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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2015

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

for the transition period from            to           

 

Commission file number 1-08323

 

Cigna Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

06-1059331

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

900 Cottage Grove Road Bloomfield, Connecticut

 

06002

(Address of principal executive offices)

 

(Zip Code)

(860) 226-6000

Registrant’s telephone number, including area code

(860) 226-6741

Registrant’s facsimile number, including area code

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark

 

YES

 

NO

 

· 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.

 

R

 

o

 

· 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).

 

R

 

o

 

· 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.

 

Large accelerated filer R

Accelerated filer o

Non-accelerated filer o

Smaller Reporting Company o

 

· whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

o

 

 

R

 

As of April 15, 2015, 257,367,068 shares of the issuer’s common stock were outstanding.

 



Table of Contents

 

Cigna Corporation

 

INDEX

 

 

 

 

PART I

FINANCIAL INFORMATION

Page

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

Consolidated Statements of Income

1

 

Consolidated Statements of Comprehensive Income

2

 

Consolidated Balance Sheets

3

 

Consolidated Statements of Changes in Total Equity

4

 

Consolidated Statements of Cash Flows

5

 

Notes to the Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

37

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

57

Item 4.

Controls and Procedures

58

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

59

Item 1.A.

Risk Factors

60

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 4.

Mine Safety Disclosures

61

Item 6.

Exhibits

62

SIGNATURE

63

INDEX TO EXHIBITS

E-1

 

 

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

 

 

 

Unaudited

 

 

 

Three Months Ended
March 31,

 

(In millions, except per share amounts)

 

2015

 

2014

 

Revenues

 

 

 

 

 

Premiums

 

$

7,402

 

$

6,676

 

Fees and other revenues

 

1,138

 

1,006

 

Net investment income

 

276

 

277

 

Mail order pharmacy revenues

 

578

 

495

 

Net realized investment gains

 

73

 

42

 

Total revenues

 

9,467

 

8,496

 

 

 

 

 

 

 

Benefits and Expenses

 

 

 

 

 

Global Health Care medical costs

 

4,604

 

4,031

 

Other benefit expenses

 

1,269

 

1,166

 

Mail order pharmacy costs

 

492

 

414

 

Other operating expenses

 

2,204

 

1,980

 

Amortization of other acquired intangible assets

 

44

 

52

 

Total benefits and expenses

 

8,613

 

7,643

 

Income before Income Taxes

 

854

 

853

 

Income taxes:

 

 

 

 

 

Current

 

308

 

310

 

Deferred

 

15

 

14

 

Total income taxes

 

323

 

324

 

Net Income

 

531

 

529

 

Less: Net Income (Loss) Attributable to Noncontrolling Interests

 

(2)

 

1

 

Shareholders’ Net Income

 

$

533

 

$

528

 

Shareholders’ Net Income Per Share:

 

 

 

 

 

Basic

 

$

2.08

 

$

1.96

 

Diluted

 

$

2.04

 

$

1.92

 

Dividends Declared Per Share

 

$

0.04

 

$

0.04

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

1



Table of Contents

 

Cigna Corporation

Consolidated Statements of Comprehensive Income

 

 

 

Unaudited

 

 

 

Three Months Ended
March 31,

 

(In millions)

 

2015

 

 

2014

 

Shareholders’ net income

 

$

533

 

 

$

528

 

Shareholders’ other comprehensive income:

 

 

 

 

 

 

Net unrealized appreciation, securities

 

88

 

 

86

 

Net unrealized appreciation, derivatives

 

7

 

 

-

 

Net translation of foreign currencies

 

(104)

 

 

(11)

 

Postretirement benefits liability adjustment

 

11

 

 

12

 

Shareholders’ other comprehensive income

 

2

 

 

87

 

Shareholders’ comprehensive income

 

535

 

 

615

 

Comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

 

Net income attributable to redeemable noncontrolling interests

 

-

 

 

3

 

Net (loss) attributable to other noncontrolling interest

 

(2)

 

 

(2)

 

Other comprehensive (loss) attributable to redeemable noncontrolling interests

 

(9)

 

 

(3)

 

Other comprehensive income attributable to other noncontrolling interest

 

-

 

 

1

 

Total comprehensive income

 

$

524

 

 

$

614

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

2



Table of Contents

 

Cigna Corporation

Consolidated Balance Sheets

 

 

 

Unaudited

 

 

 

As of

 

 

As of

 

 

 

March 31,

 

 

December 31,

 

(In millions, except per share amounts)

 

2015

 

 

2014

 

Assets

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

Fixed maturities, at fair value (amortized cost, $17,252; $17,278)

 

$

19,141

 

 

$

18,983

 

Equity securities, at fair value (cost, $187; $199)

 

182

 

 

189

 

Commercial mortgage loans

 

2,010

 

 

2,081

 

Policy loans

 

1,430

 

 

1,438

 

Other long-term investments

 

1,473

 

 

1,488

 

Short-term investments

 

172

 

 

163

 

Total investments

 

24,408

 

 

24,342

 

Cash and cash equivalents

 

2,620

 

 

1,420

 

Premiums, accounts and notes receivable, net

 

3,309

 

 

2,757

 

Reinsurance recoverables

 

7,098

 

 

7,080

 

Deferred policy acquisition costs

 

1,554

 

 

1,502

 

Property and equipment

 

1,486

 

 

1,502

 

Deferred tax assets, net

 

241

 

 

293

 

Goodwill

 

6,029

 

 

5,989

 

Other assets, including other intangibles

 

2,985

 

 

2,683

 

Separate account assets

 

8,392

 

 

8,328

 

Total assets

 

$

58,122

 

 

$

55,896

 

Liabilities

 

 

 

 

 

 

Contractholder deposit funds

 

$

8,452

 

 

$

8,430

 

Future policy benefits

 

9,702

 

 

9,642

 

Unpaid claims and claim expenses

 

4,581

 

 

4,400

 

Global Health Care medical costs payable

 

2,408

 

 

2,180

 

Unearned premiums

 

634

 

 

621

 

Total insurance and contractholder liabilities

 

25,777

 

 

25,273

 

Accounts payable, accrued expenses and other liabilities

 

6,851

 

 

6,264

 

Short-term debt

 

999

 

 

147

 

Long-term debt

 

5,062

 

 

5,005

 

Separate account liabilities

 

8,392

 

 

8,328

 

Total liabilities

 

47,081

 

 

45,017

 

Contingencies — Note 16

 

 

 

 

 

 

Redeemable noncontrolling interests

 

83

 

 

90

 

Shareholders’ Equity

 

 

 

 

 

 

Common stock (par value per share, $0.25; shares issued, 296; authorized, 600)

 

74

 

 

74

 

Additional paid-in capital

 

2,823

 

 

2,769

 

Accumulated other comprehensive loss

 

(934)

 

 

(936)

 

Retained earnings

 

10,635

 

 

10,289

 

Less treasury stock, at cost

 

(1,656)

 

 

(1,422)

 

Total shareholders’ equity

 

10,942

 

 

10,774

 

Noncontrolling interest

 

16

 

 

15

 

Total equity

 

10,958

 

 

10,789

 

Total liabilities and equity

 

$

58,122

 

 

$

55,896

 

Shareholders’ Equity Per Share

 

$

42.46

 

 

$

41.55

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

3



Table of Contents

 

Cigna Corporation

Consolidated Statements of Changes in Total Equity

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

Unaudited

 

 

 

Additional

 

Other

 

 

 

 

 

 

 

Non-

 

 

 

Non-

 

For the three months ended March 31, 2015

 

Common

 

Paid-in

 

Comprehensive

 

Retained

 

Treasury

 

Shareholders’

 

controlling

 

Total

 

controlling

 

(In millions)

 

Stock

 

Capital

 

Loss

 

Earnings

 

Stock

 

Equity

 

Interest

 

Equity

 

Interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2015

 

$

74

 

$

2,769

 

$

(936)

 

$

10,289

 

$

(1,422)

 

$

10,774

 

$

15

 

$

10,789

 

$

90

 

Effect of issuing stock for employee benefit plans

 

 

 

55

 

 

 

(177)

 

184

 

62

 

 

 

62

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

2

 

 

 

 

 

2

 

 

 

2

 

(9)

 

Net income (loss)

 

 

 

 

 

 

 

533

 

 

 

533

 

(2)

 

531

 

 

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(418)

 

(418)

 

 

 

(418)

 

 

 

Capital contribution by noncontrolling interest

 

 

 

(1)

 

 

 

 

 

 

 

(1)

 

3

 

2

 

2

 

Balance at March 31, 2015

 

$

74

 

$

2,823

 

$

(934)

 

$

10,635

 

$

(1,656)

 

$

10,942

 

$

16

 

$

10,958

 

$

83

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

Additional

 

Other

 

 

 

 

 

 

 

Non-

 

 

 

Non-

 

For the three months ended March 31, 2014

 

Common

 

Paid-in

 

Comprehensive

 

Retained

 

Treasury

 

Shareholders’

 

controlling

 

Total

 

controlling

 

(In millions)

 

Stock

 

Capital

 

Loss

 

Earnings

 

Stock

 

Equity

 

Interest

 

Equity

 

Interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2014

 

$

92

 

$

3,356

 

$

(520)

 

$

13,676

 

$

(6,037)

 

$

10,567

 

$

14

 

$

10,581

 

$

96

 

Effect of issuing stock for employee benefit plans

 

 

 

36

 

 

 

(57)

 

49

 

28

 

 

 

28

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

87

 

 

 

 

 

87

 

1

 

88

 

(3)

 

Net income (loss)

 

 

 

 

 

 

 

528

 

 

 

528

 

(2)

 

526

 

3

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(11)

 

 

 

(11)

 

 

 

(11)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(643)

 

(643)

 

 

 

(643)

 

 

 

Balance at March 31, 2014

 

$

92

 

$

3,392

 

$

(433)

 

$

14,136

 

$

(6,631)

 

$

10,556

 

$

13

 

$

10,569

 

$

96

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

4



Table of Contents

 

Cigna Corporation

Consolidated Statements of Cash Flows

 

 

 

 

Unaudited

 

 

 

Three Months Ended March 31,

 

(In millions)

 

2015

 

 

2014

 

Cash Flows from Operating Activities

 

 

 

 

 

 

Net income

 

$

531

 

 

$

529

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

151

 

 

150

 

Realized investment gains

 

(73)

 

 

(42)

 

Deferred income taxes

 

15

 

 

14

 

Net changes in assets and liabilities, net of non-operating effects:

 

 

 

 

 

 

Premiums, accounts and notes receivable

 

(549)

 

 

(431)

 

Reinsurance recoverables

 

(11)

 

 

42

 

Deferred policy acquisition costs

 

(76)

 

 

(67)

 

Other assets

 

(101)

 

 

(63)

 

Insurance liabilities

 

455

 

 

262

 

Accounts payable, accrued expenses and other liabilities

 

157

 

 

(107)

 

Current income taxes

 

221

 

 

250

 

Other, net

 

(56)

 

 

(47)

 

Net cash provided by operating activities

 

664

 

 

490

 

Cash Flows from Investing Activities

 

 

 

 

 

 

Proceeds from investments sold:

 

 

 

 

 

 

Fixed maturities and equity securities

 

393

 

 

194

 

Investment maturities and repayments:

 

 

 

 

 

 

Fixed maturities and equity securities

 

284

 

 

396

 

Commercial mortgage loans

 

166

 

 

127

 

Other sales, maturities and repayments (primarily short-term and other long-term investments)

 

488

 

 

879

 

Investments purchased or originated:

 

 

 

 

 

 

Fixed maturities and equity securities

 

(648)

 

 

(1,445)

 

Commercial mortgage loans

 

(90)

 

 

-

 

Other (primarily short-term and other long-term investments)

 

(420)

 

 

(572)

 

Property and equipment purchases

 

(115)

 

 

(97)

 

Acquisitions, net of cash acquired

 

(107)

 

 

-

 

Other, net

 

-

 

 

12

 

Net cash used in investing activities

 

(49)

 

 

(506)

 

Cash Flows from Financing Activities

 

 

 

 

 

 

Deposits and interest credited to contractholder deposit funds

 

386

 

 

411

 

Withdrawals and benefit payments from contractholder deposit funds

 

(361)

 

 

(351)

 

Net change in short-term debt

 

(5)

 

 

(6)

 

Net proceeds on issuance of long-term debt

 

894

 

 

-

 

Repurchase of common stock

 

(413)

 

 

(615)

 

Issuance of common stock

 

99

 

 

43

 

Other, net

 

3

 

 

19

 

Net cash provided by / (used in) financing activities

 

603

 

 

(499)

 

Effect of foreign currency rate changes on cash and cash equivalents

 

(18)

 

 

(4)

 

Net increase / (decrease) in cash and cash equivalents

 

1,200

 

 

(519)

 

Cash and cash equivalents, January 1,

 

1,420

 

 

2,795

 

Cash and cash equivalents, March 31,

 

$

2,620

 

 

$

2,276

 

Supplemental Disclosure of Cash Information:

 

 

 

 

 

 

Income taxes paid, net of refunds

 

$

49

 

 

$

43

 

Interest paid

 

$

69

 

 

$

70

 

 

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

 

5



Table of Contents

 

CIGNA CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Note 1 — Basis of Presentation

 

 

Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”)  is a global health services organization dedicated to a mission of helping individuals improve their health, well-being and sense of security.  To execute on our mission, Cigna’s strategy is to “Go Deep”, “Go Global” and “Go Individual” with a differentiated set of medical, dental, disability, life and accident insurance and related products and services offered by our subsidiaries.  The majority of these products are offered through employers and other groups (e.g. governmental and non-governmental organizations, unions and associations).  Cigna also offers commercial health and dental insurance, Medicare and Medicaid products and health, life and accident insurance coverages to individuals in the U.S. and selected international markets.  In addition to its ongoing operations described above, Cigna also has certain run-off operations.

 

The Consolidated Financial Statements include the accounts of Cigna Corporation and its subsidiaries.  Intercompany transactions and accounts have been eliminated in consolidation.  These Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  Amounts recorded in the Consolidated Financial Statements necessarily reflect management’s estimates and assumptions about medical costs, investment valuation, interest rates and other factors.  Significant estimates are discussed throughout these Notes; however, actual results could differ from those estimates.  The impact of a change in estimate is generally included in earnings in the period of adjustment.  Certain reclassifications have been made to prior year amounts to conform to the current presentation.

 

These 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 included in the Company’s 2014 Form 10-K.  The preparation of interim Consolidated Financial Statements necessarily relies heavily on estimates.  This and certain other factors, including 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.

 

Note 2 — Recent Accounting Changes

 

 

Simplifying the Presentation of Debt Issuance Costs (Accounting Standards Update (“ASU”) 2015-03).  In April 2015, the Financial Accounting Standards Board (“FASB”) issued guidance to simplify the presentation of debt issuance costs in financial statements.  The amendment requires debt issuance costs to be presented as a direct deduction from the associated debt liability, consistent with the presentation of a debt discount.  In addition, amortization of discount or premium is reported as interest expense.  This amendment is effective beginning January 1, 2016, with early adoption permitted, and shall be applied retrospectively.  The Company is evaluating this guidance to determine any resulting estimated effects on its financial statements.

 

Amendments to the Consolidation Analysis (ASU 2015-02).  In February 2015, the FASB issued guidance to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability companies and securitization structures.  In addition to reducing the number of consolidation models, the new standard aims to simplify and improve GAAP by placing more emphasis on risk of loss when determining a controlling financial interest.  This new standard is effective beginning January 1, 2016, with early adoption permitted.  The Company is evaluating this guidance to determine any resulting estimated effects on its financial statements.

 

Revenue from Contracts with Customers (ASU 2014-09).   In May 2014, the FASB issued new revenue recognition guidance that will apply to various contracts with customers to provide goods or services, including the Company’s non-insurance, administrative services contracts.  This new guidance introduces a model that requires companies to estimate and allocate the expected contract revenue among distinct goods or services in the contract based on relative stand-alone selling prices.  Revenue is recognized as goods or services are delivered.  This new method replaces the current GAAP approach of recognizing revenue that is fixed and determinable primarily based on contract terms.  In addition, extensive new disclosures will be required.  The Company may choose to adopt these changes through retrospective restatement with or without using certain practical expedients or with a cumulative effect adjustment on adoption.  As issued, the new revenue recognition standard would take effect beginning on January 1, 2017; however, in April 2015, the FASB proposed a one-year deferral to January 1, 2018.  The Company continues to monitor developing guidance and to evaluate any resulting estimated effects on its financial statements.

 

6



Table of Contents

 

Accounting for Health Care Reform’s Risk Mitigation Programs.  Beginning in 2014, as prescribed by the Patient Protection and Affordable Care Act (referred to as “Health Care Reform”), programs went into effect to reduce the risk for participating health insurance companies selling coverage on the public exchanges.

 

·                  A three-year (2014-2016) reinsurance program is designed to provide reimbursement to insurers for high cost individual business sold on or off the public exchanges.  The reinsurance entity established by the U.S. Department of Health and Human Services (“HHS”) is funded by a per-customer reinsurance fee assessed on all insurers, HMOs and self-insured group health plans, excluding certain products such as Medicare Advantage and Medicare Part D.  Only non-grandfathered individual plans are eligible for recoveries if claims exceed a specified threshold, up to a reinsurance cap.  Reinsurance contributions associated with non-grandfathered individual plans are reported as a reduction in premium revenue, and estimated reinsurance recoveries are established with an offsetting reduction in Global Health Care medical costs.  Reinsurance fee contributions for other insured business are reported in other operating expenses. Final recoverable amounts are determined and settled with HHS in the year following the policy year.

·                  A premium stabilization program is comprised of two components:  1) a permanent component that reallocates funds from insurers with lower risk populations to insurers with higher risk populations based on the relative risk scores of participants in non-grandfathered plans in the individual and small group markets, both on and off the exchanges.  We estimate our receivable or payable based on the risk of our members compared to the risk of other members in the same state and market, considering data obtained from industry studies; and  2) a temporary (2014-2016) component designed to limit insurer gains and losses by comparing allowable medical costs to a target amount as defined by HHS.  This program applies to individual and small group qualified health plans, operating on and off the exchanges.  Variances from the target amount exceeding certain thresholds may result in amounts due to or due from HHS.

 

For the premium stabilization program, the Company records  receivables or payables as adjustments to premium revenue based on our year-to-date experience when the amounts are reasonably estimable and collection is reasonably assured.  Final revenue adjustments are determined by HHS in the year following the policy year.

 

Fees Paid to the Federal Government by Health Insurers (ASU 2011-06).  Effective January 1, 2014, the Company adopted the FASB’s accounting guidance for the health insurance industry assessment (the “tax”) mandated by Health Care Reform.  This non-deductible tax is being levied based on a ratio of an insurer’s net health insurance premiums written for the previous calendar year compared to the U.S. health insurance industry total.  As required by the guidance, the Company reports a liability at the beginning of each year in accounts payable, accrued expenses and other liabilities and a corresponding deferred cost in other assets, including other intangibles based on a preliminary assessment of the full year.  The Company recognizes the tax in operating expenses on a straight line basis and reduces the deferred cost correspondingly.  Based on industry studies, the Company recorded a liability in accounts payable, accrued expenses and other liabilities in the first quarter of 2015 of approximately $310 million representing an estimate of the fee for 2015. This is compared to a full-year 2014 tax of $238 million.  The Company will update this estimate for any adjustment in subsequent quarters. During the first quarter of 2015, approximately $80 million of the deferred cost was recognized in other operating expenses compared with $60 million for the same period in 2014.

 

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Note 3Earnings Per Share (“EPS”)

 

 

Basic and diluted earnings per share were computed as follows:

 

 

 

 

 

Effect of

 

 

 

(Shares in thousands, dollars in millions, except per share amounts)

 

Basic

 

Dilution

 

Diluted

 

Three Months Ended March 31,

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

Shareholders’ net income

 

$

533

 

 

 

$

533

 

Shares:

 

 

 

 

 

 

 

Weighted average

 

256,707

 

 

 

256,707

 

Common stock equivalents

 

 

 

4,539

 

4,539

 

Total shares

 

256,707

 

4,539

 

261,246

 

EPS

 

$

2.08

 

$

(0.04)

 

$

2.04

 

 

 

 

 

 

 

 

 

2014

 

 

 

 

 

 

 

Shareholders’ net income

 

$

528

 

 

 

$

528

 

Shares:

 

 

 

 

 

 

 

Weighted average

 

269,979

 

 

 

269,979

 

Common stock equivalents

 

 

 

 4,488

 

 4,488

 

Total shares

 

269,979

 

 4,488

 

 274,467

 

EPS

 

$

 1.96

 

$

(0.04)

 

$

 1.92

 

 

The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months ended March 31, 2015 and 2014 because their effect was anti-dilutive.

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2015

 

2014

 

Anti-dilutive options

 

1.4

 

-

 

 

The Company held 38,421,636 shares of common stock in Treasury as of March 31, 2015, and 97,428,469 shares as of March 31, 2014.  In the fourth quarter of 2014, the Company retired 70 million shares of treasury stock.

 

Note 4 — Global Health Care Medical Costs Payable

 

 

Medical costs payable for the Global Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not yet reported, those that have been reported but not yet paid (reported claims in process), and other medical care expenses and services payable that are primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities, as follows:

 

 

 

March 31,

 

December 31,

 

(In millions)

 

2015

 

2014

 

Incurred but not yet reported

 

$

1,830

 

$

1,777

 

Reported claims in process

 

439

 

288

 

Physician incentives and other medical care expenses and services payable

 

139

 

115

 

Medical costs payable

 

$

2,408

 

$

2,180

 

 

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Table of Contents

 

Activity in medical costs payable was as follows:

 

 

 

For the period ended

 

 

March 31,

 

December 31,

 

(In millions)

 

2015

 

2014

 

Balance at January 1,

 

$

2,180

 

$

2,050

 

Less:  Reinsurance and other amounts recoverable

 

252

 

194

 

Balance at January 1, net

 

1,928

 

1,856

 

Incurred costs related to:

 

 

 

 

 

Current year

 

4,713

 

16,853

 

Prior years

 

(109)

 

(159)

 

Total incurred

 

4,604

 

16,694

 

Paid costs related to:

 

 

 

 

 

Current year

 

3,025

 

14,966

 

Prior years

 

1,343

 

1,656

 

Total paid

 

4,368

 

16,622

 

Ending Balance, net

 

2,164

 

1,928

 

Add:  Reinsurance and other amounts recoverable

 

244

 

252

 

Ending Balance

 

$

2,408

 

$

2,180

 

 

Reinsurance and other amounts recoverable includes 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 5 for additional information on reinsurance.  For the three months ended March 31, 2015, actual experience differed from the Company’s key assumptions resulting in favorable incurred costs related to prior years’ medical costs payable of $109 million, or 0.6% of the current year incurred costs as reported for the year ended December 31, 2014. Actual completion factors accounted for $36 million, or 0.2% of the favorability, while actual medical cost trend resulted in the remaining $73 million, or 0.4%.

 

For the year ended December 31, 2014, actual experience differed from the Company’s key assumptions, resulting in favorable incurred costs related to prior years’ medical costs payable of $159 million, or 1.0% of the current year incurred costs as reported for the year ended December 31, 2013. Actual completion factors accounted for $61 million, or 0.4% of favorability, while actual medical cost trend resulted in the remaining $98 million, or 0.6%.

 

The impact of prior year development on shareholders’ net income was $25 million for the three months ended March 31, 2015 compared with $30 million for the three months ended March 31, 2014.  The favorable effect of prior year development for both years primarily reflects low utilization of medical services.  The change in the amount of the incurred costs related to prior years in the medical costs payable liability does not directly correspond to an increase or decrease in the Company’s shareholders’ net income recognized for the following reasons:

 

First, the Company consistently recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice that require 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 relates to a release of the prior year’s provision for moderately adverse conditions, the Company does not consider that amount as  impacting  shareholders’ net income to the extent that it is offset by an increase determined appropriate to address moderately adverse conditions for the current year incurred claims.

 

Second, as a result of the medical loss ratio (“MLR”) provisions of Health Care Reform, changes in medical cost estimates due to prior year development may be offset by a change in the MLR rebate accrual.

 

Third, changes in reserves for the Company’s retrospectively experience-rated business for accounts in surplus do not usually impact shareholders’ net income because such amounts are generally offset by a change in the liability to the policyholder.  An account is in surplus when the accumulated premium received exceeds the accumulated medical costs and administrative charges, including profit charges.  For additional information regarding the Company’s retrospectively experience-rated business, see page 3 of the Company’s 2014 Form 10-K.

 

The determination of liabilities for the Global Health Care medical costs payable requires the Company to make critical accounting estimates.  See Note 2(N) to the Consolidated Financial Statements in the Company’s 2014 Form 10-K.

 

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Note 5 — 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 or assumed losses.  Reinsurance is also used in acquisition and disposition transactions when 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.

 

Effective Exit of GMDB and GMIB Business

 

In 2013, the Company entered into an agreement with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) to effectively exit the guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) business via a reinsurance transaction.  Berkshire reinsured 100% of the Company’s future claim payments in these businesses, net of other reinsurance arrangements existing at that time.  The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.7 billion remaining.

 

Because this effective exit was accomplished via a reinsurance contract, the amounts related to the reinsured GMDB and GMIB contracts cannot be netted, so the gross assets and liabilities must continue to be measured and reported.  The following disclosures provide further context to the methods and assumptions used to determine GMDB assets and liabilities.

 

GMDB

 

The Company estimates this liability with an internal model based on the Company’s experience and future expectations over an extended period, consistent with the long-term nature of this product.  Because the product is premium deficient, the Company records increases to the reserve if it is inadequate based on the model.  As a result of the reinsurance transaction, reserve increases have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB assets).

 

Activity in the future policy benefit reserve for the GMDB business was as follows:

 

 

 

For the period ended

 

 

 

March 31,

 

December 31,

 

(In millions)

 

2015

 

2014

 

Balance at January 1

 

$

1,270

 

$

1,396

 

Add: Unpaid claims

 

16

 

18

 

Less: Reinsurance and other amounts recoverable

 

1,186

 

1,317

 

Balance at January 1, net

 

100

 

97

 

Add: Incurred benefits

 

-

 

3

 

Less: Paid benefits

 

-

 

-

 

Ending balance, net

 

100

 

100

 

Less: Unpaid claims

 

19

 

16

 

Add: Reinsurance and other amounts recoverable

 

1,163

 

1,186

 

Ending balance

 

$

1,244

 

$

1,270

 

 

Benefits paid and incurred are net of ceded amounts.  The ending net retained reserve is to cover ongoing administrative expenses, as well as the few claims retained by the Company.

 

The death benefit coverage in force for GMDB contracts assumed by the Company was $2.7 billion as of March 31, 2015 and $2.8 billion as of December 31, 2014 assuming no reinsurance.  The death benefit coverage in force is the amount the Company would have to pay if all contract holders (approximately 346,000 as of March 31, 2015 and 354,000 as of December 31, 2014) died as of the specified date.  The Company should be reimbursed in full for these payments unless the Berkshire reinsurance limit is exceeded.  The aggregate value of the underlying mutual fund investments for these GMDB contracts was $12.9 billion as of March 31, 2015 and $13.1 billion as of December 31, 2014.

 

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Effects of Reinsurance

 

In the Company’s Consolidated Statements of Income, premiums were reported net of amounts ceded to reinsurers and Global Health Care medical costs and other benefit expenses were reported net of reinsurance recoveries in the following amounts:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2015

 

2014

 

Ceded premiums

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

41

 

$

45

 

Other

 

89

 

96

 

Total

 

$

130

 

$

141

 

Reinsurance recoveries

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

86

 

$

99

 

Other

 

73

 

82

 

Total

 

$

159

 

$

181

 

 

Reinsurance Recoverables

 

Components of the Company’s reinsurance recoverables are presented below:

 

(In millions)

Line of Business

 

Reinsurer(s)

 

March 31,
2015

 

December 31,
2014

 

Collateral and Other Terms
at March 31, 2015

 

 

 

 

 

 

 

 

 

 

 

GMDB

 

Berkshire

 

$

1,125

 

 $

1,147

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

38

 

39

 

99% secured by assets in a trust or letter of credit.

 

 

 

 

 

 

 

 

 

 

 

Individual Life and Annuity (sold in 1998)

 

Lincoln National Life and Lincoln Life &Annuity of New York

 

3,846

 

3,817

 

Both companies’ ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.

 

 

 

 

 

 

 

 

 

 

 

Retirement Benefits Business (sold in 2004)

 

Prudential Retirement Insurance and Annuity

 

1,070

 

1,092

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Supplemental Benefits business (2012 acquisition)

 

Great American Life

 

331

 

336

 

99% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Global Health Care, Global Supplemental Benefits, Group Disability and Life

 

Various

 

600

 

561

 

Recoverables from more than 80 reinsurers used in the ordinary course of business. Balances range from less than $1 million up to $191 million, with 9% secured by assets in trusts or letters of credit.

 

 

 

 

 

 

 

 

 

 

 

Other run-off reinsurance

 

Various

 

88

 

88

 

100% of this balance is secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total reinsurance recoverables

 

 

 

$

7,098

 

$

7,080

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Over 90% of the Company’s reinsurance recoverables were from companies that are rated A or higher by Standard & Poor’s at March 31, 2015.  The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable.  As of March 31, 2015, the Company’s recoverables were net of a reserve of $4 million.  The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.

 

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Note 6 — Organizational Efficiency Plan

 

 

The Company is regularly evaluating ways to deliver its products and services more efficiently and at a lower cost.  During the fourth quarter of 2013, the Company committed to a plan to increase its organizational efficiency and reduce costs through a series of actions that includes employee headcount reductions.  As a result, the Company recognized charges in other operating expenses of $60 million pre-tax ($40 million after-tax) in the fourth quarter of 2013, primarily for severance costs.   As of March 31, 2015, the remaining balance is $21 million, primarily related to severance, most of which will be paid by the end of 2015.

 

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 measured at fair value under certain conditions, such as when impaired.

 

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.

 

The Company’s financial assets and liabilities carried at fair value have been classified based upon a hierarchy defined by GAAP.  The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3).  An asset’s or a liability’s classification is based on the lowest level of input that is significant to its measurement.  For example, a financial asset or liability carried at fair value would be classified in Level 3 if unobservable inputs were significant to the instrument’s fair value, even though the measurement may be derived using inputs that are both observable (Levels 1 and 2) and unobservable (Level 3).

 

The Company estimates fair values using prices from third parties or internal pricing methods.  Fair value estimates received from third-party pricing services are based on reported trade activity and quoted market prices when available, and other market information that a market participant may use to estimate fair value.  The internal pricing methods are performed by the Company’s investment professionals and generally involve using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality, as well as other qualitative factors.  In instances where there is little or no market activity for the same or similar instruments, fair value is estimated 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 that becomes significant with increasingly complex instruments or pricing models.

 

The Company is responsible for determining fair value, as well as the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs.  The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates.  The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value.  The controls completed by the Company and third-party pricing services include reviewing to ensure that prices do not become stale and whether changes from prior valuations are reasonable or require additional review.  The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates.  Exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations.

 

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Financial Assets and Financial Liabilities Carried at Fair Value

 

The following tables provide information as of March 31, 2015 and December 31, 2014 about the Company’s financial assets and liabilities carried at fair value.  Separate account assets that are also recorded at fair value on the Company’s Consolidated Balance Sheets are reported separately under the heading “Separate account assets” as gains and losses related to these assets generally accrue directly to policyholders.

 

March 31, 2015
(In millions)

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

258

 

$

665

 

$

-

 

$

923

State and local government

 

-

 

1,832

 

-

 

1,832

Foreign government

 

-

 

1,953

 

3

 

1,956

Corporate

 

-

 

13,371

 

350

 

13,721

Mortgage-backed

 

-

 

63

 

1

 

64

Other asset-backed

 

-

 

226

 

419

 

645

Total fixed maturities (1)

 

258

 

18,110

 

773

 

19,141

Equity securities

 

34

 

103

 

45

 

182

Subtotal

 

292

 

18,213

 

818

 

19,323

Short-term investments

 

-

 

172

 

-

 

172

GMIB assets (2)

 

-

 

-

 

970

 

970

Other derivative assets (3)

 

-

 

16

 

-

 

16

Total financial assets at fair value, excluding separate accounts

 

$

292

 

$

18,401

 

$

1,788

 

$

20,481

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

948

 

$

948

Total financial liabilities at fair value

 

$

-

 

$

-

 

$

948

 

$

948

 

(1)

Fixed maturities included $817 million of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $71 million of appreciation for securities classified in Level 3.  See Note 8 for additional information.

(2)

The GMIB assets represent retrocessional contracts in place from three external reinsurers that cover the exposures on these contracts.

(3)

Other derivative assets included $15 million of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million of interest rate swaps qualifying as fair value hedges.  See Note 9 for additional information.

 

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December 31, 2014
(In millions)

 

Quoted Prices in
Active Markets for
Identical Assets

(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs

(Level 3)

 

Total

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

290

 

$

664

 

$

-

 

$

954

State and local government

 

-

 

1,856

 

-

 

1,856

Foreign government

 

-

 

1,936

 

4

 

1,940

Corporate

 

-

 

13,105

 

393

 

13,498

Mortgage-backed

 

-

 

84

 

1

 

85

Other asset-backed

 

-

 

234

 

416

 

650

Total fixed maturities (1)

 

290

 

17,879

 

814

 

18,983

Equity securities

 

61

 

85

 

43

 

189

Subtotal

 

351

 

17,964

 

857

 

19,172

Short-term investments

 

-

 

163

 

-

 

163

GMIB assets (2)

 

-

 

-

 

953

 

953

Other derivative assets (3)

 

-

 

6

 

-

 

6

Total financial assets at fair value, excluding separate accounts

 

$

351

 

$

18,133

 

$

1,810

 

$

20,294

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

929

 

$

929

Other derivative liabilities (3)

 

-

 

1

 

-

 

1

Total financial liabilities at fair value

 

$

-

 

$

1

 

$

929

 

$

930

 

(1)

Fixed maturities included $756 million of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $65 million of appreciation for securities classified in Level 3.  See Note 8 for additional information.

(2)

The GMIB assets represented retrocessional contracts in place from three external reinsurers that cover the exposures on these contracts.

(3)

Other derivative assets included $5 million of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million of interest rate swaps qualifying as fair value hedges.  Other derivative liabilities reflected interest rate and foreign currency swaps qualifying as cash flow hedges.  See Note 9 for additional information.

 

Level 1 Financial Assets

 

Inputs for instruments classified in Level 1 include unadjusted quoted prices for identical assets in active markets accessible at the measurement date.  Active markets provide pricing data for trades occurring at least weekly and include exchanges and dealer markets.

 

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

 

Inputs for instruments classified in Level 2 include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are market observable or can be corroborated by market data for the term of the instrument.  Such other inputs include market interest rates and volatilities, spreads and yield curves.  An instrument is classified in Level 2 if the Company determines that unobservable inputs are insignificant.

 

Fixed maturities and equity securities.  Approximately 94% of the Company’s investments in fixed maturities and equity securities are classified in Level 2 including most public and private corporate debt and equity securities, federal agency and municipal bonds, non-government mortgage-backed securities and preferred stocks.  Because many fixed maturities do not trade daily, third-party pricing services and internal methods often use 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, a combination of benchmark yields, reported trades, issuer spreads, liquidity, benchmark securities, bids, offers, reference data, and industry and economic events.  For mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit rating.

 

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Nearly all of these instruments are valued using recent trades or pricing models.  Less than 1% of the fair value of investments classified in Level 2 represents foreign bonds that are valued using a single unadjusted market-observable input derived by averaging multiple broker-dealer quotes, consistent with local market practice.

 

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 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, 2015 or December 31, 2014.  Level 2 also includes exchange-traded interest rate swap contracts.  Credit risk related to the clearinghouse counterparty and the Company is considered minimal when estimating the fair values of these derivatives because of upfront margin deposits and daily settlement requirements.  The nature and use of these other derivatives are described in Note 9.

 

Level 3 Financial Assets and Financial Liabilities

 

Certain inputs for instruments classified in Level 3 are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement.  Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date.

 

The Company classifies certain newly issued, privately-placed, complex or illiquid securities, as well as assets and liabilities relating to GMIB, in Level 3.  Approximately 4% of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category.

 

Fair values of other asset and mortgage-backed securities, corporate and government fixed maturities are primarily 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, spreads and liquidity of assets with similar characteristics.  For other asset and mortgage-backed securities, inputs and assumptions for 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.

 

Quantitative Information about Unobservable Inputs

The following tables summarize the fair value and significant unobservable inputs used in pricing Level 3 securities that were developed directly by the Company as of March 31, 2015 and December 31, 2014.  The range and weighted average basis point amounts (“bps”)  for fixed maturity spreads (adjustment to discount rates) and price to earnings multiples for equity investments reflect the Company’s best estimates of the unobservable adjustments a market participant would make to calculate the fair values.

 

Other asset and mortgage-backed securities.  The significant unobservable inputs used to value the following other asset and mortgage-backed securities are liquidity and weighting of credit spreads.  When there is limited trading activity for the security, an adjustment for liquidity is made as of the measurement date that considers current market conditions, issuer circumstances and complexity of the security structure.  An adjustment to weight credit spreads is needed to value a more complex bond structure with multiple underlying collateral and no standard market valuation technique.  The weighting of credit spreads is primarily based on the underlying collateral’s characteristics and their proportional cash flows supporting the bond obligations.  The resulting wide range of unobservable adjustments in the table below is due to the varying liquidity and quality of the underlying collateral, ranging from high credit quality to below investment grade.

 

Corporate and government fixed maturities.  The significant unobservable input used to value the following corporate and government fixed maturities is an adjustment for liquidity.  When there is limited trading activity for the security, an adjustment is needed to reflect current market conditions and issuer circumstances.

 

Equity securities.  The significant unobservable input used to value the following equity securities is a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”).  These securities are comprised of private equity investments with limited trading activity and therefore a ratio of EBITDA is used to estimate value based on company circumstances and relative risk characteristics.

 

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Table of Contents

 

As of March 31, 2015
(Fair value in millions )

 

Fair Value

 

Unobservable

Input

 

Unobservable Adjustment
Range (Weighted Average)

 

Fixed maturities:

 

 

 

 

 

 

 

 

Other asset and mortgage-backed securities

 

$

419

 

Liquidity

 

60 - 390 (150) bps

 

 

 

 

 

Weighting of credit spreads

 

170 - 2,630 (290) bps

 

Corporate and government fixed maturities

 

 

301

 

Liquidity

 

80 -930 (280) bps

 

Total fixed maturities

 

 

720

 

 

 

 

 

Equity securities

 

 

45

 

Price-to-earnings multiples

 

4.2 - 9.8 (8.0)

 

Subtotal

 

 

765

 

 

 

 

 

Pricing exemption securities(1)

 

 

53

 

 

 

 

 

Total Level 3 securities

 

$

818

 

 

 

 

 

 

(1) The fair values for these securities use single, unadjusted non-binding broker quotes not developed directly by the Company.

 

As of December 31, 2014
(Fair value in millions )

 

Fair Value

 

Unobservable

Input

 

Unobservable Adjustment
Range (Weighted Average)

 

Fixed maturities:

 

 

 

 

 

 

 

 

Other asset and mortgage-backed securities

 

$

417

 

Liquidity

 

60 - 370 (140) bps

 

 

 

 

 

Weighting of credit spreads

 

160 - 2,560 (290) bps

 

Corporate and government fixed maturities

 

 

344

 

Liquidity

 

80 - 930 (262) bps

 

Total fixed maturities

 

 

761

 

 

 

 

 

Equity securities

 

 

43

 

Price-to-earnings multiples

 

4.2 - 9.8 (8.1)

 

Subtotal

 

 

804

 

 

 

 

 

Pricing exemption securities(1)

 

 

53

 

 

 

 

 

Total Level 3 securities

 

$

857

 

 

 

 

 

 

(1) The fair values for these securities use single, unadjusted non-binding broker quotes not developed directly by the Company.

 

Significant increases in fixed maturity spreads would result in a lower fair value measurement while decreases in these inputs would result in a higher fair value measurement.  Significant decreases in equity price-to-earnings multiples would result in a lower fair value measurement while increases in these inputs would result in a higher fair value measurement.  Generally, the unobservable inputs are not interrelated and a change in the assumption used for one unobservable input is not accompanied by a change in the other unobservable input.  See the preceding discussion regarding the Company’s valuation processes and controls.

 

GMIB contracts.  As discussed in Note 5, the Company effectively exited the GMIB business in 2013.  Although these GMIB assets and liabilities must continue to be reported as derivatives at fair value, the only assumption that is expected to impact future shareholders’ net income is the risk of non-performance.  This assumption reflects a market participant’s view of (a) the risk of the Company not fulfilling its GMIB obligations (GMIB liabilities) and (b) the credit risk that the reinsurers do not pay their obligations (GMIB assets).  As of March 31, 2015, there were three reinsurers for GMIB, with collateral securing 70% of the balance.

 

The Company reports GMIB liabilities and assets as derivatives at fair value because cash flows of these 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.  Under the terms of these written and purchased contracts, the Company periodically receives and pays fees based on either contractholders’ account values or deposits increased at a contractual rate.  The Company will also pay and receive cash depending on account values and interest rates when a contractholder elects to begin to receive minimum income payments.  The Company estimates the fair value of the assets and liabilities for GMIB contracts by calculating the results for many scenarios run through a model utilizing various assumptions that include non-performance risk, among other things.

 

The non-performance risk adjustment is incorporated by adding an additional spread to the discount rate in the calculation of both (a) the GMIB liabilities to reflect a market participant’s view of the risk of the Company not fulfilling its GMIB obligations, and (b) the GMIB assets to reflect a market participant’s view of the credit risk of the reinsurers, after considering collateral.

 

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Other assumptions that affect GMIB assets and liabilities include capital market assumptions (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments) and future annuitant behavior (including mortality, lapse, and annuity election rates).  As certain assumptions used to estimate fair values for these contracts are largely unobservable (primarily related to future annuitant behavior), the Company classifies GMIB assets and liabilities in Level 3.

 

The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities.  Significant decreases in assumed lapse rates or spreads used to calculate non-performance risk, or increases in assumed annuity election rates, would result in higher fair value measurements.  A change in one of these assumptions is not necessarily accompanied by a change in another assumption.

 

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 three external reinsurers and are reported in the Company’s Consolidated Balance Sheets in other assets, including other intangibles.

 

Changes in Level 3 Financial Assets and Financial Liabilities Carried at Fair Value

 

The following tables summarize the changes in financial assets and financial liabilities classified in Level 3 for the three months ended March 31, 2015 and 2014.  Separate account asset changes are reported separately under the heading “Separate account assets” as the changes in fair values of these assets accrue directly to the policyholders.  Gains and losses reported in these tables may include net changes in fair value that are attributable to both observable and unobservable inputs.

 

For the Three Months Ended March 31, 2015
(In millions)

 

Fixed Maturities &
Equity Securities

 

GMIB Assets

 

GMIB Liabilities

 

GMIB Net

 

Balance at January 1, 2015

 

$

857

 

$

953

 

$

(929)

 

$

24

 

Gains (losses) included in shareholders’ net income:

 

 

 

 

 

 

 

 

 

GMIB fair value gain/(loss)

 

-

 

27

 

(27)

 

-

 

Other

 

13

 

(1)

 

(1)

 

(2)

 

Total gains (losses) included in shareholders’ net income

 

13

 

26

 

(28)

 

(2)

 

Gains included in other comprehensive income

 

2

 

-

 

-

 

-

 

Gains required to adjust future policy benefits for settlement annuities (1)

 

6

 

-

 

-

 

-

 

Purchases, sales and settlements:

 

 

 

 

 

 

 

 

 

Purchases

 

11

 

-

 

-

 

-

 

Sales

 

(18)

 

-

 

-

 

-

 

Settlements

 

(3)

 

(9)

 

9

 

-

 

Total purchases, sales and settlements

 

(10)

 

(9)

 

9

 

-

 

Transfers into/(out of) Level 3:

 

 

 

 

 

 

 

 

 

Transfers into Level 3

 

1

 

-

 

-

 

-

 

Transfers out of Level 3

 

(51)

 

-

 

-

 

-

 

Total transfers into/(out of) Level 3

 

(50)

 

-

 

-

 

-

 

Balance at March 31, 2015

 

$

818

 

$

970

 

$

(948)

 

$

22

 

Total gains (losses) included in shareholders’ net income attributable to instruments held at the reporting date

 

$

-

 

$

26

 

$

(28)

 

$

(2)

 

(1)  Amounts do not accrue to shareholders.

 

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Table of Contents

 

For the Three Months Ended March 31, 2014
(In millions)

 

Fixed Maturities & Equity
Securities

 

GMIB Assets

 

GMIB Liabilities

 

GMIB Net

 

Balance at January 1, 2014

 

$

1,190

 

$

751

 

$

(741)

 

$

10

 

Gains (losses) included in shareholders’ net income:

 

 

 

 

 

 

 

 

 

GMIB fair value gain/(loss)

 

-

 

77

 

(77)

 

-

 

Other

 

12

 

(1)

 

12

 

11

 

Total gains (losses) included in shareholders’ net income

 

12

 

76

 

(65)

 

11

 

Gains included in other comprehensive income

 

8

 

-

 

-

 

-

 

Gains required to adjust future policy benefits for settlement annuities (1)

 

22

 

-

 

-

 

-

 

Purchases, sales and settlements:

 

 

 

 

 

 

 

 

 

Purchases

 

24

 

-

 

-

 

-

 

Sales

 

(24)

 

-

 

-

 

-

 

Settlements

 

(61)

 

(12)

 

12

 

-

 

Total purchases, sales and settlements

 

(61)

 

(12)

 

12

 

-

 

Transfers into/(out of) Level 3:

 

 

 

 

 

 

 

 

 

Transfers into Level 3

 

124

 

-

 

-

 

-

 

Transfers out of Level 3

 

(97)

 

-

 

-

 

-

 

Total transfers into/(out of) Level 3

 

27

 

-

 

-

 

-

 

Balance at March 31, 2014

 

$

1,198

 

$

815

 

$

(794)

 

$

21

 

Total gains (losses) included in shareholders’ net income attributable to instruments held at the reporting date

 

$

1

 

$

76

 

$

(65)

 

$

11

 

(1)  Amounts do not accrue to shareholders.

 

As noted in the tables above, total gains and losses included in shareholders’ net income are reflected in the following captions in the Consolidated Statements of Income:

 

·

Realized investment gains (losses) and net investment income for amounts related to fixed maturities and equity securities and realized investment gains (losses) for the impact of changes in non-performance risk related to GMIB assets and liabilities, similar to hedge ineffectiveness; and

·

Other operating expenses for amounts related to GMIB assets and liabilities (GMIB fair value gain/loss), except for the impact of changes in non-performance risk.

 

In the tables above, gains and losses included in other comprehensive income are reflected in net unrealized appreciation (depreciation) on securities in the Consolidated Statements of Comprehensive Income.

 

Reclassifications impacting Level 3 financial instruments are reported as transfers into 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.

 

Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company’s best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement.  For the three months ended March 31, 2015 and March 31, 2014, transfers between Level 2 and Level 3 primarily reflect the change in significance of the unobservable inputs used to value certain public and private corporate bonds, principally related to liquidity of the securities and credit risk of the issuers.

 

Because GMIB 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.

 

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Table of Contents

 

Separate account assets

 

Fair values and changes in the fair values of separate account assets generally accrue directly to the policyholders and are excluded from the Company’s revenues and expenses.  As of March 31, 2015 and December 31, 2014 separate account assets were as follows:

 

March 31, 2015
(In millions)

 

Quoted Prices in Active
Markets for Identical
Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant Unobservable
Inputs
(Level 3)

 

Total

 

Guaranteed separate accounts (See Note 16)

 

$

238

 

$

302

 

$