10-Q 1 unh201493010-q.htm 10-Q UNH 2014.9.30 10-Q

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________ 
Form 10-Q
__________________________________________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014
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: 1-10864
__________________________________________________________ 
    
UnitedHealth Group Incorporated
(Exact name of registrant as specified in its charter)
 __________________________________________________________ 
Minnesota
 
41-1321939
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
UnitedHealth Group Center
9900 Bren Road East
Minnetonka, Minnesota
 
55343
(Address of principal executive offices)
 
(Zip Code)
(952) 936-1300
(Registrant’s telephone number, including area code)
__________________________________________________________  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
x
 
Accelerated filer
o
 
Non-accelerated filer
o
 
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No x
As of October 31, 2014, there were 959,791,117 shares of the registrant’s Common Stock, $.01 par value per share, issued and outstanding.
 
 
 
 
 



UNITEDHEALTH GROUP
Table of Contents
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 







PART I
ITEM 1.    FINANCIAL STATEMENTS

UnitedHealth Group
Condensed Consolidated Balance Sheets
(Unaudited)
(in millions, except per share data)
 
September 30,
2014
 
December 31,
2013
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
7,233

 
$
7,276

Short-term investments
 
1,979

 
1,937

Accounts receivable, net
 
3,826

 
3,052

Other current receivables, net
 
5,189

 
3,998

Assets under management
 
2,855

 
2,757

Deferred income taxes
 
520

 
430

Prepaid expenses and other current assets
 
1,361

 
930

Total current assets
 
22,963

 
20,380

Long-term investments
 
19,346

 
19,605

Property, equipment and capitalized software, net
 
4,309

 
4,010

Goodwill
 
32,357

 
31,604

Other intangible assets, net
 
3,579

 
3,844

Other assets
 
2,872

 
2,439

Total assets
 
$
85,426

 
$
81,882

Liabilities and shareholders’ equity
 
 
 
 
Current liabilities:
 
 
 
 
Medical costs payable
 
$
12,328

 
$
11,575

Accounts payable and accrued liabilities
 
8,394

 
7,458

Other policy liabilities
 
5,792

 
5,279

Commercial paper and current maturities of long-term debt
 
2,925

 
1,969

Unearned revenues
 
1,691

 
1,600

Total current liabilities
 
31,130

 
27,881

Long-term debt, less current maturities
 
14,592

 
14,891

Future policy benefits
 
2,487

 
2,465

Deferred income taxes
 
1,901

 
1,796

Other liabilities
 
1,326

 
1,525

Total liabilities
 
51,436

 
48,558

Commitments and contingencies (Note 9)
 
 
 


Redeemable noncontrolling interests
 
1,386

 
1,175

Shareholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value - 10 shares authorized; no shares issued or outstanding
 

 

Common stock, $0.01 par value - 3,000 shares authorized;
962 and 988 issued and outstanding
 
10

 
10

Retained earnings
 
33,578

 
33,047

Accumulated other comprehensive loss
 
(984
)
 
(908
)
Total shareholders’ equity
 
32,604

 
32,149

Total liabilities and shareholders’ equity
 
$
85,426

 
$
81,882

See Notes to the Condensed Consolidated Financial Statements

1


UnitedHealth Group
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
(in millions, except per share data)
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
 
Premiums
 
$
28,972

 
$
27,356

 
$
85,927

 
$
81,850

Services
 
2,535

 
2,280

 
7,386

 
6,636

Products
 
1,080

 
825

 
3,115

 
2,325

Investment and other income
 
172

 
163

 
613

 
561

Total revenues
 
32,759

 
30,624

 
97,041

 
91,372

Operating costs:
 
 
 
 
 
 
 
 
Medical costs
 
23,092

 
22,044

 
69,823

 
66,786

Operating costs
 
5,436

 
4,869

 
15,836

 
14,308

Cost of products sold
 
955

 
731

 
2,776

 
2,082

Depreciation and amortization
 
373

 
349

 
1,097

 
1,025

Total operating costs
 
29,856

 
27,993

 
89,532

 
84,201

Earnings from operations
 
2,903

 
2,631

 
7,509

 
7,171

Interest expense
 
(152
)
 
(178
)
 
(467
)
 
(532
)
Earnings before income taxes
 
2,751

 
2,453

 
7,042

 
6,639

Provision for income taxes
 
(1,149
)
 
(883
)
 
(2,933
)
 
(2,393
)
Net earnings
 
1,602

 
1,570

 
4,109

 
4,246

Earnings attributable to noncontrolling interests
 

 

 

 
(48
)
Net earnings attributable to UnitedHealth Group common shareholders
 
$
1,602

 
$
1,570

 
$
4,109

 
$
4,198

Earnings per share attributable to UnitedHealth Group common shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
1.65

 
$
1.56

 
$
4.21

 
$
4.16

Diluted
 
$
1.63

 
$
1.53

 
$
4.15

 
$
4.09

Basic weighted-average number of common shares outstanding
 
969

 
1,004

 
977

 
1,009

Dilutive effect of common share equivalents
 
13

 
20

 
13

 
17

Diluted weighted-average number of common shares outstanding
 
982

 
1,024

 
990

 
1,026

Anti-dilutive shares excluded from the calculation of dilutive effect of common share equivalents
 
7

 
7

 
8

 
11

Cash dividends declared per common share
 
$
0.3750

 
$
0.2800

 
$
1.0300

 
$
0.7725


See Notes to the Condensed Consolidated Financial Statements

2



UnitedHealth Group
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
 
2014
 
2013
 
2014
 
2013
Net earnings
 
$
1,602

 
$
1,570

 
$
4,109

 
$
4,246

Other comprehensive loss:
 
 
 
 
 
 
 
 
Gross unrealized (losses) gains on investment securities during the period
 
(53
)
 
26

 
427

 
(475
)
Income tax effect
 
20

 
(9
)
 
(155
)
 
172

Total unrealized (losses) gains, net of tax
 
(33
)
 
17

 
272

 
(303
)
Gross reclassification adjustment for net realized gains included in net earnings
 
(30
)
 
(31
)
 
(183
)
 
(137
)
Income tax effect
 
11

 
11

 
67

 
50

Total reclassification adjustment, net of tax
 
(19
)
 
(20
)
 
(116
)
 
(87
)
Total foreign currency translation losses
 
(642
)
 
(49
)
 
(232
)
 
(635
)
Other comprehensive loss
 
(694
)
 
(52
)
 
(76
)
 
(1,025
)
Comprehensive income
 
908

 
1,518

 
4,033

 
3,221

Comprehensive income attributable to noncontrolling interests
 

 

 

 
(48
)
Comprehensive income attributable to UnitedHealth Group common shareholders
 
$
908

 
$
1,518

 
$
4,033

 
$
3,173


See Notes to the Condensed Consolidated Financial Statements

3


UnitedHealth Group
Condensed Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited)
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total Shareholders’
Equity
(in millions)
 
Shares
 
Amount
 
 
 
Net Unrealized Gains (Losses) on Investments
 
Foreign Currency Translation Losses
 
Balance at January 1, 2014
 
988

 
$
10

 
$

 
$
33,047

 
$
54

 
$
(962
)
 
$
32,149

Net earnings attributable to UnitedHealth Group common shareholders
 
 
 
 
 
 
 
4,109

 
 
 
 
 
4,109

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
156

 
(232
)
 
(76
)
Issuances of common shares, and related tax effects
 
12

 

 
130

 
 
 
 
 
 
 
130

Share-based compensation, and related tax benefits
 
 
 
 
 
320

 
 
 
 
 
 
 
320

Common share repurchases
 
(38
)
 

 
(450
)
 
(2,574
)
 
 
 
 
 
(3,024
)
Cash dividends paid on common shares
 
 
 
 
 
 
 
(1,004
)
 
 
 
 
 
(1,004
)
Balance at September 30, 2014
 
962

 
$
10

 
$

 
$
33,578

 
$
210

 
$
(1,194
)
 
$
32,604

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
 
1,019

 
$
10

 
$
66

 
$
30,664

 
$
516

 
$
(78
)
 
$
31,178

Net earnings attributable to UnitedHealth Group common shareholders
 
 
 
 
 
 
 
4,198

 
 
 
 
 
4,198

Other comprehensive loss
 
 
 
 
 
 
 
 
 
(390
)
 
(635
)
 
(1,025
)
Issuances of common shares, and related tax effects
 
16

 

 
397

 
 
 
 
 
 
 
397

Share-based compensation, and related tax benefits
 
 
 
 
 
312

 
 
 
 
 
 
 
312

Common share repurchases
 
(37
)
 

 
(856
)
 
(1,492
)
 
 
 
 
 
(2,348
)
Acquisition of noncontrolling interests and related tax effects
 
 
 
 
 
81

 
 
 
 
 
 
 
81

Cash dividends paid on common shares
 
 
 
 
 
 
 
(777
)
 
 
 
 
 
(777
)
Balance at September 30, 2013
 
998

 
$
10

 
$

 
$
32,593

 
$
126

 
$
(713
)
 
$
32,016



See Notes to the Condensed Consolidated Financial Statements

4


UnitedHealth Group
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
Nine Months Ended September 30,
(in millions)
 
2014
 
2013
Operating activities
 
 
 
 
Net earnings
 
$
4,109

 
$
4,246

Noncash items:
 
 
 
 
Depreciation and amortization
 
1,097

 
1,025

Deferred income taxes
 
(107
)
 
93

Share-based compensation
 
269

 
255

Other, net
 
(253
)
 
(118
)
Net change in other operating items, net of effects from acquisitions and changes in AARP balances:
 
 
 
 
Accounts receivable
 
(545
)
 
(120
)
Other assets
 
(819
)
 
(590
)
Medical costs payable
 
654

 
788

Accounts payable and other liabilities
 
1,126

 
392

Other policy liabilities
 

 
(68
)
Unearned revenues
 
91

 
20

Cash flows from operating activities
 
5,622

 
5,923

Investing activities
 
 
 
 
Purchases of investments
 
(7,823
)
 
(8,798
)
Sales of investments
 
5,810

 
3,779

Maturities of investments
 
2,266

 
3,871

Cash paid for acquisitions, net of cash assumed
 
(851
)
 
(330
)
Purchases of property, equipment and capitalized software
 
(1,121
)
 
(986
)
Proceeds from disposal of property, equipment and capitalized software
 

 
146

Other, net
 
(139
)
 
45

Cash flows used for investing activities
 
(1,858
)
 
(2,273
)
Financing activities
 
 
 
 
Acquisition of noncontrolling interest shares
 

 
(1,474
)
Common stock repurchases
 
(3,024
)
 
(2,348
)
Cash dividends paid
 
(1,004
)
 
(777
)
Proceeds from common stock issuances
 
400

 
538

Repayments of long-term debt
 
(812
)
 
(1,560
)
Proceeds from (repayments of) commercial paper, net
 
1,355

 
(529
)
Proceeds from issuance of long-term debt
 

 
2,235

Customer funds administered
 
(440
)
 
308

Other, net
 
(285
)
 
(76
)
Cash flows used for financing activities
 
(3,810
)
 
(3,683
)
Effect of exchange rate changes on cash and cash equivalents
 
3

 
(87
)
Decrease in cash and cash equivalents
 
(43
)
 
(120
)
Cash and cash equivalents, beginning of period
 
7,276

 
8,406

Cash and cash equivalents, end of period
 
$
7,233

 
$
8,286


See Notes to the Condensed Consolidated Financial Statements

5


UnitedHealth Group
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
1.Basis of Presentation
Basis of Presentation
UnitedHealth Group Incorporated (individually and together with its subsidiaries, “UnitedHealth Group” and “the Company”) is a diversified health and well-being company dedicated to helping people live healthier lives and making health care work better. The Company offers a broad spectrum of products and services through two distinct platforms: UnitedHealthcare, which provides health care coverage and benefits services; and Optum, which provides information and technology-enabled health services.
The Company has prepared the Condensed Consolidated Financial Statements according to U.S. Generally Accepted Accounting Principles (GAAP) and has included the accounts of UnitedHealth Group and its subsidiaries. The year-end condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by GAAP. In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC), the Company has omitted certain footnote disclosures that would substantially duplicate the disclosures contained in its annual audited Consolidated Financial Statements. Therefore, these Condensed Consolidated Financial Statements should be read together with the Consolidated Financial Statements and the Notes included in Part II, Item 8, “Financial Statements” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the SEC (2013 10-K). The accompanying Condensed Consolidated Financial Statements include all normal recurring adjustments necessary to present the interim financial statements fairly.
On January 1, 2014, the Company realigned certain of its businesses to respond to changes in the markets it serves and the opportunities that are emerging as the health system evolves. The Company’s Optum business platform took responsibility for certain technology operations and business processing activities with the intention of pursuing additional third-party commercial opportunities in addition to continuing to serve UnitedHealthcare. These activities, which were historically a corporate function, are now included in OptumInsight’s results of operations. The Company’s reportable segments remain the same and prior period segment financial information has been recast to conform to the 2014 presentation. See Note 10 for segment financial information.
Use of Estimates
These Condensed Consolidated Financial Statements include certain amounts based on the Company’s best estimates and judgments. The Company’s most significant estimates relate to estimates and judgments for medical costs payable and revenues, valuation and impairment analysis of goodwill and other intangible assets, estimates of other policy liabilities and other current receivables, valuations of certain investments, and estimates and judgments related to income taxes and contingent liabilities. Certain of these estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any change in estimates is included in earnings in the period in which the estimate is adjusted.
Accounting Policies
Industry Tax. The Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (together, Health Reform Legislation or ACA) include an annual, nondeductible insurance industry tax (Industry Tax) to be levied proportionally across the insurance industry for risk-based health insurance products that began on January 1, 2014.
The Company estimates its liability for the Industry Tax based on a ratio of the Company’s applicable net premiums written compared to the U.S. health insurance industry total applicable net premiums, both for the previous calendar year. The Company records in full the estimated liability for the Industry Tax at the beginning of the calendar year with a corresponding deferred cost that is amortized to operating costs on the Condensed Consolidated Statements of Operations using a straight-line method of allocation over the calendar year. The liability is recorded in accounts payable and accrued liabilities and the corresponding deferred cost is recorded in prepaid expenses and other current assets on the Condensed Consolidated Balance Sheets. In September 2014, the Company paid its 2014 Industry Tax liability of $1.3 billion. As of September 30, 2014 the unamortized asset related to the Industry Tax was $335 million. The Company has experienced a higher effective income tax rate in 2014 as compared to 2013 due to the nondeductible nature of the Industry Tax.
Premium Stabilization Programs. Since the beginning of 2014, Health Reform Legislation has included three programs designed to stabilize health insurance markets (Premium Stabilization Programs): a permanent risk adjustment program; a temporary risk corridors program; and a transitional reinsurance program (Reinsurance Program).


6


The risk-adjustment provisions of Health Reform Legislation are permanent regulations and apply to market reform compliant individual and small group plans in the commercial markets. Under the program, each covered member is assigned a risk score based upon demographic information and applicable diagnostic codes from the current year paid claims, in order to determine an average risk score for each plan in a particular state and market risk pool. Generally, a plan with an average risk score that is less than the state’s average risk score will pay into a pool, while a plan with an average risk score that is greater than the state’s average risk score will receive money from the pool.
The risk corridors provisions of Health Reform Legislation will be in place for three years and are intended to limit the gains and losses of individual and small group qualified health plans. Plans are required to calculate the U.S. Department of Health and Human Services (HHS) risk corridor ratio of allowable costs (defined as medical claims plus quality improvement costs adjusted for the impact of reinsurance recoveries and the risk adjustment program) to the defined target amount (defined as actual premiums less defined allowable administrative costs inclusive of taxes and profits). Qualified health plans with ratios below 97% are required to make payments to HHS, while plans with ratios greater than 103% will receive funds from HHS.
The Reinsurance Program is a temporary three year program that is funded on a per capita basis from all commercial lines of business including insured and self-funded arrangements. Only issuers of market reform compliant individual plans are eligible for reinsurance recoveries from the risk pools.
None of the Premium Stabilization Programs have had a material impact on the Condensed Consolidated Financial Statements.
All other accounting policies disclosed in Note 2 of Notes to the Consolidated Financial Statements in Part II, Item 8, “Financial Statements” in the 2013 10-K remain unchanged.
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (ASU 2014-09). ASU 2014-09 will supersede existing revenue recognition standards with a single model unless those contracts are within the scope of other standards (e.g., an insurance entity’s insurance contracts). The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, new and enhanced disclosures will be required. Companies can adopt the new standard either using the full retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach. ASU 2014-09 will become effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the effect of the new revenue recognition guidance.
The Company has determined that there have been no other recently adopted or issued accounting standards that had, or will have, a material impact on its Condensed Consolidated Financial Statements.

7


2.Investments
A summary of short-term and long-term investments by major security type is as follows:
(in millions)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
September 30, 2014
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
1,839

 
$
3

 
$
(3
)
 
$
1,839

State and municipal obligations
 
6,609

 
221

 
(4
)
 
6,826

Corporate obligations
 
7,459

 
113

 
(22
)
 
7,550

U.S. agency mortgage-backed securities
 
2,053

 
27

 
(13
)
 
2,067

Non-U.S. agency mortgage-backed securities
 
884

 
10

 
(4
)
 
890

Total debt securities - available-for-sale
 
18,844

 
374

 
(46
)
 
19,172

Equity securities - available-for-sale
 
1,628

 
24

 
(16
)
 
1,636

Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
178

 
3

 

 
181

State and municipal obligations
 
28

 

 

 
28

Corporate obligations
 
311

 

 

 
311

Total debt securities - held-to-maturity
 
517

 
3

 

 
520

Total investments
 
$
20,989

 
$
401

 
$
(62
)
 
$
21,328

December 31, 2013
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
2,211

 
$
5

 
$
(21
)
 
$
2,195

State and municipal obligations
 
6,902

 
147

 
(72
)
 
6,977

Corporate obligations
 
7,265

 
130

 
(60
)
 
7,335

U.S. agency mortgage-backed securities
 
2,256

 
23

 
(61
)
 
2,218

Non-U.S. agency mortgage-backed securities
 
697

 
12

 
(7
)
 
702

Total debt securities - available-for-sale
 
19,331

 
317

 
(221
)
 
19,427

Equity securities - available-for-sale
 
1,576

 
9

 
(13
)
 
1,572

Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
181

 
1

 

 
182

State and municipal obligations
 
28

 

 

 
28

Corporate obligations
 
334

 

 

 
334

Total debt securities - held-to-maturity
 
543

 
1

 

 
544

Total investments
 
$
21,450

 
$
327

 
$
(234
)
 
$
21,543


8



The fair values of the Company’s mortgage-backed securities by credit rating (when multiple credit ratings are available for an individual security, the average of the available ratings is used) and origination date as of September 30, 2014 were as follows:
(in millions)
 
AAA
 
AA
 
Non-Investment
Grade
 
Total Fair
Value
2014
 
$
212

 
$

 
$

 
$
212

2013
 
164

 

 

 
164

2012
 
84

 

 

 
84

2011
 
17

 

 

 
17

2010
 
23

 

 

 
23

2009
 
6

 

 

 
6

Pre - 2009
 
370

 
2

 
12

 
384

U.S. agency mortgage-backed securities
 
2,065

 
2

 

 
2,067

Total
 
$
2,941

 
$
4

 
$
12

 
$
2,957

The Company includes any securities backed by Alt-A or subprime mortgages and any commercial mortgage loans in default in the non-investment grade column in the table above.
The amortized cost and fair value of available-for-sale debt securities as of September 30, 2014, by contractual maturity, were as follows:
(in millions)
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
2,068

 
$
2,077

Due after one year through five years
 
7,055

 
7,152

Due after five years through ten years
 
4,955

 
5,068

Due after ten years
 
1,829

 
1,918

U.S. agency mortgage-backed securities
 
2,053

 
2,067

Non-U.S. agency mortgage-backed securities
 
884

 
890

Total debt securities - available-for-sale
 
$
18,844

 
$
19,172

The amortized cost and fair value of held-to-maturity debt securities as of September 30, 2014, by contractual maturity, were as follows:
(in millions)
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
84

 
$
85

Due after one year through five years
 
218

 
218

Due after five years through ten years
 
119

 
120

Due after ten years
 
96

 
97

Total debt securities - held-to-maturity
 
$
517

 
$
520


9


The fair value of available-for-sale investments with gross unrealized losses by major security type and length of time that individual securities have been in a continuous unrealized loss position were as follows:
 
 
Less Than 12 Months
 
12 Months or Greater
 
 Total
(in millions)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
747

 
$
(2
)
 
$
61

 
$
(1
)
 
$
808

 
$
(3
)
State and municipal obligations
 
254

 
(2
)
 
138

 
(2
)
 
392

 
(4
)
Corporate obligations
 
2,331

 
(12
)
 
452

 
(10
)
 
2,783

 
(22
)
U.S. agency mortgage-backed securities
 
213

 
(1
)
 
378

 
(12
)
 
591

 
(13
)
Non-U.S. agency mortgage-backed securities
 
279

 
(1
)
 
120

 
(3
)
 
399

 
(4
)
Total debt securities - available-for-sale
 
$
3,824

 
$
(18
)
 
$
1,149

 
$
(28
)
 
$
4,973

 
$
(46
)
Equity securities - available-for-sale
 
$
99

 
$
(4
)
 
$
95

 
$
(12
)
 
$
194

 
$
(16
)
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
1,055

 
$
(19
)
 
$
17

 
$
(2
)
 
$
1,072

 
$
(21
)
State and municipal obligations
 
2,491

 
(62
)
 
128

 
(10
)
 
2,619

 
(72
)
Corporate obligations
 
2,573

 
(51
)
 
103

 
(9
)
 
2,676

 
(60
)
U.S. agency mortgage-backed securities
 
1,393

 
(51
)
 
105

 
(10
)
 
1,498

 
(61
)
Non-U.S. agency mortgage-backed securities
 
289

 
(6
)
 
26

 
(1
)
 
315

 
(7
)
Total debt securities - available-for-sale
 
$
7,801

 
$
(189
)
 
$
379

 
$
(32
)
 
$
8,180

 
$
(221
)
Equity securities - available-for-sale
 
$
180

 
$
(13
)
 
$

 
$

 
$
180

 
$
(13
)
The Company’s unrealized losses from all securities as of September 30, 2014 were generated from approximately 5,100 positions out of a total of 22,000 positions. The Company believes that it will collect the principal and interest due on its debt securities that have an amortized cost in excess of fair value. The unrealized losses were primarily caused by interest rate increases and not by unfavorable changes in the credit quality associated with these securities. At each reporting period, the Company evaluates securities for impairment when the fair value of the investment is less than its amortized cost. The Company evaluated the underlying credit quality and credit ratings of the issuers, noting neither a significant deterioration since purchase nor other factors leading to an other-than-temporary impairment (OTTI). As of September 30, 2014, the Company did not have the intent to sell any of the securities in an unrealized loss position. Therefore, the Company believes these losses to be temporary.
The Company’s investments in equity securities consist of investments in Brazilian real denominated fixed-income funds, employee savings plan related investments, venture capital funds, and dividend paying stocks. The Company evaluated its investments in equity securities for severity and duration of unrealized loss, overall market volatility and other market factors.

10


Net realized gains reclassified out of accumulated other comprehensive income were from the following sources:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions)
 
2014
 
2013
 
2014
 
2013
Total OTTI
 
$
(18
)
 
$
(3
)
 
$
(25
)
 
$
(7
)
Portion of loss recognized in other comprehensive income
 

 

 

 

Net OTTI recognized in earnings
 
(18
)
 
(3
)
 
(25
)
 
(7
)
Gross realized losses from sales
 
(3
)
 

 
(42
)
 
(3
)
Gross realized gains from sales
 
51

 
34

 
250

 
147

Net realized gains (included in investment and other income on the Condensed Consolidated Statements of Operations)
 
30

 
31

 
183

 
137

Income tax effect (included in provision for income taxes on the Condensed Consolidated Statements of Operations)
 
(11
)
 
(11
)
 
(67
)
 
(50
)
Realized gains, net of taxes
 
$
19

 
$
20

 
$
116

 
$
87

3.
Fair Value
Certain assets and liabilities are measured at fair value in the Condensed Consolidated Financial Statements or have fair values disclosed in the Notes to the Condensed Consolidated Financial Statements. These assets and liabilities are classified into one of three levels of a hierarchy defined by GAAP. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement is categorized in its entirety based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
The fair value hierarchy is summarized as follows:
Level 1 — Quoted prices (unadjusted) for identical assets/liabilities in active markets.
Level 2 — Other observable inputs, either directly or indirectly, including:
Quoted prices for similar assets/liabilities in active markets;
Quoted prices for identical or similar assets/liabilities in nonactive markets (e.g., few transactions, limited information, noncurrent prices, high variability over time);
Inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, implied volatilities, credit spreads); and
Inputs that are corroborated by other observable market data.
Level 3 — Unobservable inputs that cannot be corroborated by observable market data.
Transfers between levels, if any, are recorded as of the beginning of the reporting period in which the transfer occurs; there were no transfers between Levels 1, 2 or 3 of any financial assets or liabilities during 2014 or 2013.
Nonfinancial assets and liabilities or financial assets and liabilities that are measured at fair value on a nonrecurring basis are subject to fair value adjustments only in certain circumstances, such as when the Company records an impairment. There were no significant fair value adjustments for these assets and liabilities recorded during the nine months ended September 30, 2014 or 2013.
The following methods and assumptions were used to estimate the fair value and determine the fair value hierarchy classification of each class of financial instrument included in the tables below:
Cash and Cash Equivalents. The carrying value of cash and cash equivalents approximates fair value as maturities are less than three months. Fair values of cash equivalent instruments that do not trade on a regular basis in active markets are classified as Level 2.
Debt and Equity Securities. Fair values of debt and equity securities are based on quoted market prices, where available. The Company obtains one price for each security primarily from a third-party pricing service (pricing service), which generally uses quoted or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, and, if necessary, makes adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to,

11


benchmark yields, credit spreads, default rates, prepayment speeds and nonbinding broker quotes. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to prices reported by a secondary pricing source, such as its custodian, its investment consultant and third-party investment advisors. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. The Company’s internal price verification procedures and reviews of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
Fair values of debt securities that do not trade on a regular basis in active markets but are priced using other observable inputs are classified as Level 2.
Fair value estimates for Level 1 and Level 2 equity securities are based on quoted market prices for actively traded equity securities and/or other market data for the same or comparable instruments and transactions in establishing the prices.
The fair values of Level 3 investments in venture capital portfolios are estimated using a market valuation technique that relies heavily on management assumptions and qualitative observations. Under the market approach, the fair values of the Company’s various venture capital investments are computed using limited quantitative and qualitative observations of activity for similar companies in the current market. The Company’s market modeling utilizes, as applicable, transactions for comparable companies in similar industries that also have similar revenue and growth characteristics and preferences in their capital structure. Key significant unobservable inputs in the market technique include implied earnings before interest, taxes, depreciation and amortization (EBITDA) multiples and revenue multiples. Additionally, the fair values of certain of the Company’s venture capital securities are based off of recent transactions in inactive markets for identical or similar securities. Significant changes in any of these inputs could result in significantly lower or higher fair value measurements.
Throughout the procedures discussed above in relation to the Company’s processes for validating third-party pricing information, the Company validates the understanding of assumptions and inputs used in security pricing and determines the proper classification in the hierarchy based on that understanding.
AARP Program-related Investments. The Company provides health insurance products and services to members of AARP under a Supplemental Health Insurance Program (AARP Program). AARP Program-related investments consist of debt securities and other investments held to fund costs associated with the AARP Program and are priced and classified using the same methodologies as the Company’s investments in debt and equity securities.
Interest Rate Swaps. Fair values of the Company’s swaps are estimated using the terms of the swaps and publicly available information including market yield curves. Because the swaps are unique and not actively traded but are valued using other observable inputs, the fair values are classified as Level 2.
Long-term Debt. The fair values of the Company’s long-term debt are estimated and classified using the same methodologies as the Company’s investments in debt securities.
AARP Program-related Other Liabilities. AARP Program-related other liabilities consist of liabilities that represent the amount of net investment gains and losses related to AARP Program-related investments that accrue to the benefit of the AARP policyholders.

12


The following table presents a summary of fair value measurements by level and carrying values for items measured at fair value on a recurring basis in the Condensed Consolidated Balance Sheets excluding AARP Program-related assets and liabilities, which are presented in a separate table below:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
Fair and Carrying
Value
September 30, 2014
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
7,221

 
$
12

 
$

 
$
7,233

Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
1,612

 
227

 

 
1,839

State and municipal obligations
 

 
6,826

 

 
6,826

Corporate obligations
 

 
7,490

 
60

 
7,550

U.S. agency mortgage-backed securities
 

 
2,067

 

 
2,067

Non-U.S. agency mortgage-backed securities
 

 
884

 
6

 
890

Total debt securities - available-for-sale
 
1,612

 
17,494

 
66

 
19,172

Equity securities - available-for-sale
 
1,323

 
12

 
301

 
1,636

Interest rate swap assets
 

 
21

 

 
21

Total assets at fair value

$
10,156

 
$
17,539

 
$
367

 
$
28,062

Percentage of total assets at fair value
 
36
%
 
63
%
 
1
%
 
100
%
Interest rate swap liabilities
 
$

 
$
62

 
$

 
$
62

December 31, 2013
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
7,005

 
$
271

 
$

 
$
7,276

Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
1,750

 
445

 

 
2,195

State and municipal obligations
 

 
6,977

 

 
6,977

Corporate obligations
 
25

 
7,274

 
36

 
7,335

U.S. agency mortgage-backed securities
 

 
2,218

 

 
2,218

Non-U.S. agency mortgage-backed securities
 

 
696

 
6

 
702

Total debt securities - available-for-sale
 
1,775

 
17,610

 
42

 
19,427

Equity securities - available-for-sale
 
1,291

 
12

 
269

 
1,572

Total assets at fair value
 
$
10,071

 
$
17,893

 
$
311

 
$
28,275

Percentage of total assets at fair value
 
36
%
 
63
%
 
1
%
 
100
%
Interest rate swap liabilities
 
$

 
$
163

 
$

 
$
163


13


The following table presents a summary of fair value measurements by level and carrying values for certain financial instruments not measured at fair value on a recurring basis in the Condensed Consolidated Balance Sheets:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
Fair
Value
 
Total Carrying Value
September 30, 2014
 
 
 
 
 
 
 
 
 
 
Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
181

 
$

 
$

 
$
181

 
$
178

State and municipal obligations
 

 

 
28

 
28

 
28

Corporate obligations
 
48

 
9

 
254

 
311

 
311

Total debt securities - held-to-maturity
 
$
229

 
$
9

 
$
282

 
$
520

 
$
517

Long-term debt and other financing obligations
 
$

 
$
16,557

 
$

 
$
16,557

 
$
15,047

December 31, 2013
 
 
 
 
 
 
 
 
 
 
Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
182

 
$

 
$

 
$
182

 
$
181

State and municipal obligations
 

 

 
28

 
28

 
28

Corporate obligations
 
47

 
9

 
278

 
334

 
334

Total debt securities - held-to-maturity
 
$
229

 
$
9

 
$
306

 
$
544

 
$
543

Long-term debt and other financing obligations
 
$

 
$
16,602

 
$

 
$
16,602

 
$
15,745

The carrying amounts reported on the Condensed Consolidated Balance Sheets for other financial assets and liabilities approximate fair value because of their short-term nature. These assets and liabilities are not listed in the table above.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows:
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
Debt
Securities
 
Equity
Securities
 
Total
 
Debt
Securities
 
Equity
Securities
 
Total
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
57

 
$
302

 
$
359

 
$
42

 
$
269

 
$
311

Purchases
 
11

 
36

 
47

 
24

 
86

 
110

Sales
 

 
(18
)
 
(18
)
 

 
(169
)
 
(169
)
Net unrealized (losses) gains in other comprehensive income
 
(2
)
 
(4
)
 
(6
)
 

 
6

 
6

Net realized (losses) gains in investment and other income
 

 
(15
)
 
(15
)
 

 
109

 
109

Balance at end of period
 
$
66

 
$
301

 
$
367

 
$
66

 
$
301

 
$
367

September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
38

 
$
245

 
$
283

 
$
17

 
$
224

 
$
241

Purchases
 
3

 
9

 
12

 
25

 
51

 
76

Sales
 
(7
)
 

 
(7
)
 
(7
)
 
(21
)
 
(28
)
Net unrealized losses in other comprehensive income
 

 
(7
)
 
(7
)
 
(1
)
 
(13
)
 
(14
)
Net realized (losses) gains in investment and other income
 
(1
)
 
(1
)
 
(2
)
 
(1
)
 
5

 
4

Balance at end of period
 
$
33

 
$
246

 
$
279

 
$
33

 
$
246

 
$
279


14


The following table presents quantitative information regarding unobservable inputs that were significant to the valuation of assets measured at fair value on a recurring basis using Level 3 inputs:
 
 
 
 
 
 
 
 
Range
(in millions)
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Low
 
High
September 30, 2014
 
 
 
 
 
 
 
 
 
 
Equity securities - available-for-sale
 
 
 
 
 
 
 
 
 
 
Venture capital portfolios
 
$
245

 
Market approach - comparable companies
 
Revenue multiple
 
1.0
 
5.0
 
 
 
 
 
 
EBITDA multiple
 
8.0
 
10.0
 
 
56

 
Market approach - recent transactions
 
Inactive market transactions
 
N/A
 
N/A
Total equity securities
     available-for-sale
 
$
301

 
 
 
 
 
 
 
 
Also included in the Company’s assets measured at fair value on a recurring basis using Level 3 inputs were $66 million of available-for-sale debt securities as of September 30, 2014, which were not significant.
The Company elected to measure the entirety of the AARP Program assets under management at fair value pursuant to the fair value option. See Note 2 of Notes to the Consolidated Financial Statements in Item II, Part 8, “Financial Statements” in the Company’s 2013 10-K for further detail on the AARP Program. The following table presents fair value information about the AARP Program-related financial assets and liabilities:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Total
Fair and Carrying
Value
September 30, 2014
 
 
 
 
 
 
Cash and cash equivalents
 
$
330

 
$

 
$
330

Debt securities:
 
 
 
 
 
 
U.S. government and agency obligations
 
409

 
245

 
654

State and municipal obligations
 

 
81

 
81

Corporate obligations
 

 
1,180

 
1,180

U.S. agency mortgage-backed securities
 

 
365

 
365

Non-U.S. agency mortgage-backed securities
 

 
166

 
166

Total debt securities
 
409

 
2,037

 
2,446

Other investments
 

 
79

 
79

Total assets at fair value
 
$
739

 
$
2,116

 
$
2,855

Other liabilities
 
$
4

 
$
12

 
$
16

December 31, 2013
 
 
 
 
 
 
Cash and cash equivalents
 
$
265

 
$

 
$
265

Debt securities:
 
 
 
 
 
 
U.S. government and agency obligations
 
426

 
301

 
727

State and municipal obligations
 

 
63

 
63

Corporate obligations
 

 
1,145

 
1,145

U.S. agency mortgage-backed securities
 

 
414

 
414

Non-U.S. agency mortgage-backed securities
 

 
139

 
139

Total debt securities
 
426

 
2,062

 
2,488

Equity securities - available-for-sale
 

 
4

 
4

Total assets at fair value
 
$
691

 
$
2,066

 
$
2,757

Other liabilities
 
$
3

 
$
11

 
$
14


15


4.
Medicare Part D Pharmacy Benefits
The Condensed Consolidated Balance Sheets include the following amounts associated with the Medicare Part D program:
 
 
September 30, 2014
 
December 31, 2013
(in millions)
 
Subsidies
 
Drug Discount
 
Risk-Share
 
Subsidies
 
Drug Discount
 
Risk-Share
Other current receivables
 
$
1,626

 
$
592

 
$

 
$
881

 
$
425

 
$

Other policy liabilities
 

 
313

 
165

 

 
152

 
214

The Catastrophic Reinsurance and Low-Income Member Cost Sharing Subsidies (Subsidies) and drug discounts represent cost reimbursements under the Medicare Part D program. The Company is fully reimbursed by the Centers for Medicare & Medicaid Services (CMS) for costs incurred for these contract elements and, accordingly, there is no insurance risk to the Company. Amounts received for these contract elements are not reflected as premium revenues, but rather are accounted for as a reduction of receivables and/or increase in deposit liabilities. CMS provides prospective payments for the drug discounts, which the Company records as liabilities when received. The drug discounts are ultimately funded by the pharmaceutical manufacturers. The Company bills manufacturers for claims under the program and records those bills as receivables. Related cash flows for all of these cost reimbursements are presented as customer funds administered within financing activities on the Condensed Consolidated Statements of Cash Flows.
Premiums from CMS are subject to risk-sharing provisions based on a comparison of the Company’s annual bid estimates of prescription drug costs and the actual costs incurred. Variances may result in CMS making additional payments to the Company or require the Company to remit funds to CMS subsequent to the end of the year. The Company records risk-share adjustments to premium revenue and to other current receivables or other policy liabilities on the Condensed Consolidated Balance Sheets. See Note 2 of Notes to the Consolidated Financial Statements in Item II, Part 8, “Financial Statements” in the Company’s 2013 10-K for further detail on Medicare Part D.
5.
Medical Cost Reserve Development
The following table provides details of the Company's favorable medical cost reserve development:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
 
2014
 
2013
 
2014
 
2013
Related to prior years
 
$
120

 
$
180

 
$
380

 
$
580

Related to current year
 
150

 
110

 
N/A

 
N/A

In both the three and nine months ended September 30, 2014, the favorable medical cost reserve development was driven by a number of individual factors that were not material. Lower than expected health system utilization levels were a significant driver in both the three and nine months ended September 30, 2013.

16