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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 March 31, 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 o 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 April 17, 2009, 272,776,207 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 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.
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 three months ended March 31, 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 three months ended March 31, 2008 represented $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
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 three months ended March 31, 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 Financial Accounting Standards
Board Staff Position (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 earnings per share data have been
restated to reflect the adoption of this FSP. For the three months ended March 31, 2008, diluted
EPS related to shareholders’ net income was reduced by $.01 compared with the previously reported
amount. Other EPS amounts for the three months ended March 31, 2008 were unchanged.
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 9 for information on
the Company’s derivative financial instruments including these additional required disclosures.
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Fair value measurements. Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements.” This standard expands disclosures about fair value measurements and clarifies how
to measure fair value by focusing on the price that would be received when selling an asset or paid
to transfer a liability (exit price). In addition, the Financial Accounting Standards Board (FASB)
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 7 for information on
the Company’s fair value measurements.
The Company carries certain financial instruments at fair value in the financial statements
including approximately $11.8 billion in invested assets at March 31, 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 7 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.
In addition, the FASB recently amended SFAS No. 157 to 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. The Company does not expect
material changes to their fair value measurements when this new guidance is adopted as required in
the second quarter of 2009.
Other-than-temporary impairments. In 2009, the FASB issued FASB FSP No. FAS 115-2 and FAS 124-2,
“Recognition and Presentation of Other-Than-Temporary Impairments,” to improve the accounting and
reporting for other-than-temporary impairments (impairment), particularly for debt securities that
are expected to recover a portion of their decline in fair value over their holding period. Under
these new requirements, an impairment has occurred if the fair value of a debt security is less
than its amortized cost and:
In the first situation, an impairment is recognized in shareholders’ net income equal to the entire
difference between the debt security’s fair value and amortized cost. In the second situation,
this new guidance requires that an impairment be recognized in shareholders’ net income for the
expected credit loss (the excess of the debt security’s amortized cost over the present value of
the cash flows expected to be collected). In addition, any non-credit loss (the present value of
the cash flows expected to be collected less fair value) is reported in a separate component of
accumulated other comprehensive income within shareholders’ equity. At adoption, a
reclassification adjustment from retained earnings to accumulated other comprehensive income is
required for impaired debt securities that meet the second situation. This reclassification
adjustment is measured as any non-credit losses less related tax effects as of the adoption date.
Finally, new and expanded quarterly disclosures about impaired securities and their credit and
non-credit losses are required.
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The Company will adopt this new impairment guidance as required on April 1, 2009. Although the
Company continues to evaluate these new requirements and emerging implementation guidance, the
cumulative effect of adoption for impaired securities held on
April 1, 2009 is currently not expected
to have a material impact on retained earnings or accumulated other comprehensive
income, with no net change to total shareholders’ equity.
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.
As part of the reinsurance and administrative service arrangements, the Company is responsible to
pay claims for the group medical and long-term disability business of Great-West Healthcare and
collect related amounts due from their third party reinsurers. Any such amounts not collected will
represent additional assumed liabilities of the Company and decrease shareholders’ net income if
and when these amounts are determined uncollectible. At March 31, 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 $26 million.
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, 2007. The pro forma information does not purport to
represent what the Company’s actual results would have been if the acquisition had occurred as of
the date indicated or what such results would be for any future periods.
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Note 4 — Earnings Per Share
Basic and diluted earnings per share were computed as follows:
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.
There was no change to previously reported earnings per share from shareholders’ income from
continuing operations.
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 78,169,190 shares of common stock in Treasury as of March 31, 2009, and 70,130,685
shares as of March 31, 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 10 for
additional information on reinsurance. For the three months ended March 31, 2009, actual experience
differed from the Company’s key assumptions resulting in favorable incurred claims related to prior
years’ medical claims payable of $40 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 $17 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 $23 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 factor and medical cost trend
variances is primarily due to the release of the provision for moderately adverse conditions, which
is a component of the assumptions for both completion factors and medical cost trend, established
for claims incurred related to prior years. This release was substantially offset by the 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 ended March 31, 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 — 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.
The Company had future policy benefit reserves for GMDB contracts of $1.8 billion as of March 31,
2009, and $1.6 billion as of December 31, 2008. The increase in reserves during the first quarter
of 2009 is primarily due to declines in the equity market driving down the value of the underlying
mutual fund investments.
In the first quarter of 2009, the Company reported a loss related to GMDB of $75 million pre-tax
($49 million after-tax), which included a charge of $73 million pre-tax ($47 million after-tax) to
strengthen GMDB reserves following an analysis of experience. The components of the charge
included the following:
Management estimates reserves for GMDB exposures based on assumptions regarding lapse, future
partial surrenders, mortality, interest rates (mean investment performance and discount rate) and
volatility. These assumptions are based on the Company’s experience and future expectations over
the long-term period. The Company monitors actual experience to update these reserve estimates as
necessary.
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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.
The determination of liabilities for GMDB requires the Company to make critical accounting
estimates. The Company regularly evaluates the assumptions used in establishing reserves and
changes its estimates if actual experience or other evidence suggests that earlier assumptions
should be revised. If actual experience differs from the assumptions (including lapse, future
partial surrenders, mortality, interest rates and volatility) used in estimating these reserves,
the resulting change could have a material adverse effect on the Company’s consolidated results of
operations, and in certain situations, could have a material adverse effect on the Company’s
financial condition.
The following provides information about the Company’s reserving methodology and assumptions for
GMDB as of March 31, 2009:
Activity in future policy benefit reserves for these GMDB contracts 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.
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As of March 31, 2009, the aggregate value of the underlying mutual fund investments was $14.4
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 630,000 contractholders had died on that
date) was $11.9 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 March 31, 2009 was $1.2 billion. The
Company recorded in Other revenues pre-tax gains of $117 million for the three months ended March
31, 2009, and $42 million for the three months ended March 31, 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 7 for further
information.
Note 7 — 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 SFAS No. 157. 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 March 31, 2009 and December 31, 2008 about the
Company’s financial assets and liabilities measured at fair value on a recurring basis. SFAS No.
157 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
and asset-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 and asset-backed
securities, inputs and assumptions may also include characteristics of the issuer, collateral
attributes, prepayment speeds and credit rating.
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 March 31, 2009 or December 31, 2008. The nature and
use of these other derivatives are described in Note 9.
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 8% as of March 31, 2009 and 7% as of
December 31, 2008 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.
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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:
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 March 31, 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.
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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 March 31, 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.
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 ended March 31, 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.
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As noted in the table 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.
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 table 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 driven by a decrease in the net GMIB liability of $32 million for the three months
ended March 31, 2009 was primarily due to increases in interest rates since December 31, 2008 of
$78 million, partially offset by:
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Excluding the one-time implementation effect of adopting SFAS No. 157, the net loss driven by an
increase in the net GMIB liability of $102 million for the three months ended March 31, 2008 was
primarily due to:
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 March 31,
2009 and December 31, 2008 separate account assets were as follows:
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.
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The following table summarizes the changes in separate account assets reported in Level 3 for the
three months ended March 31, 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. As of March 31, 2009 and December 31, 2008, the
amounts required to adjust these assets and liabilities to their fair values were not significant.
Note 8 — Investments
Realized Investment Gains and Losses
The following realized gains and losses on investments exclude amounts required to adjust future
policy benefits for run-off settlement annuity business:
Included in pre-tax realized investment gains (losses) above were asset write-downs and changes in
valuation reserves as follows:
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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 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.
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 for
impairment based on criteria that include:
Excluding trading and hybrid securities, as of March 31, 2009 fixed maturities with a decline in
fair value from cost (which were primarily investment grade corporate bonds) were as follows,
including the length of time of such decline:
The unrealized depreciation of investment grade fixed maturities is primarily due to increases in
market yields since purchase. Approximately $365 million of the unrealized depreciation is due to
securities with a decline in value of greater than 20%. Approximately 80% of these securities had
been in that position for less than six months. The remaining $284 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 March 31, 2009.
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Note 9 — 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
(GMIB) and to enhance investment returns. See Note 6 for a discussion of derivatives associated
with GMDB contracts and Note 7 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 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 (OTC) 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 March 31, 2009 was $9 million for which the Company was not
required to post collateral. If the contingent features underlying the agreements were triggered
as of March 31, 2009, the Company would be required to post collateral of $7 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 March 31, 2009, the net liability position under such derivative
instruments was less than $1 million.
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 months ended March 31, 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 10 — 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
March 31, 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
held in a trust established for the benefit of the Company. As of March 31, 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 March 31, 2009 and 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 March 31, 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 $302 million as of
March 31, 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 March 31, 2009, the Company’s
recoverables related to these segments were net of a reserve of $12 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 7 and 16 for
additional discussion of the GMIB assets and liabilities).
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The reinsurance recoverables for GMDB, workers’ compensation, and personal accident of $178 million
as of March 31, 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 March 31, 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 March 31, 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 11 — Pension and Other Postretirement Benefit Plans
The Company’s postretirement benefit liability adjustment decreased by $7 million pre-tax ($4
million after-tax) for the three months ended March 31, 2009, and $6 million pre-tax ($3 million
after-tax) for the three months ended March 31, 2008, resulting in increases to shareholders’
equity. The decrease in the liability for each period was primarily due to net amortization of
actuarial losses.
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 $300 million in domestic
pension plan contributions in the first quarter of 2009, and expects to make additional
contributions of $110 million for the remainder of 2009.
Other postretirement benefits. Components of net other postretirement benefit cost were as
follows:
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Note 12 — Debt
Under a universal shelf registration statement filed with the Securities and Exchange Commission
(SEC), the Company issued $300 million of 6.35% Notes on March 4, 2008 (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:
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 March 31, 2009, the Company had $373 million in commercial paper
outstanding at a weighted average interest rate of 2.70%.
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Note 13 — Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) excludes amounts required to adjust future policy
benefits for run-off settlement annuity business. Changes in accumulated other comprehensive
income (loss) were as follows:
Note 14 — Income Taxes
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 reflects 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 by $39 million during the first quarter of 2009, primarily
due to the completion of the 2005 and 2006 IRS examinations. However, as noted above, the effect
on shareholders’ net income was only $8 million related to the completion of the IRS examinations.
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 $6
million in the first quarter of 2009.
Over the next 12 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 considered 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 12 months. The
Company, however, is currently unable to reasonably estimate the potential impact of such changes.
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During the first quarter of 2009, final resolution was reached for one of the two disputed issues
associated with the IRS examination of the 2003 and 2004 consolidated federal income tax returns.
The second of these disputed matters remains unresolved and will be proceeding to litigation. Due
to the nature of the litigation process, the timing of the resolution of this matter is uncertain.
In addition, two unresolved issues remain from the IRS examination of the 2005 and 2006
consolidated federal income tax returns, which have now moved to the administrative appeals level.
One of these unresolved issues is the same matter which remains in dispute from the prior IRS
examination.
The Company has historically accrued U.S. income taxes on the undistributed earnings of foreign
subsidiaries because the Company has not considered such earnings to be permanently invested
overseas. Management is currently assessing whether undistributed earnings of certain foreign
operations may meet the “permanently invested overseas” criteria and, if so, the Company’s
consolidated effective tax rate may decrease in future reporting periods.
Note 15 — 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 16 — 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 March 31, 2009, employers maintained assets that exceeded the benefit obligations.
Benefit obligations under these arrangements were $1.8 billion as of March 31, 2009. Approximately
77% 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 March 31, 2009.
Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the SFAS
No. 157 fair value hierarchy. See Note 7 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 effective January 1, 2008 to reflect the requirements of SFAS
No. 157. See Note 7 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 $1.8 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 $203
million as of March 31, 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 March 31, 2009.
As of March 31, 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
additional liabilities for these guarantees of $5 million as of March 31, 2009.
The Company had indemnification obligations as of March 31, 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 March
31, 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.
Other possible regulatory and legislative changes or judicial decisions that could have an adverse
effect on the Company’s employee benefits businesses include:
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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 26% of the segment’s revenues for the three months ended
March 31, 2009. South Korea generated 32% of the segment’s earnings for the three months ended
March 31, 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. 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 14. 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.
CIGNA has received insurance recoveries related to this litigation. In 2008, the 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 has appealed that decision.
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.
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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 is responding 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 and Georgia.
The Company is also a defendant in 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 three 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. and Pain
Management and Surgery Center of Southern Indiana et al. v. CIGNA Corp. 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 federal district court in 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. The parties are conducting significant discovery, and we expect the class
certification hearing to occur in the third quarter of 2009. On August 15, 2008, a second putative
member class action was filed in federal district court in New Jersey 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 federal district court in New Jersey. 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 federal district
court in New Jersey, asserting claims on behalf of non-physician providers for the time period 2005
to present. On April 14, 2009, a third putative provider class action, Pain Management and
Surgery Center of Southern Indiana, was filed in federal district court in Indiana, asserting
claims under ERISA, the RICO statute and the Sherman Antitrust Act. The alleged damages period is
1999 to the present for the ERISA claims and 2005 to the present for the RICO and Antitrust claims.
The Company denies the allegations asserted in the investigations and litigation and will
vigorously defend itself in these matters.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INDEX
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 59. 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 March 31, 2009,
compared with December 31, 2008, and its results of operations for the three months ended March 31,
2009 compared with the same period 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 manage these risks, the Company operates a GMDB equity hedge
program to substantially reduce the impact of equity market movements. The Company actively
monitors the performance of the hedge program, and evaluates the cost/benefit of hedging other
risks. The Company also actively studies policyholder behavior experience and adjusts future
expectations based on the results of the studies, as warranted. We also perform regular audits of
the ceding companies to ensure treaty compliance that premiums received and claims paid are
properly reflective of the underlying risks and to maximize the probability of subsequent
collection of claims from retrocessionaires. Finally, the Company monitors the credit standing of
the retrocessionaires.
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.
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
The special item for 2009 is a result of the completion of the 2005 and 2006 IRS examinations.
See Note 14 to the Consolidated Financial Statements for additional information.
The special item for 2008 consisted of charges related to certain litigation matters which were
reported in the Health Care segment.
Overview of March 31, 2009 Consolidated Results of Operations
Shareholders’ income from continuing operations for the first three months of 2009 increased
significantly compared with the first three months of 2008, as a result of:
Partially offsetting these favorable effects were lower segment earnings in the remaining segments
and higher net realized investment losses in 2009 primarily due to the absence of a significant
gain on the sale of real estate reported in the first quarter of 2008. See the Investment Assets
section of the MD&A beginning on page 56 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 in line with 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 stabilize in 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 the unfavorable equity market and interest rate movements continue, the Company could
experience additional losses related to the GMDB business.
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Information is not available for management to reasonably estimate the future results of the GMIB
business, realized investment gains (losses), or to identify or reasonably estimate special items
in 2009. However, if unfavorable equity market and interest rate movements continue, the Company
could also experience additional losses related to the GMIB business and investment impairments.
Potential losses related to the GMDB and GMIB businesses, as well as investment impairments, could
adversely impact the 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 impacts associated with a cost
reduction initiative, employee benefits changes and debt-related expenses.
Revenues
Total revenue increased by 4% for the first three months of 2009, compared with the first three
months of 2008. Changes in the components of total revenue are described more fully below.
Premiums and Fees
Premiums and fees increased by 5% for the first three months of 2009, compared with the first three
months of 2008 reflecting the impact of the acquired business and growth in the Disability and Life
segment. See segment reporting discussions for additional detail and drivers.
Net Investment Income
Net investment income decreased 14% in the first three months of 2009, compared with the first
three months of 2008 primarily due to lower yields driven by declines in short-term interest rates
and lower income from security partnerships and real estate funds, which reflects declines in
market values due to the deterioration in economic conditions.
Mail Order Pharmacy Revenues
Mail order pharmacy revenues increased 5% in the first three months of 2009, compared with the
first three months of 2008 due to rate increases.
Other Revenues
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, other
revenues were level in the first three months of 2009, compared with the first three months of
2008. In 2009, the Company reported gains of $117 million associated with the GMDB equity hedge
program, compared with gains of $42 million in 2008. The gains in 2009 and 2008 primarily reflect
the declines in stock market values.
Realized Investment Results
Realized investment results in the first three months of 2009 were lower than the first three
months of 2008, primarily due to the absence of a real estate gain reported in the first three
months of 2008. In addition, the Company reported higher losses associated with its hybrid
securities for which fair value changes are reported in realized investment losses. These losses
primarily reflect continued market pressure in the financial sector. See Note 8 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.
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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:
The Company regularly evaluates items which may impact critical accounting estimates. During the
three months ended March 31, 2009, the Company updated the following critical accounting estimates:
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 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 ability and intent to hold the security until 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 March 31, 2009 would have decreased by approximately $420
million after-tax. See Note 8 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.
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:
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Results of Operations
FINANCIAL SUMMARY
The Health Care segment’s earnings for the three months ended March 31, 2009, as compared with the
three months ended March 31, 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
three months ended March 31, 2009 were higher compared to the three months ended March 31, 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 increased by 8% for the three months ended March 31, 2009, compared with the
three months ended March 31, 2008, primarily reflecting:
These factors were partially offset by decreases due to membership declines in the experience-rated
and guaranteed cost business, with the latter driven by commercial HMO, both partially offset by
rate increases.
Net investment income decreased by 28% for the three months ended March 31, 2009 compared with the
three months ended March 31, 2008 primarily reflecting lower real estate and 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 increased 2% for the three months ended March 31, 2009 compared with the
three months ended March 31, 2008 largely due to the impact of the acquired business and membership
growth in the Medicare private fee for service business. In addition, medical trend was largely
offset by lower risk and experience-rated membership.
Other operating expenses include expenses related to:
Excluding the items noted above, other operating expenses increased for the three months ended
March 31, 2009, compared with the three months ended March 31, 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 March 31, 2009, estimated medical
membership was as follows:
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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. The Company expects to take additional actions during 2009 to further
reduce operating expenses and improve its competitive cost position in the marketplace. These
actions could include additional job eliminations through consolidation of functions and real
estate locations, purchasing-related activities and employee benefit changes.
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.
Profitably growing medical membership. The Company continues to focus on growing its medical
membership by:
The Company is also focused on segment and product expansion. In segments, our focus is
predominantly in the “Select” (employers with 51-250 employees), small business (employers with
2-50 employees) and individual segments. We also expect to expand our voluntary capabilities and to
focus on health as well as pharmacy and dental. As part of its effort to achieve these objectives,
the Company completed the acquisition of Great-West Healthcare of Denver, Colorado on April 1,
2008. Also, our Star HRG acquisition serves as our platform to further develop our voluntary
portfolio. These acquisitions will enable the Company to broaden its distribution reach and
provider network, particularly in the western regions of the United States, and expand the range of
health benefits and product offerings. Additionally, the Company has recently developed new product
offerings for both our guaranteed cost and experienced-rated portfolios. Driving additional cross
selling is also key to our value proposition. We are expanding network access for our dental
product and improving network flexibility to ensure better alignment with our customers’ needs.
Also, with the acquisition of Great-West Healthcare, we will be working in 2009 to transition this
book to CIGNA pharmacy and increase penetration across the entire book.
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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 and experience-rated businesses.
Effectively managing medical costs. The Company operates under a centralized medical management
model, which helps facilitate consistent levels of care for its members and reduces infrastructure
expenses.
The Company is focused on continuing to effectively manage medical utilization and unit costs. The
Company believes that by increasing the quality of medical care and improving access to care we can
drive reductions in total medical cost 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 include the favorable after-tax impact of reserve studies of $9 million for the
three months ended March 31, 2009 and $3 million for the three months ended March 31, 2008.
Excluding the impact of reserve studies and the special item noted above, segment earnings
decreased due to less favorable life and disability claims experience, lower net investment income
and a slightly higher expense ratio, partially offset by favorable accident claims experience.
Revenues
Premiums and fees increased 6% for the three months ended March 31, 2009 reflecting new sales
growth and strong customer retention in the disability and life lines of business partially offset
by less favorable customer retention in the accident and specialty lines of business.
Net investment income decreased 11% for the three months ended March 31, 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 of $13 million for
the three months ended March 31, 2009 and $5 million for the three months ended March 31, 2008.
Excluding the impact of the reserve studies, benefits and expenses increased 9%, primarily
reflecting business growth and less favorable claims experience in the life and disability
businesses and a slightly higher expense ratio. The less favorable life claims experience was
driven by a higher average size of death claims. The less favorable disability claims experience
was driven by higher new claims partially offset by higher resolutions. The higher expense ratio
reflects investments in the claim operations and strategic information technology initiatives.
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:
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Results of Operations
FINANCIAL SUMMARY
Excluding the special item noted in the table above, International segment earnings decreased 21%
for the three months ended March 31, 2009, compared with the three months ended March 31, 2008.
The decrease is primarily due to unfavorable currency movements, mostly in South Korea, and
unfavorable claims experience in the expatriate benefits business, partially offset by strong
fundamental revenue growth and continued competitively strong margins in the life, accident and
supplemental health business. International segment earnings, excluding the impact of foreign
currency movements and the special item noted in the table above, decreased 4% for the three months
ended March 31, 2009 compared with the three months ended March 31, 2008. The impact of foreign
currency movements is calculated by comparing the reported results to what the results would have
been had the monthly average exchange rates remained constant with the prior year’s comparable
period exchange rates.
Revenues
Premiums and fees. The decrease in premiums and fees of 8% for the three months ended March 31,
2009 compared with the three months ended March 31, 2008 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.
Premiums and fees, excluding the effect of foreign currency movements, were: $528 million for the
three months ended March 31, 2009 and $464 million for the three months ended March 31, 2008.
Excluding the effect of foreign currency movements, premiums and fees increased 12% for the three
months ended March 31, 2009 compared with the three months ended March 31, 2008.
Benefits and Expenses
Benefits and expenses decreased 6% for the three months ended March 31, 2009 compared with the
three months ended March 31, 2008 primarily due to foreign currency movements, partially offset by
business growth in all lines of business, and higher loss ratios in the expatriate benefits
business.
Loss ratios increased in the expatriate benefits business for the three months ended March 31, 2009
compared with the three months ended March 31, 2008 due to claims volatility.
Expense ratios decreased for the three months ended March 31, 2009 compared with the three months
ended March 31, 2008 reflecting effective expense management.
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Other Items Affecting International Results
For the Company’s International segment, South Korea is the single largest geographic market. South
Korea generated 26% of the segment’s revenues and 32% of the segment’s earnings for the three
months ended March 31, 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.
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 6
to the Consolidated Financial Statements and for the assets and liabilities associated with GMIB in
Note 7 to the Consolidated Financial Statements.
Results of Operations
FINANCIAL SUMMARY
Segment losses for the three months ended March 31, 2009 included a gain from the GMIB business of
$23 million, and a loss from the GMDB business of $49 million. The gain in GMIB was primarily
related to increases in interest rates, partially offset by declines in equity markets and
decreases in lapse assumptions, while the loss in GMDB primarily reflects declines in equity
markets. Segment losses for the three months ended March 31, 2008 included GMIB losses of $195
million, including the charge on adoption of SFAS No. 157 and the impact of declines in equity
markets and interest rates. Excluding the results of the GMIB and GMDB businesses, segment
earnings for Run-off Reinsurance were lower for the three months ended March 31, 2009 than for the
three months ended March 31, 2008, reflecting reduced favorable settlement activity related to
personal accident and workers’ compensation.
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Other Revenues
Other revenues included pre-tax gains from futures contracts used in the GMDB equity hedge program
(see Note 6 to the Consolidated Financial Statements) of $117 million for the three months ended
March 31, 2009, compared with pre-tax gains of $42 million for the three months ended March 31,
2008. Amounts reflecting corresponding changes in liabilities for GMDB contracts were included in
benefits and expenses consistent with GAAP when a premium deficiency exists (see below “Other
Benefits and Expenses”). The notional amount of the futures contract positions held by the Company
at March 31, 2009 related to this program was $1.2 billion.
Benefits and Expenses
Benefits and expenses were comprised of the following:
GMIB Expense. Under SFAS No. 157, the Company’s results of operations are expected to be volatile
in future periods because assumptions will be based largely on market-observable inputs at the
close of each reporting period including interest rates (LIBOR swap curve) and market-implied
volatilities.
The GMIB business generated pre-tax gains of $32 million for the three months ended March 31, 2009
primarily as a result of increases in interest rates since December 31, 2008 of $78 million,
partially offset by:
Included in benefits and expenses for the three months ended March 31, 2008 was a pre-tax charge of
$202 million for the adoption of SFAS No. 157, which is discussed further in Note 2 to the
Consolidated Financial Statements. Excluding the one-time implementation effect of adopting SFAS No. 157, the net loss driven by an
increase in the net GMIB liability of $102 million for the three months ended March 31, 2008 was
primarily due to:
The GMIB liabilities and related assets are calculated using a complex internal model and
assumptions from the viewpoint of a hypothetical market participant. This resulting liability (and
related asset) is higher than the Company believes will ultimately be required to settle claims
primarily because market-observable interest rates are used to project growth in account values of
the underlying mutual funds to estimate fair value from the viewpoint of a hypothetical market
participant. The Company’s payments for GMIB claims are expected to occur over the next 15 to 20
years and will be based on actual values of the underlying mutual funds and the 7-year Treasury
rate at the dates benefits are elected. Management does not believe that current market-observable
interest rates reflect actual growth expected for the underlying mutual funds over that timeframe,
and therefore believes that the recorded liability and related asset do not represent what will
ultimately be required as this business runs off.
However, the significant decline in financial markets during the latter half of 2008 and into early
2009 has had an unfavorable impact on the GMIB business. Significant declines in mutual fund
values that underlie the contracts (increasing the exposure to the Company) together with declines
in the 7-year Treasury rate during 2008 (used to determine claim payments) increased the expected
amount of claims that will be paid out for contractholders who choose to annuitize while these
conditions continue. It is also possible that these unfavorable market conditions will have an
impact on the level of contractholder annuitizations, particularly if these unfavorable market
conditions persist for an extended period.
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Other Benefits and Expenses. For the three months ended March 31, 2009, the Company recorded
additional other benefits and expenses of $73 million ($47 million after-tax) primarily to
strengthen GMDB reserves following an analysis of experience. These amounts were primarily due to:
In addition to the reserve strengthening discussed above, other benefits and expenses were higher
for the three months ended March 31, 2009 than for the three months ended March 31, 2008 due to the
impact of changes in the equity markets on GMDB contracts. Equity market declines result in
decreases in the underlying annuity account values, which increases the exposure under the
contracts. Although equity markets decreased in both periods, the exposure over the three months
ended March 31, 2009 was higher, leading to higher benefits expense. These changes in benefits
expense are partially offset by futures gains and losses, discussed in Other Revenues above.
See Note 6 to the Consolidated Financial Statements for additional information about assumptions
and reserve balances related to GMDB.
Segment Summary
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 and GMIB, claim payments
vary because of changes in equity markets and interest rates, as well as mortality and policyholder
behavior. For workers’ compensation and personal accident, the claim payments relate to accidents
and injuries. Any of these claim payments can extend many years into the future, and the amount of
the ceding companies’ ultimate claims, and therefore the amount of the Company’s ultimate payment
obligations and corresponding ultimate collection from retrocessionaires may not be known with
certainty for some time.
The Company’s reserves for underlying reinsurance exposures assumed by the Company, as well as for
amounts recoverable from retrocessionaires, are considered appropriate as of March 31, 2009, based
on current information. However, it is possible that future developments, which could include but
are not limited to worse than expected claim experience and higher than expected volatility, could
have a material adverse effect on the Company’s consolidated results of operations and could have a
material adverse effect on the Company’s financial condition. The Company bears the risk of loss
if its payment obligations to cedents increase or if its retrocessionaires are unable to meet, or
successfully challenge, their reinsurance obligations to the Company.
Other Operations Segment
Segment Description
Other Operations consist of:
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Results of Operations
FINANCIAL SUMMARY
Segment earnings for Other Operations for the three months ended March 31, 2009 declined compared
with the three months ended March 31, 2008, reflecting lower COLI earnings driven by less favorable
mortality as well as continuing decline in deferred gain amortization associated with sold
businesses.
Corporate
Description
Corporate reflects amounts not allocated to segments, such as interest expense on corporate debt
and on uncertain tax positions, certain litigation matters, net investment income on investments
not supporting segment operations, intersegment eliminations, compensation cost for stock options
and certain corporate overhead expenses such as directors’ expenses.
FINANCIAL SUMMARY
Excluding the special item noted above (see Consolidated Results of Operations section of the MD&A
beginning on page 36 for more information on special items), Corporate losses were higher for the
three months ended March 31, 2009, compared with the three months ended March 31, 2008. The
increase in losses primarily reflects higher net interest expense attributable to lower average
invested assets and increased debt to finance the acquired business. In addition, directors’
expenses increased due to increases in the Company’s stock price in the first quarter of 2009
compared with a decrease in the first quarter of 2008.
DISCONTINUED OPERATIONS
Description
Discontinued operations represent results associated with certain investments or businesses that
have been sold or are held for sale.
Discontinued operations for the three months ended March 31, 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 three months ended March 31, 2008 represented $3 million
after-tax from the settlement of certain issues related to a past
divestiture.
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INDUSTRY DEVELOPMENTS AND OTHER MATTERS
The disability industry is under continuing review by regulators and legislators with respect to
its offset practices regarding Social Security Disability Insurance (“SSDI”). There has been
specific inquiry as to the industry’s role in assisting individuals with their applications for
SSDI. The Company has received one Congressional inquiry and has responded to the information
request. Also, legislation prohibiting the offset of SSDI payments against private disability
insurance payments for prospectively issued policies has been introduced in the Connecticut state
legislature. The Company is also involved in related pending litigation. If the industry is
forced to change its offset SSDI procedures, the practices and products for the Company’s
Disability & Life segment could be significantly impacted.
In 1998, the Company sold its individual life insurance and annuity business to Lincoln National
Life Insurance Company and its affiliates (“Lincoln”). Because this business was sold in an
indemnity reinsurance transaction, the Company is not relieved of primary liability for the
reinsured business and had reinsurance recoverables totaling $4.5 billion as of March 31, 2009.
Lincoln has secured approximately 90% of its reinsurance obligations under these arrangements by
placing assets into a trust which qualifies under Regulation 114 of the New York Insurance
Department.
The Company’s remaining reinsurance recoverables are unsecured. If Lincoln does not maintain a
specified financial strength rating, at the Company’s request, Lincoln is contractually required to
provide additional assurance that it will meet its reinsurance obligations, to include placing
assets in a trust to secure these remaining reinsurance recoverables.
Since the
filing of the Company’s 2008 Form 10-K, Moody’s has downgraded the financial strength rating
of the Lincoln affiliated reinsurer to A2 from A1 and S&P has downgraded its rating to AA- from AA. In
light of the downgrades, the Company is closely monitoring the situation.
Ratings
CIGNA and certain of its insurance subsidiaries are rated by nationally recognized rating agencies.
Ratings are always subject to change and there can be no assurance that CIGNA’s current ratings
will continue for any given period of time. As of April 30, 2009, the current ratings of CIGNA and
Connecticut General Life Insurance Company (CG Life), CIGNA’s principal subsidiary were as follows:
The above table reflects during the first three months of 2009: (1) the affirmation of CG Life’s
financial strength ratings at Moody’s and S&P and the affirmation of the Company’s senior debt
rating at Moody’s; and (2) downgrades to CG Life’s financial strength rating at Fitch and
downgrades to the Company’s debt ratings at S&P and Fitch.
CIGNA is committed to maintaining appropriate levels of capital in its subsidiaries to support
ratings that meet customers’ expectations, and to improving the earnings of the health care
business. Ratings downgrades of CG Life could adversely affect new sales and retention of current
business. Lower ratings at the parent company level would increase the cost to borrow funds.
There are certain other matters that present significant uncertainty, which could result in a
material adverse impact on the Company’s consolidated results of operations. See Note 16 to the
Consolidated Financial Statements for further information.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The Company maintains liquidity at two levels: the subsidiary level and the parent company level.
Liquidity requirements at the subsidiary level generally consist of:
The Company’s subsidiaries normally meet their operating requirements by:
Liquidity requirements at the parent level generally consist of:
The parent normally meets its liquidity requirements by:
Cash flows for the three months ended March 31, were as follows:
Cash flow from operating activities consists of cash receipts and disbursements for premiums and
fees, gains (losses) recognized in connection with the Company’s GMDB equity hedge program,
investment income, taxes, benefits and expenses.
Because certain income and expense transactions do not generate cash, and because cash transactions
related to revenue and expenses may occur in periods different from when those revenues and
expenses are recognized in shareholders’ net income, cash flow from operating activities can be
significantly different from shareholders’ net income. The Company assesses cash flows from
operating activities by comparing it with adjusted income from operations, which is defined as
shareholders’ income from continuing operations excluding the results of GMIB and special items,
and further adjusted to exclude pre-tax realized investment results as well as depreciation and
amortization charges.
Cash flows from investing activities generally consist of net investment purchases or sales and net
purchases of property and equipment, which includes capitalized software, as well as cash used to
acquire businesses.
Cash flows from financing activities is generally comprised of issuances and re-payment of debt at
the parent level, proceeds on the issuance of common stock resulting from stock option exercises,
and stock repurchases. In addition, the subsidiaries report net deposits/withdrawals to/from
investment contract liabilities (which include universal life insurance liabilities) because such
liabilities are considered financing activities with policyholders.
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2009:
Operating activities
For the three months ended March 31, 2009, cash flows from operating activities were less than
adjusted income from operations by $198 million. Cash flows from operating activities include cash
inflows of $117 million associated with the GMDB equity hedge program which did not affect
shareholders’ net income. Excluding those inflows, cash flows from operating activities were lower
than adjusted income from operations by $315 million, primarily reflecting contributions to the
qualified domestic pension plan of $300 million in the first quarter of 2009.
Cash flows from operating activities decreased by $280 million compared with the three months ended
March 31, 2008. Excluding the results of the GMDB equity hedge program (which did not affect
shareholders’ net income), cash flows from operating activities decreased by $355 million. This
decrease primarily reflects contributions to the qualified domestic pension plan of $300 million in
the first quarter of 2009.
Investing activities
Cash used in investing activities was $166 million. This use of cash primarily consisted of net
purchases of investments of $106 million and net purchases of property and equipment of $60
million.
Financing activities
Cash provided from financing activities primarily consisted of proceeds from the net issuance of
short-term debt of $74 million. These borrowing arrangements were entered into for general
corporate purposes. Financing activities also included net deposits to contractholder deposit
funds of $51 million.
2008:
Operating activities
For the three months ended March 31, 2008, cash flows from operating activities exceeded adjusted
income from operations by $39 million, primarily due to cash inflows of $42 million associated with
futures contracts used by the Run-off Reinsurance segment which did not effect shareholders’ net
income. Annual payments of incentive compensation in the first quarter were largely offset by the
absence of federal tax payments.
Investing activities
Cash used in investing activities was funded from cash flow from operating activities, and
primarily consisted of net purchases of investments of $88 million and net purchases of property and
equipment of $68 million.
Financing activities
Cash provided from financing activities primarily consisted of proceeds from the net issuance of
short-term debt and long-term debt of $248 million and $298 million, respectively. These borrowing
arrangements were entered into for general corporate purposes, including the financing of the
acquisition of Great-West Healthcare. Financing activities also included net deposits to
contractholder deposit funds of $50 million and proceeds from the issuance of common stock under
the Company’s stock plans of $33 million.
Interest Expense
Interest expense on long-term debt, short-term debt and capital leases was as follows:
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The increase in interest expense for the three months ended March 31, 2009 was primarily due to the
issuance of debt in connection with the Great-West Healthcare acquisition. At March 31, 2009, the
Company has recognized cumulative losses of $26 million pre-tax ($17 million after-tax) related to
its treasury rate lock derivative in accumulated other comprehensive income. The Company expects
to issue debt in the first half of 2009, and these cumulative losses would increase the effective
interest rate recognized over the life of the debt. If the Company is unable to issue debt in the
first half of 2009, this loss would be recognized as a reduction to results of operations in the
second quarter of 2009.
Capital Resources
The Company’s capital resources (primarily retained earnings and the proceeds from the issuance of
debt and equity securities) provide protection for policyholders, furnish the financial strength to
underwrite insurance risks and facilitate continued business growth.
Management, guided by regulatory requirements and rating agency capital guidelines, determines the
amount of capital resources that the Company maintains. Management allocates resources to new
long-term business commitments when returns, considering the risks, look promising and when the
resources available to support existing business are adequate.
The Company prioritizes its use of capital resources to:
The availability of capital resources will be impacted by equity and credit market conditions.
Extreme volatility in credit or equity market conditions may reduce the Company’s ability to issue
debt or equity securities. Significant volatility and deterioration of the equity markets during
2008 resulted in reduced retained earnings and reduced the capital available for growth,
acquisitions, and share repurchase.
On March 14, 2008, the Company entered into a new commercial paper program (“the Program”). Under
the Program, the Company is authorized to sell from time to time short-term unsecured commercial
paper notes up to a maximum of $500 million. The proceeds are used for general corporate purposes,
including working capital, capital expenditures, acquisitions and share repurchases. The Company
uses the credit facility described below as back-up liquidity to support the outstanding commercial
paper. If at any time funds are not available on favorable terms under the Program, the Company
may use the Credit Agreement (see below) for funding. In October 2008, the Company added an
additional dealer to its Program. As of March 31, 2009, the Company had $373 million in commercial
paper outstanding, at a weighted average interest rate of 2.70%.
On March 4, 2008, the Company issued $300 million of 6.35% Notes (with an effective interest rate
of 6.68% per year). Interest is payable on March 15 and September 15 of each year beginning
September 15, 2008. The proceeds of this debt were used for general corporate purposes, including
financing the acquisition of Great-West Healthcare. These Notes will mature on March 15, 2018.
The Company may redeem these Notes, at any time, in whole or in part, at a redemption price equal
to the greater of:
Liquidity and Capital Resources Outlook
At March 31, 2009, there was approximately $50 million in cash available at the parent company
level. For the remainder of 2009, the parent company’s debt service consists of scheduled interest
payments of approximately $105 million on outstanding long-term debt of $2.1 billion at March 31,
2009 and approximately $375 million of commercial paper that will mature over the next three
months. There are no scheduled long-term debt repayments in 2009. The Company expects to
refinance the commercial paper either by issuing long-term debt or re-issuing commercial paper. An
issuance of long-term debt would increase scheduled interest payments in 2009.
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The Company’s best estimate is that contributions to the domestic qualified pension plan for the
full year of 2009 will be approximately $410 million pre-tax. The parent company’s primary funding
sources for the full-year $410 million pre-tax contribution will be parent company tax benefits
related to pension contributions and subsidiary contributions to the parent equal to pre-tax GAAP
pension expense. The parent company would fund the estimated remaining $130 million net after-tax
contribution with ongoing parent company cash sources including, but not limited to, subsidiary
dividends.
During the first quarter of 2009, the Company contributed $300 million to its domestic qualified
pension plan to satisfy minimum funding requirements. The contribution was funded through a
combination of subsidiary dividends and short-term borrowings, both from subsidiaries and
externally. The remaining $110 million will be contributed quarterly over the remainder of 2009.
These estimates do not include funding requirements related to the litigation matter discussed in
Note 16 to the Consolidated Financial Statements, as management does not expect this matter to be
resolved in 2009. Future years’ contributions will ultimately be based on a wide range of factors
including but not limited to asset returns, discount rates, and funding targets.
The availability of resources at the parent company level is partially dependent on dividends from
the Company’s subsidiaries, most of which are subject to regulatory restrictions and rating agency
capital guidelines, and partially dependent on the availability of liquidity from the issuance of
debt or equity securities.
The Company expects, based on current projections for cash activity, to have sufficient liquidity
to meet its obligations.
However, the Company’s cash projections may not be realized and the demand for funds could exceed
available cash if:
In those cases, the Company expects to have the flexibility to satisfy liquidity needs through a
variety of measures, including intercompany borrowings and sales of liquid investments. The parent
company may borrow up to $400 million from Connecticut General Life Insurance Company (CGLIC)
without prior state approval. As of March 31, 2009, the parent company had borrowed $80 million
from CGLIC, which it expects to repay by the end of 2009. In addition, the Company may use
short-term borrowings, such as the commercial paper program and the committed line of credit
agreement of up to $1.75 billion subject to the maximum debt leverage covenant in its line of
credit agreement. As of March 31, 2009, the Company had an additional $800 million of borrowing
capacity within the maximum debt leverage covenant in the line of credit agreement in addition to
the $2.5 billion of debt outstanding as of March 31, 2009.
Though the Company believes it has adequate sources of liquidity, continued significant disruption
or volatility in the capital and credit markets could affect the Company’s ability to access those
markets for additional borrowings or increase costs associated with borrowing funds.
Solvency regulation. Many states have adopted some form of the National Association of Insurance
Commissioners (“NAIC”) model solvency-related laws and risk-based capital rules (“RBC rules”) for
life and health insurance companies. The RBC rules recommend a minimum level of capital depending
on the types and quality of investments held, the types of business written and the types of
liabilities incurred. If the ratio of the insurer’s adjusted surplus to its risk-based capital
falls below statutory required minimums, the insurer could be subject to regulatory actions ranging
from increased scrutiny to conservatorship.
In addition, various non-U.S. jurisdictions prescribe minimum surplus requirements that are based
upon solvency, liquidity and reserve coverage measures. During 2008, the Company’s HMOs and life
and health insurance subsidiaries, as well as non-U.S. insurance subsidiaries, were compliant with
applicable RBC and non-U.S. surplus rules.
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In 2008, the NAIC adopted Actuarial Guideline VACARVM, which will be effective December 31, 2009.
VACARVM will impact statutory and tax reserves for CIGNA’s GMDB and GMIB contracts. Upon
implementation, it is anticipated that statutory reserves for these contracts will increase and
thus statutory surplus for Connecticut General Life Insurance Company will be reduced. The
magnitude of any impact depends on equity market and interest rate levels at the time of
implementation.
Guarantees and Contractual Obligations
The Company, through its subsidiaries, is contingently liable for various contractual obligations
entered into in the ordinary course of business. See Note 16 to the Consolidated Financial
Statements for additional information.
Contractual obligations. The Company has updated its contractual obligations previously provided
on page 71 of the Company’s 2008 Form 10-K for certain items as follows:
INVESTMENT ASSETS
The Company’s investment assets do not include separate account assets. Additional information
regarding the Company’s investment assets and related accounting policies is included in Notes 2,
7, 8 and 13 to the Consolidated Financial Statements. More detailed information about the fixed
maturities and mortgage loan portfolios by type of issuer, maturity dates, and, for mortgages by
property type and location is included in Notes 2, 11, 12 and 15 to the Consolidated Financial
Statements in the Company’s 2008 Form 10-K.
Investments in fixed maturities (bonds) include publicly traded and privately placed debt
securities, mortgage and other asset-backed securities, preferred stocks redeemable by the investor
and trading securities. Fixed maturities and equity securities include hybrid securities. Fair
values are based on quoted market prices when available. When market prices are not available,
fair value is generally estimated using discounted cash flow analyses, incorporating current market
inputs for similar financial instruments with comparable terms and credit quality. In instances
where there is little or no market activity for the same or similar instruments, the Company
estimates fair value using methods, models and assumptions that the Company believes a hypothetical
market participant would use to determine a current transaction price.
The Company performs ongoing analyses on prices to conclude that they represent reasonable
estimates of fair value. This process involves quantitative and qualitative analysis and is
overseen by the Company’s investment professionals. This process also includes review of pricing
methodologies, pricing statistics and trends and backtesting recent trades.
As of March 31, 2009, the Company’s mix of investments and their primary characteristics have not
materially changed since December 31, 2008. The Company’s fixed maturity portfolio continues to be
diversified by issuer and industry type, with no single industry constituting more than 10% of
total invested assets as of March 31, 2009. The Company’s commercial mortgage loans continue to be
diversified by property type, location and borrower to reduce exposure to potential losses.
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Problem and Potential Problem Investments
“Problem” bonds and commercial mortgage loans are either delinquent by 60 days or more or have been
restructured as to terms (interest rate or maturity date). “Potential problem” bonds and
commercial mortgage loans are considered current (no payment more than 59 days past due), but
management believes they have certain characteristics that increase the likelihood that they may
become “problems.” These characteristics include, but are not limited to, the following:
The Company recognizes interest income on “problem” bonds and commercial mortgage loans only when
payment is actually received because of the risk profile of the underlying investment. The amount
that would have been reflected in net income if interest on non-accrual investments had been
recognized in accordance with the original terms was not significant for the three months ended
March 31, 2009 and 2008.
The following table shows problem and potential problem investments at amortized cost, net of
valuation reserves and write-downs:
Summary
The Company recorded after-tax realized investment losses for investment asset write-downs and
changes in valuation reserves as follows:
The U.S. and global financial markets continued to experience significant challenges in the first
quarter of 2009. While credit spreads eased modestly into quarter end, credit markets remain
uncertain and volatile with future prospects heavily reliant on the success of government policy
initiatives. Credit spreads remain at near historically high levels and market yields are elevated
in spite of near record low Treasury rates. Both debt and equity markets are expected to remain
volatile until confidence is restored. As a result of this economic environment, the credit risks
in the Company’s investment portfolio remain elevated.
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While market yield levels for new investments are higher, the market value of the Company’s
existing investment portfolio remains depressed. The Company’s corporate fixed maturity and
commercial mortgage loan portfolios are well diversified by borrower, sector, and geographic
region, limiting exposure. However, if broad economic conditions and/or illiquidity in the capital
markets persist or worsen, this would likely result in an increase in the severity and duration of
the decline in asset values, and may cause the Company to experience additional problem loans and
investment losses.
Commercial real estate market values have declined since our last in depth commercial mortgage
portfolio review was completed during the third quarter of 2008, which included a review of each
property’s December 31, 2007 audited financial statements, current rent rolls, a physical
inspection and other pertinent factors. Based on an evaluation of available market information,
average property value declines are currently estimated to be between 20% and 30%, depending upon
property type, asset quality, leasing, and geographic location. These declines will substantially
increase the portfolios’ loan to value ratio when the next in depth loan review is completed during
the third quarter of 2009. Applying a 30% decline to property values determined as of the last
portfolio review would result in 48 loans where the carrying value of the mortgage loan exceeds the
value of the underlying property by $117 million.
Although these estimated value declines increase loan to value ratios, all but one of the 184 loans
that comprises our total mortgage loan portfolio continue to perform under their contractual terms,
and the actual aggregate default rate is 1.6%. Given the quality and diversity of the underlying
real estate, positive debt service coverage, significant borrower cash investment averaging nearly
30%, and only $115 million of loans maturing in the next 12 months, the Company remains confident
that the vast majority of borrowers will continue to perform as required and the mortgage loan
portfolio will perform well competitively. Management does not expect potential losses to have a
material effect on current year’s shareholders’ net income or the Company’s financial condition.
The next in depth mortgage portfolio review is expected to be completed during the third quarter of
2009.
The value of the Company’s fixed maturity portfolio decreased $210 million in the first quarter of
2009 driven by changes in market yields. Current or further increases in market investment yields
for an extended period could cause the Company to recognize impairment losses if it cannot
demonstrate the intent and ability to hold certain investments until recovery. Future realized and
unrealized investment results will be impacted largely by market conditions that exist when a
transaction occurs or at the reporting date. These future conditions are not reasonably
predictable. Management believes that the vast majority of the Company’s fixed maturity
investments will continue to perform under their contractual terms, and that the recent declines in
their fair values are temporary. Based on the Company’s strategy to match the duration of invested
assets to the duration of insurance and contractholder liabilities, it has both the intent and
ability to hold these assets to recovery. Therefore, future credit related losses are not expected
to have a material adverse effect on the Company’s liquidity or financial condition.
MARKET RISK
Financial Instruments
The Company’s assets and liabilities include financial instruments subject to the risk of potential
losses from adverse changes in market rates and prices. The Company’s primary market risk
exposures are interest-rate risk, foreign currency exchange rate risk and equity price risk.
The Company uses futures contracts as part of a GMDB equity hedge program to substantially reduce
the effect of equity market changes on certain reinsurance contracts that guarantee minimum death
benefits based on unfavorable changes in underlying variable annuity account values. The
hypothetical effect of a 10% increase in the S&P 500, S&P 400, Russell 2000, NASDAQ, TOPIX
(Japanese), EUROSTOXX and FTSE (British) equity indices and a 10% weakening in the U.S. dollar to
the Japanese yen, British pound and euro would have been a decrease of approximately $120 million
in the fair value of the futures contracts outstanding under this program as of March 31, 2009. A
corresponding decrease in liabilities for GMDB contracts would result from the hypothetical 10%
increase in these equity indices and 10% weakening in the U.S. dollar. See Note 6 to the
Consolidated Financial Statements for further discussion of this program and related GMDB
contracts.
Stock Market Performance
The performance of equity markets can have a significant effect on the Company’s businesses,
including on:
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CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 The Company and its representatives may from time to time make written and oral forward-looking
statements, including statements contained in press releases, in the Company’s filings with the
Securities and Exchange Commission, in its reports to shareholders and in meetings with analysts
and investors. Forward-looking statements may contain information about financial prospects,
economic conditions, trends and other uncertainties. These forward-looking statements are based on
management’s beliefs and assumptions and on information available to management at the time the
statements are or were made. Forward-looking statements include but are not limited to the
information concerning possible or assumed future business strategies, financing plans, competitive
position, potential growth opportunities, potential operating performance improvements, trends and,
in particular, the Company’s productivity initiatives, litigation and other legal matters,
operational improvement in the health care operations, and the outlook for the Company’s full year
2009 results. Forward-looking statements include all statements that are not historical facts and
can be identified by the use of forward-looking terminology such as the words “believe”, “expect”,
“plan”, “intend”, “anticipate”, “estimate”, “predict”, “potential”, “may”, “should” or similar
expressions.
You should not place undue reliance on these forward-looking statements. The Company cautions that
actual results could differ materially from those that management expects, depending on the outcome
of certain factors. Some factors that could cause actual results to differ materially from the
forward-looking statements include:
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This list of important factors is not intended to be exhaustive. Other sections of the Company’s
2008 Annual Report on Form 10-K, including the “Risk Factors” section, and other documents filed
with the Securities and Exchange Commission include both expanded discussion of these factors and
additional risk factors and uncertainties that could preclude the Company from realizing the
forward-looking statements. The Company does not assume any obligation to update any
forward-looking statements, whether as a result of new information, future events or otherwise,
except as required by law.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information responsive to this item is contained under the caption “Market Risk” in Item 2 above,
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 4. CONTROLS AND PROCEDURES
Based on an evaluation of the effectiveness of CIGNA’s disclosure controls and procedures
conducted under the supervision and with the participation of CIGNA’s management, CIGNA’s Chief
Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered
by this report, CIGNA’s disclosure controls and procedures are effective to ensure that information
required to be disclosed by CIGNA in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules
and forms.
During the period covered by this report, there have been no changes in CIGNA’s internal
control over financial reporting that have materially affected, or are reasonably likely to
materially affect, CIGNA’s internal control over financial reporting.
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Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The information contained under “Litigation and Other Legal Matters” in Note 16 to CIGNA’s
Financial Statements is incorporated herein by reference.
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Item 1A. RISK FACTORS
CIGNA’s Annual Report on Form 10-K for the year ended December 31, 2008 includes a detailed
description of its risk factors.
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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information about CIGNA’s share repurchase activity for the quarter
ended March 31, 2009:
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Date: April 30, 2009
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INDEX TO EXHIBITS
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