 
 
6

 
(333
)
Total revenue
 
 
 
15,335

 
15,165

Benefits and expenses:
 
 
 
 
 
 
Benefit costs (2)
 
 
 
10,574

 
11,461

Cost of products sold (1)
 
 
 
373

 

Operating expenses
 
 
 
2,787

 
3,853

Interest expense
 
 
 
89

 
173

Amortization of other acquired intangible assets
 
 
 
47

 
60

Loss on early extinguishment of long-term debt
 
 
 

 
246

Total benefits and expenses
 
 
 
13,870

 
15,793

Income (loss) before income taxes
 
 
 
1,465

 
(628
)
Income taxes:
 
 
 
 
 
 
Current
 
 
 
335

 
(7
)
Deferred
 
 
 
(89
)
 
(242
)
Total income tax expense (benefit)
 
 
 
246

 
(249
)
Net income (loss) including non-controlling interests
 
 
 
1,219

 
(379
)
Less: Net income attributable to non-controlling interests
10

 
2

Net income (loss) attributable to Aetna
 
 
 
$
1,209

 
$
(381
)
Earnings (loss) per common share:
 
 
 
 
 
 
Basic
 
 
 
$
3.69

 
$
(1.11
)
Diluted
 
 
 
$
3.67

 
$
(1.11
)
 
 
 
 
 
 
 
(1) 
Fees and other revenue include administrative services contract member co-payments and plan sponsor reimbursements related to our home delivery and specialty pharmacy operations of $31 million (net of pharmaceutical and processing costs of $340 million) for the three months ended March 31, 2017. As a result of the adoption of new accounting guidance related to revenue recognition from contracts with customers for the three months ended March 31, 2018, (a) specialty and home delivery pharmacy revenue reflects the price of the prescription on a gross basis and (b) specialty and home delivery pharmacy costs of products sold reflects the cost of the prescription and certain administrative expenses. Refer to Note 2 for further discussion.
(2) 
Health care costs have been reduced by Insured member co-payments related to our home delivery and specialty pharmacy operations of $32 million and $34 million for the three months ended March 31, 2018 and 2017, respectively.

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

Page 3


Consolidated Statements of Comprehensive Income
(Unaudited)


 
Three Months Ended
March 31,
(Millions)
2018

 
2017

Net income (loss) including non-controlling interests
$
1,219

 
$
(379
)
Other comprehensive (loss) income, net of tax:
 
 
 
    Previously impaired debt securities
(1
)
 

    All other securities
(220
)
 
44

    Derivatives and foreign currency
1

 
222

Pension and other postretirement employee benefit plans
12

 
10

Other comprehensive (loss) income
(208
)
 
276

Comprehensive income (loss) including non-controlling interests
1,011

 
(103
)
Less: Comprehensive income attributable to non-controlling interests
10

 
2

Comprehensive income (loss) attributable to Aetna
$
1,001

 
$
(105
)
 
 
 
 



Refer to accompanying Condensed Notes to Consolidated Financial Statements (Unaudited), including Note 10 for further information about other comprehensive income (loss).


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

Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
326.8

 
$
4,706

 
$
12,118

 
$
(1,244
)
 
$
15,580

 
$
257

 
$
15,837

Adoption of new accounting standards (Note 2)



 

 
277

 
(277
)
 

 

 

Net income

 

 
1,209

 

 
1,209

 
10

 
1,219

Other comprehensive loss (Note 10)

 

 

 
(208
)
 
(208
)
 

 
(208
)
Common shares issued for benefit plans, including tax benefits, net of employee tax withholdings
0.3

 
(19
)
 

 

 
(19
)
 

 
(19
)
Dividends declared

 

 
(164
)
 

 
(164
)
 

 
(164
)
Balance at March 31, 2018
327.1

 
$
4,687

 
$
13,440

 
$
(1,729
)
 
$
16,398

 
$
267

 
$
16,665

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
351.7

 
$
4,716

 
$
14,717

 
$
(1,552
)
 
$
17,881

 
$
62

 
$
17,943

Net (loss) income

 

 
(381
)
 

 
(381
)
 
2

 
(379
)
Other increases in non-controlling interest

 

 

 

 

 
13

 
13

Other comprehensive income (Note 10)

 

 

 
276

 
276

 

 
276

Common shares issued for benefit plans, including tax benefits, net of employee tax withholdings
0.9

 
(49
)
 

 

 
(49
)
 

 
(49
)
Repurchases of common shares
(20.9
)
 
(661
)
 
(2,639
)
 

 
(3,300
)
 

 
(3,300
)
Dividends declared

 

 
(166
)
 

 
(166
)
 

 
(166
)
Balance at March 31, 2017
331.7

 
$
4,006

 
$
11,531

 
$
(1,276
)
 
$
14,261

 
$
77

 
$
14,338



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


Page 5


Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
 
Three Months Ended
March 31,
(Millions)
 
2018

 
2017

Cash flows from operating activities:
 
 
 
 
 
 
Net income (loss) including non-controlling interests
 
 
 
$
1,219

 
$
(379
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
Net realized capital (gains) losses
 
 
 
(6
)
 
333

Depreciation and amortization
 
 
 
132

 
160

Debt fair value amortization
 
 
 
(3
)
 
(7
)
Equity in earnings of affiliates, net
 
 
 
(10
)
 
(38
)
Stock-based compensation expense
 
 
 
39

 
54

Amortization of net investment premium
 
 
 
15

 
17

Loss on early extinguishment of long-term debt
 
 
 

 
246

Gain on sale of businesses
 
 
 
(113
)
 

Changes in assets and liabilities:
 
 
 
 
 
 
Premiums due and other receivables
 
 
 
(384
)
 
(477
)
Income taxes
 
 
 
240

 
(271
)
Other assets and other liabilities
 
 
 
319

 
(95
)
Health care and insurance liabilities
 
 
 
1,893

 
1,356

Net cash provided by operating activities
 
 
 
3,341

 
899

Cash flows from investing activities:
 
 
 
 

 
 

Proceeds from sales and maturities of investments
 
 
 
2,410

 
2,738

Cost of investments
 
 
 
(1,621
)
 
(2,723
)
Additions to property, equipment and software
 
 
 
(99
)
 
(71
)
Cash used for acquisitions, net of cash acquired
 
 
 
(6
)
 

Net cash provided by (used for) investing activities
 
 
 
684

 
(56
)
Cash flows from financing activities:
 
 
 
 

 
 

Repayment of long-term debt
 
 
 

 
(11,484
)
Common shares issued under benefit plans, net
 
 
 
(72
)
 
(103
)
Common shares repurchased
 
 
 

 
(3,300
)
Dividends paid to shareholders
 
 
 
(164
)
 
(88
)
Contributions, non-controlling interests
 
 
 
10

 
13

Net cash used for financing activities
 
 
 
(226
)
 
(14,962
)
Net increase (decrease) in cash and cash equivalents
 
 
 
3,799

 
(14,119
)
Cash and cash equivalents, beginning of period
 
 
 
4,076

 
17,996

Cash and cash equivalents, end of period
 
 
 
$
7,875

 
$
3,877

Supplemental cash flow information:
 
 
 
 

 
 

Interest paid
 
 
 
$
66

 
$
130

Income taxes paid
 
 
 
6

 
22

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

Page 6


Condensed Notes to Consolidated Financial Statements
(Unaudited)

1.
Organization

Effective for the first quarter of 2018, we realigned our business segments to correspond with changes to our management structure and internal management reporting which reflect our evolving business strategy of helping our members live healthier lives. As a result of this realignment, our operations are now conducted in the Health Care reportable segment. Health Care offers a broad range of traditional, voluntary and consumer-directed health insurance products and related services to large and small employers, public sector employers, and Medicaid and Medicare beneficiaries. Our Health Care products are 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 the risk). Health Care also includes emerging business products and services that complement and enhance our medical products.

We present the remainder of our financial results in the Corporate/Other category, which consists of:
Products for which we no longer solicit or accept new customers such as our large case pensions and long-term care products;
Contracts we have divested through reinsurance or other contracts, such as our domestic group life insurance, group disability insurance and absence management businesses; and
Corporate expenses not supporting our business operations, including transaction and integration-related costs, income taxes, interest expense on our outstanding debt and the financing components of our pension and other postretirement employee benefit plans (“OPEB”) expense.

Prior period segment financial information has been restated to conform to the current year presentation. Refer to Note 14 for segment financial 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 2017 Annual Report on Form 10-K (our “2017 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 2017 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 from the financial statement date through the date the financial statements were issued and determined there were no subsequent events to disclose.

Reclassifications
Certain reclassifications were made to 2017 financial information to conform with the 2018 presentation.

Revenue Recognition
Our revenue includes premiums, fees and other revenue. Refer to Note 2 and Note 18 in our 2017 Annual Report for further discussion of our revenue recognition. Our fees and other revenue relate to contracts that can include various combinations of products, services, or series of services, which are generally capable of being distinct and accounted for as separate performance obligations. Fee revenue of approximately $1.3 billion for the three months ended March 31, 2018 consists primarily of ASC fees which are received in exchange for performing certain claim processing and member services for our medical members and are recognized as revenue over the period the service is provided. Other revenue of $767 million for the three months ended March 31, 2018 primarily relates to our (a) specialty and home delivery pharmacy services to ASC groups and (b) workers’ compensation administrative services products and services. Specialty and home delivery pharmacy services revenue and cost of products sold are recognized when the prescription is shipped. Effective for the first quarter 2018, specialty

Page 7



and home delivery pharmacy services revenue reflects the price of the prescription on a gross basis (ASC member co-payments and plan sponsor reimbursements) and specialty and home delivery pharmacy cost of products sold reflects the cost of the prescription and certain administrative costs incurred for dispensing the prescription.

Accounts receivable related to fees and other revenue was $933 million and $942 million at March 31, 2018 and December 31, 2017, respectively. At March 31, 2018, there were no material contract assets, contract liabilities or deferred costs to obtain or fulfill a contract with a customer related to our fees and other revenue. For the three months ended March 31, 2018, we had no material bad debt expense.

For the three months ended March 31, 2018, revenue recognized from performance obligations related to prior periods (for example, due to changes in transaction price) was not material. The aggregate amount of transaction price allocated to our remaining performance obligations (excluding revenue pertaining to contracts that have an original expected duration of one year or less) was not material. We expect to recognize the majority of our fees and other revenue related to our remaining performance obligations within one calendar year.

Health Insurer Fee
Since January 1, 2014, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (as amended, collectively, the “ACA”) imposes an annual premium-based health insurer fee (“HIF”) for each calendar year payable in September which is not deductible for tax purposes. In December 2015, the Consolidated Appropriation Act was enacted which included a one-year suspension of the HIF for 2017. Accordingly, there was no expense related to the HIF in 2017. We recorded an operating expense of $233 million for the three months ended March 31, 2018 related to our estimated share of the 2018 HIF. In January 2018, the HIF was suspended for 2019.

Income Taxes
The accounting for certain income tax effects of the Tax Cuts and Jobs Act of 2017 (the “TCJA”) was considered provisional at December 31, 2017, including the assessment of the mandatory repatriation of foreign earnings, the minimum tax on global intangible low-taxed income and the assertion of permanent reinvestment of foreign earnings. Accordingly, the items were recorded at a reasonable estimate at December 31, 2017. We are still evaluating the income tax effects of these provisions and accordingly there have been no adjustments recorded for these items at March 31, 2018.

New Accounting Standards
Revenue from Contracts with Customers
Effective January 1, 2018, we adopted, on a modified retrospective basis, 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. The new guidance only impacted contracts with customers outside of the scope of ASC Topic 944. As a result of adopting this new guidance, fees and other revenue, cost of products sold and operating expenses increased by $435 million, $373 million and $62 million, respectively, for the three months ended March 31, 2018 primarily related to modifications to principal versus agent guidance for our home delivery and specialty pharmacy operations. There were no material changes in the timing of our recognition of revenue or net income. We included additional disclosures required by the new accounting guidance under “Revenue Recognition” above.

Recognition and Measurement of Financial Assets and Financial Liabilities
Effective January 1, 2018, we adopted 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 are measured at fair value with changes in fair value recognized in net income. We adopted this provision on a modified retrospective basis and recorded an immaterial cumulative effect adjustment from accumulated other comprehensive income to retained earnings in our Consolidated Balance Sheet during the three months ended March 31, 2018. We also elected, on a prospective basis, to report equity investments without a readily determinable fair value at cost less impairment, plus or minus subsequent adjustments for observable price changes. The new guidance also revises certain disclosures regarding financial assets and liabilities. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
Effective January 1, 2018, we adopted, on a retrospective basis, new accounting guidance related to the presentation of net periodic pension costs and net periodic postretirement benefit costs. Under the new guidance, the service cost component of

Page 8



these net periodic costs is required to be reported in the same income statement line item as other employee compensation costs for services rendered during the period. The other components of these net periodic costs generally are required to be presented in the income statement separately from the service cost component and outside of a subtotal of income from operations. The other components of these net periodic costs are included within operating expenses in our Consolidated Statements of Income because the amounts are not material and thus separate presentation is not required. The net periodic benefit costs for the our pension and other postretirement employee benefit plans do not contain a service cost component as these defined benefit plans have been frozen for an extended period of time. The adoption of this new guidance did not have a material impact on our financial position or operating results.

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income to Retained Earnings
During the first quarter of 2018, we elected to early adopt new accounting guidance related to the reclassification of certain tax effects from accumulated other comprehensive income to retained earnings. We adopted the new accounting guidance as of the beginning of the first quarter of 2018 using the aggregate portfolio approach for available for sale securities and reclassified the stranded tax effects resulting from the TCJA of $273 million from accumulated other comprehensive loss to retained earnings in our Consolidated Balance Sheet.

Future Application of Accounting Standards
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 2017 Annual Report) on our Consolidated Balance Sheets. The adoption of this new guidance is not expected to have a material impact on our operating results.

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 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 adoption of this new guidance on our financial position and operating results.

3.
Proposed Acquisition, Completed Divestiture, Terminated Acquisition and Terminated Divestiture

Proposed Acquisition by CVS Health
On December 3, 2017, we entered into a definitive agreement (the “CVS Merger Agreement”) under which CVS Health Corporation (“CVS Health”) has agreed to acquire all of our outstanding shares for a combination of cash and stock. Under terms of the agreement, our shareholders will receive $145 in cash and 0.8378 of a CVS Health common share for each of our common shares. The proposed transaction (the “CVS Health Transaction”) is subject to customary closing conditions, including the expiration of the federal Hart-Scott-Rodino anti-trust waiting period and approvals of certain state departments of insurance and other regulators. On February 1, 2018, Aetna and CVS Health each received a request for additional information (also known as a “second request”) from the U.S. Department of Justice (the “DOJ”) in connection with the DOJ’s review of the transactions contemplated by the CVS Merger Agreement. On March 13, 2018, our shareholders approved and adopted the CVS Merger Agreement and CVS Health’s stockholders approved the issuance of CVS Health shares in the transaction.

Divestiture of Domestic Group Life Insurance, Group Disability Insurance and Absence Management Businesses
On November 1, 2017, we completed the sale of our domestic group life insurance, group disability insurance and absence management businesses (the “Group Insurance sale”) to Hartford Life and Accident Insurance Company (“HLAIC”) for cash consideration of $1.45 billion. The transaction was accomplished through an indemnity reinsurance arrangement under which HLAIC contractually assumed certain of our policyholder liabilities and obligations, although we remain directly obligated to

Page 9



policyholders. Assets related to and supporting the reinsured life and disability insurance policies were transferred to a trust established by HLAIC for our benefit, and we recorded a reinsurance receivable from HLAIC. The sale is expected to result in an after-tax gain of approximately $710 million ($1.1 billion pre-tax), a significant portion of which has been deferred and will be amortized into earnings: (i) over the remaining contract period (estimated to be approximately 3 years) in proportion to the amount of insurance protection provided for the prospective reinsurance portion of the gain; and (ii) as we recover amounts due from HLAIC over a period estimated to be approximately 30 years for the retrospective reinsurance portion of the gain. The deferred gain liability was recorded in accrued expenses and other current liabilities and in other long-term liabilities in our Consolidated Balance Sheets, and the gain recognition is being recorded in fees and other revenue in our Consolidated Statements of Income. During the three months ended March 31, 2018, we recognized $113 million pre-tax of the deferred gain into earnings.

Revenue and income before income taxes for the businesses sold were $570 million and $26 million, respectively, for the three months ended March 31, 2017.

Terminated Acquisition of Humana
On July 2, 2015, we entered into a definitive agreement (the “Humana Merger Agreement”) to acquire Humana Inc. (“Humana”). On July 21, 2016, 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 Humana 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 Humana Merger Agreement, the “Transaction Documents”), effective immediately as of February 14, 2017. Under the Termination Agreement, Aetna agreed to pay Humana the Regulatory Termination Fee (as defined in the Humana Merger Agreement) of $1.0 billion in cash in full satisfaction of any amounts required to be paid by Aetna under the Humana 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 operating 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 three months ended March 31, 2017. Refer to Note 7 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 operating expenses. The payments were funded with the proceeds of the 2016 senior notes.


Page 10



4.    Investments

Total investments at March 31, 2018 and December 31, 2017 were as follows:
 
March 31, 2018
 
December 31, 2017
(Millions)
Current

 
Long-term

 
Total

 
Current

 
Long-term

 
Total

Debt securities available for sale
$
2,386

 
$
13,573

 
$
15,959

 
$
2,101

 
$
14,849

 
$
16,950

Mortgage loans
127

 
1,287

 
1,414

 
166

 
1,330

 
1,496

Other investments
8

 
1,549

 
1,557

 
13

 
1,614

 
1,627

Total investments
$
2,521

 
$
16,409

 
$
18,930

 
$
2,280

 
$
17,793

 
$
20,073


Debt Securities
Debt securities available for sale at March 31, 2018 and December 31, 2017 were as follows:
(Millions)
Amortized
Cost

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
Fair
Value

March 31, 2018
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,303

 
$
28

 
$
(2
)
 
$
1,329

States, municipalities and political subdivisions
2,984

 
74

 
(21
)
 
3,037

U.S. corporate securities
6,651

 
240

 
(84
)
 
6,807

Foreign securities
2,568

 
127

 
(27
)
 
2,668

Residential mortgage-backed securities
491

 
2

 
(11
)
 
482

Commercial mortgage-backed securities
608

 
1

 
(21
)
 
588

Other asset-backed securities
1,020

 
5

 
(7
)
 
1,018

Redeemable preferred securities
27

 
3

 

 
30

Total debt securities (1)(2)
$
15,652

 
$
480

 
$
(173
)
 
$
15,959

December 31, 2017
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

U.S. government securities
$
1,319

 
$
44

 
$
(1
)
 
$
1,362

States, municipalities and political subdivisions
3,287

 
116

 
(12
)
 
3,391

U.S. corporate securities
6,886

 
388

 
(22
)
 
7,252

Foreign securities
2,498

 
187

 
(7
)
 
2,678

Residential mortgage-backed securities
570

 
5

 
(4
)
 
571

Commercial mortgage-backed securities
641

 
3

 
(9
)
 
635

Other asset-backed securities
1,031

 
8

 
(4
)
 
1,035

Redeemable preferred securities
22

 
4

 

 
26

Total debt securities(1)(2)
$
16,254

 
$
755

 
$
(59
)
 
$
16,950

 
 
 
 
 
 
 
 
(1) 
At both March 31, 2018 and December 31, 2017, we held securities for which we previously recognized an immaterial amount of non-credit related impairments in accumulated other comprehensive loss. These securities had an immaterial amount of net unrealized capital gains at both March 31, 2018 and December 31, 2017.
(2) 
Investment risks associated with our experience-rated and discontinued products generally do not impact our operating results (refer to Note 15 for additional information on our accounting for discontinued products). At March 31, 2018, debt securities with a fair value of approximately $2.5 billion, gross unrealized capital gains of $122 million and gross unrealized capital losses of $36 million and, at December 31, 2017, debt securities with a fair value of approximately $2.6 billion, gross unrealized capital gains of $199 million and gross unrealized capital losses of $8 million were included in total debt 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 11



The fair value of debt securities at March 31, 2018 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
$
1,004

 
$
1,009

One year through five years
5,647

 
5,677

After five years through ten years
3,208

 
3,224

Greater than ten years
3,674

 
3,961

Residential mortgage-backed securities
491

 
482

Commercial mortgage-backed securities
608

 
588

Other asset-backed securities
1,020

 
1,018

Total
$
15,652

 
$
15,959

 
Mortgage-Backed and Other Asset-Backed Securities
All of our residential mortgage-backed securities at March 31, 2018 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, 2018, our residential mortgage-backed securities had an average credit quality rating of AAA and a weighted average duration of 5.1 years.

Our commercial mortgage-backed securities have underlying loans that are dispersed throughout the United States.  Significant market observable inputs used to value these securities include loss severity and probability of default.  At March 31, 2018, these securities had an average credit quality rating of AAA and a weighted average duration of 6.5 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, 2018, these securities had an average credit quality rating of AA- and a weighted average duration of 1.0 years.




























Page 12



Summarized below are the debt securities we held at March 31, 2018 and December 31, 2017 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

March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
201

 
$
762

 
$
2

 
16

 
$
14

 
$

 
217

 
$
776

 
$
2

States, municipalities and political subdivisions
444

 
1,015

 
15

 
69

 
168

 
6

 
513

 
1,183

 
21

U.S. corporate securities
2,289

 
3,307

 
61

 
276

 
458

 
23

 
2,565

 
3,765

 
84

Foreign securities
646

 
1,011

 
19

 
87

 
182

 
8

 
733

 
1,193

 
27

Residential mortgage-backed securities
158

 
294

 
7

 
87

 
111

 
4

 
245

 
405

 
11

Commercial mortgage-backed securities
114

 
332

 
8

 
73

 
217

 
13

 
187

 
549

 
21

Other asset-backed securities
272

 
443

 
4

 
66

 
131

 
3

 
338

 
574

 
7

Redeemable preferred securities
4

 
5

 

 

 

 

 
4

 
5

 

Total debt securities(1)
4,128

 
$
7,169

 
$
116

 
674

 
$
1,281

 
$
57

 
4,802

 
$
8,450

 
$
173

December 31, 2017
 
 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

Debt securities:
 
 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

U.S. government securities
77

 
$
200

 
$
1

 
14

 
$
22

 
$

 
91

 
$
222

 
$
1

States, municipalities and political subdivisions
318

 
616

 
4

 
111

 
308

 
8

 
429

 
924

 
12

U.S. corporate securities
989

 
1,469

 
6

 
284

 
494

 
16

 
1,273

 
1,963

 
22

Foreign securities
262

 
419

 
3

 
91

 
194

 
4

 
353

 
613

 
7

Residential mortgage-backed securities
111

 
179

 
1

 
98

 
134

 
3

 
209

 
313

 
4

Commercial mortgage-backed securities
38

 
135

 
1

 
79

 
241

 
8

 
117

 
376

 
9

Other asset-backed securities
150

 
304

 
2

 
79

 
151

 
2

 
229

 
455

 
4

Total debt securities(1)
1,945

 
$
3,322

 
$
18

 
756

 
$
1,544

 
$
41

 
2,701

 
$
4,866

 
$
59

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
At March 31, 2018 and December 31, 2017, debt securities in an unrealized capital loss position of $36 million and $8 million, respectively, and with related fair value of $1.2 billion and $515 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, 2018, 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 13



The maturity dates for debt securities in an unrealized capital loss position at March 31, 2018 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
$
11

 
$

 
$
631

 
$
2

 
$
642

 
$
2

One year through five years
243

 
4

 
3,147

 
46

 
3,390

 
50

After five years through ten years
471

 
14

 
1,315

 
32

 
1,786

 
46

Greater than ten years
301

 
11

 
803

 
25

 
1,104

 
36

Residential mortgage-backed securities
23

 
1

 
382

 
10

 
405

 
11

Commercial mortgage-backed securities
153

 
6

 
396

 
15

 
549

 
21

Other asset-backed securities
11

 

 
563

 
7

 
574

 
7

Total
$
1,213

 
$
36

 
$
7,237

 
$
137

 
$
8,450

 
$
173

 
 
 
 
 
 
 
 
 
 
 
 

Mortgage Loans
Our mortgage loans are collateralized by commercial real estate.  During the three months ended March 31, 2018 and 2017 we had the following activity in our mortgage loan portfolio:
 
Three Months Ended
March 31,
(Millions)
2018

 
2017

New mortgage loans
$
15

 
$
54

Mortgage loans fully repaid
85

 
48

 
 
 
 
 
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 - 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.
Category 7 - Represents loans where collections are potentially at risk; if necessary, an impairment is recorded.
Based upon our most recent assessments at March 31, 2018 and December 31, 2017, our mortgage loans were given the following credit quality indicators:
(In Millions, except credit ratings indicator)
March 31, 2018

 
December 31, 2017

1
$
39

 
$
40

2 to 4
1,366

 
1,447

5 and 6
9

 
9

7

 

Total
$
1,414

 
$
1,496

 
 
 
 
 


Page 14



Net Investment Income
Sources of net investment income for the three months ended March 31, 2018 and 2017 were as follows:
 
Three Months Ended
March 31,
(Millions)
2018

 
2017

Debt securities
$
145

 
$
190

Mortgage loans
20

 
22

Other investments
42

 
58

Gross investment income
207

 
270

Investment expenses
(10
)
 
(10
)
Net investment income (1)
$
197

 
$
260

 
 
 
 
(1) 
Net investment income includes $48 million and $66 million for the three months ended March 31, 2018 and 2017, respectively, related to investments supporting our experience-rated and discontinued products.

The decrease in net investment income for the three months ended March 31, 2018 compared to the corresponding period of 2017 was primarily due to the transfer of investments supporting our reinsured life and disability insurance policies into a trust established by HLAIC for our benefit as part of the Group Insurance sale during the fourth quarter of 2017.

Realized Capital Gains/Losses
Net realized capital gains (losses) for the three months ended March 31, 2018 and 2017, excluding amounts related to experience-rated contract holders and discontinued products, were as follows:
 
Three Months Ended
March 31,
(Millions)
2018

 
2017

Other-than-temporary impairment (“OTTI”) losses on debt securities recognized in earnings
$
(13
)
 
$
(2
)
Other net realized capital gains (losses)
19

 
(331
)
Net realized capital gains (losses)
$
6

 
$
(333
)
 
The net realized capital gains for the three months ended March 31, 2018 were primarily attributable to gains from the sale of debt securities, investment real estate and other investments, substantially offset by yield related impairments taken during the quarter. The net realized capital losses for the three months ended March 31, 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 the entire $750 million aggregate principal amount of our senior notes due 2020.

We had no individually material realized capital losses on debt or equity securities that impacted our operating results during the three months ended March 31, 2018 or 2017.

The portion of unrealized capital gains and losses recognized during the three months ended March 31, 2018 related to investments in equity securities held as of the reporting date was not material.

Excluding amounts related to experience-rated and discontinued products, proceeds from the sale of available for sale debt securities and the related gross realized capital gains and losses for the three months ended March 31, 2018 and 2017 were as follows:
 
Three Months Ended
March 31,
(Millions)
2018

 
2017

Proceeds on sales
$
1,472

 
$
1,084

Gross realized capital gains
23

 
9

Gross realized capital losses
15

 
12

 
 
 
 



Page 15



Variable Interest Entities
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. We were not the primary beneficiary of any VIE at March 31, 2018 or December 31, 2017.

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 in 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 in our Consolidated Balance Sheets at March 31, 2018 and December 31, 2017 were as follows:
(Millions)
 
March 31, 2018

 
December 31, 2017

Hedge fund investments
 
$
361

 
$
351

Private equity investments
 
472

 
453

Real estate partnerships
 
247

 
247

Total
 
$
1,080

 
$
1,051


The carrying value of the total assets and liabilities of our other variable interest holder VIE investments at March 31, 2018 and December 31, 2017 were as follows:
(Millions)
 
March 31, 2018

 
December 31, 2017

Assets:
 
 
 
 
Hedge fund investments
 
$
45,289

 
$
54,789

Private equity investments
 
27,889

 
27,342

Real estate partnerships
 
6,290

 
6,451

Total
 
$
79,468

 
$
88,582

 
 
 
 
 
Liabilities:
 
 
 
 
Hedge fund investments
 
$
8,920

 
$
12,073

Private equity investments
 
2,692

 
2,461

Real estate partnerships
 
4,600

 
4,691

Total
 
$
16,212

 
$
19,225



Page 16




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 Consolidated 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.

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 consist 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, 2018 or December 31, 2017.

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, 2018 or December 31, 2017.  The total fair value of our broker quoted debt securities was $65 million at March 31, 2018 and $67 million at December 31, 2017.  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

Page 17



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.

There were no financial liabilities measured at fair value on a recurring basis in our Consolidated Balance Sheets at March 31, 2018 or December 31, 2017. Financial assets measured at fair value on a recurring basis in our Consolidated Balance Sheets at March 31, 2018 and December 31, 2017 were as follows:
 
 
 
 
 
 
 
 
(Millions)
Level 1

 
Level 2

 
Level 3

 
Total

March 31, 2018
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,294

 
$
35

 
$

 
$
1,329

States, municipalities and political subdivisions

 
3,037

 

 
3,037

U.S. corporate securities

 
6,725

 
82

 
6,807

Foreign securities

 
2,665

 
3

 
2,668

Residential mortgage-backed securities

 
482

 

 
482

Commercial mortgage-backed securities

 
588

 

 
588

Other asset-backed securities

 
1,018

 

 
1,018

Redeemable preferred securities

 
23

 
7

 
30

Total debt securities
1,294

 
14,573

 
92

 
15,959

Equity securities
17

 

 
31

 
48

Total
$
1,311

 
$
14,573

 
$
123

 
$
16,007

December 31, 2017
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

U.S. government securities
$
1,313

 
$
49

 
$

 
$
1,362

States, municipalities and political subdivisions

 
3,390

 
1

 
3,391

U.S. corporate securities

 
7,167

 
85

 
7,252

Foreign securities

 
2,675

 
3

 
2,678

Residential mortgage-backed securities

 
571

 

 
571

Commercial mortgage-backed securities

 
635

 

 
635

Other asset-backed securities

 
1,035

 

 
1,035

Redeemable preferred securities

 
19

 
7

 
26

Total debt securities
1,313

 
15,541

 
96

 
16,950

Equity securities
43

 

 
27

 
70

Total
$
1,356

 
$
15,541

 
$
123

 
$
17,020


There were no transfers between Levels 1 and 2 during the three months ended March 31, 2018 or 2017. During the three months ended March 31, 2018, there were no transfers into or out of Level 3. During the three months ended March 31, 2017, we had an immaterial amount of gross transfers into and out of Level 3.

Page 18



Financial Instruments Not Measured at Fair Value in our Consolidated Balance Sheets
The carrying value and estimated fair value classified by level of fair value hierarchy for our financial instruments carried in our Consolidated Balance Sheets at adjusted cost or contract value at March 31, 2018 and December 31, 2017 were as follows:
 
Carrying
Value

 
 Estimated Fair Value
(Millions)
 
Level 1

 
Level 2

 
Level 3

 
Total

March 31, 2018
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Mortgage loans
$
1,414

 
$

 
$

 
$
1,427

 
$
1,427

Bank loans
7

 

 

 
7

 
7

Equity securities (1)
50

 
N/A

 
N/A

 
N/A

 
N/A

Liabilities:
 
 
 
 
 
 
 
 
 
Investment contract liabilities:
 
 
 
 
 
 
 
 
 
With a fixed maturity
5

 

 

 
5

 
5

Without a fixed maturity
367

 

 

 
346

 
346

Long-term debt
9,159

 

 
9,495

 

 
9,495

 
 
 
 
 
 
 
 
 
 
(Millions)
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Mortgage loans
$
1,496

 
$

 
$

 
$
1,524

 
$
1,524

Bank loans
7

 

 

 
7

 
7

Equity securities (1)
45

 
N/A

 
N/A

 
N/A

 
N/A

Liabilities:
 

 
 
 
 
 
 
 
 

Investment contract liabilities:
 

 
 
 
 
 
 
 
 

With a fixed maturity
7

 

 

 
7

 
7

Without a fixed maturity
363

 

 

 
354

 
354

Long-term debt
9,159

 

 
9,815

 

 
9,815

 
 
 
 
 
 
 
 
 
 
(1)  
It was not practical to estimate the fair value of these cost-method investments as it represents shares of unlisted companies.

Separate Accounts Measured at Fair Value in our Consolidated Balance Sheets
Separate Accounts assets related to our large case pensions products represent funds maintained to meet specific objectives of contract holders.  Since contract holders bear the investment risk of these assets, a corresponding Separate Accounts liability has been established equal to the assets.  These assets and liabilities are carried at fair value.  Net investment income and capital gains and losses accrue directly to such contract holders.  The assets of each account are legally segregated and are not subject to claims arising from our other businesses.  Deposits, withdrawals, net investment income and realized and unrealized capital gains and losses on Separate Accounts assets are not reflected in our Consolidated Statements of Income, Shareholders’ Equity or Cash Flows.

Separate Accounts assets include debt and equity securities and derivative instruments.  The valuation methodologies used for these assets are similar to the methodologies described above in this Note 5.  Separate Accounts assets also include investments in common/collective trusts that are carried at fair value. Common/collective trusts invest in other investment funds otherwise known as the underlying funds. The Separate Accounts’ interests in the common/collective trust funds are based on the fair values of the investments of the underlying funds and therefore are classified in Level 2. The assets in the underlying funds primarily consist of equity securities. Investments in common/collective trust funds are valued at their respective net asset value per share/unit on the valuation date.









Page 19



Separate Accounts financial assets at March 31, 2018 and December 31, 2017 were as follows:
 
 
March 31, 2018