CIGNA Corporation 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2009
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 þ No o
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 o No þ
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 o No þ
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2009 was approximately $6.6 billion.
As of January 30, 2010, 274,968,520 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, 2010.
TABLE OF CONTENTS
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. 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 operation. CIGNA Corporation had consolidated shareholders equity of $5.4 billion and assets of $43.0 billion as of December 31, 2009, and revenues of $18.4 billion for the year then ended. CIGNAs major insurance subsidiary, Connecticut General Life Insurance Company (CGLIC), 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 Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (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:
CIGNAs annual, quarterly and current reports, proxy statements and other filings, and any amendments to these filings, are made available free of charge on its website (http://www.cigna.com, under the InvestorsSEC Filings captions) as soon as reasonably practicable after the Company electronically files these materials with, or furnish them to, the Securities and Exchange Commission (the SEC). The Company uses its 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 beginning on page 171 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 2009 presentation. Industry rankings and percentages set forth herein are for the year ended December 31, 2009, 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 22 to the Consolidated Financial Statements beginning on page 160 of this Form 10-K.
As a global health service organization, CIGNAs mission remains focused on helping the people it serves improve their health, well-being and sense of security. CIGNAs long-term growth strategy is based on: (1) growth in targeted geographies, product lines, buying segments and distribution channels; (2) improving its strategic and financial flexibility; and (3) pursuing additional opportunities in high-growth markets with particular focus on individuals.
CIGNA expects to focus on the following areas it believes represent the markets or areas with the most potential for profitable growth:
The Company plans to improve its strategic and financial flexibility by driving further reductions in its Health Care operating expenses, improving its medical cost competitiveness in targeted markets and effectively managing balance sheet exposures.
Also, in connection with CIGNAs long-term business strategy, the Company remains committed to health advocacy as a means of creating sustainable solutions for employers, improving the health of the individuals that the Company serves, and lowering the costs of health care for all constituencies.
Details on the Companys operational strategies are discussed further in the Health Care segment discussion of Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section on page 62 of this Form 10-K.
D. 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 companies offer these products and services in all 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands.
CIGNA HealthCare is focused on helping to improve the health, well-being and sense of security of the individuals it serves. CIGNA HealthCare believes the most sustainable approach to enhancing quality and managing health care costs is to fully engage individuals in the decisions that affect their health and the health care services they receive. To assist individuals in making informed choices about health care for themselves and their families, CIGNA HealthCare makes available to its members actionable information about health and advocacy programs as well as about the cost and quality of health care services and supplies provided to them.
Underlying CIGNA HealthCares operations is a foundation of clinical expertise and an ability to provide quality service. CIGNA HealthCares strengths include its ability to: (1) integrate medical and specialty product offerings to achieve a more holistic and integrated approach to individuals health that promotes consistent care management; and (2) 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 Health Maintenance Organization (HMO) as well as Medicare Part D and Private Fee for Service 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 MD&A beginning on page 62 of this Form 10-K reflects both the product type and funding arrangement.
CIGNA HealthCare provides a wide array of products and services to meet the needs of employers, other sponsors of health benefit plans and their plan participants (i.e., employees/members and their eligible dependents), and individuals, including:
Health Advocacy. CIGNA HealthCare offers medical management, disease management, and other health advocacy services to employers and other plan sponsors. Services are not only offered to members covered under CIGNA HealthCare administered plans but also to those individuals who have elected coverage under a plan offered through their employer by competing insurers/third party administrators. CIGNA offers a seamless integration of services to address the clinical and administrative challenges that are inherent in coordinating multiple vendors. Through its health advocacy programs, CIGNA HealthCare works to help: (1) healthy people stay healthy; (2) people change behaviors that are putting their health at risk; (3) people with existing health care issues access quality care and practice healthy self-care; and (4) people with a disabling illness or injury return to productive work quickly and safely.
CIGNA HealthCare offers a wide array of health advocacy programs and services to help individuals improve the health of the mind and body, including:
Behavioral Health. CIGNA arranges for the provision of behavioral health care services to individuals through its network of participating behavioral health care providers and offers behavioral health care management services, employee assistance programs, and work/life programs to employer and other groups sponsoring health 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, 2009, CIGNAs behavioral national network had approximately 76,000 access points to independent psychiatrists, psychologists and clinical social workers and approximately 6,100 facilities and clinics that are reimbursed on a contracted fee-for-service basis.
Dental. CIGNA Dental Health offers a variety of dental care products including dental health maintenance organization plans, dental preferred provider organization (DPPO) plans, dental exclusive provider organization plans, traditional dental indemnity plans and a dental discount program. Employers and other groups can purchase CIGNA Dental Health products as stand-alone products or integrated with CIGNA HealthCares medical products. As of December 31, 2009, CIGNA Dental Health members totaled approximately 9.9 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 160,000 DPPO-contracted access points (approximately 75,500 unique providers) and approximately 45,400 dental HMO-contracted access points (approximately 14,000 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.
Pharmacy. CIGNA Pharmacy offers prescription drug plans to its insured and self-funded customers both in conjunction with its medical products and on a stand-alone basis. With a nationwide network of approximately 60,300 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:
Private Fee For Service. CIGNAs Medicare Advantage private fee-for-service plan, CIGNA Medicare Access Plan, has been approved by the Centers for Medicare and Medicaid Services to be a replacement for Original Medicare. The CIGNA Medicare Access Plan offers the same benefits as Original Medicare Parts A & B, as well as supplemental benefits, including annual physicals, emergency worldwide coverage and health and wellness programs.
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 and Medicaid eligible members. CIGNA Medicare Rx is available in all 50 states and the District of Columbia.
Retail Pharmacies. CIGNA HealthCare operates 20 retail pharmacies, including on-site retail pharmacies for members to serve the needs of CIGNA HealthCare members.
CIGNA Onsite Health was formed in 2007. The Company operates onsite health centers at five CIGNA employee locations and expects to open several onsite health clinics at other employer locations during 2010. In addition, the Company has multiple health advocates at employer sites across the country. Onsite operations are projected to expand throughout 2010 and beyond.
Cost Containment Service. CIGNA administers cost containment programs with respect to health care services/supplies that are covered under benefit plans. These programs, which may involve contracted vendors, are intended to control health costs through the reduction of out-of-network utilization, the auditing of provider bills and recovery of overpayments from other insurance carriers or providers. CIGNA earns fees for providing or arranging these services.
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 48,000 providers in approximately 21,800 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.
The segments health care products and services are offered through the following funding arrangements:
Guaranteed Cost. Under guaranteed cost funding arrangements, policyholders pay a fixed premium and CIGNA HealthCare bears the risk for claims and costs. The HMO product is offered only on a guaranteed cost basis.
Experience-rated (Shared ReturnsSM, including minimum premium). Under insurance policies using an 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. If premiums exceed claims and expenses, any surplus amount is generally first used to offset prior deficits and otherwise generally returned to the policyholder. For additional discussion, see Pricing, Reserves and Reinsurance later within this section of the Form 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 monthly amount, and CIGNA HealthCare bears the risk for claim costs incurred in excess of that amount. As with other experience-rated insurance products, CIGNA HealthCare may recover deficits from margins in future years if the policy is renewed.
Administrative Services Only. CIGNA HealthCare contracts with employers, unions and other groups sponsoring self-insured plans 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 these self-insured plans with access to CIGNA HealthCares applicable participating provider network and for providing other services and programs including: claim administration; quality management; utilization management; cost containment; health advocacy; 24-hour help line; 24/7 call center; case management; disease management; pharmacy benefit management; behavioral health care management services (through its provider networks); or any combination of these services. The self-insured 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 Healthcare). See Note 3 to the Consolidated Financial Statements beginning on page 112 of this Form 10-K for details about this purchase.
Financial information, including premiums and fees, is presented in the Health Care section of the MD&A beginning on page 62 and in Note 22 to CIGNAs Consolidated Financial Statements beginning on page 160 of this Form 10-K.
Service and Quality
CIGNA HealthCare operates 11 service centers that together processed approximately 122 million medical claims in 2009. Satisfying customers and members is a primary business objective and critical to the Companys success. To further this objective, in 2009, the Company made its call centers available 24 hours a day, seven days a week. As of December 31, 2009, CIGNA operates six member service centers that members can call toll-free about their healthcare benefits, wellness programs and claims. CIGNA HealthCare customer service representatives are empowered to immediately resolve a wide range of issues to help members obtain the most from their benefit plans. In addition, a customer service representative can resolve a 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 of 1974 (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: credentialing medical providers and facilities that participate in CIGNA HealthCares managed care and PPO networks; developing the CIGNA CareSM specialist physician designation described below; and participating 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, 2009, consisted of approximately 5,400 hospitals and approximately 612,000 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 continues to consolidate the network it acquired from Great-West Healthcare with its existing participating provider network.
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 CareSM. 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. CIGNA continues to demonstrate its commitment to quality and has expanded its scope of external validation of its quality programs through nationally recognized accreditation organizations. Each of CIGNAs 23 HMO and POS plans that have undergone an accreditation review has earned Excellent or Commendable status from the NCQA, a private, nonprofit organization dedicated to improving health care quality. CIGNAs PPO and Open Access Plus plans in all 50 states have full accreditation status from NCQA. In addition to achieving outstanding accreditation outcomes for its HMO, POS, PPO and OAP products, CIGNAs provider transparency, wellness, utilization management, case management and demand management programs have been awarded the highest outcomes possible. From NCQA, CIGNA earned Physician & Hospital Quality Certification and Wellness and Health Promotion Accreditation. From URAC, an independent, nonprofit health care accrediting organization dedicated to promoting health care quality through accreditation, certification and commendation, CIGNA has full accreditation for Health Utilization Management, Case Management and Health Call Centers.
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 its 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 strategically 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:
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 typically guaranteed for one year (unless specified events occur, such as changes in benefits, significant changes in enrollment or laws affecting the coverage or costs). 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 future claims impact on the reimbursement rates in the provider contracts. 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. See Note 23 to the Consolidated Financial Statements beginning on page 163 of this Form 10-K for details about these guarantees.
In addition to paying current benefits and expenses under HMO and health insurance policies, CIGNA HealthCare establishes reserves for amounts estimated to fund 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, 2009, approximately $1.0 billion, or 59% of the reserves of CIGNA HealthCares operations comprised 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. The reserve amount expected to be paid within one year includes $206 million recoverable from certain ASO customers and from minimum premium policyholders. The remaining reserves relate 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. Interest-crediting rates are set at CIGNA HealthCares discretion. Higher rates are credited to funds with longer expected payout terms reflecting the fact that higher yields are generally available on investments with longer maturities. For 2009, the rates of interest credited ranged from 2.25% to 4.0%, with a weighted average rate of approximately 2.7%.
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 offers products in the following markets:
To date, the national and middle markets have comprised a significant amount of CIGNA HealthCares business. With the acquisition of Great-West Healthcare, the Select, small business, and emerging markets now constitute a larger share of CIGNA HealthCares business than before the acquisition.
CIGNA HealthCare employs 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, 2009, the field sales force for the products and services of this segment consisted of approximately 880 sales representatives in approximately 110 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 and political 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; price; cost-containment services; technology; 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 K beginning on page 32 of this Form 10-K. CIGNA HealthCare believes that its health advocacy capabilities, integrated approach to consumer engagement, breadth of product 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. CIGNA HealthCare also believes that its focus on helping to improve the health, well-being and sense of security of its members will allow it to distinguish itself from its competitors.
CIGNA HealthCares 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.
Both state and federal lawmakers have supported a broad range of health care reform efforts. These efforts intensified in 2009 with major health care legislative proposals being considered in the U.S. Congress. The possible enactment of proposed reform legislation is uncertain but, if enacted, could affect the health care industry in general and CIGNA, specifically. To improve the United States (U.S.) healthcare system in a sustainable way, CIGNA believes that three fundamental issues need to be addressed; cost, quality and access. CIGNA is intensely committed to developing workable solutions for reforming the U.S. healthcare system and believes such solutions must first address the underlying drivers of health care costs. Through continued development and wider adoption of health advocacy programs, cost management and wellness initiatives, CIGNA believes the U.S. health care system can better provide all its citizens access to affordable quality healthcare. For more information concerning health care reform, see Proposed Health Care Reform in the Industry Developments and Other Matters section of the MD&A on page 79.
E. Disability and Life
CIGNAs Disability and Life segment (CIGNA Disability and Life) provides the following insurance products and their related services: group long-term and short-term disability insurance, group life 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 products in all 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands and Canada.
Principal Products and Services
CIGNA Disability and Life markets group long-term and short-term disability insurance products and services. These products and services generally provide a fixed level of income to replace a portion of wages lost because of disability. CIGNA Disability and Life also provides 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, but may also include coverage paid for entirely by employees.
CIGNA Disability and Life, through its Intracorp® subsidiary, 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 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. Coordinating the administration of 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 CIGNAs 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 8,200 insured disability policies covering approximately 5.1 million lives were outstanding as of December 31, 2009.
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 Disability and Life provides group universal life insurance to employers. 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.
Approximately 4,300 group life insurance policies covering approximately 4.7 million lives were outstanding as of December 31, 2009.
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 disability and life, accident, and medical insurance to professional associations, financial institutions, and participant organizations. Renewal rights to CIGNAs block of student and participant accident insurance business were sold to an unaffiliated insurer during 2009.
Voluntary benefits are those paid by the employee and are offered at the employers worksite. CIGNA Disability and Life plans provide employers, 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.
Financial information, including premiums and fees, is presented in the Disability and Life section of the MD&A beginning on page 69 and in Note 22 to CIGNAs Consolidated Financial Statements beginning on page 160 of this Form 10-K.
Pricing, Reserves and Reinsurance
CIGNA Disability and Lifes products and services are offered on a fully insured, experience-rated and ASO basis. Under fully insured arrangements, policyholders pay a fixed premium and CIGNA Disability and Life bears the risk for claims and costs. Under experience-rated funding arrangements, a premium that typically includes a margin to partially protect against adverse claim fluctuations is determined at the beginning of the policy period. CIGNA Disability and Life generally bears the risk if claims and expenses exceed this premium. If premiums exceed claims and expenses, any surplus amount is generally first used to offset prior deficits and is otherwise generally returned to the policyholder if surplus exceeds minimum contractual levels. With experience-rated insurance products, CIGNA Disability and Life may recover deficits from margins in future years if the policy is renewed. Under ASO arrangements, CIGNA Disability and Life contracts with groups sponsoring self-insured plans to administer claims and perform other plan related services in return for service fees. The self-insured plan sponsor is responsible for self funding all claims. The majority of CIGNA Disability and Lifes products and services are fully insured.
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 and selectively guaranteed for up to five years, but policies can in most cases be subject to early termination by the policyholder or by the insurance company.
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.
Premiums for group universal life insurance products consist of mortality, administrative and surrender charges assessed against the policyholders fund balance. Interest credited and mortality charges for group universal life, and mortality charges on group variable universal life, may be adjusted prospectively to reflect expected interest and mortality experience. Mortality charges are subject to guaranteed maximum rates, based on standard mortality tables, which rates are stated in the policy.
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 5% for claims that were incurred in 2009 and 4.75% for claims that were incurred in 2008. For group 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 and investment returns relative to claims and expenses. The effectiveness of return to work programs and mortality levels also impact the profitability of disability insurance products. 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, although the impact of the current adverse economic conditions is not clear. For life insurance products, the degree to which future experience deviates from mortality, morbidity and expense assumptions also affects profitability.
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 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, 2009, the field sales force for the products and services of this segment consisted of approximately 200 sales professionals in 27 office 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 K beginning on page 32 of this Form 10-K.
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, 2009, CIGNA is one of the top five providers of group disability, life and accident insurance in the United States, 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 re-evaluate 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. Employers continue to shift towards greater employee participatory coverage and voluntary purchases.
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. CIGNA is well-positioned to offer employers 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). The Company has received one Congressional inquiry and has responded to the information request. Also, at least one state has considered legislation that would restrict the use of such offset provisions in disability policies. The Company is also involved in related pending civil litigation. If the industry is forced to change its offset SSDI procedures, the practices and products for this segment could be significantly impacted.
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. CIGNA Internationals life, accident and supplemental health insurance products are offered in South Korea, Taiwan, the European Union, Hong Kong, Indonesia, China, New Zealand and Thailand.
International Health Care
CIGNA Internationals health care businesses 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 D beginning on page 3 of this Form 10-K. 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, China and other international locations.
In addition, CIGNA Internationals health care businesses include medical products, which are primarily provided through group benefits programs to local employees in the United Kingdom and Spain. These products include medical indemnity insurance coverage, with some offerings having managed care or administrative service aspects. These products generally provide an alternative or supplement to government provided national health care programs.
Financial information, including premiums and fees, is presented in the International section of the MD&A beginning on page 71 and in Note 22 to CIGNAs Consolidated Financial Statements beginning on page 160 of this Form 10-K.
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, membership demographics, 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), membership demographics, the adequacy of fees charged for administration 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, telemarketing, direct response marketing 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 and in-branch bancassurance. Marketing campaigns are conducted through these channels under a variety of arrangements with affinity partners. These affinity partners primarily include banks, credit card companies and other financial institutions. CIGNA International also distributes directly to consumers via direct response television and the Internet. CIGNA Internationals life, accident and supplemental health insurance businesses are located in South Korea, Taiwan, the European Union, Hong Kong, Indonesia, China, New Zealand and Thailand.
CIGNA Internationals health care products are distributed through independent brokers and consultants, select partners and 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, China and other international locations. In addition, CIGNA Internationals health care businesses include medical products, which are provided through group and individual benefits programs in the United Kingdom and Spain.
For CIGNA Internationals life, accident and supplemental health insurance products, a significant portion of 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 would result in both a reduction of revenue and an acceleration of the amortization of acquisition related costs.
South Korea represents the single largest geographic market for CIGNA Internationals businesses. In 2009, South Korea generated 29% of CIGNA Internationals revenues and 49% of its segment earnings. For information on the concentration of risk with respect to CIGNA Internationals business in South Korea, see Other Items Affecting International Results in the International section of the MD&A beginning on page 71 of this Form 10-K.
Competitive factors in CIGNA Internationals life, accident and supplemental health and expatriate benefits businesses include product and distribution innovation and differentiation, efficient management of marketing processes and costs, commission levels paid to distribution partners, and quality of claims and customer services.
The principal competitive factors that affect CIGNA Internationals health care businesses are underwriting and pricing, relative operating efficiency, relative effectiveness in network development and medical cost management, product innovation and differentiation, broker 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 primarily in Asia and Europe. 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.
With respect to the expatriate benefits business, CIGNA International is a market leader in the U.S. Its primary competitors include U.S.-based and European health insurance companies with global expatriate benefits operations. For the health care operations in the United Kingdom 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. Increased regulations requiring foreign workers to show proof of health insurance are creating opportunities for CIGNA Internationals health care businesses. See Risk Factors beginning on page 35 of this Form 10-K for a discussion of risks related to CIGNA International.
G. 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) and accident policies (workers compensation, personal accident, and catastrophe coverages). 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, international life, 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 approximately 5% 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 GMDB contracts, see Guaranteed Minimum Death Benefits under Run-off Reinsurance section of the MD&A beginning on page 73 and Note 7 to CIGNAs Consolidated Financial Statements beginning on page 117 of this Form 10-K.
Guaranteed Minimum Income Benefit Contracts
In certain circumstances where CIGNAs reinsurance operations reinsured the GMDB, 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 GMIB contracts, see Guaranteed Minimum Income Benefits under Run-off Reinsurance section of the MD&A beginning on page 73 and Note 11 to CIGNAs Consolidated Financial Statements beginning on page 132 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 reduce the risk of loss on these contracts.
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 GMIB contracts discussed above, as Other Assets.
For more information on policy and claim reserves see the Run-off Reinsurance section of the MD&A beginning on page 73, and Notes 8 and 11 to CIGNAs Consolidated Financial Statements beginning on pages 121 and 132 respectively of this Form 10-K. For more information on the risk associated with Run-off Reinsurance, see the Risk Factors beginning on page 35 of this Form 10-K, and the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K.
H. 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 COLI 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. 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.
Cash values on variable universal life policies vary directly with the performance of a specific pool of investments underlying the policy. A limited number of variable universal life policies guarantee that the realized investment performance for a quarter, excluding the impact of unrealized gains/losses and the impact of credit-related events, will not be negative.
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
From 2004 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 actively pursuing new 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, and there are ongoing discussions at the state and federal levels that have the potential to impact the policyholders tax treatment and/or administrative requirements. 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 benefits 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 $4.4 billion as of December 31, 2009. 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, 2009, 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 each of these companies a rating of AA-.
CIGNAs sale of its retirement benefits 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, 2009, assets totaling $2.4 billion remained in the Ceded Business Trust, and the remaining reserves for the purchased business were $1.7 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 that 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 103 of this Form 10-K for additional information regarding reserves for this business.
For more information, see the Other Operations section of the MD&A beginning on page 77 of this Form 10-K.
I. 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). Additionally, CIGNA subsidiaries or external managers manage Separate Account assets on behalf of contractholders. These assets are legally segregated from the Companys other businesses and are not included in the General Account Invested Assets. Income, gains and losses generally accrue directly to the contractholders.
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 and 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, 2009 totaled $19.8 billion. See Schedule I to CIGNAs 2009 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, 2009, 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.
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 87 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 2009, was approximately 77% 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. 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 also could take possession of real estate through foreclosure of delinquent 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. As of December 31, 2009, CIGNA held $59 million of foreclosed properties.
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, 2009, CIGNA held no indexed credit default swaps or other credit derivatives. For information about CIGNAs use of derivative financial instruments, see Note 13 to CIGNAs 2009 Consolidated Financial Statements beginning on page 146 of this Form 10-K.
See also the Investment Assets section of the MD&A beginning on page 87, and Notes 1, 12, and 14 to the Consolidated Financial Statements beginning on pages 103, 141 and 149, respectively, of this Form 10-K for additional information about CIGNAs investments.
Domestic Portfolios Investment Strategy
As of December 31, 2009, the Domestic Portfolios had $18.3 billion in Invested Assets, allocated among fixed maturity investments (66%); commercial mortgage loan investments (19%); 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, 2009, 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, 51%; fully guaranteed annuity, 18%; and interest-sensitive life insurance, 31%.
While the businesses and products supported are described elsewhere in this Form 10-K, the Invested Assets supporting the insurance and contractholder liabilities of each of the Companys 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, 2009 the International Portfolios had $1.5 billion in Invested Assets, allocated among fixed maturity investments (93%), short-term investments (5%) and other investments (2%). 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 applicable regulation. CIGNA Internationals Invested Assets as of December 31, 2009 were held primarily in support of statutory surplus and liabilities associated with the life, accident and supplemental health and healthcare products described in Section F on page 17 of this Form 10-K.
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.
Regulatory agencies conduct routine and targeted market conduct examinations of CIGNAs insurance and HMO subsidiaries to assess compliance with applicable laws and regulations. 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 23 to CIGNAs Consolidated Financial Statements beginning on page 163 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 2009, 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.
Effective December 31, 2009 the Companys principal life insurance subsidiary, Connecticut General Life Insurance Company (CGLIC), implemented the NAICs Actuarial Guideline XLIII (also known as AG 43 or VACARVM), which is applicable to CGLICs statutory reserves for GMDB and GMIB contracts totaling $1.6 billion as of December 31, 2009. As provided under this guidance, CGLIC received approval from the State of Connecticut to grade-in the full effect of the guideline over a 3-year period. Accordingly, upon implementation at December 31, 2009, statutory surplus for CGLIC was reduced by $40 million. If the guidance had been fully implemented at December 31, 2009, statutory surplus would have been reduced by $110 million. Management does not anticipate that this implementation will have a material impact on the amount of dividends expected to be paid by CGLIC to the parent company in 2010. This implementation has no impact on measurement of the Companys results of operations or financial condition as determined under GAAP.
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.
Marketing, Advertising, and Products
In most states, CIGNAs insurance companies and HMO subsidiaries are required to certify compliance with applicable advertising regulations on an annual basis. CIGNAs insurance companies and HMO subsidiaries are also required in most states to file and secure regulatory approval of products prior to the marketing, advertising, and sale of such products. 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. Product offerings, such as the CIGNA limited benefits plans issued by the Star HRG business acquired in July 2006, attracted increased regulatory scrutiny in 2009.
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.
International Licensure Laws
CIGNA International subsidiaries are often required to be licensed when entering new markets or starting new operations in certain jurisdictions. The licensure requirements for these CIGNA subsidiaries vary by country and are subject to change.
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 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:
Several CIGNA subsidiaries are also subject to reporting requirements pursuant to Section 111 of the Medicare, Medicaid and SCHIP Extension Act of 2007.
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 these programs. These audits may occur in years subsequent to CIGNA providing 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 D beginning on page 3 of this Form 10-K for additional information about CIGNAs participation in government health-related programs.
Health Insurance Portability and Accountability Act Regulations
The federal Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (HIPAA) impose several different requirements on health insurers, HMOs, health plans, health care providers and clearinghouses. Health insurers and HMOs are further subject to regulations related to guaranteed issuance (for groups with 50 or fewer lives), guaranteed renewal, and portability of health insurance.
HIPAA also imposes minimum standards for health plans, health insurers, health care providers and their vendors to safeguard the privacy and security of individually identifiable or protected health information (PHI). In 2009, HIPAAs privacy and security requirements were expanded by the Health Information Technology for Economic and Clinical Health Act (HITECH) which enhanced penalties for HIPAA violations and required regulated entities to provide notice of breaches of unsecured PHI. CIGNA has a project team addressing the provisions of HITECH.
HIPAA also establishes rules to standardize the format and content of certain electronic transactions, including but not limited to, eligibility and claims. In 2008, federal regulations were issued requiring entities subject to HIPAA to update their transaction formats for electronic data interchange from the current HIPAA 4010 standards to new HIPAA 5010 standards. CIGNA has launched a project to migrate to the required HIPAA 5010 standards by the January 1, 2012 effective date. Regulations were also issued in 2008 requiring a conversion from the ICD-9 diagnosis and procedure code set to the ICD-10 diagnosis and procedure code set. Implementation of the HIPAA 5010 standards is necessary to support the IDC-10 code set. CIGNA has initiated a project to deliver ICD-10 capabilities by the October 1, 2013 effective date.
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 products (Covered Products as defined in the Bank Secrecy Act) are subject to U.S. Department of the Treasury anti-money laundering regulations. CIGNA has implemented anti-money laundering policies designed to ensure that its Covered Products are underwritten and sold in compliance with these 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.
Regulatory and Legislative Developments
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, health reimbursement accounts and flexible spending accounts are also regulated by the U.S. Department of the Treasury and the Internal Revenue Service. For information on Regulatory and Industry Developments, see page 79 in the MD&A and Note 23 to CIGNAs Consolidated Financial Statements beginning on page 163 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 the expansion of the governments role in the health care arena and alternative assessments and tax increases specific to the health care insurance industry or health care insurance products as part of federal health care reform initiatives, as well as other modifications of the Medicare program, and employee benefit regulation.
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, 2010, the insurance financial strength ratings for CIGNA subsidiaries, CGLIC 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, 2010, 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 CGLIC 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 2009. 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 29,300, 30,300, and 26,600 employees as of December 31, 2009, 2008 and 2007, respectively.
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 on its strategic and operational initiatives effectively.
The future performance of CIGNAs business will depend in large part on CIGNAs ability to execute effectively and implement its growth strategy. These strategic and operational initiatives include (1) growth in targeted geographies, product lines, buying segments and distribution channels; (2) improving its strategic and financial flexibility; and (3) pursuing additional opportunities in high-growth markets with particular focus on individuals.
Successful execution of these strategic and operational initiatives depends on a number of factors including:
If these initiatives fail or are not executed effectively, it could harm the Companys consolidated financial position and results of operations. For example, if not managed effectively, the plan to reduce operating expenses could cut necessary resources and the Companys talent pool and, consequently, could have long-term effects on the business by decreasing or slowing improvements in its products and limiting its ability to retain or hire key personnel.
If CIGNA does not adequately invest in and effectively execute on improvements in its information technology infrastructure and improve its functionality, it will not be able to deliver the services required in the evolving marketplace at a competitive cost.
CIGNAs success in executing on 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 and specialty service providers.
Arrangements with key vendors may make CIGNAs operations vulnerable if third parties fail to satisfy their obligations to the Company, including their obligations to maintain and protect the security and confidentiality of the Companys information and data, as a result of their performance, changes in their own operations, financial condition, or other matters outside of CIGNAs control. In addition, to the extent CIGNA outsources selected services or selected functions to third parties in foreign jurisdictions, the Company could be exposed to risks inherent in conducting business outside of the United States, including international economic and political conditions, additional costs associated with complying with foreign laws and fluctuations in currency values. 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. Terminating or transitioning arrangements with key vendors could result in additional costs and a risk of operational delays, potential errors and possible control issues as a result of the termination or during the transition phase.
In 2006, CIGNA entered into an agreement with IBM pursuant to which IBM operates certain software applications and significant portions of CIGNAs 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 and the fees paid could be a subject of dispute between the parties. In addition, some of CIGNAs termination rights are contingent upon payment of a fee, which may be significant. If CIGNAs relationship with IBM is abruptly terminated, the Companys customers may experience disruption of service.
Sustained or significant deterioration in economic conditions could significantly impact the Companys customers.
The Company is exposed to risks associated with the potential financial instability of its customers, many of which could be adversely affected by volatile conditions in the financial markets. Customers could experience cash flow problems and other financial difficulties in times of a sustained or significant deterioration in the economy. 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 has lead and may continue to 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.
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 and affect ability to access capital.
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 K beginning on page 32 of this Form 10-K.
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. See Run-off Reinsurance in Section G beginning on page 20 of this Form 10-K 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. In addition, the Company 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 117 and 132, respectively of this Form 10-K, 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 larger net liabilities for guaranteed minimum death benefit contracts or for guaranteed minimum income benefit contracts, the recognition of additional pension obligations and increased funding for those obligations, and increased pension plan expenses.
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 its 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 sufficiently 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 and related losses.
CIGNA currently has unfunded obligations in its frozen pension plan. A significant decline in the value of the plans equity and fixed income investments or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding, which could increase CIGNAs expenses and reduce the cash available to CIGNA, including its subsidiaries. See Note 10 to CIGNAs Consolidated Financial Statements beginning on page 126 of this Form 10-K for more information on the Companys obligations under the pension plan.
Significant changes in market interest rates affect the value of CIGNAs financial instruments that promise a fixed return or benefit and the value of particular assets and liabilities.
As an insurer, CIGNA has substantial investment assets that support insurance and contractholder deposit 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 could have an adverse impact on the funded status of the Companys pension plans and the Companys re-investment yield on new investments.
Changes in interest rates may also impact the discount rate and expected long-term rate of return assumptions associated with the Companys guaranteed minimum death benefit liabilities. Significant, sustained declines in interest rates could cause the Company to reduce these long-term assumptions, resulting in increased liabilities.
In addition, changes in interest rates impact the assumed market returns and the discount rate used in the fair value calculations for the Companys liabilities for guaranteed minimum income benefits. Significant interest rate declines could significantly increase the Companys liabilities for these contracts.
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 of operations and financial condition.
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. It is possible that the resolution of one or more of the legal matters and claims described in this risk factor could result in losses material to CIGNAs consolidated results of operations, liquidity or financial condition.
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 44, Note 23 to CIGNAs Consolidated Financial Statements beginning on page 163 of this Form 10-K and Regulation in Section J beginning on page 28. 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 J beginning on page 28 and Legal Proceedings in Item 3 beginning on page 44 of this Form 10-K.
CIGNA operates a pharmacy benefit management business, primary care clinics and a staff model HMO, which are 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 federal and state anti-remuneration laws, ERISA, HIPAA and laws related to the operation of Internet and mail-service pharmacies.
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.
The Company employs physicians, nurse practitioners, nurses and other health care professionals at onsite low acuity and primary care clinics it operates for the Companys customers (as well as certain clinics for Company employees). The Company also owns and operates medical facilities in the Phoenix, Arizona metropolitan area, including multispecialty health care centers, outpatient surgery and urgent care centers, low acuity clinics, laboratory, pharmacy and other operations that employ primary care as well as specialty care physicians and other types of health care professionals. As a direct employer of health care professionals and as an operator of primary and low-acuity care clinics and other types of medical facilities, the Company is subject to liability for negligent acts, omissions, or injuries occurring at one of its clinics or caused by one of its employees. Even if any claims brought against the Company were unsuccessful or without merit, it would have to defend against such claims. The defense of any such actions may be time-consuming and costly, and may distract managements attention. As a result, CIGNA may incur significant expenses and the Companys financial results could be adversely affected.
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 competitive 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 CIGNA 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 current 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.
Global market, economic and geopolitical conditions may cause fluctuations in equity market prices, interest rates and credit spreads which could impact the Companys ability to raise or deploy capital as well as affect the Companys overall liquidity.
If the capital markets and credit market experience extreme volatility and disruption, there could be downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers underlying financial strength. Extreme disruption in the credit markets could adversely impact the Companys availability and cost of credit in the future. In addition, unpredictable or unstable market conditions could 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 and alternative assessments and tax increases specific to the health care insurance industry or health care insurance products as part of federal health care reform initiatives, could fundamentally change the dynamics of CIGNAs industry.
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 Select market, 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 compliance with CIGNAs internal policies, including data systems security and unethical conduct by managers and employees, could adversely affect CIGNAs reputation and also expose it to litigation and other proceedings, fines and 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 CIGNAs medical costs or those of its self-insured customers. Further, during an economic downturn, CIGNAs segments, including HealthCare, Disability and Life and International, may see increased fraudulent claims volume which may lead to additional cost because of an increase in disputed claims and litigation.
The Companys international operations face political, legal, operational, regulatory, economic and other risks that present unique challenges and could negatively affect those operations or our long-term growth.
The Companys international operations face political, legal, operational, regulatory, economic and other risks, including government intervention and censorship that the Company does not face in its domestic operations. CIGNA International faces the risk of discriminatory regulation, nationalization or expropriation of assets, price controls or other pricing issues and exchange controls or other restrictions that prevent it from transferring funds from these operations out of the countries in which it operates or converting local currencies that CIGNA International holds into U.S. dollars or other currencies. Additionally, foreign currency exchange rates and fluctuations may have an impact on the future costs or on future sales and cash flows from the Companys international operations, and any measures that it may implement to reduce the effect of volatile currencies and other risks of its international operations may not be effective. Some of CIGNAs foreign insurance operations are, and are likely to continue to be, in emerging markets where these risks are heightened. In addition, CIGNA International relies on local sales forces for some of its operations in these countries and may encounter labor problems and less flexible employee relationships which can be difficult and expensive to terminate. In some countries, CIGNA International voluntarily operates or is required to operate with local business partners with the resulting risk of managing partner relationships to the business objectives.
The Company is currently planning to expand its international operations in markets where it currently operates and in targeted new markets. This may require considerable management time before any significant revenues and earnings are generated.
International operations also require the Company to devote significant management resources to implement its controls and systems in new markets, to comply with the U.S. anti-bribery and anti-corruption as well as anti-money laundering provisions and similar laws in local jurisdictions and to overcome logistical and other challenges based on differing languages, cultures and time zones.
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 460,000 square feet of leased office space at Two Liberty Place, 1601 Chestnut Street, Philadelphia, Pennsylvania. 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 21 to CIGNAs Consolidated Financial Statements beginning on pages 103 and 159 of this Form 10-K. This paragraph does not include information on investment properties.
The information contained under Litigation and Other Legal Matters in Note 23 to CIGNAs 2009 Financial Statements which begins on page 163 of this Form 10-K, is incorporated herein by reference.
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, 59, 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.
DAVID M. CORDANI, 44, Chief Executive Officer of CIGNA beginning December 2009; President of CIGNA beginning June 2008; Chief Operating Officer of CIGNA from June 2008 until December 2009; President, CIGNA HealthCare from July 2005 until June 2008; Senior Vice President, Customer Segments & Marketing, CIGNA HealthCare from July 2004 until July 2005; Senior Vice President and Chief Financial Officer, CIGNA HealthCare, from September 2002 until July 2004; and a Director of CIGNA since October 2009.
ANNMARIE T. HAGAN, 49, Executive Vice President and Chief Financial Officer of CIGNA beginning May 2009; Vice President, Chief Accounting Officer and Controller of CIGNA from July 2008 until May 2009; and Vice President and Chief Accounting Officer of CIGNA from March 2003 until July 2008.
MATTHEW G. MANDERS, 48, President, CIGNA, US Service, Clinical and Specialty beginning January 2010; President, CIGNA HealthCare, Total Health, Productivity, Network & Middle Market from June 2009 until January 2010; Customer Segments from July 2006 until June 2009; and President, CIGNA HealthCare, Middle Market Segment from August 2004 until July 2006.
JOHN M. MURABITO, 51, Executive Vice President of CIGNA beginning August 2003, with responsibility for Human Resources and Services.
CAROL ANN PETREN, 57, 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.
MICHAEL WOELLER, 57, 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.
The information under the caption Quarterly Financial DataStock and Dividend Data appears on page 169 and the number of shareholders of record as of December 31, 2009 appears under the caption Highlights on page 47 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, 2009:
Effective January 1, 2009, the Company adopted the Financial Accounting Standards Boards (FASB) updated earnings per share guidance. Prior year amounts have been restated. See Note 4 to the Consolidated Financial Statements for additional information.
Effective January 1, 2009, the Company adopted the FASBs updated guidance on accounting for noncontrolling interests. Prior years net income, income from continuing operations, and revenues have been restated. See Note 2(B) to the Consolidated Financial Statements for additional information.
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 62 of this Form 10-K.
In 2008, the Company recorded significant charges related to the guaranteed minimum income benefits and guaranteed minimum death benefits businesses as well as an after-tax litigation charge of $52 million in Corporate related to the CIGNA pension plan. For additional information, see the Run-off Reinsurance section of the Managements Discussion and Analysis beginning on page 73 and Note 23 to the Consolidated Financial Statements.
During 2007, CIGNA completed a three-for-one stock split of CIGNAs common shares. Per share figures for 2006 and 2005 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 and 363,573 in 2005.
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 2010). 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 95 of this Form 10-K. The forward-looking statements contained in this filing represent managements estimate as of the date of this filing. Management does not assume any obligation to update these estimates.
Unless otherwise indicated, financial information in the MD&A is presented in accordance with accounting principles generally accepted in the United States (GAAP). Certain reclassifications have been made to prior period amounts to conform to the presentation of 2009 amounts. In addition, certain amounts have been restated as a result of the adoption of new accounting pronouncements. See Note 2 to the Consolidated Financial Statements for additional information.
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 Companys ability to increase revenue, shareholders net income and operating cash flows from ongoing operations is directly related to progress on the execution of its strategic initiatives, the success of which is measured by certain key factors, including the Companys ability to:
As a global health service organization, CIGNAs mission remains focused on helping the people it serves improve their health, well-being and sense of security. CIGNAs long-term growth strategy is based on: (1) growth in targeted geographies, product lines, buying segments and distribution channels; (2) improving its strategic and financial flexibility; and (3) pursuing additional opportunities in high-growth markets with particular focus on individuals.
CIGNA expects to focus on the following areas it believes represent the markets or areas with the most potential for profitable growth:
The Company plans to improve its strategic and financial flexibility by driving further reductions in its Health Care operating expenses, improving its medical cost competitiveness in targeted markets and effectively managing balance sheet exposures.
Also, in connection with CIGNAs long-term business strategy, the Company remains committed to health advocacy as a means of creating sustainable solutions for employers, improving the health of the individuals that the Company serves, and lowering the costs of health care for all constituencies.
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. In order to substantially reduce the impact of equity market movements on the liability for guaranteed minimum death benefits (GMDB, also known as VADBe), the Company operates an equity hedge program. The Company actively monitors the performance of the hedge program, and evaluates the cost/benefit of hedging other risks. Results are also influenced by behavioral factors, including future partial surrender election rates for GMDB contracts, annuity election rates for guaranteed minimum income benefits (GMIB) contracts, annuitant lapse rates, as well as the collection of amounts recoverable from retrocessionaires. The Company actively studies policyholder behavior experience and adjusts future expectations based on the results of the studies, as warranted. The Company also performs regular audits of ceding companies to ensure that premiums received and claims paid properly reflect the underlying risks, and to maximize the probability of subsequent collection of claims from retrocessionaires. Finally, the Company monitors the financial strength and credit standing of the retrocessionaires and establishes or collects collateral when warranted.
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 to appropriately respond to economic and other factors affecting its operations. The Companys ability to achieve its financial objectives is dependent upon its ability to effectively execute on its strategy and to appropriately respond to emerging economic, industry and company-specific trends. See the Health Care section of the MD&A beginning on page 62 of this Form 10-K for further discussion on the Companys plans to execute on its strategic initiatives.
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). See Note 3 to the Consolidated Financial Statements for additional information.
Initiatives to Lower Operating Expenses
As part of its strategy, 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.
During 2008 and 2009, the Company conducted a comprehensive review to reduce the operating expenses of its ongoing businesses (cost reduction program). As a result, the Company recognized severance-related and real estate charges in other operating expenses.
Severance charges in 2008 and 2009 resulted from reductions of approximately 2,350 positions in the Companys workforce.
Cost reduction activity for 2008 and 2009 was as follows:
The Health Care segment recorded $37 million pre-tax ($24 million after-tax) of the 2009 charges and $44 million pre-tax ($27 million after-tax) of the 2008 charge. The remainder of the 2009 and 2008 charges were reported as follows: Disability and Life: $5 million pre-tax ($4 million after-tax) in 2009 and $3 million pre-tax ($2 million after-tax) in 2008; and International: $2 million pre-tax ($1 million after-tax) in 2009 and $8 million pre-tax ($6 million after-tax) in 2008.
Substantially all severance is expected to be paid by the end of 2010. Upon completion of the job eliminations, the Company expects annualized after-tax savings from this cost reduction program to be approximately $130 million in 2011 and beyond. A portion of the savings was realized in 2009 while most is expected to be realized in 2010.
CONSOLIDATED RESULTS OF OPERATIONS
The Company measures the financial results of its segments using segment earnings (loss), which is defined as shareholders income (loss) from continuing operations before after-tax realized investment results. Adjusted income from operations is defined as consolidated segment earnings (loss) excluding special items (defined below) and the results of the GMIB business. Adjusted income from operations is another measure of profitability used by the Companys management because it presents the underlying results of operations of the Companys businesses and permits analysis of trends in underlying revenue, expenses and shareholders net income. This measure is not determined in accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP measure, which is shareholders income from continuing operations.
Summarized below is a reconciliation between shareholders income from continuing operations and adjusted income from operations.
Summarized below is adjusted income from operations by segment:
Overview of 2009 Consolidated Results of Operations
Shareholders income from continuing operations for the year ended December 31, 2009 was significantly higher than 2008, reflecting improved adjusted income from operations, as explained below, as well as the following:
Adjusted income from operations increased 16% in 2009 compared with 2008, primarily reflecting significantly improved results in the Run-off Reinsurance segment due to a lower amount of reserve strengthening for the GMDB business in 2009 compared with 2008. This result was primarily due to improved equity market conditions in 2009. Also, in the aggregate, adjusted income from operations from the Companys ongoing operating segments (Health Care, Disability and Life, and International) improved slightly in 2009 over 2008. These favorable effects were partially offset by higher unallocated costs (including interest) reported in Corporate.
Overview of 2008 Consolidated Results of Operations
Shareholders income from continuing operations for the year ended December 31, 2008 declined significantly compared with 2007, reflecting lower adjusted income from operations as explained below, as well as the following:
Adjusted income from operations decreased 20% in 2008 compared with 2007 due to losses in the GMDB business resulting from the adverse equity market conditions in 2008, partially offset by higher earnings in each of the Companys ongoing operating segments.
Special Items and GMIB
Management does not believe that the special items noted in the table above are representative of the Companys underlying results of operations. Accordingly, the Company excluded these special items from adjusted income from operations in order to facilitate an understanding and comparison of results of operations and permit analysis of trends in underlying revenue, expenses and shareholders income from continuing operations.
Special items for 2009 included a curtailment gain resulting from the decision to freeze the pension plan (see Note 10 to the Consolidated Financial Statements for additional information), cost reduction charges related to the previously announced 2008 cost reduction program (see the Introduction section of the MD&A beginning on page 48 of this Form 10-K), and benefits resulting from the completion of the 2005 and 2006 IRS examinations (see Note 19 to the Consolidated Financial Statements for additional information).
Special items for 2008 included a cost reduction charge related to the previously announced 2008 cost reduction program (see the Introduction section of the MD&A beginning on page 48 of this Form 10-K), a litigation matter related to the CIGNA Pension Plan (see Note 23 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.
The Company also excludes the results of the GMIB business from adjusted income from operations because the fair value of GMIB assets and liabilities must be recalculated each quarter using updated capital market assumptions. The resulting changes in fair value, which are reported in shareholders net income, are volatile and unpredictable. See the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K for more information on the effect of capital market assumption changes on shareholders net income. Because of this volatility, and since the GMIB business is in run-off, management does not believe that its results are meaningful in assessing underlying results of operations.
Outlook for 2010
The Company expects 2010 adjusted income from operations to be comparable to or slightly higher than 2009. Information is not available for management to reasonably estimate the future results of the GMIB business or realized investment results due in part to interest rate and stock market volatility and other internal and external factors. This outlook includes an assumption that GMDB (also known as VADBe) results will be approximately break-even for full-year 2010, reflective of the Companys view that the long-term reserve assumptions are appropriate and assumes that capital markets remain stable during the year. In addition, the Company is not able to identify or reasonably estimate the financial impact of special items in 2010 however they may include potential adjustments associated with cost reduction, litigation, and tax-related items.
The Companys outlook for 2010 is subject to the factors cited in the Cautionary Statement beginning on page 95 of this Form 10-K and the sensitivities discussed in the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K. If unfavorable equity market and interest rate movements occur, the Company could experience losses related to investment impairments and the GMIB and GMDB businesses. These losses could adversely impact the Companys consolidated results of operations and financial condition by potentially reducing the capital of the Companys insurance subsidiaries and reducing their dividend-paying capabilities.
Total revenues decreased by 4% in 2009, compared with 2008, and increased by 8% in 2008 compared with 2007. Changes in the components of total revenue are described more fully below.
Premiums and Fees
Premiums and fees decreased by 1% in 2009, compared with 2008, reflecting membership declines in Health Care resulting from higher unemployment and the unfavorable effect of foreign currency translation in International, offset by the absence of premium and fees from the acquired business in the first quarter of 2008 since this business was acquired April 1, 2008.
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 details.
Net Investment Income
Net investment income decreased by 5% in 2009, compared with 2008, primarily due to lower income from real estate funds and security partnerships, unfavorable foreign exchange rates and lower investment yields partially offset by higher invested assets.
Net investment income decreased by 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.
Mail Order Pharmacy Revenues
Mail order pharmacy revenues increased by 6% in 2009, compared with 2008, primarily due to rate increases and by 8% in 2008, compared with 2007 due to increased script volume and rate increases.
Other revenues include the impact of futures contracts associated with the GMDB equity hedge program. In 2009, the Company reported losses of $282 million associated with the GMDB equity hedge program, compared with gains of $333 million in 2008. The losses in 2009 primarily reflected increases in stock market values, while the gains in 2008 primarily reflected declines in stock market values. Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues decreased 4% in 2009, compared with 2008, primarily reflecting declines in amortization of deferred gains on the sales of the retirement benefits and individual life insurance and annuity businesses.
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues increased 5% in 2008, compared with 2007, primarily reflecting the impact of the acquired business. In 2008, the Company reported a gain of $333 million associated with the GMDB equity hedge program, compared with a loss of $32 million in 2007.
Realized Investment Results
Realized investment results in 2009 were significantly improved compared to 2008 primarily due to:
These favorable effects were partially offset by higher impairments of investments in real estate entities and commercial mortgage loans in 2009 due to the impact of the continued weak economic environment on the commercial real estate market and the absence of significant gains on the sales of real estate ventures reported during 2008.
Realized investment results in 2008 were lower than in 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 adverse economic conditions during 2008. 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 14 to the Consolidated Financial Statements for additional information.
CRITICAL ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in accordance with 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 shareholders income (loss) from continuing operations excluding after-tax realized investment gains and losses. Adjusted income from operations for each segment is defined as segment earnings excluding special items and the results of the Companys GMIB business. Adjusted income from operations is another measure of profitability used by the Companys management because it presents the underlying results of operations of the segment and permits analysis of trends. This measure is not determined in accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP measure, which is segment earnings. Each segment provides a reconciliation between segment earnings and adjusted income from operations.
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 adjusted income from operations for 2009, as compared with 2008, was favorably impacted by the absence of a $7 million after-tax adjustment related to a large experience-rated life and non-medical account in run-out recorded in the first quarter of 2008.
Excluding this item, adjusted income from operations for 2009 was slightly higher than 2008 reflecting:
These favorable effects were largely offset by:
The Health Care segments adjusted income from operations in 2008, as compared with 2007, was favorably impacted by lower management incentive compensation expense of $21 million after-tax.
Excluding the items mentioned above, adjusted income from operations increased in 2008 compared with 2007 due to:
These favorable effects were partially offset by:
The table below shows premiums and fees for the Health Care segment:
Premiums and fees decreased by 2% in 2009, compared with 2008, primarily reflecting lower membership largely due to disenrollment resulting from higher unemployment. This impact was partially offset by:
Premiums and fees increased 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.
Net investment income decreased by 10% in 2009 compared with 2008 primarily reflecting lower income from real estate funds partially offset by higher invested assets. Net investment income decreased by 1% in 2008 compared with 2007 primarily reflecting lower yields partially offset by higher average assets.
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.
Benefits and Expenses
Health Care segment benefits and expenses consist of the following:
Medical claims expense decreased by 4% in 2009 compared with 2008 largely due to lower membership, particularly in the experience-rated and guaranteed cost businesses. This impact was partially offset by growth in Medicare membership and increases in medical expenses due to medical cost inflation as well as H1N1 flu-related claims.
Medical claims expense increased 7% in 2008 compared with 2007 largely due to the impact of the acquired business.
Other benefit expenses include expenses associated with life, long-term disability and other non-medical products. These expenses have decreased 12% in 2009 compared with 2008 and 14% in 2008 compared with 2007, primarily reflecting the continued run-off of this business, as the Health Care segment no longer actively markets these products.
Other operating expenses include expenses related to:
Excluding the items noted above, as well as special items, other operating expenses increased slightly in 2009, compared with 2008, primarily due to expenses related to the acquired business (effective April 1, 2008), higher management incentive compensation and higher information technology spend, mostly offset by cost reduction initiatives and pension plan changes as a result of the comprehensive review of ongoing expenses, as well as lower volume-related expenses. Other operating expenses increased in 2008, compared with 2007, primarily reflecting expenses related to the acquired business and higher spending on operational improvement initiatives, including market segment expansion and investments in information technology. This increase was partially offset by lower management incentive compensation expenses in 2008.
Other Items Affecting Health Care Results
The Health Care segments 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:
The net decrease in the Health Care segments medical membership was 5.5% as of December 31, 2009 when compared with December 31, 2008. The decrease was primarily driven by disenrollment across all funding arrangements as a result of higher unemployment. The net increase in medical membership of 15% as of December 31, 2008 compared with December 31, 2007 was due to the acquisition of Great-West Healthcare, effective April 1, 2008.
The Health Care segment is focused on several operational strategies including improving the efficiency of its operations, while growing its customer base in targeted markets and meeting the needs of its customers. Savings generated from the reduction of operating expenses will provide the financial flexibility and capital to make investments that will enable the Company to enhance its capabilities, particularly in product development and the delivery of customer service, health advocacy and related technology. These capabilities are critical to enabling the Health Care segment to execute on its strategies to achieve profitable growth and retain customers. Successful execution of these operational strategies is critical to maintaining and improving its competitive position in the healthcare marketplace.
The operational strategies currently underway are discussed below.
Reducing operating expenses. The Company operates in an intensely competitive marketplace and its ability to establish a competitive cost structure over time is crucial to achieving its overall strategy. Accordingly, the Health Care segment is focused on reducing operating expenses, while investing prudently in technology and service capabilities to drive future growth.
The Health Care segments operating expenses are comprised of three components and are approximately allocated as follows: healthcare (70%), specialty and market segment expansion (20%), and premium taxes/commissions (10%).
In 2009, excluding the impact of Great-West Healthcare, the Health Care segment significantly reduced healthcare operating expenses and expects to continue to meaningfully reduce these over time. These reductions are, and will continue to be, driven by actions in the following areas:
The Health Care segment expects to drive reductions in its operating expenses while remaining focused on its other business strategies including investing in areas that are critical to the Companys growth initiatives and segment expansions, ensuring continued excellence in customer service and clinical programs, and leveraging technology to drive further operating efficiencies.
Profitable growth and customer retention. The Health Care segment continues to focus on retaining profitable relationships, expanding on those relationships and growing profitable new business by focusing on:
The Health Care segment is focused on market segment and product expansion. With respect to market segment expansion, the focus is predominantly in the Middle Market (employers with generally more than 250 but fewer than 5,000 employees), Select (employers with generally more than 50 but fewer than 250 employees), and Individual market segments. The Health Care segment is focusing on several strategic growth industries and targeting key geographic markets within the Select and Middle Market segments that align with our competitive strengths. The Health Care segment expects to grow its presence in these market segments by leveraging its customer knowledge, differentiated service model, product portfolio and distribution model. The Health Care segment continues to increase its penetration into the Individual market segment and will refine its strategy for this market segment pending the outcome of health care reform legislation. In the National market segment (multi-site, multi-state commercial employers with generally more than 5,000 employees), the Company will selectively focus on clients that value its differentiated product offering. These clients include those seeking engagement and incentive based programs designed to improve health, and those that purchase multiple products and services from a single company.
Driving additional cross-selling is also key to the Companys integrated benefits value proposition. The Company is expanding network access for its dental product and improving network flexibility to drive better alignment with customers needs including increasing disability and pharmacy penetration across the entire book.
Offering products that meet emerging customer and market trends. In addition to designing lower cost plan offerings to meet emerging customer and market trends, enhancements to the Companys suite of products (CIGNA Choice Fund® CIGNA Health Advisor, CIGNA Incentive Points Program, CIGNA Choicelinx/Custom Benefit Builder) offer various options to customers and employers that are key to our customer engagement strategy. By providing tools to our customers which will facilitate access and greater understanding of their healthcare choices, customers are better equipped to make effective health related decisions. CIGNAs Cost of Care Estimator, Quicken Health and improvements to customer Explanation of Benefits and Health Statements are a part of the Companys strategy to engage the individual by making information more available and easier to understand.
Effectively managing medical costs. The Health Care segment operates under a centralized medical management model, which helps improve the health, well being and sense of security of its members, while reducing infrastructure expenses and driving productivity.
The Health Care segment 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 it can drive reductions in total medical cost and better outcomes, resulting in healthier members. To help achieve this, the Company continues to focus on contracting with providers to strengthen its networks in targeted markets, enhancing clinical capabilities and engaging its customers and clients/employers. In connection with the April 2008 Great-West Healthcare acquisition, the Company continues to integrate its offerings onto one extensive preferred provider network, in order to offer access to a broad range of utilization review and case management services at a competitive medical cost.
Delivering superior service to customers and health care professionals. The Company is focused on delivering consistent, reliable and superior service to customers, health care professionals and clients. The Company believes that further enhancing service can improve customer retention and, when combined with useful health information and tools, can help motivate customers to become more engaged in their personal health. This will help to promote healthy outcomes thereby removing cost from the healthcare system. The evolution of the consumer-driven health care 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 continues to focus on the development and enhancement of its 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 provider service experience for customers and health care professionals (e.g. opening its Call Center 24/7), thereby enhancing its capabilities and improving its competitive position.
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
The Disability and Life segments adjusted income from operations increased 1% in 2009 compared to 2008 reflecting:
Largely offsetting these factors were:
The Disability and Life segments adjusted income from operations increased 11% in 2008 compared to 2007 reflecting:
These factors were partially offset by:
Premiums and fees increased by 3% in 2009 reflecting disability and life sales growth and solid persistency, partially offset by lower employment levels at the customers we serve, the Companys exit from a large, low-margin assumed government life reinsurance program and the sale of the renewal rights for the student and participant accident business. Premiums and fees increased by 8% in 2008 reflecting new sales growth and solid customer retention in the disability, life and accident lines of business, partially offset by less favorable customer retention in the specialty line of business.
Net investment income decreased by 5% in 2009 reflecting lower yields and lower security and real estate partnership income. Net investment income decreased by 7% in 2008 reflecting lower yields and lower security partnership income.
Benefits and Expenses
Excluding the pre-tax impact of the reserve studies, expense charge and special items noted above, benefits and expenses increased 3% in 2009 compared with 2008, primarily reflecting:
These effects were partially offset by:
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:
These effects were partially offset by:
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
During the second quarter of 2009, the Companys International segment implemented a capital management strategy to permanently invest the earnings of its South Korean operation overseas. Income taxes for this operation will therefore be recorded at the tax rate of the foreign jurisdiction. The International segments adjusted income from operations reflected favorable tax adjustments of $14 million from the implementation of this strategy for 2009. In addition to the implementation effect, adjusted income from operations also reflects $8 million from the ongoing impact of the lower tax rate on the permanently invested earnings for 2009. Excluding the impact of the South Korean tax adjustments and foreign currency movements, the International segments adjusted income from operations decreased 7% for 2009, compared with 2008. The decrease was primarily driven by unfavorable claims experience in the life, accident and supplemental health insurance business and the expatriate employee benefits business. The unfavorable effects were partially offset by revenue growth and competitively strong margins in both businesses. The impact of foreign currency movements was calculated by comparing the reported results to what the results would have been had the exchange rates remained constant with the prior years comparable period exchange rates. Special items were generally not denominated in foreign currency.
Excluding the impact of foreign currency movements noted in the table above, the International segments adjusted income from operations increased 16% in 2008 compared with 2007, 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.
Premiums and fees. Excluding the effect of foreign currency movements, premiums and fees were $2,042 million in 2009 compared with reported premiums of $1,870 million in 2008, an increase of 9%. The increase was primarily attributable to new sales growth in the life, accident and supplemental health insurance operations, particularly in South Korea, and membership growth in the expatriate employee benefits business. Excluding the effect of foreign currency movements, premiums and fees were $1,971 million in 2008 compared with reported premiums of $1,800 million in 2007, an increase of 10%. This increase 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.
To exclude the effect of foreign currency movements, premiums and fees were calculated using the prior years comparable period exchange rates, allowing foreign currency neutral comparison to the prior years reported premiums and fees.
Net investment income decreased by 13% in 2009 compared with 2008. The decrease was primarily due to unfavorable foreign currency movements, particularly in South Korea. Net investment income increased by 3% in 2008 compared with 2007. The increase was primarily due to higher asset levels offset by unfavorable foreign currency movements.
Benefits and Expenses
Benefits and expenses increased by 2% in 2009, compared with 2008. The increase was primarily driven by higher loss ratios, business growth and increased amortization of deferred acquisition costs, partially offset by foreign currency movements.
Benefits and expenses increased by 4% in 2008 compared with 2007, 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 in the life, accident and supplemental health business due to favorable claims experience.
Expense ratios decreased in 2009 reflecting effective expense management. 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 49% of the segments earnings in 2009. 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 GMDB, GMIB, workers compensation and personal accident reinsurance products.
The determination of liabilities for GMDB and GMIB requires the Company to make critical accounting estimates. In 2008, the Company updated the assumptions for GMIB and the effects of hypothetical changes in those assumptions in connection with the implementation of the FASBs fair value disclosure and measurement guidance (ASC 820). The Company describes the assumptions used to develop the reserves for GMDB in Note 7 to the Consolidated Financial Statements and for the assets and liabilities associated with GMIB in Note 11 to the Consolidated Financial Statements. The Company also provides the effects of hypothetical changes in those assumptions in the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K.
The Company excludes the results of the GMIB business from adjusted income from operations because the fair value of GMIB assets and liabilities must be recalculated each quarter using updated capital market assumptions. The resulting changes in fair value, which are reported in shareholders net income, are volatile and unpredictable. See the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K for more information on the effect of capital market assumption changes on shareholders net income.
Results of Operations
Overview of 2009 Results
Overall segment results, including GMIB, improved significantly in 2009 compared with 2008. Segment earnings were favorably affected by substantially higher results from the GMIB business reflecting improved equity markets and generally higher interest rates. In addition, adjusted income from operations for Run-off Reinsurance improved significantly in 2009 compared with 2008 due to significantly reduced losses in the GMDB business ($52 million after-tax for 2009, compared with $267 million for 2008) resulting from a substantially lower amount of reserve strengthening. The improvement in GMDB results in 2009 primarily reflected the recovery and stabilization of the financial markets. Adjusted income from operations also included the favorable after-tax impact of reserve studies for the workers compensation and personal accident business of $16 million in 2009 and $30 million in 2008.
Overview of 2008 Results
Segment loss for 2008 reflected significant losses from the GMIB business of $437 million, including a charge of $131 million related to the implementation of new fair value accounting guidance in 2008. Excluding this charge, GMIB losses in 2008 primarily reflected the declines in equity market and interest rates and increased market volatility.
In addition, adjusted loss from operations for Run-off Reinsurance was significantly higher in 2008 primarily reflecting a loss in the GMDB business of $267 million after-tax primarily reflecting reserve strengthening. This loss was primarily related to declines in equity markets and interest rates and increased market volatility. Adjusted loss from operations for Run-off Reinsurance in 2008 compared with 2007 was also negatively impacted by reduced favorable settlement activity related to personal accident and workers compensation.
See the Benefits and Expenses section for further discussion around the results of the GMIB and GMDB businesses.
Other revenues included pre-tax losses of $282 million in 2009 from futures contracts used in the GMDB equity hedge program (see Note 7 to the Consolidated Financial Statements), compared with pre-tax gains of $333 million in 2008 and pre-tax losses of $32 million in 2007. 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 Company held futures contract positions related to this program with a notional amount of $1.0 billion at December 31, 2009.
Benefits and Expenses
Benefits and expenses were comprised of the following:
GMIB (Income) Expense. Under the GAAP guidance for fair value measurements, the Companys results of operations are expected to be volatile in future periods because capital market assumptions needed to estimate the assets and liabilities for the GMIB business are based largely on market-observable inputs at the close of each reporting period including interest rates (LIBOR swap curve) and market-implied volatilities. See Note 11 to the Consolidated Financial Statements for additional information about assumptions and asset and liability balances related to GMIB.
For 2009 the pre-tax income for GMIB was $304 million, and was primarily due to the following factors:
These favorable effects were partially offset by:
GMIB expense in 2008 includes a pre-tax charge of $202 million for the adoption of the FASBs fair value disclosure and measurement guidance, which is discussed in Notes 2(B) and 11 to the Consolidated Financial Statements.
Excluding the charge on adoption of the FASBs fair value disclosure and measurement guidance, 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 elections 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 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. Management 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, significant declines in mutual fund values that underlie the contracts (increasing the exposure to the Company) together with declines in the 7-year treasury rates (used to determine claim payments) similar to what occurred during 2008 would increase the expected amount of claims that would be paid out for contractholders who choose to annuitize. It is also possible that such unfavorable market conditions would have an impact on the level of contractholder annuitizations, particularly if these unfavorable market conditions persisted for an extended period.
Other Benefits and Expenses. Other benefits and expenses reflected income for 2009, compared to expense during 2008. This fluctuation reflects the impact of significant improvements in the equity markets on guaranteed minimum death benefit contracts, compared with equity market declines during 2008. Equity market improvements result in increases in the underlying annuity account values, which decreases the exposure under the contracts. Equity market declines result in decreases in the 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.
Although 2009 benefit expenses included reserve strengthening of $73 million ($47 million after-tax) to increase GMDB reserves, no additional reserve strengthening was required for GMDB after the first quarter, primarily due to the stabilization and recovery of equity markets. The components of the first quarter reserve strengthening were:
During 2008, the Company recorded additional other benefits expenses of $412 million ($267 million after-tax) primarily to strengthen GMDB reserves following an analysis of experience and reserve assumptions. These amounts were due to:
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, 2009, 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:
COLI has contributed the majority of the earnings in 2009, 2008 and 2007 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 initiative to have a significant impact on the future operating results of the segment.
Results of Operations
Adjusted income from operations for Other Operations declined in 2009 compared with 2008, reflecting a continued decline in deferred gain amortization associated with the sold businesses offset by increased COLI earnings driven by higher investment income and improved operating expenses.
Adjusted income from operations 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.
Net investment income. Net investment income decreased 2% in 2009 compared with 2008, primarily reflecting lower average invested assets and lower real estate 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.
Other revenues. Other revenues decreased 10% in 2009 compared with 2008 and decreased 13% in 2008 compared with 2007 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 $32 million in 2009, $38 million in 2008 and $47 million in 2007.
Corporate reflects amounts not allocated to other segments, such as net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment operations), interest on uncertain tax positions, certain litigation matters, intersegment eliminations, compensation cost for stock options and certain corporate overhead expenses such as directors expenses.
Corporates adjusted loss from operations was higher in 2009, compared with 2008, primarily reflecting:
Corporates adjusted loss from operations was higher 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 deferred compensation expenses caused by a decline in the Companys stock price in 2008.
Discontinued operations represent results associated with certain investments or businesses that have been sold or are held for sale.
Discontinued operations for 2009 primarily represents a tax benefit from a past divestiture resolved at the completion of the 2005 and 2006 IRS examinations.
Discontinued operations for 2008 primarily represents a gain of $3 million after-tax from the settlement of certain issues related to a past divestiture.
Discontinued operations for 2007 primarily reflects:
INDUSTRY DEVELOPMENTS AND OTHER MATTERS
Proposed Health Care Reform
Addressing the affordability and availability of health insurance, including reducing the number of uninsured, is a major initiative of President Obama and the U.S. Congress, and proposals that may address these issues are pending in the U.S. Congress. The proposals vary and include measures that would change the dynamics of the health care industry and/or the employers role in the provision of benefits, such as the potential creation of a new government-run health plan(s) that would compete with the Company and other private health plans; the potential creation of federal or state-level exchanges (or similar constructs) that could serve as a distribution mechanism and/or additional regulatory structure for certain segments of the health care market; potential changes to medical coverage, such as expansion of eligibility under existing public programs, minimum medical benefit ratios for health plans, and mandatory issuance of insurance coverage; requirements that would limit the ability of health plans and insurers to vary premiums based on assessments of underlying risk; and new taxes and assessments specific to health care insurers and/or certain benefit plan designs. Any comprehensive health care reform package enacted will likely be phased in over a number of years and would be subject to a broader regulatory process. Because of the unsettled nature of these initiatives and the numerous steps required to implement them the Company remains uncertain as to the ultimate impact these changes will have on its business. For additional discussion regarding our risks related to health care reform, see Item 1A. Risk Factors beginning on page 35 of this Form 10-K.
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 providing assistance to 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 was introduced but not enacted 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 and Life segment could be significantly impacted.
In 1998, the Company sold its individual life insurance and annuity business to The Lincoln National Life Insurance Company and its affiliates (Lincoln). Because this business was sold in an indemnity reinsurance transaction, the Company is not relieved of primary liability for the reinsured business and had reinsurance recoverables totaling $4.4 billion as of December 31, 2009. Lincoln has secured approximately 90% of its reinsurance obligations under these arrangements by placing assets into a trust which qualifies under Regulation 114 of the New York Insurance Department.
The Companys remaining reinsurance recoverables from Lincoln are unsecured. If Lincoln National Life Insurance Company and Lincoln Life & Annuity of New York do not maintain a specified financial strength rating, at the Companys request, Lincoln is contractually required to provide additional assurance that it will meet its reinsurance obligations, to include placing assets in a trust to secure these remaining reinsurance recoverables. S&P has assigned each of these reinsurers a rating of AA-.
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:
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 flows from operating activities consist of cash receipts and disbursements for premiums and fees, mail order pharmacy and other revenues, 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 shareholders net income, cash flows from operating activities can be significantly different from shareholders net income.
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 are 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, 2009, cash flows from operating activities were less than net income by $560 million. Net income contains certain after-tax non-cash income and expense items, including:
Cash flows from operating activities were lower than net income excluding the non-cash items noted above by $530 million. This decrease was primarily due to pre-tax cash outflows of $282 million associated with the GMDB equity hedge program which did not affect shareholders net income and pre-tax contributions to the domestic pension plans of approximately $410 million, partially offset by the favorable effect of the pension contributions on tax payments.
Cash flows from operating activities decreased by $911 million in 2009 compared with 2008. Excluding the results of the GMDB equity hedge program (which did not affect net income), cash flows from operating activities decreased by $296 million. This decrease in 2009 primarily reflects pre-tax contributions to the qualified domestic pension plan of approximately $410 million for 2009 compared with none for 2008, partially offset by the favorable effect of the pension contributions on tax payments.
Cash used in investing activities was $1.5 billion. This use of cash primarily consisted of net purchases of investments of $1.2 billion and net purchases of property and equipment of $307 million.
Cash provided from financing activities primarily consisted of net proceeds from the issuance of long-term debt of $346 million, partially offset by repayments of short-term debt, principally commercial paper, of $199 million. Financing activities also included net deposits to contractholder deposit funds of $89 million and proceeds on issuances of common stock of $30 million.
For the year ended December 31, 2008, cash flows from operating activities were greater than net income by $1.4 billion. Net income contains certain after-tax non-cash income and expense items, including:
Cash flows from operating activities were higher than net income excluding the non-cash items noted above by $278 million. This increase was primarily due to cash inflows associated with the GMDB equity hedge program of $333 million.
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.
Cash used in investing activities was $2.6 billion, consisting of $1.3 billion to fund the acquisition of Great-West Healthcare, 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 to 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.
Interest expense on long-term debt, short-term debt and capital leases was as follows:
The increase in interest expense in 2009 was primarily due to the issuance of debt used for general corporate purposes, including the repayment of some of the Companys outstanding commercial paper issued to finance the acquired business.
The increase in 2008 was primarily due to the issuance of debt in connection with the Great-West Healthcare acquisition.
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 resulted in reduced retained earnings and the capital available for growth, acquisitions, and share repurchase.
On May 4, 2009, the Company issued $350 million of 8.50% Notes ($349 million, net of debt discount, with an effective interest rate of 9.90% per year). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. See Note 13 to the Consolidated Financial Statements for further information. Interest is payable on May 1 and November 1 of each year beginning November 1, 2009. The proceeds of this debt were used for general corporate purposes, including the repayment of some of the Companys outstanding commercial paper. These Notes will mature on May 1, 2019.
On March 4, 2008, the Company issued $300 million of 6.35% Notes (with an effective interest rate of 6.68% per year). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. 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:
On March 14, 2008, the Company entered into a 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, 2009, the Company had $100 million in commercial paper outstanding, at a weighted average interest rate of 0.35% and remaining maturities ranging from 11 to 35 days.
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 $27 million letter of credit issued as of December 31, 2009.
Liquidity and Capital Resources Outlook
At December 31, 2009, there was approximately $475 million in cash available at the parent company level. In 2010, the parent companys debt service consists of scheduled interest payments of $168 million on outstanding long-term debt of $2.4 billion at December 31, 2009 and approximately $100 million of commercial paper that will mature over the next three months. There are no scheduled long-term debt repayments in 2010. The Company expects to either repay the commercial paper or refinance it either by issuing long-term debt or re-issuing commercial paper.
The Company funds its qualified pension plans at least at the minimum amount required by the Employee Retirement Income Security Act of 1974 (ERISA) and the Pension Protection Act of 2006. For 2010, the Company expects minimum required contributions to be approximately $70 million. This amount could change based on final valuation amounts. In addition, the Company currently plans to make voluntary contributions of approximately $140 million during 2010. Based on its current funded status, the Company does not believe that the litigation matter discussed in Note 23 to the Consolidated Financial Statements would have an impact on 2010 funding requirements even if resolved in 2010. 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 CGLIC 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, 2009, the Company had an additional $1.5 billion of borrowing capacity within the maximum debt leverage covenant in the line of credit agreement in addition to the $2.5 billion of debt outstanding.
Though the Company believes it has adequate sources of liquidity, 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 2009, 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.
Effective December 31, 2009 the Companys principal life insurance subsidiary, CGLIC, implemented the NAICs Actuarial Guideline XLIII (also known as AG 43 or VACARVM), which is applicable to CGLICs statutory reserves for GMDB and GMIB contracts totaling $1.6 billion as of December 31, 2009. As provided under this guidance, CGLIC received approval from the State of Connecticut to grade-in the full effect of the guideline over a 3-year period. Accordingly, upon implementation at December 31, 2009, statutory surplus for CGLIC was reduced by $40 million. If the guidance had been fully implemented at December 31, 2009, statutory surplus would have been reduced by $110 million. Management does not anticipate that this implementation will have a material impact on the amount of dividends expected to be paid by CGLIC to the parent company in 2010. This implementation has no impact on measurement of the Companys results of operations or financial condition as determined under GAAP.
Guarantees and Contractual Obligations
The Company 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, 2009, are estimated to be as follows:
Estimated payments of $127 million for deferred compensation, non-qualified and International pension plans and other postretirement and postemployment benefit plans are expected to be paid in less than one year. The Companys best estimate is that contributions to the qualified domestic pension plan during 2010 will be approximately $210 million. The Company expects to make payments subsequent to 2010 for these obligations, however subsequent payments have been excluded from the table as their timing is based on plan assumptions which may materially differ from actual activities (see Note 10 to the Consolidated Financial Statements for further information on pension and other postretirement benefit obligations).
The above table also does not contain $214 million of gross liabilities for uncertain tax positions because the Company cannot reasonably estimate the timing of their resolution with the respective taxing authorities. See Note 19 to the Consolidated Financial Statements for the year ended December 31, 2009 for further information.
The Company had commitments to invest in limited liability entities that hold real estate, loans to real estate entities or securities. See Note 12(C) to the Consolidated Financial Statements for additional information.
Future service commitments include an agreement with IBM for various information technology (IT) infrastructure services. The Companys remaining commitment under this contract is approximately $376 million over the next four years. The Company has the ability to terminate this agreement with 90 days notice, subject to termination fees.
The Company, through its subsidiaries, is contingently liable for various financial and other guarantees provided in the ordinary course of business. See Note 23 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. The decision to repurchase shares depends 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 did not repurchase any shares in 2009. In 2008 the Company repurchased 10.0 million shares for $378 million.
The total remaining share repurchase authorization as of February 25, 2010, 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, 14 and 17 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 back testing 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, 2009.
Other mortgage-backed assets consist principally of commercial mortgage-backed securities and collateralized mortgage obligations of which $37 million were residential mortgages and home equity lines of credit, all of which were originated using standard underwriting practices and are not considered sub-prime loans.
As of December 31, 2009, $12.3 billion, or 92%, of the fixed maturities in the Companys investment portfolio were investment grade (Baa and above, or equivalent), and the remaining $1.1 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 publicly-traded bonds, but yields on these investments tend to be higher than yields on publicly-traded bonds with comparable credit risk. The fair value of private placement investments was $5.1 billion as of December 31, 2009 and $4.4 billion as of December 31, 2008. 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.
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.
The value of the Companys fixed maturity portfolio increased $574 million in 2009 driven by a decline in market yields. Although asset values have improved significantly, there are securities with amortized cost in excess of fair value by $133 million as of December 31, 2009.
As of December 31, 2009, approximately 64% or $1,605 million of the Companys total investments in state and local government securities of $2,521 million were guaranteed by monoline bond insurers. The quality ratings of these investments with and without this guaranteed support as of December 31, 2009 were as follows:
As of December 31, 2009, approximately 79% or $428 million of the Companys total investments in other asset-backed securities of $541 million were guaranteed by monoline bond insurers. All of these securities had quality ratings of Baa2 or better. Quality ratings without considering the guarantees for these other asset-backed securities were not available.
As of December 31, 2009, the Company had no direct investments in monoline bond insurers. Guarantees provided by various monoline bond insurers for certain of the Companys investments in state and local governments and other asset-backed securities as of December 31, 2009 were:
The Company continues to underwrite investments in these securities focusing on the underlying issuers credit quality, without regard for guarantees. As such, this portfolio of state and local government securities, guaranteed by monoline bond insurers is of high quality with approximately 92% rated A3 or better without their guarantees.
Commercial Mortgage Loans
The Companys commercial mortgage loans are made exclusively to commercial borrowers. 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 at origination of the loan. In addition to property value, the Company evaluates the quality of each commercial mortgage loan using debt service coverage, which is the ratio of the estimated cash flows from the property to the required loan payments (principal and interest).
The Company completed its annual in depth review of its commercial mortgage loan portfolio in the third quarter of 2009. This review included an analysis of each propertys financial statements as of December 31, 2008, rent rolls and operating plans and budgets for 2009, a physical inspection of the property and other pertinent factors. Based on each propertys value determined during this review, the portfolios average loan to value ratio increased from 64% as of December 31, 2008 to 77% at December 31, 2009, driven by an average decline in property values of 18% since completion of the previous review during the third quarter of 2008. This 18% decrease is less than reported declines in commercial real estate values of 20% to 30% from peak prices achieved in late 2006 and into early 2007 to real estate values estimated during the second quarter of 2009. This was driven by managements decision to not fully reflect peak prices in prior valuations, along with declines in value recognized during the Companys 2008 portfolio review. In 2009, overall debt service coverage for the portfolio of commercial mortgage loans was approximately 1.5, which was unchanged since the 2008 portfolio review.
The following table reflects the commercial mortgage loan portfolio as of December 31, 2009 summarized by loan to value ratio based on the annual loan review completed in July, 2009.
As summarized above, $352 million or 10% of the commercial mortgage loan portfolio is comprised of subordinated notes and loans, including $319 million of loans secured by first mortgages, which were fully underwritten and originated by the Company using its standard underwriting procedures. Senior interests in these first mortgage loans were then sold to other institutional investors. This strategy allowed the Company to effectively utilize its origination capabilities to underwrite high quality loans with strong borrower sponsorship, limit individual loan exposures, and achieve attractive risk adjusted yields. In the event of a default, the Company would pursue remedies up to and including foreclosure jointly with the holders of the senior interests, but would receive repayment only after satisfaction of the senior interest.
There are seven loans where the aggregate carrying value of the mortgage loans exceeds the value of the underlying properties by $16 million. Five of these loans have current debt service coverage of 1.0 or greater and two with debt service coverage below 1.0 have other mitigating factors including strong borrower sponsorship.
Although the property value declines increased the portfolio loan to value ratios, all but four of the approximately 180 loans that comprise the Companys total mortgage loan portfolio continue to perform under their contractual terms, and the actual aggregate default rate is 3.6%. Given the quality and diversity of the underlying real estate, positive debt service coverage, significant borrower cash investment averaging nearly 30%, and only $201 million of loans maturing in the next twelve months, the Company remains confident that the vast majority of borrowers will continue to perform as required.
Commercial real estate fundamentals and values continued to decline in 2009 after completion of the portfolio review in the third quarter. While the vast majority of loans in the Companys portfolio have positive debt service coverage of at least 1.0, the Company expects declines in debt service coverage to reflect further deterioration in fundamentals (higher vacancy rates and lower rental rates) resulting from ongoing weak economic conditions. Managements current view is that property values have fallen by approximately 10% on average from values estimated as part of the third quarter 2009 portfolio review. However, the value of well located, well leased, institutional quality real estate appears to be stabilizing. See Critical Accounting Estimates beginning on page 55 of this Form 10-K for more information on the effect of declines in property values on commercial mortgage loans.
Other Long-term Investments
The Companys other long-term investments include $561 million in private equity and real estate funds as well as direct investments in real estate joint ventures. The funds typically invest in mezzanine debt or equity of privately held companies and equity real estate. Because these investments have a subordinate position in the capital structure, the Company assumes a higher level of risk for higher expected returns. Many of these entities have experienced a decline in value over the last several quarters due to economic weakness and the disruption in the capital markets. To mitigate risk, these investments are diversified across approximately 60 separate partnerships, and approximately 35 general partners who manage one or more of these partnerships. Also, the funds underlying investments are diversified by industry sector, property type, and geographic region. No single partnership investment exceeds 8% of the Companys private equity and real estate partnership portfolio. Given the current economic environment, future impairments are possible; however, management does not expect those losses to have a material effect on the Companys financial condition.
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. The characteristics management considers 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 for 2009 or 2008.
The following table shows problem and potential problem investments at amortized cost, net of valuation reserves and write-downs:
Net problem investments represent 1.5% of total investments excluding policy loans. Net problem investments increased $236 million during 2009 primarily reflecting deterioration on six commercial mortgage loans totaling $217 million, one of which is held as foreclosed real estate.
Net potential problem investments represent 1.8% of total investments excluding policy loans. Net potential problem investments increased $105 million during 2009 primarily reflecting the addition of nine loans totaling $169 million to the potential problem loan list that were exhibiting signs of distress such as an elevated loan to value ratio or a low or negative debt service coverage. These loans were all performing according to their original contractual terms as of December 31, 2009 and although they are showing signs of distress, most of these loans are adequately collateralized. These additional nine loans were added to potential problem investments as a result of managements in-depth commercial mortgage loan portfolio review completed in the third quarter of 2009.
Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the original loan agreement. Problem and potential problem commercial mortgage loans totaling $222 million, presented in the above table, are considered impaired. During 2009, the Company recorded a $17 million pre-tax ($11 million after-tax) increase to valuation reserves on impaired commercial mortgage loans. See Note 12 to the Consolidated Financial Statements and the Critical Accounting Estimates section of the MD&A beginning on page 55 of this Form 10-K for additional information regarding impaired commercial mortgage loans.
The Company recorded after-tax realized investment losses for investment asset write-downs and changes in valuation reserves as follows:
The financial markets experienced a significant improvement during 2009. Both investment grade and below investment grade corporate credit indices reported significantly lower credit spreads and the S&P 500 posted a return of approximately 25% during this period. While credit spreads tightened in 2009 and asset values increased significantly, substantial uncertainty remains concerning the economic environment. As a result of this economic environment, risks in the Companys investment portfolio remain elevated.
Continued economic weakness for an extended period could cause default rates to increase and recoveries to decline resulting in additional impairment losses for the Company. 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 the vast majority of the Companys fixed maturity investments will continue to perform under their contractual terms, and that declines in their fair values below carrying value are temporary. Based on the strategy to match the duration of invested assets to the duration of insurance and contractholder liabilities, the Company expects to hold a significant portion of these assets for the long term. Therefore, future credit-related losses are not expected to have a material adverse effect on the Companys liquidity or financial condition.
While management believes the commercial mortgage loan portfolio is positioned to perform well due to the solid aggregate loan to value ratio, strong debt service coverage and minimal underwater position, the commercial real estate market continues to exhibit significant signs of distress and if these conditions remain for an extended period or worsen substantially, it could result in an increase in problem and potential problem loans. Given the current economic environment, future impairments are possible; however, management does not expect those losses to have a material effect on the Companys 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 13 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.