10-Q 1 a17-8864_110q.htm 10-Q

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2017

 

OR

 

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

 

for the transition period from            to           

 

Commission file number 1-08323

 

Cigna Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

06-1059331

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

900 Cottage Grove Road Bloomfield, Connecticut

 

06002

(Address of principal executive offices)

 

(Zip Code)

(860) 226-6000

Registrant’s telephone number, including area code

(860) 226-6741

Registrant’s facsimile number, including area code

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark

 

YES

 

NO

 

·  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.

 

R

 

o

 

· 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

R

 

o

 

·  whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See 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 R

Accelerated filer o

Non-accelerated filer o

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

 

·  whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

o

 

 

R

 

As of April 14, 2017,  256,014,619 shares of the issuer’s common stock were outstanding.

 



Table of Contents

 

Cigna Corporation

 

TABLE OF CONTENTS

 

 

 

 

 

PART I

FINANCIAL INFORMATION

Page

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

Consolidated Statements of Income

1

 

Consolidated Statements of Comprehensive Income

2

 

Consolidated Balance Sheets

3

 

Consolidated Statements of Changes in Total Equity

4

 

Consolidated Statements of Cash Flows

5

 

Notes to the Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

45

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

65

Item 4.

Controls and Procedures

65

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

66

Item 1.A.

Risk Factors

67

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

68

Item 4.

Mine Safety Disclosures

68

Item 6.

Exhibits

69

SIGNATURE

70

INDEX TO EXHIBITS

E-1

 

 

As used herein, “Cigna” or the “Company” refers to one or more of Cigna Corporation and its consolidated subsidiaries.

 



Table of Contents

 

 

 

 

 

Part I.   FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.   FINANCIAL STATEMENTS

 

 

Cigna Corporation

Consolidated Statements of Income

 

 

 

Unaudited

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions, except per share amounts)

 

2017

 

2016

 

Revenues

 

 

 

 

 

Premiums

 

$

8,103

 

$

7,746

 

Fees and other revenues

 

1,223

 

1,201

 

Net investment income

 

303

 

272

 

Mail order pharmacy revenues

 

710

 

697

 

Realized investment gains (losses):

 

 

 

 

 

Other-than-temporary impairments on fixed maturities

 

(7)

 

(27)

 

Other realized investment gains (losses), net

 

53

 

(5)

 

Net realized investment gains (losses)

 

46

 

(32)

 

TOTAL REVENUES

 

10,385

 

9,884

 

Benefits and Expenses

 

 

 

 

 

Global Health Care medical costs

 

4,985

 

4,761

 

Other benefit expenses

 

1,367

 

1,368

 

Mail order pharmacy costs

 

581

 

574

 

Other operating expenses

 

2,530

 

2,321

 

Amortization of other acquired intangible assets, net

 

32

 

41

 

TOTAL BENEFITS AND EXPENSES

 

9,495

 

9,065

 

Income before Income Taxes

 

890

 

819

 

Income taxes:

 

 

 

 

 

Current

 

286

 

294

 

Deferred

 

11

 

11

 

TOTAL INCOME TAXES

 

297

 

305

 

Net Income

 

593

 

514

 

Less: Net (Loss) Attributable to Noncontrolling Interests

 

(5)

 

(5)

 

SHAREHOLDERS’ NET INCOME

 

$

598

 

$

519

 

Shareholders’ Net Income Per Share:

 

 

 

 

 

Basic

 

$

2.34

 

$

2.04

 

Diluted

 

$

2.30

 

$

2.00

 

Dividends Declared Per Share

 

$

0.04

 

$

0.04

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

1



Table of Contents

 

Cigna Corporation

Consolidated Statements of Comprehensive Income

 

 

 

Unaudited

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2017

 

2016

 

Shareholders’ net income

 

$

598

 

$

519

 

Shareholders’ other comprehensive income, net of tax:

 

 

 

 

 

Net unrealized appreciation, securities

 

7

 

173

 

Net unrealized (depreciation), derivatives

 

(3)

 

(3)

 

Net translation of foreign currencies

 

112

 

81

 

Postretirement benefits liability adjustment

 

14

 

11

 

Shareholders’ other comprehensive income, net of tax

 

130

 

262

 

Shareholders’ comprehensive income

 

728

 

781

 

Comprehensive income (loss) attributable to noncontrolling interests:

 

 

 

 

 

Net (loss) attributable to redeemable noncontrolling interests

 

(2)

 

(1)

 

Net (loss) attributable to other noncontrolling interests

 

(3)

 

(4)

 

Other comprehensive income (loss) attributable to redeemable noncontrolling interests

 

(2)

 

3

 

Total comprehensive (loss) attributable to noncontrolling interests

 

(7)

 

(2)

 

TOTAL COMPREHENSIVE INCOME

 

$

721

 

$

779

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

2



Table of Contents

 

Cigna Corporation

Consolidated Balance Sheets

 

 

 

Unaudited

 

 

 

As of

 

As of

 

 

 

March 31,

 

December 31,

 

(In millions, except per share amounts)

 

2017

 

2016

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost, $20,639; $19,942)

 

$

21,734

 

$

20,961

 

Equity securities, at fair value (cost, $584; $583)

 

574

 

583

 

Commercial mortgage loans

 

1,752

 

1,666

 

Policy loans

 

1,431

 

1,452

 

Other long-term investments

 

1,465

 

1,462

 

Short-term investments

 

303

 

691

 

Total investments

 

27,259

 

26,815

 

Cash and cash equivalents

 

4,155

 

3,185

 

Premiums, accounts and notes receivable, net

 

3,154

 

3,077

 

Reinsurance recoverables

 

6,386

 

6,478

 

Deferred policy acquisition costs

 

1,982

 

1,818

 

Property and equipment

 

1,519

 

1,536

 

Deferred tax assets, net

 

263

 

304

 

Goodwill

 

5,982

 

5,980

 

Other assets, including other intangibles

 

2,250

 

2,227

 

Separate account assets

 

8,197

 

7,940

 

TOTAL ASSETS

 

$

61,147

 

$

59,360

 

Liabilities

 

 

 

 

 

Contractholder deposit funds

 

$

8,415

 

$

8,458

 

Future policy benefits

 

9,840

 

9,648

 

Unpaid claims and claim expenses

 

5,006

 

4,917

 

Global Health Care medical costs payable

 

2,770

 

2,532

 

Unearned premiums

 

1,204

 

634

 

Total insurance and contractholder liabilities

 

27,235

 

26,189

 

Accounts payable, accrued expenses and other liabilities

 

6,667

 

6,414

 

Short-term debt

 

142

 

276

 

Long-term debt

 

4,621

 

4,756

 

Separate account liabilities

 

8,197

 

7,940

 

TOTAL LIABILITIES

 

46,862

 

45,575

 

Contingencies — Note 16

 

 

 

 

 

Redeemable noncontrolling interests

 

56

 

58

 

Shareholders’ Equity

 

 

 

 

 

Common stock (par value per share, $0.25; shares issued, 296; authorized, 600)

 

74

 

74

 

Additional paid-in capital

 

2,912

 

2,892

 

Accumulated other comprehensive (loss)

 

(1,252)

 

(1,382)

 

Retained earnings

 

14,356

 

13,855

 

Less treasury stock, at cost

 

(1,864)

 

(1,716)

 

TOTAL SHAREHOLDERS’ EQUITY

 

14,226

 

13,723

 

Other noncontrolling interests

 

3

 

4

 

Total equity

 

14,229

 

13,727

 

Total liabilities and equity

 

$

61,147

 

$

59,360

 

SHAREHOLDERS’ EQUITY PER SHARE

 

$

55.52

 

$

53.42

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

3



Table of Contents

 

Cigna Corporation

Consolidated Statements of Changes in Total Equity

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

Unaudited

 

 

 

Additional

 

Other

 

 

 

 

 

 

 

Other non-

 

 

 

Non-

 

For the three months ended March 31, 2017

 

Common

 

Paid-in

 

Comprehensive

 

Retained

 

Treasury

 

Shareholders’

 

controlling

 

Total

 

controlling

 

(In millions)

 

Stock

 

Capital

 

Loss

 

Earnings

 

Stock

 

Equity

 

Interests

 

Equity

 

Interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2017

 

$

74

 

$

2,892

 

$

(1,382)

 

$

13,855 

 

$

(1,716)

 

$

13,723 

 

$

 

$

13,727

 

$

58

 

Effect of issuing stock for employee benefit plans

 

 

 

23

 

 

 

(87)

 

102

 

38

 

 

 

38

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

130

 

 

 

 

 

130

 

 

 

130

 

(2)

 

Net income (loss)

 

 

 

 

 

 

 

598

 

 

 

598

 

(3)

 

595

 

(2)

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(250)

 

(250)

 

 

 

(250)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

(3)

 

 

 

 

 

 

 

(3)

 

2

 

(1)

 

2

 

BALANCE AT MARCH 31, 2017

 

$

74

 

$

2,912

 

$

(1,252)

 

$

14,356 

 

$

(1,864)

 

$

14,226 

 

$

 

$

14,229

 

$

56

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended March 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2016

 

$

74

 

$

2,859

 

$

(1,250)

 

$

12,121

 

$

(1,769)

 

$

12,035

 

$

9

 

$

12,044

 

$

69

 

Effect of issuing stock for employee benefit plans

 

 

 

21

 

 

 

(89)

 

53

 

(15)

 

 

 

(15)

 

 

 

Other comprehensive (loss)

 

 

 

 

 

262

 

 

 

 

 

262

 

 

 

262

 

3

 

Net income (loss)

 

 

 

 

 

 

 

519

 

 

 

519

 

(4)

 

515

 

(1)

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(110)

 

(110)

 

 

 

(110)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

(6)

 

 

 

 

 

 

 

(6)

 

4

 

(2)

 

2

 

BALANCE AT MARCH 31, 2016

 

$

74

 

$

2,874

 

$

(988)

 

$

12,541

 

$

(1,826)

 

$

12,675

 

$

 

$

12,684

 

$

73

 

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

4



Table of Contents

 

Cigna Corporation

Consolidated Statements of Cash Flows

 

 

 

 

Unaudited

 

 

 

Three Months Ended March 31,

 

(In millions)

 

2017

 

 

2016

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

593

 

 

$

514

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

146

 

 

158

 

Realized investment (gains) losses

 

(46)

 

 

32

 

Deferred income taxes

 

11

 

 

11

 

Net changes in assets and liabilities, net of non-operating effects:

 

 

 

 

 

 

Premiums, accounts and notes receivable

 

(55)

 

 

(237)

 

Reinsurance recoverables

 

41

 

 

24

 

Deferred policy acquisition costs

 

(76)

 

 

(62)

 

Other assets

 

(22)

 

 

(57)

 

Insurance liabilities

 

868

 

 

507

 

Accounts payable, accrued expenses and other liabilities

 

(186)

 

 

(263)

 

Current income taxes

 

291

 

 

262

 

Distributions from partnership investments (1)

 

45

 

 

27

 

Other, net

 

(31)

 

 

5

 

NET CASH PROVIDED BY OPERATING ACTIVITIES (1)

 

1,579

 

 

921

 

Cash Flows from Investing Activities

 

 

 

 

 

 

Proceeds from investments sold:

 

 

 

 

 

 

Fixed maturities and equity securities

 

414

 

 

361

 

Investment maturities and repayments:

 

 

 

 

 

 

Fixed maturities and equity securities

 

475

 

 

255

 

Commercial mortgage loans

 

21

 

 

18

 

Other sales, maturities and repayments (primarily short-term and other long-term investments) (1)

 

667

 

 

75

 

Investments purchased or originated:

 

 

 

 

 

 

Fixed maturities and equity securities

 

(1,240)

 

 

(758)

 

Commercial mortgage loans

 

(107)

 

 

(1)

 

Other (primarily short-term and other long-term investments)

 

(256)

 

 

(198)

 

Property and equipment purchases

 

(91)

 

 

(112)

 

NET CASH (USED IN) INVESTING ACTIVITIES (1)

 

(117)

 

 

(360)

 

Cash Flows from Financing Activities

 

 

 

 

 

 

Deposits and interest credited to contractholder deposit funds

 

374

 

 

383

 

Withdrawals and benefit payments from contractholder deposit funds

 

(385)

 

 

(343)

 

Net change in short-term debt

 

(10)

 

 

(6)

 

Repayment of long-term debt

 

(250)

 

 

 

Repurchase of common stock

 

(239)

 

 

(139)

 

Issuance of common stock

 

38

 

 

10

 

Other, net

 

(43)

 

 

(51)

 

NET CASH (USED IN) FINANCING ACTIVITIES

 

(515)

 

 

(146)

 

Effect of foreign currency rate changes on cash and cash equivalents

 

23

 

 

18

 

Net increase in cash and cash equivalents

 

970

 

 

433

 

Cash and cash equivalents, January 1,

 

 

3,185

 

 

 

1,968

 

Cash and cash equivalents, March 31,

 

$

4,155

 

 

$

2,401

 

Supplemental Disclosure of Cash Information:

 

 

 

 

 

 

 

 

Income taxes paid, net of refunds

 

$

(8)

 

 

$

37

 

Interest paid

 

$

70

 

 

$

69

 

 

(1) As required in adopting Accounting Standard Update (“ASU”) 2016-15, the Company retrospectively reclassified $27 million of cash distributions from partnership earnings from investing to operating activities for the first quarter of 2016.  The comparable amount reported in operating activities in 2017 was $45 million.  See Note 2 for further discussion.

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

5



Table of Contents

 

CIGNA CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

TABLE OF CONTENTS

 

Note
Number

Footnote

Page

 

 

 

BUSINESS AND CAPITAL STRUCTURE

 

1

Description of Business

7

2

Significant Accounting Policies

8

3

Mergers and Acquisitions

10

4

Earnings Per Share

11

5

Debt

12

INSURANCE INFORMATION

 

6

Global Health Care Medical Costs Payable

13

7

Liabilities for Unpaid Claims and Claim Expenses

14

8

Reinsurance

15

INVESTMENTS

 

9

Fair Value Measurements

18

10

Investments

28

11

Derivatives

33

12

Variable Interest Entities

35

13

Accumulated Other Comprehensive Income (Loss)

36

WORKFORCE MANAGEMENT AND COMPENSATION

 

14

Pension and Other Postretirement Benefit Plans

37

COMPLIANCE, REGULATION AND CONTINGENCIES

 

15

Income Taxes

37

16

Contingencies and Other Matters

38

RESULTS DETAILS

 

17

Segment Information

43

 

6



Table of Contents

 

Note 1 – Description of Business

 

 

Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”)  is a global health services organization dedicated to a mission of helping individuals improve their health, well-being and sense of security.  To execute on our mission, Cigna’s strategy is to “Go Deep”, “Go Global” and “Go Individual” with a differentiated set of medical, dental, disability, life and accident insurance and related products and services offered by our insurance and other subsidiaries.  The majority of these products are offered through employers and other groups (e.g. governmental and non-governmental organizations, unions and associations).  Cigna also offers commercial health and dental insurance, Medicare and Medicaid products and health, life and accident insurance coverages to individuals in the U.S. and selected international markets.  In addition to its ongoing operations described above, Cigna also has certain run-off operations.

 

The financial results of the Company’s businesses are reported in the following segments:

 

Global Health Care aggregates the Commercial and Government operating segments due to their similar economic characteristics, products and services and regulatory environment:

 

·     The Commercial operating segment encompasses both the U.S. commercial and certain international health care businesses serving employers and their employees, other groups and individuals.  Products and services include medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services to insured and self-insured customers.

 

·     The Government operating segment offers Medicare Advantage and Medicare Part D plans to seniors.  This segment also offers Medicaid plans in selected markets.

 

Global Supplemental Benefits includes supplemental health, life and accident insurance products offered in selected international markets and in the U.S.

 

Group Disability and Life provides group long-term and short-term disability, group life, accident and specialty insurance products and related services.

 

Other Operations consist of:

 

·     corporate-owned life insurance (“COLI”);

 

·     run-off reinsurance business that is predominantly comprised of guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) business effectively exited through reinsurance with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) in 2013;

 

·     deferred gains recognized from the 1998 sale of the individual life insurance and annuity business and the 2004 sale of the retirement benefits business; and

 

·     run-off settlement annuity business.

 

Corporate reflects amounts not allocated to operating segments, such as net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment operations), interest on uncertain tax positions, certain litigation matters, intersegment eliminations, compensation cost for stock options, excess tax benefits on stock compensation, expense associated with frozen pension plans and certain costs for corporate projects, including overhead.

 

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Table of Contents

 

Note 2 – Significant Accounting Policies

 

 

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 may be made to prior year amounts to conform to the current presentation.

 

These interim Consolidated Financial Statements are unaudited but include all adjustments (including normal recurring adjustments) necessary, in the opinion of management, for a fair statement of financial position and results of operations for the periods reported.  The interim Consolidated Financial Statements and Notes should be read in conjunction with the Consolidated Financial Statements and Notes included in the Company’s 2016 Annual Report on Form 10-K (“2016 Form 10-K”).  The preparation of interim Consolidated Financial Statements necessarily relies heavily on estimates.  This and certain other factors, including the seasonal nature of portions of the health care and related benefits business as well as competitive and other market conditions, call for caution in estimating full year results based on interim results of operations.

 

Recent Accounting Pronouncements

 

The Company’s 2016 Form 10-K includes discussion of significant recent accounting pronouncements that either have impacted or may impact our financial statements in the future.

 

The following tables provide information about recently adopted and recently issued or changed accounting guidance (applicable to Cigna) that have occurred since the Company filed its 2016 Form 10-K.

 

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)

 

 

 

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 impacted the Company.

 

 

 

 

Early adopted as of December 31, 2016

 

Effects of adoption: using the nature of distribution approach, the Company reported $45 million of cash receipts related to distributions from partnership earnings in operating activities for the three months ended March 31, 2017. The Company reclassified $27 million for the three months ended March 31, 2016 from investing to operating activities in the Consolidated Statements of Cash Flows.

 

 

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Table of Contents

 

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

 

 

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07)

 

 

Required as of January 1, 2018

 

 

Requires employers to separate the service cost component from the other components of net benefit cost.  Under the new guidance, only service cost is eligible for capitalization (either deferred policy acquisition costs or capitalized software).  The change in the capitalization rule is to be applied prospectively upon adoption.  In addition, the income statement caption(s) where each component of net benefit cost is presented must be disclosed.

 

Expected effects: the Company expects the effect of this new guidance to be immaterial to its results of operations.

 

 

 

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 $240 million as of March 31, 2017 will be reported at fair value at adoption

· An increase to retained earnings of approximately $50 million, after-tax, if implemented as of March 31, 2017.  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 currently expects to adopt the new guidance as of January 1, 2018 through retrospective restatement

· The Company does not currently expect the adoption of the new guidance to have a material impact to its pattern of revenue recognition or net income

· The Company is continuing to evaluate the new requirements.  Specifically, the Company is evaluating the combination of contract guidance for certain customers when 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.

 

 

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Note 3 – Mergers and Acquisitions

 

 

Proposed Merger

 

On July 23, 2015, the Company entered into a merger agreement with Anthem, Inc. (“Anthem”) and Anthem Merger Sub Corp. (“Merger Sub”), a direct wholly-owned subsidiary of Anthem.

 

The merger agreement provides (a) for the merger of the Company and Merger Sub, with the Company continuing as the surviving corporation and (b) if certain tax opinions are delivered, immediately following the completion of the initial merger, for the surviving corporation to be merged with and into Anthem, with Anthem continuing as the surviving corporation (collectively, the “merger”).  Subject to certain terms, conditions, and customary operating covenants, each share of Cigna common stock issued and outstanding immediately prior to the effective time of the merger would be converted into the right to receive (a) $103.40 in cash, without interest, and (b) 0.5152 of a share of Anthem common stock.  The closing price of Anthem common stock on May 4, 2017 was $179.89.

 

At special shareholders’ meetings held in December 2015, Cigna shareholders approved the merger and Anthem shareholders approved the issuance of shares of Anthem common stock in connection with the merger.  Completing the merger remains subject to certain customary conditions, including the receipt of certain necessary governmental and regulatory approvals and the absence of a legal restraint prohibiting the merger.  Completing the merger is not subject to a financing condition.

 

On July 21, 2016, the U.S. Department of Justice (“DOJ”) and certain state attorneys general filed a civil antitrust lawsuit in the U.S. District Court for the District of Columbia (the “District Court”) seeking to block the merger and, on January 4, 2017, the parties concluded the District Court trial.

 

On January 18, 2017, the Company received a written notice from Anthem seeking to extend the termination date of the merger agreement from January 31, 2017 to April 30, 2017.

 

On February 8, 2017, the District Court issued an order enjoining the proposed merger.  Anthem filed a notice of appeal of the District Court’s order with the U.S. Court of Appeals for the District of Columbia Circuit (the “Appeals Court”) and requested an expedited appeal.

 

On February 14, 2017, the Company delivered a notice to Anthem terminating the merger agreement and filed suit in the Delaware Court of Chancery (the “Chancery Court”) seeking, among other things, declaratory judgment that Cigna’s termination of the merger agreement is lawful and that Anthem does not have the right to extend the merger agreement termination date.  Later that day, Anthem filed a lawsuit in the Chancery Court against the Company seeking, among other things, a temporary restraining order to enjoin Cigna from terminating the merger agreement, specific performance and damages, and, on February 15, 2017, the Chancery Court issued an order temporarily enjoining the Company from terminating the merger agreement.  This order will be subject to further review at a preliminary injunction hearing scheduled for May 8, 2017.

 

On February 17, 2017, the Appeals Court granted Anthem’s motion for an expedited appeal.  That same day, the Company filed its notice of appeal of the District Court’s order enjoining the merger with the Appeals Court.  Oral arguments were heard on March 24, 2017.  On April 28, 2017, the Appeals Court affirmed the decision of the District Court. On May 5, 2017, Anthem filed a petition for a writ of certiorari with the United States Supreme Court seeking appeal of the U.S. Court of Appeals decision affirming the District Court’s order enjoining the merger.

 

The merger agreement contains customary covenants, including covenants that Cigna conduct its business in the ordinary course during the period between entering into the merger agreement and closing.  In addition, Cigna’s ability to take certain actions prior to closing without Anthem’s consent is subject to certain limitations.  These limitations relate to, among other matters, the payment of dividends, capital expenditures, the payment or retirement of indebtedness or the incurrence of new indebtedness, settlement of material claims or proceedings, mergers or acquisitions, and certain employment-related matters.

 

The Company incurred $63 million pre-tax ($49 million after-tax) for the three months ended March 31, 2017 in costs directly related to the proposed merger.  Comparable merger-related costs for the three months ended March 31, 2016 were $40 million pre-tax ($36 million after-tax).  Since entering into this merger agreement in 2015, the Company has incurred pre-tax merger-related costs of approximately $295 million that primarily consisted of fees for legal, advisory and other professional services.  If the merger is consummated, a significant portion of these merger-related costs would not be deductible for federal income tax purposes.  If the merger is not consummated, these otherwise non-deductible costs would become tax deductible for federal income tax purposes, resulting in an incremental tax benefit of approximately $60 million.

 

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Note 4 Earnings Per Share (“EPS”)

 

 

Basic and diluted earnings per share were computed as follows:

 

 

 

Three Months Ended

 

 

 

March 31, 2017

 

March 31, 2016

 

(Shares in thousands, dollars in millions, except per share amounts)

 

Basic

 

Effect of
Dilution

 

Diluted

 

Basic

 

Effect of
Dilution

 

Diluted

 

Shareholders’ net income

 

$

598

 

 

 

$

598

 

$

519

 

 

 

$

519

 

Shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average

 

255,680

 

 

 

255,680

 

254,822

 

 

 

254,822

 

Common stock equivalents

 

 

 

4,094

 

4,094

 

 

 

4,625

 

4,625

 

Total shares

 

255,680

 

4,094

 

259,774

 

254,822

 

4,625

 

259,447

 

EPS

 

$

2.34

 

$

(0.04)

 

$

2.30

 

$

2.04

 

$

(0.04)

 

$

2.00

 

 

The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months ended March 31, 2017 and 2016 because their effect was anti-dilutive.

 

 

 

Three Months Ended

 

(In millions)

 

March 31, 2017

 

March 31, 2016

 

Anti-dilutive options

 

2.5

 

1.3

 

 

The Company held 39,928,289 shares of common stock in Treasury as of March 31, 2017, and 39,638,264 shares as of March 31, 2016.

 

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Note 5 Debt

 

 

The outstanding amounts of debt and capital leases were as follows:

 

 

 

March 31,

 

December 31,

 

(In millions)

 

2017

 

2016

 

Short-term:

 

 

 

 

 

Current maturities of long-term debt

 

$

131

 

$

250

 

Other, including capital leases

 

11

 

26

 

Total short-term debt

 

$

142

 

$

276

 

Long-term:

 

 

 

 

 

$131 million, 6.35% Notes due 2018

 

$

-

 

$

131

 

$250 million, 4.375% Notes due 2020 (1)

 

252

 

252

 

$300 million, 5.125% Notes due 2020 (1)

 

301

 

301

 

$78 million, 6.37% Notes due 2021

 

78

 

78

 

$300 million, 4.5% Notes due 2021 (1)

 

301

 

302

 

$750 million, 4% Notes due 2022

 

744

 

744

 

$100 million, 7.65% Notes due 2023

 

100

 

100

 

$17 million, 8.3% Notes due 2023

 

17

 

17

 

$900 million, 3.25% Notes due 2025

 

893

 

893

 

$300 million, 7.875% Debentures due 2027

 

299

 

299

 

$83 million, 8.3% Step Down Notes due 2033

 

82

 

82

 

$500 million, 6.15% Notes due 2036

 

498

 

498

 

$300 million, 5.875% Notes due 2041

 

296

 

296

 

$750 million, 5.375% Notes due 2042

 

743

 

743

 

Other, including capital leases

 

17

 

20

 

Total long-term debt

 

$

4,621

 

$

4,756

 

 

(1) The Company has entered into interest rate swap contracts hedging a portion of these fixed-rate debt instruments.  See Note 11 for further information about the Company’s interest rate risk management and these derivative instruments.

 

The Company repaid $250 million of long-term notes that matured in the first quarter of 2017.

 

The Company has a five-year revolving credit and letter of credit agreement for $1.5 billion that permits up to $500 million to be used for letters of credit.  This agreement extends through December 12, 2019 and is diversified among 16 banks, with three banks each having 12% of the commitment and the remainder spread among 13 banks in varying amounts.  The credit agreement includes options subject to consent by the administrative agent and the committing banks to increase the commitment amount to $2 billion and to extend the term past December 12, 2019.  The credit agreement is available for general corporate purposes, including for the issuance of letters of credit.  The credit agreement contains customary covenants and restrictions, including a financial covenant that the Company may not permit its leverage ratio – which is total consolidated debt to total consolidated capitalization (each as defined in the credit agreement) – to be greater than 0.50.  The leverage ratio calculation excludes the following items that are included in accumulated other comprehensive loss on the Company’s consolidated balance sheets: net unrealized appreciation on fixed maturities and the portion of the post-retirement benefits liability adjustment attributable to pension.

 

In addition to the $4.8 billion of debt outstanding as of March 31, 2017, the Company had $10.5 billion of borrowing capacity within the maximum debt coverage covenant in the credit agreement.  This additional borrowing capacity includes the $1.5 billion available under the credit agreement.  Letters of credit outstanding as of March 31, 2017 totaled $13 million.

 

The Company was in compliance with its debt covenants as of March 31, 2017.

 

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Note 6 — Global Health Care Medical Costs Payable

 

 

Medical costs payable for the Global Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not reported, those that have been reported but not yet paid (reported claims in process), and other medical care expenses and services payable that are primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities.  See Note 7 to the Consolidated Financial Statements in the Company’s 2016 Form 10-K for further information about the assumptions and estimates used to establish this liability.

 

Components of the Global Health Care medical costs payable balances as of March 31 were as follows:

 

 

 

March 31,

 

March 31,

 

(In millions)

 

2017

 

2016

 

Incurred but not reported

 

$

2,088

 

$

1,960

 

Reported claims in process

 

542

 

506

 

Physician incentives and other medical care expenses and services payable

 

140

 

180

 

Global Health Care medical costs payable

 

$

2,770

 

$

2,646

 

 

Activity in medical costs payable was as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

March 31,

 

(In millions)

 

2017

 

2016

 

Beginning balance

 

$

2,532

 

$

2,355

 

Less: Reinsurance and other amounts recoverable

 

275

 

243

 

Beginning balance, net

 

2,257

 

2,112

 

Incurred costs related to:

 

 

 

 

 

Current year

 

5,161

 

4,825

 

Prior years

 

(176)

 

(64)

 

Total incurred

 

4,985

 

4,761

 

Paid costs related to:

 

 

 

 

 

Current year

 

3,219

 

2,985

 

Prior years

 

1,509

 

1,449

 

Total paid

 

4,728

 

4,434

 

Ending balance, net

 

2,514

 

2,439

 

Add: Reinsurance and other amounts recoverable

 

256

 

207

 

Ending balance

 

$

2,770

 

$

2,646

 

 

Reinsurance and other amounts recoverable includes amounts due from reinsurers and policyholders to cover incurred but not reported and pending claims for certain business where the Company administers the plan benefits but the right of offset does not exist.  See Note 8 for additional information on reinsurance.

 

For the periods ended March 31, incurred costs related to prior years were attributable to the following factors:

 

 

 

Three Months Ended

 

(Dollars in millions)

 

March 31, 2017

 

March 31, 2016

 

 

 

$

 

%(1)

 

$

 

%(2)

 

Actual completion factors

 

$

78

 

0.4%

 

$

51

 

0.3%

 

Medical cost trend

 

98

 

0.5

 

28

 

0.1

 

Other (3)

 

-

 

-

 

(15)

 

(0.1)

 

Total favorable (unfavorable) variance

 

$

176

 

0.9%

 

$

64

 

0.3%

 

 

(1) Percentage of current year incurred costs as reported for the year ended December 31, 2016.

(2) Percentage of current year incurred costs as reported for the year ended December 31, 2015.

(3) Other amounts in 2016 related to increased medical costs in the Government segment resulting from additional provider risk sharing.

 

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Incurred costs related to prior years in the table above, although adjusted through shareholders’ net income, do not directly correspond to an increase or decrease to shareholders’ net income.  The primary reason for this difference is that decreases to prior year incurred costs pertaining to the portion of the liability established for moderately adverse conditions are not considered as impacting shareholders’ net income if they are offset by increases in the current year provision for moderately adverse conditions.

 

The net impact of prior year development on shareholders’ net income was a $61 million increase for the three months ended March 31, 2017 compared with a $14 million increase for the three months ended March 31, 2016.  Favorable prior year development implies primarily lower than expected utilization of medical services.

 

Note 7 Liabilities for Unpaid Claims and Claim Expenses

 

 

The following information relates to the Company’s unpaid claims and claim expense liabilities that are related to short-duration insurance contracts.  See Note 8 to the Consolidated Financial Statements in the Company’s 2016 Form 10-K for further information about the assumptions and estimates used to establish this liability.

 

The liability for unpaid claims and claim expenses by segment as of March 31 is as follows:

 

 

 

March 31,

 

March 31,

 

(In millions)

 

2017

 

2016

 

Group Disability and Life

 

$

4,384

 

$

4,146

 

Global Supplemental Benefits

 

425

 

367

 

Other Operations

 

197

 

211

 

Unpaid claims and claim expenses

 

$

5,006

 

$

4,724

 

 

Activity in the Company’s Group Disability and Life and the Global Supplemental Benefits segments’ liabilities for unpaid claims and claim expenses are presented in the following table.  Liabilities associated with the Company’s Other Operations segment are excluded because they pertain to obligations for long-duration insurance contracts or, if short-duration, the liabilities have been fully reinsured.

 

 

 

Three Months Ended

 

(In millions)

 

March 31, 2017

 

March 31, 2016

 

Beginning balance

 

$

4,726

 

$

4,359

 

Less: Reinsurance

 

121

 

115

 

Beginning balance, net

 

4,605

 

4,244

 

Incurred claims related to:

 

 

 

 

 

Current year

 

1,148

 

988

 

Prior years:

 

 

 

 

 

Interest accretion

 

43

 

43

 

All other incurred

 

(64)

 

105

 

Total incurred

 

1,127

 

1,136

 

Paid claims related to:

 

 

 

 

 

Current year

 

371

 

327

 

Prior years

 

691

 

660

 

Total paid

 

1,062

 

987

 

Foreign currency

 

16

 

5

 

Ending balance, net

 

4,686

 

4,398

 

Add: Reinsurance

 

123

 

115

 

Ending balance

 

$

4,809

 

$

4,513

 

 

Reinsurance in the table above reflects amounts due from reinsurers related to unpaid claims liabilities.  The Company’s insurance subsidiaries enter into agreements with other companies primarily to limit losses from large exposures and to permit recovery of a portion of incurred losses.  See Note 8 for additional information on reinsurance.

 

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Table of Contents

 

The majority of the liability for unpaid claims and claim expenses is related to disability claims with long-tailed payouts.  Interest earned on assets backing these liabilities is an integral part of pricing and reserving, and is therefore the basis for determining the rate used to discount these liabilities.  Accordingly, interest accreted on prior year balances is shown as a separate component of prior year incurred claims.  This interest is calculated by applying the average discount rate used in determining the liability balance to the average liability balance over the period.  The remaining prior year incurred claims amount primarily reflects updates to the Company’s liability estimates and variances between actual experience during the period relative to the assumptions and expectations reflected in determining the liability.  Assumptions reflect the Company’s expectations over the life of the book of business and will vary from actual experience in any period, both favorably and unfavorably, with variation in resolution rates being the most significant driver for the long-term disability business.  Favorable prior year incurred claims reported in 2017 largely reflect improved claim resolution rates.  Unfavorable prior year incurred claims reported in 2016 included the impact of modifications made to our disability claims management process and a period of elevated life claims.

 

Note 8 — Reinsurance

 

 

The Company’s insurance subsidiaries enter into agreements with other insurance companies to assume and cede reinsurance.  Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct or assumed losses.  Reinsurance is also used in acquisition and disposition transactions when the underwriting company is not being acquired.  Reinsurance does not relieve the originating insurer of liability.  The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of its credit risk.

 

Reinsurance Recoverables

 

The majority of the Company’s reinsurance recoverables resulted from acquisition and disposition transactions in which the underwriting company was not acquired.  Components of the Company’s reinsurance recoverables are presented below:

 

(In millions)

Line of Business

 

Reinsurer(s)

 

March 31,
2017

 

December 31,
2016

 

Collateral and Other Terms
at March 31, 2017

 

 

 

 

 

 

 

 

 

 

 

Ongoing operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Health Care, Global Supplemental Benefits, Group Disability and Life

 

Various

 

$

 478

 

$

 478

 

Recoverables from approximately 80 reinsurers including the U.S. Government, used in the ordinary course of business. Current balances range from less than $1 million up to $93 million. Excluding the recoverable from the U.S. Government of $39 million, over 60% of the balance is from companies rated investment grade by Standard & Poor’s, and 13% is secured by assets in trusts or letters of credit.

 

 

 

 

 

 

 

 

 

 

 

Total recoverables related to ongoing operations

 

 

 

478

 

478

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition, disposition or runoff activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individual Life and Annuity (sold in 1998)

 

Lincoln National Life and Lincoln Life & Annuity of New York

 

3,551

 

3,586

 

Both companies’ ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.

 

 

 

 

 

 

 

 

 

 

 

GMDB

 

Berkshire

 

1,052

 

1,085

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

42

 

44

 

100% secured by assets in a trust or letters of credit.

 

 

 

 

 

 

 

 

 

 

 

Retirement Benefits Business (sold in 2004)

 

Prudential Retirement Insurance and Annuity

 

904

 

921

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Supplemental Benefits Business (2012 acquisition)

 

Great American Life

 

293

 

297

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Other run-off reinsurance

 

Various

 

66

 

67

 

100% secured by assets in trusts.

 

 

 

 

 

 

 

 

 

 

 

Total recoverables related to acquisition, disposition or runoff activities

 

 

 

5,908

 

6,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total reinsurance recoverables

 

 

 

$

 6,386

 

$

 6,478

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.  The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable.  As of March 31, 2017, the Company’s recoverables were net of a reserve of approximately $3 million.

 

Effects of Reinsurance

 

In the Company’s Consolidated Statements of Income, premiums were reported net of amounts ceded to reinsurers and Global Health Care medical costs and other benefit expenses were reported net of reinsurance recoveries in the following amounts:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2017

 

2016

 

Ceded premiums:

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

39

 

$

41

 

Other

 

81

 

95

 

Total ceded premiums

 

$

120

 

$

136

 

Reinsurance recoveries:

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

70

 

$

68

 

Other

 

29

 

96

 

Total reinsurance recoveries

 

$

99

 

$

164

 

 

The decrease in reinsurance recoveries in 2017 is primarily due to the ceded GMDB business.  The ceded reserves declined during the three months ended March 31, 2017 due primarily to favorable equity market conditions, while the ceded reserves increased during the three months ended March 31, 2016 due to changes in the capital market assumptions that are used to calculate the reserves.

 

Effective Exit of GMDB and GMIB Business

 

In 2013, the Company entered into an agreement with Berkshire to effectively exit the GMDB and GMIB business via a reinsurance transaction.  Berkshire reinsured 100% of the Company’s future claim payments in this business, net of other reinsurance arrangements existing at that time.  The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.5 billion remaining as of March 31, 2017.

 

A discussion of each of these businesses follows.  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.

 

GMDB

 

The Company estimates the gross liability and reinsurance recoverable with an internal model based on the Company’s experience and future expectations over an extended period, consistent with the long-term nature of this product.  As a result of the reinsurance transaction, reserve increases have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB asset presented below).  The ending net retained reserve covers ongoing administrative expenses, as well as minor claim exposure retained by the Company.

 

Because the product is premium deficient, the Company records an increase to the net retained reserve if it is inadequate based on the model.

 

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Activity in future policy benefit reserves for the GMDB business was as follows:

 

 

 

For the period ended

 

 

March 31,

 

December 31,

 

(In millions)

 

2017

 

2016

 

Balance at January 1

 

$

1,224

 

$

1,252

 

Add: Unpaid claims

 

16

 

18

 

Less: Reinsurance and other amounts recoverable

 

1,129

 

1,164

 

Balance at January 1, net

 

111

 

106

 

Add: Incurred benefits

 

-

 

4

 

Less: Paid benefits (recoveries)

 

(1)

 

(1)

 

Ending balance, net

 

112

 

111

 

Less: Unpaid claims

 

18

 

16

 

Add: Reinsurance and other amounts recoverable

 

1,094

 

1,129

 

Ending balance

 

$

1,188

 

$

1,224

 

 

Benefits paid and incurred are net of ceded amounts.

 

The table below presents the account value, net amount at risk and number of underlying contractholders for guarantees assumed by the Company in the event of death.  The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date.  Unless the Berkshire reinsurance limit is exceeded, the Company should be reimbursed in full for these payments.

 

(Dollars in millions, excludes impact of reinsurance ceded)

 

March 31, 2017

 

December 31, 2016

 

Account value

 

$

10,755

 

$

10,650

 

Net amount at risk

 

$

2,335

 

$

2,458

 

Number of contractholders

 

280,000

 

285,000

 

 

GMIB

 

In this business, the Company reinsured contracts with issuers of GMIB products.  The Company’s exposure represents the excess of a contractually guaranteed amount over the level of variable annuity account values.  Payment by the Company depends on the actual account value in the underlying mutual funds and the level of interest rates when the contractholders elect to receive minimum income payments that must occur within 30 days of a policy anniversary after the appropriate waiting period.  The Company has purchased retrocessional coverage (“GMIB assets”) for these contracts.

 

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.

 

As of March 31, 2017, there were three reinsurers for GMIB as follows:

 

(In millions)

Line of Business

 

Reinsurer(s)

 

March 31,
2017

 

December 31,
2016

 

Collateral and Other Terms
at March 31, 2017

 

 

 

 

 

 

 

 

 

 

 

GMIB

 

Berkshire

 

  $

360

 

  $

370

 

100% secured by assets in a trust.

 

 

 

Sun Life Assurance Company of Canada

 

220

 

227

 

 

 

 

 

Liberty Re (Bermuda) Ltd.

 

197

 

202

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total GMIB recoverables reported in other assets

 

  $

777

 

  $

799

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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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 9.

 

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.

 

GMIB guarantees.  Future payments are not fixed and determinable under the terms of these contracts.  Accordingly, the Company calculated exposure, without considering any reinsurance coverage, using the following hypothetical assumptions:

 

·                  no annuitants surrendered their accounts;

·                  all annuitants lived to elect their benefit;

·                  all annuitants elected to receive their benefit on the next available date (2017 through 2021); and

·                  all underlying mutual fund investment values remained at the March 31, 2017 value of $818 million with no future returns.

 

The Company has reinsurance coverage in place that covers the exposures on these contracts.  Using these hypothetical assumptions, GMIB exposure is $665 million, which is lower than the recorded liability for GMIB calculated using fair value assumptions.

 

Note 9 — Fair Value Measurements

 

 

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.

 

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Table of Contents

 

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 for a sample of securities held across various asset types to validate the documented pricing process.

 

Financial Assets and Financial Liabilities Carried at Fair Value

 

The following tables provide information as of March 31, 2017 and December 31, 2016 about the Company’s financial assets and liabilities carried at fair value.  Separate account assets that are also recorded at fair value on the Company’s Consolidated Balance Sheets are reported separately under the heading “separate account assets” as gains and losses related to these assets generally accrue directly to policyholders.

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

 

Significant Other
Observable Inputs

 

Significant
Unobservable
Inputs

 

 

(In millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

March 31, 2017

 

 

 

 

 

 

 

 

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

372

 

$

525

 

$

-

 

$

897

State and local government

 

-

 

1,419

 

-

 

1,419

Foreign government

 

-

 

2,273

 

39

 

2,312

Corporate

 

-

 

16,144

 

483

 

16,627

Mortgage and other asset-backed

 

-

 

324

 

155

 

479

Total fixed maturities (1)

 

372

 

20,685

 

677

 

21,734

Equity securities

 

402

 

122

 

50

 

574

Subtotal

 

774

 

20,807

 

727

 

22,308

Short-term investments

 

-

 

303

 

-

 

303

GMIB assets

 

-

 

-

 

777

 

777

Other derivative assets

 

-

 

4

 

-

 

4

Total financial assets at fair value, excluding separate accounts

 

$

774

 

$

21,114

 

$

1,504

 

$

23,392

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

761

 

$

761

Other derivative liabilities

 

-

 

2

 

-

 

2

Total financial liabilities at fair value

 

$

-

 

$

2

 

$

761

 

$

763

 

(1) Fixed maturities includes $543 million of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $14 million of appreciation for securities classified in Level 3.  See Note 10 for additional information.

 

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Table of Contents

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

 

Significant Other
Observable Inputs

 

Significant
Unobservable
Inputs

 

 

(In millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

December 31, 2016

 

 

 

 

 

 

 

 

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

374

 

$

503

 

$

-

 

$

877

State and local government

 

-

 

1,435

 

-

 

1,435

Foreign government

 

-

 

2,066

 

47

 

2,113

Corporate

 

-

 

15,552

 

498

 

16,050

Mortgage and other asset-backed

 

-

 

329

 

157

 

486

Total fixed maturities (1)

 

374

 

19,885

 

702

 

20,961

Equity securities

 

396

 

113

 

74

 

583

Subtotal

 

770

 

19,998

 

776

 

21,544

Short-term investments

 

-

 

691

 

-

 

691

GMIB assets

 

-

 

-

 

799

 

799

Other derivative assets

 

-

 

10

 

-

 

10

Total financial assets at fair value, excluding separate accounts

 

$

770

 

$

20,699

 

$

1,575

 

$

23,044

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

780

 

$

780

Other derivative liabilities

 

-

 

5

 

-

 

5

Total financial liabilities at fair value

 

$

-

 

$

5

 

$

780

 

$

785

 

(1) Fixed maturities includes $524 million of net appreciation required to adjust future policy benefits for run-off settlement annuity business including $14 million of appreciation for securities classified in Level 3.

 

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 f