CIGNA Corporation 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
[ ] 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 1-8323
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (215) 761-1000
Securities registered pursuant to section 12(b) of the Act:
Securities registered pursuant to section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes X No ___
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ___No X
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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ___No X
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2008 was approximately
As of January 30, 2009, 271,037,887 shares of the registrants Common Stock were outstanding.
Part III of this Form 10-K incorporates by reference information from the registrants proxy statement to be dated on or about
March 19, 2009.
TABLE OF CONTENTS
Item 1. BUSINESS
A. Description of Business
CIGNA Corporation and its subsidiaries constitute one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace, including: health care products and services; group disability, life and accident insurance; and workers compensation case management and related services. The Company also has certain inactive businesses, including a run-off reinsurance operation. CIGNA Corporation had consolidated shareholders equity of $3.6 billion and assets of $41.4 billion as of December 31, 2008, and revenues of $19.1 billion for the year then ended. CIGNAs major insurance subsidiary, Connecticut General Life Insurance Company (CG Life), traces its origins to 1865. CIGNA Corporation was incorporated in the State of Delaware in 1981.
As used in this document, CIGNA and the Company may refer to CIGNA Corporation itself, one or more of its subsidiaries, or CIGNA Corporation and its consolidated subsidiaries. CIGNA Corporation is a holding company and is not an insurance company. Its subsidiaries conduct various businesses, which are described in this Form 10-K.
CIGNAs revenues are derived principally from premiums, fees, mail order pharmacy, other revenues and investment income. The financial results of CIGNAs businesses are reported in the following segments:
Our annual, quarterly and current reports, proxy statements and other information are also made available free of charge on our website (http://www.cigna.com, under the InvestorsSEC Filings captions) as soon as reasonably practicable after we electronically file these materials with, or furnish them to, the Securities and Exchange Commission (the SEC). We use our website as a channel of distribution for material company information. Important information, including [news releases, analyst presentations and financial information] regarding CIGNA is routinely posted on and accessible at www.cigna.com. See Code of Ethics and Other Corporate Governance Disclosures in Part III, Item 10 on page 140 of this Form 10-K for additional available information.
B. Financial Information about Business Segments
The financial information included herein is in conformity with accounting principles generally accepted in the United States of America (GAAP), unless otherwise indicated. Certain reclassifications have been made to prior years financial information to conform to the 2008 presentation. Industry rankings and percentages set forth herein are for the year ended December 31, 2007, unless otherwise indicated. Unless otherwise noted, statements set forth in this document concerning CIGNAs rank or position in an industry or particular line of business have been developed internally, based on publicly available information.
Financial data for each of CIGNAs business segments is set forth in Note 21 to the Consolidated Financial Statements beginning on page 130 of this Form 10-K.
C. Health Care
CIGNAs Health Care segment (CIGNA HealthCare) offers insured and self-funded medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services that may be integrated to provide individuals with comprehensive health care benefit programs. CIGNA HealthCare also provides disability and life insurance products
that were historically sold in connection with certain experience-rated medical products. These products and services are provided and administered by subsidiaries of CIGNA Corporation.
CIGNA HealthCare is focused on helping to improve the health, well-being and security of the individuals which it serves. CIGNA HealthCare believes the most sustainable approach to enhancing quality and managing health care costs is to fully engage customers in their own health care. Therefore, CIGNA HealthCare seeks to engage its members by providing actionable information about health and advocacy programs, including information about the cost and quality of care that members can use to make informed choices about health care for themselves and their families.
Underlying CIGNA HealthCares operations is a foundation of clinical expertise and an ability to provide quality service. CIGNA HealthCares strengths include: (1) its ability to integrate medical and specialty product offerings to achieve a more holistic and integrated approach to members health that promotes consistent case management; and (2) its ability to provide predictive modeling and other analytical tools (for example, through the Companys exclusive access to analytical tools and algorithms developed by the University of Michigan), to assist in providing targeted outreach and health advocacy by CIGNAs clinical professionals to CIGNA HealthCare members.
Principal Products and Services and Funding Arrangements
With the exception of HMO and Medicare Part D products, each of CIGNA HealthCares products (as described below) is offered with multiple funding options (also described below). CIGNA may sell multiple products under the same funding arrangement to the same employer. Accordingly, the revenue table included in the Health Care section of the Managements Discussion and Analysis (MD&A) beginning on page 54 reflects both the product type and funding arrangement as well as the impact from the acquisition in April of 2008 of Great-West Healthcare, the health care division of Great-West Life & Annuity Insurance Company. CIGNA HealthCare companies offer products and services in all 50 states, the District of Columbia, Puerto Rico and the US Virgin Islands.
CIGNA HealthCare provides a wide array of products and services to meet the needs of employers and other sponsors of health benefit plans and the employees and dependents participating in these plans, including:
Health Advocacy and CareAllies®. Through its CareAllies brand, CIGNA HealthCare offers medical management, disease management, and health advocacy services to employers and other plan sponsors. CareAllies services are not only offered to members covered under CIGNA HealthCare administered plans but also to those employees who have elected coverage under a plan offered through their employer by competing insurers/third party administrators. CareAllies offers a consistent set of services to address the clinical and administrative inconsistencies that are inherent in the multi-vendor approach. Through its health advocacy programs, CIGNA HealthCare works to:
In addition, CIGNA HealthCare offers a wide array of programs and services to help individuals improve the health of the mind and body, including:
Behavioral Health. CIGNA Behavioral Health arranges for the provision of behavioral health care services to individuals through its network of participating behavioral health care providers, offers behavioral health care management services, employee assistance programs, and work/life programs to employer sponsored benefit plans, HMOs, governmental entities and disability insurers. CIGNA Behavioral Health focuses on integrating its programs and services to facilitate customized, holistic care.
As of December 31, 2008, CIGNA Behavioral Healths national network had approximately 66,800 access points to independent psychiatrists, psychologists and clinical social workers and approximately 5,600 facilities and clinics that are reimbursed on a contracted fee-for-service basis.
In 2008, CIGNA completed its integration of the CIGNA Behavioral Health, vielife® and CareAllies brands and operations into a unified Health Solutions unit that supports CIGNAs health advocacy strategy and manages the delivery of the Companys health and wellness programs, including: condition and disease management, maternity management, case management, lifestyle management, health coaching (including online), employee assistance, work/life balance, mental health and substance abuse, health assessment, oncology support, transplant network/management, 24-hour health information line, wellness consulting, and the Healthy Rewards® discount program.
Dental. CIGNA Dental Health offers a variety of dental care products including dental health maintenance organization (DHMO), dental preferred provider organization (DPPO), dental exclusive provider organization (DEPO), traditional indemnity products and a dental discount program. Customers can purchase CIGNA Dental Health products as stand-alone products or integrated with CIGNA HealthCares medical products. As of December 31, 2008, CIGNA Dental Health members totaled approximately 10.6 million, representing employees at more than one-third of all Fortune 100 companies. Managed dental care products are offered in 36 states and the District of Columbia through a network of independent providers that have contracted with CIGNA Dental Health to provide dental services to members.
CIGNA Dental Health members access care from one of the largest dental HMO and dental PPO networks in the U.S., with approximately 110,000 DPPO-contracted access points (approximately 56,000 unique providers) and approximately 41,500 dental HMO-contracted access points (approximately 10,500 unique providers).
CIGNA Dental Health stresses preventive dentistry; it believes that promoting preventive care contributes to a healthier workforce, an improved quality of life, increased productivity and fewer treatment claims and associated costs over time. CIGNA Dental Health offers members a dental treatment cost estimator to educate individuals on oral health and aid them in their dental health care decision-making.
Vision. CIGNA Vision offers flexible, cost-effective PPO coverage that includes a range of both in and out-of-network benefits for routine vision services. CIGNAs national vision care network, which consists of over 40,000 providers in approximately 20,000 locations, includes private practice ophthalmologist and optometrist offices, as well as retail eye care centers. Routine vision products are offered in conjunction with CIGNA HealthCares medical and dental product offerings.
Pharmacy. CIGNA Pharmacy offers prescription drug plans to its insured and self-funded members both in conjunction with its medical products and on a stand-alone basis. With a nationwide network of approximately 58,000 contracted pharmacies, CIGNA Pharmacy is a comprehensive pharmacy benefits manager offering clinical integration programs, specialty pharmacy solutions, and fast, efficient home delivery pharmacy capabilities that improve outcomes and reduce costs for a Return On Health®.
Programs that reflect this integration of medical, behavioral and pharmacy offerings include:
Medicare Part D. CIGNAs Medicare Part D prescription drug program, CIGNA Medicare Rx ®, provides a number of plan options as well as service and information support to Medicare-eligible members aged 65 and over. CIGNA Medicare Rx is available in all 50 states and the District of Columbia.
Retail Pharmacies. CIGNA HealthCare operates 19 retail pharmacies, including on-site retail pharmacies for members to serve the needs of CIGNA HealthCare members.
The segments health care products and services are offered through the following funding arrangements:
Guaranteed Cost. Under guaranteed cost funding arrangements, group policyholders pay a fixed premium and CIGNA HealthCare bears the risk for claims and costs that exceed the premium. Some insurance policies are offered on a guaranteed cost basis. The HMO product is offered only on a guaranteed cost basis.
Retrospectively Experience-rated (including Minimum Premium). Under insurance policies using a retrospectively experience-rated funding arrangement, a premium that typically includes a margin to partially protect against adverse claim fluctuations is determined at the beginning of the policy period. CIGNA HealthCare generally bears the risk if claims and expenses exceed this premium, but has the potential to recover any deficit from margins in future years if the policy is renewed. For additional discussion, see Pricing, Reserves and Reinsurance later in this section of the 10-K.
Under insurance policies using a minimum premium funding arrangement, instead of paying a fixed monthly premium, the group policyholder establishes and funds a bank account and authorizes the insurer to draw upon funds in the account to pay claims and other authorized expenses. The policyholder pays a significantly reduced monthly residual premium while the policy is in effect and a supplemental premium (to cover reserves for run-out claims and administrative expenses) upon termination. Minimum premium funding arrangements combine insurance protection with an element of self-funding. The policyholder is responsible for funding all claims up to a predetermined aggregate, maximum amount, and CIGNA HealthCare bears the risk for claim costs incurred in excess of that amount. CIGNA HealthCare has the potential to recover this deficit from margins in future years if the policy is renewed. Accordingly, minimum premium funding arrangements have a risk profile similar to retrospectively experience-rated insurance arrangements.
Administrative Service. Under the administrative service funding arrangement, CIGNA HealthCare contracts with employers on an administrative services only (ASO) basis to administer claims and perform other plan related services. CIGNA HealthCare collects administrative service fees in exchange for providing ASO plans with access to CIGNA HealthCares applicable participating provider network and for providing other services and programs including: quality management; utilization management; cost
containment; health advocacy; 24-hour help line; case management; disease management; pharmacy benefit management; behavioral health care management services (through its provider networks); or any combination of the services. The employer/plan sponsor is responsible for self-funding all claims, but may purchase stop-loss insurance from CIGNA HealthCare or other insurers for claims in excess of a predetermined amount, for either individuals (specific), the entire group (aggregate), or both.
In 2008, CIGNA purchased Great-West Healthcare, the healthcare division of Great-West Life & Annuity Insurance Company (Great-West). Great-West Healthcare has historically offered similar products and services through similar funding arrangements, although Great-West Healthcare focused on smaller customers, and as a result, a substantially higher portion of the claims in their book of business are covered by some type of stop-loss arrangement.
Financial information, including premiums and fees is presented in the Health Care section of the MD&A beginning on page 54 and Note 21 to CIGNAs Consolidated Financial Statements beginning on page 130.
Service and Quality
CIGNA HealthCare operates eleven service centers that together processed approximately 122 million medical claims in 2008. Satisfying customers and members is a primary business objective and critical to the Companys success. To address a variety of member issues, CIGNA HealthCare offers members access to its grievance and appeals processes. CIGNA operates six member service centers that members can call toll-free to address requests for information and complaints and grievances. CIGNA HealthCare customer service representatives are empowered to immediately resolve a wide range of issues to help members obtain the most from their benefit plan. In many cases, a customer service representative can resolve the members issue. If an issue cannot be resolved informally, CIGNA HealthCare has a formal appeals process that can be initiated by telephone or in writing and involves two levels of internal review. For those matters not resolved by internal reviews, CIGNA HealthCare members are offered the option of a voluntary external review of claims. The CIGNA HealthCare formal appeals process addresses member inquiries and appeals concerning initial coverage determinations based on medical necessity and other benefits/coverage determinations. CIGNA HealthCares formal appeals process meets National Committee for Quality Assurance (NCQA), Employee Retirement Income Security Act (ERISA), Utilization Review Accreditation Commission (URAC) and/or applicable state regulatory requirements.
CIGNA HealthCares commitment to promoting quality care and service to its members is reflected in a variety of activities including: the credentialing of medical providers and facilities that participate in CIGNA HealthCares Managed Care and PPO networks; the development of the CIGNA Care® specialist physician designation described below, and participation in initiatives that provide information to members to enable educated health care decision-making.
Participating Provider Network. CIGNA HealthCare has an extensive national network of participating health care providers, which as of December 31, 2008 consisted of approximately 5,200 hospitals and approximately 573,000 providers as well as other facilities, pharmacies and vendors of health care services and supplies (these hospital and provider counts exclude the impact of the Great-West Healthcare acquisition). As part of the purchase of Great-West Healthcare, CIGNA acquired the participating provider network of Great-West Healthcare. In many cases, the providers in the Great-West Healthcare network were already in the CIGNA HealthCare participating provider network, however, the acquisition has expanded and strengthened CIGNA HealthCares network in some regions of the country. CIGNA HealthCare is in the process of consolidating the network it acquired from Great-West with its existing participating provider network. As of December 31, 2007, CIGNA HealthCares national network of participating health care providers consisted of approximately 5,100 hospitals and approximately 542,000 providers.
In most instances, CIGNA HealthCare contracts directly with the participating provider to provide covered services to members at agreed-upon rates of reimbursement. In some instances, however, CIGNA HealthCare companies contract with third parties for access to their provider networks. In addition, CIGNA HealthCare has entered into strategic alliances with several regional managed care organizations (Tufts Health Plan, HealthPartners, Inc., Health Alliance Plan, and MVP Health Plan) to gain access to their provider networks and discounts.
CIGNA Care®. CIGNA Care is a benefit design option available for CIGNA HealthCare administered plans in 57 service areas across the country. CIGNA Care is a subset of participating physicians in certain specialties who are designated as CIGNA Care physicians based on specific clinical quality and cost-efficiency selection criteria. Members pay reduced co-payments or co-insurance when they receive care from a specialist designated as a CIGNA Care provider. CIGNA participating specialists are evaluated annually for the CIGNA Care designation.
Provider Credentialing. CIGNA HealthCare credentials physicians, hospitals and other health care providers in its participating provider networks using quality criteria which meet or exceed the standards of external accreditation or state regulatory agencies, or both. Typically, most providers are re-credentialed every three years.
Health Plan Credentialing. Each of CIGNA HealthCares 23 HMO and POS plans that have undergone an accreditation review have earned the highest rating possible Excellent from the NCQA and have earned Distinction for NCQAs Quality Plus Member Connections and Physician and Hospital Quality standards. The Member Connections standards assess a plans web-based and telephonic consumer decision support tools. The Physician and Hospital Quality standards assess how well a plan provides members with information about physicians and hospitals in its network to help consumers make informed health care decisions. In early 2008, CIGNA HealthCare received Full accreditation (the highest rating possible) from NCQA for its PPO plans and for CIGNAs Open Access Plus plans nationwide. The case management and utilization management programs provided to CIGNA HealthCare members have been awarded full accreditation by URAC.
HEDIS® Measures. In addition, CIGNA HealthCare participates in NCQAs Health Plan Employer Data and Information Set (HEDIS®) Quality Compass Report. HEDIS® Effectiveness of Care measures are a standard set of metrics to evaluate the effectiveness of managed care clinical programs. CIGNA HealthCares national results compare favorably to industry averages.
Technology. CIGNA HealthCare understands the critical importance of information technology to the level of service the Company is able to provide to its members and to the continued growth of the health care business. The health care marketplace is evolving and the level of service that is acceptable to consumers today may not be acceptable tomorrow. Therefore, CIGNA HealthCare continues to invest in its information technology infrastructure and capabilities including technology essential to fundamental claim administration and customer service, as well as tools and Internet-enabled technology that support CIGNA HealthCares focus on engaging members in health care decisions.
For example, CIGNA HealthCare has developed a range of member decision support tools including:
In addition, a special website designed for seniors was launched in 2007 to offer customized features as well as access to both the myCIGNA.com and cigna.com websites.
Pricing, Reserves and Reinsurance
Premiums and fees charged for HMO and most health insurance products and life insurance products are generally set in advance of the policy period and are guaranteed for one year. Premium rates for fully insured products are established either on a guaranteed cost basis or on a retrospectively experience-rated basis.
Charges to customers established on a guaranteed cost basis at the beginning of the policy period cannot be adjusted to reflect actual claim experience during the policy period. A guaranteed cost pricing methodology reflects assumptions about future claims, health care inflation (unit cost, location of delivery of care and utilization), effective medical cost management, expenses, credit risk, enrollment mix, investment returns, and profit margins. Claim and expense assumptions may be based in whole or in part on prior experience of the account or on a pool of accounts, depending on the group size and the statistical credibility of the experience. Generally, guaranteed cost groups are smaller and less statistically credible than retrospectively experience-rated groups. In addition, pricing for health care products that use networks of contracted providers reflects assumptions about the impact of the reimbursement rates in the provider contracts on future claims. Premium rates may vary among accounts to reflect the anticipated contract mix,
family size, industry, renewal date, and other cost-predictive factors. In some states, premium rates must be approved by the state insurance departments, and state laws may restrict or limit the use of rating methods.
Premiums established for retrospectively experience-rated business may be adjusted for the actual claim and, in some cases, administrative cost experience of the account through an experience settlement process subsequent to the policy period. To the extent that the cost experience is favorable in relation to the prospectively determined premium rates, a portion of the initial premiums may be credited to the policyholder as an experience refund. If claim experience is adverse in relation to the initial premiums, CIGNA HealthCare may recover the resulting experience deficit, according to contractual provisions, through future premiums and experience settlements, provided the policy remains in force.
CIGNA HealthCare contracts on an ASO basis with customers who fund their own claims. CIGNA HealthCare charges these customers administrative fees based on the expected cost of administering their self-funded programs. In some cases, CIGNA HealthCare provides performance guarantees associated with meeting certain service related and other performance standards. If these standards are not met, CIGNA HealthCare may be financially at risk up to a stated percentage of the contracted fee or a stated dollar amount. CIGNA HealthCare establishes liabilities for estimated payouts associated with these guarantees.
In addition to paying current benefits and expenses under HMO and health insurance policies, CIGNA HealthCare establishes reserves for amounts estimated to settle reported claims not yet paid, as well as claims incurred, but not yet reported. Also, liabilities are established for estimated experience refunds based on the results of retrospectively experience-rated policies and applicable contract terms.
As of December 31, 2008, approximately $1.0 billion, or 65% of the reserves of CIGNA HealthCares operations comprise liabilities that are likely to be paid within one year, primarily for medical and dental claims, as well as certain group disability and life insurance claims. Of the reserve amount expected to be paid within one year, $202 million relates to amounts recoverable from certain ASO customers and from minimum premium policyholders, and is offset by a receivable. The remaining reserves related primarily to contracts that are short term in nature, but have long term payouts and include liabilities for group long-term disability insurance benefits and group life insurance benefits for disabled and retired individuals, benefits paid in the form of both life and non-life contingent annuities to survivors and contractholder deposit funds.
CIGNA HealthCare credits interest on experience refund balances to retrospectively experience-rated policyholders through rates that are set by CIGNA HealthCare taking investment performance and market rates into consideration. Generally, for interest-crediting rates set at CIGNA HealthCares discretion, higher rates are credited to funds with longer terms reflecting the fact that higher yields are generally available on investments with longer maturities. For 2008, the rates of interest credited ranged from 2.75% to 4.00%, with a weighted average rate of 3.15%.
The profitability of CIGNA HealthCares fully insured health care products depends on the adequacy of premiums charged relative to claims and expenses. For medical and dental products, profitability reflects the accuracy of cost projections for health care (unit costs and utilization), the adequacy of fees charged for administration and risk assumption and effective medical cost and utilization management.
CIGNA HealthCare reduces its exposure to large catastrophic losses under group life, disability and accidental death contracts by purchasing reinsurance from unaffiliated reinsurers.
Markets and Distribution
CIGNA HealthCare targets the following markets for its products:
To date, the national and regional account markets have comprised a significant amount of CIGNA HealthCares business. With the acquisition of Great-West Healthcare, the healthcare division of Great-West, the Select, small business, and emerging markets now constitute a larger share of CIGNA HealthCares business.
CIGNA HealthCare employs group sales representatives to distribute its products and services through insurance brokers and insurance consultants or directly to employers. CIGNA HealthCare also employs representatives to sell utilization review services, managed behavioral health care and employee assistance services directly to insurance companies, HMOs, third party administrators and employer groups. As of December 31, 2008, the field sales force for the products and services of this segment consisted of approximately 970 sales representatives in approximately 120 field locations.
CIGNA HealthCares business is subject to intense competition, and industry consolidation has created an even more competitive business environment. While no one competitor dominates the health care market, CIGNA HealthCare expects a continuing trend of consolidation in the industry given the current economic environment.
In certain geographic locations, some health care companies may have significant market share positions. A large number of health care companies and other entities compete in offering similar products. Competition in the health care market exists both for employers and other groups sponsoring plans and for the employees in those instances where the employer offers its employees the choice of products of more than one health care company. Most group policies are subject to annual review by the policyholder, who may seek competitive quotations prior to renewal.
The principal competitive factors are: quality and cost-effectiveness of service and provider networks; effectiveness of medical care management; product responsiveness to the needs of customers and their employees; cost-containment services; technology; price; and effectiveness of marketing and sales. Financial strength of the insurer, as indicated by ratings issued by nationally recognized rating agencies, is also a competitive factor. For more information concerning insurance ratings, see Ratings in Section J beginning on page 28. CIGNA HealthCare believes that its national scope, integrated approach to consumer engagement, breadth of product and funding offerings, clinical care and medical management capabilities and funding options are strategic competitive advantages. These advantages allow CIGNA HealthCare to respond to the diverse needs of its customer base in each market in which it operates. CIGNA HealthCare also believes that its focus on helping to improve the health, well-being and security of its members will allow it to distinguish itself from its competitors.
The principal competitors are:
Competition also arises from smaller regional or specialty companies with strength in a particular geographic area or product line, administrative service firms and, indirectly, self-insurers. In addition to these traditional competitors, a new group of competitors is emerging. These new competitors are focused on delivering employee benefits and services through Internet-enabled technology that allows consumers to take a more active role in the management of their health. This is accomplished primarily through financial incentives, access to enhanced medical quality data and other information sharing. The effective use of the Companys health advocacy capabilities, decision support tools (some of which are web-based) and enabling technology are critical to success in the health care industry, and CIGNA HealthCare believes they will be competitive differentiators.
Industry Developments and Strategic Overview
Both state and federal lawmakers have supported a broad range of health care reform efforts due to the recent demand for changes to the health care industry. The Company expects that these efforts will intensify in 2009. The proposal and/or passing of any reform initiatives would affect the health care industry in general and CIGNA, specifically. CIGNA advocates creating a value-based healthcare system that provides access to care for the uninsured, fosters and rewards quality, and makes care more affordable by educating consumers to the true costs and quality of care and supporting better decision making. CIGNA envisions such a system as a partnership between private and public sectors, taking the best of what the private and public sector programs offer and creating a system that addresses the needs of all. CIGNA is intensely involved in developing workable solutions for reforming Americas healthcare system.
As part of its business strategy, CIGNA continually evaluates potential acquisitions and other transactions that could enhance the Companys competitive capabilities and provide a basis for membership growth and/or improved medical costs. In 2008, CIGNA acquired the assets of Great-West Healthcare, the healthcare division of Great-West.
Also, in connection with CIGNAs long-term business strategy, the Company intends to continue to focus on the fundamentals of its health care business in order to provide consistent, reliable service to customers at a competitive cost; differentiating the health care business from its competitors by facilitating consumer engagement to realize improvement in the individuals health and well-being; and segment expansion, particularly in the voluntary, individual, small business and Select markets.
D. Disability and Life
Principal Products and Services
CIGNAs Disability and Life segment (CIGNA Disability and Life) provides the following insurance products and their related services: group life insurance, long-term and short-term disability insurance, workers compensation and disability case management, and accident and specialty insurance. These products and services are provided by subsidiaries of CIGNA Corporation.
CIGNA Disability and Life markets group long-term and short-term disability insurance products and services in all 50 states and statutorily required disability insurance plans in certain states. These products and services generally provide a fixed level of income to replace a portion of wages lost because of disability. They also provide assistance to the employee in returning to work and assistance to the employer in managing the cost of employee disability. Group disability coverage is typically employer-paid or a combination of employer and employee-paid.
CIGNA Disability and Life also provides case management and related services to workers compensation insurers and employers who self-fund workers compensation and disability benefits.
CIGNA Disability and Lifes disability insurance products may be integrated with other disability benefit programs, behavioral programs, workers compensation, medical programs, social security advocacy, and the Family and Medical Leave Act and leave of absence administration. CIGNA Disability and Life believes this integration provides customers with increased efficiency and effectiveness in disability claims management, enhances productivity and reduces overall costs to employers. Combining CIGNA Disability and Life disability and CIGNA HealthCares medical programs may provide enhanced opportunities to influence outcomes, reduce the cost of both medical and disability events and improve the return to work rate. CIGNA Disability and Life has formalized an integrated approach to health and wellness through the Disability and Healthcare Connect Program. This program uses information from the CIGNA HealthCare and CIGNA Disability and Life databases to help identify, treat and manage disabilities before they become chronic, longer in duration and more costly. Proactive outreach from CIGNA Behavioral Health assists employees suffering from a mental health condition, either as a primary condition or as a result of another condition. CIGNA may receive fees for providing these integrated services to customers.
CIGNA Disability and Life is an industry leader in returning employees to work quickly. Shorter disability claim durations mean higher productivity and lower cost for employers and a better quality of life for their employees. Data from a recent industry customer satisfaction survey showed that CIGNA Disability and Lifes short-term and long-term disability claimant satisfaction levels meet and in certain metrics exceed those of our competitors.
Approximately 7,100 insured disability policies covering approximately 4.9 million lives were outstanding as of December 31, 2008.
Group life insurance products include group term life and group universal life. Group term life insurance may be employer-paid basic life insurance, employee-paid supplemental life insurance or a combination thereof.
CIGNA no longer actively markets group universal life insurance to new employers, but continues to administer the product for and markets to existing policyholders. Group universal life insurance is a voluntary life insurance product in which the owner may accumulate cash value. The cash value earns interest at rates declared from time to time, subject to a minimum guaranteed contracted rate, and may be borrowed, withdrawn, or, within certain limits, used to fund future life insurance coverage. With group variable universal life insurance, the cash value varies directly with the performance of the underlying investments and neither the return nor the principal is guaranteed.
Approximately 6,500 group life insurance policies covering approximately 6.2 million lives were outstanding as of December 31, 2008.
Other Products and Services
CIGNA Disability and Life offers personal accident insurance coverage, which consists primarily of accidental death and dismemberment and travel accident insurance to employers. Group accident insurance may be employer-paid or employee-paid.
CIGNA Disability and Life also offers specialty insurance services that consist primarily of life, accident, student accident medical and disability insurance to professional associations, financial institutions, schools and participant organizations.
Voluntary benefits are those paid by the employee and are offered at the employers worksite. CIGNA Disability and Life plans provide, among other services, flexible enrollment options, list billing, medical underwriting, and individual record keeping. CIGNA Disability and Life designed its voluntary offerings to offer employers a complete and simple way to manage their benefits, including personalized enrollment communication and administration of the benefits program.
Pricing, Reserves and Reinsurance
Premiums and fees charged for disability and life insurance products are generally established in advance of the policy period and are generally guaranteed for one to three years, but policies may be subject to early termination.
Premium rates reflect assumptions about future claims, expenses, credit risk, investment returns and profit margins. Assumptions may be based in whole or in part on prior experience of the account or on a pool of accounts, depending on the group size and the statistical credibility of the experience, which varies by product.
Fees for universal life insurance products consist of mortality, administrative and surrender charges assessed against the policyholders fund balance. Interest credited and mortality charges for universal life, and mortality charges on variable universal life, may be adjusted prospectively to reflect expected interest and mortality experience.
In addition to paying current benefits and expenses, CIGNA Disability and Life establishes reserves in amounts estimated to be sufficient to pay reported claims not yet paid, as well as claims incurred but not yet reported. For liabilities with longer-term pay-out periods such as long-term disability, reserves represent the present value of future expected payments. CIGNA Disability and Life discounts these expected payments using assumptions for interest rates and the length of time over which claims are expected to be paid. The annual effective interest rate assumptions used in determining reserves for most of the long-term disability insurance business is 4.75% for claims that were incurred in 2008 and 2007. For universal life insurance, CIGNA Disability and Life establishes reserves for deposits received and interest credited to the policyholder, less mortality and administrative charges assessed against the policyholders fund balance.
The profitability of this segments products depends on the adequacy of premiums charged relative to claims, including the degree to which future experience deviates from mortality and morbidity assumptions, expenses and investment returns. CIGNA Disability and Lifes previous claim experience and industry data indicate a correlation between disability claim incidence levels and economic conditions, with submitted claims rising under adverse economic conditions. The effectiveness of return to work programs and mortality levels also impact the profitability of disability insurance products.
In order to reduce its exposure to large individual and catastrophic losses under group life, disability and accidental death policies, CIGNA Disability and Life purchases reinsurance from unaffiliated reinsurers.
Markets and Distribution
CIGNA Disability and Life markets the group insurance products and services described above to employers, employees, professional and other associations and groups. In marketing these products, CIGNA Disability and Life employs a captive sales force to target customers with 50 or more employees and the products and services of this segment are primarily distributed through insurance brokers and consultants, along with some direct sales. As of December 31, 2008, the field sales force for the products and services of this segment consisted of approximately 200 sales professionals in 27 field locations.
The principal competitive factors that affect the CIGNA Disability and Life segment are underwriting and pricing, the quality and effectiveness of claims management, relative operating efficiency, investment and risk management, distribution methodologies and producer relations, the breadth and variety of products and services offered, and the quality of customer service. The Company believes that CIGNA Disability and Lifes claims management capabilities and integration with CIGNA HealthCares benefits provide a competitive advantage in this marketplace.
For certain products with longer-term liabilities, such as group long-term disability insurance, the financial strength of the insurer, as indicated by ratings issued by nationally recognized rating agencies, is also a competitive factor. For more information concerning insurance ratings, see Ratings in Section J beginning on page 28.
The principal competitors of CIGNAs group disability, life and accident businesses are other large and regional insurance companies that market and distribute these or similar types of products.
As of December 31, 2008, CIGNA is one of the top providers of group disability, life and accident insurance, based on premiums.
Industry Developments and Strategic Initiatives
The group insurance market remains highly competitive as the rising cost of providing medical coverage to employees has forced companies to reevaluate their overall employee benefit spending. Demographic shifts have further driven demand for products and services that are sufficiently flexible to meet the evolving needs of employers and employees who want innovative, cost-effective solutions to their insurance needs. A shift to greater employee participatory coverage and voluntary purchases is also an emerging trend.
Employers are also expressing a growing interest in employee wellness, absence management and productivity and recognizing a strong link between health, productivity and their profitability. As a result, employers are looking to offer programs that promote a healthy lifestyle, offer assistance in returning to work and integrate health care and disability programs. CIGNA believes it is well positioned to deliver integrated solutions that address these broad employer and employee needs. CIGNA also believes that its strong disability management portfolio and fully integrated programs provide employers and employees tools to improve health status. This focus on managing the employees total absence enables CIGNA to increase the number and likelihood of interventions and minimize disabling events.
The disability industry is under continuing review by regulators and legislators with respect to its offset practices regarding Social Security Disability Insurance (SSDI). There has been specific inquiry as to the industrys role in assisting individuals with their applications for SSDI. The Company has received one Congressional inquiry and has responded to the information request. Also legislation prohibiting the offset of SSDI payments against private disability insurance payments for prospectively issued policies has been introduced in the Connecticut state legislature. The Company is also involved in related pending litigation. If the industry is forced to change its offset SSDI procedures, the practices and products for this segment could be significantly impacted.
For more information on Disability and Life, see the Industry Developments and Other Matters section beginning on page 67 of this Form 10-K and Note 21 to the Consolidated Financial Statements beginning on page 130.
CIGNAs International segment (CIGNA International) offers life, accident and supplemental health insurance products as well as international health care products and services. These products and services are provided by subsidiaries of CIGNA Corporation, including foreign operating entities.
Principal Products and Services
Life, Accident and Supplemental Health Insurance
CIGNA Internationals life, accident and supplemental health insurance products generally provide simple, affordable coverage of risks for the health and financial security of individuals. Supplemental health products provide a specified payment for a variety of health risks and include personal accident, accidental death, critical illness, hospitalization, dental, cancer and other dread disease coverages. Variable universal life insurance products are also included in the product portfolio.
International Health Care
CIGNA Internationals health care operations primarily consist of products and services to meet the needs of multinational companies and their expatriate employees and dependents. These benefits include medical, dental, vision, life, accidental death and dismemberment and disability products. The expatriate benefits products and services are offered through guaranteed cost, experience-rated, administrative services only, and minimum premium funding arrangements. For definitions of funding arrangements, see Funding Arrangements in Section C beginning on page 1.
In addition, CIGNA Internationals health care operations include medical products, which are provided through group benefits programs. These products are primarily medical indemnity insurance coverage, with some offerings having managed care or administrative service aspects. These products generally provide an alternative or supplement to government programs.
Pricing, Reserves and Reinsurance
Premiums for CIGNA Internationals life, accident and supplemental health insurance products are based on assumptions about mortality, morbidity, customer retention, expenses and target profit margins, as well as interest rates. The profitability of these products is primarily driven by mortality, morbidity, and customer retention.
Fees for variable universal life insurance products consist of mortality, administrative, asset management and surrender charges assessed against the contractholders fund balance. Mortality charges on variable universal life may be adjusted prospectively to reflect expected mortality experience.
Premiums and fees for CIGNA Internationals health care products reflect assumptions about future claims, expenses, investment returns, and profit margins. For products using networks of contracted providers, premiums reflect assumptions about the impact of provider contracts and utilization management on future claims. Most of the premium volume for the medical indemnity business is on a guaranteed cost basis. Other premiums are established on an experience-rated basis. Most contracts permit rate changes at least annually.
The profitability of health care products is dependent upon the accuracy of projections for health care inflation (unit cost, location of delivery of care, including currency of incurral and utilization), the adequacy of fees charged for administration and risk assumptions and effective medical cost management.
In addition to paying current benefits and expenses, CIGNA International establishes reserves in amounts estimated to be sufficient to settle reported claims not yet paid, claims incurred but not yet reported as well as future amounts payable on experience rated arrangements. Additionally, for some individual life insurance and supplemental health insurance products, CIGNA International establishes policy reserves which reflect the present value of expected future obligations less the present value of expected future premiums attributable to policyholder obligations. CIGNA International defers acquisition costs, such as commissions, solicitation and policy fulfillment costs, incurred in the sales of long-duration life, accident and supplemental health products. For most products, these costs are amortized in proportion to premium revenue recognized, which is impacted by customer retention. For variable universal life products, acquisition costs are amortized in proportion to expected gross profits.
CIGNA International reduces its exposure to large and/or multiple losses arising out of a single occurrence by purchasing reinsurance from unaffiliated reinsurers.
Markets and Distribution
CIGNA Internationals life, accident and supplemental health insurance products are generally marketed through distribution partners with whom the individual insured has an affinity relationship. These products are sold primarily through direct marketing channels, such as outbound telemarketing, in-branch bancassurance and direct response television. Marketing campaigns are conducted through these channels under a variety of arrangements with affinity partners. These affinity partners primarily include banks, credit card companies, other financial institutions, and other businesses. CIGNA Internationals life, accident and supplemental health insurance operations are located in South Korea, Taiwan, Hong Kong, Indonesia, New Zealand, China, Thailand, and the European Union. In the second quarter of 2008, CIGNA sold its run-off Brazilian life insurance business.
CIGNA Internationals health care products are distributed through independent brokers and consultants, select partners as well as CIGNA Internationals own sales personnel. The customers of CIGNA Internationals expatriate benefits business are multinational companies and international organizations headquartered in the United States, Canada, Europe, the Middle East, Hong Kong and other international locations. In addition, CIGNA Internationals health care operations include medical products, which are provided through group benefits programs in the United Kingdom and Spain.
For CIGNA Internationals life, accident and supplemental health insurance products a significant portion of the premiums are billed and collected through credit cards. A substantial contraction in consumer credit could impact CIGNA Internationals ability to retain existing policies and sell new policies. A decline in customer retention can result in both a reduction of revenue and an acceleration of the amortization of acquisition related costs.
Competitive factors in CIGNA Internationals life, accident and supplemental health operations and expatriate benefits business include product and distribution innovation and differentiation, efficient management of direct marketing processes, commission levels paid to distribution partners, and quality of claims and customer services.
The principal competitive factors that affect CIGNA Internationals health care operations are underwriting and pricing, relative operating efficiency, relative effectiveness in medical cost management, product innovation and differentiation, producer relations, and the quality of claims and customer service. In most overseas markets, perception of financial strength is also an important competitive factor.
For the life, accident and supplemental health insurance line of business, competitors are primarily locally based insurance companies, including insurance subsidiaries of banks. However, insurance company competitors in this segment primarily focus on traditional product distribution through captive agents, with direct marketing being a secondary objective. CIGNA International estimates that it has less than 2% market share of the total life insurance premiums in any given market in which it operates.
For the expatriate benefits business, CIGNA International is the market leader in the U.S., whose primary competitors include U.S.-based and European health insurance companies with global expatriate benefits operations. For the health care operations in the UK and Spain, the primary competitors are regional and local insurers, with CIGNAs market share at less than 5% of the premiums of the total local health care market.
CIGNA International expects that the competitive environment will intensify as U.S. and Europe-based insurance and financial services providers pursue global expansion opportunities.
Pressure on social health care systems and increased wealth and education in emerging markets is leading to higher demand for products providing health insurance and financial security. In the life, accident and supplemental health business, direct marketing is growing and attracting new competitors while industry consolidation among financial institutions and other affinity partners continues. For the international health care benefits business, trade liberalization and rapid economic growth in emerging markets is leading to multi-national companies expanding foreign operations.
F. Run-off Reinsurance
Principal Products and Services
Until 2000, CIGNA offered reinsurance coverage for part or all of the risks written by other insurance companies (or ceding companies) under life and annuity policies (both group and individual); accident policies (workers compensation, personal accident, and catastrophe coverages); and health policies. The products and services related to these operations were offered by subsidiaries of CIGNA Corporation.
In 2000, CIGNA sold its U.S. individual life, group life and accidental death reinsurance businesses. CIGNA placed its remaining reinsurance businesses (including its accident, domestic health, international life and health, and annuity reinsurance businesses) into run-off as of June 1, 2000 and stopped underwriting new reinsurance business.
CIGNAs exposures stem primarily from its annuity reinsurance business, including its reinsurance of guaranteed minimum death benefits (GMDB) and guaranteed minimum income benefits (GMIB) contracts. Additional exposures arise from its reinsurance of workers compensation and other personal accident and catastrophic risks.
Life and Annuity Policies
Guaranteed Minimum Death Benefit Contracts
CIGNAs reinsurance segment reinsured GMDB (also known as variable annuity death benefits (VADBe)), under certain variable annuities issued by other insurance companies. These variable annuities are essentially investments in mutual funds combined with a death benefit. CIGNA has equity and other market exposures as a result of this product. The Company purchased retrocessional protection that covers a portion of the assumed risks. The Company also maintains a dynamic hedge program (GMDB equity hedge program) to substantially reduce the equity market exposures relating to GMDB contracts by entering into exchange-traded futures contracts.
For additional information about guaranteed minimum death benefit contracts, see Run-off Reinsurance beginning on page 62 and Note 7 to CIGNAs Consolidated Financial Statements beginning on page 100 of this Form 10-K.
Guaranteed Minimum Income Benefit Contracts
In certain circumstances where CIGNAs reinsurance operations reinsured the guaranteed minimum death benefit, CIGNA also reinsured GMIB under certain variable annuities issued by other insurance companies. These variable annuities are essentially investments in mutual funds combined with minimum income and death benefits. All reinsured GMIB policies also have a GMDB benefit reinsured by the Company. When annuitants elect to receive these minimum income benefits, CIGNA may be required to make payments which will vary based on changes in underlying mutual fund values and interest rates. CIGNA has retrocessional coverage for 55% of the exposures on these contracts, provided by two external reinsurers.
For additional information about guaranteed minimum income benefit contracts, see Guaranteed Minimum Income Benefits under Run-off Reinsurance beginning on page 62 and Note 11 to CIGNAs Consolidated Financial Statements beginning on page 110 of this Form 10-K.
Workers Compensation, Personal Accident and Catastrophe
CIGNA reinsured workers compensation and other personal accident and catastrophic risks in the London market and in the United States. CIGNA purchased retrocessional coverage in these markets to substantially reduce the risk of loss on these contracts.
The health policies have been substantially run off.
Markets and Distribution
These products under CIGNAs Run-off Reinsurance segment were sold principally in North America and Europe through a small sales force and through intermediaries.
Prior to 2000, CIGNA also purchased reinsurance to reduce the risk of losses on contracts that it had written. CIGNA determines its net exposure for run-off reinsurance contracts by estimating the portion of its policy and claim reserves that it expects will be recovered from its reinsurers (or retrocessionaires) and reflecting these in its financial statements as Reinsurance Recoverables, or, with respect to guaranteed minimum income benefit contracts discussed above, as Other Assets.
For more information see Run-off Reinsurance beginning on page 62, and Note 8 to CIGNAs Consolidated Financial Statements beginning on page 103 of this Form 10-K. For more information on the risk associated with Run-off Reinsurance, see the Risk Factors beginning on page 31 of this Form 10-K, and the Critical Accounting Estimates section of the MD&A beginning on page 49 of this Form 10-K.
G. Other Operations
Other Operations consists of:
The products and services related to these operations are offered by subsidiaries of CIGNA Corporation.
Corporate-owned Life Insurance (COLI)
Principal Products and Services
The principal products of the COLI business are permanent insurance contracts sold to corporations to provide coverage on the lives of certain of their employees. Permanent life insurance provides coverage that, when adequately funded, does not expire after a term of years. The contracts are primarily non-participating universal life policies. The key distinction between leveraged and non-leveraged COLI products is that, with leveraged COLI, the product design anticipates borrowing by the policy owner of a portion of the surrender value, while policy loans are not a significant feature of non-leveraged COLI.
Universal life policies typically provide flexible coverage and flexible premium payments. Policy cash values fluctuate with the amount of the premiums paid, mortality and expense charges assessed, and interest credited to the policy. Variable universal life policies are universal life contracts in which the cash values vary directly with the performance of a specific pool of investments underlying the policy.
The principal services provided by the corporate-owned life insurance business are issuance and administration of the insurance policies (e.g., maintenance of records regarding cash values and death benefits, claims processing, etc.) as well as oversight of the investment management for separate account assets that support the variable universal life product.
Cash values on universal life policies are credited interest at a declared interest rate that reflects the anticipated investment results of the assets backing these policies and may vary with the characteristics of each product. Universal life policies generally have a minimum guaranteed declared interest rate which may be cumulative from the issuance date of the policy. The declared interest rate may be changed monthly, but is generally changed less frequently. While variable universal life products may have a guaranteed minimum crediting rate, CIGNA did not have any such contracts at December 31, 2008.
In lieu of credited interest rates, holders of certain universal life policies may elect to receive credited income based on changes in an equity index, such as the S&P 500®. No such elections have been made since 2004.
Mortality risk is retained according to guidelines established by CIGNA. To the extent a given policy carries mortality risk that exceeds these guidelines, reinsurance is purchased from third parties for the balance.
Pricing, Reserves, and Reinsurance
Fees for universal life insurance products consist of mortality, administrative and surrender charges assessed against the policyholders fund balance. Interest credited and mortality charges for universal life and mortality charges on variable universal life may be adjusted prospectively to reflect expected interest and mortality experience.
For universal life insurance, CIGNA establishes reserves for deposits received and interest credited to the contractholder, less mortality and administrative charges assessed against the contractholders fund balance.
In order to reduce its exposure to large individual and catastrophe losses, CIGNA purchases reinsurance from unaffiliated reinsurers.
Markets and Distribution
Prior to 2008, the Company was not actively marketing and distributing COLI products. In 2008, the Company decided to re-enter the market for COLI products, and is currently actively pursuing opportunities associated with the COLI business.
The principal markets for COLI products are regional to national account-sized corporations, including banks. CIGNAs COLI products are offered through a select group of independent brokers with particular expertise in the bank market and in the use of COLI for the financing of benefit plan liabilities.
The principal competitive factors that affect CIGNAs COLI business are pricing, service, product innovation and access to third-party distribution.
For CIGNAs COLI business, competitors are primarily national life insurance companies, including insurance subsidiaries of banks.
CIGNA expects that the competitive environment will intensify as the economy recovers and competitors develop new investment strategies and product designs, and aggressively price their offerings to build distribution capacity and gain market share.
Industry Developments and Strategic Initiatives
The legislative environment surrounding COLI has evolved considerably over the past decade. Most recently, the Pension Protection Act of 2006 included provisions related to the notice requirements given to insured employees and limited coverage to certain more highly compensated employees. These changes were widely viewed as clarification of existing rules or industry best practices.
Sale of Individual Life Insurance & Annuity and Retirement Benefits Businesses
CIGNA sold its individual life insurance and annuity business in 1998 and its retirement business in 2004. Portions of the gains from these sales were deferred because the principal agreements to sell these businesses were structured as reinsurance arrangements. The deferred portion relating to the remaining reinsurance is being recognized at the rate that earnings from the sold businesses would have been expected to emerge, primarily over 15 years on a declining basis.
Because the individual life and annuity business was sold in an indemnity reinsurance transaction, CIGNA is not relieved of primary liability for the reinsured business and had reinsurance recoverables totaling $4.6 billion as of December 31, 2008. Effective as of December 14, 2007, the purchaser placed a significant portion of the assets supporting the reserves for the purchased business into a trust for the benefit of CIGNA which qualifies to support CIGNAs credit for the reinsurance ceded under Regulation 114 of the New York Department of Insurance. Trust assets are limited to cash, certificates of deposits in U.S. banks, and securities specified by section 1404 (a) of the New York insurance law and consist primarily of fixed maturities. At December 31, 2008, the value of the trust assets secured approximately 90% of the reinsurance recoverable. The remaining balance is currently unsecured. If Lincoln National Life Insurance Company and Lincoln Life & Annuity of New York do not maintain a specified minimum credit or claims paying rating, these reinsurers are required to fully secure the outstanding balance. S&P has assigned both of these reinsurers a rating of AA.
CIGNAs sale of its retirement business primarily took the form of an arrangement under which CIGNA reinsured with the purchaser of the retirement business the general account contractholder liabilities under an indemnity reinsurance arrangement and the separate account liabilities under modified coinsurance and indemnity reinsurance arrangements.
Since the sale of the retirement benefits business in 2004, the purchaser of that business has entered into agreements with certain insured party contractholders (novation agreements), which relieved CIGNA of any remaining contractual obligations to the contractholders. As a result, CIGNA reduced reinsurance recoverables, contractholder deposit funds, and separate account balances
for these obligations. The purchaser of the retirement benefits business deposited assets associated with the reinsurance of general account contracts into a trust (the Ceded Business Trust) to provide security to CIGNA for the related reinsurance recoverables. The purchaser is permitted to withdraw assets from the Ceded Business Trust equal to the reduction in CIGNAs reserves whenever a reduction occurs. For example, reductions will occur when the purchaser enters into additional novation agreements and directly assumes liability to the insured party. Assets in the trust must be greater than or equal to general account statutory liabilities of the ceded business. Trust assets are limited to those types of investments that are permitted by the state of Connecticut for general account investing and consist primarily of fixed maturities. As of December 31, 2008, assets totaling $2.5 billion remained in the Ceded Business Trust, and the remaining reserves for the purchased business were $1.9 billion.
Settlement Annuity Business
CIGNAs settlement annuity business is a run-off block of contracts. These contracts are primarily liability settlements with approximately 35% of the liabilities associated with payments which are guaranteed and not contingent on survivorship. In the case of the contracts that involve non-guaranteed payments, such payments are contingent on the survival of one or more parties involved in the settlement.
The Settlement Annuities business is premium deficient, meaning initial premiums were not sufficient to cover all claims and profit. Liabilities are estimates of the present value of benefits to be paid less the present value of investment income generated by the assets supporting the product including realized and unrealized capital gains. The company estimates these liabilities based on assumptions for investment yields, mortality, and administrative expenses. Refer to Note 2 to CIGNAs Consolidated Financial Statements beginning on page 86 for additional information regarding reserves for this business.
For more information, see Other Operations beginning on page 65 of this Form 10-K.
H. Investments and Investment Income
CIGNAs investment operations provide investment management and related services primarily for CIGNAs corporate invested assets and the insurance-related invested assets in its General Account (Invested Assets). CIGNA acquires or originates, directly or through intermediaries, various investments including private placements, public securities, commercial mortgage loans, real estate and short-term investments. CIGNAs Invested Assets are managed primarily by CIGNA subsidiaries and external managers with whom CIGNAs subsidiaries contract.
The Invested Assets comprise a majority of the combined assets of the Health Care, Disability and Life, Run-off Reinsurance and Other Operations segments (collectively, the Domestic Portfolios). There are, in addition, portfolios containing Invested Assets that consist of the assets of the International segment (collectively, the International Portfolios).
Net investment income and realized investment gains (losses) are not reported separately in the investment operations. Instead, net investment income is included as a component of earnings for each of CIGNAs operating segments (Health Care, Disability and Life, Run-off Reinsurance, Other Operations, International and Corporate), net of the expenses attributable to the investment operations. Realized investment gains (losses) are reported for each of CIGNAs operating segments.
Assets Under Management
CIGNAs Invested Assets under management at December 31, 2008 totaled $18.0 billion. See Schedule I to CIGNAs 2008 Consolidated Financial Statements on page FS-3 of this Form 10-K for more information as to the allocation to types of investments.
As of December 31, 2008, CIGNAs separate account funds consisted of:
Types of Investments
CIGNA invests in a broad range of asset classes, including domestic and international fixed maturities and common stocks, commercial mortgage loans, real estate and short-term investments. Fixed maturity investments include publicly traded and private placement corporate bonds, government bonds, publicly traded and private placement asset-backed securities, and redeemable preferred stocks. In connection with CIGNAs investment strategy to enhance investment yields by selling senior participations of commercial mortgage loans, as of December 31, 2008, commercial mortgage loans include $75 million of commercial mortgage loans originated with the intent to sell. These commercial mortgage loans held for sale are carried at the lower of cost or fair value with any resulting valuation allowance reported in realized investment gains and losses.
For the International Portfolios, CIGNA invests primarily in publicly traded fixed maturities, short-term investments and time deposits denominated in the currency of the relevant liabilities and surplus.
CIGNAs fixed maturities are 92% investment grade as determined by external rating agencies (for public investments) and by CIGNA (for private investments). These assets are well diversified by individual holding and industry sector. For information about below investment grade holdings, see the Investment Assets section of the MD&A beginning on page 73 of this Form 10-K.
Commercial Mortgages and Real Estate
Commercial mortgage loan investments are subject to underwriting criteria addressing loan-to-value ratio, debt service coverage, cash flow, tenant quality, leasing, market, location and borrowers financial strength. Such investments consist primarily of first
mortgage loans on commercial properties and are diversified by property type, location and borrower. CIGNA invests primarily in commercial mortgages on fully completed and substantially leased commercial properties. Virtually all of CIGNAs commercial mortgage loans are balloon payment loans, under which all or a substantial portion of the loan principal is due at the end of the loan term. CIGNA holds no direct residential mortgages. The weighted average loan to value ratio of the Companys commercial mortgage loan portfolio, based on managements annual valuation completed in the third quarter of 2008, was approximately 64% and the weighted average debt service coverage was approximately 1.5 times.
CIGNA enters into joint ventures with local partners to develop, lease, manage, and sell commercial real estate to maximize investment returns. CIGNAs portfolio of real estate investments consists of properties under development and stabilized properties, and is diversified relative to property type and location. CIGNA also acquires real estate through foreclosure of commercial mortgage loans. CIGNA rehabilitates, re-leases, and sells foreclosed properties, a process that usually takes from two to four years unless management considers a near-term sale preferable. Additionally, CIGNA invests in third party sponsored real estate funds to maximize investment returns and to maintain diversity with respect to its real estate related exposure. CIGNA sold its remaining foreclosed property and did not acquire any properties through foreclosure in 2008.
Mezzanine and Private Equity Partnerships
CIGNA invests in limited partnership interests in partnerships formed and managed by seasoned, experienced fund managers with diverse mezzanine and private equity strategies.
CIGNA generally uses derivative financial instruments to minimize its exposure to certain market risks. CIGNA has also written derivative instruments to minimize certain insurance customers market risks. In addition, to enhance investment returns, CIGNA may invest in indexed credit default swaps or other credit derivatives from time to time. However, as of December 31, 2008, CIGNA held no indexed credit default swaps or other credit derivatives. For information about CIGNAs use of derivative financial instruments, see Note 12 to CIGNAs 2008 Consolidated Financial Statements beginning on page 115 of this Form 10-K.
See also the Investment Assets section of the MD&A beginning on page 73, and Notes 2, 12, and 13 to the Consolidated Financial Statements beginning on pages 86, 115 and 121, respectively, of this Form 10-K for additional information about CIGNAs investments.
Domestic Portfolios Investment Strategy
As of December 31, 2008 the Domestic Portfolios had $16.6 billion in Invested Assets, allocated among fixed maturity investments (63%); commercial mortgage loan investments (22%); and policy loans, real estate investments, short-term investments and mezzanine and private equity partnership investments (15%).
CIGNA generally manages the characteristics of these assets to reflect the underlying characteristics of related insurance and contractholder liabilities and related capital requirements, as well as regulatory and tax considerations pertaining to those liabilities, and state investment laws. CIGNAs domestic insurance and contractholder liabilities as of December 31, 2008, excluding liabilities of businesses sold through the use of reinsurance arrangements, were associated with the following products, and the Invested Assets are allocated proportionally as follows: other life and health, 52%; fully guaranteed annuity, 19%; and interest-sensitive life insurance, 29%.
While the businesses and products supported are described elsewhere in this Form 10-K, the Invested Assets supporting CIGNAs insurance and contractholder liabilities related to each of its segments are as follows:
Investment strategy and results are affected by the amount and timing of cash available for investment, competition for investments, economic conditions, interest rates and asset allocation decisions. CIGNA routinely monitors and evaluates the status of its investments in light of current economic conditions, trends in capital markets and other factors. Such factors include industry sector considerations for fixed maturity investments and mezzanine and private equity partnership investments, and geographic and property-type considerations for commercial mortgage loan and real estate investments.
International Portfolios Investment Strategy
As of December 31, 2008 the International Portfolios had $1.4 billion in Invested Assets. The International Portfolios are primarily managed by external managers with whom CIGNAs subsidiaries contract.
The characteristics of these assets are generally managed to reflect the underlying characteristics of related insurance and contractholder liabilities, as well as regulatory and tax considerations in the countries where CIGNAs subsidiaries operate. CIGNA Internationals Invested Assets are generally invested in the currency of related liabilities, typically the currency in which the subsidiaries operate and with an aggregate duration generally matching the duration of insurance liabilities and surplus. CIGNAs investment policy allows the investment of subsidiary assets in U.S. dollars to the extent permitted by regulation. CIGNA Internationals Invested Assets as of December 31, 2008 were held primarily in support of statutory surplus and liabilities associated with the life, accident and supplemental health and healthcare products described in Section E on page 14.
CIGNA and its subsidiaries are subject to federal, state and international regulations and CIGNA has established policies and procedures to comply with applicable requirements.
CIGNAs insurance and HMO subsidiaries must be licensed by the jurisdictions in which they conduct business. These subsidiaries are subject to numerous state and federal regulations related to their business operations, including, but not limited to:
CIGNA and its international subsidiaries comply with regulations in international jurisdictions where foreign insurers are, in some countries, faced with greater restrictions than their domestic competitors. These restrictions may include discriminatory licensing procedures, compulsory cessions of reinsurance, required localization of records and funds, higher premium and income taxes, and requirements for local participation in an insurers ownership.
CIGNA and its subsidiaries are also subject to state and federal laws relating to business entities.
Other types of regulatory oversight predominantly as to CIGNA and its subsidiaries products and services are described below.
Regulation of Insurance Companies
Regulators closely monitor the financial condition of licensed insurance companies and HMOs. States regulate the form and content of statutory financial statements and the type and concentration of permitted investments. CIGNAs insurance and HMO subsidiaries are required to file periodic financial reports with regulators in most of the jurisdictions in which they do business, and their operations and accounts are subject to examination by such agencies at regular intervals.
Guaranty Associations, Indemnity Funds, Risk Pools and Administrative Funds
Most states and certain non-U.S. jurisdictions require insurance companies to support guaranty associations or indemnity funds, which are established to pay claims on behalf of insolvent insurance companies. In the United States, these associations levy assessments on member insurers licensed in a particular state to pay such claims.
Several states also require HMOs to participate in guaranty funds, special risk pools and administrative funds. For additional information about guaranty fund and other assessments, see Note 22 to CIGNAs Consolidated Financial Statements beginning on page 133 of this Form 10-K.
Some states also require health insurers and HMOs to participate in assigned risk plans, joint underwriting authorities, pools or other residual market mechanisms to cover risks not acceptable under normal underwriting standards.
Solvency and Capital Requirements
Many states have adopted some form of the National Association of Insurance Commissioners (NAIC) model solvency-related laws and risk-based capital rules (RBC rules) for life and health insurance companies. The RBC rules recommend a minimum level of capital depending on the types and quality of investments held, the types of business written and the types of liabilities incurred. If the ratio of the insurers adjusted surplus to its risk-based capital falls below statutory required minimums, the insurer could be subject to regulatory actions ranging from increased scrutiny to conservatorship.
In addition, various non-U.S. jurisdictions prescribe minimum surplus requirements that are based upon solvency, liquidity and reserve coverage measures. During 2008, CIGNAs HMOs and life and health insurance subsidiaries, as well as non-U.S. insurance subsidiaries, were compliant with applicable RBC and non-U.S. surplus rules.
In 2008, the NAIC adopted Actuarial Guideline VACARVM, Commissioners Annuity Reserve Valuation Method for Variable Annuities, which will be effective December 31, 2009. VACARVM will impact statutory and tax reserves for CIGNAs contracts covering guaranteed minimum death benefits and guaranteed minimum income benefits. Upon implementation, it is anticipated that statutory reserves for those products will increase and thus statutory surplus for Connecticut General Life Insurance Company will be reduced. The magnitude of any impact depends on equity market and interest rate levels at the time of implementation.
Holding Company Laws
CIGNAs domestic insurance companies and certain of its HMOs are subject to state laws regulating subsidiaries of insurance holding companies. Under such laws, certain dividends, distributions and other transactions between an insurance or HMO subsidiary and its affiliates may require notification to, or approval by, one or more state insurance commissioners.
Oversight of Marketing, Advertising and Broker Compensation
State and/or federal regulatory scrutiny of life and health insurance company and HMO marketing and advertising practices, including the adequacy of disclosure regarding products and their administration, may result in increased regulation. Products offering limited benefits, such as those issued in connection with the Star HRG business acquired in July 2006, may attract increased regulatory scrutiny. States have responded to concerns about the marketing, advertising and administration of insurance and HMO products and administrative practices by increasing the number and frequency of market conduct examinations and imposing larger penalties for violations of applicable laws and regulations.
In recent years, perceived abuses in broker compensation practices have been the focus of greatly heightened regulatory scrutiny. This increased regulatory focus may lead to legislative or regulatory changes that would affect the manner in which CIGNA and its competitors compensate brokers. For more information regarding general governmental inquiries relating to CIGNA subsidiaries, see Legal Proceedings in Item 3 beginning on page 39.
Pharmacy Licensure Laws
Certain CIGNA subsidiaries are pharmacies, which dispense prescription drugs to participants of benefit plans administered or insured by CIGNA subsidiary HMOs and insurance companies. These pharmacy-subsidiaries are subject to state licensing requirements and regulation.
Claim Administration, Utilization Review and Related Services
Certain CIGNA subsidiaries contract for the provision of claim administration, utilization management and other related services with respect to the administration of self-insured benefit plans. These CIGNA subsidiaries may be subject to state third-party administration and other licensing requirements and regulation.
Employee Retirement Income Security Act
CIGNA subsidiaries sell most of their products and services to sponsors of employee benefit plans that are governed by the Federal Employee Retirement Income Security Act (ERISA). CIGNA subsidiaries may be subject to requirements imposed by ERISA on plan fiduciaries and parties in interest, including regulations affecting claim and appeals procedures for health, dental, disability, life and accident plans.
Several CIGNA subsidiaries engage in businesses that are subject to federal Medicare regulations such as:
Federal Audits of Government Sponsored Health Care Programs
Participation in government sponsored health care programs subjects CIGNA to a variety of federal laws and regulations and risks associated with audits conducted under the programs (which may occur in years subsequent to provision by CIGNA of the relevant services under audit). These risks may include reimbursement claims as well as potential fines and penalties. For example, the federal government requires Medicare and Medicaid providers to file detailed cost reports for health care services provided. These reports may be audited in subsequent years. CIGNA HMOs that contract to provide community-rated coverage to participants in the federal Employees Health Benefit Plan may be required to reimburse the federal government if, following an audit, it is determined that a federal employee group did not receive the benefit of a discount offered by a CIGNA HMO to one of the two groups closest in size to the federal employee group. See Health Care in Section C beginning on page 1 for additional information about CIGNAs participation in government health-related programs.
Privacy and Information Disclosure and Portability Regulations
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) imposes requirements for guaranteed issuance (for groups with 50 or fewer lives), electronic data security standards, and renewal and portability, on health care insurers and HMOs. In addition, HIPAA regulations required the assignment of a unique national identifier for providers by May 2007. The federal government, states and territories (as well as most non-U.S. jurisdictions) impose requirements regarding the use and disclosure of identifiable information about individuals and, in an effort to deal with the growing threat of identity theft, the handling of privacy and security breaches.
CIGNA subsidiaries are also engaged in activities that may be scrutinized under federal and state antitrust laws and regulations. These activities include the administration of strategic alliances with competitors, information sharing with competitors and provider contracting.
Anti-Money Laundering Regulations
Certain CIGNA subsidiaries are subject to United States Department of the Treasury anti-money laundering regulations. Those subsidiaries have implemented anti-money laundering policies designed to insure their affected products comply with the regulations.
Depending upon their nature, CIGNAs investment management activities are subject to U.S. federal securities laws, ERISA, and other federal and state laws governing investment related activities. In many cases, the investment management activities and investments of individual insurance companies are subject to regulation by multiple jurisdictions.
The business of administering and insuring employee benefit programs, particularly health care programs, is heavily regulated by federal and state laws and administrative agencies, such as state departments of insurance and the federal Departments of Labor and Justice, as well as the courts. In the growing area of consumer-driven plans, health savings accounts and health reimbursement accounts are also regulated by the United States Department of the Treasury and the Internal Revenue Service. For information on Regulatory and Industry Developments, see page 67 in the MD&A and Note 22 to CIGNAs Consolidated Financial Statements beginning on page 133 of this Form 10-K.
Federal and state regulation and legislation may affect CIGNAs operations in a variety of ways. In addition to proposals discussed above related to increased regulation of the health care industry, other proposed measures that may significantly affect CIGNAs operations include calls for universal health care coverage and for government sponsored single payor, market reforms achieved through state and federal legislation, modifications of the Medicare program, and employee benefit regulation including modification to the tax treatment of employee benefits.
The economic and competitive effects of the legislative and regulatory proposals discussed above on CIGNAs business operations will depend upon the final form of any such legislation or regulation.
CIGNA and certain of its insurance subsidiaries are rated by nationally recognized rating agencies. The significance of individual ratings varies from agency to agency. However, companies that are assigned ratings at the top end of the range have, in the opinion of the rating agency, the strongest capacity for repayment of debt or payment of claims, while companies at the bottom end of the range have the weakest capacity.
Insurance ratings represent the opinions of the rating agencies on the financial strength of a company and its capacity to meet the obligations of insurance policies. The principal agencies that rate CIGNAs insurance subsidiaries characterize their insurance rating scales as follows:
As of February 25, 2009, the insurance financial strength ratings for CIGNA subsidiaries, Connecticut General Life Insurance Company (CG Life) and Life Insurance Company of North America (LINA) were as follows:
Debt ratings are assessments of the likelihood that a company will make timely payments of principal and interest. The principal agencies that rate CIGNAs senior debt characterize their rating scales as follows:
The commercial paper rating scales for those agencies are as follows:
As of February 25, 2009, the debt ratings assigned to CIGNA Corporation by the following agencies were as follows:
CIGNA is committed to maintaining appropriate levels of capital in its subsidiaries to support financial strength ratings that meet customers expectations, and to improving the earnings of the health care business. Lower ratings at the parent company level increase the cost to borrow funds. Lower ratings of CG Life and LINA could adversely affect new sales and retention of current business.
CIGNA and its principal subsidiaries are not dependent on business from one or a few customers. No customer accounted for 10% or more of CIGNAs consolidated revenues in 2008. CIGNA and its principal subsidiaries are not dependent on business from one or a few brokers or agents. In addition, CIGNAs insurance businesses are generally not committed to accept a fixed portion of the business submitted by independent brokers and agents, and generally all such business is subject to its approval and acceptance.
CIGNA had approximately 30,300, 26,600, and 27,100 employees as of December 31, 2008, 2007 and 2006, respectively.
Item 1A. RISK FACTORS
As a large company operating in a complex industry, CIGNA encounters a variety of risks and uncertainties including those identified in this Risk Factor discussion and elsewhere in this report. CIGNA devotes resources to developing enterprise-wide risk management processes, in addition to the risk management processes within its businesses. These factors represent risks and uncertainties that could have a material adverse effect on CIGNAs business, liquidity, results of operations or financial condition. These risks and uncertainties are not the only ones CIGNA faces. Other risks and uncertainties that CIGNA does not know about now, or that the Company does not now think are significant and does not appropriately identify and manage, may impair its business or the trading price of its securities. The following are significant risks identified by CIGNA.
Future performance of CIGNAs business will depend on the Companys ability to execute its strategic initiatives.
The future performance of CIGNAs business will depend in large part on CIGNAs ability to execute effectively and implement its strategic initiatives. These initiatives include: executing CIGNAs customer engagement strategy, including designing products to meet emerging market trends and ensuring that an appropriate infrastructure is in place to meet the needs of customers; continuing to reduce medical costs; market expansion, in particular in the individual and small business markets, as well as growth in medical and specialty membership; and further improving the efficiency of operations, including lowering operating costs per member and enabling higher value services.
Successful execution of these initiatives depends on a number of factors including:
If CIGNA does not adequately invest in and effectively execute improvements in its information technology infrastructure and improve its functionality, it will not be able to deliver the service required in the evolving marketplace at a competitive cost.
CIGNAs success in executing its consumer engagement strategy depends on the Companys continued improvements to its information technology infrastructure and customer service offerings. The marketplace is evolving and the level of service that is acceptable to customers today will not necessarily be acceptable tomorrow. The Company must continue to invest in long term solutions that will enable it to meet customer expectations. CIGNAs success is dependent, in large part, on maintaining the effectiveness of existing technology systems and continuing to deliver and enhance technology systems that support the Companys business processes in a cost-efficient and resource-efficient manner. CIGNA also must develop new systems to meet the current market standard and keep pace with continuing changes in information processing technology, evolving industry and regulatory standards and customer needs. System development projects are long term in nature, may be more costly than expected to complete, and may not deliver the expected benefits upon completion.
CIGNAs business depends on its ability to properly maintain the integrity or security of its data or to strategically implement new information systems.
CIGNAs business depends on effective information systems and the integrity and timeliness of the data it uses to run its business. CIGNAs business strategy requires providing members and providers with Internet-enabled products and information to meet their needs. CIGNAs ability to adequately price its products and services, establish reserves, provide effective and efficient service to its customers, and to timely and accurately report its financial results also depends significantly on the integrity of the data in its information systems. If the information CIGNA relies upon to run its businesses were found to be inaccurate or unreliable due to fraud or other error, or if CIGNA were to fail to maintain effectively its information systems and data integrity, the Company could have problems with, among other things: operational disruptions, which may impact customers, physicians and other health care providers; determining medical cost estimates and establishing appropriate pricing; retaining and attracting customers; and regulatory compliance.
If CIGNA were unable to maintain the security of any sensitive data residing on the Companys systems whether due to its own actions or those of any vendors, CIGNAs reputation would be adversely affected and the Company could be exposed to litigation or other actions, fines or penalties.
If CIGNA fails to manage successfully its outsourcing projects and key vendors, CIGNAs business could be disrupted.
CIGNA takes steps to monitor and regulate the performance of independent third parties who provide services or to whom the Company delegates selected functions. These third parties include information technology system providers, independent practice associations, call center and claim service providers, specialty service providers and include those vendor relationships that the Company acquired from Great-West HealthCare.
In addition to the software applications and human resource operations support IBM had previously provided pursuant to several smaller contracts, in 2006, CIGNA entered into an agreement with IBM to operate significant portions of its information technology infrastructure, including the provision of services relating to its call center application, enterprise content management, risk-based capital analytical infrastructure and voice and data communications network. The 2006 contract with IBM includes several service level agreements, or SLAs, related to issues such as performance and job disruption with significant financial penalties if these SLAs are not met. However, the Company may not be adequately indemnified against all possible losses through the terms and conditions of the agreement. In addition, some of CIGNAs termination rights are contingent upon payment of a fee, which may be significant. If CIGNAs relationship with IBM is terminated, the Company may experience disruption of service to customers.
Arrangements with key vendors may make CIGNAs operations vulnerable if third parties fail to satisfy their obligations to the Company, as a result of their performance, changes in their own operations, financial condition, or other matters outside of CIGNAs control. Certain legislative authorities have in recent periods discussed or proposed legislation that would restrict outsourcing and, if enacted, could materially increase CIGNAs costs. Further, CIGNA may not fully realize on a timely basis the anticipated economic and other benefits of the outsourcing projects or other relationships it enters into with key vendors, which could result in substantial costs or other operational or financial problems for the Company.
Sustained or significant deterioration in economic conditions could significantly impact the Companys customers and vendors.
The Company is exposed to risks associated with the potential financial instability of its customers, many of which may be adversely affected by the volatile conditions in the financial markets. As a result of the difficult economic environment, customers may experience serious cash flow problems and other financial difficulties. As a result, they may modify, delay or cancel plans to purchase the Companys products, may make changes in the mix of products purchased that are unfavorable to the Company, or may be forced to reduce their workforces. Specifically, higher unemployment rates as a result of a prolonged economic downturn could lead to lower enrollment in the Companys employer group plans, lower enrollment in our non-employer individual plans and a higher number of employees opting out of CIGNAs employer group plans. The adverse economic conditions could also cause employers to stop offering certain health care coverage as an employee benefit or elect to offer this coverage on a voluntary, employee-funded basis as a means to reduce their operating costs. In addition, the economic downturn could negatively impact the Companys employer group renewal prospects and our ability to increase premiums and could result in cancellation of products and services by customers. This could also result in increased unemployment and an increase in the number of claims submitted. All of these developments could lead to a decrease in CIGNAs membership levels and premium and fee revenues. Further, if customers are not successful in generating sufficient revenue or are precluded from securing financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to the Company. Any inability of current and/or potential customers to pay the Company for its products may adversely affect the Companys earnings and cash flow.
In addition, the Company is susceptible to risks associated with the potential financial instability of the vendors on which it relies to provide services or to whom it delegates certain functions. The same conditions that may affect CIGNAs customers also could adversely affect its vendors, causing them to significantly and quickly increase their prices or reduce their output. CIGNAs business depends on its ability to perform, in an efficient and uninterrupted fashion, its necessary business functions.
A downgrade in the financial strength ratings of CIGNAs insurance subsidiaries could adversely affect new sales and retention of current business, and a downgrade in CIGNAs debt ratings would increase the cost of borrowed funds.
Financial strength, claims paying ability and debt ratings by recognized rating organizations are an important factor in establishing the competitive position of insurance companies and health benefits companies. Ratings information by nationally recognized ratings agencies is broadly disseminated and generally used throughout the industry. CIGNA believes the claims paying ability and financial strength ratings of its principal insurance subsidiaries are an important factor in marketing its products to certain of CIGNAs customers. In addition, CIGNA Corporations debt ratings impact both the cost and availability of future borrowings, and accordingly, its cost of capital. Each of the rating agencies reviews CIGNAs ratings periodically and there can be no assurance that current ratings will be maintained in the future. In addition, a downgrade of these ratings could make it more difficult to raise capital and to support business growth at CIGNAs insurance subsidiaries.
A description of CIGNA Corporation ratings, other subsidiary ratings, as well as more information on these ratings, is included in Ratings in Section J beginning on page 28.
Unfavorable claims experience related to workers compensation and personal accident insurance exposures in CIGNAs Run-off Reinsurance business could result in losses.
Unfavorable claims experience related to workers compensation and personal accident insurance exposures in CIGNAs run-off reinsurance business is possible and could result in future losses. Further, CIGNA could have losses attributable to its inability to recover amounts from retrocessionaires or ceding companies either due to disputes with the retrocessionaires or ceding companies or their financial condition. If CIGNAs reserves for amounts recoverable from retrocessionaires or ceding companies, as well as reserves associated with underlying reinsurance exposures are insufficient, it could result in losses.
CIGNAs equity hedge program for its guaranteed minimum death benefits contracts could fail to reduce the risk of stock market declines.
As part of its run-off reinsurance business, CIGNA reinsured a guaranteed minimum death benefit under certain variable annuities issued by other insurance companies. CIGNA maintains a hedge program to reduce equity market risks related to these contracts by selling domestic and foreign-denominated exchange-traded futures contracts. The purpose of this program is to reduce the adverse effects of potential future domestic and international stock market declines on CIGNAs liabilities for these contracts. Under the program, increases in liabilities under the annuity contracts from a declining equity market are offset by gains on the futures contracts. However the program will not perfectly offset the change in the liability in part because the market does not offer futures contracts that exactly match the diverse mix of equity fund investments held by contractholders. The impact of this mismatch may be higher in periods of significant volatility and may result in higher losses to the Company. In addition, the number of futures contracts used in the program is adjusted only when certain tolerances are exceeded and in periods of highly volatile equity markets when actual volatility exceeds the expected volatility assumed in the liability calculation, losses will result. Further, CIGNA could have difficulty in entering into appropriate futures contracts or there could be an adverse interest rate impact, (which are not covered by the program). See Run-off Reinsurance in Section F on page 16 for more information on the program.
Actual experience could differ significantly from CIGNAs assumptions used in estimating CIGNAs liabilities for reinsurance contracts covering guaranteed minimum death benefits or minimum income benefits.
CIGNA estimates reserves for guaranteed minimum death benefit and minimum income benefit exposures based on assumptions regarding lapse, partial surrender, mortality, interest rates, volatility, reinsurance recoverables, and, for minimum income benefit exposures, annuity income election rates. These estimates are currently based on CIGNAs experience and future expectations. CIGNA monitors actual experience to update these reserve estimates as necessary. CIGNA regularly evaluates the assumptions used in establishing reserves and changes its estimates if actual experience or other evidence suggests that earlier assumptions should be revised. Further, CIGNA could have losses attributable to its inability to recover amounts from retrocessionaires. See Notes 7 and 11 to CIGNAs Consolidated Financial Statements beginning on pages 100 and 110, respectively, for more information on assumptions used for the Companys guaranteed minimum death benefit and minimum income benefit exposures.
Significant stock market declines could result in increased pension plan expenses, the recognition of additional pension obligations and increased funding for those obligations as well as larger net liabilities for guaranteed minimum death benefit contracts or for guaranteed minimum income benefit contracts.
CIGNA has a pension plan that covers a large number of current employees and retirees. Unfavorable investment performance due to significant stock market declines or changes in estimates of benefit costs if significant, could significantly increase the Companys pension plan expenses and obligations.
In addition, CIGNA currently has unfunded obligations in its pension plan. A significant decline in the value of the plan investments or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding, which could reduce the cash available to CIGNA, including its subsidiaries. See Note 10 to CIGNAs Consolidated Financial Statements beginning on page 106 for more information on the Companys obligations under the pension plan.
The Company calculates a provision for expected future partial surrenders as part of the liability for guaranteed minimum death benefit contracts. As equity markets decline, the amount of guaranteed death benefit exposure increases and the equity hedge program is designed to offset the corresponding change in the liability. If a contractholder withdraws substantially all of their mutual fund investments, the liability increases reflecting the lower assumed future premiums, the lower likelihood of lapsation, and the lower likelihood of account values recovering sufficient to reduce death benefit exposure in future periods. These effects are not covered by the Companys equity hedge program. Thus if equity markets decline, the provision for expected future partial surrenders increases and there is no corresponding offset from the hedge program. As equity markets decline, the claim amounts that the Company expects to pay out for the guaranteed minimum income benefit business increases resulting in increased net liabilities.
Significant changes in market interest rates affect the value of CIGNAs financial instruments that promise a fixed return or benefit.
As an insurer, CIGNA has substantial investment assets that support insurance and contractholder deposit policy liabilities. Generally low levels of interest rates on investments, such as those experienced in United States financial markets during recent years, have negatively impacted the level of investment income earned by the Company in recent periods, and such lower levels of investment income would continue if these lower interest rates were to continue. Substantially all of the Companys investment assets are in fixed interest-yielding debt securities of varying maturities, fixed redeemable preferred securities and commercial mortgage loans. The value of these investment assets can fluctuate significantly with changes in market conditions. A rise in interest rates could reduce the value of the Companys investment portfolio and increase interest expense if CIGNA were to access its available lines of credit.
The Company is also exposed to interest rate and equity risk based upon the discount rate and expected long-term rate of return assumptions associated with the Companys pension and other post-retirement obligations. Sustained declines in interest rates or equity returns could have an adverse impact on the funded status of the Companys pension plans and the Companys re-investment yield on new investments.
As the 7-year Treasury rate (claim interest rate) declines, the claim amounts that the Company expects to pay out for the guaranteed minimum income benefit business increases. For a subset of the business, there is a contractually guaranteed floor of 3% for the claim interest rate. Significant interest rate declines could significantly increase the Companys net liabilities for guaranteed minimum income benefit contracts because of increased exposures.
New accounting pronouncements or guidance could require CIGNA to change the way in which it accounts for operations.
The Financial Accounting Standards Board, the Securities and Exchange Commission, and other regulatory bodies may issue new accounting standards or pronouncements, or changes in the interpretation of existing standards or pronouncements, from time to time, which could have a significant effect on CIGNAs reported results.
CIGNA faces risks related to litigation and regulatory investigations.
CIGNA is routinely involved in numerous claims, lawsuits, regulatory audits, investigations and other legal matters arising in the ordinary course of the business of administering and insuring employee benefit programs. Such legal matters include benefit claims, breach of contract actions, tort claims, and disputes regarding reinsurance arrangements. In addition, CIGNA incurs and likely will continue to incur liability for claims related to its health care business, such as failure to pay for or provide health care, poor outcomes for care delivered or arranged, provider disputes, including disputes over compensation, and claims related to self-funded business. Also, there are currently, and may be in the future, attempts to bring class action lawsuits against the industry.
Court decisions and legislative activity may increase CIGNAs exposure for any of these types of claims. In some cases, substantial non-economic or punitive damages may be sought. CIGNA currently has insurance coverage for some of these potential liabilities. Other potential liabilities may not be covered by insurance, insurers may dispute coverage or the amount of insurance may not be sufficient to cover the entire damages awarded. In addition, certain types of damages, such as punitive damages, may not be covered by insurance, and insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.
A description of material legal actions and other legal matters in which CIGNA is currently involved is included under Legal Proceedings in Item 3 beginning on page 39, Note 22 to CIGNAs Consolidated Financial Statements beginning on page 133 of this Form 10-K and Regulation in Section I beginning on page 24. The outcome of litigation and other legal matters is always uncertain, and outcomes that are not justified by the evidence or existing law can occur. CIGNA believes that it has valid defenses to the legal matters pending against it and is defending itself vigorously.
CIGNAs business is subject to substantial government regulation, which, along with new regulation, could increase its costs of doing business and could adversely affect its profitability.
CIGNAs business is regulated at the international, federal, state and local levels. The laws and rules governing CIGNAs business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Existing or future laws and rules could force CIGNA to change how it does business, restrict revenue and enrollment growth, increase health care, technology and administrative costs including pension costs and capital requirements, take other actions such as changing its reserve levels with respect to certain reinsurance contracts, change business practices in disability payments and increase CIGNAs liability in federal and state courts for coverage determinations, contract interpretation and other actions.
CIGNA must comply with the various regulations applicable to its business. In addition, CIGNA must obtain and maintain regulatory approvals to market many of its products, to increase prices for certain regulated products and to consummate some of its acquisitions and divestitures. Delays in obtaining or failure to obtain or maintain these approvals could reduce the Companys revenue or increase its costs.
For further information on regulatory matters relating to CIGNA, see Regulation in Section I beginning on page 24 and Legal Proceedings in Item 3 beginning on page 39.
CIGNA operates a pharmacy benefit management business, which is subject to a number of risks and uncertainties, in addition to those CIGNA faces with its health care business.
CIGNAs pharmacy benefit management business is subject to federal and state regulation, including: the application of federal and state anti-remuneration laws; compliance requirements for pharmacy benefit manager fiduciaries under ERISA, including compliance with fiduciary obligations under ERISA in connection with the development and implementation of items such as formularies, preferred drug listings and therapeutic intervention programs, contracting network practices, specialty drug distribution and other transactions and potential liability regarding the use of patient-identifiable medical information; and federal and state laws and regulations related to the operation of Internet and mail-service pharmacies. Furthermore, a number of federal and state legislative proposals are being considered that could adversely affect a variety of pharmacy benefit industry practices, including without limitation, the receipt of rebates from pharmaceutical manufacturers, the regulation of the development and use of formularies, and legislation imposing additional rights to access drugs for individuals enrolled in managed care plans.
The Companys pharmacy benefit management business would also be adversely affected by an inability to contract on favorable terms with pharmaceutical manufacturers and could suffer claims and reputational harm in connection with purported errors by CIGNAs mail order or retail pharmacy businesses. Disruptions at any of the Companys pharmacy business facilities due to failure of
technology or any other failure or disruption to these systems or to the infrastructure due to fire, electrical outage, natural disaster, acts of terrorism or some other catastrophic event could reduce CIGNAs ability to process and dispense prescriptions and provide products and services to customers.
CIGNA faces competitive pressure, particularly price competition, which could result in premiums which are insufficient to cover the cost of the healthcare services delivered to its members and inadequate medical claims reserves.
While health plans compete on the basis of many factors, including service quality of clinical resources, claims administration services and medical management programs, and quality and sufficiency of provider networks, CIGNA expects that price will continue to be a significant basis of competition. CIGNAs customer contracts are subject to negotiation as customers seek to contain their costs, and customers may elect to reduce benefits in order to constrain increases in their benefit costs. Such an election may result in lower premiums for the Companys products, although it may also reduce CIGNAs costs. Alternatively, the Companys customers may purchase different types of products that are less profitable, or move to a competitor to obtain more favorable premiums.
In addition, significant merger and acquisition activity has occurred in the health care industry giving rise to speculation and uncertainty regarding the status of companies, which potentially can affect marketing efforts and public perception. Consolidation may make it more difficult for the Company to retain or increase customers, to improve the terms on which CIGNA does business with its suppliers, or to maintain its position or increase profitability. Factors such as business consolidations, strategic alliances, legislative reform and marketing practices create pressure to contain premium price increases, despite increasing medical costs. For example, the Gramm-Leach-Bliley Act gives banks and other financial institutions the ability to affiliate with insurance companies, which may lead to new competitors with significant financial resources in the insurance and health benefits fields.
If CIGNA does not compete effectively in its markets, if the Company sets rates too high in highly competitive markets to keep or increase its market share, if membership does not increase as it expects, or if it declines, or if CIGNA loses accounts with favorable medical cost experience while retaining or increasing membership in accounts with unfavorable medical cost experience, CIGNAs product margins and growth could be adversely affected.
CIGNAs profitability depends, in part, on its ability to accurately predict and control future health care costs through underwriting criteria, provider contracting, utilization management and product design. Premiums in the health care business are generally fixed for one-year periods. Accordingly, future cost increases in excess of medical cost projections reflected in pricing cannot generally be recovered in the contract year through higher premiums. Although CIGNA bases the premiums it charges on its estimate of future health care costs over the fixed premium period, actual costs may exceed what was estimated and reflected in premiums. Factors that may cause actual costs to exceed premiums include: medical cost inflation; higher than expected utilization of medical services; the introduction of new or costly treatments and technology; and membership mix.
CIGNA records medical claims reserves for estimated future payments. The Company continually reviews estimates of future payments relating to medical claims costs for services incurred in the current and prior periods and makes necessary adjustments to its reserves. However, actual health care costs may exceed what was estimated.
Public perception of CIGNAs products and practices as well as of the health benefits industry, if negative, could reduce enrollment in CIGNAs health benefits programs.
The health care industry in general, and CIGNA specifically, are subject to negative publicity, which can arise either from perceptions regarding the industry or CIGNAs business practices or products. This risk may be increased as CIGNA offers new products, such as products with limited benefits or an integrated line of products, targeted at market segments, beyond those in which CIGNA traditionally has operated. Negative publicity may adversely affect the CIGNA brand and its ability to market its products and services, which could reduce the number of enrollees in CIGNAs health benefits programs.
Large-scale public health epidemics, bio-terrorist activity, natural disasters or other extreme events could cause CIGNAs covered medical and disability expenses, pharmacy costs and mortality experience to rise significantly, and in severe circumstances, could cause operational disruption.
If widespread public health epidemics such as an influenza pandemic, bio-terrorist or other attack, or catastrophic natural disaster were to occur, CIGNAs covered medical and disability expenses, pharmacy costs and mortality experience could rise significantly, depending on the governments actions and the responsiveness of public health agencies and insurers. In addition, depending on the severity of the situation, a widespread outbreak could curtail economic activity in general, and CIGNAs operations in particular,
which could result in operational and financial disruption to CIGNA. Such disruption could, among other things impact the timeliness of claims and revenue.
CIGNAs business depends on the uninterrupted operation of its systems and business functions, including information technology and other business systems.
CIGNAs business is highly dependent upon its ability to perform, in an efficient and uninterrupted fashion, its necessary business functions, such as: claims processing and payment; internet support and customer call centers; and the processing of new and renewal business. A power outage, pandemic, or failure of one or more of information technology, telecommunications or other systems could cause slower system response times resulting in claims not being processed as quickly as clients desire, decreased levels of client service and client satisfaction, and harm to CIGNAs reputation. In addition, because CIGNAs information technology and telecommunications systems interface with and depend on third party systems, CIGNA could experience service denials if demand for such service exceeds capacity or a third party system fails or experiences an interruption. If sustained or repeated, such a business interruption, systems failure or service denial could result in a deterioration of CIGNAs ability to pay claims in a timely manner, provide customer service, write and process new and renewal business, or perform other necessary corporate functions. This could result in a materially adverse effect on CIGNAs business results and liquidity.
A security breach of CIGNAs computer systems could also interrupt or damage CIGNAs operations or harm CIGNAs reputation. In addition, CIGNA could be subject to liability if sensitive customer information is misappropriated from CIGNAs computer systems. These systems may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. Any publicized compromise of security could result in a loss of customers or a reduction in the growth of customers, increased operating expenses, financial losses, additional litigation or other claims, which could have a material adverse effect on CIGNAs business.
CIGNA is focused on further developing its business continuity program to address the continuation of core business operations. While CIGNA continues to test and assess its business continuity program to satisfy the needs of CIGNAs core business operations and addresses multiple business interruption events, there is no assurance that core business operations could be performed upon the occurrence of such an event.
CIGNAs business may be adversely impacted by global market, economic and geopolitical conditions that may cause fluctuations in equity market prices, interest rates and credit spreads which could reduce the Companys ability to raise or deploy capital as well as affect the Companys overall liquidity.
The capital markets and credit market have been experiencing volatility and disruption. In recent months, the volatility and disruption has reached unusual levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers underlying financial strength. If current levels of market disruption and volatility continue or worsen, they may adversely impact the Companys availability and cost of credit in the future. In addition, continued unpredictable or unstable market conditions may result in reduced opportunities to find suitable opportunities to raise capital.
CIGNA is subject to potential changes in the political environment, which could adversely affect the markets for its products.
Policy changes on the local, state and federal level, such as the expansion of the governments role in the health care arena, could fundamentally change the dynamics of CIGNAs industry, such as a much larger role of the government in the health care arena. For example, a broad based public sector alternative providing comprehensive health benefits could materially reduce the number of private sector members and exacerbate existing competitive and economic pressures. While private healthcare plans may be solicited to provide administrative services to an expanded national public plan, this business opportunity may be less profitable and favor larger and lower cost competitors.
CIGNA faces risks in successfully managing the integration of Great-West Healthcare (or any other acquisition).
CIGNA acquired Great-West Healthcare with the expectation that the acquisition will result in various benefits, including, among others, a broader distribution and provider network in certain geographic areas, an expanded range of health benefits and products, cost savings, increased profitability of the acquired business by improving its total medical cost position, and achievement of operating efficiencies. Achieving the anticipated benefits of the acquisition is subject to a number of uncertainties, including whether CIGNA integrates Great-West Healthcare in an efficient and effective manner, and general competitive factors in the marketplace.
Failure to achieve these anticipated benefits could limit CIGNAs ability to grow membership, particularly in the small business segment, result in increased costs, decreases in the amount of expected revenues and diversion of managements time and energy.
CIGNA faces intense competition to attract and retain key people.
CIGNA would be adversely impacted if it failed to attract additional key people and retain current key people, as this could result in the inability to effectively execute the Companys key initiatives and business strategy.
CIGNA would be adversely affected if its prevention, detection or control systems fail to detect and implement required changes to maintain regulatory compliance or prevent fraud.
Failure of CIGNAs prevention, detection or control systems related to regulatory compliance and/or compliance with its internal policies, including data systems security and/or unethical conduct by managers and/or employees, could adversely affect its reputation and also expose us to litigation and other proceedings, fines and/or penalties. Federal and state governments have made investigating and prosecuting health care and other insurance fraud and abuse a priority. Fraud and abuse prohibitions encompass a wide range of activities, including kickbacks for referral of members, billing for unnecessary medical services, improper marketing, and violations of patient privacy rights. The regulations and contractual requirements applicable to us and other participants are complex and subject to change. Although the Company believes its compliance efforts are adequate, ongoing vigorous law enforcement and the highly technical regulatory scheme mean that its compliance efforts in this area will continue to require significant resources.
In addition, provider or member fraud that is not prevented or detected could impact its medical costs or those of its self-insured customers. Further during an economic downturn, CIGNAs businesses, HealthCare, Group and Disability and International, may see increased fraudulent claims volume which may lead to additional cost because of an increase in disputed claims and litigation.
Item 1B. UNRESOLVED STAFF COMMENTS
Item 2. PROPERTIES
CIGNAs headquarters, including staff support operations, along with CIGNA Disability and Life Insurance, the domestic office of CIGNA International, and portions of CIGNA HealthCare, are located in approximately 450,000 square feet of leased office space at Two Liberty Place, 1601 Chestnut Street, Philadelphia. CIGNA HealthCare is located in approximately 825,000 square feet of owned office space in the Wilde Building, located at 900 Cottage Grove Road, Bloomfield, Connecticut. In addition, CIGNA owns or leases office buildings, or parts thereof, throughout the United States and in other countries. CIGNA believes its properties are adequate and suitable for its business as presently conducted. For additional information concerning leases and property, see Notes 2 and 20 to CIGNAs Consolidated Financial Statements beginning on pages 86 and 130 of this Form 10-K. This paragraph does not include information on investment properties.
Item 3. LEGAL PROCEEDINGS
The information contained under Litigation and Other Legal Matters in Note 22 to CIGNAs 2008 Financial Statements which begins on page 133 of this Form 10-K, is incorporated herein by reference.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Executive Officers of the Registrant
All officers are elected to serve for a one-year term or until their successors are elected. Principal occupations and employment during the past five years are listed below.
WILLIAM L. ATWELL, 58, President of CIGNA International beginning September 2008; Managing Director of Atwell and Associates, LLC from January 2006 until August 2008; and Executive Vice President of The Charles Schwab Corporation from August 2000 to December 2005.
MICHAEL W. BELL, 45, Executive Vice President and Chief Financial Officer of CIGNA beginning December 2002.
DAVID M. CORDANI, 43, President and Chief Operating Officer of CIGNA beginning June 2008; President, CIGNA HealthCare from July 2005 until June 2008; Senior Vice President, Customer Segments & Marketing, CIGNA HealthCare from July 2004 until July 2005; and Senior Vice President and Chief Financial Officer, CIGNA HealthCare, from September 2002 until July 2004.
H. EDWARD HANWAY, 57, Chairman of CIGNA since December 2000; Chief Executive Officer of CIGNA since January 2000; and President and a Director of CIGNA since January 1999.
JOHN M. MURABITO, 50, Executive Vice President of CIGNA beginning August 2003, with responsibility for Human Resources and Services.
CAROL ANN PETREN, 56, Executive Vice President and General Counsel of CIGNA beginning May 2006, and Senior Vice President and Deputy General Counsel of MCI from August 2003 until March 2006.
KAREN S. ROHAN, 46, President of CIGNA Group Insurance beginning November 2005; President of CIGNA Dental & Vision Care beginning April 2004; President of CIGNA Specialty Companies from November 2004 until November 2005; and Chief Underwriting Officer, CIGNA HealthCare from January 2003 until April 2004.
MICHAEL WOELLER, 56, Executive Vice President and Chief Information Officer of CIGNA beginning October 2007; Vice Chairman and Senior Vice President and Chief Information Officer, Canadian Imperial Bank of Commerce from April 2000 until October 2007.
Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The information under the caption Quarterly Financial DataStock and Dividend Data appears on page 138 and the number of shareholders of record as of December 31, 2008 appears under the caption Highlights on page 42 of this Form 10-K. CIGNAs common stock is listed with, and trades on, the New York Stock Exchange under the symbol CI.
Issuer Purchases of Equity Securities
The following table provides information about CIGNAs share repurchase activity for the quarter ended December 31, 2008:
Item 6. SELECTED FINANCIAL DATA
On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc. For additional information, see the Health Care section of the Managements Discussion and Analysis beginning on page 54.
In 2008, the Company recorded significant charges related to the guaranteed minimum income benefits and guaranteed minimum death benefits businesses. For additional information, see the Run-off Reinsurance section of the Managements Discussion and Analysis beginning on page 62.
In 2008, the Company recorded an after-tax litigation charge of $52 million in Corporate related to the CIGNA pension plan. See Note 22 to the Consolidated Financial Statements for additional information.
Effective January 1, 2007, CIGNA changed its presentation to report the results of the Run-off Retirement business within Other Operations. Prior period results have been restated to conform to this presentation.
During 2007, CIGNA completed a three-for-one stock split of CIGNAs common shares. Per share figures have been adjusted to reflect the stock split.
Pro forma common shares outstanding, calculated as if the stock split had occurred at the beginning of the prior periods, were as follows: 295,963 in 2006; 363,573 in 2005; and 396,021 in 2004.
Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this filing and in other marketplace communications, CIGNA Corporation and its subsidiaries (the Company) make certain forward-looking statements relating to the Companys financial condition and results of operations, as well as to trends and assumptions that may affect the Company. Generally, forward-looking statements can be identified through the use of predictive words (e.g., Outlook for 2009). Actual results may differ from the Companys predictions. Some factors that could cause results to differ are discussed throughout Managements Discussion and Analysis (MD&A), including in the Cautionary Statement beginning on page 78. The forward-looking statements contained in this filing represent managements current estimate as of the date of this filing. Management does not assume any obligation to update these estimates.
Certain reclassifications have been made to prior period amounts to conform to the presentation of 2008 amounts.
The Company constitutes one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace. In addition, the Company has an international operation that offers life, accident and supplemental health insurance products as well as international health care products and services to businesses and individuals in selected markets. The Company also has certain inactive businesses, including a Run-off Reinsurance segment.
The Company generates revenues, net income and cash flow from ongoing operations by:
The Companys ability to increase revenue, net income and operating cash flow is directly related to its ability to address broad economic and industry factors and execute its strategic initiatives, the success of which is measured by certain key factors as discussed below.
Key factors affecting the Companys results from ongoing operations include:
Effectively managing the various exposures of its run-off operations is important to the Companys ongoing profitability, operating cash flows and available capital. The results are influenced by a range of economic factors, especially movements in equity markets and interest rates. Results are also influenced by behavioral factors, including partial surrender election rates for GMDB contracts and annuity election rates for GMIB contracts, as well as the collection of amounts recoverable from retrocessionaires. In order to manage these risks, the Company operates a GMDB equity hedge program to substantially reduce the impact of equity market movements. The Company actively monitors the performance of the hedge program, and evaluates the cost/benefit of hedging other risks. The Company also actively studies policyholder behavior experience and adjusts future expectations based on the results of the studies, as warranted. We also perform regular audits of the ceding companies to ensure treaty compliance that premiums received and claims paid are properly reflective of the underlying risks and to maximize the probability of subsequent collection of claims from retrocessionaires. Finally, the Company monitors the credit standing of the retrocessionaires.
The Companys overall results are influenced by a range of economic and other factors, especially:
The Company regularly monitors the trends impacting operating results from the above mentioned key factors and economic and other factors affecting its operations. The Company develops strategic and tactical plans designed to improve performance and maximize its competitive position in the markets it serves. The Companys ability to achieve its financial objectives is dependent upon its ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.
The Company is continuing to improve the performance of and profitably grow its ongoing businesses and manage the risks associated with the run-off reinsurance operations.
Acquisition of Great-West Healthcare
On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc. (Great-West Healthcare or the acquired business) through 100% indemnity reinsurance agreements and the acquisition of certain affiliates and other assets and liabilities of Great-West Healthcare. The purchase price was approximately $1.5 billion and consisted of a payment to the seller of approximately $1.4 billion for the net assets acquired and the assumption of net liabilities under the reinsurance agreement of approximately $0.1 billion. Great-West Healthcare primarily sells medical plans on a self-funded basis with stop-loss coverage to select and regional employer groups. Great-West Healthcares offerings also include the following specialty products: stop-loss, life, disability, medical, dental, vision, prescription drug coverage, and accidental death and dismemberment insurance. The acquisition, which was accounted for as a purchase, was financed through a combination of cash and the issuance of both short and long-term debt.
See Note 3 to the Consolidated Financial Statements for additional information.
Initiatives to Lower Operating Expenses
The Company has undertaken several initiatives to realign its organization and consolidate support functions in an effort to increase efficiency and responsiveness to customers and to reduce costs.
In 2008, the Company conducted a comprehensive review of its ongoing businesses with an emphasis on reducing operating expenses in the Health Care segment. As a result of the review, during the fourth quarter of 2008, the Company committed to a plan to reduce operating costs in order to meet the challenges and opportunities presented by the current economic environment. The Company anticipates the plan will be substantially complete by the end of 2009. As a result, the Company recognized in other operating expenses a total charge of $55 million pre-tax ($35 million after-tax), which included $44 million pre-tax ($28 million after-tax) for severance and other related costs resulting from reductions of approximately 1,100 positions in its workforce and $11 million pre-tax ($7 million after-tax) resulting from consolidation of facilities. The Company expects to pay $53 million in cash related to this charge, most of which will occur in 2009. The Health Care segment reported $44 million pre-tax ($27 million after-tax) of the total charge. The remainder was reported as follows: Disability and Life: $3 million pre-tax ($2 million after-tax), and International: $8 million pre-tax ($6 million after-tax). As a result of these actions, the Company expects annualized after-tax savings of approximately $70 million, a portion of which is expected to be realized in 2009.
CONSOLIDATED RESULTS OF OPERATIONS
In order to facilitate an understanding and comparison of results of operations and permit analysis of trends in underlying revenue, expenses and income from continuing operations, presented below are special items, which management believes are not representative of the underlying results of operations.
Special items for 2008 included a cost reduction charge (see the Introduction section of the MD&A beginning on page 43), a litigation matter related to the CIGNA Pension Plan (see Note 22 to the Consolidated Financial Statements for additional information) reported in Corporate and charges related to certain other litigation matters, which are reported in the Health Care segment.
The special item for 2007 consisted of previously unrecognized tax benefits resulting from the completion of the IRS examination for the 2003 and 2004 tax years.
Special items for 2006 consisted of:
Overview of 2008 Consolidated Results of Operations
Income from continuing operations for the year ended December 31, 2008 declined significantly compared with 2007, as a result of the following:
These factors were partially offset by higher segment earnings in each of the Companys ongoing operating segments (Health Care, Disability and Life, and International).
Overview of 2007 Consolidated Results of Operations
Excluding the special items discussed above, income from continuing operations decreased in 2007, compared with 2006, principally reflecting lower realized investment gains primarily due to lower gains from sales of equity interests in real estate limited liability entities of $145 million.
These factors were partially offset by higher earnings in the Health Care (see page 54), Disability and Life (see page 59), International (see page 60) and Run-off Reinsurance (see page 62) segments.
Outlook for 2009
The Company expects 2009 income from continuing operations, excluding realized investments results, the results of the GMIB business, and special items, to be higher than 2008 due to overall earnings growth in the ongoing operating segments, as well as lower losses in the Run-off Reinsurance segment. This outlook includes an assumption that results of the GMDB business will be approximately break-even for full-year 2009. This assumption reflects managements view that the long-term reserve assumptions are appropriate and that equity market conditions and volatility will return to more normal levels in 2009. The Companys outlook is subject to the factors cited in the Cautionary Statement and the sensitivities discussed in the Critical Accounting Estimates section of the MD&A on pages 49 through 53. If the unfavorable equity market and interest rate movements continue, the Company could experience additional losses related to the GMDB business.
Information is not available for management to reasonably estimate the future results of the GMIB business, realized investment gains (losses), or to identify or reasonably estimate special items in 2009. However, if unfavorable equity market and interest rate movements continue, the Company could also experience additional losses related to the GMIB business and investment impairments. Potential losses related to the GMDB and GMIB businesses, as well as investment impairments, could adversely impact the Companys consolidated results of operations and financial condition, and could reduce the capital of the Companys insurance subsidiaries as well as their dividend paying capabilities.
Total revenue increased by 8% in 2008, compared with 2007; and 7% in 2007 compared with 2006. Changes in the components of total revenue are described more fully below.
Premiums and Fees
Premiums and fees increased by 8% in 2008, compared with 2007 reflecting the impact of the acquired business, growth in the Disability and Life segment, as well as growth and rate increases in the International segment. See segment reporting discussions for additional detail and drivers.
Premiums and fees increased 10% in 2007, compared with 2006, primarily attributable to higher specialty revenues and growth in medical membership as well as strong renewal pricing on existing business in the Health Care segment and strong business growth in the Disability and Life and International segments.
Net Investment Income
Net investment income decreased 5% in 2008, compared with 2007 primarily due to lower yields driven by declines in short-term interest rates, commercial mortgage pre-payment fees, and income from security partnerships.
Net investment income decreased 7% in 2007. This decrease was primarily attributable to lower average assets due to share repurchase activity and a decline in the Health Care segment average invested assets resulting from:
Mail Order Pharmacy Revenues
Mail order pharmacy revenues increased 8% in 2008, compared with 2007 due to increased script volume and rate increases.
Mail order pharmacy revenues in 2007 were comparable to 2006.
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues increased 17% in 2008, compared with 2007, primarily reflecting the impact of the acquired business. In 2008, the Company reported gains of $333 million associated with the GMDB equity hedge program, compared with losses of $32 million in 2007. The gains in 2008 primarily reflect the decline in stock market values.
Excluding the impact of the GMDB equity hedge program, Other revenues decreased 10% in 2007, compared with 2006 primarily due to lower revenues from the disability and workers compensation case management business reported in the Disability and Life segment. The Company reported losses on futures contracts associated with the GMDB equity hedge program of $32 million in 2007, compared with losses of $96 million in 2006. The decline in losses in 2007 primarily reflects lower stock market appreciation compared with 2006.
Realized Investment Results
Realized investment results in 2008 were lower than 2007, primarily due to higher losses associated with asset write-downs and increases in valuation allowances primarily due to higher interest rates and credit losses resulting from current economic conditions. In addition, the Company had higher losses on sales of fixed maturities and equity securities. These losses were partially offset by higher gains on sales of real estate investments held in joint ventures. See Note 13 to the Consolidated Financial Statements for additional information.
Realized investment gains (losses) were lower in 2007, compared with 2006, primarily due to sales of equity interests in real estate limited liability entities in 2006.
CRITICAL ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect reported amounts and related disclosures in the consolidated financial statements. Management considers an accounting estimate to be critical if:
Management has discussed the development and selection of its critical accounting estimates with the Audit Committee of the Companys Board of Directors and the Audit Committee has reviewed the disclosures presented below.
In addition to the estimates presented in the following table, there are other accounting estimates used in the preparation of the Companys consolidated financial statements, including estimates of liabilities for future policy benefits other than those identified in the following table, as well as estimates with respect to goodwill, unpaid claims and claim expenses, postemployment and postretirement benefits other than pensions, certain compensation accruals, and income taxes.
Management believes the current assumptions used to estimate amounts reflected in the Companys consolidated financial statements are appropriate. However, if actual experience differs from the assumptions used in estimating amounts reflected in the Companys consolidated financial statements, the resulting changes could have a material adverse effect on the Companys consolidated results of operations, and in certain situations, could have a material adverse effect on the Companys liquidity and financial condition.
See Note 2 to the Consolidated Financial Statements for further information on significant accounting policies that impact the Company.
Operating segments generally reflect groups of related products, but the International segment is generally based on geography. The Company measures the financial results of its segments using segment earnings (loss), which is defined as income (loss) from continuing operations excluding after-tax realized investment gains and losses.
Health Care Segment
The Health Care segment includes medical, dental, behavioral health, prescription drug and other products and services that may be integrated to provide consumers with comprehensive health care solutions. This segment also includes group disability and life insurance products that were historically sold in connection with certain experience-rated medical products. These products and services are offered through a variety of funding arrangements such as guaranteed cost, retrospectively experience-rated and administrative services only arrangements.
The Company measures the operating effectiveness of the Health Care segment using the following key factors:
Results of Operations
The Health Care segments earnings in 2008, as compared with 2007, were favorably impacted by lower management incentive compensation expense of $21 million after-tax. In addition, the segments earnings include the after-tax impact of favorable prior year claim development of $7 million in 2008, $8 million in 2007 and $54 million in 2006. The amount of prior year claim development recorded in 2008 and 2007, compared with 2006, is lower because actual medical cost trends and completion factors were more in line with initial assumptions.
Excluding the special items for cost reduction and litigation charges as well as the items mentioned above, segment earnings increased in 2008 compared with 2007 due to:
These favorable effects were partially offset by:
Excluding prior year claim development and the special items for cost reduction, segment earnings in 2007 increased over 2006 due to:
These factors were partially offset by lower margins in the experience-rated business as well as lower net investment income due to lower average assets and lower yields.
The table below shows premiums and fees for the Health Care segment:
(1) Premiums and/or fees associated with certain specialty products are also included.
(2) Includes premiums associated with other risk-related products, primarily network and PPO plans.
(3) Includes minimum premium members, who have a risk profile similar to experience-rated funding arrangements. The risk portion of minimum premium revenue is reported in experience-rated medical premium whereas the self funding portion of minimum premium revenue is recorded in fees. Also, includes certain non-participating cases for which special customer level reporting of experience is required.
(4) Other medical premiums include risk revenue for stop-loss and specialty products.
(5) Represents administrative service fees for medical members and related specialty product fees for non-medical members as well as fees related to Medicare Part D of $96 million in 2008, $61 million in 2007, and $27 million in 2006.
Premiums and fees increased by 9% in 2008, compared with 2007, primarily reflecting:
These factors were partially offset by a decrease in the guaranteed cost business which was due to membership declines largely in commercial HMO business partially offset by rate increases.
Premiums and fees increased 9% in 2007, compared with 2006, primarily reflecting:
In addition, premiums and fees in 2007 reflect a change in the mix of products to more service-only products from guaranteed cost products.
Net investment income decreased by 1% in 2008 compared with 2007 reflecting lower yields partially offset by higher average assets. Net investment income decreased by 23% in 2007 compared with 2006 reflecting primarily lower average assets and to a lesser extent lower yields.
Other revenues for the Health Care segment consist of revenues earned on direct channel sales of certain specialty products, including behavioral health and disease management.
Other revenues increased 27% in 2008 and 11% in 2007. In 2008, the increase primarily reflected the impact of the acquired business, while the increase in 2007 was primarily due to business growth.
Benefits and Expenses
Health Care segment benefits and expenses consist of the following:
Medical claims expense included favorable prior year claim development of approximately $11 million in 2008, $12 million in 2007 and $83 million in 2006. Medical claims expense increased 7% in 2008 compared with 2007 largely due to the impact of the acquired business. In addition, medical trend was largely offset by lower risk membership. Excluding the prior year claim development, medical claims expense increased 10% in 2007 compared with 2006 primarily due to medical trend, increased Medicare Part D membership and the impact of the Star HRG operations.
Other operating expenses include expenses related to:
Excluding the items noted above, other operating expenses increased in 2008, compared with 2007, primarily reflecting higher spending on operational improvement initiatives, including segment expansion and investments in information technology. This increase was partially offset by lower management incentive compensation expenses in 2008, as well as productivity savings which were reflected in lower operating expenses per member due to the success of various expense reduction initiatives. Other operating expenses increased in 2007, compared with 2006, reflecting membership growth and higher spending on information technology, including market facing capabilities.
Other Items Affecting Health Care Results
The Companys medical membership includes any individual for whom the Company retains medical underwriting risk, who uses the Companys network for services covered under their medical coverage or for whom the Company administers medical claims. As of December 31, estimated medical membership was as follows:
(1) Includes membership associated with other risk-related products, primarily network and PPO plans.
(2) Includes minimum premium members, who have a risk profile similar to experience-rated funding arrangements. The risk portion of minimum premium revenue is reported in experience-rated medical premium whereas the self funding portion of minimum premium revenue is recorded in fees. Also, includes certain non-participating cases for which special customer level reporting of experience is required.
(3) Represents members associated with the acquisition of Great-West Healthcare effective April 1, 2008.
Operational Improvement Initiatives
The Company is focused on several initiatives including developing and enhancing a customer focused service model. This effort is expected to require significant investments over the next 3 to 5 years. These investments are expected to enable the Company to grow its membership and to improve operational effectiveness and profitability by developing innovative products and services that promote customer engagement at a competitive cost. Executing on these operational improvement initiatives is critical to attaining a leadership position in the health care marketplace.
The operational improvement initiatives currently underway are discussed below.
Reducing other operating expenses. The Company operates in an intensely competitive marketplace and its ability to establish a fully competitive cost advantage is key to achieving its initiatives. Accordingly, the Company is focused on reducing operating expenses in three key areas primarily to facilitate operating efficiency and responsiveness to customers. These three areas include: customer acquisition, which encompasses spending on sales, the account management process, underwriting and marketing; fulfillment, mainly claims processing and billing; and reducing overhead in various administrative and staffing functions. In connection with these efforts, in the fourth quarter of 2008, the Company completed a review of staffing levels and organization and announced a plan to reorganize its business model and supporting areas to more tightly align the ongoing operating segments. See the Introduction section to this MD&A for further discussion beginning on page 43. The Company expects to take additional actions during 2009 to further reduce operating expenses and improve its competitive cost position in the marketplace.
Maintaining and upgrading information technology systems. The Companys current business model and long-term strategy require effective and reliable information technology systems. The Companys current systems architecture will require continuing investment to meet the challenges of increasing customer demands from both our existing and emerging customer base to support its business growth and strategies, improve its competitive position and provide appropriate levels of service to customers. The Company is focused on providing these enhanced strategic capabilities in response to increasing customer expectations, while continuing to provide a consistent, high quality customer service experience with respect to the Companys current programs. Accordingly, in 2009, the Companys efforts will be focused primarily on optimizing the technology underlying our claims processing and call servicing capabilities with specific emphasis on reducing handling time and improving customer service. Continued integration of the Companys multiple administrative and customer facing platforms is also required to support the Companys growth strategies, and to ensure reliable, efficient and effective customer service both in todays employer focused model as well as in a customer directed model. The Companys ability to effectively deploy capital to make these investments will influence the timing and the impact these initiatives will have on its operations.
Profitably growing medical membership. The Company continues to focus on growing its medical membership by:
The Company is also focused on segment and product expansion. In segments, our focus is predominantly in the Select (employers with 51-250), small business (employers with 2-50) and individual segments. We also expect to expand our voluntary capabilities and to focus on health as well as pharmacy and dental. As part of its effort to achieve these objectives, the Company completed the acquisition of Great-West Healthcare of Denver, Colorado on April 1, 2008. Also, our Star HRG acquisition serves as our platform to further develop our voluntary portfolio. These acquisitions will enable the Company to broaden its distribution reach and provider network, particularly in the western regions of the United States, and expand the range of health benefits and product offerings. Additionally, the Company has recently developed new product offerings for both our guaranteed cost and experienced rated portfolios. Driving additional cross selling is also key to our value proposition. We are expanding network access for our dental product and improving network flexibility to ensure better alignment with our customers needs. Also, with the acquisition of Great-West Healthcare, we will be working in 2009 to transition this book to CIGNA pharmacy and increase penetration across the entire book.
Offering products that meet emerging customer and market trends. In order to meet emerging customer and market trends, the Companys suite of products (CIGNATURE®, CareAllies®, and CIGNA Choice Fund®) offers various options to customers and employers and is key to our customer engagement strategy. Offerings include: choice of benefit, participating provider network, funding, medical management, and health advocacy options. Through the CIGNA Choice Fund®, the Company offers a set of customer-directed capabilities that includes options for health reimbursement arrangements and/or health savings accounts and enables customers to make effective health decisions using information tools provided by the Company.
Underwriting and pricing products effectively. One of the Companys key priorities is to achieve strong profitability in a competitive health care market. The Company is focused on effectively managing pricing and underwriting decisions at both the case and overall book of business level, particularly for the guaranteed cost and experience-rated businesses.
Effectively managing medical costs. The Company operates under a centralized medical management model, which helps facilitate consistent levels of care for its members and reduces infrastructure expenses.
The Company is focused on continuing to effectively manage medical utilization and unit costs. The Company believes that by increasing the quality of medical care and improving access to care we can drive reductions in total medical cost. To help achieve this, the Company continues to focus on renegotiating contracts with providers and certain facilities to limit increases in medical reimbursement costs. In addition, the Company seeks to strengthen its network position in selected markets. In connection with the Great-West Healthcare acquisition in April 2008, the Company is converting and integrating these acquired members to its extensive preferred provider network which offers access to a broad range of utilization review and case management services. By directing members to the highest quality and most efficient network providers and leveraging their clinical engagement protocols we are realizing benefits from the increased utilization.
Delivering quality member and provider service. The Company is focused on delivering competitive service to members, providers and customers. The Company believes that further enhancing quality service can improve member retention and, when combined with useful health information and tools, can help motivate members to become more engaged in their personal health, and will help promote healthy outcomes thereby removing cost from the system. The evolution of the consumer-driven healthcare market is driving increased product and service complexity and is raising customers expectations with respect to service levels, which is expected to require significant investment, management attention and heightened interaction with customers.
The Company is focused on the development and enhancement of a service model that is capable of meeting the challenges brought on by the increasing product and service complexity and the heightened expectations of health care customers. The Company continues to make significant investments in the development and implementation of systems and technology to improve the member and provider service experience, enhance its capabilities and improve its competitive position.
The Companys health advocacy capabilities support its recent membership growth efforts. The Company must be able to deliver those capabilities efficiently and cost-effectively. The Company continues to identify additional cost savings to further improve its competitive cost position. Savings generated from the Companys operating efficiency initiatives provide capital to make investments that will enhance its capabilities in the areas of customer engagement, particularly product development, the delivery of member service and health advocacy and related technology.
Disability and Life Segment
The Disability and Life segment includes group disability, life, accident and specialty insurance and case management for disability and workers compensation.
Key factors for this segment are:
Results of Operations
Segment earnings in 2008 include the favorable after-tax impact of reserve studies and a favorable reinsurance settlement which aggregated to $19 million, partially offset by a special item for a cost reduction charge of $2 million. Segment earnings in 2007 include the favorable after-tax impact of reserve studies of $12 million and a special item of $6 million of previously unrecognized tax benefits resulting from the completion of the IRS examination for the 2003 and 2004 tax years. Segment earnings in 2006 include the favorable after-tax impact of reserve studies of $28 million, partially offset by severance charges of $6 million. Excluding the impact
of the items noted above, segment earnings increased 8% in 2008, compared with 2007 reflecting:
These factors were partially offset by less favorable claims experience in the life and accident businesses and lower net investment income primarily due to lower average yields.
Excluding the impact of reserve studies and the items noted above, segment earnings increased 16% in 2007, compared with 2006 reflecting:
Premiums and fees increased 8% in 2008 and 13% in 2007 reflecting new sales growth in the disability, life and accident lines of business and strong customer retention.
Benefits and Expenses
Excluding the pre-tax impact of the reserve studies, reinsurance settlement and cost reduction charge noted above, benefits and expenses increased 5% in 2008 compared with 2007, reflecting overall business growth, partially offset by favorable claims experience in the disability and specialty businesses tempered by less favorable claims experience in the life and accident businesses. In addition, lower expenses were driven by continued focus on operating expense management, lower disability and workers compensation case management expenses and lower management incentive compensation expenses.
Excluding the pre-tax impact of the reserve studies and severance charge noted above, benefits and expenses increased 9% in 2007 compared with 2006, reflecting overall business growth, continued strong disability claims management and unfavorable life claims experience largely offset by favorable accident and specialty claims experience. In addition, lower expenses were driven by continued focus on operating expense management and lower disability and workers compensation case management expenses.
The International segment includes life, accident and supplemental health insurance products and international health care products and services, including those offered to expatriate employees of multinational corporations.
The key factors for this segment are:
Results of Operations
Excluding the special items noted in the table above, International segment earnings increased 8% in 2008, compared with 2007, and 26% in 2007 compared with 2006, primarily due to continued growth in the life, accident and supplemental health insurance business and the expatriate employee benefits business, as well as continued competitively strong margins. Earnings growth in 2008 was partially offset by unfavorable currency movements, primarily in South Korea. International segment earnings, excluding the impact of foreign currency movements and the special items noted in the table above, increased 16% in 2008, compared with 2007, and 23% in 2007 compared with 2006. The impact of foreign currency movements is calculated by comparing the reported results to what the results would have been had the monthly average exchange rates remained constant with the prior years comparable period exchange rates.
Premiums and fees. The increase in premiums and fees of 4% in 2008, compared with 2007, and 18% in 2007 compared with 2006, was primarily attributable to new sales growth in the life, accident and supplemental health insurance operations, particularly in Taiwan and South Korea, and membership growth in the expatriate employee benefits business. These increases also continue to reflect rate adjustments on the renewal of existing business. Premium growth in 2008 was partially offset by unfavorable foreign currency movements in South Korea.
Premiums and fees, excluding the effect of foreign currency movements, were (in millions): $1,971 in 2008, $1,745 in 2007 and $1,494 in 2006.
Benefits and Expenses
Benefits and expenses increased 4% in 2008, compared with 2007 and 16% in 2007 compared with 2006, primarily due to business growth in all lines of business, partially offset by foreign currency movements, primarily in South Korea.
Loss ratios decreased in 2008 and 2007 in the life, accident and supplemental health business due to favorable claims experience and a shift away from traditional life products toward accident and health products. In the expatriate business, loss ratios decreased slightly in 2008 and increased slightly in 2007 due to claims volatility.
Expense ratios increased slightly in 2008 in the life, accident and supplemental health business and the expatriate benefits business as a result of higher expenses to support growth initiatives and expansion. Expense ratios in the life, accident and health and expatriate benefits businesses continue to be strong due to effective expense management.
Other Items Affecting International Results
For the Companys International segment, South Korea is the single largest geographic market. South Korea generated 29% of the segments revenues and 39% of the segments earnings in 2008. Due to the concentration of business in South Korea, the International segment is exposed to potential losses resulting from economic and geopolitical developments in that country, as well as
foreign currency movements affecting the South Korean currency, which could have a significant impact on the segments results and the Companys consolidated financial results.
Run-off Reinsurance Segment
The Companys reinsurance operations were discontinued and are now an inactive business in run-off mode since the sale of the U.S. individual life, group life and accidental death reinsurance business in 2000. This segment is predominantly comprised of guaranteed minimum death benefit (GMDB, also known as VADBe), guaranteed minimum income benefit (GMIB), workers compensation and personal accident reinsurance products.
The determination of liabilities for GMDB and GMIB requires the Company to make critical accounting estimates. The Company has updated the assumptions for GMIB and the effects of hypothetical changes in those assumptions in connection with the implementation of SFAS No. 157. The Company describes the assumptions used to develop the reserves for GMDB and the assets and liabilities for GMIB and provides the effects of hypothetical changes in those assumptions in the Critical Accounting Estimates section of the MD&A beginning on page 49.
Results of Operations
Segment losses for the year included losses from the GMIB business of $437 million, and losses from the GMDB business of $267 million. Excluding the charge on adoption of SFAS No. 157 for the GMIB business, (see Note 2(B) to the Consolidated Financial Statements) these losses were primarily related to declines in equity markets and interest rates and increased market volatility. Excluding the results of the GMIB and GMDB businesses, segment earnings for Run-off Reinsurance were lower in 2008 than 2007, reflecting reduced favorable settlement activity related to personal accident and workers compensation.
Excluding the results of the GMIB business, segment earnings improved in 2007 compared with 2006. The improvement was predominantly due to an increase in earnings from several settlements and commutations that were favorable to the Companys reserve position at the time, as well as higher earnings in the workers compensation and personal accident business, resulting from more favorable claim development.
Other revenues included pre-tax gains from futures contracts used in the GMDB equity hedge program (see Note 7 to the Consolidated Financial Statements) of $333 million in 2008, compared with pre-tax losses of $32 million in 2007 and $96 million in 2006. Amounts reflecting corresponding changes in liabilities for GMDB contracts were included in benefits and expenses consistent with GAAP when a premium deficiency exists (see below Other Benefits and Expenses). The notional amount of the futures contract positions held by the Company at December 31, 2008 related to this program was $1.4 billion.
Benefits and Expenses
Benefits and expenses were comprised of the following:
GMIB Expense. GMIB expense in 2008 includes a pre-tax charge of $202 million for the adoption of SFAS No. 157, which is discussed in Notes 2(B) and 11 to the Consolidated Financial Statements. GMIB expense in 2007 includes a pre-tax charge of $86 million related to updated assumptions for annuity election and lapse rates. With the adoption of SFAS No. 157 in 2008, the Companys results of operations are expected to be more volatile in future periods both because the liabilities, net of receivables from reinsurers, are larger and because these assumptions will be based largely on market-observable inputs at the close of each reporting period including interest rates (LIBOR swap curve) and market-implied volatilities.
Excluding the charge on adoption of SFAS No. 157, the GMIB business generated additional pre-tax expense of $488 million in 2008 primarily as a result of:
Excluding the charge to update assumptions for annuity election and lapse rates, the GMIB business generated additional pre-tax expense of $61 million in 2007, primarily the result of unfavorable annuitization and lapse experience.
The GMIB liabilities and related assets are calculated using a complex internal model and assumptions that in 2008 are from the viewpoint of a hypothetical market participant. This resulting liability (and related asset) is higher than the Company believes will ultimately be required to settle claims primarily because market-observable interest rates are used to project growth in account values of the underlying mutual funds to estimate fair value from the viewpoint of a hypothetical market participant. The Companys payments for GMIB claims are expected to occur over the next 15 to 20 years and will be based on actual values of the underlying mutual funds and the 7-year Treasury rate at the dates benefits are elected. The Company does not believe that current market-observable interest rates reflect actual growth expected for the underlying mutual funds over that timeframe, and therefore believes that the recorded liability and related asset do not represent what management believes will ultimately be required as this business runs off.
However, the significant decline in financial markets during 2008 has had an unfavorable impact on the GMIB business. Significant declines in mutual fund values that underlie the contracts (increasing the exposure to the Company) together with declines in the 7-year Treasury rate (used to determine claim payments) increased the expected amount of claims that will be paid out for contractholders who choose to annuitize while these conditions continue. It is also possible that these unfavorable market conditions will have an impact on the level of contractholder annuitizations, particularly if these unfavorable market conditions persist for an extended period.
Other Benefits and Expenses. During 2008, the Company recorded additional other benefits and expenses of $412 million ($267 million after-tax) primarily to strengthen GMDB reserves following an analysis of experience and reserve assumptions. These amounts were primarily due to:
In addition to the reserve strengthening discussed above, other benefits and expenses were higher in 2008 than 2007 due to the impact of changes in the equity markets on GMDB contracts. Equity markets decreased significantly in 2008 while they increased in 2007 leading to higher benefits expense in 2008. Equity market declines result in decreases in underlying annuity account values, which increases the exposure under the contracts. These changes in benefits expense are partially offset by futures gains and losses, discussed in Other Revenues above. In addition, benefits expense related to personal accident and workers compensation was higher in 2008 than 2007, as a result of reduced favorable settlement activity in 2008.
Other benefits and expenses were lower in 2007, compared with 2006, due to lower expense in the workers compensation and personal accident businesses, due to the impact of favorable claim experience and settlements and commutations that were favorable to the Companys reserved position. This was partially offset by higher benefits expense for the guaranteed minimum death benefit business, as improvements in equity markets for 2007 were smaller than in 2006.
See Note 7 to the Consolidated Financial Statements for additional information about assumptions and reserve balances related to GMDB.
The Companys payment obligations for underlying reinsurance exposures assumed by the Company under these contracts are based on ceding companies claim payments. For GMDB and GMIB, claim payments vary because of changes in equity markets and interest rates, as well as mortality and policyholder behavior. For workers compensation and personal accident, the claim payments relate to accidents and injuries. Any of these claim payments can extend many years into the future, and the amount of the ceding companies ultimate claims, and therefore the amount of the Companys ultimate payment obligations and corresponding ultimate collection from retrocessionaires may not be known with certainty for some time.
The Companys reserves for underlying reinsurance exposures assumed by the Company, as well as for amounts recoverable from retrocessionaires, are considered appropriate as of December 31, 2008, based on current information. However, it is possible that future developments, which could include but are not limited to worse than expected claim experience and higher than expected volatility, could have a material adverse effect on the Companys consolidated results of operations and could have a material adverse effect on the Companys financial condition. The Company bears the risk of loss if its payment obligations to cedents increase or if its retrocessionaires are unable to meet, or successfully challenge, their reinsurance obligations to the Company.
Other Operations Segment
Other Operations consist of:
The COLI portion of this business has contributed the majority of the earnings in 2008, 2007 and 2006 for Other Operations. Federal legislation enacted in 1996 affected certain policies sold by the COLI business by eliminating on a prospective basis the tax deduction for policy loan interest for most leveraged COLI products. There have been no sales of this particular product since 1997. As a result of an Internal Revenue Service initiative to settle tax disputes regarding leveraged products, some customers have surrendered their policies and management expects earnings associated with these products to continue to decline. Management does not expect this to have a significant impact on the future operating results of the segment.
From April 1, 2004 through March 31, 2006, the Company had a modified coinsurance arrangement relating to the single premium annuity business sold to the buyer of the retirement benefits business. Under that arrangement, the Company retained the invested assets supporting the reinsured liabilities. These invested assets were held in a business trust established by the Company. Effective April 1, 2006, the buyer converted this modified coinsurance arrangement to an indemnity reinsurance structure and took ownership of the trust assets.
Results of Operations
Excluding the special item noted above, segment earnings for Other Operations declined in 2008 compared with 2007, reflecting lower results from the COLI business driven by less favorable mortality and lower interest margins. Interest margins decreased due to the movement of assets from the general account to separate accounts, and lower interest rates. In addition, the continuing decline in deferred gain amortization associated with sold businesses contributed to lower earnings.
Excluding the special item noted above, segment earnings decreased for Other Operations in 2007, primarily reflecting expected lower deferred gain amortization associated with the sales of the individual life insurance and annuity and retirement benefits businesses. This decrease was partially offset by higher COLI earnings primarily reflecting favorable mortality experience.
Net investment income. Net investment income decreased 5% in 2008 compared with 2007, primarily reflecting lower average invested assets due in part to the movement of assets from the general account to separate accounts in the COLI business as well as lower interest rates. Net investment income decreased 6% in 2007 compared with 2006 primarily due to a reduction in assets resulting from the conversion of the single premium annuity business to indemnity reinsurance and the resulting transfer of trust assets to the buyer of the retirement benefits business.
Other revenues. Other revenues decreased 13% in 2008 compared with 2007, and 20% in 2007 compared with 2006 primarily due to lower deferred gain amortization related to the sold retirement benefits and individual life insurance and annuity businesses. The amount of the deferred gain amortization recorded was $38 million in 2008, $47 million in 2007 and $62 million in 2006.
Corporate reflects amounts not allocated to segments, such as interest expense on corporate debt and on uncertain tax positions, certain litigation matters, net investment income on investments not supporting segment operations, intersegment eliminations, compensation cost for stock options and certain corporate overhead expenses such as directors expenses.
Excluding the special items noted above (see Consolidated Results of Operations section of the MD&A beginning on page 46 for more information on special items), Corporate results were lower in 2008, compared with 2007, primarily reflecting higher net interest expense attributable to lower average invested assets and increased debt to finance the acquired business. These factors were partially offset by lower directors expenses due to reduced deferred compensation obligations caused by a decline in the Companys stock price.
Excluding the special items noted in the table above, Corporate results in 2007, compared with 2006, were lower, reflecting higher net interest expense resulting from the issuance of additional debt combined with lower average assets due to share repurchase activity. In addition, the increase in segment loss also reflects the absence in 2007 of certain favorable expense items recorded in 2006.
Discontinued operations represent results associated with certain investments or businesses that have been sold or are held for sale.
Discontinued operations for 2008 primarily represents a gain of $3 million after-tax from the settlement of certain issues related to a past divestiture.
For 2007 and 2006, discontinued operations primarily reflects:
INDUSTRY DEVELOPMENTS AND OTHER MATTERS
The disability industry is under continuing review by regulators and legislators with respect to its offset practices regarding Social Security Disability Insurance (SSDI). There has been specific inquiry as to the industrys role in assisting individuals with their applications for SSDI. The Company has received one Congressional inquiry and has responded to the information request. Also, legislation prohibiting the offset of SSDI payments against private disability insurance payments for prospectively issued policies has been introduced in the Connecticut state legislature. The Company is also involved in related pending litigation. If the industry is forced to change its offset SSDI procedures, the practices and products for the Companys Disability & Life segment could be significantly impacted.
There are certain other matters that present significant uncertainty, which could result in a material adverse impact on the Companys consolidated results of operations. See Note 22 to the Consolidated Financial Statements for further information.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains liquidity at two levels: the subsidiary level and the parent company level.
Liquidity requirements at the subsidiary level generally consist of:
The Companys subsidiaries normally meet their operating requirements by:
Liquidity requirements at the parent level generally consist of:
The parent normally meets its liquidity requirements by:
Cash flows for the years ended December 31, were as follows:
Cash flow from operating activities consists of cash receipts and disbursements for premiums and fees, gains (losses) recognized in connection with the Companys GMDB equity hedge program, investment income, taxes, and benefits and expenses.
Because certain income and expense transactions do not generate cash, and because cash transactions related to revenue and expenses may occur in periods different from when those revenues and expenses are recognized in net income, cash flow from operating activities can be significantly different from net income. The Company assesses cash flows from operating activities by comparing it with adjusted income from operations, which is defined as income from continuing operations excluding the results of GMIB and special items, and further adjusted to exclude pre-tax realized investment results and depreciation and amortization charges.
Cash flows from investing activities generally consist of net investment purchases or sales and net purchases of property and equipment, which includes capitalized software, as well as cash used to acquire businesses.
Cash flows from financing activities is generally comprised of issuances and re-payment of debt at the parent level, proceeds on the issuance of common stock resulting from stock option exercises, and stock repurchases. In addition, the subsidiaries report net deposits/withdrawals to/from investment contract liabilities (which include universal life insurance liabilities) because such liabilities are considered financing activities with policyholders.
For the year ended December 31, 2008, cash flows from operating activities were greater than adjusted income from operations by $406 million, including cash inflows of $333 million associated with the GMDB equity hedge program which did not affect net income. Excluding those inflows, cash flows from operating activities were higher than adjusted income from operations by $73 million, primarily reflecting favorable receivable collections and increases in GMDB reserves due to the 2008 charges. These factors were partially offset by payments for certain prepaid expenses and litigation matters.
Cash flows from operating activities increased by $314 million in 2008 compared with 2007. Excluding the results of the GMDB equity hedge program (which did not affect net income), cash flows from operating activities decreased by $51 million. This decrease in 2008 primarily reflects higher payments for certain prepaid expenses in 2008.
The Company used net cash of $1.3 billion to fund the acquisition of Great-West Healthcare, consisting of a cash payment to Great-West Life and Annuity, Inc. of approximately $1.4 billion, partially offset by cash acquired from Great-West Healthcare of approximately $0.1 billion. Excluding this item, cash used in investing activities was $1.3 billion. This use of cash primarily consisted of net purchases of investments of $988 million and net purchases of property and equipment of $257 million.
Cash provided from financing activities primarily consisted of proceeds from the net issuance of short-term debt of $298 million and long-term debt of $297 million. These borrowing arrangements were entered into for general corporate purposes, including the
financing of the acquisition of Great-West Healthcare. Financing activities also included net deposits from contractholder deposit funds of $91 million, proceeds from the issuance of common stock under the Companys stock plans of $37 million and dividends on and repurchases of common stock of $392 million.
For the year ended December 31, 2007, cash flows from operating activities were lower than adjusted income from operations by $21 million, including cash outflows of $32 million associated with the GMDB equity hedge program which did not affect net income. Excluding those outflows, cash flows from operating activities were higher than adjusted income from operations by $11 million.
Cash provided by investing activities primarily consisted of net sales of investments of $495 million and net purchases of property and equipment of $180 million.
Cash used in financing activities primarily consisted of dividends on and repurchases of common stock of $1.2 billion and repayment of debt of $378 million, partially offset by proceeds from the issuance of debt of $498 million and proceeds from the issuance of common stock under the Companys stock plans of $248 million.
Interest expense on long-term debt, short-term debt and capital leases was as follows:
The increase in interest expense in 2008 was primarily due to the issuance of debt in connection with the Great-West Healthcare acquisition. At December 31, 2008, the Company has recognized cumulative losses of $40 million pre-tax ($26 million after-tax) related to its treasury rate lock derivative in accumulated other comprehensive income. The loss on this derivative will continue to fluctuate until it closes in 2009. If the Company issues debt in the first half of 2009 as expected, the loss at the time the derivative closes would increase the effective interest rate recognized over the life of the debt. If the Company is unable to issue debt in the first half of 2009, this loss would be recognized as a reduction to results of operations in the first half of 2009.
The Companys capital resources (primarily retained earnings and the proceeds from the issuance of debt and equity securities) provide protection for policyholders, furnish the financial strength to underwrite insurance risks and facilitate continued business growth.
Management, guided by regulatory requirements and rating agency capital guidelines, determines the amount of capital resources that the Company maintains. Management allocates resources to new long-term business commitments when returns, considering the risks, look promising and when the resources available to support existing business are adequate.
The Company prioritizes its use of capital resources to:
The availability of capital resources will be impacted by equity and credit market conditions. Extreme volatility in credit or equity market conditions may reduce the Companys ability to issue debt or equity securities. Significant volatility and deterioration of the equity markets during 2008 has resulted in reduced retained earnings and has reduced the capital available for growth, acquisitions, and share repurchase.
On March 14, 2008, the Company entered into a new commercial paper program (the Program). Under the Program, the Company is authorized to sell from time to time short-term unsecured commercial paper notes up to a maximum of $500 million. The proceeds are used for general corporate purposes, including working capital, capital expenditures, acquisitions and share repurchases. The Company uses the credit facility described below as back-up liquidity to support the outstanding commercial paper. If at any time funds are not available on favorable terms under the Program, the Company may use the Credit Agreement (see below) for funding. In October 2008, the Company added an additional dealer to its Program. As of December 31, 2008, the Company had $299 million in commercial paper outstanding, at a weighted average interest rate of 6.31%, used to finance the Great-West Healthcare acquisition and for other corporate purposes.
On March 4, 2008, the Company issued $300 million of 6.35% Notes (with an effective interest rate of 6.68% per year). Interest is payable on March 15 and September 15 of each year beginning September 15, 2008. The proceeds of this debt were used for general corporate purposes, including financing the acquisition of Great-West Healthcare. These Notes will mature on March 15, 2018. The Company may redeem these Notes, at any time, in whole or in part, at a redemption price equal to the greater of:
In June 2007, the Company amended and restated its five-year committed revolving credit and letter of credit agreement for $1.75 billion, which permits up to $1.25 billion to be used for letters of credit. This agreement is diversified among 22 banks, with three banks each having 11% of the commitment and the other 21 banks having the remaining 67% of the commitment. The credit agreement includes options, which are subject to consent by the administrative agent and the committing banks, to increase the commitment amount up to $2.0 billion and to extend the term of the agreement. The Company entered into the agreement for general corporate purposes, including support for the issuance of commercial paper and to obtain statutory reserve credit for certain reinsurance arrangements. There was a $25 million letter of credit issued as of December 31, 2008.
Liquidity and Capital Resources Outlook
At December 31, 2008, there was approximately $90 million in cash available at the parent company level. In 2009, the parent companys debt service consists of scheduled interest payments of approximately $140 million on outstanding long term debt of $2.1 billion at December 31, 2008 and approximately $300 million of commercial paper that will mature over the next three months. There are no scheduled long-term debt repayments in 2009. The company expects to refinance the commercial paper either by issuing long-term debt or re-issuing commercial paper.
The Companys best estimate is that contributions to the qualified pension plan will be approximately $410 million pre-tax during 2009. The parent company expects to fund the $410 million pre-tax contribution with subsidiary contributions equal to GAAP expense and parent company tax benefits. However, this amount could change based on final valuation amounts and the level at which the Company decides to fund the plan. The parent company would fund the estimated remaining $130 million net after-tax contribution with ongoing parent company cash sources including, but not limited to, subsidiary dividends. These estimates do not include funding requirements related to the litigation matter discussed in Note 22 to the Consolidated Financial Statements, as management does not expect this matter to be resolved in 2009. Future years contributions will ultimately be based on a wide range of factors including but not limited to asset returns, discount rates, and funding targets.
The availability of resources at the parent company level is partially dependent on dividends from the Companys subsidiaries, most of which are subject to regulatory restrictions and rating agency capital guidelines, and partially dependent on the availability of liquidity from the issuance of debt or equity securities.
The Company expects, based on current projections for cash activity, to have sufficient liquidity to meet its obligations.
However, the Companys cash projections may not be realized and the demand for funds could exceed available cash if:
In those cases, the Company expects to have the flexibility to satisfy liquidity needs through a variety of measures, including intercompany borrowings and sales of liquid investments. The parent company may borrow up to $400 million from Connecticut General Life Insurance Company without prior state approval. In addition, the Company may use short-term borrowings, such as the commercial paper program and the committed line of credit agreement of up to $1.75 billion subject to the maximum debt leverage covenant in its line of credit agreement. As of December 31, 2008, the Company had an additional $750 million of borrowing capacity within the maximum debt leverage covenant in the line of credit agreement in addition to the $2.4 billion of debt outstanding as of December 31, 2008.
Though the Company believes it has adequate sources of liquidity, continued significant disruption or volatility in the capital and credit markets could affect the Companys ability to access those markets for additional borrowings or increase costs associated with borrowing funds.
Solvency regulation Many states have adopted some form of the National Association of Insurance Commissioners (NAIC) model solvency-related laws and risk-based capital rules (RBC rules) for life and health insurance companies. The RBC rules recommend a minimum level of capital depending on the types and quality of investments held, the types of business written and the types of liabilities incurred. If the ratio of the insurers adjusted surplus to its risk-based capital falls below statutory required minimums, the insurer could be subject to regulatory actions ranging from increased scrutiny to conservatorship.
In addition, various non-U.S. jurisdictions prescribe minimum surplus requirements that are based upon solvency, liquidity and reserve coverage measures. During 2008, the Companys HMOs and life and health insurance subsidiaries, as well as non-U.S. insurance subsidiaries, were compliant with applicable RBC and non-U.S. surplus rules.
In 2008, the NAIC adopted Actuarial Guideline VACARVM, which will be effective December 31, 2009. VACARVM will impact statutory and tax reserves for CIGNAs GMDB and GMIB contracts. Upon implementation, it is anticipated that statutory reserves for these contracts will increase and thus statutory surplus for Connecticut General Life Insurance Company will be reduced. The magnitude of any impact depends on equity market and interest rate levels at the time of implementation.
Guarantees and Contractual Obligations
The Company, through its subsidiaries, is contingently liable for various contractual obligations entered into in the ordinary course of business. The maturities of the Companys primary contractual cash obligations, as of December 31, 2008, are estimated to be as follows:
The Company, through its subsidiaries, is contingently liable for various financial guarantees provided in the ordinary course of business. See Note 22 to the Consolidated Financial Statements for additional information on guarantees.
The Company maintains a share repurchase program, which was authorized by its Board of Directors. Decisions to repurchase shares depend on market conditions and alternative uses of capital. The Company has, and may continue from time to time, to repurchase shares on the open market through a Rule 10b5-1 plan which permits a company to repurchase its shares at times when it otherwise might be precluded from doing so under insider trading laws or because of self-imposed trading blackout periods.
The Company repurchased 10.0 million shares in 2008 for $378 million and 23.7 million shares in 2007 for $1.2 billion. The total remaining share repurchase authorization as of February 25, 2009, was $449 million.
The Companys investment assets do not include separate account assets. Additional information regarding the Companys investment assets and related accounting policies is included in Notes 2, 11, 12, 13 and 16 to the Consolidated Financial Statements.
Investments in fixed maturities (bonds) include publicly traded and privately placed debt securities, mortgage and other asset-backed securities, preferred stocks redeemable by the investor and trading securities. Fixed maturities and equity securities include hybrid securities. Fair values are based on quoted market prices when available. When market prices are not available, fair value is generally estimated using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality. In instances where there is little or no market activity for the same or similar instruments, the Company estimates fair value using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price.
The Company performs ongoing analyses on prices to conclude that they represent reasonable estimates of fair value. This process involves quantitative and qualitative analysis and is overseen by the Companys investment professionals. This process also includes review of pricing methodologies, pricing statistics and trends and backtesting recent trades.
The Companys fixed maturity portfolio continues to be diversified by issuer and industry type, with no single industry constituting more than 10% of total invested assets as of December 31, 2008.
Other mortgage-backed assets consist principally of commercial mortgage-backed securities and collateralized mortgage obligations of which $41 million were residential mortgages and home equity lines of credit, all of which were originated utilizing standard underwriting practices and are not considered sub-prime loans.
As of December 31, 2008, $10.8 billion, or 92%, of the fixed maturities in the Companys investment portfolio were investment grade (Baa and above, or equivalent), and the remaining $1.0 billion were below investment grade. Most of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum.
Private placement investments are generally less marketable than public bonds, but yields on these investments tend to be higher than yields on publicly offered debt with comparable credit risk. The fair value of private placement investments was $4.4 billion as of December 31, 2008 and 2007. The Company maintains controls on its participation in private placement investments. In particular, the Company performs a credit analysis of each issuer, diversifies investments by industry and issuer and requires financial and other covenants that allow the Company to monitor issuers for deteriorating financial strength so the Company can take remedial actions, if warranted. See the Critical Accounting Estimates section of the MD&A beginning on page 49 for additional information.
Because of the higher yields and the inherent risk associated with privately placed investments and below investment grade securities, gains or losses from such investments could affect future results of operations. However, since management matches the duration of assets to the duration of liabilities, it expects to hold a significant portion of these assets for the long term and therefore, does not expect such gains or losses to be material to the Companys liquidity or financial condition.
Commercial Mortgage Loans
The Companys commercial mortgage loans are made exclusively to commercial borrowers; therefore there is no exposure to either prime or sub-prime residential mortgages. These fixed rate loans are diversified by property type, location and borrower to reduce exposure to potential losses. Loans are secured by the related property and are generally made at less than 75% of the propertys value. The Company routinely monitors and evaluates the status of its commercial mortgage loans by reviewing loan and property-related information, including cash flows, expiring leases, financial health of the borrower and major tenants, loan payment history, occupancy and room rates for hotels and market conditions. The Company evaluates this information in light of current economic conditions as well as geographic and property type considerations.
Problem and Potential Problem Investments
Problem bonds and commercial mortgage loans are either delinquent by 60 days or more or have been restructured as to terms (interest rate or maturity date). Potential problem bonds and commercial mortgage loans are considered current (no payment more than 59 days past due), but management believes they have certain characteristics that increase the likelihood that they may become problems. These characteristics include, but are not limited to, the following:
The Company recognizes interest income on problem bonds and commercial mortgage loans only when payment is actually received because of the risk profile of the underlying investment. The amount that would have been reflected in net income if interest on non-accrual investments had been recognized in accordance with the original terms was not significant in 2008, 2007 or 2006.
The following table shows problem and potential problem investments at amortized cost as of December 31:
(1) The Company sold its remaining foreclosed property and did not acquire any properties through foreclosure in 2008.
The Company recorded after-tax realized investment losses for investment asset write-downs and changes in valuation reserves as follows:
(1) Other primarily represents the impact of rising interest rates on investments where the Company cannot demonstrate the intent and ability to hold until recovery.
In addition to these asset write-downs, in 2008, the Company recognized after-tax losses of $9 million on hybrid securities (classified as equity securities) of certain quasi-federal government agencies where the Company believes that the decline in fair value is other-than-temporary.
The U.S. and global financial markets experienced significant challenges throughout 2008. The unprecedented downgrading of billions of dollars of previously highly rated, liquid public securities led to a significant crisis of confidence and a dramatic tightening of credit conditions leading to historically wide credit spreads and substantially higher market yields in spite of near record low treasury rates. Both debt and equity markets are expected to remain volatile until confidence is restored. As a result of this economic environment, the credit risks in the Companys investment portfolio are elevated.
The market conditions described above resulted in a significant net increase in investment yields across the credit spectrum. While this increase is positive for new investments, it drove a significant decline in value for the Companys existing investment portfolio. The Companys corporate fixed maturity and commercial mortgage loan portfolios are well diversified by borrower, sector, and geographic region, limiting exposure. However, if broad economic conditions and/or illiquidity in the capital markets persist or worsen, this would likely result in an increase in the severity and duration of the decline in asset values, and may cause the Company to experience additional investment losses.
The value of the Companys fixed maturity portfolio declined substantially throughout 2008 resulting in after-tax unrealized depreciation of $147 million. The Companys commercial mortgage portfolio also declined substantially in 2008, resulting in after-tax unrealized depreciation of $140 million (a decline in fair value versus carrying value). The possibility of increased market investment yields for an extended period could cause the Company to recognize impairment losses if it cannot demonstrate the intent and ability to hold certain
investments until recovery. Future realized and unrealized investment results will be impacted largely by market conditions that exist when a transaction occurs or at the reporting date. These future conditions are not reasonably predictable.
Management believes that a significant portion of the Companys fixed maturity and commercial mortgage investments will continue to perform under their contractual terms, and that the recent declines in their fair values are temporary. Based on the Companys strategy to match the duration of invested assets to the duration of insurance and contractholder liabilities, it has both the intent and ability to hold these assets to recovery. Therefore, future credit related losses are not expected to have a material adverse effect on the Companys liquidity or financial condition.
The Companys assets and liabilities include financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. The Companys primary market risk exposures are:
For further discussion of reinsured contracts, see Note 7 for GMDB contracts and Note 11 for GMIB contracts in the Consolidated Financial Statements.
The Companys Management of Market Risks
The Company predominantly relies on three techniques to manage its exposure to market risk:
See Notes 2(C) and 12(F) to the Consolidated Financial Statements for additional information about financial instruments, including derivative financial instruments.
Effect of Market Fluctuations on the Company
The examples that follow illustrate the effect of hypothetical changes in market rates or prices on the fair value of certain financial instruments including:
In addition, hypothetical effects of changes in equity indices and foreign exchange rates are presented separately for futures contracts used in the GMDB equity hedge program.
Management believes that actual results could differ materially from these examples because:
The effects of hypothetical changes in market rates or prices on the fair values of certain of the Companys financial instruments, subject to the exclusions noted above (particularly insurance liabilities), would have been as follows as of December 31:
The effect of a hypothetical increase in interest rates on the fair value of certain of the Companys financial instruments decreased in 2008 as a result of increased net liabilities for GMIB contracts, along with declining fair values of fixed maturities, partially offset by a decrease in the duration of long-term debt. Net liabilities for GMIB contracts increased in 2008 primarily due to the adoption of SFAS No. 157 and declines in the equity markets and interest rates. During 2008, the underlying equity account values from GMIB contracts decreased by 50% primarily due to equity market declines. Therefore, the current effect of a hypothetical 10% decrease in market prices for equity exposures at December 31, 2008 is expected to be less than at December 31, 2007. See the Critical Accounting Estimates section of the MD&A beginning on page 49 for further discussion of guaranteed minimum income benefits.
The effect of a hypothetical increase in interest rates was determined by estimating the present value of future cash flows using various models, primarily duration modeling and, for GMIB contracts, stochastic modeling. The effect of a hypothetical strengthening of the U.S. dollar relative to the foreign currencies held by the Company was estimated to be 10% of the U.S. dollar equivalent fair value. The effect of a hypothetical decrease in the market prices of equity exposures was estimated based on a 10% decrease in the equity mutual fund values underlying guaranteed minimum income benefits reinsured by the Company and a 10% decrease in the value of equity securities held by the Company. See Note 11 to the Consolidated Financial Statements for additional information.
The Company uses futures contracts as part of a GMDB equity hedge program to substantially reduce the effect of equity market changes on certain reinsurance contracts that guarantee minimum death benefits based on unfavorable changes in underlying variable annuity account values. The hypothetical effect of a 10% increase in the S&P 500, S&P 400, Russell 2000, NASDAQ, TOPIX (Japanese), EUROSTOXX and FTSE (British) equity indices and a 10% weakening in the U.S. dollar to the Japanese yen, British pound and euro would have been a decrease of approximately $140 million in the fair value of the futures contracts outstanding under this program as of December 31, 2008. A corresponding decrease in liabilities for GMDB contracts would result from the hypothetical 10% increase in these equity indices and 10% weakening in the U.S. dollar. See Note 7 to the Consolidated Financial Statements for further discussion of this program and related GMDB contracts.
As noted above, the Company manages its exposures to market risk by matching investment characteristics to its obligations.
Stock Market Performance
The performance of equity markets can have a significant effect on the Companys businesses, including on:
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company and its representatives may from time to time make written and oral forward-looking statements, including statements contained in press releases, in the Companys filings with the Securities and Exchange Commission, in its reports to shareholders and in meetings with analysts and investors. Forward-looking statements may contain information about financial prospects, economic conditions, trends and other uncertainties. These forward-looking statements are based on managements beliefs and assumptions and on information available to management at the time the statements are or were made. Forward-looking statements include but are not limited to the information concerning possible or assumed future business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, trends and, in particular, the Companys productivity initiatives, litigation and other legal matters, operational improvement in the health care operations, and the outlook for the Companys full year 2009 results. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words believe, expect, plan, intend, anticipate, estimate, predict, potential, may, should or similar expressions.
You should not place undue reliance on these forward-looking statements. The Company cautions that actual results could differ materially from those that management expects, depending on the outcome of certain factors. Some factors that could cause actual results to differ materially from the forward-looking statements include:
This list of important factors is not intended to be exhaustive. Other sections of the Companys 2008 Annual Report on Form 10-K, including the Risk Factors section, and other documents filed with the Securities and Exchange Commission include both expanded discussion of these factors and additional risk factors and uncertainties that could preclude the Company from realizing the forward-looking statements. The Company does not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Managements Annual Report on Internal Control over Financial Reporting
Management of CIGNA Corporation (the Company) is responsible for establishing and maintaining adequate internal controls over financial reporting. The Companys internal controls were designed to provide reasonable assurance to the Companys Management and Board of Directors that the Companys consolidated published financial statements for external purposes were prepared in accordance with generally accepted accounting principles. The Companys internal controls over financial reporting include those policies and procedures that:
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Management assessed the effectiveness of the Companys internal controls over financial reporting as of December 31, 2008. In making this assessment, Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on Managements assessment and the criteria set forth by COSO, it was determined that the Companys internal controls over financial reporting are effective as of December 31, 2008.
The Companys independent registered public accounting firm, PricewaterhouseCoopers, has audited the effectiveness of the Companys internal control over financial reporting, as stated in their report located on page 137 in this Form 10-K.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained under the caption Market Risk in the MD&A section of this Form 10-K is incorporated by reference.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Statements of Income
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Balance Sheets
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Comprehensive Income
and Changes in Shareholders Equity
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Note 1 Description of Business
CIGNA Corporation together with its subsidiaries (referred to collectively as the Company) constitutes one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace, including health care products and services such as medical coverages, pharmacy, behavioral health, dental benefits, and disease management; group disability, life and accident insurance; and disability and workers compensation case management and related services. In addition, the Company has an international operation that offers life, accident and supplemental health insurance products and international health care products and services to businesses and individuals in selected markets. The Company also has certain inactive businesses, including a run-off reinsurance operation.
Note 2 Summary of Significant Accounting Policies
A. Basis of Presentation
The consolidated financial statements include the accounts of CIGNA Corporation, its significant subsidiaries, and variable interest entities of which CIGNA Corporation is the primary beneficiary. Intercompany transactions and accounts have been eliminated in consolidation.
These consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Amounts recorded in the consolidated financial statements reflect managements estimates and assumptions about medical costs, investment valuation, interest rates and other factors. Significant estimates are discussed throughout these Notes; however, actual results could differ from those estimates.
Certain reclassifications have been made to prior period amounts to conform to the presentation of 2008 amounts.
Discontinued operations. Summarized financial data for discontinued operations in 2008 primarily represents a gain of $3 million after-tax from the settlement of certain issues related to a past divestiture.
For 2007 and 2006, discontinued operations primarily reflects:
Unless otherwise indicated, amounts in these Notes exclude the effects of discontinued operations.
Variable interest entities. As of December 31, 2008 the Company is no longer a primary beneficiary in any variable interest entities. As of 2007, the Company consolidated $5 million in assets and $5 million in liabilities as the primary beneficiary of one real estate joint venture.
B. Recent Accounting Pronouncements
Fair value measurements. Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. (SFAS No.) 157, Fair Value Measurements. This standard expands disclosures about fair value measurements and clarifies how to measure fair value by focusing on the price that would be received when selling an asset or paid to transfer a liability (exit price). In addition, the Financial Accounting Standards Board (FASB) amended SFAS No. 157 to provide additional guidance for determining the fair value of a financial asset when the market for that instrument is not active. See Note 11 for information on the Companys fair value measurements including new required disclosures.
The Company carries certain financial instruments at fair value in the financial statements including approximately $12.1 billion in invested assets at December 31, 2008. The Company also carries derivative instruments at fair value, including assets and liabilities for reinsurance contracts covering guaranteed minimum income benefits (GMIB assets and liabilities) under certain variable annuity contracts issued by other insurance companies and related retrocessional contracts. The Company also reports separate account assets at fair value; however, changes in the fair values of these assets accrue directly to policyholders and are not included in the Companys revenues and expenses. At the adoption of SFAS No. 157, there were no effects to the Companys measurements of fair values for financial instruments other than for GMIB assets and liabilities discussed below. In addition, there were no effects to the Companys measurements of financial assets of adopting the recent amendment to SFAS No. 157.
At adoption, the Company was required to change certain assumptions used to estimate the fair values of GMIB assets and liabilities. As a result, the Company recorded a charge of $131 million after-tax, net of reinsurance ($202 million pre-tax), in Run-off Reinsurance. Because there is no market for these contracts, the assumptions used to estimate their fair values at adoption were determined using a hypothetical market participants view of an exit price. The Company considered the following in determining the view of a hypothetical market participant:
At adoption, the assumptions used to estimate the fair value of these contracts were determined using a hypothetical market participants view of an exit price rather than using historical market data and actual experience to establish the Companys future expectations. For many of these assumptions, there is limited or no observable market data so determining an exit price requires the Company to exercise significant judgment and make critical accounting estimates.
The Company considers the various assumptions used to estimate fair values of these contracts in two categories: capital markets and future annuitant and retrocessionaire behavior assumptions. Estimated components of the charge by category (net of reinsurance) are described below, including how these updated assumptions differ from those used historically to estimate fair values for these contracts.
Assumptions Related to Capital Markets - $183 million of the $202 million pre-tax charge, net of estimated receivables for reinsurance, reflected the impact of changes in capital markets assumptions including market return, discount rate, the projected interest rate used to calculate the reinsured income benefits at the time of annuitization (claim interest rate), and volatility. These assumptions were updated to reflect market-observable interest rates (LIBOR swap curve) and volatility consistent with that implied by derivative instruments in a consistently active market, under the assumption that a hypothetical market participant would hedge all or a portion of the net liability. The capital markets pre-tax charge is comprised of:
Assumptions Related to Future Annuitant and Retrocessionaire Behavior - $19 million of the $202 million pre-tax charge, net of estimated receivables for reinsurance, reflected the impact of the Companys view of a hypothetical market participants assumptions for future annuitant and retrocessionaire behavior and primarily reflects an incremental risk and profit charge.
The Companys results of operations related to this business are expected to continue to be volatile in future periods both because underlying assumptions will be based on current market-observable inputs which will likely change each period and because the recorded liabilities, net of receivables from reinsurers, are higher after adoption of SFAS No. 157. See Note 11 for additional information.
The FASB deferred the effective date of SFAS No. 157 until the first quarter of 2009 for non-financial assets and liabilities (such as intangible assets, property and equipment and goodwill) that are required to be measured at fair value on a periodic basis (such as at impairment). On adoption in the first quarter of 2009, the Company does not expect material changes to their periodic fair value measurements for non-financial assets and liabilities.
Fair value option. Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose fair value measurement for many financial instruments, including insurance contracts, with subsequent changes in fair value to be reported in net income for the period. This choice is made for each individual financial instrument, is irrevocable and, after implementation, must be determined when the entity first commits to or recognizes the financial instrument. The adoption of SFAS No. 159 did not impact the Companys consolidated financial statements, as no items were elected for fair value measurement. For financial assets and liabilities acquired after adoption, the Company determines whether to use the fair value election at the time of acquisition.
Uncertain tax positions. Effective January 1, 2007, the Company implemented FASB Interpretation No. (FIN No.) 48, Accounting for Uncertainty in Income Taxes. This interpretation provides guidance for recognizing and measuring uncertain tax positions that are more likely than not to result in a benefit if challenged by the Internal Revenue Service (IRS). The guidance clarifies that the amount of tax benefit recognized should be measured using managements best estimate based on the most favorable expected benefit with greater than fifty percent likelihood of being realized. The interpretation also requires that interest expense and penalties be recognized for any reserved portion of an uncertain tax position beginning when the effect of that position is reported to tax authorities. The cumulative effect of implementing the interpretation for unrecognized tax benefits decreased opening retained earnings by $29 million. See Note 18 for additional information.
Certain financial instruments. Effective January 1, 2007, the Company implemented SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140. This standard clarifies when certain financial instruments and features of financial instruments must be treated as derivatives and reported on the balance sheet at fair value with changes in fair value reported in net income. At adoption, the Company elected to fair value certain existing investments in preferred stock and debt securities with call or conversion features (hybrid securities) and future changes in the fair value of these investments will be reported in net income. As a result, the Company reclassified $12 million after-tax of unrealized appreciation from the opening balance of accumulated other comprehensive loss to retained earnings with no net change to total shareholders equity. In addition, this standard may affect future income recognition for certain future financial instruments if the fair value election is used or if additional derivatives are identified because any changes in their fair values will be recognized in net income each period. See Note 12(A) for a review of instruments that the Company has elected to fair value.
Deferred acquisition costs. Effective January 1, 2007, the Company implemented the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. The SOP requires that deferred acquisition costs be expensed in full when the original contract is substantially changed by election or amendment of an existing contract feature or by replacement with a new contract. There were no material effects to the consolidated financial statements at implementation. Although substantial contract changes are not expected to occur, the effect of this SOP in future periods may vary based on the nature and volume of any such contract changes.
Pension and other postretirement benefit plans. Effective December 31, 2006, the Company implemented SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Benefits Plans. This standard requires that the overfunded or underfunded status of all defined benefit postretirement plans be measured as the difference between the fair value of plan assets and the benefit obligation and recognized in the balance sheet. Changes in actuarial gains and losses and prior service costs are required to be recognized in accumulated other comprehensive income, net of tax, each period. The effects on the consolidated financial statements were as follows:
Liabilities for pension benefits and other postretirement benefits are recorded in accounts payable, accrued expenses and other liabilities on the Companys Consolidated Balance Sheets.
The implementation of SFAS No. 158 did not impact the Companys pension expense, funding requirements or financial covenants. See Note 10 for further information on pension and other postretirement benefit plans.
Earnings per share. In 2008, the FASB issued FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, to require outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends to be included in the denominator of both basic and diluted earnings per share calculations. These new requirements must be applied through restatement of prior-period earnings per share data beginning in the first quarter of 2009. On adoption, the Company does not expect material changes to either basic or diluted earnings per share data.
Business combinations. In 2007, the FASB issued SFAS No. 141 (revised 2007, referred to as SFAS No. 141R,) Business Combinations, to require fair value measurements for all future acquisitions, including contingent purchase price and contingent assets or liabilities of the entity to be acquired. This standard also expands the definition of business combination to include all transactions or events in which an entity obtains control of a business, requires acquisition related and restructuring costs to be expensed as incurred and requires changes in deferred tax asset valuation allowances and acquired income tax uncertainties after the acquisition date to be reported in income tax expense. SFAS No. 141R is effective for all business combinations beginning in 2009. The effect of these new requirements on the Companys financial condition and results of operations will depend on the volume and terms of acquisitions in 2009 and beyond, but will likely increase the amount and change the timing of recognizing expenses related to acquisition activities.
Noncontrolling interests in subsidiaries. In 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51, to require that noncontrolling interests in subsidiaries be presented as part of equity of the consolidated group, separate from the parent shareholders equity. In addition, net income and components of other comprehensive income of the subsidiary must be allocated between the controlling and noncontrolling interests and presented separately based on relative ownership interests or contractual arrangements. These new presentation requirements must be applied through retrospective restatement of prior financial statements beginning in 2009. On adoption, the Company does not expect material changes to the results of operations or financial condition.
C. Financial Instruments
In the normal course of business, the Company enters into transactions involving various types of financial instruments. These financial instruments may include:
These instruments may change in value due to interest rate and market fluctuations, and most also have credit risk. The Company evaluates and monitors each financial instrument individually and, when management considers it appropriate, uses a derivative instrument or obtains collateral or another form of security to minimize risk of loss.
Most financial instruments that are subject to fair value disclosure requirements are carried in the consolidated financial statements at amounts that approximate fair value. The following table shows the fair values and carrying values of the Companys financial instruments not carried at fair value that are subject to fair value disclosure requirements, at the end of 2008 and 2007:
Fair values of off-balance-sheet financial instruments were not material.
Fair values of financial instruments are based on quoted market prices when available. When market prices are not available, management generally estimates fair value based on discounted cash flow analyses, which use current interest rates for similar financial instruments with comparable terms and credit quality. Management estimates the fair value of the liabilities for contractholder deposit funds using the amount payable on demand.
The Companys accounting policies for investment assets are discussed below:
Fixed maturities and equity securities. Fixed maturities include bonds, mortgage- and other asset-backed securities and preferred stocks redeemable by the investor. Equity securities include common stocks and preferred stocks that are non-redeemable or redeemable only by the issuer. These investments are primarily classified as available for sale and are carried at fair value with changes in fair value recorded in accumulated other comprehensive income (loss) within shareholders equity. Fixed maturities and equity securities are considered impaired, and their cost basis is written down to fair value through earnings, when management expects a decline in value to persist (i.e. the decline is other than temporary). Fixed maturities and equity securities include certain trading and hybrid securities carried at fair value with changes in fair value reported in realized investment gains and losses, beginning after the implementation of SFAS No. 155 on January 1, 2007 for hybrid securities. The Company elected fair value accounting for certain hybrid securities to simplify accounting and mitigate volatility in results of operations and financial condition.
Commercial mortgage loans. Mortgage loans held by the Company are made exclusively to commercial borrowers, therefore there is no exposure to either prime or sub-prime residential mortgages. Generally, commercial mortgage loans are carried at unpaid principal balances and are issued at a fixed rate of interest. Commercial mortgage loans held for sale are carried at the lower of unpaid principal balance or fair value with any resulting valuation allowance reported in realized investment gains and losses. Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the loan agreement. Impaired loans are carried at the lower of unpaid principal or fair value of the underlying collateral. The Company estimates the fair value of the underlying collateral using internal valuations generally based on discounted cash flow analyses.
Policy loans. Policy loans are carried at unpaid principal balances.
Real estate. Investment real estate can be held and used or held for sale. The Company accounts for real estate as follows:
At the time of foreclosure, properties are reclassified from commercial mortgage loans to real estate. The Company rehabilitates, re-leases and sells foreclosed properties. This process usually takes from 2 to 4 years unless management considers a near-term sale preferable.
Other long-term investments. Other long-term investments include investments in unconsolidated entities. These entities include certain limited partnerships and limited liability companies holding real estate, securities or loans. These investments are carried at cost plus the Companys ownership percentage of reported income or loss in cases where the Company has significant influence, otherwise the investment is carried at cost. Also included in other long-term investments are loans to unconsolidated real estate entities secured by the equity interests of these real estate entities, which are carried at unpaid principal balances (mezzanine loans). Additionally, other long-term investments include interest rate and foreign currency swaps carried at fair value. See Note 12(F) for information on the Companys accounting policies for these derivative financial instruments.
Short-term investments. Investments with maturities of less than one year from time of purchase are classified as short-term, available for sale and carried at fair value, which approximates cost.
Derivative financial instruments. Note 12(F) discusses the Companys accounting policies for derivative financial instruments.
Net investment income. When interest and principal payments on investments are current, the Company recognizes interest income when it is earned. The Company stops recognizing interest income when interest payments are delinquent or when certain terms (interest rate or maturity date) of the investment have been restructured. Net investment income on these investments is only recognized when interest payments are actually received. Interest and dividends earned on trading and hybrid securities are included in net investment income.
Investment gains and losses. Realized investment gains and losses result from sales, investment asset write-downs, changes in the fair values of trading and hybrid securities and certain derivatives and changes in valuation reserves, based on specifically identified assets. Realized investment gains and losses on the disposition of certain directly owned real estate investments are eliminated from ongoing operations and reported in discontinued operations when the operations and cash flows of the underlying assets are clearly distinguishable and the Company has no significant continuing involvement in their operations.
Unrealized gains and losses on fixed maturities and equity securities carried at fair value (excluding trading and hybrid securities) and certain derivatives are included in accumulated other comprehensive income (loss), net of:
E. Cash and Cash Equivalents
Cash equivalents consist of short-term investments with maturities of three months or less from the time of purchase that are classified as held to maturity and carried at amortized cost. The Company reclassifies cash overdraft positions to accounts payable, accrued expenses and other liabilities when the legal right of offset does not exist.
F. Premiums, Accounts and Notes Receivable and Reinsurance Recoverables
Premiums, accounts and notes receivable are reported net of an allowance for doubtful accounts of $50 million as of December 31, 2008 and $54 million as of December 31, 2007. Reinsurance recoverables are estimates of amounts that the Company will receive from reinsurers and are recorded net of an allowance for unrecoverable reinsurance of $23 million as of December 31, 2008 and $27 million as of December 31, 2007.
G. Deferred Policy Acquisition Costs
Acquisition costs include sales compensation, commissions, premium taxes and other costs that the Company incurs in connection with new and renewal business. Depending on the product line they relate to, the Company records acquisition costs in different ways. Acquisition costs for:
For universal life, annuity and other individual products, management estimates the present value of future revenues less expected payments. For group health indemnity products, management estimates the sum of future expected claims and related costs less unearned premiums and anticipated net investment income. If managements estimates are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. Anticipated investment income is considered in the calculation of premium deficiency losses for short-duration contracts. The Company recorded in other operating expenses amortization for policy acquisition costs of $314 million in 2008, $242 million in 2007 and $202 million in 2006. There are no deferred policy acquisition costs attributable to the sold individual life insurance and annuity and retirement businesses or the run-off reinsurance operations.
H. Property and Equipment
Property and equipment is carried at cost less accumulated depreciation. When applicable, cost includes interest, real estate taxes and other costs incurred during construction. Also included in this category is internal-use software that is acquired, developed or modified solely to meet the Companys internal needs, with no plan to market externally. Costs directly related to acquiring, developing or modifying internal-use software are capitalized. See Note 9 for additional information on internal-use software.
The Company calculates depreciation and amortization principally using the straight-line method based on the estimated useful life of each asset as follows: buildings and improvements, 1 year to 40 years; equipment and software, 1 year to 10 years. Depreciation and amortization expense on property and equipment, including internal-use software, was $219 million in 2008, $185 million in 2007 and $187 million in 2006. Accumulated depreciation and amortization on property and equipment, including internal-use software was $1.5 billion at December 31, 2008 and $1.4 billion at December 31, 2007.
Goodwill represents the excess of the cost of businesses acquired over the fair value of their net assets. Substantially all goodwill relates to the Health Care segment. The Company evaluates goodwill for impairment annually during the third quarter at the reporting unit level, based on discounted cash flow analyses and writes it down through results of operations if impaired. Consistent with prior years, the Companys evaluations used the best information available at the time, including reasonable assumptions and projections consistent with those used in its annual planning process. The discounted cash flow analyses used a range of discount rates that correspond with the Companys weighted average cost of capital, consistent with that used for investment decisions considering the specific and detailed operating plans and strategies within the Health Care segment. The resulting discounted cash flow analyses indicated an estimated fair value for the reporting units of the Health Care segment exceeding their carrying values, including goodwill and other intangibles. Finally, the Company determined that no events or circumstances occurred subsequent to the annual evaluation of goodwill that would more likely than not reduce the fair value of the reporting units of the Health Care segment below their carrying values. See Note 9 for additional information.
J. Other Assets, including Other Intangibles
Other assets consist of various insurance-related assets and the gain position of certain derivatives, primarily GMIB assets. The Companys other intangible assets include purchased customer and producer relationships, provider networks, and trademarks. The Company amortizes other intangibles on an accelerated or straight-line basis over periods from 1 to 30 years. Management revises amortization periods if it believes there has been a change in the length of time that an intangible asset will continue to have value. See Note 9 for additional information.
K. Separate Account Assets and Liabilities
Separate account assets and liabilities are contractholder funds maintained in accounts with specific investment objectives. The assets of these accounts are legally segregated and are not subject to claims that arise out of any of the Companys other businesses. These separate account assets are carried at fair value with equal amounts for related separate account liabilities. The investment income, gains and losses of these accounts generally accrue to the contractholders and are not included in the Companys revenues and expenses. Fees earned for asset management services are reported in premiums and fees.
L. Contractholder Deposit Funds
Liabilities for contractholder deposit funds include deposits received from customers for investment-related and universal life products and investment earnings on their fund balances. These liabilities are adjusted to reflect administrative charges and, for universal life fund balances, mortality charges.
M. Future Policy Benefits
Future policy benefits are liabilities for the present value of estimated future obligations under long-term life and supplemental health insurance policies and annuity products currently in force. These obligations are estimated using actuarial methods and primarily consist of reserves for annuity contracts, life insurance benefits, guaranteed minimum death benefit contracts and certain life, accident and health insurance products in our International operations.
Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies represent benefits to be paid to policyholders, net of future premiums to be received. Management estimates these obligations based on assumptions as to premiums, interest rates, mortality and surrenders, allowing for adverse deviation. Mortality, morbidity, and surrender assumptions are based on either the Companys own experience or actuarial tables. Interest rate assumptions are based on managements judgment considering the Companys experience and future expectations, and range from 1.5% to 10.0%. Obligations for the run-off settlement annuity business include adjustments for investment returns consistent with requirements of GAAP when a premium deficiency exists.
Certain reinsurance contracts guarantee a minimum death benefit (GMDB) under variable annuities issued by other insurance companies. These obligations represent the guaranteed death benefit in excess of the contractholders account values (based on underlying equity and bond mutual fund investments). These obligations are estimated based on assumptions regarding lapse, partial surrenders, mortality, interest rates (mean investment performance and discount rate), market volatility as well as investment returns and premiums, consistent with the requirements of GAAP when a premium deficiency exists. Lapse, partial surrenders, mortality, interest rates and volatility are based on managements judgment considering the Companys experience and future expectations. The results of futures contracts used in the GMDB equity hedge program are reflected in the liability calculation as a component of investment returns. See also Note 7 for additional information.
N. Unpaid Claims and Claims Expenses
Liabilities for unpaid claims and claim expenses are estimates of payments to be made under insurance coverages (primarily long-term disability, workers compensation and life and health) for reported claims and for losses incurred but not yet reported.
The Company develops these estimates for losses incurred but not yet reported using actuarial principles and assumptions based on historical and projected claim incidence patterns, claim size and the length of time over which payments are expected to be made. The Company consistently applies these actuarial principles and assumptions each reporting period, with consideration given to the variability of these factors, and recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice, which require that the liabilities be adequate under moderately adverse conditions.
The Companys estimate of the liability for disability claims reported but not yet paid is primarily calculated as the present value of expected benefit payments to be made over the estimated time period that a policyholder remains disabled. The Company estimates the expected time period that a policyholder may be disabled by analyzing the rate at which an open claim is expected to close (claim resolution rate). Claim resolution rates may vary based upon the length of time a policyholder is disabled, the covered benefit period, cause of disability, benefit design and the policyholders age, gender and income level. The Company uses historical resolution rates combined with an analysis of current trends and operational factors to develop current estimates of resolution rates. The reserve for the gross monthly disability benefits due to a policyholder is reduced (offset) by the income that the policyholder receives under other benefit programs, such as Social Security Disability Income, workers compensation, statutory disability or other group disability benefit plans. For awards of such offsets that have not been finalized, the Company estimates the probability and amount of the offset based on the Companys experience over the past three to five years.
Because benefit payments may be made over an extended time period, the Company discounts certain claim liabilities related to group long-term disability and workers compensation. Discount rate assumptions are based on projected investment returns for the asset portfolios that support these liabilities and range from 2.1% to 6.5%. When estimates change, the Company records the adjustment in benefits and expenses in the period in which the change in estimate is identified. Discounted liabilities associated with the long-term disability and certain workers compensation businesses were $3.2 billion at December 31, 2008 and $3.1 billion at December 31, 2007.
O. Health Care Medical Claims Payable
Medical claims payable for the Health Care segment include both reported claims and estimates for losses incurred but not yet reported.
The Company develops these estimates using actuarial principles and assumptions based on historical and projected claim payment patterns, medical cost trends, which are impacted by the utilization of medical services and the related costs of the services provided (unit costs), benefit design, seasonality, and other relevant operational factors. The Company consistently applies these actuarial principles and assumptions each reporting period, with consideration given to the variability of these factors, and recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice, which require that the liabilities be adequate under moderately adverse conditions.
The Companys estimate of the liability for medical claims incurred but not yet reported is primarily calculated using historical claim payment patterns and expected medical cost trends. The Company analyzes the historical claim payment patterns by comparing the dates claims were incurred, generally the dates services were provided, to the dates claims were paid to determine completion factors, which are a measure of the time to process claims. A completion factor is calculated for each month of incurred claims. The Company uses historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. The Company estimates the ultimate liability for claims incurred in each month by applying the current estimates of completion factors to the current paid claims data. The difference between this estimate of the ultimate liability and the current paid claims data is the estimate of the remaining claims to be paid for each incurral month. These monthly estimates are aggregated and included in the Companys Health Care medical claims payable at the end of each reporting period. Completion factors are used to estimate the Health Care medical claims payable for all months where claims have not been completely resolved and paid, except for the most recent month as described below.
Completion factors are impacted by several key items including changes in the level of claims processed electronically versus manually (auto-adjudication), changes in provider claims submission rates, membership changes and the mix of products. As noted, the Company uses historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. This approach implicitly assumes that historical completion rates will be a useful indicator for the current period. It is possible that the actual completion rates for the current period will develop differently from historical patterns, which could have a material impact on the Companys medical claims payable and net income.
Claims incurred in the most recent month have limited paid claims data, since a large portion of health care claims are not submitted to the Company for payment in the month services have been provided. This makes the completion factor approach less reliable for claims incurred in the most recent month. As a result, in any reporting period, for the estimates of the ultimate claims incurred in the most recent month, the Company primarily relies on medical cost trend analysis, which reflects expected claim payment patterns and other relevant operational considerations. Medical cost trend is impacted by several key factors including medical service utilization and unit costs and the Companys ability to manage these factors through benefit design, underwriting, provider contracting and the Companys medical management initiatives. These factors are affected by changes in the level and mix of medical benefits offered, including inpatient, outpatient and pharmacy, the impact of copays and deductibles, changes in provider practices and changes in consumer demographics and consumption behavior.
Because historical trend factors are often not representative of current claim trends, the trend experienced for the most recent history along with an analysis of emerging trends, have been taken into consideration in establishing the liability for Health Care medical claims payable at December 31, 2008 and 2007. It is possible that the actual medical trend for the current period will develop differently from that expected, which could have a material impact on the Companys medical claims payable and net income.
For each reporting period, the Company evaluates key assumptions by comparing the assumptions used in establishing the medical claims payable to actual experience. When actual experience differs from the assumptions used in establishing the liability, medical claims payable are increased or decreased through current period net income. Additionally, the Company evaluates expected future developments and emerging trends which may impact key assumptions. The estimation process involves considerable judgment, reflecting the variability inherent in forecasting future claim payments. The adequacy of these estimates is highly sensitive to changes in the Companys key assumptions, specifically completion factors, which are impacted by actual or expected changes in the submission and payment of medical claims, and medical cost trends, which are impacted by actual or expected changes in the utilization of medical services and unit costs.
P. Unearned Premiums and Fees
Premiums for life, accident and health insurance are recognized as revenue on a pro rata basis over the contract period. Fees for mortality and contract administration of universal life products are recognized ratably over the coverage period. The unrecognized portion of these amounts is recorded as unearned premiums and fees.
Q. Accounts Payable, Accrued Expenses and Other Liabilities
Accounts payable, accrued expenses and other liabilities consist principally of pension, other postretirement and postemployment benefits and various insurance-related liabilities, including amounts related to reinsurance contracts and insurance-related assessments that management can reasonably estimate. Accounts payable, accrued expenses and other liabilities also include certain overdraft positions and the loss position of certain derivatives, primarily for GMIB contracts (see Note 12(F)). Legal costs to defend the Companys litigation and arbitration matters are expensed when incurred in larger cases for which the Company cannot reasonably estimate the ultimate cost to defend. In smaller cases for which the Company can reasonably estimate the cost to defend, these costs are recognized when the claim is reported.
R. Translation of Foreign Currencies
The Company generally conducts its international business through foreign operating entities that maintain assets and liabilities in local currencies, which are generally their functional currencies. The Company uses exchange rates as of the balance sheet date to translate assets and liabilities into U.S. dollars. Translation gains or losses on functional currencies, net of applicable taxes, are recorded in accumulated other comprehensive income (loss). The Company uses average monthly exchange rates during the year to translate revenues and expenses into U.S. dollars.
S. Premiums and Fees, Revenues and Related Expenses
Premiums for life, accident and health insurance and managed care coverages are recognized as revenue on a pro rata basis over the contract period. Benefits and expenses are recognized when incurred.
Premiums for individual life insurance and individual and group annuity products, excluding universal life and investment-related products, are recognized as revenue when due. Benefits and expenses are matched with premiums.
Revenue for investment-related products is recognized as follows:
Benefits and expenses for investment-related products consist primarily of income credited to policyholders in accordance with contract provisions.
Revenue for universal life products is recognized as follows:
Benefits and expenses for universal life products consist of benefit claims in excess of policyholder account balances. Expenses are recognized when claims are submitted, and income is credited in accordance with contract provisions.
Contract fees and expenses for administrative services only programs and pharmacy programs and services are recognized as services are provided. Mail order pharmacy revenues and cost of goods sold are recognized as each prescription is shipped.
T. Stock Compensation
The Company records compensation expense for stock awards and options over their vesting periods based on the estimated fair value of the stock options, which is calculated using an option-pricing model. Compensation expense is recorded for restricted stock grants and deferred stock units over their vesting periods based on fair value, which is equal to the market price of the Companys common stock on the date of grant.
U. Participating Business
The Companys participating life insurance policies entitle policyholders to earn dividends that represent a portion of the earnings of the Companys life insurance subsidiaries. Participating insurance accounted for approximately 2% of the Companys total life insurance in force at the end of 2008, 2007 and 2006.
V. Income Taxes
The Company and its domestic subsidiaries file a consolidated United States federal income tax return. The Companys foreign subsidiaries file tax returns in accordance with foreign law. U.S. taxation of these foreign subsidiaries may differ in timing and amount from taxation under foreign laws. Reportable amounts, including credits for foreign tax paid by these subsidiaries, are reflected in the U.S. tax return of the affiliates domestic parent.
The Company recognizes deferred income taxes when the financial statement and tax based carrying values of assets and liabilities are different and recognizes deferred income tax liabilities on the unremitted earnings of foreign subsidiaries. The Company establishes valuation allowances against deferred tax assets if it is more likely than not that the deferred tax asset will not be realized. The need for a valuation allowance is determined based on the evaluation of various factors, including expectations of future earnings and managements judgment. Note 18 contains detailed information about the Companys income taxes.
The Company recognizes interim period income taxes by estimating an annual effective tax rate and applying it to year-to-date results. The estimated annual effective tax rate is periodically updated throughout the year based on actual results to date and an updated projection of full year income. Although the effective tax rate approach is generally used for interim periods, taxes on significant, unusual and infrequent items are recognized at the statutory tax rate entirely in the period the amounts are realized.
Note 3 Acquisitions and Dispositions
The Company may from time to time acquire or dispose of assets, subsidiaries or lines of business. Significant transactions are described below.
A. Great-West Healthcare Acquisition
On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc. (Great-West Healthcare or the acquired business) through 100% indemnity reinsurance agreements and the acquisition of certain affiliates and other assets and liabilities of Great-West Healthcare. The purchase price of approximately $1.5 billion consisted of a payment to the seller of approximately $1.4 billion for the net assets acquired and the assumption of net liabilities under the reinsurance agreement of approximately $0.1 billion. Great-West Healthcare primarily sells medical plans on a self-funded basis with stop loss coverage to select and regional employer groups. Great-West Healthcares offerings also include the following specialty products: stop loss, life, disability, medical, dental, vision, prescription drug coverage, and accidental death and dismemberment insurance. The acquisition, which was accounted for as a purchase, was financed through a combination of cash and the issuance of both short and long-term debt.
In accordance with SFAS No. 141, Business Combinations, the Company has substantially completed its allocation of the total purchase price to the tangible and intangible net assets acquired based on managements estimates of their fair values and expects only minor adjustments in the first quarter of 2009, the remaining allocation period. Accordingly, approximately $290 million was allocated to intangible assets, primarily customer relationships and internal-use software. The weighted average amortization period is 9 years for customer relationships and 6 years for internal-use software. The remainder, net of tangible net assets acquired, is goodwill which approximated $1.1 billion and was allocated entirely to the Health Care segment. Substantially all of the goodwill is tax deductible and will be amortized over the next 15 years for federal income tax purposes.
As part of the reinsurance and administrative service arrangements, the Company is responsible to pay claims for the group medical and long-term disability business of Great-West Healthcare and collect related amounts due from their third party reinsurers. Any such amounts not collected will represent additional assumed liabilities of the Company and decrease net income if and when these amounts are determined uncollectible. At December 31, 2008, receivables recorded for paid claims due from third party reinsurers for this business approximated $1 million and unpaid claims related to this business were estimated at $27 million.
The condensed balance sheet of Great-West Healthcare at the acquisition date was as follows:
The results of Great-West Healthcare are included in the Companys Consolidated Financial Statements from the date of acquisition.
The following table presents selected unaudited pro forma information for the Company assuming the acquisition had occurred as of January 1, 2007. The pro forma information does not purport to represent what the Companys actual results would have been if the acquisition had occurred as of the date indicated or what such results would be for any future periods.
B. Sale of the Chilean Insurance Operations
On August 10, 2007, the Company completed the sale of its Chilean insurance operations, which was classified as a discontinued operation in the second quarter of 2007. The Company recognized an impairment loss in the second quarter of 2007 for this business of $19 million after-tax primarily relating to the write-off of unrecoverable tax assets and foreign currency translation losses. As of
December 31, 2006, the assets and liabilities of the Chilean insurance operations, which were held for sale, were reported in other assets and accounts payable, accrued expenses and other liabilities.
C. Sale of Retirement Benefits Business
In 2004, the Company sold its retirement benefits business, excluding the corporate life insurance business, for cash proceeds of $2.1 billion. The sale resulted in an initial after-tax gain of $809 million, of which $267 million after-tax was recognized immediately and the remaining amount was deferred. The Company recognized deferred gains of $3 million after-tax in 2008, $5 million after-tax in 2007 and $14 million after-tax in 2006. As of December 31, 2008, the remaining deferred gain of $33 million after-tax will be recognized in the Companys results of operations through 2032.
D. Sale of Individual Life Insurance and Annuity Business
In 1998, the Company sold its individual life insurance and annuity business for cash proceeds of $1.4 billion. The sale generated an after-tax gain of approximately $800 million, the majority of which was deferred and is recognized at the rate that earnings from the sold business would have been expected to emerge (primarily over 15 years on a declining basis). The Company recognized deferred gains of $22 million after-tax in 2008, $25 million after-tax in 2007 and $28 million after-tax in 2006. The remaining deferred gain as of December 31, 2008, was $108 million after-tax.
Note 4 Earnings Per Share
Basic and diluted earnings per share were computed as follows: