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CIGNA Corporation 10-Q 2008 SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the
quarterly period endedSeptember
30, 2008
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
for the
transition period from _____ to _____
Commission
file number 1-08323
CIGNA
Corporation
(Exact
name of registrant as specified in its charter)
Two
Liberty Place, 1601 Chestnut Street
Philadelphia, Pennsylvania 19192
(Address
of principal executive offices) (Zip
Code)
Registrant's
telephone number, including area code (215)
761-1000
Not
Applicable
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No
_
Indicate
by check mark 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
_ No x
As
of October 17, 2008, 271,723,618 shares of the issuer's common stock were
outstanding.
CIGNA
CORPORATION
INDEX
As used
herein, “CIGNA” or the “Company” refers to one or more of CIGNA Corporation and
its consolidated subsidiaries.
Part I. FINANCIAL INFORMATION
Item
1. Financial Statements
1
2
3
4
5
CIGNA CORPORATION
NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE
1 – BASIS OF PRESENTATION
The
consolidated financial statements include the accounts of CIGNA Corporation, its
significant subsidiaries, and variable interest entities of which CIGNA
Corporation is the primary beneficiary, which are referred to collectively as
“the Company.” Intercompany transactions and accounts have been
eliminated in consolidation. These consolidated financial statements
were prepared in conformity with accounting principles generally accepted in the
United States of America (GAAP).
The
interim consolidated financial statements are unaudited but include all
adjustments (including normal recurring adjustments) necessary, in the opinion
of management, for a fair statement of financial position and results of
operations for the periods reported. The interim consolidated
financial statements and notes should be read in conjunction with the
Consolidated Financial Statements and Notes in the Company’s Form 10-K for the
year ended December 31, 2007.
The
preparation of interim consolidated financial statements necessarily relies
heavily on estimates. This and certain other factors, such as the
seasonal nature of portions of the health care and related benefits business as
well as competitive and other market conditions, call for caution in estimating
full year results based on interim results of operations.
Certain
reclassifications have been made to prior period amounts to conform to the
presentation of 2008 amounts.
Discontinued
operations for the third quarter of 2008
included a gain of $1 million after-tax from the settlement of certain
issues related to a past divestiture. Discontinued operations for the nine
months ended September 30, 2008 included a gain of $3 million after-tax from the
settlement of certain issues related to a past divestiture.
Discontinued
operations for the third quarter and nine months ended September 30, 2007
reflected a tax benefit associated with the disposition of Lovelace Health
Systems, Inc. in 2003, an impairment loss associated with the sale of the
Chilean insurance operations, and realized gains from the disposition of certain
directly-owned real estate investments.
Unless
otherwise indicated, amounts in these Notes exclude the effects of discontinued
operations.
NOTE
2 – ACQUISITIONS AND DISPOSITIONS
The
Company may from time to time acquire or dispose of assets, subsidiaries or
lines of business. Significant transactions are described
below.
In
accordance with Statement of Financial
Accounting Standards (SFAS) No. 141, “Business
Combinations”, the total purchase price has been allocated to the tangible and
intangible net assets acquired based on management’s estimates of their fair
values and may change as additional information becomes
available. Accordingly, approximately $290 million was allocated to
intangible assets, primarily customer relationships and internal-use software.
The weighted average amortization period for these intangible assets is
currently estimated at eight years. The remainder, net of tangible net
assets acquired, is goodwill which is currently estimated at $1.1 billion.
Substantially all of the goodwill is tax deductible and will be amortized over
the next 15 years for federal income tax purposes.
During
the next several months, the Company will complete its fair value analysis of
Great-West Healthcare’s tangible and intangible net assets and finalize
integration plans. The effect on tangible and intangible net assets
and net income from these initiatives will continue to be refined and updated
through March 31, 2009.
The
results of Great-West Healthcare are included in the Company’s Consolidated
Financial Statements from the date of acquisition.
6
The
following supplemental information presents selected unaudited pro forma
information for the Company assuming the acquisition had occurred as of January
1, 2007. The pro forma information does not purport to represent what
the Company’s actual results would have been if the acquisition had occurred as
of the date indicated or what such results would be for any future
periods.
NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS
Fair value
measurements. >Effective January 1, 2008, the Company adopted
SFAS No. 157, “Fair Value Measurements.” This standard expands
disclosures about fair value measurements and clarifies how to measure fair
value by focusing on the price that would be received when selling an asset or
paid to transfer a liability (exit price). In addition, the Financial
Accounting Standards Board (FASB) recently amended SFAS No. 157 to provide
additional guidance for determining the fair value of a financial asset when the
market for that instrument is not active. See Note 7
for information on the Company’s fair value measurements including new required
disclosures.
The
Company carries certain financial instruments at fair value in the financial
statements including approximately $12.1 billion in invested assets at September
30, 2008. The Company also carries derivative instruments at fair
value, including assets and liabilities for reinsurance contracts covering
guaranteed minimum income benefits (GMIB) under certain variable annuity
contracts issued by other insurance companies and related retrocessional
contracts. The Company also reports separate account assets at fair value;
however, changes in the fair values of these assets accrue directly to
policyholders and are not included in the Company’s revenues and
expenses. At the adoption of SFAS No. 157, there were no effects to
the Company’s measurements of fair values for financial instruments other than
for assets and liabilities for reinsurance contracts covering guaranteed minimum
income benefits discussed below. In addition, there were no effects to the
Company’s measurements of financial assets of adopting the recent amendment to
SFAS No. 157.
At
adoption, the Company was required to change certain assumptions used to
estimate the fair values of assets and liabilities for reinsurance contracts
covering guaranteed minimum income benefits. As a result, the Company
recorded a charge of $131 million after-tax, net of reinsurance ($202 million
pre-tax), in Run-off Reinsurance. This charge did not have an impact
on the Company’s cash flows.
7
Because
there is no market for these contracts, the assumptions used to estimate their
fair values at adoption were determined using a hypothetical market
participant's view of an exit price. The Company considered the following
in determining the view of a hypothetical market participant:
At
adoption, the assumptions used to estimate the fair value of these contracts
were determined using a hypothetical market participant’s view of an exit price
rather than using historical market data and actual experience to establish the
Company’s future expectations. For many of these assumptions, there
is limited or no observable market data so determining an exit price requires
the Company to exercise significant judgment and make critical accounting
estimates.
The
Company considers the various assumptions used to estimate fair values of these
contracts in two categories: capital markets and future annuitant and
retrocessionaire behavior assumptions. Estimated components of the
charge by category (net of reinsurance) are described below, including how these
updated assumptions differ from those used historically to estimate fair values
for these contracts.
The
Company’s results of operations related to this business are expected to
continue to be volatile in future periods both because underlying assumptions
will be based on current market-observable inputs which will likely change each
period and because the recorded liabilities, net of receivables from
reinsurers, are higher after adoption of SFAS No. 157. See Note 7 for additional information.
The FASB
deferred the effective date of SFAS No. 157 until the first quarter of 2009 for
non-financial assets and liabilities (such as intangible assets, property and
equipment and goodwill) that are required to be measured at fair value on a
periodic basis (such as at acquisition or impairment). The FASB
expects to address implementation issues during this
delay. Accordingly, the Company will adopt SFAS No. 157 for
non-financial assets and liabilities in the first quarter of 2009 and will
evaluate the effects of adoption when the FASB provides implementation
guidance.
8
Earnings per
share.> In 2008, the FASB issued FSP EITF 03-6-1, "Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities," to require outstanding unvested share-based payment
awards that contain rights to nonforfeitable dividends to be included in the
denominator of both basic and diluted earnings per share
calculations. These new requirements must be applied through
restatement of prior-period earnings per share data beginning in the first
quarter of 2009. On adoption, the Company does not expect material
changes to either basic or diluted earnings per share data.
9
NOTE
4 – EARNINGS PER SHARE
Basic and
diluted earnings per share were computed as follows:
The
following outstanding employee stock options were not included in the
computation of diluted earnings per share because their effect would have
increased diluted earnings per share (antidilutive) as their exercise price was
greater than the average share price of the Company's common stock for the
period.
The
Company held 78,693,702 shares of common stock in Treasury as of September 30,
2008, and 71,788,175 shares as of September 30, 2007.
10
NOTE 5 – HEALTH CARE MEDICAL CLAIMS PAYABLE
Medical
claims payable for the Health Care segment reflects estimates of the ultimate
cost of claims that have been incurred but not yet reported, those which have
been reported but not yet paid (reported claims in process) and other medical
expense payable, which primarily comprises accruals for provider incentives and
other amounts payable to providers. Incurred but not yet reported comprises the
majority of the reserve balance as follows:
Activity
in medical claims payable was as follows:
Reinsurance
and other amounts recoverable reflect amounts due from reinsurers and
policyholders to cover incurred but not reported and pending claims for minimum
premium products and certain administrative services only business where the
right of offset does not exist. See Note 9 for
additional information on reinsurance. For the nine months ended
September 30, 2008, actual experience differed from the Company’s key
assumptions resulting in favorable incurred claims related to prior years’
medical claims payable of $59 million, or 0.9% of the current year incurred
claims as reported for the year ended December 31, 2007. Actual completion
factors resulted in a reduction in medical claims payable of $22 million, or
0.3% of the current year incurred claims as reported for the year ended December
31, 2007 for the insured book of business. Actual medical cost trend resulted in
a reduction in medical claims payable of $37 million, or 0.6% of the current
year incurred claims as reported for the year ended December 31, 2007 for the
insured book of business.
For the
year ended December 31, 2007, actual experience differed from the Company's key
assumptions, resulting in favorable incurred claims related to prior years’
medical claims payable of $80 million, or 1.3% of the current year incurred
claims as reported for the year ended December 31, 2006. Actual completion
factors resulted in a reduction of the medical claims payable of $46 million, or
0.7% of the current year incurred claims as reported for the year ended December
31, 2006 for the insured book of business. Actual medical cost trend
resulted in a reduction of the medical claims payable of $34 million, or 0.6% of
the current year incurred claims as reported for the year ended December 31,
2006 for the insured book of business.
11
The
favorable impact in 2008 and 2007 relating to completion factor and medical cost
trend variances is primarily due to the release of the provision for moderately
adverse conditions, which is a component of the assumptions for both completion
factors and medical cost trend, established for claims incurred related to prior
years. This release was substantially offset by the establishment of
the provision for moderately adverse conditions established for claims incurred
related to the current year.
The
corresponding impact of prior year development on net income was not material
for the third quarter or the nine months ended September 30, 2008. The change in
the amount of the incurred claims related to prior years in the medical claims
payable liability does not directly correspond to an increase or decrease in the
Company's net income recognized for the following reasons:
First,
due to the nature of the Company's retrospectively experience-rated business,
only adjustments to medical claims payable on accounts in deficit affect net
income. An increase or decrease to medical claims payable on accounts
in deficit, in effect, accrue to the Company and directly impact net
income. An account is in deficit when the accumulated medical costs
and administrative charges, including profit charges, exceed the accumulated
premium received. Adjustments to medical claims payable on accounts
in surplus accrue directly to the policyholder with no impact on the Company’s
net income. An account is in surplus when the accumulated
premium received exceeds the accumulated medical costs and administrative
charges, including profit charges.
Second,
the Company consistently recognizes the actuarial best estimate of the ultimate
liability within a level of confidence, as required by actuarial standards of
practice, which require that the liabilities be adequate under moderately
adverse conditions. As the Company establishes the liability for each
incurral year, the Company ensures that its assumptions appropriately consider
moderately adverse conditions. When a portion of the development related to the
prior year incurred claims is offset by an increase deemed appropriate to
address moderately adverse conditions for the current year incurred claims, the
Company does not consider that offset amount as having any impact on net
income.
The
determination of liabilities for Health Care medical claims payable requires the
Company to make critical accounting estimates. See Note 2(O) to the
Consolidated Financial Statements in the Company’s 2007 Form 10-K.
NOTE 6 – GUARANTEED MINIMUM DEATH BENEFIT
CONTRACTS
The
Company’s reinsurance operations, which were discontinued in 2000 and are now an
inactive business in run-off mode, reinsured a guaranteed minimum death benefit,
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. The Company has equity and other market exposures as a
result of this product. The Company maintains a program to substantially reduce
the equity market exposures relating to guaranteed minimum death benefit
contracts by entering into exchange-traded futures
contracts.
The
determination of liabilities for guaranteed minimum death benefits requires the
Company to make critical accounting estimates. The Company 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. If actual experience differs from the
assumptions (including lapse, partial surrender, mortality, interest rates and
volatility) used in estimating these reserves, the resulting change could have a
material adverse effect on the Company’s consolidated results of operations, and
in certain situations, could have a material adverse effect on the Company’s
financial condition.
The
Company had future policy benefit reserves for guaranteed minimum death benefit
contracts of $1.1 billion as of September 30, 2008, and $848 million as of
December 31, 2007. The increase in reserves is primarily due to
declines in the equity market driving down the value of the underlying mutual
fund investments.
During
the third quarter of 2008, the Company completed its normal review of reserves
(including assumptions) and recorded a charge of $111 million pre-tax ($72
million after-tax). The charge is due to:
12
Activity
in future policy benefit reserves for these guaranteed minimum death benefits
contracts was as follows:
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