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Accounting Policies (Policies)
 12 Months Ended
Dec. 31, 2016
Accounting Policies [Abstract]  
Basis of Presentation

Basis of Presentation

 

The Consolidated Financial Statements include the accounts of Cigna Corporation and its subsidiaries. Intercompany transactions and accounts have been eliminated in consolidation.  These Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Amounts recorded in the Consolidated Financial Statements necessarily reflect management's estimates and assumptions about medical costs, investment valuation, interest rates and other factors. Significant estimates are discussed throughout these Notes; however, actual results could differ from those estimates. The impact of a change in estimate is generally included in earnings in the period of adjustment. Certain reclassifications have been made to prior year amounts to conform to the current presentation.

 
Recent Accounting Changes

Recent Accounting Changes

 

The following tables provide information about recently adopted and recently issued accounting guidance applicable to Cigna.

 

Recently Adopted Accounting Guidance

 

Accounting Standard and Adoption Date

Requirements and Effects of Adopting New Guidance

Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (Accounting Standards Update (“ASU”) 2016-15) Early adopted as of December 31, 2016

Specifies how certain transactions should be classified in the statement of cash flows. While the standard addresses multiple types of transactions, only a change in the treatment of distributions from equity method investments will impact the Company.

Effects of adoption: using the nature of distribution approach, the Company reported $144 million of cash receipts related to distributions from partnership earnings in operating activities in 2016. The Company reclassified $137 million for 2015 and $111 million for 2014 from investing to operating activities in the Consolidated Statement of Cash Flows.

Improvements to Employee Share-Based Payment Accounting (ASU 2016-09) Early adopted on January 1, 2016

Requires:

• Excess tax benefits or deficiencies to be recorded prospectively in the income statement when awards vest or are settled; previously these effects were reported in additional paid-in capital • Cash flows related to excess tax benefits to be classified prospectively as an operating activity in the statement of cash flows (previously financing) • All cash payments made on an employee’s behalf for withheld shares to be presented retrospectively as a financing activity in the statement of cash flows • Prospective changes to the calculation of common stock equivalents for earnings per share

Permits:

• Repurchasing more of an employee’s shares for tax withholding purposes than previously allowed without triggering liability accounting • An accounting policy election to record forfeitures as they occur instead of estimating

Effects of adoption:

• $29 million of excess tax benefits recorded in net income during 2016 (in Corporate) • $72 million of tax withholding cash flows reported in financing activities in 2016; reclassified $79 million for 2015 and $53 million for 2014 of tax withholding from operating to financing activities in the Consolidated Statement of Cash Flows • Approximately one million additional weighted average shares in 2016 for the diluted earnings per share calculations • No changes in our employee tax withholding practices for stock compensation • The amount of compensation cost recognized in each period continues to be determined based on estimated forfeitures

Disclosures about Short-Duration Insurance Contracts (ASU 2015-09) Adopted December 31, 2016

Requires additional information about an insurance entity’s initial claim estimates and subsequent adjustments to those estimates; methodologies and judgments in estimating claims; and the timing, frequency and severity of claims.

Effects of adoption:

• See Note 7 for these disclosures about our Global Health Care medical cost payable liabilities • See Note 8 for these disclosures about our unpaid claims and claim expense liabilities

Accounting Standard and Adoption Date

Requirements and Effects of Adopting New Guidance

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2015-07) Adopted January 1, 2016

Removes fair value disclosure requirement for all investments measured using the practical expedient of net asset value (“NAV”) per share. Certain additional disclosures are now required for such investments.

Effects of adoption: see Note 10 for these disclosures about separate account investments that use NAV as a practical expedient; comparable prior year amounts are also disclosed.

Amendments to the Consolidation Analysis (ASU 2015-02) Adopted January 1, 2016

Defines limited partnerships as variable interest entities unless substantive kick-out rights or participating rights exist.

Effects of adoption:

• No material effect on the Company’s financial statements • See Note 13 for disclosures about various limited partnerships newly identified as variable interest entities for which the Company is not the primary beneficiary

Recently Issued Accounting Guidance Not Yet Adopted

 

Accounting Standard and Effective Date Applicable for Cigna

Requirements and Expected Effects of New Guidance Not Yet Adopted

Simplifying the Test for Goodwill Impairment (ASU 2017-04) Required as of January 1, 2020, with early adoption permitted as of January 1, 2017

Simplifies the accounting for goodwill impairment by eliminating the need to determine the fair value of individual assets and liabilities of a reporting unit to measure a goodwill impairment.

Expected effects: the Company is evaluating this new standard and its expected timing of adoption.

Clarifying the Definition of a Business (ASU 2017-01) Required as of January 1, 2018, with early adoption permitted as of January 1, 2017

Revises the definition of a business and provides a more robust framework for entities to use in determining when a set of assets and activities is a business.

Expected effects: if a group of assets acquired after adoption is not considered a business, no goodwill will be recorded and most intangible assets recorded from the acquisition will be amortized to shareholders’ net income over their useful lives. The Company is evaluating this new standard and its expected timing of adoption.

Intra-Entity Asset Transfers of Assets Other than Inventory (ASU 2016-16) Required as of January 1, 2018, with early adoption permitted as of January 1, 2017

Requires:

• Entities to recognize the tax impacts of all intra-entity sales of assets other than inventory even though the pre-tax effects of those transactions are eliminated in consolidation • Modified retrospective approach for adoption, with a cumulative-effect adjustment recorded in retained earnings

Expected effects: the Company is evaluating this new standard, its expected timing of adoption and effects on its financial statements and disclosures.

Measurement of Credit Losses on Financial Instruments (ASU 2016-13) Required as of January 1, 2020, with early adoption permitted as of January 1, 2019

Requires:

• A new approach (based on expected credit losses) to estimate and recognize credit losses for certain financial instruments such as mortgage loans, reinsurance recoverables and other receivables • Changes in the criteria for impairment of available-for-sale debt securities • Modified retrospective approach for adoption, with a cumulative-effect adjustment recorded in retained earnings

Expected effects: the Company is evaluating this new standard, its expected timing of adoption and effects on its financial statements and disclosures. It is possible that an additional allowance for future expected credit losses for certain financial instruments may be required at adoption.

Leases (ASU 2016-02) Required as of January 1, 2019

Requires:

• Balance sheet recognition of assets and liabilities arising from leases, including from leases embedded in other contracts • Additional disclosures of the amount, timing and uncertainty of cash flows from leases will be required • Modified retrospective approach for leases in effect as of and after the date of adoption with a cumulative-effect adjustment recorded in retained earnings

Expected effects: the Company is still evaluating the impact the standard could have on the Consolidated Financial Statements; however, while the Company has not yet quantified the amount, we do expect the standard will have a material impact on our Consolidated Balance Sheets due to the recognition of additional assets and liabilities for operating leases. The actual increase in assets and liabilities will depend on the volume and terms of leases in place at adoption.

Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01) Required as of January 1, 2018

Requires:

• Entities to measure equity investments at fair value in net income if they are neither consolidated nor accounted for under the equity method • Cumulative effect adjustment to the beginning balance of retained earnings at adoption

Expected effects:

• Certain limited partnership interests carried at cost of $260 million as of December 31, 2016 will be reported at fair value at adoption • An increase to retained earnings of approximately $60 million, after-tax, if implemented as of December 31, 2016. Actual cumulative effect adjustment will depend on investments held and market conditions at adoption.

Revenue from Contracts with Customers (ASU 2014-09 and related amendments) Required as of January 1, 2018, with early adoption permitted as of January 1, 2017

Requires:

• Companies to estimate and allocate the expected customer contract revenues among distinct goods or services based on relative standalone selling prices • Revenues to be recognized as goods or services are delivered • Extensive new disclosures including the presentation of additional categories of revenues and information about related contract assets and liabilities • Adoption through retrospective restatement with or without using certain practical expedients or adoption with a cumulative effect adjustment

Expected effects:

• Applies to the Company’s non-insurance, administrative service contracts but does not apply to certain contracts within the scope of other GAAP, such as insurance contracts • The Company will adopt the new guidance as of January 1, 2018 but has not yet selected a method of adoption • The Company does not currently expect the adoption of the new guidance to have a material impact to its pattern of revenue recognition

• The Company is continuing to evaluate the new requirements. Specifically, the Company is evaluating the combination of contract guidance for certain customers where the Company provides both insurance and non-insurance products, the deferral of revenue for services provided after the termination of certain administrative contracts and the Company’s status as principal or agent for certain performance obligations.
Investments - Policy Loans

  • Investments – Policy Loans

     

    Policy loans are carried at unpaid principal balances plus accumulated interest, the total of which approximates fair value. These loans are collateralized by life insurance policy cash values and therefore have minimal exposure to credit loss. Interest rates are reset annually based on an index.

 
Cash and Cash Equivalents

  • Cash and Cash Equivalents

     

    Cash and cash equivalents are carried at cost that approximates fair value. Cash equivalents consist of short-term investments with maturities of three months or less from the time of purchase. The Company reclassifies cash overdraft positions to accounts payable, accrued expenses and other liabilities when the legal right of offset does not exist.

 
Premiums, Accounts and Notes Receivable and Reinsurance Recoverables

  • Premiums, Accounts and Notes Receivable and Reinsurance Recoverables

     

    Premiums, accounts and notes receivable and reinsurance recoverables are reported net of allowances for doubtful accounts and unrecoverable reinsurance of $203 million as of December 31, 2016 and $ 78 million as of December 31, 2015. The Company estimates these allowances for doubtful accounts and unrecoverable reinsurance using management's best estimates of collectability, taking into consideration the age of the outstanding amounts, historical collection patterns and other economic factors. See Note 22 for additional discussion of the allowance established in 2016 for the risk corridor receivable.

 
Deferred Policy Acquisition Costs

  • Deferred Policy Acquisition Costs

     

    Costs eligible for deferral include incremental, direct costs of acquiring new or renewal insurance and investment contracts and other costs directly related to successful contract acquisition. Examples of deferrable costs include commissions, sales compensation and benefits, policy issuance and underwriting costs and premium taxes. The Company records acquisition costs differently depending on the product line. Acquisition costs for:

 

 

  • Universal life products are deferred and amortized in proportion to the present value of total estimated gross profits over the expected lives of the contracts.
  • Supplemental health, life and accident insurance (primarily individual products) and group health and accident insurance products are deferred and amortized, generally in proportion to the ratio of periodic revenue to the estimated total revenues over the contract periods.
  • Other products are expensed as incurred.

 

 

Deferred policy acquisition costs also include the value of business acquired with certain acquisitions.

 

Each year, deferred policy acquisition costs are tested for recoverability. For universal life and other individual products, management estimates the present value of future revenues less expected payments. For group health and accident insurance products, management estimates the sum of unearned premiums and anticipated net investment income less future expected claims and related costs. If management's estimates of these sums are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. The Company recorded amortization for policy acquisition costs of $292 million in 2016, $286 million in 2015 and $289 million in 2014 primarily in other operating expenses.

 
Other Assets, including Other Intangibles

  • Other Assets, including Other Intangibles

     

    Other assets, including other intangibles consist primarily of GMIB assets, accrued net investment income, other intangible assets and various other insurance-related assets. See Note 17 for the Company's accounting policy for other intangibles. Additionally, these other assets include the carrying value of our equity-method investments in joint ventures in China and other foreign jurisdictions.

 
Contractholder Deposit Funds

  • Contractholder Deposit Funds

Liabilities for contractholder deposit funds primarily include deposits received from customers for investment-related and universal life products and investment earnings on their fund balances. These liabilities are adjusted to reflect administrative charges and, for universal life fund balances, mortality charges. In addition, this caption includes: 1) premium stabilization reserves under group insurance contracts representing experience refunds left with the Company to pay future premiums; 2) deposit administration funds used to fund non-pension retiree insurance programs; 3) retained asset accounts; and 4) annuities or supplementary contracts without significant life contingencies. Interest credited on these funds is accrued ratably over the contract period.

Future Policy Benefits

  • Future Policy Benefits

     

    Future policy benefits represent the present value of estimated future obligations under long-term life and supplemental health insurance policies and annuity products currently in force. These obligations are estimated using actuarial methods and consist primarily of reserves for annuity contracts, life insurance benefits, GMDB contracts (see Note 9 for additional information) and certain health, life and accident insurance products of our Global Supplemental Benefits segment.

     

    Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies and GMDB contracts represent benefits to be paid to policyholders, net of future premiums to be received. Management estimates these obligations based on assumptions as to premiums, interest rates, mortality or morbidity, future claim adjudication expenses and surrenders, allowing for adverse deviation as appropriate. Mortality, morbidity and surrender assumptions are based on the Company's own experience and published actuarial tables. Interest rate assumptions are based on management's judgment considering the Company's experience and future expectations, and range from 0.1% to 9%. Obligations for the run-off settlement annuity business include adjustments for realized and unrealized investment returns consistent with GAAP when a premium deficiency exists.

 
Redeemable Noncontrolling Interests

  • Redeemable Noncontrolling Interests

     

    Products and services are offered in Turkey and India through joint venture entities for which the Company is the principal equity holder or primary beneficiary. Accordingly, these entities are consolidated. The redeemable noncontrolling interests on our Consolidated Balance Sheets represent our joint venture partners' preferred and common stock interests in these entities. Our joint venture partners may, at their election, require the Company to purchase their redeemable noncontrolling interests. We also have the right to require our joint venture partners to sell their redeemable noncontrolling interests to us. The redeemable noncontrolling interests were recorded at fair value as of the dates of purchase.  When the estimated redemption value for a redeemable noncontrolling interest exceeds its carrying value, an adjustment to increase the redeemable noncontrolling interest is recorded with an offsetting reduction to additional paid-in capital. When an adjustment is made to the carrying value of the redeemable noncontrolling interest, the calculation of shareholders' net income per share will be adjusted if the redemption value exceeds the greater of the carrying value or fair value.

 
Accounts Payable, Accrued Expenses and Other Liabilities

  • Accounts Payable, Accrued Expenses and Other Liabilities

     

Accounts payable, accrued expenses and other liabilities include liabilities for pension, other postretirement and postemployment benefits (see Note 15), GMIB contract liabilities (see Note 9), self-insured exposures, management compensation, cash overdraft positions and various insurance-related liabilities, including experience-rated refunds, reinsurance contracts and the minimum medical loss ratio rebate accrual under The Patient Protection and Affordable Care Act (the “Health Care Reform Act” or “ACA”). Legal costs to defend the Company's litigation and arbitration matters are expensed when incurred in cases where the Company cannot reasonably estimate the ultimate cost to defend. In cases where the Company can reasonably estimate the cost to defend, a liability for these costs is accrued when the claim is reported.
Translation of Foreign Currencies

  • Translation of Foreign Currencies

     

    The Company generally conducts its international business through foreign operating entities that maintain assets and liabilities in local currencies that are generally their functional currencies. The Company uses exchange rates as of the balance sheet date to translate assets and liabilities into U.S. dollars. Translation gains or losses on functional currencies, net of applicable taxes, are recorded in accumulated other comprehensive income (loss). The Company uses average monthly exchange rates during the year to translate revenues and expenses into U.S. dollars.

 
Premiums and Related Expenses

  • Premiums and Related Expenses

     

    Premiums for group life, accident and health insurance and managed care coverages are recognized as revenue on a pro rata basis over the contract period. Benefits and expenses are recognized when incurred and, for our Global Health Care insured business, medical costs are presented net of pharmaceutical manufacturer rebates. For experience-rated contracts, premium revenue includes an adjustment for experience-rated refunds based on contract terms and calculated using the customer's experience (including estimates of incurred but not reported claims).

     

    Premium revenue also includes an adjustment to reflect the estimated effect of rebates due to customers under the commercial minimum medical loss ratio provisions of the Health Care Reform Act. These rebates are settled in the year following the policy year.

     

    Premiums received for the Company's Medicare Advantage Plans and Medicare Part D products from the Centers for Medicare and Medicaid Services (“CMS”) and customers are recognized as revenue ratably over the contract period. CMS provides risk-adjusted premium payments for Medicare Advantage Plans and Medicare Part D products based on the demographics and wellness of enrollees. The Company recognizes periodic changes to risk-adjusted premiums as revenue when the amounts are determinable and collection is reasonably assured. Additionally, Medicare Part D premiums include payments from CMS for risk sharing adjustments. The risk sharing adjustments that are estimated quarterly based on claim experience, compare actual incurred drug benefit costs to estimated costs submitted in original contracts and may result in more or less revenue from CMS. Final revenue adjustments are determined and settled with CMS in the year following the contract year. Premium revenue also includes an adjustment to reflect the estimated effect of rebates due to CMS under the Medicare Advantage and Medicare Part D minimum medical loss ratio provisions of the Health Care Reform Act.

     

    Accounting for the Health Care Reform Act's Risk Mitigation Programs. Beginning in 2014, as prescribed by the Health Care Reform Act, programs went into effect to reduce the risk for participating health insurance companies selling coverage on the public exchanges.

     

  • A three-year (2014-2016) reinsurance program is designed to provide reimbursement to insurers for high cost individual business sold on or off the public exchanges. The reinsurance entity established by the U.S. Department of Health and Human Services (“HHS”) is funded by a per-customer reinsurance fee assessed on all insurers, Health Maintenance Organizations (“HMOs”) and self-insured group health plans, excluding certain products such as Medicare Advantage and Medicare Part D. Only non-grandfathered individual plans are eligible for recoveries if claims exceed a specified threshold, up to a reinsurance cap.

     

  • A permanent risk adjustment program reallocates funds from insurers with lower risk populations to insurers with higher risk populations based on the relative risk scores of participants in non-grandfathered plans in the individual and small group markets, both on and off the exchanges. We estimate our receivable or payable based on the risk of our members compared to the risk of other members in the same state and market, considering data obtained from industry studies and HHS.

  • A three-year (2014-2016) risk corridor program is designed to limit insurer gains and losses by comparing allowable medical costs to a target amount as defined by HHS. This program applies to individual and small group qualified health plans, operating on and off the exchanges. Variances from the target amount exceeding certain thresholds may result in amounts due to or due from HHS.

 

Reinsurance contributions associated with non-grandfathered individual plans are reported as reductions in premium revenues, and estimated reinsurance recoveries are established with offsetting reductions in Global Health Care medical costs. Reinsurance fee contributions for other insured business are reported in other operating expenses. Final recoverable amounts are determined and settled with HHS in the year following the policy year. For the risk adjustment and risk corridor programs, the Company records receivables or payables as adjustments to premium revenue based on our year-to-date experience when the amounts are reasonably estimable and collection is reasonably assured. Final revenue adjustments are determined by HHS in the year following the policy year. For additional discussion on our revenue recognition considerations for the risk corridor program in 2016, see Note 22.

 

Premiums for individual life, accident and supplemental health insurance and annuity products, excluding universal life and investment-related products, are recognized as revenue when due. Benefits and expenses are matched with premiums.

 

Revenue for universal life products is recognized as follows:

 

  • Investment income on assets supporting universal life products is recognized in net investment income as earned.
  • Charges for mortality, administration and policy surrender are recognized in premiums as earned. Administrative fees are considered earned when services are provided.

 

Benefits and expenses for universal life products consist of benefit claims in excess of policyholder account balances and income earned by policyholders. Expenses are recognized when claims are incurred, and income is credited to policyholders in accordance with contract provisions.

 

The unrecognized portion of premiums received is recorded as unearned premiums.

 
Fees, Related Expenses and Mail Order Revenue and Costs

  • Fees, Related Expenses and Mail Order Pharmacy Revenues and Costs

 

Contract fees for administrative services only (“ASO”) programs and pharmacy programs and services are recognized in fees and other revenues as services are provided, net of estimated pharmaceutical manufacturer rebates payable to ASO clients using our network of retail pharmacies and estimated refunds under performance guarantees. Expenses associated with these programs and services are recognized in other operating expenses as incurred, net of estimated pharmaceutical rebates from manufacturers for prescriptions filled through our network of retail pharmacies.

 

In some cases, the Company provides performance guarantees associated with meeting certain service standards, clinical outcomes or financial metrics. If these service standards, clinical outcomes or financial metrics are not met, the Company may be financially at risk up to a stated percentage of the contracted fee or a stated dollar amount. The Company defers revenues for estimated payouts associated with these performance guarantees. Approximately 10% of ASO fees reported for the year ended December 31, 2016 were at risk under performance guarantees, with reimbursements estimated to be less than 1% of revenues.

 

Revenues for investment-related products are recognized as follows:

 

  • Investment income on assets supporting investment-related products is recognized in net investment income as earned.
  • Contract fees based upon related administrative expenses are recognized in fees and other revenues as they are earned ratably over the contract period.

 

Benefits and expenses for investment-related products consist primarily of income credited to policyholders in accordance with contract provisions.

 

Mail order pharmacy revenues and the cost of prescriptions are recognized as each prescription is shipped. Mail order pharmacy revenues are presented net of estimated pharmaceutical manufacturer rebates payable to ASO clients using our mail order business. Mail order pharmacy costs include the cost of prescriptions sold and other costs to operate this business including supplies, shipping and handling, net of estimated pharmaceutical rebates from manufacturers for prescriptions filled through our mail order business.

 
Mergers and Aquisitions

In accordance with GAAP, the purchase price for each acquisition was allocated to the tangible and intangible net assets acquired based on management's estimates of their fair values.
Earnings Per Share

Accounting policy. The Company computes basic earnings per share using the weighted-average number of unrestricted common and deferred shares outstanding. Diluted earnings per share also includes the dilutive effect of outstanding employee stock options and restricted stock using the treasury stock method and the effect of strategic performance shares.

 
Reinsurance

Reinsurance does not relieve the originating insurer of liability.  Therefore, reinsured liabilities must continue to be reported along with the related reinsurance recoverables.

While GMDB is accounted for as reinsurance, GMIB assets and liabilities are reported as derivatives at fair value as discussed below. Accordingly, GMIB assets are reported in other assets, including intangibles, and GMIB liabilities are reported in accounts payable, accrued expenses and other liabilities.

 
Fair Value Measurements

Assumptions used in fair value measurement. The Company estimates the fair value of the assets and liabilities for GMIB contracts by calculating the results for many scenarios run through a model utilizing various assumptions. The only assumption expected to impact future shareholders' net income is non-performance risk. The non-performance risk adjustment reflects a market participant's view of nonpayment risk by adding an additional spread to the discount rate in the calculation of both (a) the GMIB liabilities to be paid by the Company, and (b) the GMIB assets to be paid by the reinsurers, after considering collateral.

 

Other assumptions that affect GMIB assets and liabilities include capital market assumptions (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments) and future annuitant behavior (including mortality, lapse, and annuity election rates). As certain assumptions used to estimate fair values for these contracts are largely unobservable (primarily related to future annuitant behavior), the Company classifies GMIB assets and liabilities in Level 3 in the fair value hierarchy presented in Note 10.

 

The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities. Significant decreases in assumed lapse rates or spreads used to calculate non-performance risk of the Company, or significant increases in assumed annuity election rates or spreads used to calculate the non-performance risk of the reinsurers, would result in higher fair value measurements. A change in one of these assumptions is not necessarily accompanied by a change in another assumption.

 

The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, equity securities, short-term investments and derivatives. Other financial instruments are measured at fair value only under certain conditions, such as when impaired.

 

Fair value is defined as the price at which an asset could be exchanged in an orderly transaction between market participants at the balance sheet date. A liability's fair value is defined as the amount that would be paid to transfer the liability to a market participant, not the amount that would be paid to settle the liability with the creditor.

 

The Company's financial assets and liabilities carried at fair value have been classified based upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). An asset's or a liability's classification is based on the lowest level of input that is significant to its measurement. For example, a financial asset or liability carried at fair value would be classified in Level 3 if unobservable inputs were significant to the instrument's fair value, even though the measurement may be derived using inputs that are both observable (Levels 1 and 2) and unobservable (Level 3).

 

 

The Company estimates fair values using prices from third parties or internal pricing methods. Fair value estimates received from third-party pricing services are based on reported trade activity and quoted market prices when available, and other market information that a market participant may use to estimate fair value. The internal pricing methods are performed by the Company's investment professionals and generally involve using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality, as well as other qualitative factors. In instances where there is little or no market activity for the same or similar instruments, fair value is estimated using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. These valuation techniques involve some level of estimation and judgment that becomes significant with increasingly complex instruments or pricing models.

 

 

The Company is responsible for determining fair value, as well as for assigning the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs. The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates. The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value. The controls executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations. The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates. The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations. Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls. This on-site review includes a walk-through of inputs of a sample of securities held across various asset types to validate the documented pricing process.

 

Level 1 Financial Assets

 

Inputs for instruments classified in Level 1 include unadjusted quoted prices for identical assets in active markets accessible at the measurement date.  Active markets provide pricing data for trades occurring at least weekly and include exchanges and dealer markets.

 

Assets in Level 1 include actively-traded U.S. government bonds and exchange-listed equity securities. Given the narrow definition of Level 1 and the Company's investment asset strategy to maximize investment returns, a relatively small portion of the Company's investment assets are classified in this category.

 

Level 2 Financial Assets and Financial Liabilities

 

Inputs for instruments classified in Level 2 include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are market observable or can be corroborated by market data for the term of the instrument.  Such other inputs include market interest rates and volatilities, spreads and yield curves. An instrument is classified in Level 2 if the Company determines that unobservable inputs are insignificant.

 

Fixed maturities and equity securities.  Approximately 93% of the Company's investments in fixed maturities and equity securities are classified in Level 2 including most public and private corporate debt and equity securities, federal agency and municipal bonds, non-government mortgage-backed securities and preferred stocks.  Because many fixed maturities do not trade daily, third-party pricing services and internal methods often use recent trades of securities with similar features and characteristics. When recent trades are not available, pricing models are used to determine these prices.  These models calculate fair values by discounting future cash flows at estimated market interest rates.  Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry and structure of the asset. Typical inputs and assumptions to pricing models include, but are not limited to, a combination of benchmark yields, reported trades, issuer spreads, liquidity, benchmark securities, bids, offers, reference data, and industry and economic events.  For mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit rating.

 

Nearly all of these instruments are valued using recent trades or pricing models. Less than 1% of the fair value of investments classified in Level 2 represents foreign bonds that are valued using a single unadjusted market-observable input derived by averaging multiple broker-dealer quotes, consistent with local market practice.

 

Short-term investments are carried at fair value that approximates cost.  On a regular basis, the Company compares market prices for these securities to recorded amounts to validate that current carrying amounts approximate exit prices.  The short-term nature of the investments and corroboration of the reported amounts over the holding period support their classification in Level 2.

 

Other derivatives classified in Level 2 represent over-the-counter instruments such as interest rate and foreign currency swap contracts.  Fair values for these instruments are determined using market observable inputs including forward currency and interest rate curves and widely published market observable indices.  Credit risk related to the counterparty and the Company is considered when estimating the fair values of these derivatives.  However, the Company is largely protected by collateral arrangements with counterparties and determined that no adjustment for credit risk was required as of December 31, 2016 or 2015.  Level 2 also includes exchange-traded interest rate swap contracts. Credit risk related to the clearinghouse counterparty and the Company is considered minimal when estimating the fair values of these derivatives because of upfront margin deposits and daily settlement requirements. The nature and use of these other derivatives are described in Note 12.

 

Level 3 Financial Assets and Financial Liabilities

 

Certain inputs for instruments classified in Level 3 are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement.  Unobservable inputs reflect the Company's best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date.

 

The Company classifies certain newly issued, privately-placed, complex or illiquid securities, as well as assets and liabilities relating to GMIB, in Level 3. Approximately 4% of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category.

 

Fair values of mortgage and other asset-backed securities, corporate and government fixed maturities are primarily determined using pricing models that incorporate the specific characteristics of each asset and related assumptions including the investment type and structure, credit quality, industry and maturity date in comparison to current market indices, spreads and liquidity of assets with similar characteristics.  For mortgage and other-backed securities, inputs and assumptions for pricing may also include collateral attributes and prepayment speeds.  Recent trades in the subject security or similar securities are assessed when available, and the Company may also review published research in its evaluation, as well as the issuer's financial statements.

 

Mortgage and other asset-backed securities. The significant unobservable inputs used to value the following mortgage and other asset-backed securities are liquidity and weighting of credit spreads. When there is limited trading activity for the security, an adjustment for liquidity is made as of the measurement date that considers current market conditions, issuer circumstances and complexity of the security structure. An adjustment to weight credit spreads is needed to value a more complex bond structure with multiple underlying collateral and no standard market valuation technique. The weighting of credit spreads is primarily based on the underlying collateral's characteristics and their proportional cash flows supporting the bond obligations. The resulting wide range of unobservable adjustments in the table below is due to the varying liquidity and quality of the underlying collateral, ranging from high credit quality to below investment grade.

 

Corporate and government fixed maturities. The significant unobservable input used to value the following corporate and government fixed maturities is an adjustment for liquidity. When there is limited trading activity for the security, an adjustment is needed to reflect current market conditions and issuer circumstances.

 

Equity securities. The significant unobservable input used to value the following equity securities is a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”). These securities are comprised of private equity investments with limited trading activity and therefore a ratio of price to EBITDA is used to estimate value based on company circumstances and relative risk characteristics.

 

Significant increases in fixed maturity spreads would result in lower fair value measurements while decreases in these inputs would result in higher fair value measurements. Significant decreases in equity price-to-EBITDA multiples would result in lower fair value measurements while increases in these inputs would result in higher fair value measurements. Generally, the unobservable inputs are not interrelated and a change in the assumption used for one unobservable input is not accompanied by a change in the other unobservable input.

 

As noted in the preceding tables, total gains and losses included in shareholders' net income are reflected in the following captions in the Consolidated Statements of Income:

 

  • Realized investment gains (losses) and net investment income for amounts related to fixed maturities and equity securities and realized investment gains (losses) for the impact of changes in non-performance risk related to GMIB assets and liabilities, similar to hedge ineffectiveness; and
  • Other operating expenses for amounts related to GMIB assets and liabilities (GMIB fair value gain/loss), except for the impact of changes in non-performance risk.

 

In the tables above, gains and losses included in other comprehensive income are reflected in net unrealized appreciation (depreciation) on securities in the Consolidated Statements of Comprehensive Income.

 

Reclassifications impacting Level 3 financial instruments are reported as transfers into or out of the Level 3 category as of the beginning of the quarter in which the transfer occurs. Therefore gains and losses in income only reflect activity for the period the instrument was classified in Level 3. 

 

Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company's best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement.

Separate account assets in Level 1 primarily include exchange-listed equity securities.  Level 2 assets primarily include:

 

  • corporate and structured bonds valued using recent trades of similar securities or pricing models that discount future cash flows at estimated market interest rates as described above; and
  • actively-traded institutional and retail mutual fund investments and separate accounts priced using the daily net asset value that is the exit price.

 

Separate account assets classified in Level 3 primarily support Cigna's pension plans, and include certain newly issued, privately-placed, complex, or illiquid securities that are priced using methods discussed above, as well as commercial mortgage loans that are valued according to the methodologies discussed below.

Separate account investments in securities partnerships, real estate, and hedge funds are generally valued based on the separate account's ownership share of the equity of the investee (NAV as a practical expedient), including changes in the fair values of its underlying investments.

Some financial assets and liabilities are not carried at fair value each reporting period, but may be measured using fair value only under certain conditions, such as investments in real estate, partnership entities and commercial mortgage loans when they become impaired.

Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans generally by discounting the contractual cash flows at estimated market interest rates that reflect the Company's assessment of the credit quality of the loans. Market interest rates are derived by calculating the appropriate spread over comparable U.S. Treasury rates based on the property type, quality rating and average life of the loan. The quality ratings reflect the relative risk of the loan considering debt service coverage, the loan-to-value ratio and other factors. Fair values of impaired mortgage loans are based on the estimated fair value of the underlying collateral generally determined using an internal discounted cash flow model. The fair value measurements were classified in Level 3 because the cash flow models incorporate significant unobservable inputs.

 

Contractholder deposit funds, excluding universal life products. Generally, these funds do not have stated maturities. Approximately 70% of these balances can be withdrawn by the customer at any time without prior notice or penalty. The fair value for these contracts is the amount estimated to be payable to the customer as of the reporting date, which is generally the carrying value. Most of the remaining contractholder deposit funds are reinsured by the buyers of the individual life and annuity and retirement benefits businesses. The fair value for these contracts is determined using the fair value of these buyers' assets supporting these reinsured contracts. The Company had reinsurance recoverables equal to the carrying value of these reinsured contracts. These instruments were classified in Level 3 because certain inputs are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement.

 

Long-term debt, including current maturities, excluding capital leases. The fair value of long-term debt is based on quoted market prices for recent trades. When quoted market prices are not available, fair value is estimated using a discounted cash flow analysis and the Company's estimated current borrowing rate for debt of similar terms and remaining maturities. These measurements were classified in Level 2 because the fair values are based on quoted market prices or other inputs that are market observable or can be corroborated by market data.

 
Separate Accounts

Separate Accounts

 

Accounting policy. Separate account assets and liabilities are contractholder funds maintained in accounts with specific investment objectives.  The assets of these accounts are legally segregated and are not subject to claims that arise out of any of the Company's other businesses.  These separate account assets are carried at fair value with equal amounts recorded for related separate account liabilities.  The investment income and fair value gains and losses of these accounts generally accrue directly to the contractholders and, together with their deposits and withdrawals, are excluded from the Company's Consolidated Statements of Income and Cash Flows.  Fees and charges earned for mortality risks, asset management or administrative services are reported in either premiums or fees and other revenues. Beginning in 2016, investments that are measured using the practical expedient of NAV (see Note 2 for additional information) are excluded from the fair value hierarchy. Prior periods have been reclassified to conform to the current presentation.

 
Investments

Fixed Maturities and Equity Securities

 

Accounting policy. Fixed maturities (including bonds, mortgage and other asset-backed securities and preferred stocks redeemable by the investor) and most equity securities are classified as available for sale and are carried at fair value with changes in fair value recorded in accumulated other comprehensive income (loss) within shareholders' equity. Net unrealized appreciation on investments supporting the Company's run-off settlement annuity business is reported in future policy benefit liabilities rather than accumulated other comprehensive income (loss).

 

Equity securities include hybrid investments consisting of preferred stock with call features that are carried at fair value with changes in fair value reported in other realized investment gains (losses) and dividends reported in net investment income.

The Company records impairment losses in net income for fixed maturities with fair value below amortized cost that meet either of the following conditions:

 

  • If the Company intends to sell or determines that it is more likely than not to be required to sell these fixed maturities before their fair values recover, an impairment loss is recognized for the excess of the amortized cost over fair value.
  • If the net present value of projected future cash flows of a fixed maturity (based on qualitative and quantitative factors, including the probability of default, and the estimated timing and amount of recovery) is below the amortized cost basis, that difference is recognized as an impairment loss. For mortgage and asset-backed securities, estimated future cash flows are also based on assumptions about the collateral attributes including prepayment speeds, default rates and changes in value.

 

Review of declines in fair value. Management reviews fixed maturities with a decline in fair value from cost for impairment based on criteria that include:

 

  •        length of time and severity of decline;
  •        financial health and specific near term prospects of the issuer;
  •        changes in the regulatory, economic or general market environment of the issuer's industry or geographic region; and
  •        the Company's intent to sell or the likelihood of a required sale prior to recovery.

 

Accounting policy. Commercial mortgage loans are carried at unpaid principal balances or, if impaired, the lower of unpaid principal or fair value of the underlying real estate. See the “Impaired commercial mortgage loans” section below for the Company's accounting policy for impaired commercial mortgage loans.

 

Credit quality. The Company regularly evaluates and monitors credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal credit quality rating system designed to evaluate the relative risk of the transaction at origination that is then updated each year as part of the annual portfolio loan review. The Company evaluates and monitors credit quality on a consistent and ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.

 

Quality ratings are based on our evaluation of a number of key inputs related to the loan, including real estate market-related factors such as rental rates and vacancies, and property-specific inputs such as growth rate assumptions and lease rollover statistics. However, the two most significant contributors to the credit quality rating are the debt service coverage and loan-to-value ratios. The debt service coverage ratio measures the amount of property cash flow available to meet annual interest and principal payments on debt, with a ratio below 1.0 indicating that there is not enough cash flow to cover the required loan payments. The loan-to-value ratio, commonly expressed as a percentage, compares the amount of the loan to the fair value of the underlying property collateralizing the loan.

 

The Company's annual in-depth review of its commercial mortgage loan investments is the primary mechanism for identifying emerging risks in the portfolio. The most recent review was completed by the Company's investment professionals in the second quarter of 2016 and included an analysis of each underlying property's most recent annual financial statements, rent rolls, operating plans, budgets, a physical inspection of the property and other pertinent factors. Based on historical results, current leases, lease expirations and rental conditions in each market, the Company estimates the current year and future stabilized property income and fair value and categorizes the investments as loans in good standing, potential problem loans or problem loans.

The Company will reevaluate a loan's credit quality between annual reviews if new property information is received or an event such as delinquency or a borrower's request for restructure causes management to believe that the Company's estimate of financial performance, fair value or the risk profile of the underlying property has been impacted.

 

       Potential problem mortgage loans are considered current (no payment is more than 59 days past due), but they exhibit certain characteristics that increase the likelihood of future default. The characteristics management considers include, but are not limited to, the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and requests from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms that could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.

 

Impaired commercial mortgage loans. A commercial mortgage loan is considered impaired when it is probable that the Company will not collect all amounts due according to the terms of the original loan agreement. These loans are included in either problem or potential problem loans. The Company monitors credit risk and assesses the impairment of loans individually and on a consistent basis for all loans in the portfolio. Impaired loans are carried at the lower of unpaid principal balance or the fair value of the underlying real estate. The Company estimates the fair value of the underlying real estate using internal valuations generally based on discounted cash flow analyses. Certain commercial mortgage loans without valuation reserves are considered impaired because the Company will not collect all interest due according to the terms of the original agreements; however, the Company expects to recover the unpaid principal because it is less than the fair value of the underlying real estate. Because of the risk profile of the underlying investment, the Company recognizes interest income on impaired mortgage loans only when payment is actually received.

 

Other Long-Term Investments

 

Accounting policy. Other long-term investments include investments in unconsolidated entities. These entities include certain limited partnerships and limited liability companies holding real estate, securities or loans. These investments are carried at cost plus the Company's ownership percentage of reported income or loss in cases where the Company has significant influence; otherwise the investment is carried at cost. Income from certain entities is reported on a one quarter lag depending on when their financial information is received. Other long-term investments are considered impaired, and written down to their fair value, when cash flows indicate that the carrying value may not be recoverable. Fair value is generally determined based on a discounted cash flow analysis.

 

Other long-term investments also include investment real estate carried at depreciated cost less any impairment write downs to fair value when cash flows indicate that the carrying value may not be recoverable. Depreciation is generally recorded using the straight-line method based on the estimated useful life of each asset. Investment real estate as of December 31, 2016 and 2015 is expected to be held longer than one year and includes real estate acquired through the foreclosure of commercial mortgage loans.

Additionally, other long-term investments include interest rate and foreign currency swaps carried at fair value

Short-Term Investments and Cash Equivalents

 

Accounting policy. Security investments with maturities of greater than three months to one year from time of purchase are classified as short-term, available for sale and carried at fair value that approximates cost. Cash equivalents consist of short-term investments with maturities of three months or less from the time of purchase and are carried at cost that approximates fair value.

 

  • Net Investment Income

 

Accounting policy. When interest and principal payments on investments are current, the Company recognizes interest income when it is earned. The Company recognizes interest income on a cash basis when interest payments are delinquent based on contractual terms or when certain terms (interest rate or maturity date) of the investment have been restructured.

 

  • Realized Investment Gains And Losses

 

Accounting policy. Realized investment gains and losses are based on specifically identified assets and result from sales, investment asset write-downs, changes in the fair values of certain derivatives and changes in valuation reserves on commercial mortgage loans.

 
Derivative Financial Instruments

Accounting policy. The Company reports GMIB liabilities and assets as derivatives at fair value because cash flows of these liabilities and assets are affected by equity markets and interest rates, but are without significant life insurance risk and are settled in lump sum payments. Periodically, the Company receives and pays fees based on either contractholders' account values or deposits increased at a contractual rate. The Company will also pay and receive cash depending on changes in account values and interest rates when contractholders first elect to receive minimum income payments. Cash flows on these contracts are reported in operating activities.

 

 

Accounting Policy. The Company applies hedge accounting when derivatives are designated, qualified and highly effective as hedges. Effectiveness is formally assessed and documented at inception and each period throughout the life of a hedge using various quantitative methods appropriate for each hedge, including regression analysis and dollar offset. Under hedge accounting, the changes in fair value of the derivative and the hedged risk are generally recognized together and offset each other when reported in shareholders' net income. Changes in the fair value of a derivative instrument may not always equal changes in the fair value of the hedged item. This is referred to as “hedge ineffectiveness” and is generally recorded in realized investment gains and losses. In the event of an early hedge termination, the changes in fair value of derivatives that qualified for hedge accounting are reported in shareholders' net income, generally as a part of realized investment gains and losses. Derivative cash flows are generally reported in operating activities.

 

Accounting. Using fair value hedge accounting, the fair values of the swap contracts are reported in other assets, including other intangibles, or accounts payable, accrued expenses, and other liabilities. The critical terms of these swaps match those of the long-term debt being hedged. As a result, the carrying value of the hedged debt is adjusted to reflect changes in its fair value driven by LIBOR. The effects of those adjustments on other operating expenses are offset by the effects of corresponding changes in the swaps' fair value. The net impact from the hedge reported in other operating expenses reflects interest expense on the hedged debt at the variable interest rate.

Accounting. Using cash flow hedge accounting, fair values are reported in other long-term investments or accounts payable, accrued expenses, and other liabilities. Changes in fair values are reported in accumulated other comprehensive income and amortized into net investment income or other realized investment gains and losses as interest or principal payments are received.

Accounting. Using fair value hedge accounting, fair values are reported in other long-term investments or accounts payable, accrued expenses, and other liabilities. Changes in fair values of the swap contracts, as well as changes in the fair values of the hedged bonds attributable to the hedged risk are reported in other realized investment gains and losses.

Accounting. As these arrangements were not designated as accounting hedges, fair values are reported in short-term investments or accounts payable, accrued expenses, and other liabilities, and changes in fair values are reported in other realized investment gains and losses.
Variable Interest Entities

 

When the Company becomes involved with a variable interest entity, as well as when there is a change in the Company's involvement with an entity, the Company evaluates the following to determine if it is the primary beneficiary and must consolidate the entity:

 

  • the structure and purpose of the entity;
  • the risks and rewards created by and shared through the entity; and
  • the Company's ability to direct its activities, receive its benefits and absorb its losses relative to the other parties involved with the entity including its sponsors, equity holders, guarantors, creditors and servicers.

 
Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss) excludes amounts required to adjust future policy benefits for the run-off settlement annuity business.

Pension and other postretirement benefits

Accounting policy. The Company measures the assets and liabilities of its domestic pension and other postretirement benefit plans as of December 31. Benefit obligations are measured at the present value of estimated future payments based on actuarial assumptions. The Company uses the “corridor” method to account for changes in the benefit obligation when actual results differ from those assumed, or when assumptions change. These changes are called net unrecognized actuarial gains (losses). Under the corridor method, net unrecognized actuarial gains (losses) are initially recorded in accumulated other comprehensive income. When the unrecognized gain (loss) exceeds 10% of the benefit obligation, that excess is amortized to other operating expense over the expected remaining lives of plan participants.

 

For balance sheet purposes, we measure plan assets at fair value. When the actual return differs from the expected return, those differences are reflected in the net unrealized actuarial gain (loss) discussed above. However, to measure pension benefit costs, we use a “market-related” asset valuation for domestic pension plan assets invested in non-fixed income investments that is different than the actual fair value. The “market-related” value recognizes the difference between actual and expected long-term returns in the portfolio over five years, a method that reduces the short-term impact of market fluctuations on pension costs. At December 31, 2016, the market-related asset value was approximately $3.9 billion compared with a fair value of approximately $4.0 billion.

 

The Company used the Society of Actuaries mortality table RP2014and the updated improvement scales published in 2015 and 2016 to value its benefit obligations because the Company's mortality experience closely matched these tables based on internal studies. The updated improvement scales published in 2015 and 2016 both indicated that mortality improvement is expected to be lower than was originally projected when the study was first published in 2014, resulting in decreases to the benefit obligations in both years.

The Company sets discount rates by applying actual annualized yields for high quality bonds at various durations to the expected cash flows of the pension and other postretirement benefits liabilities. The discount rate curve is constructed using an array of bonds in various industries throughout the domestic market, but only selects those for the curve that have an above average return at each duration. Management believes that this curve is representative of the yields that the Company is able to achieve through its plan asset investment strategy.

 

Expected long-term rates of return on plan assets were developed considering actual long-term historical returns, expected long-term market conditions, plan asset mix and management's investment strategy that continues a significant allocation to domestic and foreign equity securities as well as securities partnerships, real estate and hedge funds. Expected long-term market conditions take into consideration certain key macroeconomic trends including expected domestic and foreign GDP growth, employment levels and inflation.

 

See Note 10 for further details regarding how fair value is determined, including the level within the fair value hierarchy and the procedures we use to validate fair value measurements. The Company classifies substantially all pension assets fixed maturities in Level 2. These assets are valued using recent trades of similar securities or are fund investments priced using their daily net asset value that is the exit price. Within pension assets, a substantial portion of domestic equity securities are classified as Level 1, while international equity funds are predominantly classified in Level 2 using daily net asset value.

 

Securities partnerships, real estate and hedge funds are valued using NAV as a practical expedient and are excluded from the fair value hierarchy. See Note 10 for additional disclosures related to these assets invested in the separate accounts of the Company's subsidiaries. Certain securities as described in Note 10, as well as commercial mortgage loans and guaranteed deposit account contracts, are classified in Level 3 because unobservable inputs used in their valuation are significant.

 

 
Employee Incentive Plans

The Company issues shares from Treasury stock for option exercises, awards of restricted stock grants and payment of strategic performance shares, deferred stock units and restricted stock units.

 

The Company records compensation expense for stock and option awards over their vesting periods primarily based on the estimated fair value at the grant date. Fair value is determined differently for each type of award as discussed under each award type below.

 

Accounting policy. The Company awards options to purchase Cigna common stock at the market price of the stock on the grant date. Options vest over periods ranging from one to five years and expire no later than 10 years from grant date. Fair value is estimated using the Black-Scholes option-pricing model by applying the assumptions presented below. That fair value is reduced by options expected to be forfeited during the vesting period. The Company estimates forfeitures at the grant date based on our experience and adjust the expense to reflect actual forfeitures over the vesting period. The fair value of options, net of forfeitures, is recognized in operating expenses on a straight line basis over the vesting period.

 

Black-Scholes option-pricing model assumptions and the resulting fair value of options are presented in the following table.

  2016 2015 2014
Dividend yield 0.0% 0.0% 0.1%
Expected volatility 35.0% 35.0% 35.0%
Risk-free interest rate 1.2% 1.3% 1.3%
Expected option life 4.3 years 4.3 years 4.3 years
Weighted average fair value of options$ 42.01$ 36.40$ 23.56

The expected volatility reflects the past daily stock price volatility of Cigna stock. The Company does not consider volatility implied in the market prices of traded options to be a good indicator of future volatility because remaining traded options will expire within one year. The risk-free interest rate is derived using the four-year U.S. Treasury bond yield rate as of the award date for the primary annual grant. Expected option life reflects the Company's historical experience.

 

Accounting policy. Fair value of restricted stock awards is equal to the market price of Cigna's common stock on the date of grant. This fair value is reduced by awards that are expected to forfeit. At the grant date, the Company estimates forfeitures based on experience and adjusts the expense to reflect actual forfeitures over the vesting period. This fair value, net of forfeitures, is recognized in other operating expenses over the vesting period on a straight line basis.

 

Accounting policy. Compensation expense for strategic performance shares is recorded over the performance period. For strategic performance shares with payment dependent on a market condition, fair value is determined at the grant date using a Monte Carlo simulation model and not subsequently adjusted regardless of the final outcome. For strategic performance shares with payment dependent on performance conditions, expense is initially accrued based on the most likely outcome, but evaluated for adjustment each period for updates in the expected outcome. At the end of the performance period, expense is adjusted to the actual outcome (number of shares awarded times the share price at the grant date). At the grant date, the Company estimates forfeitures based on experience and adjusts the expense to reflect actual forfeitures over the vesting period.

 

During the vesting period, the Company records tax benefits in shareholders' net income based on the amount of expense being recognized. Beginning in 2016, in connection with the early adoption of ASU 2016-09 discussed in Note 2, when stock options are exercised, or when restricted stock and strategic performance share awards vest, the difference between tax benefits based on the expense and the actual tax benefit realized are also recorded in net income. Prior to 2016, such excess tax benefits were recorded as an adjustment to additional paid-in capital. The table below provides information about the cost and tax benefits related to all of our share-based compensation arrangements.

 
Goodwill

Accounting policy. Goodwill represents the excess of the cost of businesses acquired over the fair value of their net assets. The resulting goodwill is assigned to those reporting units expected to realize cash flows from the acquisition, allocated to reporting units based on relative fair values, primarily reported in the Global Health Care segment ($5.7 billion) and, to a lesser extent, the Global Supplemental Benefits segment ($0.3 billion).

 

The Company evaluates goodwill for impairment at least annually during the third quarter at the reporting unit level and writes it down through shareholders' net income if impaired. Fair value of a reporting unit is generally estimated based on either market data or a discounted cash flow analysis using assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. The significant assumptions and estimates used in determining fair value include the discount rate and future cash flows. A range of discount rates is used that corresponds with the reporting unit's weighted average cost of capital, consistent with that used for investment decisions considering the specific and detailed operating plans and strategies within the reporting unit. Projections of future cash flows for the reporting unit are consistent with our annual planning process for revenues, claims, operating expenses, taxes, capital levels and long-term growth rates.

 
Other intangibles

Other Intangibles

 

Accounting policy. The Company's other intangible assets include purchased customer and producer relationships, provider networks and trademarks. The fair value of purchased customer relationships and the amortization method were determined as of the dates of purchase using an income approach that relies on projected future net cash flows including key assumptions for the customer attrition rate and discount rate. The Company amortizes other intangibles on an accelerated or straight-line basis over periods from five to 30 years. Management revises amortization periods if it believes there has been a change in the length of time that an intangible asset will continue to have value. Costs incurred to renew or extend the terms of these intangible assets are generally expensed as incurred.

 
Property and Equipment

Accounting policy. Property and equipment is carried at cost less accumulated depreciation. When applicable, cost includes interest, real estate taxes and other costs incurred during construction. Also included in this category is internal-use software that is acquired, developed or modified solely to meet the Company's internal needs, with no plan to market externally. Costs directly related to acquiring, developing or modifying internal-use software are capitalized.

 

The Company calculates depreciation and amortization principally using the straight-line method generally based on the estimated useful life of each asset as follows: buildings and improvements, 10 to 40 years; purchased software, one to five years; internally developed software, three to seven years; and furniture and equipment (including computer equipment), three to 10 years. Improvements to leased facilities are depreciated over the lesser of the remaining lease term or the estimated life of the improvement. The Company considers events and circumstances that would indicate the carrying value of property, equipment or capitalized software might not be recoverable. If the Company determines the carrying value of any of these assets is not recoverable, an impairment charge is recorded.

 
Income Taxes

Accounting policy. Deferred income tax assets and liabilities are recognized for differences between the financial and income tax reporting bases of the underlying assets and liabilities and established based upon enacted tax rates and laws. Deferred income tax assets are recognized when available evidence indicates that realization is more likely than not. The deferred income tax provision generally represents the net change in deferred income tax assets and liabilities during the year, excluding amounts reported as adjustments to accumulated other comprehensive income or amounts initially recorded due to business combinations. The current income tax provision generally represents estimated amounts due on various income tax returns for the year reported plus the effect of any uncertain tax positions. Uncertain tax positions are evaluated in accordance with GAAP.

 

 

As part of its global capital management strategy, the Company's foreign operations retain a significant portion of their earnings overseas. These undistributed earnings are deployed outside of the U.S. in support of the liquidity and capital needs of our foreign operations. The Company does not intend to repatriate these earnings to the U.S. and as a result, income taxes are provided using the respective foreign jurisdictions' tax rate.

 

 

Income tax provisions related to the Company's foreign operations are generally determined based upon the local country income tax rate.

The Company establishes a valuation allowance when it determines that realization of a deferred tax asset does not meet the more likely than not standard. Valuation allowances have been established against certain federal, foreign and state deferred tax assets, generally when there is a requirement to assess them on a separate entity basis.

Commitments and Contingencies

Separate account assets are contractholder funds maintained in accounts with specific investment objectives. The Company records separate account liabilities equal to separate account assets. In certain cases, the Company guarantees a minimum level of benefits for retirement and insurance contracts written in separate accounts. The Company establishes an additional liability if management believes that the Company will be required to make a payment under these guarantees.

 

 

When the Company (in the course of its regular review of pending litigation and legal or regulatory matters) has determined that a material loss is reasonably possible, the matter is disclosed. Such matters are described below. In accordance with GAAP, when litigation and regulatory matters present loss contingencies that are both probable and estimable, the Company accrues the estimated loss by a charge to shareholders' net income. The amount accrued represents the Company's best estimate of the probable loss at the time. If only a range of estimated losses can be determined, the Company accrues an amount within the range that, in the Company's judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, the Company accrues the minimum amount of the range. In cases when the Company has accrued an estimated loss, the accrued amount may differ materially from the ultimate amount of the loss. In many proceedings, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount or range of any loss. The Company provides disclosure in the aggregate for material pending litigation and legal or regulatory matters, including accruals, range of loss, or a statement that such information cannot be estimated. As a litigation or regulatory matter develops, the Company monitors the matter for further developments that could affect the amount previously accrued, if any, and updates such amount accrued or disclosures previously provided as appropriate.

 
Segment Information

In the Company's segment disclosures, we present “operating revenues,” defined as total revenues excluding realized investment results. The Company excludes realized investment results from this measure because its portfolio managers may sell investments based on factors largely unrelated to the underlying business purposes of each segment. As a result, gains or losses created in this process may not be indicative of past or future underlying performance of the business.

 

The Company uses “adjusted income (loss) from operations” as its principal financial measure of segment operating performance because management believes it best reflects the underlying results of business operations and permits analysis of trends in underlying revenue, expenses and profitability. Adjusted income from operations is defined as shareholders' net income (loss) excluding after-tax realized investment gains and losses, net amortization of other acquired intangible assets and special items. Income or expense amounts are excluded from adjusted income from operations for the following reasons:

 

  • Realized investment results are excluded because, as noted above, our portfolio managers may sell investments based on factors largely unrelated to the underlying business purposes of each segment.
  • Net amortization of other intangible assets is excluded because it relates to costs incurred for acquisitions and, as a result, it does not relate to the core performance of the Company's business operations. In 2015, the amortization amount was net of a bargain purchase gain on an acquisition.

  • Special items, if any, are excluded because management believes they are not representative of the underlying results of operations.

  • This is generally because the nature and size of these matters are not indicative of our ongoing business operations. Additional details about these items that provide further context as to why they are not considered indicative of ongoing business operations may be found in the footnotes referenced in the table below.