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CIGNA Corporation 10-Q 2009 Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2009
OR
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 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 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
As of July 17, 2009, 272,704,706 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.
Table of Contents
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CIGNA Corporation
Consolidated Statements of Income
The accompanying Notes to the Consolidated Financial Statements are an integral part of these
statements.
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CIGNA Corporation
Consolidated Balance Sheets
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
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CIGNA Corporation
Consolidated Statements of Comprehensive Income and Changes in Total Equity
The accompanying Notes to the Consolidated Financial Statements are an integral part of these
statements.
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CIGNA Corporation
Consolidated Statements of Comprehensive Income and Changes in Total Equity
The accompanying Notes to the Consolidated Financial Statements are an integral part of these
statements.
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CIGNA Corporation
Consolidated Statements of Cash Flows
The accompanying Notes to the Consolidated Financial Statements are an integral part of these
statements.
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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
(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, 2008.
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.
In preparing these interim consolidated financial statements, the Company has evaluated events that
occurred between the balance sheet date and July 30, 2009.
Certain reclassifications and restatements have been made to prior period amounts to conform to the
presentation of 2009 amounts. In addition, certain restatements have been made in connection with
the adoption of new accounting pronouncements. See Note 2 for further information.
Discontinued operations. Discontinued operations for the six months ended June 30, 2009 primarily
represented a tax benefit associated with a past divestiture related to the completion of the 2005
and 2006 IRS examinations.
Discontinued operations for the second quarter of 2008 included a loss of $1 million after-tax
related to the sale of the Brazilian Life Insurance Company. Discontinued operations for the six
months ended June 30, 2008 also includes a gain of $3 million after-tax from the settlement of
certain issues related to a past divestiture.
Unless otherwise indicated, amounts in these Notes exclude the effects of discontinued operations.
Note 2 — Recent Accounting Pronouncements
Other-than-temporary impairments. On April 1, 2009, the Company adopted Financial Accounting
Standards Board (FASB) Staff Position (FSP) No. FAS 115-2, “Recognition and Presentation of
Other-Than-Temporary Impairments”. This FSP provides new guidance for evaluating whether an
impairment is other than temporary for fixed maturities with declines in fair value below amortized
cost. It requires assessing the Company’s intent to sell or whether it is more likely than not
that the Company will be required to sell such fixed maturities before their fair values recover.
If so, an impairment loss is recognized in net income for the excess of the amortized cost over
fair value. The Company must also determine if it does not expect to recover the amortized cost of
fixed maturities with declines in fair value (even if it does not intend to sell or will not be
required to sell). In this case, the credit portion of the impairment loss is recognized in net
income and the non-credit portion of an impairment loss is recognized in a separate component of
shareholders’ equity. A reclassification adjustment from retained earnings to accumulated other
comprehensive income is required for previously impaired fixed maturities that have a non-credit
loss as of the date of adoption, less related tax effects.
The cumulative effect of adoption increased the Company’s retained earnings with an offsetting
decrease to accumulated other comprehensive income of $18 million, with no overall change to
shareholders’ equity. See Note 9 for information on the Company’s other-than-temporary impairments
including additional required disclosures.
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Noncontrolling interests in subsidiaries. Effective January 1, 2009, the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 160, “Noncontrolling Interests in Consolidated
Financial Statements, an amendment of ARB No. 51,” through retroactive restatement of prior
financial statements and reclassified its $6 million of noncontrolling interest as of January 1,
2009 and 2008 from Accounts payable, accrued expenses and other liabilities to Noncontrolling
interest in total equity. In addition, for the six months ended June 30, 2008, net income of $1
million attributable to the noncontrolling interest has been reclassified to be included in net
income, with a reduction to net income to determine net income attributable to the Company’s
shareholders (“shareholders’ net income”).
Earnings per share. Effective January 1, 2009, the Company adopted FSP EITF 03-6-1, “Determining
Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.”
This FSP requires unvested restricted stock awards that contain rights to nonforfeitable dividends
to be included in the denominator of both basic and diluted earnings per share (“EPS”)
calculations. Prior period EPS data have been restated to reflect the adoption of this FSP. See
Note 4 for the effects of this FSP on previously reported EPS amounts.
Business combinations. Effective January 1, 2009, the Company adopted SFAS No. 141 (revised 2007,
referred to as SFAS No. 141R), “Business Combinations”. This standard requires fair value
measurements for all future acquisitions, including contingent purchase price and certain
contingent assets or liabilities of the entity to be acquired; requires acquisition related and
restructuring costs to be expensed as incurred and requires changes in tax items after the
acquisition date to be reported in income tax expense. There were no effects to the Company’s
Consolidated Financial Statements at adoption.
Derivatives disclosures. Effective January 1, 2009, the Company adopted SFAS No. 161, “Disclosures
about Derivative Instruments and Hedging Activities.” This standard expands required disclosures
to include the purpose for using derivative instruments, their accounting treatment and related
effects on financial condition, results of operations and liquidity. See Note 10 for information
on the Company’s derivative financial instruments including these additional required disclosures.
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 FASB amended SFAS No. 157 in 2008 to provide
additional guidance for determining the fair value of a financial asset when the market for that
instrument is not active. See Note 8 for information on the Company’s fair value measurements.
The Company carries certain financial instruments at fair value in the financial statements
including approximately $12.7 billion in invested assets at June 30, 2009. The Company also
carries derivative instruments at fair value, including assets and liabilities for reinsurance
contracts covering guaranteed minimum income benefits (GMIB assets and liabilities) under certain
variable annuity contracts issued by other insurance companies and related retrocessional
contracts. The Company also reports separate account assets at fair value; however, changes in the
fair values of these assets accrue directly to policyholders and are not included in the 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 GMIB assets and liabilities
discussed below. In addition, there were no effects to the Company’s measurements of financial
assets of adopting the 2008 amendment to SFAS No. 157.
At adoption, the Company was required to change certain assumptions used to estimate the fair
values of GMIB assets and liabilities. 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 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. On adoption, the Company recorded a
charge of $131 million after-tax, net of reinsurance ($202 million pre-tax), in Run-off
Reinsurance.
The Company’s results of operations related to this business are expected to continue to be
volatile in future periods because underlying assumptions will be based on current
market-observable inputs which will likely change each period. See Note 8 for additional
information.
In the first quarter of 2009, the Company adopted the provisions of SFAS No. 157 for non-financial
assets and liabilities (such as intangible assets, property and equipment and goodwill) that are
required to be measured at fair value on a periodic basis (such as at impairment). The effect on
the Company’s periodic fair value measurements for non-financial assets and liabilities was not
material.
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In addition, the Company adopted recent amendments to SFAS No. 157 that provide additional guidance
in determining fair value when the volume and level of activity for an asset or liability have
significantly decreased and in identifying transactions that are not orderly. There were no
effects to the Company’s Consolidated Financial Statements at adoption.
Variable
interest entities. In 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R),” which amended existing guidance to require periodic qualitative analyses
to determine whether a variable interest entity must be consolidated by the Company. In addition,
this standard requires the Company to disclose any significant judgments and assumptions made in
determining whether it must consolidate a variable interest entity. Any changes in consolidated
entities resulting from these requirements must be applied through retrospective restatement of
prior financial statements beginning in 2010. The Company is presently evaluating the impact of
these new requirements.
Transfers
of financial assets. In 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of
Financial Assets, an amendment of FASB Statement No. 140,” to provide greater transparency about
transfers of financial assets. This guidance changes the requirements for recognizing the transfer
of financial assets and requires additional disclosures about a transferor’s continuing involvement
in transferred financial assets. The guidance also eliminates the concept of a “qualifying special
purpose entity” when assessing transfers of financial instruments. The recognition and measurement
provisions of this guidance must be applied to transfers that occur on or after January 1, 2010.
The Company is presently evaluating the impact of these new requirements.
Note 3 — Acquisitions and Dispositions
The Company may from time to time acquire or dispose of assets, subsidiaries or lines of
business. Significant transactions are described below.
Great-West Healthcare Acquisition. On April 1, 2008, the Company acquired the Healthcare division
of Great-West Life and Annuity, Inc. (“Great-West Healthcare” or the “acquired business”) through
100% indemnity reinsurance agreements and the acquisition of certain affiliates and other assets
and liabilities of Great-West Healthcare. The purchase price of approximately $1.5 billion
consisted of a payment to the seller of approximately $1.4 billion for the net assets acquired and
the assumption of net liabilities under the reinsurance agreement of approximately $0.1 billion.
Great-West Healthcare primarily sells medical plans on a self-funded basis with stop loss coverage
to select and regional employer groups. Great-West Healthcare’s offerings also include the
following specialty products: stop loss, life, disability, medical, dental, vision, prescription
drug coverage, and accidental death and dismemberment insurance. The acquisition, which was
accounted for as a purchase, was financed through a combination of cash and the issuance of both
short and long-term debt.
In the first quarter of 2009, the Company completed its allocation of the total purchase price to
the tangible and intangible net assets acquired based on management’s estimates of their fair
values without material changes from December 31, 2008.
The results of Great-West Healthcare are included in the Company’s Consolidated Financial
Statements from the date of acquisition.
The following table presents selected unaudited pro forma information for the Company assuming the
acquisition had occurred as of January 1, 2008. 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
that date or what such results will be for any future periods.
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Note 4 — Earnings Per Share
Basic and diluted earnings per share were computed as follows:
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As described in Note 2, effective in 2009, the Company adopted FSP EITF 03-06-1, which
requires the Company’s unvested restricted stock awards to be included in weighted average shares
instead of being considered a common stock equivalent. Prior period share information has been
restated 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 78,223,221 shares of common stock in Treasury as of June 30, 2009, and
75,590,075 shares as of June 30, 2008.
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:
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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 11 for additional information on reinsurance. For the six months ended June 30, 2009, actual
experience differed from the Company’s key assumptions resulting in favorable incurred claims
related to prior years’ medical claims payable of $35 million, or 0.5% of the current year incurred
claims as reported for the year ended December 31, 2008. Actual completion factors resulted in a
reduction in medical claims payable of $15 million, or 0.2% of the current year incurred claims as
reported for the year ended December 31, 2008 for the insured book of business. Actual medical cost
trend resulted in a reduction in medical claims payable of $20 million, or 0.3% of the current year
incurred claims as reported for the year ended December 31, 2008 for the insured book of business.
For the year ended December 31, 2008, actual experience differed from the Company’s key
assumptions, resulting in favorable incurred claims related to prior years’ medical claims payable
of $60 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 of the medical claims payable of $29
million, or 0.4% 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 of the
medical claims payable of $31 million, or 0.5% of the current year incurred claims as reported for
the year ended December 31, 2007 for the insured book of business.
The favorable impact in 2009 and 2008 relating to completion factors 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 provision
for moderately adverse conditions established for claims incurred related to the current year.
The corresponding impact of prior year development on shareholders’ net income was not material for
the three months and six months ended June 30, 2009 and 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 shareholders’ 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 shareholders’ net income. An
increase or decrease to medical claims payable on accounts in deficit, in effect, accrues to the
Company and directly impacts shareholders’ 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 shareholders’ net income. An account
is in surplus when the accumulated premium received exceeds the accumulated medical costs and
administrative charges, including profit charges.
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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 shareholders’ net income.
The determination of liabilities for Health Care medical claims payable required the Company to
make critical accounting estimates. See Note 2(O) to the Consolidated Financial Statements in the
Company’s 2008 Form 10-K.
Note 6 — Cost Reduction
During the second quarter of 2009, the Company continued its previously announced comprehensive
review of its ongoing businesses. As a result, in the second quarter of 2009 the Company recognized
in other operating expenses a total charge of $14 million pre-tax ($9 million after-tax), for
severance resulting from reductions of 465 positions in its workforce. The Company expects to pay
substantially all of this charge in cash during 2009. The Health Care segment reported
substantially all of this charge.
The following table presents the activity related to the cost reduction initiatives begun in the
fourth quarter of 2008:
Note 7 — 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 guaranteed minimum death benefits (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. The Company has equity and other market exposures as a result of this product. In
periods of declining equity markets and in periods of flat equity markets following a decline, the
Company’s liabilities for these guaranteed minimum death benefits increase. Conversely, in periods
of rising equity markets, the Company’s liabilities for these guaranteed minimum death benefits
decrease.
In order to substantially reduce the equity market exposures relating to guaranteed minimum death
benefit contracts, the Company operates a dynamic hedge program (GMDB equity hedge program), using
exchange-traded futures contracts. The hedge program is designed to substantially offset both
positive and negative impacts of changes in equity markets on the GMDB liability. The hedge
program involves detailed, daily monitoring of equity market movements and rebalancing the futures
contracts within established parameters. While the hedge program is actively managed, it may not
exactly offset changes in the GMDB liability due to, among other things, divergence between the
performance of the underlying mutual funds and the hedge instruments, high levels of volatility in
the equity markets, and differences between actual contractholder behavior and what is assumed.
The performance of the underlying mutual funds compared to the hedge instruments is further
impacted by a time lag, since the data is not reported and incorporated into the required hedge
position on a real time basis. Although this hedge program does not qualify for GAAP hedge
accounting, it is an economic hedge because it is designed and operated to substantially reduce
equity market exposures resulting from this product. The results of the futures contracts are
included in other revenue and amounts reflecting corresponding changes in liabilities for these
GMDB contracts are included in benefits and expenses, consistent with GAAP when a premium
deficiency exists.
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The GMDB reinsurance business is considered premium deficient because the expected present value of
future claims and expenses exceeds the expected present value of future premiums and investment
income using revised assumptions based on actual and expected experience. The Company performs a
reserve review on a quarterly basis using current market conditions and assumptions. Under premium
deficiency accounting if the recorded reserve is determined insufficient, an increase to the
reserve is reflected as a charge to current period income. Consistent with GAAP, the Company does
not recognize gains on premium deficient long duration products.
The Company had future policy benefit reserves for GMDB contracts of $1.5 billion as of June 30,
2009, and $1.6 billion as of December 31, 2008. The determination of liabilities for GMDB
requires the Company to make critical accounting estimates. The Company estimates its liabilities
for GMDB exposures using a complex internal model, run using many scenarios, and based on
assumptions regarding lapse, future partial surrenders, mortality, interest rates (mean investment
performance and discount rate) and volatility. Lapse refers to the full surrender of an annuity
prior to a contractholder’s death. Future partial surrender refers to the fact that most
contractholders have the ability to withdraw substantially all of their mutual fund investments
while retaining the death benefit coverage in effect at the time of the withdrawal. Mean
investment performance refers to market rates to be earned over the life of the GMDB equity hedge
program, and market volatility refers to market fluctuation. These assumptions are based on the
Company’s experience and future expectations over the long-term period, consistent with the
long-term nature of this product. The Company regularly evaluates these assumptions and changes
its estimates if actual experience or other evidence suggests that assumptions should be revised.
If actual experience differs from the assumptions (including lapse, future partial surrenders,
mortality, interest rates and volatility) used in estimating these liabilities, the result 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 following provides information about the Company’s reserving methodology and assumptions for
GMDB as of June 30, 2009:
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Although the year to date results include a first quarter charge of $73 million pre-tax ($47
million after-tax) to strengthen GMDB reserves following an analysis of experience, no additional
reserve strengthening was required for GMDB during the second quarter of 2009, primarily due to the
stabilization and recovery of equity markets. The components of the first quarter charge were:
Activity in future policy benefit reserves for the GMDB business was as follows:
Benefits paid and incurred are net of ceded amounts. Incurred benefits reflect the favorable
or unfavorable impact of a rising or falling equity market on the liability, and include the
charges discussed above. As discussed below, losses or gains have been recorded in other revenues
as a result of the GMDB equity hedge program to reduce equity market exposures.
As of June 30, 2009, the aggregate value of the underlying mutual fund investments was $15.8
billion. The death benefit coverage in force as of that date (representing the amount that the
Company would have to pay if all of the approximately 615,000 contractholders had died on that
date) was $9.6 billion. As of December 31, 2008, the aggregate value of the underlying mutual fund
investments was $16.3 billion. The death benefit coverage in force as of that date (representing
the amount that the Company would have to pay if all of the approximately 650,000 contractholders
had died on that date) was $11.1 billion. The death benefit coverage in force represents the
excess of the guaranteed benefit amount over the value of the underlying mutual fund investments.
As discussed above, the Company operates a GMDB equity hedge program to substantially reduce the
equity market exposures of this business by selling exchange-traded futures contracts, which are
expected to rise in value as the equity market declines and decline in value as the equity market
rises. In addition, the Company uses foreign currency futures contracts to reduce the
international equity market and foreign currency risks associated with this business. The notional
amount of futures contract positions held by the Company at June 30, 2009 was $1.3 billion. The
Company recorded in other revenues pre-tax losses of $188 million for the three months ended June
30, 2009 and $71 million for the six months ended June 30, 2009, and pre-tax gains of $6 million
for the three months ended June 30, 2008 and $48 million for the six months ended June 30, 2008.
The Company has also written reinsurance contracts with issuers of variable annuity contracts that
provide annuitants with certain guarantees related to minimum income benefits (GMIB). All reinsured
GMIB policies also have a GMDB benefit reinsured by the Company. See Note 8 for further
information.
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Note 8 — Fair Value Measurements
The Company carries certain financial instruments at fair value in the financial statements
including fixed maturities, equity securities, short-term investments and derivatives. Other
financial instruments are periodically measured at fair value, such as when impaired, or, for
commercial mortgage loans, when classified as “held for sale.”
Fair value is defined as the price at which an asset could be exchanged in an orderly transaction
between market participants at the balance sheet date. A liability’s fair value is defined as the
amount that would be paid to transfer the liability to a market participant, not the amount that
would be paid to settle the liability with the creditor.
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. These
valuation techniques involve some level of estimation and judgment by the Company which becomes
significant with increasingly complex instruments or pricing models. Where appropriate,
adjustments are included to reflect the risk inherent in a particular methodology, model or input
used.
The Company’s financial assets and liabilities carried at fair value have been classified based
upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking to fair values
determined using unadjusted quoted prices in active markets for identical assets and liabilities
(Level 1) and the lowest ranking to fair values determined using methodologies and models with
unobservable inputs (Level 3). An asset’s or a liability’s classification is based on the lowest
level input that is significant to its measurement. For example, a Level 3 fair value measurement
may include inputs that are both observable (Levels 1 and 2) and unobservable (Level 3). The
levels of the fair value hierarchy are as follows:
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Financial Assets and Financial Liabilities Measured at Fair Value on a Recurring Basis
The following tables provide information as of June 30, 2009 and December 31, 2008 about the
Company’s financial assets and liabilities measured at fair value on a recurring basis. Similar
disclosures for separate account assets, which are also recorded at fair value on the Company’s
Consolidated Balance Sheets, are provided separately as gains and losses related to these assets
generally accrue directly to policyholders.
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Level 1 Financial Assets
Assets in Level 1 include actively-traded U.S. government bonds and exchange-listed equity
securities. Given the narrow definition of Level 1 and the Company’s investment asset strategy to
maximize investment returns, a relatively small portion of the Company’s investment assets are
classified in this category.
Level 2 Financial Assets and Financial Liabilities
Fixed maturities and equity securities. Approximately 92% of the Company’s investments in fixed
maturities and equity securities are classified in Level 2 including most public and private
corporate debt and equity securities, federal agency and municipal bonds, non-government
mortgage-backed securities and preferred stocks. Because many fixed maturities and preferred
stocks do not trade daily, fair values are often derived using recent trades of securities with
similar features and characteristics. When recent trades are not available, pricing models are
used to determine these prices. These models calculate fair values by discounting future cash
flows at estimated market interest rates. Such market rates are derived by calculating the
appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry
and structure of the asset.
Typical inputs and assumptions to pricing models include, but are not limited to, benchmark yields,
reported trades, broker-dealer quotes, issuer spreads, liquidity, benchmark securities, bids,
offers, reference data, and industry and economic events. For mortgage-backed securities, inputs
and assumptions may also include characteristics of the issuer, collateral attributes, prepayment
speeds and credit rating.
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Short-term investments. Short-term investments are carried at fair value, which approximates cost.
On a regular basis the Company compares market prices for these securities to recorded amounts to
validate that current carrying amounts approximate exit prices. The short-term nature of the
investments and corroboration of the reported amounts over the holding period support their
classification in Level 2.
Other derivatives. Amounts classified in Level 2 represent over-the-counter instruments such as
interest rate and foreign currency swap contracts. Fair values for these instruments are
determined using market observable inputs including forward currency and interest rate curves and
widely published market observable indices. Credit risk related to the counterparty and the
Company is considered when estimating the fair values of these derivatives. However, the Company
is largely protected by collateral arrangements with counterparties, and determined that no
adjustment for credit risk was required as of June 30, 2009 or December 31, 2008. The nature and
use of these other derivatives are described in Note 10.
Level 3 Financial Assets and Financial Liabilities
The Company classifies certain newly issued, privately placed, complex or illiquid securities, as
well as assets and liabilities relating to guaranteed minimum income benefits in Level 3.
Fixed maturities and equity securities. Approximately 7% of fixed maturities and equity securities
are priced using significant unobservable inputs and classified in this category, including:
Fair values of mortgage and asset-backed securities and corporate bonds are determined using
pricing models that incorporate the specific characteristics of each asset and related assumptions
including the investment type and structure, credit quality, industry and maturity date in
comparison to current market indices and spreads, liquidity and economic events. For mortgage and
asset-backed securities, inputs and assumptions to pricing may also include collateral attributes
and prepayment speeds. Recent trades in the subject security or similar securities are assessed
when available, and the Company may also review published research as well as the issuer’s
financial statements in its evaluation. Subordinated loans and private equity investments are
valued at transaction price in the absence of market data indicating a change in the estimated fair
values.
Guaranteed minimum income benefit contracts. Because cash flows of the GMIB liabilities and
assets are affected by equity markets and interest rates but are without significant life insurance
risk and are settled in lump sum payments, the Company reports these liabilities and assets as
derivatives at fair value. The Company estimates the fair value of the assets and liabilities for
GMIB contracts using assumptions regarding capital markets (including market returns, interest
rates and market volatilities of the underlying equity and bond mutual fund investments), future
annuitant and retrocessionaire behavior (including mortality, lapse, annuity election rates and
retrocessional credit), as well as risk and profit charges. At adoption of SFAS No. 157 in 2008,
the Company updated assumptions to reflect those that the Company believes a hypothetical market
participant would use to determine a current exit price for these contracts, and recorded a charge
to shareholders’ net income as described in Note 2. As certain assumptions used to estimate fair
values for these contracts are largely unobservable, the Company classifies GMIB assets and
liabilities in Level 3. The Company considered the following in determining the view of a
hypothetical market participant:
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These GMIB assets and liabilities are estimated using a complex internal model run using many
scenarios to determine the present value of net amounts expected to be paid, less the present value
of net future premiums expected to be received adjusted for risk and profit charges that the
Company estimates a hypothetical market participant would require to assume this business. Net
amounts expected to be paid include the excess of the expected value of the income benefits over
the values of the annuitants’ accounts at the time of annuitization. Generally, market return,
interest rate and volatility assumptions are based on market observable information. Assumptions
related to annuitant behavior reflect the Company’s belief that a hypothetical market participant
would consider the actual and expected experience of the Company as well as other relevant and
available industry resources in setting policyholder behavior assumptions. The significant
assumptions used to value the GMIB assets and liabilities as of June 30, 2009 were as follows:
In addition, the company has considered other assumptions related to model, expense and
non-performance risk in calculating the GMIB liability.
The Company regularly evaluates each of the assumptions used in establishing these assets and
liabilities by considering how a hypothetical market participant would set assumptions at each
valuation date. Capital markets assumptions are expected to change at each valuation date
reflecting current observable market conditions. Other assumptions may also change based on a
hypothetical market participant’s view of actual experience as it emerges over time or other
factors that impact the net liability. If the emergence of future experience or future assumptions
differs from the assumptions used in estimating these assets and liabilities, the resulting impact
could be material to the Company’s consolidated results of operations, and in certain situations,
could be material to the Company’s financial condition.
GMIB liabilities are reported in the Company’s Consolidated Balance Sheets in Accounts payable,
accrued expenses and other liabilities. GMIB assets associated with these contracts represent net
receivables in connection with reinsurance that the Company has purchased from two external
reinsurers and are reported in the Company’s Consolidated Balance Sheets in Other assets, including
other intangibles. As of June 30, 2009, Standard & Poor’s (S&P) has given a financial strength
rating of AA to one reinsurer and a financial strength rating of A- to the parent company that
guarantees the receivable from the other reinsurer.
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Changes in Level 3 Financial Assets and Financial Liabilities Measured at Fair Value on a Recurring
Basis
The following tables summarize the changes in financial assets and financial liabilities classified
in Level 3 for the three months and six months ended June 30, 2009 and 2008. These tables exclude
separate account assets as changes in fair values of these assets accrue directly to policyholders.
Gains and losses reported in these tables may include changes in fair value that are attributable
to both observable and unobservable inputs.
For the Three Months Ended June 30, 2009
For the Three Months Ended June 30, 2008
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As noted in the tables above, total gains and losses included in shareholders’ net income are
reflected in the following captions in the Consolidated Statements of Income:
Reclassifications impacting Level 3 financial instruments are reported as transfers in or out of
the Level 3 category as of the beginning of the quarter in which the transfer occurs. Therefore
gains and losses in income only reflect activity for the period the instrument was classified in
Level 3. Typically, investments that transfer out of Level 3 are classified in Level 2 as market
data on the securities becomes more readily available.
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The Company provided reinsurance for other insurance companies that offer a guaranteed minimum
income benefit, and then retroceded a portion of the risk to other insurance companies. These
arrangements with third party insurers are the instruments still held at the reporting date for
GMIB assets and liabilities in the tables above. Because these reinsurance arrangements remain in
effect at the reporting date, the Company has reflected the total gain or loss for the period as
the total gain or loss included in income attributable to instruments still held at the reporting
date. However, the Company reduces the GMIB assets and liabilities resulting from these
reinsurance arrangements when annuitants lapse, die, elect their benefit, or reach the age after
which the right to elect their benefit expires.
Under SFAS No. 157, the Company’s GMIB assets and liabilities are expected to be volatile in future
periods because the underlying assumptions will be based largely on market-observable inputs at the
close of each reporting period including interest rates and market-implied volatilities.
The net gain for GMIB was $164 million for the three months ended June 30, 2009 and $196 million
for the six months ended June 30, 2009, and was primarily due to the following factors:
These favorable effects were partially offset by:
For the second quarter of 2008, gains on the GMIB liabilities and offsetting losses on the GMIB
assets were primarily the result of increases in interest rates. For the six months ended June 30,
2008, excluding the implementation impact of SFAS No. 157, losses on the GMIB liabilities and
offsetting gains on the GMIB assets were primarily the result of declines in equity markets.
Separate account assets
Fair values and changes in the fair values of separate account assets generally accrue directly to
the policyholders and are not included in the Company’s revenues and expenses. As of June 30, 2009
and December 31, 2008 separate account assets were as follows:
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Separate account assets in Level 1 include exchange-listed equity securities. Level 2 assets
primarily include:
Separate account assets classified in Level 3 include investments primarily in securities
partnerships and real estate generally valued at transaction price in the absence of market data
indicating a change in the estimated fair value. Values may be adjusted when evidence is available
to support such adjustments. Evidence may include market data as well as changes in the financial
results and condition of the investment.
The following tables summarize the changes in separate account assets reported in Level 3 for the
three months and six months ended June 30, 2009 and 2008.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
Certain financial assets and liabilities are measured at fair value on a non-recurring basis, such
as commercial mortgage loans held for sale and investments in real estate entities that are
impaired. In the second quarter of 2009, impaired real estate entities carried at cost of $41
million were written down to their fair values of $8 million, resulting in realized investment
losses of $33 million. These fair value measurements were based on discounted cash flow analyses
using significant unobservable inputs, and were classified in Level 3. As of December 31, 2008,
the amounts required to adjust these assets and liabilities to their fair values were not
significant.
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Fair Value Disclosures for Financial Instruments Not Carried at Fair Value
Most financial instruments that are subject to fair value disclosure requirements are carried in
the consolidated financial statements at amounts that approximate fair value. The following table
shows the fair values and carrying values of the Company’s financial instruments not recorded at
fair value that are subject to fair value disclosure requirements at June 30, 2009 and December
31, 2008:
The fair values presented in the table above have been estimated using market information when
available. The following is a description of the valuation methodologies and inputs used by the
Company to determine fair value.
Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans
generally by discounting the contractual cash flows at estimated market interest rates that reflect
the Company’s assessment of the credit quality of the loans. Market interest rates are derived by
calculating the appropriate spread over comparable U.S. Treasury rates, based on the property type,
quality rating and average life of the loan. The quality ratings reflect the relative risk of the
loan, considering debt service coverage, the loan to value ratio and other factors. Fair values of
impaired mortgage loans are based on the estimated fair value of the underlying collateral
generally using an internal discounted cash flow model.
Contractholder deposit funds, excluding universal life products. Generally, the
Company’s contractholder deposit funds do not have stated maturities. Approximately 45% of these
balances can be withdrawn by the customer at any time without prior notice or penalty. The fair
value for these contracts is the amount estimated to be payable to the customer as of the reporting
date, which is generally the carrying value. Most of the remaining contractholder deposit funds
are reinsured by the buyers of the individual life and annuity and retirement benefits businesses.
The fair value for these contracts is determined using the fair value of these buyers’ assets
supporting these reinsured contracts. The Company had a reinsurance recoverable equal to the
carrying value of these reinsured contracts.
Long-term debt, excluding capital leases. The fair value of long-term debt is based on quoted
market prices for recent trades. When quoted market prices are not available, fair value is
estimated using a discounted cash flow analysis and the Company’s estimated current borrowing rate
for debt of similar terms and remaining maturities.
Fair values of off-balance-sheet financial instruments were not material.
Note 9 — Investments
Total Realized Investment Gains and Losses
The following total realized gains and losses on investments include other than temporary
impairments on debt securities but exclude amounts required to adjust future policy benefits for
run-off settlement annuity business:
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Included in pre-tax realized investment losses above were other than temporary impairments on
debt securities, asset write-downs and changes in valuation reserves as follows:
Fixed Maturities and Equity Securities
Securities in the following table are included in fixed maturities and equity securities on the
Company’s Consolidated Balance Sheets. These securities are carried at fair value with changes in
fair value reported in other realized investment gains and interest and dividends reported in net
investment income. The Company’s hybrid investments include preferred stock or debt securities
with call or conversion features. The Company elected fair value accounting for certain hybrid
securities to simplify accounting and mitigate volatility in results of operations and financial
condition.
Fixed maturities and equity securities included $218 million at June 30, 2009, which were
pledged as collateral to brokers as required under certain futures contracts. These fixed
maturities and equity securities were primarily corporate securities.
The following information about fixed maturities excludes trading and hybrid securities. The
amortized cost and fair value by contractual maturity periods for fixed maturities were as follows
at June 30, 2009:
Actual maturities could differ from contractual maturities because issuers may have the right
to call or prepay obligations, with or without penalties. Also, in some cases the Company may
extend maturity dates.
Mortgage-backed assets consist principally of commercial mortgage-backed securities and
collateralized mortgage obligations of which $38 million were residential mortgages and home equity
lines of credit, all of which were originated utilizing standard underwriting practices and are not
considered sub-prime loans.
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Gross unrealized appreciation (depreciation) on fixed maturities (excluding trading securities and
hybrid securities) by type of issuer is shown below.
The above table includes investments with a fair value of $2.1 billion supporting the
Company’s run-off settlement annuity business, with gross unrealized appreciation of $296 million
and gross unrealized depreciation of $122 million at June 30, 2009. Such unrealized amounts are
required to support future policy benefit liabilities of this business and, as such, are not
included in accumulated other comprehensive income.
Sales information for available-for-sale fixed maturities and equity securities were as follows:
Review of declines in fair value. Management reviews fixed maturities and equity securities
with a decline in fair value from cost for impairment based on criteria that include:
Excluding
trading and hybrid securities, as of June 30, 2009, fixed maturities with a decline in
fair value from amortized cost (which were primarily investment grade corporate bonds) were as
follows, including the length of time of such decline:
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The unrealized depreciation of investment grade fixed maturities is primarily due to increases
in market yields since purchase. Approximately $119 million of the unrealized depreciation is due
to securities with a decline in value of greater than 20%. Approximately 40% of these securities
had been in that position for less than six months and approximately 90% less than twelve months.
The remaining $264 million of the unrealized depreciation is due to securities with declines in
value of less than 20%. There were no equity securities with a fair value significantly lower than
cost as of June 30, 2009.
Note 10 — Derivative Financial Instruments
The Company’s investment strategy is to manage the characteristics and risks of investment assets
(such as duration, yield, currency and liquidity) to meet the varying demands of the related
insurance and contractholder liabilities (such as paying claims, investment returns and
withdrawals). As part of this investment strategy, the Company typically uses
derivatives to minimize interest rate, foreign currency and equity price risks of chosen investment
assets to conform to the characteristics and risks of the related insurance and contractholder
liabilities. The Company routinely monitors exposure to credit risk associated with derivatives
and diversifies the portfolio among approved dealers of high credit quality to minimize credit
risk. In addition, the Company has written or sold contracts to guarantee minimum income benefits
and to enhance investment returns. See Note 7 for a discussion of derivatives associated
with GMDB contracts and Note 8 for a discussion of derivatives arising from GMIB contracts.
The Company uses hedge accounting when derivatives are designated, qualify and are highly effective
as hedges. Effectiveness is formally assessed and documented at inception and each period
throughout the life of a hedge using various qualitative and quantitative methods appropriate for
each hedge, including regression analysis and dollar offset. Under hedge accounting, the changes
in fair value of the derivative and the hedged risk are generally recognized together and offset
each other when reported in shareholders’ net income.
The Company accounts for derivative instruments as follows:
Certain subsidiaries of the Company are parties to over-the-counter derivative instruments that
contain bilateral provisions requiring the parties to such instruments to post collateral depending
on net liability thresholds and the party’s financial strength or credit rating. The collateral
posting requirements vary by counterparty. The aggregate fair value of derivative instruments with
such credit-risk-related contingent features where a subsidiary of the Company was in a net
liability position as of June 30, 2009 was $19 million for which the Company was not required to
post collateral. If the contingent features underlying the agreements were triggered as of June
30, 2009, the Company would be required to post collateral of $19 million with its counterparties.
Such subsidiaries are parties to certain other derivative instruments that contain termination
provisions for which the counterparties could demand immediate payment of the total net liability
position if the financial strength rating of the subsidiary were to decline below specified levels.
As of June 30, 2009, there was no net liability position under such derivative instruments.
The table below presents information about the nature and accounting treatment of the Company’s
primary derivative financial instruments including the Company’s purpose for entering into specific
derivative transactions, and their locations in and effect on the financial statements as of and
for the three and six month periods ended June 30, 2009. Derivatives in the Company’s separate
accounts are not included because associated gains and losses generally accrue directly to
policyholders.
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The amount of gains (losses) reclassified from accumulated other comprehensive income into
income was not significant. No gains (losses) were recognized due to ineffectiveness and no
amounts were excluded from the assessment of hedge ineffectiveness.
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Note 11 — Reinsurance
The Company’s insurance subsidiaries enter into agreements with other insurance companies to assume
and cede reinsurance. Reinsurance is ceded primarily to limit losses from large exposures and to
permit recovery of a portion of direct losses. Reinsurance is also used in acquisition and
disposition transactions where the underwriting company is not being acquired. Reinsurance does not
relieve the originating insurer of liability. The Company regularly evaluates the financial
condition of its reinsurers and monitors its concentrations of credit risk.
Retirement benefits business. The Company had a reinsurance recoverable of $1.8 billion as of June
30, 2009, and $1.9 billion as of December 31, 2008 from Prudential Retirement Insurance and Annuity
Company resulting from the sale of the retirement benefits business, which was primarily in the
form of a reinsurance arrangement. The reinsurance recoverable, which is reduced as the Company’s
reinsured liabilities are paid or directly assumed by the reinsurer, is secured primarily by fixed
maturities and mortgage loans equal to or greater than 100% of the reinsured liabilities. These
fixed maturities and mortgage loans are held in a trust established for the benefit of the Company.
As of June 30, 2009, the trust was adequately funded and S&P had assigned this reinsurer a rating
of AA-.
Individual life and annuity reinsurance. The Company had reinsurance recoverables totaling $4.5
billion as of June 30, 2009 and $4.6 billion as of December 31, 2008 from The Lincoln National Life
Insurance Company and Lincoln Life & Annuity of New York resulting from the 1998 sale of the
Company’s individual life insurance and annuity business through indemnity reinsurance
arrangements. Effective December 31, 2007, a substantial portion of the reinsurance recoverables
are secured by investments held in a trust established for the benefit of the Company. At June 30,
2009, the trust assets secured approximately 90% of the reinsurance recoverables and S&P had
assigned both of these reinsurers a rating of AA-.
Other Ceded and Assumed Reinsurance
Ceded Reinsurance: Ongoing operations. The Company’s insurance subsidiaries have reinsurance
recoverables from various reinsurance arrangements in the ordinary course of business for its
Health Care, Disability and Life, and International segments as well as the non-leveraged and
leveraged corporate-owned life insurance business. Reinsurance recoverables of $309 million as of
June 30, 2009 are expected to be collected from more than 90 reinsurers which have been assigned
the following financial strength ratings from S&P:
The Company reviews its reinsurance arrangements and establishes reserves against the
recoverables in the event that recovery is not considered probable. As of June 30, 2009, the
Company’s recoverables related to these segments were net of a reserve of $11 million.
Assumed and Ceded reinsurance: Run-off Reinsurance segment. The Company’s Run-off Reinsurance
operations assumed risks related to GMDB contracts, GMIB contracts, workers’ compensation, and
personal accident business. The Company’s Run-off Reinsurance operations also purchased
retrocessional coverage to reduce the risk of loss on these contracts.
Liabilities related to GMDB, workers’ compensation and personal accident are included in future
policy benefits and unpaid claims. Because the GMIB contracts are treated as derivatives under
GAAP, the asset related to GMIB is recorded in the Other assets, including other intangibles
caption and the liability related to GMIB is recorded in the Accounts payable, accrued expenses,
and other liabilities caption on the Company’s Consolidated Balance Sheets (see Notes 8 and 17 for
additional discussion of the GMIB assets and liabilities).
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The reinsurance recoverables for GMDB, workers’ compensation, and personal accident of $144 million
as of June 30, 2009 are expected to be collected from more than 100 retrocessionaires which have
been assigned the following financial strength ratings from S&P:
The Company reviews its reinsurance arrangements and establishes reserves against the
recoverables in the event that recovery is not considered probable. As of June 30, 2009, the
Company’s recoverables related to this segment were net of a reserve of $11 million.
The Company’s payment obligations for underlying reinsurance exposures assumed by the Company under
these contracts are based on ceding companies’ claim payments. For GMDB, 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 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 Company’s ultimate payment
obligations and corresponding ultimate collection from retrocessionaires, may not be known with
certainty for some time.
Summary. The Company’s reserves for underlying reinsurance exposures assumed by the Company, as
well as for amounts recoverable from reinsurers/retrocessionaires for both ongoing operations and
the run-off reinsurance operation, are considered appropriate as of June 30, 2009, based on current
information. However, it is possible that future developments could have a material adverse effect
on the Company’s consolidated results of operations and, in certain situations, such as if actual
experience differs from the assumptions used in estimating reserves for GMDB, could have a material
adverse effect on the Company’s financial condition. The Company bears the risk of loss if its
retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
Effects of reinsurance. In the Company’s Consolidated Statements of Income, premiums and fees were
net of ceded premiums, and benefits and expenses were net of reinsurance recoveries, in the
following amounts:
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Note 12 — Pension and Other Postretirement Benefit Plans
The Company and certain of its subsidiaries provide pension, health care and life insurance defined
benefits to eligible retired employees, spouses and other eligible dependents through various
plans.
On May 8, 2009, the Company announced a freeze of its domestic pension plans effective July 1,
2009. As a result of this action, the Company re-measured the benefit obligations of the affected
plans effective May 31, 2009, causing a reduction in the pension obligation of $47 million in the
second quarter of 2009. The reduction primarily reflects an increase in the discount rates used to
re-measure the pension plan obligations from 6.25% at December 31, 2008 to 6.5% at May 31, 2009
reflecting the change in market interest rates. A curtailment of benefits occurs as a result of
this action because it eliminates all future service for active employees in the domestic pension
plans. Accordingly, the Company recognized an after-tax curtailment gain of $30 million during the
second quarter of 2009, which was the remaining unamortized negative prior service cost at May 31,
2009.
Significant changes from the Company’s disclosures at December 31, 2008 as a result of the decision
to freeze the domestic pension plans are as follows:
Pension benefits. Components of net pension cost were as follows:
The Company funds its qualified pension plans at least at the minimum amount required by the
Pension Protection Act of 2006, which requires companies to fully fund defined benefit pension
plans over a seven-year period beginning in 2008. The Company made $320 million in domestic
pension plan contributions during the six months ended June 30, 2009, and expects to make
an additional contribution of $90 million which will be contributed over the remainder of
2009.
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Other postretirement benefits. Components of net other postretirement benefit cost were as
follows:
Note 13 — Debt
Under a universal shelf registration statement filed with the Securities and Exchange
Commission (SEC), the Company issued $350 million of 8.5% Notes on May 4, 2009 ($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 a treasury lock. See Note
10 for further information. Interest is payable on May 1 and November 1 of each year beginning
November 1, 2009. 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). Interest is payable on March 15 and September 15 of each year beginning
September 15, 2008. 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:
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On March 14, 2008, the Company entered into a new commercial paper program (“the Program”). Under
the Program, the Company is authorized to sell from time to time short-term unsecured commercial
paper notes up to a maximum of $500 million. The proceeds are used for general corporate purposes,
including working capital, capital expenditures, acquisitions and share repurchases. The Company
uses the credit facility entered into in June 2007, 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 its credit agreement for funding. In October 2008, the Company added an additional
dealer to its Program. As of June 30, 2009, the Company had $102 million in commercial paper
outstanding at a weighted average interest rate of 1.13% and
remaining maturities ranging from one to 34 days.
Note 14 — Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss excludes amounts required to adjust future policy benefits for
run-off settlement annuity business. Changes in accumulated other comprehensive loss were as
follows:
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Note 15 — Income Taxes
The Company has historically accrued U.S. income taxes on the undistributed earnings of foreign
subsidiaries. In 2009, the Company determined that the prospective earnings of its South Korean
operation are to be permanently invested overseas. Income taxes for this operation will therefore
be accrued at the tax rate of the foreign jurisdiction. As a result, shareholders’ net income
increased for the three and six months ended June 30, 2009 by $20 million, which included $18
million representing the unrecognized deferred tax liabilities attributable to its investment in
the South Korean subsidiary that are considered permanent in nature. Management is currently
assessing whether the undistributed earnings of certain other foreign operations are permanently
invested overseas.
During the first quarter of 2009, the IRS completed its examination of the Company’s 2005 and 2006
consolidated federal income tax returns, resulting in an increase to shareholders’ net income of
$21 million ($20 million in continuing operations and $1 million in discontinued operations). This
increase reflected a reduction in net unrecognized tax benefits of $8 million ($17 million reported
in income tax expense, partially offset by a $9 million pre-tax charge) and a reduction of interest
and penalties of $13 million (reported in income tax expense).
Gross unrecognized tax benefits declined for the first six months of 2009 by $34 million. This
decline was primarily due to completion of the previously referenced IRS examination which
increased shareholders’ net income by $8 million. There were other non-audit related changes in
net unrecognized tax benefits, resulting in a net increase to shareholders’ net income due to the
reduction of unrecognized tax benefits of $2 million for the first six months of 2009.
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Over the next twelve months, the Company has determined it reasonably possible that the level of
unrecognized tax benefits could increase or decrease significantly, subject to developments in
certain matters in dispute with the IRS. It is also reasonably possible there could be a
significant change in the level of valuation allowances recorded against deferred tax benefits of
the reinsurance operations and certain unrealized investment losses within the next twelve months.
The Company, however, is currently unable to reasonably estimate the potential impact of such
changes.
During the first quarter, final resolution was reached in one of the two disputed issues associated
with the IRS examination of the Company’s 2003 and 2004 consolidated federal income tax returns.
The second of these disputed matters remains unresolved and on June 4, 2009 the Company initiated
litigation of this matter by filing a petition in the United States Tax Court. Due to the nature
of the litigation process, the timing of the resolution of this matter is uncertain. Though the
Company expects to prevail, unfavorable resolution of this litigation would result in a charge to
shareholder’s net income of up to $15 million, representing net interest expense on the cumulative
incremental tax for all affected years. In addition, there remain two unresolved issues from the
IRS examination of the Company’s 2005 and 2006 consolidated federal income tax returns. The
Company initiated a regulatory appeal of these matters on March 31, 2009 by filing a formal protest
of the proposed adjustments. One of these unresolved issues is the same matter which remains in
dispute from the prior IRS examination.
On
May 7, 2009, the proposed 2010 federal budget was issued which included various specific
income tax provisions that could affect the Company. Management is in the process of assessing the
impact of these provisions, particularly those related to the U.S. taxation of foreign operations.
Note 16 — Segment Information
The Company’s operating segments generally reflect groups of related products, except for the
International segment which is generally based on geography. In accordance with GAAP, operating
segments that do not require separate disclosure have been combined into Other Operations. The
Company measures the financial results of its segments using “segment earnings (loss),” which
subsequent to the implementation of SFAS No. 160, is defined as shareholders’ income (loss) from
continuing operations excluding after-tax realized investment gains and losses.
Summarized segment financial information was as follows:
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Note 17 — Contingencies and Other Matters
The Company, through its subsidiaries, is contingently liable for various financial guarantees
provided in the ordinary course of business.
Financial Guarantees Primarily Associated with the Sold Retirement Benefits Business
Separate account assets are contractholder funds maintained in accounts with specific investment
objectives. The Company records separate account liabilities equal to separate account assets. In
certain cases, primarily associated with the sold retirement benefits business (which was sold in
April 2004), the Company guarantees a minimum level of benefits for retirement and insurance
contracts, written in separate accounts. The Company establishes an additional liability if
management believes that the Company will be required to make a payment under these guarantees.
The Company guarantees that separate account assets will be sufficient to pay certain retiree or
life benefits. The sponsoring employers are primarily responsible for ensuring that assets are
sufficient to pay these benefits and are required to maintain assets that exceed a certain
percentage of benefit obligations. This percentage varies depending on the asset class within a
sponsoring employer’s portfolio (for example, a bond fund would require a lower percentage than a
riskier equity fund) and thus will vary as the composition of the portfolio changes. If employers
do not maintain the required levels of separate account assets, the Company or an affiliate of the
buyer has the right to redirect the management of the related assets to provide for benefit
payments. As of June 30, 2009, employers maintained assets that exceeded the benefit obligations.
Benefit obligations under these arrangements were $1.8 billion as of June 30, 2009. Approximately
76% of these guarantees are reinsured by an affiliate of the buyer of the retirement benefits
business. The remaining guarantees are provided by the Company with minimal reinsurance from third
parties. There were no additional liabilities required for these guarantees as of June 30, 2009.
Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the GAAP
fair value hierarchy. See Note 8 for further information on the fair value hierarchy.
Other Financial Guarantees
Guaranteed minimum income benefit contracts. The Company’s reinsurance operations, which were
discontinued in 2000 and are now an inactive business in run-off mode, reinsured minimum income
benefits under certain variable annuity contracts issued by other insurance companies. A
contractholder can elect the guaranteed minimum income benefit (GMIB) within 30 days of any
eligible policy anniversary after a specified contractual waiting period. The Company’s exposure
arises when the guaranteed annuitization benefit exceeds the annuitization benefit based on the
policy’s current account value. At the time of annuitization, the Company pays the excess (if any)
of the guaranteed benefit over the benefit based on the current account value in a lump sum to the
direct writing insurance company.
In periods of declining equity markets or declining interest rates, the Company’s GMIB liabilities
increase. Conversely, in periods of rising equity markets and rising interest rates, the Company’s
liabilities for these benefits decrease.
The Company estimates the fair value of the GMIB assets and liabilities using assumptions for
market returns and interest rates, volatility of the underlying equity and bond mutual fund
investments, mortality, lapse, annuity election rates, non-performance risk, and risk and profit
charges. Assumptions were updated beginning with January 1, 2008 to reflect the requirements of
SFAS No. 157. See Note 8 for additional information on how fair values for these liabilities and
related receivables for retrocessional coverage are determined.
The Company is required to disclose the maximum potential undiscounted future payments for
guarantees related to minimum income benefits. Under these guarantees, the future payment amounts
are dependent on equity and bond fund market and interest rate levels prior to and at the date of
annuitization election, which must occur within 30 days of a policy anniversary, after the
appropriate waiting period. Therefore, the future payments are not fixed and determinable under
the terms of the contract. Accordingly, the Company has estimated the maximum potential
undiscounted future payments using hypothetical adverse assumptions, defined as follows:
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The maximum potential undiscounted payments that the Company would make under those assumptions
would aggregate $1.5 billion before reinsurance recoveries. The Company expects the amount of
actual payments to be significantly less than this hypothetical undiscounted aggregate amount. The
Company has retrocessional coverage in place from two external reinsurers which covers 55% of the
exposures on these contracts. The Company bears the risk of loss if its retrocessionaires do not
meet or are unable to meet their reinsurance obligations to the Company.
Certain Other Guarantees. The Company had indemnification obligations to lenders of up to $243
million as of June 30, 2009 related to borrowings by certain real estate joint ventures which the
Company either records as an investment or consolidates. These borrowings, which are nonrecourse to
the Company, are secured by the joint ventures’ real estate properties with fair values in excess
of the loan amounts and mature at various dates beginning in 2009 through 2017. The Company’s
indemnification obligations would require payment to lenders for any actual damages resulting from
certain acts such as unauthorized ownership transfers, misappropriation of rental payments by
others or environmental damages. Based on initial and ongoing reviews of property management and
operations, the Company does not expect that payments will be required under these indemnification
obligations. Any payments that might be required could be recovered through a refinancing or sale
of the assets. In some cases, the Company also has recourse to partners for their proportionate
share of amounts paid. There were no liabilities required for these indemnification obligations as
of June 30, 2009.
As of June 30, 2009, the Company guaranteed that it would compensate the lessors for a shortfall of
up to $44 million in the market value of certain leased equipment at the end of the lease.
Guarantees of $28 million expire in 2012 and $16 million expire in 2016. The Company had liabilities for these guarantees of $7 million as of June 30, 2009.
As part of the reinsurance and administrative service arrangements acquired from Great West Life
and Annuity, Inc., the Company is responsible to pay claims for the group medical and long-term
disability business of Great-West Healthcare and collect related amounts due from their third party
reinsurers. Any such amounts not collected will represent additional assumed liabilities of the
Company and decrease shareholders’ net income if and when these amounts are determined
uncollectible. At June 30, 2009, there were no receivables recorded for paid claims due from third
party reinsurers for this business and unpaid claims related to this business were estimated at $25
million.
The Company had indemnification obligations as of June 30, 2009 in connection with acquisition and
disposition transactions. These indemnification obligations are triggered by the breach of
representations or covenants provided by the Company, such as representations for the presentation
of financial statements, the filing of tax returns, compliance with law or the identification of
outstanding litigation. These obligations are typically subject to various time limitations,
defined by the contract or by operation of law, such as statutes of limitation. In some cases, the
maximum potential amount due is subject to contractual limitations based on a percentage of the
transaction purchase price, while in other cases limitations are not specified or applicable. The
Company does not believe that it is possible to determine the maximum potential amount due under
these obligations, since not all amounts due under these indemnification obligations are subject to
limitation. There were no liabilities required for these indemnification obligations as of June
30, 2009.
The Company does not expect that these guarantees will have a material adverse effect on the
Company’s consolidated results of operations, liquidity or financial condition.
Regulatory and Industry Developments
Employee benefits regulation. 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. Regulation and judicial decisions have resulted in
changes to industry and the Company’s business practices and will continue to do so in the future.
In addition, the Company’s subsidiaries are routinely involved with various claims, lawsuits and
regulatory and IRS audits and investigations that could result in financial liability, changes in
business practices, or both. Health care regulation in its various forms could have an adverse
effect on the Company’s health care operations if it inhibits the Company’s ability to respond to
market demands or results in increased medical or administrative costs without improving the
quality of care or services.
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Other possible regulatory and legislative changes or judicial decisions that could have an adverse
effect on the Company’s employee benefits businesses include:
The employee benefits industry remains under scrutiny by various state and federal government
agencies and could be subject to government efforts to bring criminal actions in circumstances that
could previously have given rise only to civil or administrative proceedings.
Concentration of risk. For the Company’s International segment, South Korea is the single largest
geographic market. South Korea generated 29% of the segment’s revenues for the second quarter of
2009 and 27% for the six months ended June 30, 2009. South Korea generated 55% of the segment’s
earnings for the second quarter of 2009 and 46% of the segment’s earnings for the six months ended
June 30, 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 segment’s results and the Company’s consolidated financial results.
Litigation and Other Legal Matters
The Company is routinely involved in numerous claims, lawsuits, regulatory and IRS audits,
investigations and other legal matters arising, for the most part, in the ordinary course of the
business of administering and insuring employee benefit programs including payments to providers
and benefit level disputes. Litigation of income tax matters is accounted for under the provisions
of FIN No. 48, Accounting for Uncertainty in Income Taxes. Further information can be found in
Note 15. An increasing number of claims are being made for substantial non-economic,
extra-contractual or punitive damages. The outcome of litigation and other legal matters is always
uncertain, and outcomes that are not justified by the evidence can occur. The Company believes
that it has valid defenses to the legal matters pending against it and is defending itself
vigorously. Nevertheless, it is possible that resolution of one or more of the legal matters
currently pending or threatened could result in losses material to the Company’s consolidated
results of operations, liquidity or financial condition.
Managed care litigation. On April 7, 2000, several pending actions were consolidated in the United
States District Court for the Southern District of Florida in a multi-district litigation
proceeding captioned In re Managed Care Litigation challenging, in general terms, the mechanisms
used by managed care companies in connection with the delivery of or payment for health care
services. The consolidated cases include Shane v. Humana, Inc., et al., Mangieri v. CIGNA
Corporation, Kaiser and Corrigan v. CIGNA Corporation, et al. and Amer. Dental Ass’n v. CIGNA Corp.
et al.
In 2004, the court approved a settlement agreement between the physician class and CIGNA. However,
a dispute over disallowed claims under the settlement submitted by a representative of certain
class member physicians is in arbitration. Separately, in 2005, the court approved a settlement
between CIGNA and a class of non-physician health care providers. Only the American Dental
Association case remains unresolved. On March 2, 2009, the Court dismissed five of the six counts
of the complaint with prejudice. On March 20, 2009, the Court declined to exercise supplemental
jurisdiction over the remaining state law claim and dismissed the case. Plaintiffs filed a notice
of appeal on April 17, 2009. CIGNA denies the allegations and will continue to vigorously defend
itself.
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CIGNA has received insurance recoveries related to this litigation. In 2008, the trial court ruled
that the Company is not entitled to insurance recoveries from one of the two insurers from which
the Company is pursuing further recoveries. CIGNA appealed that decision and on June 3, 2009, the
Superior Court of Pennsylvania reversed the trial court’s decision, remanding the case to the trial
court for further proceedings. The insurer continues to challenge this decision and is seeking
re-argument before the Superior Court of Pennsylvania.
Broker compensation. Beginning in 2004, the Company, other insurance companies and certain
insurance brokers received subpoenas and inquiries from various regulators, including the New York
and Connecticut Attorneys General, the Florida Office of Insurance Regulation, the U.S. Attorney’s
Office for the Southern District of California and the U.S. Department of Labor relating to their
investigations of insurance broker compensation. CIGNA is cooperating with the inquiries and
investigations.
On August 1, 2005, two CIGNA subsidiaries, Connecticut General Life Insurance Company and Life
Insurance Company of North America, were named as defendants in a multi-district litigation
proceeding, In re Insurance Brokerage Antitrust Litigation, consolidated in the United States
District Court for the District of New Jersey. The complaint alleges that brokers and insurers
conspired to hide commissions, increasing the cost of employee benefit plans, and seeks treble
damages and injunctive relief. Numerous insurance brokers and other insurance companies are named
as defendants. In 2008, the court ordered the clerk to enter judgment against plaintiffs and in
favor of the defendants. Plaintiffs have filed an appeal. CIGNA denies the allegations and will
continue to vigorously defend itself.
Amara cash balance pension plan litigation. On December 18, 2001, Janice Amara filed a class
action lawsuit, now captioned Janice C. Amara, Gisela R. Broderick, Annette S. Glanz, individually
and on behalf of all others similarly situated v. CIGNA Corporation and CIGNA Pension Plan, in the
United States District Court for the District of Connecticut against CIGNA Corporation and the
CIGNA Pension Plan on behalf of herself and other similarly situated participants in the CIGNA
Pension Plan affected by the 1998 conversion to a cash balance formula. The plaintiffs allege
various ERISA violations including, among other things, that the Plan’s cash balance formula
discriminates against older employees; the conversion resulted in a wear away period (during which
the pre-conversion accrued benefit exceeded the post-conversion benefit); and these conditions are
not adequately disclosed in the Plan.
In 2008, the court issued a decision finding in favor of CIGNA Corporation and the CIGNA Pension
Plan on the age discrimination and wear away claims. However, the court found in favor of the
plaintiffs on many aspects of the disclosure claims and ordered an enhanced level of benefits from
the existing cash balance formula for the majority of the class, requiring class members to receive
their frozen benefits under the pre-conversion CIGNA Pension Plan and their accrued benefits under
the post-conversion CIGNA Pension Plan. The court also ordered, among other things, pre-judgment
and post-judgment interest. The court has stayed implementation of the decision until the parties’
appeals have been exhausted. Both parties have appealed the court’s decisions. In the second
quarter of 2008, the Company recorded a charge of $80 million pre-tax ($52 million after-tax),
which principally reflects the Company’s current best estimate of the liabilities related to the
court order. The Company will continue to vigorously defend itself in this case.
Ingenix. On February 13, 2008, State of New York Attorney General Andrew M. Cuomo announced an
industry-wide investigation into the use of data provided by Ingenix, Inc., a subsidiary of
UnitedHealthcare, used to calculate payments for services provided by out-of-network providers.
The Company received four subpoenas from the New York Attorney General’s office in connection with
this investigation and responded appropriately. On February 17, 2009, the Company entered into an
Assurance of Discontinuance resolving the investigation. In connection with the industry-wide
resolution, the Company will contribute $10 million to the establishment of a new non-profit
company that will compile and provide the data currently provided by Ingenix. In addition, on
March 28, 2008, the Company received a voluntary request for production of documents from the
Connecticut Attorney General’s office seeking certain out-of-network claim payment information.
The Company has responded appropriately. Since January 2009, the Company has received and is
responding to inquiries regarding the use of Ingenix data from the Texas Attorney General and the
Departments of Insurance in Illinois, Florida, Vermont, Georgia, Pennsylvania, Connecticut and
Alaska.
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The Company is also a defendant in two putative class actions brought on behalf of members (Franco
et al. v. Connecticut General Life Insurance Co. et al. and Chazen et al. v. Connecticut General
Life Insurance Co. et al.), and five putative class actions brought on behalf of providers (AMA et
al. v. Connecticut General Life Insurance Co. et al., Shiring et al. v. CIGNA Corp. et al., Pain
Management and Surgery Center of Southern Indiana et al. v. CIGNA Corp. et al, Higashi v.
Connecticut General Life Insurance Co. et al. and North Peninsula Surgical Center v. Connecticut
General Life Insurance Co. et al.), asserting that due to the use of Ingenix data, the Company
improperly underpaid claims, an industry-wide issue. The Franco putative class action, filed on
March 22, 2004 in the United States District Court for the District of New Jersey, asserts claims
under ERISA and the RICO statute on behalf of members of CIGNA plans. Plaintiff seeks to recover
alleged underpayments in relation to out-of-network claims for the period from 1998 to present. In
2008, the court denied the Company’s motion to dismiss for lack of standing while indicating that
the named plaintiff’s unique situation might undermine her adequacy as a class representative. On
August 15, 2008, a second putative member class action was filed in the same court as Franco on
behalf of a different class representative, David Chazen. The Chazen complaint asserts claims under
ERISA and New Jersey state law for the time period 2002 to present. On February 9, 2009, the AMA
putative provider class action was filed in the same court as Franco and Chazen. The complaint
asserts claims under ERISA, the RICO statute and the Sherman Antitrust Act for the time period 2005
to the present. On April 17, 2009, a second putative provider class action, Shiring, was filed in
the same court, asserting claims on behalf of non-physician providers for the time period 2005 to
present. On June 17, 2009, the court consolidated the Franco, Chazen, AMA and Shiring cases and
issued a case management order providing for coordinated discovery, with class certification to be
litigated in March and April of 2010. On April 14, 2009, a third putative provider class action,
Pain Management and Surgery Center of Southern Indiana, was filed in the United States District
Court for the Southern District of Indiana, asserting claims under ERISA, the RICO statute and the
Sherman Antitrust Act, which was amended on June 26, 2009. The alleged damages period is 2005 to
the present. On June 17, 2009, a fourth putative provider class action, Higashi, was filed in the
United States District Court for the Central District of California, asserting claims under the
RICO statute and the Sherman Antitrust Act for the time period 2005 to the present. On July 6,
2009, a fifth putative provider class action, North Peninsula Surgical Center, was also filed in
the United States District Court for the Central District of California, asserting claims under
ERISA, the Sherman Antitrust Act and state unfair competition law for the time period 2005 to the
present.
On June 9, 2009, CIGNA filed motions in the United States District Court for the Southern District
of Florida to enforce the Managed Care MDL settlement by enjoining the RICO and antitrust causes of
action alleged in the AMA, Shiring and Pain Management cases on the ground that they arose prior to
and were released in the April, 2004 settlement. A parallel motion
was filed in the Higashi matter on July 28, 2009.
It is reasonably possible that others could initiate additional litigation or additional regulatory
action against the Company with respect to use of data provided by Ingenix, Inc. The Company
denies the allegations asserted in the investigations and litigation and will vigorously defend
itself in these matters.
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INTRODUCTION
In this filing and in other marketplace communications, CIGNA Corporation and its subsidiaries (the
Company) make certain forward-looking statements relating to the Company’s financial condition and
results of operations, as well as to trends and assumptions that may affect the Company.
Generally, forward-looking statements can be identified through the use of predictive words (e.g.,
“Outlook for 2009”). Actual results may differ from the Company’s predictions. Some factors that
could cause results to differ are discussed throughout Management’s Discussion and Analysis (MD&A),
including in the Cautionary Statement beginning on page 76. The forward-looking statements
contained in this filing represent management’s current estimate as of the date of this filing.
Management does not assume any obligation to update these estimates.
The following discussion addresses the financial condition of the Company as of June 30, 2009,
compared with December 31, 2008, and its results of operations for the second quarter of 2009 and
six months ended June 30, 2009 compared with the same periods last year. This discussion should be
read in conjunction with Management’s Discussion and Analysis included in the Company’s 2008 Form
10-K, to which the reader is directed for additional information.
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 and restatements 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.
Overview
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.
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Ongoing Operations
The Company generates revenues, shareholders’ net income and cash flow from ongoing operations by:
The Company’s ability to increase revenue, shareholders’ net income and operating cash flow is
directly related to its ability to execute on its strategic initiatives, the success of which is
measured by certain key factors as discussed below.
Key factors affecting the Company’s results from ongoing operations include:
Run-off Operations
Effectively managing the various exposures of its run-off operations is important to the Company’s
ongoing profitability, operating cash flows and available capital. The results are influenced by a
range of economic factors, especially movements in equity markets and interest rates. Results are
also influenced by behavioral factors, including future partial surrender election rates for
guaranteed minimum death benefits (GMDB) contracts and annuity election rates for guaranteed
minimum income benefits (GMIB) contracts, as well as the collection of amounts recoverable from
retrocessionaires. In order to substantially reduce the impact of equity market movements, the
Company operates a GMDB equity hedge program. The Company actively monitors the performance of the
hedge program, and evaluates the cost/benefit of hedging other risks. The Company also actively
studies policyholder behavior experience and adjusts future expectations based on the results of
the studies, as warranted. The Company also performs regular audits of the ceding companies to
ensure treaty compliance that premiums received and claims paid are properly reflective of the
underlying risks and to maximize the probability of subsequent collection of claims from
retrocessionaires. Finally, the Company monitors the credit standing of the retrocessionaires.
Summary
The Company’s overall results are influenced by a range of economic and other factors, especially:
The Company regularly monitors the trends impacting operating results from the above mentioned key
factors and economic and other factors affecting its operations. The Company develops strategic and
tactical plans designed to improve performance and maximize its competitive position in the markets
it serves. The Company’s ability to achieve its financial objectives is dependent upon its ability
to effectively execute these plans and to appropriately respond to emerging economic and
company-specific trends.
The Company seeks to improve the performance of and profitably grow its ongoing businesses and
manage the risks associated with the run-off reinsurance operations.
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Acquisition of Great-West Healthcare
On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc.
(“Great-West Healthcare” or the “acquired business”) through 100% indemnity reinsurance agreements
and the acquisition of certain affiliates and other assets and liabilities of Great-West
Healthcare. The purchase price was approximately $1.5 billion and consisted of a payment to the
seller of approximately $1.4 billion for the net assets acquired and the assumption of net
liabilities under the reinsurance agreement of approximately $0.1 billion. Great-West Healthcare
primarily sells medical plans on a self-funded basis with stop-loss coverage to select and regional
employer groups. Great-West Healthcare’s offerings also include the following specialty products:
stop-loss, life, disability, medical, dental, vision, prescription drug coverage, and accidental
death and dismemberment insurance. The acquisition, which was accounted for as a purchase, was
financed through a combination of cash and the issuance of both short and long-term debt.
See Note 3 to the Consolidated Financial Statements for additional information.
Initiatives to Lower Operating Expenses
During the second quarter of 2009, the Company continued its previously announced comprehensive
review of its ongoing businesses. As a result, in the second quarter of 2009 the Company recognized
in other operating expenses a total charge of $14 million pre-tax ($9 million after-tax), for
severance resulting from reductions of 465 positions in its workforce. The Company expects to pay
substantially all of this charge in cash during 2009. The Health Care segment reported
substantially all of this charge. As a result of these actions, the Company expects annualized
after-tax savings of approximately $15 million beginning in 2010.
CONSOLIDATED RESULTS OF OPERATIONS
FINANCIAL SUMMARY
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Special Items
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,
presented below are special items, which management believes are not representative of the
underlying results of operations.
SPECIAL ITEMS
See Note 12 to the Consolidated Financial Statements for additional information related to the
curtailment gain and Note 6 to the Consolidated Financial Statements for further discussion of the
cost reduction charge. The other special item for 2009 is a result of the completion of the 2005
and 2006 IRS examinations. See Note 15 to the Consolidated Financial Statements for additional
information.
See Note 17 to the Consolidated Financial Statements for further discussion of the litigation
charge associated with the pension plan reported in the second quarter of 2008. The remaining
special item for 2008 consisted of charges related to certain litigation matters which were
reported in the Health Care segment.
Overview of Consolidated Results of Operations
Three Months Ended June 30, 2009 Compared with Three Months ended June 30, 2008
Shareholders’ income from continuing operations for the three months ended June 30, 2009 increased
significantly compared with the three months ended June 30, 2008, as a result of:
Six Months Ended June 30, 2009 Compared with Six Months ended June 30, 2008
Shareholders’ income from continuing operations was also significantly higher for the six months
ended June 30, 2009. In addition to the items cited above related to the three months ended June
30, the increase for the six months resulted from:
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Partially offsetting these favorable effects were higher net realized investment losses in 2009
primarily due to higher asset write-downs and the absence of a significant gain on the sale of real
estate reported in the first quarter of 2008, partially offset by gains on sales of fixed
maturities. See the Investment Assets section of the MD&A beginning on page 70 for more
information.
Outlook for 2009
The Company expects full-year 2009 shareholders’ income from continuing operations, excluding
realized investment results, the results of the GMIB business, and special items, to be higher than
2008 due to lower losses in the Run-off Reinsurance segment. Overall earnings in the ongoing
operating segments are expected to be slightly higher than 2008. This outlook includes an
assumption that results of the GMDB business will be approximately break-even for the remainder of
2009. This assumption reflects Management’s view that the long-term reserve assumptions are
appropriate and that equity market conditions and volatility will continue to be stable for the
remainder of 2009. The Company’s outlook is subject to the factors cited in the Cautionary
Statement and the sensitivities discussed in the Critical Accounting Estimates section of the MD&A
in the Company’s 2008 Form 10-K. If unfavorable equity market and interest rate movements or
changes in assumptions occur, the Company could experience additional losses related to the GMDB
business.
Information is not available for management to reasonably estimate the future results of the GMIB
business, realized investment gains (losses), or to identify or reasonably estimate special items
in 2009. However, if unfavorable equity market and interest rate movements occur, the Company
could also experience additional losses related to the GMIB business and investment impairments.
Potential losses related to the GMDB and GMIB businesses, as well as investment impairments, could
adversely impact the Company’s consolidated results of operations and financial condition, and
could reduce the capital of the Company’s insurance subsidiaries as well as their dividend paying
capabilities. Special items for the remainder of 2009 may include
potential charges associated with the previously announced cost
reduction plan, as well as litigation related items.
Revenues
Total revenue decreased by 8% for the three months ended June 30, 2009, compared with three months
ended June 30, 2008 and 2% for the six months ended June 30, 2009 compared with the six months
ended June 30, 2008. Changes in the components of total revenue are described more fully below.
Premiums and Fees
Premiums and fees decreased by 5% for the three months ended June 30, 2009, compared with the three
months ended June 30, 2008, primarily reflecting membership declines in the Health Care segment
largely due to disenrollment. See segment reporting discussions for additional detail and drivers.
For the six months ended June 30, 2009, premiums and fees were level with the six months ended June
30, 2008, reflecting the effect of the acquired business in the first quarter of 2009 and growth in
the Disability and Life segment, offset by membership declines in Health Care and the unfavorable
effect of foreign currency translation in International.
Net Investment Income
Net investment income decreased 2% for the three months ended June 30, 2009, compared with the
three months ended June 30, 2008 primarily due to lower yields driven by declines in short-term
interest rates and lower income from real estate funds, which reflects declines in market values
due to the deterioration in economic conditions. These factors were partially offset by higher
invested assets.
For the six months ended June 30, 2009, net investment income declined 8% compared with the six
months ended June 30, 2008. In addition to the factors cited for the three months ended June 30,
2009, lower income from security partnerships negatively affected net investment income for the six
months.
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Mail Order Pharmacy Revenues
Mail order pharmacy revenues increased 10% for the three months ended June 30, 2009, compared with
the three months ended June 30, 2008 and 8% for the six months ended June 30, 2009 compared with
the six months ended June 30, 2008. These increases were primarily due to higher volume and, to a
lesser extent, rate increases.
Other Revenues
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, other
revenues were nearly level for the three months and six months ended June 30, 2009, compared with the
same periods last year. The Company reported losses of $188 million for the three months ended and
$71 million for the six months ended June 30, 2009 associated with the GMDB equity hedge program,
compared with gains of $6 million for the three months ended June 30, 2008 and $48 million for the
six months ended June 30, 2008. The losses in 2009 reflect increases in stock market values, while
the gains in 2008 primarily reflect declines in stock market values.
Realized Investment Results
Realized investment results for the three months ended June 30, 2009 were level with the three
months ended June 30, 2008. For the six months ended June 30, 2009, realized investment losses
were substantially higher than for the six months ended June 30, 2008, primarily due to higher
asset write-downs and the absence of a significant gain on the sale of real estate reported in the
first quarter of 2008, partially offset by gains on sales of fixed maturities. In addition, for
the six months ended June 30, 2009, the Company reported higher losses associated with its hybrid
securities which are reported in other realized investment losses. These losses primarily reflect
continued market pressure in the financial sector. See Note 9 to the Consolidated Financial
Statements for additional information.
CRITICAL ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in accordance with accounting principles
generally accepted in the United States of America (GAAP) requires management to make estimates and
assumptions that affect reported amounts and related disclosures in the consolidated financial
statements. Management considers an accounting estimate to be critical if:
Management has discussed the development and selection of its critical accounting estimates with
the Audit Committee of the Company’s Board of Directors and the Audit Committee has reviewed the
disclosures presented below.
The Company’s most critical accounting estimates, as well as the effects of hypothetical changes in
material assumptions used to develop each estimate, are described in the Company’s 2008 Form 10-K
beginning on page 49 and are as follows:
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The Company regularly evaluates items which may impact critical accounting estimates. During the
six months ended June 30, 2009, the Company updated the following critical accounting estimates:
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Investments — Fixed Maturities. Losses for “other-than-temporary” impairments of fixed
maturities must be recognized in shareholders’ net income based on an estimate of fair value or the
present value of expected cash flows by management. Determining whether a decline in value is
“other-than-temporary” includes an evaluation of the reasons for, the significance of, and the
duration of the decrease in value of the security and the Company’s intent to sell or likelihood of
requirement to sell the security before recovery. For all fixed maturities with cost in excess of
their fair value, if this excess was determined to be “other-than-temporary”, the Company’s
shareholders’ net income as of June 30, 2009 would have decreased by $249 million after-tax. See
Note 9 to the Consolidated Financial Statements for more information.
Summary
There are other accounting estimates used in the preparation of the Company’s Consolidated
Financial Statements, including estimates of liabilities for future policy benefits other than
those identified above, as well as estimates with respect to unpaid claims and claim expenses,
post-employment and postretirement benefits other than pensions, certain compensation accruals and
income taxes.
Management believes the current assumptions used to estimate amounts reflected in the Company’s
Consolidated Financial Statements are appropriate. However, if actual experience differs from the
assumptions used in estimating amounts reflected in the Company’s Consolidated Financial
Statements, the resulting changes 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 liquidity and the Company’s financial condition.
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SEGMENT REPORTING
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.
Health Care Segment
Segment Description
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
FINANCIAL SUMMARY
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Excluding the special items noted in the table above, the Health Care segment’s earnings for
the second quarter of 2009 were lower than the same period last year, primarily due to:
These unfavorable effects were largely offset by:
Segment earnings for the six months ended June 30, 2009, as compared with the six months ended June
30, 2008, were favorably impacted by the absence of the following items recorded in the first
quarter of 2008:
Excluding these items and the special items noted in the table above, segment earnings for the six
months ended June 30, 2009 were slightly higher compared to the six months ended June 30, 2008
reflecting:
These favorable effects were largely offset by:
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Revenues
The table below shows premiums and fees for the Health Care segment:
Premiums and fees decreased 7% for the second quarter of 2009 and were essentially level for
the six months ended June 30, 2009, compared with the same periods of 2008, primarily reflecting
lower membership largely due to disenrollment, particularly in the guaranteed cost and
experience-rated businesses.
This impact was partially offset by rate increases and favorable revenue yields, as well as
membership growth in the Medicare private fee for services product.
Net investment income decreased 13% for the second quarter of 2009 and 20% for the six months ended
June 30, 2009 compared with the same periods of 2008, primarily reflecting lower real estate
income, with the six months ended results also impacted by lower security partnership income.
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.
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Benefits and Expenses
Health Care segment benefits and expenses consist of the following:
Medical claims expense decreased 9% for the second quarter of 2009 and 4% for the six months
ended June 30, 2009 compared with the same periods in 2008 largely due to lower membership,
particularly on experience-rated and guaranteed cost business; partially offset by increases in
medical expense related to claim trend and Medicare member driven growth.
Other operating expenses include expenses related to:
Excluding the items noted above, other operating expenses for the second quarter of 2009 were lower
than the same period last year reflecting both volume related declines as well as a reduction in
baseline expenses. Operating expenses increased for the six months ended June 30, 2009, compared
with the six months ended June 30, 2008, primarily due to expenses related to the acquired business
(effective April 1, 2008), as well as a modest increase in information technology related expenses.
Other Items Affecting Health Care Results
Medical Membership
The Company’s medical membership includes any individual for whom the Company retains medical
underwriting risk, who uses the Company’s network for services covered under their medical coverage
or for whom the Company administers medical claims. As of June 30, estimated medical membership
was as follows:
The net decrease in the Company’s medical membership is 7% as of June 30, 2009 when compared
with June 30, 2008, primarily driven by disenrollment across all funding arrangements as a result
of the current economic environment.
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Operational Improvement Initiatives
The Company is focused on several initiatives including developing and enhancing a customer focused
service model. This effort is expected to require significant investments over the next 3 to 5
years. These investments are expected to enable the Company to grow its membership and to improve
operational effectiveness and profitability by developing innovative products and services that
promote customer engagement at a competitive cost. Executing on these operational improvement
initiatives is critical to attaining a leadership position in the health care marketplace.
The operational improvement initiatives currently underway are discussed below.
Reducing other operating expenses. The Company operates in an intensely competitive marketplace
and its ability to establish a fully competitive cost advantage is key to achieving its
initiatives. Accordingly, the Company is focused on reducing operating expenses in three key areas
primarily to facilitate operating efficiency and responsiveness to customers. These three areas
include: customer acquisition, which encompasses spending on sales, the account management process,
underwriting and marketing; fulfillment, mainly claims processing and billing; and reducing
overhead in various administrative and staffing functions. In connection with these efforts, in
the fourth quarter of 2008, the Company completed a review of staffing levels and organization and
announced a plan to reorganize its business model and supporting areas to more tightly align the
ongoing operating segments. During the second quarter of 2009 the Company continued its review of
operating expenses in the HealthCare segment, identifying additional job eliminations, in order to
meet the challenges and opportunities presented by the current economic environment.
Maintaining and upgrading information technology systems. The Company’s current business model and
long-term strategy require effective and reliable information technology systems. The Company’s
current systems architecture will require continuing investment to meet the challenges of
increasing customer demands from both our existing and emerging customer base to support its
business growth and strategies, improve its competitive position and provide appropriate levels of
service to customers. The Company is focused on providing these enhanced strategic capabilities in
response to increasing customer expectations, while continuing to provide a consistent, high
quality customer service experience with respect to the Company’s current programs. Accordingly, in
2009, the Company’s efforts will be focused primarily on optimizing the technology underlying our
claims processing and call servicing capabilities with specific emphasis on reducing handling time
and improving customer service. Continued integration of the Company’s multiple administrative
and customer facing platforms is also required to support the Company’s growth strategies, and to
ensure reliable, efficient and effective customer service both in today’s employer focused model as
well as in a customer directed model. The Company’s ability to effectively deploy capital to make
these investments will influence the timing and the impact these initiatives will have on its
operations.
Profitable
sales and customer retention. The Company continues to focus
on selling profitable new business and retaining current customers by:
The Company is also focused on segment and product expansion. With respect to segment expansion,
our focus is predominantly in the “Select” (employers with 51-250 employees), and individual
segments. As part of its effort to achieve these objectives, the Company completed the acquisition
of Great-West Healthcare of Denver, Colorado on April 1, 2008. This acquisition will enable the
Company to broaden its distribution reach and provider network, particularly in the western regions
of the United States, and expand the range of health benefits and product offerings.
The Company has also recently developed new product offerings for its guaranteed cost and
experienced-rated portfolios. These offerings will provide our employer customers with lower-cost
options for providing medical, pharmacy and dental benefits.
Driving additional cross-selling is also key to our integrated benefits value proposition. We are
expanding network access for our dental product and improving network flexibility to ensure better
alignment with our customers’ needs. Also, with the acquisition of Great-West Healthcare, we will
be working in 2009 to transition this book to CIGNA pharmacy and increase pharmacy penetration
across the entire book.
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Offering products that meet emerging customer and market trends. In order to meet emerging customer
and market trends, the Company’s suite of products (CIGNATURE®, CareAllies®, and CIGNA Choice
Fund®) offers various options to customers and employers and is key to our customer engagement
strategy. Offerings include: choice of benefit, participating provider network, funding, medical
management, and health advocacy options. Through the CIGNA Choice Fund®, the Company offers a set
of customer-directed capabilities that includes options for health reimbursement arrangements
and/or health savings accounts and enables customers to make effective health decisions using
information tools provided by the Company.
Underwriting and pricing products effectively. One of the Company’s key priorities is to achieve
strong profitability in a competitive health care market. The Company is focused on effectively
managing pricing and underwriting decisions at both the case and overall book of business level,
particularly for the guaranteed cost book, as well as its experience-rated, ASO businesses and stop
loss coverages.
Effectively managing medical costs. The Company operates under a centralized medical management
model, which helps facilitate consistent levels of care for its members and reduces infrastructure
expenses.
The Company is focused on continuing to effectively manage medical utilization and unit costs. The
Company believes that by increasing the quality of medical care and improving access to care we can
drive reductions in total medical cost and better outcomes, resulting in healthier members. To
help achieve this, the Company continues to focus on contracting with providers, enhancing clinical
activities, as well as engaging our members and clients/employers. In addition, the Company seeks
to strengthen its network position in selected markets. In connection with the Great-West
Healthcare acquisition in April 2008, the Company has made significant progress converting and
integrating these acquired members to its extensive preferred provider network which offers access
to a broad range of utilization review and case management services at a reduced medical cost. The
integration is progressing well, with savings from medical cost management initiatives (including
contract integration and enhancement of clinical activities) projected to be on target, with most
to be achieved by the end of 2009.
Delivering quality member and provider service. The Company is focused on delivering competitive
service to members, providers and customers. The Company believes that further enhancing quality
service can improve member retention and, when combined with useful health information and tools,
can help motivate members to become more engaged in their personal health, and will help promote
healthy outcomes thereby removing cost from the system. The evolution of the consumer-driven
healthcare market is driving increased product and service complexity and is raising customers’
expectations with respect to service levels, which is expected to require significant investment,
management attention and heightened interaction with customers.
The Company is focused on the development and enhancement of a service model that is capable of
meeting the challenges brought on by the increasing product and service complexity and the
heightened expectations of health care customers. The Company continues to make significant
investments in the development and implementation of systems and technology to improve the member
and provider service experience, enhance its capabilities and improve its competitive position.
The Company’s health advocacy capabilities support its recent membership growth efforts. The
Company must be able to deliver those capabilities efficiently and cost-effectively. The Company
continues to identify additional cost savings to further improve its competitive cost position.
Savings generated from the Company’s operating efficiency initiatives provide capital to make
investments that will enhance its capabilities in the areas of customer engagement, particularly
product development, the delivery of member service and health advocacy and related technology.
Disability and Life Segment
Segment Description
The Disability and Life segment includes group disability, life, accident and specialty insurance
and case management services for disability and workers’ compensation.
Key factors for this segment are:
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Results of Operations
FINANCIAL SUMMARY
Segment earnings for the three months ended June 30, 2009 include the favorable after-tax
impact of reserve studies of $20 million, which primarily reflects strong results from disability
management programs over the past several years, resulting in improved resolution rates. Results
also include the favorable after-tax impact of special items of $3 million. Segment earnings for
the three months ended June 30, 2008 include the favorable after-tax impact of reserve studies of
$8 million, also reflecting strong results from disability management programs. Excluding the
impact of reserve studies and special items, segment earnings increased due to favorable life,
disability and accident claims experience partially offset by lower net investment income.
Segment earnings for the six months ended June 30, 2009 include the favorable after-tax impact of
reserve studies of $29 million and special items of $8 million. Segment earnings for the six
months ended June 30, 2008 include the favorable after-tax impact of reserve studies of $11
million. Excluding the impact of reserve studies and special items, segment earnings decreased due
to lower investment income, higher expenses and less favorable life claims experience, partially
offset by favorable accident claims experience.
Revenues
Premiums and fees increased 4% and 5% respectively, for the three and six months ended June 30,
2009 reflecting new sales growth and solid customer retention in the disability and life lines of
business, partially offset by less favorable customer retention in the specialty line of business.
Net investment income decreased 5% for the three months ended June 30, 2009 reflecting lower yields
and 8% for the six months ended June 30, 2009 reflecting lower yields and lower real estate and
security partnership income.
Benefits and Expenses
Benefits and expenses include the favorable pre-tax impact of reserve studies and special items of
$33 million for the three months ended June 30, 2009 and $11 million for the three months ended
June 30, 2008. Excluding the impact of the reserve studies and special items, benefits and
expenses increased 1%, primarily reflecting disability and life business growth offset by more
favorable life, disability and accident claims experience. The more favorable life claims
experience was driven by lower mortality in the group life business offset by the higher average
size of death claims. The more favorable disability claims experience was driven by higher
resolutions partially offset by higher new claims. The expense ratio reflects effective operating
expense management offset by investments in the claim operations and strategic information
technology initiatives.
Benefits and expenses include the favorable pre-tax impact of reserve studies and special items of
$46 million for the six months ended June 30, 2009 and $16 million for the six months ended June
30, 2008. Excluding the impact of the reserve studies and special items, benefits and expenses
increased 5%, primarily reflecting disability and life business growth, less favorable life claims
experience partially offset by a slightly lower expense ratio and more favorable accident claims
experience. The less favorable life claims experience was driven by a higher average size of
death claims. The lower expense ratio reflects effective operating expense management offset by
investments in the claim operations and strategic information technology initiatives.
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International Segment
Segment Description
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
FINANCIAL SUMMARY
During the second quarter of 2009, the Company’s International Segment implemented a 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. Segment earnings
reflect favorable tax adjustments of $14 million for the implementation of this strategy and $5
million related to the ongoing impact of the lower tax rate on the permanently invested earnings
for the second quarter of 2009 and the six months ended June 30, 2009. Excluding the impact of the
Korean tax adjustments, the impact of foreign currency movements and the special items noted above,
International segment earnings increased 6% for the second quarter of 2009 and 1% for the six
months ended June 30, 2009, compared with the same periods last year. The increase in the second
quarter of 2009 and for six months ended June 30, 2009 was primarily driven by strong fundamental
revenue growth in the life, accident and supplemental health insurance business and the expatriate
employee benefits business, partially offset by unfavorable claims experience in both businesses.
Margins in the life, accident and supplemental health business and the expatriate employee benefits
businesses remained competitively strong. The impact of foreign currency movements is calculated
by comparing the reported results to what the results would have been had the exchange rates
remained constant with the prior year’s comparable period exchange rates.
Revenues
Premiums and fees. The decrease in premiums and fees of 4% for the second quarter of 2009 and 6%
for the six months ended June 30, 2009, compared with the same periods last year, was primarily
attributable to unfavorable currency movements partially offset by 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. These results also continue to reflect
appropriate renewal pricing on existing business.
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Premiums and fees, excluding the effect of foreign currency movements, were $527 million for the
second quarter of 2009 and $1,055 million for the six months ended June 30, 2009, compared with
$483 million for the second quarter of 2008 and $946 million for the six months ended June 30,
2008.
Benefits and Expenses
Benefits and expenses decreased 3% for the second quarter of 2009 and 4% for the six months ended
June 30, 2009, compared with the same periods last year, primarily due to foreign currency
movements and lower expenses partially offset by business growth, higher loss ratios and increased
amortization of acquisition costs.
Loss ratios increased for the second quarter of 2009 and for the six months ended June 30, 2009, in
the life accident and supplemental health and the expatriate benefits businesses due to unfavorable
claims experience.
Policy acquisition expenses decreased for the second quarter of 2009 and the six months ended June
30, 2009 in the life, accident and supplemental health business due to foreign currency movements,
partially offset by business growth and higher amortization of deferred acquisition costs
associated with lower persistency.
Expense ratios decreased for the second quarter of 2009 and six months ended June 30, 2009,
reflecting effective expense management and foreign currency movements.
Other Items Affecting International Results
For the Company’s International segment, South Korea is the single largest geographic market. South
Korea generated 29% of the segment’s revenues for the second quarter of 2009 and 27% for the six
months ended June 30, 2009. South Korea generated 55% of the segment’s earnings for the second
quarter of 2009 and 46% of the segment’s earnings for the six months ended June 30, 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 segment’s results and the Company’s consolidated financial results.
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Run-off Reinsurance Segment
Segment Description
The Company’s reinsurance operations were discontinued and are now an inactive business in run-off
mode since the sale of the U.S. individual life, group life and accidental death reinsurance
business in 2000. This segment is predominantly comprised of guaranteed minimum death benefit
(GMDB, also known as VADBe), guaranteed minimum income benefit (GMIB), workers’ compensation and
personal accident reinsurance products.
The determination of liabilities for GMDB and GMIB required the Company to make critical accounting
estimates. 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 8 to the Consolidated Financial Statements.
Results of Operations
FINANCIAL SUMMARY
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