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Aetna 10-Q 2014
AET 03.31.2014 10-Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
    
FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 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: 1-16095

Aetna Inc.
(Exact name of registrant as specified in its charter)

Pennsylvania
(State or other jurisdiction of incorporation or organization)
23-2229683
(I.R.S. Employer Identification No.)
151 Farmington Avenue, Hartford, CT
(Address of principal executive offices)
06156
(Zip Code)
Registrant's telephone number, including area code:
(860) 273-0123
 
 
Former name, former address and former fiscal year, if changed since last report: N/A

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 þ
 
Accelerated filer o
Non-accelerated filer o  (Do not check if a smaller reporting company)
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). o Yes þ No

There were 357.4 million shares of the registrant's voting common stock with a par value of $.01 per share outstanding at March 31, 2014.




Aetna Inc.
Form 10-Q
For the Quarterly Period Ended March 31, 2014

Unless the context otherwise requires, references to the terms “we”, “our” or “us” used throughout this Quarterly Report on Form 10-Q (except the Report of Independent Registered Public Accounting Firm on page 34), refer to Aetna Inc. (a Pennsylvania corporation) (“Aetna”) and its subsidiaries (collectively, the “Company”).


Table of Contents
Page
 
 
 
Part I
Financial Information
 
 
 
 
Item 1.
Financial Statements
1
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
35
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
50
Item 4.
Controls and Procedures
50
 
 
 
Part II
Other Information
 
 
 
 
Item 1.
Legal Proceedings
50
Item 1A.
Risk Factors
50
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
51
Item 4.
Mine Safety Disclosures
51
Item 6.
Exhibits
52
 
 
 
Signatures
53
Index to Exhibits
54






Part I.
Financial Information

Item 1.
Financial Statements

Consolidated Statements of Income
(Unaudited)
 
 
 
 
For the Three Months
 
 
 
 
Ended March 31,
(Millions, except per common share data)
 
2014

 
2013

Revenue:
 
 
 
 
 
 
Health care premiums
 
 
 
$
11,911.7

 
$
7,785.8

Other premiums
 
 
 
561.6

 
521.3

Fees and other revenue (1)
 
 
 
1,248.8

 
966.4

Net investment income
 
 
 
244.2

 
235.1

Net realized capital gains
 
 
 
28.5

 
30.3

Total revenue
 
 
 
13,994.8

 
9,538.9

Benefits and expenses:
 
 
 
 
 
 
Health care costs (2)
 
 
 
9,576.3

 
6,379.5

Current and future benefits
 
 
 
578.7

 
559.3

Operating expenses:
 
 
 
 
 
 
Selling expenses
 
 
 
402.8

 
297.2

General and administrative expenses
 
 
 
2,047.6

 
1,442.0

Total operating expenses
 
 
 
2,450.4

 
1,739.2

Interest expense
 
 
 
85.6

 
77.8

Amortization of other acquired intangible assets
 
 
 
62.2

 
32.4

Loss on early extinguishment of long-term debt
 
 
 
91.9

 

Total benefits and expenses
 
 
 
12,845.1

 
8,788.2

Income before income taxes
 
 
 
1,149.7

 
750.7

Income taxes:
 
 
 
 
 
 
Current
 
 
 
418.5

 
266.8

Deferred
 
 
 
61.8

 
(7.0
)
Total income taxes
 
 
 
480.3

 
259.8

Net income including non-controlling interests
 
 
 
669.4

 
490.9

Less: Net income attributable to non-controlling interests
 
3.9

 
.8

Net income attributable to Aetna
 
 
 
$
665.5

 
$
490.1

Earnings per common share:
 
 
 
 
 
 
Basic
 
 
 
$
1.84

 
$
1.50

Diluted
 
 
 
$
1.82

 
$
1.48

 
 
 
 
 
 
 
(1) 
Fees and other revenue include administrative services contract member co-payments and plan sponsor reimbursements related to our mail order and specialty pharmacy operations of $21.8 million and $22.3 million (net of pharmaceutical and processing costs of $275.4 million and $268.9 million) for the three months ended March 31, 2014 and 2013, respectively.
(2) 
Health care costs have been reduced by Insured member co-payments related to our mail order and specialty pharmacy operations of $30.6 million and $31.0 million for the three months ended March 31, 2014 and 2013, respectively.

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

Page 1



Consolidated Statements of Comprehensive Income
(Unaudited)

 
For the Three Months
 
Ended March 31,
(Millions)
2014

 
2013

Net income including non-controlling interests
$
669.4

 
$
490.9

Other comprehensive income (loss), net of tax:
 
 
 
    Previously impaired debt securities: (1)
 
 
 
Net unrealized gains (losses) ($1.7 and $(14.5) pretax)
1.1

 
(9.4
)
Less: reclassification of gains (losses) to earnings ($.6 and $(5.7) pretax)
.4

 
(3.7
)
    Total previously impaired debt securities (1)
.7

 
(5.7
)
    All other securities:
 
 
 
Net unrealized gains (losses) ($211.0 and $(120.7) pretax)
137.2

 
(78.5
)
Less: reclassification of (losses) gains to earnings ($(5.0) and $25.1 pretax)
(3.3
)
 
15.8

    Total all other securities
140.5

 
(94.3
)
    Foreign currency and derivatives:
 
 
 
Net unrealized (losses) gains ($(19.2) and $10.3 pretax)
(12.5
)
 
6.7

Less: reclassification of gains (losses) to earnings ($15.6 and $(1.3) pretax)
10.1

 
(.8
)
    Total foreign currency and derivatives
(22.6
)
 
7.5

    Pension and other postretirement benefit (“OPEB”) plans:
 
 
 
Amortization of net actuarial losses ($(11.9) and $(19.4) pretax)
7.7

 
12.6

Amortization of prior service credit ($1.0 and $1.0 pretax)
(.6
)
 
(.6
)
Total pension and OPEB plans
7.1

 
12.0

Other comprehensive income (loss)
125.7

 
(80.5
)
Comprehensive income including non-controlling interests
795.1

 
410.4

Less: Comprehensive income attributable to non-controlling interests
3.9

 
.8

Comprehensive income attributable to Aetna
$
791.2

 
$
409.6

 
 
 
 
(1) 
Represents unrealized (losses) gains on the non-credit related component of impaired debt securities that we do not intend to sell and subsequent changes in the fair value of any previously impaired security.


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


Page 2



Consolidated Balance Sheets
 
 
 
 
(Unaudited)

 
 
(Millions)
 
 
 
At March 31, 2014

 
At December 31,
2013

Assets:
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
$
2,074.1

 
$
1,412.3

Investments
 
 
 
2,209.8

 
2,063.8

Premiums receivable, net
 
 
 
1,700.2

 
1,331.2

Other receivables, net
 
 
 
1,809.0

 
1,780.8

Accrued investment income
 
 
 
212.6

 
211.1

Collateral received under securities loan agreements
 
 
 
720.7

 
792.6

Income taxes receivable
 
 
 

 
69.2

Deferred income taxes
 
 
 
449.8

 
521.5

Other current assets
 
 
 
2,238.6

 
1,536.4

Total current assets
 
 
 
11,414.8

 
9,718.9

Long-term investments
 
 
 
21,290.4

 
20,935.0

Reinsurance recoverables
 
 
 
776.5

 
782.7

Goodwill
 
 
 
10,227.5

 
10,227.5

Other acquired intangible assets, net
 
 
 
2,031.9

 
2,094.1

Property and equipment, net
 
 
 
704.1

 
721.9

Other long-term assets
 
 
 
1,494.1

 
1,419.2

Separate Accounts assets
 
 
 
4,179.7

 
3,972.5

Total assets
 
 
 
$
52,119.0

 
$
49,871.8

 
 
 
 
 
 
 
Liabilities and shareholders' equity:
 
 
 
 

 
 

Current liabilities:
 
 
 
 

 
 

Health care costs payable
 
 
 
$
5,007.2

 
$
4,547.4

Future policy benefits
 
 
 
729.4

 
734.4

Unpaid claims
 
 
 
726.1

 
705.4

Unearned premiums
 
 
 
573.3

 
458.7

Policyholders' funds
 
 
 
1,925.7

 
1,727.3

Collateral payable under securities loan and repurchase agreements
 
 
 
877.0

 
792.6

Current portion of long-term debt
 
 
 
620.2

 
387.3

Income taxes payable
 
 
 
286.6

 

Accrued expenses and other current liabilities
 
 
 
3,835.7

 
3,226.9

Total current liabilities
 
 
 
14,581.2

 
12,580.0

Future policy benefits
 
 
 
6,609.0

 
6,656.8

Unpaid claims
 
 
 
1,630.3

 
1,619.3

Policyholders' funds
 
 
 
1,184.1

 
1,188.0

Long-term debt, less current portion
 
 
 
7,618.4

 
7,865.3

Deferred income taxes
 
 
 
940.9

 
864.2

Other long-term liabilities
 
 
 
1,014.4

 
1,047.5

Separate Accounts liabilities
 
 
 
4,179.7

 
3,972.5

Total liabilities
 
 
 
37,758.0

 
35,793.6

Commitments and contingencies (Note 13)
 
 
 


 


Shareholders' equity:
 
 
 
 
 
 

Common stock ($.01 par value; 2.6 billion shares authorized and 357.4 million shares issued
 
 

and outstanding in 2014; 2.6 billion shares authorized and 362.2 million shares issued and
 
 
 
 

outstanding in 2013) and additional paid-in capital
 
 
 
4,414.5

 
4,382.2

Retained earnings
 
 
 
10,675.5

 
10,555.4

Accumulated other comprehensive loss
 
 
 
(786.4
)
 
(912.1
)
Total Aetna shareholders' equity
 
 
 
14,303.6

 
14,025.5

Non-controlling interests
 
 
 
57.4

 
52.7

Total equity
 
 
 
14,361.0

 
14,078.2

Total liabilities and equity
 
 
 
$
52,119.0

 
$
49,871.8

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

Page 3



Consolidated Statements of Shareholders’ Equity
(Unaudited)

 
 
 
Attributable to Aetna
 
 
 
 
(Millions)
Number of
Common
Shares
Outstanding

 
Common
Stock and
Additional
Paid-in
Capital

 
Retained
Earnings

Accumulated
Other
Comprehensive
Loss
 
 
Total Aetna
Shareholders'
Equity

 
Non-Controlling Interests

Total
Equity
 
Three Months Ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
362.2

 
$
4,382.2

 
$
10,555.4

 
$
(912.1
)
 
$
14,025.5

 
$
52.7

 
$
14,078.2

Net income

 

 
665.5

 

 
665.5

 
3.9

 
669.4

Other increases in non-
 
 
 
 
 
 
 
 
 
 
 
 
 
  controlling interest

 

 

 

 

 
.8

 
.8

Other comprehensive income (Note 7)

 

 

 
125.7

 
125.7

 

 
125.7

Common shares issued for benefit
 
 
 
 
 
 
 
 
 
 
 
 
 
  plans, including tax benefits
1.7

 
32.4

 

 

 
32.4

 

 
32.4

Repurchases of common shares
(6.5
)
 
(.1
)
 
(464.9
)
 

 
(465.0
)
 

 
(465.0
)
Dividends declared

 

 
(80.5
)
 

 
(80.5
)
 

 
(80.5
)
Balance at March 31, 2014
357.4

 
$
4,414.5

 
$
10,675.5

 
$
(786.4
)
 
$
14,303.6

 
$
57.4

 
$
14,361.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
327.6

 
$
1,095.3

 
$
10,343.9

 
$
(1,033.4
)
 
$
10,405.8

 
$
23.4

 
$
10,429.2

Net income

 

 
490.1

 

 
490.1

 
.8

 
490.9

Other increases in non-
 
 
 
 
 
 
 
 
 
 
 
 
 
  controlling interest

 

 

 

 

 
21.7

 
21.7

Other comprehensive loss (Note 7)

 

 

 
(80.5
)
 
(80.5
)
 

 
(80.5
)
Common shares issued for benefit
 
 
 
 
 
 
 
 
 
 
 
 
 
  plans, including tax benefits
2.0

 
114.8

 

 

 
114.8

 

 
114.8

Repurchases of common shares
(3.7
)
 

 
(184.1
)
 

 
(184.1
)
 

 
(184.1
)
Dividends declared

 

 
(65.2
)
 

 
(65.2
)
 

 
(65.2
)
Balance at March 31, 2013
325.9

 
$
1,210.1

 
$
10,584.7

 
$
(1,113.9
)
 
$
10,680.9

 
$
45.9

 
$
10,726.8



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


Page 4



Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
 
Three Months Ended
 
 
 
 
March 31,
(Millions)
 
 
 
2014

 
2013

Cash flows from operating activities:
 
 
 
 
 
 
Net income including non-controlling interests
 
 
 
$
669.4

 
$
490.9

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Net realized capital gains
 
 
 
(28.5
)
 
(30.3
)
Depreciation and amortization
 
 
 
154.7

 
108.6

Debt fair value amortization
 
 
 
(15.1
)
 

Equity in earnings of affiliates, net
 
 
 
(20.6
)
 
(18.3
)
Stock-based compensation expense
 
 
 
38.8

 
24.5

Amortization of net investment premium
 
 
 
18.3

 
9.5

Loss on early extinguishment of long-term debt
 
 
 
91.9

 

Changes in assets and liabilities:
 
 
 
 
 
 
Accrued investment income
 
 
 
(1.5
)
 
2.9

Premiums due and other receivables
 
 
 
(337.0
)
 
(413.5
)
Income taxes
 
 
 
420.3

 
189.9

Other assets and other liabilities
 
 
 
(70.6
)
 
(103.5
)
Health care and insurance liabilities
 
 
 
501.4

 
280.2

Other, net
 
 
 
.7

 
2.9

Net cash provided by operating activities
 
 
 
1,422.2

 
543.8

Cash flows from investing activities:
 
 
 
 

 
 

Proceeds from sales and maturities of investments
 
 
 
2,219.6

 
2,711.0

Cost of investments
 
 
 
(2,379.6
)
 
(2,493.6
)
Additions to property, equipment and software
 
 
 
(93.8
)
 
(86.1
)
Other, net
 
 
 

 
2.5

Net cash (used for) provided by investing activities
 
 
 
(253.8
)
 
133.8

Cash flows from financing activities:
 
 
 
 

 
 

Repayment of long-term debt
 
 
 
(839.7
)
 

Issuance of long-term debt
 
 
 
741.9

 

Net issuance of short-term debt
 
 
 

 
99.9

Deposits and interest credited for investment contracts
 
 
 
1.1

 
1.2

Withdrawals of investment contracts
 
 
 
(1.0
)
 
(4.1
)
Common shares issued under benefit plans, net
 
 
 
(17.0
)
 
37.8

Stock-based compensation tax benefits
 
 
 
13.9

 
55.0

Proceeds from repurchase agreements
 
 
 
156.2

 

Common shares repurchased
 
 
 
(465.0
)
 
(184.1
)
Dividends paid to shareholders
 
 
 
(81.6
)
 
(65.5
)
Collateral on interest rate swaps
 
 
 
(16.7
)
 
9.2

Contributions, non-controlling interests
 
 
 
1.3

 
21.7

Net cash used for financing activities
 
 
 
(506.6
)
 
(28.9
)
Net increase in cash and cash equivalents
 
 
 
661.8

 
648.7

Cash and cash equivalents, beginning of period
 
 
 
1,412.3

 
2,579.2

Cash and cash equivalents, end of period
 
 
 
$
2,074.1

 
$
3,227.9

Supplemental cash flow information:
 
 
 
 

 
 

Interest paid
 
 
 
$
72.9

 
$
32.4

Income taxes paid
 
 
 
46.2

 
13.4

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

Page 5



Condensed Notes to Consolidated Financial Statements
(Unaudited)

1.
Organization

We conduct our operations in three business segments:

Health Care consists of medical, pharmacy benefit management services, dental, behavioral health and vision plans offered on both an Insured basis (where we assume all or a majority of the risk for medical and dental care costs) and an employer-funded basis (where the plan sponsor under an administrative services contract (“ASC”) assumes all or a majority of this risk) and emerging businesses products and services, such as Accountable Care Solutions (“ACS”), that complement and enhance our medical products. Medical products include point-of-service (“POS”), preferred provider organization (“PPO”), health maintenance organization (“HMO”) and indemnity benefit plans. Medical products also include health savings accounts (“HSAs”) and Aetna HealthFund®, consumer-directed health plans that combine traditional POS or PPO and/or dental coverage, subject to a deductible, with an accumulating benefit account (which may be funded by the plan sponsor and/or the member in the case of HSAs). We also offer Medicare and Medicaid products and services and other medical products, such as medical management and data analytics services, medical stop loss insurance, workers' compensation administrative services and products that provide access to our provider network in select geographies.

Group Insurance primarily includes group life insurance and group disability products. Group life insurance products are offered on an Insured basis, and include basic and supplemental group term life, group universal life, supplemental or voluntary programs and accidental death and dismemberment coverage. Group disability products consist primarily of short-term and long-term disability products (and products which combine both), which are offered to employers on both an Insured and an ASC basis, and absence management services offered to employers, which include short-term and long-term disability administration and leave management. Group Insurance also includes long-term care products that were offered primarily on an Insured basis, which provide benefits covering the cost of care in private home settings, adult day care, assisted living or nursing facilities. We no longer solicit or accept new long-term care customers.

Large Case Pensions manages a variety of retirement products (including pension and annuity products) primarily for tax-qualified pension plans. These products provide a variety of funding and benefit payment distribution options and other services. Large Case Pensions also includes certain discontinued products (refer to Note 16 beginning on page 32 for additional information).

On May 7, 2013 (the “Effective Date”), we completed the acquisition of Coventry Health Care, Inc. (“Coventry”) in a transaction valued at approximately $8.7 billion, including the fair value of Coventry's outstanding debt. Refer to Note 3 beginning on page 8 for additional information.

2.
Summary of Significant Accounting Policies

Interim Financial Statements
These interim financial statements necessarily rely on estimates, including assumptions as to annualized tax rates.  In the opinion of management, all adjustments necessary for a fair statement of results for the interim periods have been made.  All such adjustments are of a normal, recurring nature.  The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes presented in our 2013 Annual Report on Form 10-K (our “2013 Annual Report”).  Certain financial information that is normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), but that is not required for interim reporting purposes, has been condensed or omitted.  We have omitted certain footnote disclosures that would

Page 6



substantially duplicate the disclosures in our 2013 Annual Report, unless the information contained in those disclosures materially changed and is required by GAAP.  We evaluated subsequent events that occurred after March 31, 2014 through the date the financial statements were issued and determined there were no other items to disclose other than those disclosed in Notes 3 and 10 beginning on pages 8 and 25, respectively.

Reclassifications
Certain reclassifications were made to 2013 financial information to conform with the 2014 presentation.

Principles of Consolidation
The accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP and include the accounts of Aetna and the subsidiaries we control.  All significant intercompany balances have been eliminated in consolidation.

Accounting for certain provisions of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, “Health Care Reform” or “ACA”)
We are participating in certain public health insurance exchanges established pursuant Health Care Reform. Under regulations established by the U.S. Department of Health and Human Services (“HHS”), HHS pays us a portion of the premium (“Premium Subsidy”) and/or a portion of the health care costs (“Cost Sharing Subsidy”) for low-income individual members. In addition, HHS administers certain risk management programs as described below.

We recognize monthly premiums received from members and the Premium Subsidy as premium revenue ratably over the contract period. The Cost Sharing Subsidy offsets health care costs when incurred. We record a liability if the Cost Sharing Subsidy is paid in advance or a receivable if incurred health care costs exceed the Cost Sharing Subsidy received to date.

Accounting for Health Care Reform's Reinsurance, Risk Adjustment and Risk Corridor (the “3Rs”)
Reinsurance
Health Care Reform established a temporary three-year reinsurance program, whereby all issuers of major medical commercial insurance products and self-insured plan sponsors are required to contribute funding in amounts set by HHS. Funds collected will be utilized to reimburse issuers' high claims costs incurred for qualified individual members. The expense related to this required funding is reflected in general and administrative expenses for all of our insurance products with the exception of products associated with qualified individual members; this expense for qualified individual members is reflected as a reduction of premium revenue. When annual claim costs incurred by our qualified individual members exceed a specified attachment point, we are entitled to certain reimbursements from this program. We record a receivable and offset health care costs to reflect our estimate of these recoveries.

Risk Adjustment
Health Care Reform established a permanent risk adjustment program to transfer funds from qualified individual and small group insurance plans with below average risk scores to those respective plans with above average risk scores. Based on the risk of our qualified plan members compared to the risk of members of other qualified plans in comparable markets, we estimate our ultimate 2014 risk adjustment receivable or payable and reflect the pro-rata year-to-date impact as an adjustment to our premium revenue.

Risk Corridor
Health Care Reform established a temporary three-year risk sharing program. Under this program we make (or receive) a payment to (or from) HHS based on the ratio of allowable costs to target costs (as defined by Health Care Reform). Risk corridor payments from HHS will be limited to the extent of the risk corridor collections received by HHS over the duration of the program. We record a risk corridor receivable or payable as an adjustment to premium revenue on a pro-rata year-to-date basis based on our estimate of the ultimate 2014 risk sharing amount.

We will perform a final reconciliation and settlement with HHS of the 2014 Cost Sharing Subsidy and 3Rs in 2015.


Page 7



New Accounting Standards
Fees Paid to the Federal Government by Health Insurers
Effective January 1, 2014, we adopted new accounting guidance relating to the recognition and income statement reporting of the mandated fee to be paid to the federal government by health insurers. This guidance applies to the new health insurer fee (“HIF”) included in Health Care Reform. This new accounting guidance resulted in the establishment on January 1, 2014, of a liability for our portion of the entire estimated 2014 annual HIF. This amount is reflected in accrued expenses and other liabilities with a corresponding amount reflected in other current assets.  The pro-rata year-to-date portion of the annual HIF is reflected on a straight-line basis in general and administrative expenses with a corresponding reduction in other current assets.  The HIF for 2014 is expected to be paid no later than September 30, 2014 and is not tax deductible.

Amendments to the Scope, Measurement and Disclosure Requirements of Investment Companies
Effective January 1, 2014, we adopted new accounting guidance relating to the approach for determining whether an entity is considered an investment company for accounting purposes. This guidance clarified the characteristics and set measurement and disclosure requirements for an investment company for accounting purposes. The adoption of this new guidance did not have an impact on our financial position or operating results.

Future Application of Accounting Standards
Accounting for Investments in Qualified Affordable Housing Projects
Effective January 1, 2015, we will be permitted to make an accounting policy election to adopt new accounting guidance relating to the recognition of amortization of investments in qualified affordable housing projects. The guidance sets forth a new method of measurement, referred to as the proportional amortization method, under which income and expense items related to qualified affordable housing projects would be allocated to the income taxes line item. If we elect to adopt this new guidance, such adoption is not expected to have a material impact on our financial position or operating results.

Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
Effective January 1, 2015, we will adopt amended accounting guidance related to when an entity reports a discontinued operation in its financial position and operating results.  The guidance clarifies that a discontinued operation is required to be reported if the disposal represents a significant shift that has (or will have) a major effect on an entity’s major operations and financial results when a component of an entity or a group of components of an entity are either classified as held for sale or are disposed of by sale.  The amendments also require additional disclosures about discontinued operations. If we have a discontinued operation after the effective date, these changes could result in increased reporting and disclosure requirements in our financial statements.

3.
Acquisitions; Completed Disposition

Acquisition of the InterGlobal Group
In April 2014, we acquired the InterGlobal group, a company that specializes in international private medical insurance for groups and individuals in the Middle East, Asia, Africa and Europe. The goodwill related to this acquisition will be assigned to our Health Care segment. The purchase price was not material. The transaction closed after March 31, 2014, and therefore has not been reflected in these financial statements.

Acquisition of Coventry
On August 19, 2012, we entered into a definitive agreement (as amended, the “Merger Agreement”) to acquire Coventry. On the Effective Date, we acquired Coventry in a transaction valued at approximately $8.7 billion, including the $1.8 billion fair value of Coventry's outstanding long-term debt.

Pursuant to the terms of the Merger Agreement, an Aetna subsidiary merged with and into Coventry (the “Merger”), with Coventry continuing as the surviving corporation and a wholly-owned subsidiary of Aetna. Under the terms of the Merger Agreement, Coventry stockholders received $27.30 in cash and 0.3885 of an Aetna common share for each share of Coventry common stock (including restricted shares but excluding shares held by Coventry as treasury stock) outstanding at the effective time of the Merger. As a result, on the Effective Date, we issued

Page 8



approximately 52.2 million Aetna common shares, with a fair value of approximately $3.1 billion and paid approximately $3.8 billion in cash in exchange for all of the outstanding shares of Coventry common stock and outstanding awards. Substantially all of Coventry's outstanding equity awards vested and were paid out in cash and canceled in connection with the Merger. An insignificant amount of outstanding Coventry equity awards that pursuant to their terms did not vest at the effective time of the Merger were converted into cash-settled Aetna restricted stock units in connection with the Merger. We funded the cash portion of the purchase price with a combination of proceeds from the issuance of long-term debt, commercial paper and available cash on hand.

The transaction has been accounted for using the acquisition method of accounting which requires, among other things, the assets acquired and liabilities assumed to be recognized at their fair values at the Effective Date.
The amounts recognized for certain assets acquired and liabilities assumed are preliminary until the initial accounting for the acquisition is complete. The following items, among others, are considered preliminary until we gather sufficient information for the initial accounting to be complete:
the nature and amounts recognized for current and deferred income tax assets and liabilities;
the nature, amounts recognized and measurement basis of certain liabilities, including liabilities arising from contingencies recognized at acquisition; and
quantitative information related to goodwill recorded at acquisition.

Pro Forma Impact of Acquisition
The following table presents supplemental pro forma information for the three months ended March 31, 2013, as if the Merger had occurred on January 1, 2012. The unaudited pro forma consolidated results are not necessarily indicative of what our consolidated results would have been had the Merger been completed on January 1, 2012. In addition, the unaudited pro forma consolidated results do not purport to project the future results of the combined company nor do they reflect the expected realization of any cost savings associated with the Merger.
 
Three Months Ended
(Millions, except per common share data)
March 31, 2013
Total revenue
$
12,939.4

Net income attributable to Aetna
638.6

Earnings per share:
 
Basic
$
1.69

Diluted
1.67

 
 

The unaudited pro forma consolidated results for the three months ended March 31, 2013 reflect the following pro forma adjustments:
Elimination of intercompany transactions between Aetna and Coventry, primarily related to network rental fees.
Foregone interest income associated with cash and cash equivalents and investments assumed to have been used to partially fund the Merger.
Foregone interest income associated with adjusting the amortized cost of Coventry's investment portfolio to fair value as of the completion of the Merger.
Elimination of historical Coventry intangible asset amortization expense and capitalized internal-use software amortization expense and addition of intangible asset amortization expense relating to intangibles valued as part of the acquisition.
Interest expense was reduced for the amortization of the fair value adjustment to long-term debt.
Elimination of transaction-related costs incurred by Aetna and Coventry during 2013.
Adjustment of the above pro forma adjustments for the applicable tax impact.
Conforming adjustments to align Coventry's presentation to Aetna's accounting policies.
Elimination of revenue and directly identifiable costs related to the sale of Aetna's Missouri Medicaid business, Missouri Care, Incorporated (“Missouri Care”), to WellCare Health Plans, Inc. on March 31, 2013.


Page 9



Completed Disposition
In connection with the acquisition of Coventry, on March 31, 2013, we completed the sale of Missouri Care to WellCare Health Plans, Inc. The sale price was not material, and the transaction did not have a material impact on our financial position or operating results.

4.
Earnings Per Common Share

Basic earnings per share (“EPS”) is computed by dividing net income attributable to Aetna by the weighted average number of common shares outstanding during the reporting period.  Diluted EPS is computed in a similar manner, except that the weighted average number of common shares outstanding is adjusted for the dilutive effects of our outstanding stock-based compensation awards, but only if the effect is dilutive.

The computations of basic and diluted EPS for the three months ended March 31, 2014 and 2013 are as follows:
(Millions, except per common share data)
2014

 
2013

Net income attributable to Aetna
$
665.5

 
$
490.1

Weighted average shares used to compute basic EPS
361.6

 
327.6

Dilutive effect of outstanding stock-based compensation awards
3.4

 
3.1

Weighted average shares used to compute diluted EPS
365.0

 
330.7

Basic EPS
$
1.84

 
$
1.50

Diluted EPS
$
1.82

 
$
1.48

 
 
 
 

The stock-based compensation awards excluded from the calculation of diluted EPS for the three months ended March 31, 2014 and 2013 are as follows:
(Millions)
2014

 
2013

Stock appreciation rights ("SARs") (1)
1.3

 
6.7

Market stock units ("MSUs") (2)
.4

 
.4

Performance stock units ("PSUs") (2)
.7

 
.8

Performance stock appreciation rights ("PSARs") (2)
.2

 

 
 
 
 
(1) 
SARs are excluded from the calculation of diluted EPS if the exercise price is greater than the average market price of Aetna common shares during the period (i.e., the awards are anti-dilutive).
(2) 
PSUs, certain MSUs with performance conditions and PSARs are excluded from the calculation of diluted EPS if all necessary performance conditions have not been satisfied at the end of the reporting period.

All outstanding stock options were included in the calculation of diluted EPS for the three months ended March 31, 2014 and 2013.

In connection with the May 7, 2013 acquisition of Coventry, we issued approximately 52.2 million Aetna common shares in exchange for all the outstanding shares of Coventry common stock. Those Aetna common shares were outstanding for the entire three months ended March 31, 2014 and weighted accordingly.


Page 10



5.     Operating Expenses

For the three months ended March 31, 2014 and 2013, selling expenses (which include broker commissions, the variable component of our internal sales force compensation and premium taxes) and general and administrative expenses were as follows:
(Millions)
2014

 
2013

Selling expenses
$
402.8

 
$
297.2

General and administrative expenses:
 
 
 
Salaries and related benefits
1,110.7

 
802.5

  Other general and administrative expenses  (1) (2) (3)
936.9

 
639.5

Total general and administrative expenses
2,047.6

 
1,442.0

Total operating expenses
$
2,450.4

 
$
1,739.2

 
 
 
 
(1) 
The three months ended March 31, 2014 include estimated ACA mandated fees comprised primarily of the HIF and our contribution to the funding of the reinsurance program of $154.8 million and $84.9 million, respectively. Refer to Note 2 beginning on page 6 for additional information on ACA mandated fees.
(2) 
The three months ended March 31, 2014 include $63.7 million of integration-related costs related to the acquisition of Coventry. The three months ended March 31, 2013 include $24.3 million of transaction and integration-related costs related to the acquisition of Coventry, including advisory, legal and other professional services fees and transaction-related payments.
(3) 
In the fourth quarter of 2012, we recorded a charge of $120.0 million pretax related to the settlement of purported class action litigation regarding Aetna's payment practices related to out-of-network health care providers. That charge included the estimated cost of legal fees of plaintiffs' counsel and the costs of administering the settlement. In the first quarter of 2014, we exercised our right to terminate the settlement agreement. As a result, we released the reserve established in connection with the settlement agreement, net of amounts due to the settlement administrator, which reduced first quarter 2014 other general and administrative expenses by $103.0 million pretax. Refer to Note 13 beginning on page 27 for additional information on the termination of the settlement agreement.

Refer to the reconciliation of operating earnings to net income attributable to Aetna in Note 14 beginning on page 30 for additional information.

6.     Investments

Total investments at March 31, 2014 and December 31, 2013 were as follows:
 
March 31, 2014
 
December 31, 2013
(Millions)
Current

 
Long-term

 
Total

 
Current

 
Long-term

 
Total

Debt and equity securities available for sale
$
2,121.0

 
$
18,099.2

 
$
20,220.2

 
$
1,977.4

 
$
17,753.0

 
$
19,730.4

Mortgage loans
83.1

 
1,464.5

 
1,547.6

 
84.9

 
1,464.7

 
1,549.6

Other investments
5.7

 
1,726.7

 
1,732.4

 
1.5

 
1,717.3

 
1,718.8

Total investments
$
2,209.8

 
$
21,290.4

 
$
23,500.2

 
$
2,063.8

 
$
20,935.0

 
$
22,998.8


At March 31, 2014, approximately $156 million of investments were pledged as collateral under repurchase agreements. We did not have any repurchase agreements outstanding at December 31, 2013. At March 31, 2014 and December 31, 2013, approximately $696 million and $766 million, respectively, of investments were pledged under securities loan agreements.


Page 11



Debt and Equity Securities
Debt and equity securities available for sale at March 31, 2014 and December 31, 2013 were as follows:
(Millions)
Amortized
Cost

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
 
Fair
Value

March 31, 2014
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
U.S. government securities
$
1,325.4

 
$
77.8

 
$
(1.1
)
 
 
$
1,402.1

States, municipalities and political subdivisions
4,043.1

 
182.9

 
(39.4
)
 
 
4,186.6

U.S. corporate securities
7,725.4

 
572.3

 
(55.5
)
 
 
8,242.2

Foreign securities
3,267.0

 
244.3

 
(26.1
)
 
 
3,485.2

Residential mortgage-backed securities
960.0

 
18.0

 
(14.9
)
 
 
963.1

Commercial mortgage-backed securities
1,389.4

 
84.0

 
(3.1
)
(1) 
 
1,470.3

Other asset-backed securities
336.7

 
8.2

 
(1.2
)
(1) 
 
343.7

Redeemable preferred securities
56.8

 
9.7

 

 
 
66.5

Total debt securities
19,103.8

 
1,197.2

 
(141.3
)
 
 
20,159.7

Equity securities
45.8

 
19.4

 
(4.7
)
 
 
60.5

Total debt and equity securities (2)
$
19,149.6

 
$
1,216.6

 
$
(146.0
)
 
 
$
20,220.2

December 31, 2013
 

 
 

 
 

 
 
 

Debt securities:
 

 
 

 
 

 
 
 

U.S. government securities
$
1,396.8

 
$
68.7

 
$
(3.0
)
 
 
$
1,462.5

States, municipalities and political subdivisions
4,118.5

 
126.6

 
(82.8
)
 
 
4,162.3

U.S. corporate securities
7,559.0

 
493.7

 
(110.1
)
 
 
7,942.6

Foreign securities
3,209.6

 
198.9

 
(53.0
)
 
 
3,355.5

Residential mortgage-backed securities
928.4

 
16.9

 
(21.1
)
 
 
924.2

Commercial mortgage-backed securities
1,323.5

 
88.2

 
(4.7
)
(1) 
 
1,407.0

Other asset-backed securities
343.4

 
8.3

 
(2.1
)
(1) 
 
349.6

Redeemable preferred securities
56.8

 
8.6

 

 
 
65.4

Total debt securities
18,936.0

 
1,009.9

 
(276.8
)
 
 
19,669.1

Equity securities
38.5

 
26.5

 
(3.7
)
 
 
61.3

Total debt and equity securities (2)
$
18,974.5

 
$
1,036.4

 
$
(280.5
)
 
 
$
19,730.4

 
 
 
 
 
 
 
 
 
(1) 
At March 31, 2014 and December 31, 2013, we held securities for which we previously recognized $18.6 million and $22.8 million, respectively, of non-credit related impairments in accumulated other comprehensive loss. These securities had a net unrealized capital gain at March 31, 2014 and December 31, 2013 of $5.4 million and $6.6 million, respectively.
(2) 
Investment risks associated with our experience-rated and discontinued products generally do not impact our operating results (refer to Note 16 beginning on page 32 for additional information on our accounting for discontinued products).  At March 31, 2014, debt and equity securities with a fair value of approximately $3.7 billion, gross unrealized capital gains of $348.8 million and gross unrealized capital losses of $28.6 million and, at December 31, 2013, debt and equity securities with a fair value of approximately $3.7 billion, gross unrealized capital gains of $291.3 million and gross unrealized capital losses of $60.3 million were included in total debt and equity securities, but support our experience-rated and discontinued products.  Changes in net unrealized capital gains (losses) on these securities are not reflected in accumulated other comprehensive income.


Page 12



The fair value of debt securities at March 31, 2014 is shown below by contractual maturity.  Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid.
(Millions)
Fair
Value

Due to mature:
 
Less than one year
$
949.1

One year through five years
5,424.2

After five years through ten years
5,721.0

Greater than ten years
5,288.3

Residential mortgage-backed securities
963.1

Commercial mortgage-backed securities
1,470.3

Other asset-backed securities
343.7

Total
$
20,159.7

 
Mortgage-Backed and Other Asset-Backed Securities
All of our residential mortgage-backed securities at March 31, 2014 were issued by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation and carry agency guarantees and explicit or implicit guarantees by the U.S. Government.  At March 31, 2014, our residential mortgage-backed securities had an average credit quality rating of AAA and a weighted average duration of 4.9 years.

Our commercial mortgage-backed securities have underlying loans that are dispersed throughout the United States.  Significant market observable inputs used to value these securities include probability of default and loss severity.  At March 31, 2014, these securities had an average credit quality rating of AA+ and a weighted average duration of 2.5 years.

Our other asset-backed securities have a variety of underlying collateral (e.g., automobile loans, credit card receivables and home equity loans).  Significant market observable inputs used to value these securities include the unemployment rate, loss severity and probability of default.  At March 31, 2014, these securities had an average credit quality rating of AA+ and a weighted average duration of 2.8 years.

Unrealized Capital Losses and Net Realized Capital Gains (Losses)
When a debt or equity security is in an unrealized capital loss position, we monitor the duration and severity of the loss to determine if sufficient market recovery can occur within a reasonable period of time.  We recognize an other-than-temporary impairment (“OTTI”) when we intend to sell a debt security that is in an unrealized capital loss position or if we determine a credit-related loss on a debt or equity security has occurred.


Page 13



Summarized below are the debt and equity securities we held at March 31, 2014 and December 31, 2013 that were in an unrealized capital loss position, aggregated by the length of time the investments have been in that position:
 
Less than 12 months
 
Greater than 12 months
 
Total (1)
(Millions)
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
$
51.4

 
$
.8

 
$
13.4

 
$
.3

 
$
64.8

 
$
1.1

States, municipalities and political subdivisions
1,136.1

 
31.5

 
155.7

 
7.9

 
1,291.8

 
39.4

U.S. corporate securities
1,558.4

 
39.3

 
181.9

 
16.2

 
1,740.3

 
55.5

Foreign securities
569.3

 
18.9

 
100.9

 
7.2

 
670.2

 
26.1

Residential mortgage-backed securities
462.5

 
11.7

 
35.0

 
3.2

 
497.5

 
14.9

Commercial mortgage-backed securities
183.2

 
2.7

 
24.9

 
.4

 
208.1

 
3.1

Other asset-backed securities
73.1

 
1.1

 
2.0

 
.1

 
75.1

 
1.2

Redeemable preferred securities
4.4

 

 

 

 
4.4

 

Total debt securities
4,038.4

 
106.0

 
513.8

 
35.3

 
4,552.2

 
141.3

Equity securities

 

 
15.0

 
4.7

 
15.0

 
4.7

Total debt and equity securities (1)
$
4,038.4

 
$
106.0

 
$
528.8

 
$
40.0

 
$
4,567.2

 
$
146.0

December 31, 2013
 

 
 

 
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

 
 

 
 

U.S. government securities
$
555.9

 
$
2.7

 
$
13.4

 
$
.3

 
$
569.3

 
$
3.0

States, municipalities and political subdivisions
1,779.9

 
73.1

 
132.4

 
9.7

 
1,912.3

 
82.8

U.S. corporate securities
2,196.8

 
88.0

 
170.0

 
22.1

 
2,366.8

 
110.1

Foreign securities
875.2

 
43.5

 
90.9

 
9.5

 
966.1

 
53.0

Residential mortgage-backed securities
541.1

 
17.3

 
35.0

 
3.8

 
576.1

 
21.1

Commercial mortgage-backed securities
162.4

 
4.2

 
25.0

 
.5

 
187.4

 
4.7

Other asset-backed securities
87.8

 
1.9

 
7.7

 
.2

 
95.5

 
2.1

Redeemable preferred securities
4.4

 

 

 

 
4.4

 

Total debt securities
6,203.5

 
230.7

 
474.4

 
46.1

 
6,677.9

 
276.8

Equity securities

 

 
16.2

 
3.7

 
16.2

 
3.7

Total debt and equity securities (1)
$
6,203.5

 
$
230.7

 
$
490.6

 
$
49.8

 
$
6,694.1

 
$
280.5

 
 
 
 
 
 
 
 
 
 
 
 
(1) 
At March 31, 2014 and December 31, 2013, debt and equity securities in an unrealized capital loss position of $28.6 million and $60.3 million, respectively, and with related fair value of $598.0 million and $1.0 billion, respectively, related to experience-rated and discontinued products.

We reviewed the securities in the tables above and concluded that these are performing assets generating investment income to support the needs of our business.  In performing this review, we considered factors such as the quality of the investment security based on research performed by our internal credit analysts and external rating agencies and the prospects of realizing the carrying value of the security based on the investment’s current prospects for recovery.  At March 31, 2014, we did not intend to sell these securities, and we did not believe it was more likely than not that we would be required to sell these securities prior to anticipated recovery of their carrying value.


Page 14



The maturity dates for debt securities in an unrealized capital loss position at March 31, 2014 were as follows:
 
Supporting discontinued and
experience-rated products
 
Supporting remaining
products
 
Total
(Millions)
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

 
Fair
Value

 
Unrealized
Losses

Due to mature:
 
 
 
 
 
 
 
 
 
 
 
Less than one year
$

 
$

 
$
38.9

 
$
.8

 
$
38.9

 
$
.8

One year through five years
25.6

 
.3

 
882.1

 
8.1

 
907.7

 
8.4

After five years through ten years
244.3

 
7.7