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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, 2016

 

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, 2016,  256,513,083 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

38

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

59

Item 4.

Controls and Procedures

60

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

61

Item 1.A.

Risk Factors

62

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

63

Item 4.

Mine Safety Disclosures

63

Item 6.

Exhibits

64

SIGNATURE

65

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)

 

2016

 

2015

 

Revenues

 

 

 

 

 

Premiums

 

$

7,746

 

$

7,402

 

Fees and other revenues

 

1,201

 

1,138

 

Net investment income

 

272

 

276

 

Mail order pharmacy revenues

 

697

 

578

 

Realized investment gains (losses):

 

 

 

 

 

Other than temporary impairments on debt securities

 

(27)

 

(5)

 

Other realized investment gains (losses), net

 

(5)

 

78

 

Net realized investment gains (losses)

 

(32)

 

73

 

Total revenues

 

9,884

 

9,467

 

 

 

 

 

 

 

Benefits and Expenses

 

 

 

 

 

Global Health Care medical costs

 

4,761

 

4,604

 

Other benefit expenses

 

1,368

 

1,269

 

Mail order pharmacy costs

 

574

 

492

 

Other operating expenses

 

2,321

 

2,204

 

Amortization of other acquired intangible assets, net

 

41

 

44

 

Total benefits and expenses

 

9,065

 

8,613

 

Income before Income Taxes

 

819

 

854

 

Income taxes:

 

 

 

 

 

Current

 

294

 

308

 

Deferred

 

11

 

15

 

Total income taxes

 

305

 

323

 

Net Income

 

514

 

531

 

Less: Net (Loss) Attributable to Noncontrolling Interests

 

(5)

 

(2)

 

Shareholders’ Net Income

 

$

519

 

$

533

 

Shareholders’ Net Income Per Share:

 

 

 

 

 

Basic

 

$

2.04

 

$

2.08

 

Diluted

 

$

2.00

 

$

2.04

 

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)

 

2016

 

 

2015

 

Shareholders’ net income

 

$

519

 

 

$

533

 

Shareholders’ other comprehensive income (loss):

 

 

 

 

 

 

Net unrealized appreciation, securities

 

173

 

 

88

 

Net unrealized appreciation (depreciation), derivatives

 

(3)

 

 

7

 

Net translation of foreign currencies

 

81

 

 

(104)

 

Postretirement benefits liability adjustment

 

11

 

 

11

 

Shareholders’ other comprehensive income

 

262

 

 

2

 

Shareholders’ comprehensive income

 

781

 

 

535

 

Comprehensive income (loss) attributable to noncontrolling interests:

 

 

 

 

 

 

Net (loss) attributable to redeemable noncontrolling interests

 

(1)

 

 

-

 

Net (loss) attributable to other noncontrolling interests

 

(4)

 

 

(2)

 

Other comprehensive income (loss) attributable to redeemable noncontrolling interests

 

3

 

 

(9)

 

Total comprehensive income

 

$

779

 

 

$

524

 

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)

 

2016

 

2015

 

Assets

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

Fixed maturities, at fair value (amortized cost, $18,684; $18,456)

 

$

20,087

 

 

$

19,455

 

Equity securities, at fair value (cost, $193; $190)

 

194

 

 

190

 

Commercial mortgage loans

 

1,848

 

 

1,864

 

Policy loans

 

1,419

 

 

1,419

 

Other long-term investments

 

1,434

 

 

1,404

 

Short-term investments

 

465

 

 

381

 

Total investments

 

25,447

 

 

24,713

 

Cash and cash equivalents

 

2,401

 

 

1,968

 

Premiums, accounts and notes receivable, net

 

3,956

 

 

3,694

 

Reinsurance recoverables

 

6,725

 

 

6,813

 

Deferred policy acquisition costs

 

1,743

 

 

1,659

 

Property and equipment

 

1,534

 

 

1,534

 

Deferred tax assets, net

 

276

 

 

379

 

Goodwill

 

6,029

 

 

6,019

 

Other assets, including other intangibles

 

2,788

 

 

2,476

 

Separate account assets

 

7,985

 

 

7,833

 

Total assets

 

$

58,884

 

 

$

57,088

 

Liabilities

 

 

 

 

 

 

Contractholder deposit funds

 

$

8,455

 

 

$

8,443

 

Future policy benefits

 

9,735

 

 

9,479

 

Unpaid claims and claim expenses

 

4,724

 

 

4,574

 

Global Health Care medical costs payable

 

2,646

 

 

2,355

 

Unearned premiums

 

646

 

 

629

 

Total insurance and contractholder liabilities

 

26,206

 

 

25,480

 

Accounts payable, accrued expenses and other liabilities

 

6,746

 

 

6,493

 

Short-term debt

 

399

 

 

149

 

Long-term debt

 

4,791

 

 

5,020

 

Separate account liabilities

 

7,985

 

 

7,833

 

Total liabilities

 

46,127

 

 

44,975

 

Contingencies — Note 16

 

 

 

 

 

 

Redeemable noncontrolling interests

 

73

 

 

69

 

Shareholders’ Equity

 

 

 

 

 

 

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

 

74

 

 

74

 

Additional paid-in capital

 

2,874

 

 

2,859

 

Accumulated other comprehensive loss

 

(988)

 

 

(1,250)

 

Retained earnings

 

12,541

 

 

12,121

 

Less treasury stock, at cost

 

(1,826)

 

 

(1,769)

 

Total shareholders’ equity

 

12,675

 

 

12,035

 

Noncontrolling interests

 

9

 

 

9

 

Total equity

 

12,684

 

 

12,044

 

Total liabilities and equity

 

$

58,884

 

 

$

57,088

 

Shareholders’ Equity Per Share

 

$

49.41

 

 

$

46.91

 

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, 2016

 

Common

 

Paid-in

 

Comprehensive

 

Retained

 

Treasury

 

Shareholders’

 

controlling

 

Total

 

controlling

 

(In millions)

 

Stock

 

Capital

 

Loss

 

Earnings

 

Stock

 

Equity

 

Interests

 

Equity

 

Interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2016

 

$

74

 

$

2,859

 

$

(1,250)

 

$

12,121

 

$

(1,769)

 

$

12,035

 

$

9

 

$

12,044

 

$

69

 

Effect of issuing stock for employee benefit plans

 

 

 

21

 

 

 

(89)

 

53

 

(15)

 

 

 

(15)

 

 

 

Other comprehensive income

 

 

 

 

 

262

 

 

 

 

 

262

 

 

 

262

 

3

 

Net income (loss)

 

 

 

 

 

 

 

519

 

 

 

519

 

(4)

 

515

 

(1)

 

Common dividends declared (per share: $0.04)

 

 

 

 

 

 

 

(10)

 

 

 

(10)

 

 

 

(10)

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

 

(110)

 

(110)

 

 

 

(110)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

(6)

 

 

 

 

 

 

 

(6)

 

4

 

(2)

 

2

 

Balance at March 31, 2016

 

$

74

 

$

2,874

 

$

(988)

 

$

12,541

 

$

(1,826)

 

$

12,675

 

$

9

 

$

12,684

 

$

73

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

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

 

Interests

 

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)

 

 

 

Other transactions impacting noncontrolling interests

 

 

 

(1)

 

 

 

 

 

 

 

(1)

 

3

 

2

 

2

 

Balance at March 31, 2015

 

$

74

 

$

2,823

 

$

(934)

 

$

10,635

 

$

(1,656)

 

$

10,942

 

$

16

 

$

10,958

 

$

83

 

 

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)

 

2016

 

 

2015

 

Cash Flows from Operating Activities

 

 

 

 

 

 

Net income

 

$

514

 

 

$

531

 

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

 

 

 

 

 

 

Depreciation and amortization

 

158

 

 

151

 

Realized investment (gains) losses

 

32

 

 

(73)

 

Deferred income taxes

 

11

 

 

15

 

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

 

 

 

 

 

 

Premiums, accounts and notes receivable

 

(237)

 

 

(549)

 

Reinsurance recoverables

 

24

 

 

(11)

 

Deferred policy acquisition costs

 

(62)

 

 

(76)

 

Other assets

 

(57)

 

 

(101)

 

Insurance liabilities

 

507

 

 

455

 

Accounts payable, accrued expenses and other liabilities

 

(263)

 

 

157

 

Current income taxes

 

262

 

 

221

 

Other, net (1)

 

5

 

 

17

 

Net cash provided by operating activities (1)

 

894

 

 

737

 

Cash Flows from Investing Activities

 

 

 

 

 

 

Proceeds from investments sold:

 

 

 

 

 

 

Fixed maturities and equity securities

 

361

 

 

393

 

Investment maturities and repayments:

 

 

 

 

 

 

Fixed maturities and equity securities

 

255

 

 

284

 

Commercial mortgage loans

 

18

 

 

166

 

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

 

102

 

 

488

 

Investments purchased or originated:

 

 

 

 

 

 

Fixed maturities and equity securities

 

(758)

 

 

(648)

 

Commercial mortgage loans

 

(1)

 

 

(90)

 

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

 

(198)

 

 

(420)

 

Property and equipment purchases

 

(112)

 

 

(115)

 

Acquisitions, net of cash acquired

 

-

 

 

(107)

 

Net cash used in investing activities

 

(333)

 

 

(49)

 

Cash Flows from Financing Activities

 

 

 

 

 

 

Deposits and interest credited to contractholder deposit funds

 

383

 

 

386

 

Withdrawals and benefit payments from contractholder deposit funds

 

(343)

 

 

(361)

 

Net change in short-term debt

 

(6)

 

 

(5)

 

Net proceeds on issuance of long-term debt

 

-

 

 

894

 

Repurchase of common stock

 

(139)

 

 

(413)

 

Issuance of common stock

 

10

 

 

99

 

Other, net (1)

 

(51)

 

 

(70)

 

Net cash provided by (used in) financing activities (1)

 

(146)

 

 

530

 

Effect of foreign currency rate changes on cash and cash equivalents

 

18

 

 

(18)

 

Net increase in cash and cash equivalents

 

433

 

 

1,200

 

Cash and cash equivalents, January 1,

 

1,968

 

 

1,420

 

Cash and cash equivalents, March 31,

 

$

2,401

 

 

$

2,620

 

Supplemental Disclosure of Cash Information:

 

 

 

 

 

 

Income taxes paid, net of refunds

 

$

37

 

 

$

49

 

Interest paid

 

$

69

 

 

$

69

 

 

(1) As required by the adoption of ASU 2016-09, the Company retrospectively reclassified $73 million of cash payments from operating to financing activities for the three months ended March 31, 2015.  These payments were related to employee tax obligations associated with stock compensation. The comparable amount reported in financing activities for the three months ended March 31, 2016 was $67 million.  See Note 2 for further discussion.

 

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 and Significant Events

 

 

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 insurance and other 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.  See Note 2 for further discussion.

 

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 2015 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

 

 

The Company’s 2015 Form 10-K includes discussion of significant recent accounting changes that either have impacted or may impact our financial statements in the future.  The following issuances of, and changes in, accounting pronouncements that apply to the Company have occurred since the Company filed its 2015 Form 10-K.

 

Recently Adopted Accounting Guidance

 

Amendments to the Consolidation Analysis (Accounting Standards Update (“ASU”) 2015-02).  The Company adopted this new consolidation guidance effective January 1, 2016 with no material effect on its financial statements.  Among other provisions, the guidance defines limited partnerships as VIEs unless substantive kick-out rights or participating rights exist.  See Note 10 for additional disclosures about various real estate and security limited partnerships that are newly identified as variable interest entities for which the Company is not the primary beneficiary.

 

Improvements to Employee Share-Based Payment Accounting (ASU 2016-09).  In March 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled, requires cash flows related to the excess tax benefits to be classified as an operating activity in the statement of cash flows, permits repurchasing more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares are to be presented as a financing activity in the statement of cash flows, and provides an accounting policy election to account for forfeitures as they occur. In addition, the new guidance changes the calculation of common stock equivalents for earnings per share purposes.  The new standard is required to be adopted as of January 1, 2017.

 

6



Table of Contents

 

As permitted, the Company elected to early adopt the new guidance effective January 1, 2016.  Adopting this new guidance resulted in $23 million of tax benefits recorded in net income in the first quarter of 2016 in Corporate that previously would have been reported in additional paid-in capital.  The change in the calculation of common stock equivalents added approximately one million weighted average shares for the diluted earnings per share calculations.  The Company applied these provisions prospectively.

 

The Company applied the provisions of the new guidance related to the presentation of employee taxes paid for withheld shares retrospectively that resulted in reclassifying $73 million of tax withholding from operating to financing activities in its Consolidated Statement of Cash Flows for the three months ended March 31, 2015.  For the three months ended March 31, 2016, the Company reflected $67 million of tax withholding in financing activities.  The ability under the new guidance to repurchase more employee shares for tax withholding purposes had no impact on the Company’s financial statements.  The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.

 

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2015-07).  This amendment removed the requirement to categorize all investments for which fair value is measured using the practical expedient of net asset value (“NAV”) per share within the fair value hierarchy.  The Company adopted this new guidance effective January 1, 2016.  Upon adoption, the Company began to separately disclose certain Separate Account investments and provided comparable prior period disclosure.  See Note 7 for this separate disclosure information.

 

Recently Issued Accounting Guidance Not Yet Adopted

 

Revenue from Contracts with Customers (ASU 2014-09).  During 2016, the Financial Accounting Standards Board (“FASB”) has issued two new ASUs further clarifying the broader revenue guidance: 1) “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (ASU 2016-08) that clarifies the definition of principals and agents and 2)  “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing” (ASU 2016-10) that clarifies guidance and adds examples to help companies properly identify performance obligations.  This ASU also illustrates when a license provides a customer with a right to use (point in time) versus a right to access (over time) benefit.

 

These clarifications, together with the broader revenue recognition guidance within ASU 2014-09, are required to be adopted beginning January 1, 2018.  The Company continues to monitor developing implementation guidance and evaluate these new requirements for its non-insurance customer contracts to determine its method and timing of implementation and any resulting estimated effects on its financial statements.

 

Note 3Mergers and Acquisitions

 

 

Proposed Merger

 

On July 23, 2015, the Company entered into a merger agreement with Anthem, Inc. (“Anthem”) and Anthem Merger Sub Corp. (“Merger Sub”), a direct wholly-owned subsidiary of Anthem.  The merger agreement provides (a) for the merger of the Company and Merger Sub, with the Company continuing as the surviving corporation and (b) if certain tax opinions are delivered, immediately following the completion of the initial merger, for the surviving corporation to be merged with and into Anthem, with Anthem continuing as the surviving corporation (collectively, the “merger”).  Subject to certain terms, conditions, and customary operating covenants, each share of Cigna common stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive (a) $103.40 in cash, without interest, and (b) 0.5152 of a share of Anthem common stock.  The closing price of Anthem common stock on May 5, 2016 was $137.07.

 

At special shareholders’ meetings held in December 2015, Cigna shareholders approved the merger and Anthem shareholders approved the issuance of shares of Anthem common stock in connection with the merger.  Completing the merger remains subject to certain customary conditions, including the receipt of certain necessary governmental and regulatory approvals and the absence of a legal restraint prohibiting the merger.  Completing the merger is not subject to a financing condition.

 

If the merger agreement is terminated under certain circumstances, Anthem will be required to pay Cigna a termination fee of $1.85 billion.  Anthem’s obligation to pay the termination fee arises if the merger agreement is terminated because:  (1) a governmental entity, such as the Department of Justice or a state Department of Insurance, has prevented the merger for regulatory reasons and that decision is final and non-appealable; or (2) the merger has not closed by January 31, 2017 (subject to extension to April 30, 2017 under certain circumstances) only because all necessary regulatory approvals have not been received.

 

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The merger agreement contains customary covenants, including covenants that Cigna conduct its business in the ordinary course during the period between entering into the merger agreement and closing.  In addition, Cigna’s ability to take certain actions prior to closing without Anthem’s consent is subject to certain limitations.  These limitations relate to, among other matters, the payment of dividends, capital expenditures, the payment or retirement of indebtedness or the incurrence of new indebtedness, settlement of material claims or proceedings, mergers or acquisitions, and certain employment-related matters.

 

While the Company continues to work toward achieving regulatory approval as quickly as possible and to target a closing date in the second half of 2016, the closing will ultimately be subject to the approval and timing of the regulators. In light of the complexity of the regulatory process and the dynamic environment, it is possible that such approvals may not be obtained in 2016.

 

During the three months ended March 31, 2016, the Company incurred $40 million pre-tax ($36 million after-tax) in costs directly related to the proposed merger.  These costs primarily consisted of fees for legal, advisory and other professional services.

 

Note 4 — Earnings 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,

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

Shareholders’ net income

 

$

519

 

 

 

$

519

 

Shares:

 

 

 

 

 

 

 

Weighted average

 

254,822

 

 

 

254,822

 

Common stock equivalents

 

 

 

4,625

 

4,625

 

Total shares

 

254,822

 

4,625

 

259,447

 

EPS

 

$

2.04

 

$

(0.04)

 

$

2.00

 

 

 

 

 

 

 

 

 

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

 

 

The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months ended March 31, 2016 and 2015 because their effect was anti-dilutive.

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2016

 

2015

 

Anti-dilutive options

 

1.3

 

1.4

 

 

The Company held 39,638,264 shares of common stock in Treasury as of March 31, 2016, and 38,421,636 shares as of March 31, 2015.

 

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Note 5 — 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)

 

2016

 

2015

 

Incurred but not yet reported

 

$

1,960

 

$

1,757

 

Reported claims in process

 

506

 

470

 

Physician incentives and other medical care expenses and services payable

 

180

 

128

 

Global Health Care medical costs payable

 

$

2,646

 

$

2,355

 

 

Activity in medical costs payable was as follows:

 

 

 

For the period ended

 

 

March 31,

 

December 31,

 

(In millions)

 

2016

 

2015

 

Balance at January 1,

 

$

2,355

 

$

2,180

 

Less:  Reinsurance and other amounts recoverable

 

243

 

252

 

Balance at January 1, net

 

2,112

 

1,928

 

Incurred costs related to:

 

 

 

 

 

Current year

 

4,825

 

18,564

 

Prior years

 

(64)

 

(210)

 

Total incurred

 

4,761

 

18,354

 

Paid costs related to:

 

 

 

 

 

Current year

 

2,985

 

16,588

 

Prior years

 

1,449

 

1,582

 

Total paid

 

4,434

 

18,170

 

Ending Balance, net

 

2,439

 

2,112

 

Add:  Reinsurance and other amounts recoverable

 

207

 

243

 

Ending Balance

 

$

2,646

 

$

2,355

 

 

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 6 for additional information on reinsurance.  For the three months ended March 31, 2016, actual experience differed from the Company’s key assumptions resulting in favorable incurred costs related to prior years’ medical costs payable of $64 million, or 0.3% of the current year incurred costs as reported for the year ended December 31, 2015.  Actual completion factors accounted for $51 million, or 0.3% of the favorability and actual medical cost trend resulted in $28 million, or 0.1%, offset by approximately $15 million, or 0.1%, related to increased medical costs in the Government segment because of additional provider risk sharing.

 

For the year ended December 31, 2015, actual experience differed from the Company’s key assumptions, resulting in favorable incurred costs related to prior years’ medical costs payable of $210 million, or 1.3% of the current year incurred costs as reported for the year ended December 31, 2014.  Actual completion factors accounted for $62 million, or 0.4% of favorability, while actual medical cost trend resulted in $115 million, or 0.7%.  The remaining $33 million, or 0.2%, was related to an increase in the 2014 reinsurance reimbursement rate from the Centers for Medicare and Medicaid Services (“CMS”) under The Patient Protection and Affordable Care Act (“Health Care Reform”).

 

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The impact of prior year development on shareholders’ net income was $14 million for the three months ended March 31, 2016 compared with $25 million for the three months ended March 31, 2015.  The favorable effect of prior year development for both periods primarily reflects lower than expected utilization of medical services.  Incurred costs related to prior years in the table above do not directly correspond to an increase or decrease to shareholders’ net income.  The primary reason for the difference is that decreases to prior year incurred costs pertaining to the portion of the liability established for moderately adverse conditions are not considered as impacting shareholders’ net income if they are offset by increases in the current year provision for moderately adverse conditions.  The determination of liabilities for 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 2015 Form 10-K for further information about the assumptions and estimates used to establish this liability.

 

Note 6 — 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 concentrations of its 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”) businesses 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 $3.6 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 for 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)

 

2016

 

2015

 

Balance at January 1

 

$

1,252

 

$

1,270

 

Add: Unpaid claims

 

18

 

16

 

Less: Reinsurance and other amounts recoverable

 

1,164

 

1,186

 

Balance at January 1, net

 

106

 

100

 

Add: Incurred benefits

 

1

 

3

 

Less: Paid benefits

 

-

 

(3)

 

Ending balance, net

 

107

 

106

 

Less: Unpaid claims

 

22

 

18

 

Add: Reinsurance and other amounts recoverable

 

1,201

 

1,164

 

Ending balance

 

$

1,286

 

$

1,252

 

 

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Table of Contents

 

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

 

The table below presents the account value, net amount at risk and number of underlying contractholders for guarantees assumed by the Company in the event of death.  The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date.  Unless the Berkshire limit is exceeded, the Company should be reimbursed in full for these payments.

 

(Dollars in millions, excludes impact of reinsurance ceded)

 

March 31, 2016

 

December 31, 2015

 

Account value

 

$

10,977

 

$

11,355

 

Net amount at risk

 

$

2,854

 

$

2,870

 

Number of contractholders

 

318,000

 

324,000

 

 

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)

 

2016

 

2015

 

Ceded premiums

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

41

 

$

41

 

Other

 

95

 

89

 

Total

 

$

136

 

$

130

 

Reinsurance recoveries

 

 

 

 

 

Individual life insurance and annuity business sold

 

$

68

 

$

86

 

Other

 

96

 

73

 

Total

 

$

164

 

$

159

 

 

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Table of Contents

 

Reinsurance Recoverables

 

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

 

(In millions)

Line of Business

 

Reinsurer(s)

 

March 31,
2016

 

December 31,
2015

 

Collateral and Other Terms
at March 31, 2016

 

 

 

 

 

 

 

 

 

 

 

GMDB

 

Berkshire

 

$

1,156

 

 $

1,123

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

45

 

41

 

100% 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

 

3,659

 

3,705

 

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

 

976

 

995

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

Supplemental Benefits Business (2012 acquisition)

 

Great American Life

 

312

 

315

 

100% secured by assets in a trust.

 

 

 

 

 

 

 

 

 

 

 

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

 

Various

 

497

 

553

 

Recoverables from approximately 80 reinsurers, including the U.S. Government, used in the ordinary course of business.  Excluding the recoverable from the U.S. Government of approximately $100 million, current balances range from less than $1 million up to $90 million, with 18% secured by assets in trusts or letters of credit. 

 

 

 

 

 

 

 

 

 

 

 

Other run-off reinsurance

 

Various

 

80

 

81

 

100% of this balance is secured by assets in trusts.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total reinsurance recoverables

 

 

 

$

6,725

 

$

6,813

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Over 90% of the Company’s reinsurance recoverables were from companies that were rated A or higher by Standard & Poor’s at March 31, 2016.  The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable.  As of March 31, 2016, the Company’s recoverables were net of a reserve of approximately $3 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 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 designating 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 executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations.  The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates.  The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations.  Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls.  This on-site review includes a walk-through of inputs of a sample of securities held across various asset types to validate the documented pricing process.

 

Financial Assets and Financial Liabilities Carried at Fair Value

 

The following tables provide information as of March 31, 2016 and December 31, 2015 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.

 

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Table of Contents

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

 

Significant Other
Observable Inputs

 

Significant
Unobservable
Inputs

 

 

(In millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

March 31, 2016

 

 

 

 

 

 

 

 

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

183

 

$

569

 

$

-

 

$

752

State and local government

 

-

 

1,603

 

-

 

1,603

Foreign government

 

-

 

2,068

 

4

 

2,072

Corporate

 

-

 

14,661

 

406

 

15,067

Mortgage-backed

 

-

 

40

 

1

 

41

Other asset-backed

 

-

 

243

 

309

 

552

Total fixed maturities (1)

 

183

 

19,184

 

720

 

20,087

Equity securities

 

33

 

89

 

72

 

194

Subtotal

 

216

 

19,273

 

792

 

20,281

Short-term investments

 

-

 

465

 

-

 

465

GMIB assets (2)

 

-

 

-

 

957

 

957

Other derivative assets (3)

 

-

 

11

 

-

 

11

Total financial assets at fair value, excluding separate accounts

 

$

216

 

$

19,749

 

$

1,749

 

$

21,714

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

941

 

$

941

Other derivative liabilities

 

-

 

1

 

-

 

1

Total financial liabilities at fair value

 

$

-

 

$

1

 

$

941

 

$

942

December 31, 2015

 

 

 

 

 

 

 

 

Financial assets at fair value:

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Federal government and agency

 

$

251

 

$

528

 

$

-

 

$

779

State and local government

 

-

 

1,641

 

-

 

1,641

Foreign government

 

-

 

2,010

 

4

 

2,014

Corporate

 

-

 

14,122

 

326

 

14,448

Mortgage-backed

 

-

 

48

 

1

 

49

Other asset-backed

 

-

 

198

 

326

 

524

Total fixed maturities (1)

 

251

 

18,547

 

657

 

19,455

Equity securities

 

32

 

89

 

69

 

190

Subtotal

 

283

 

18,636

 

726

 

19,645

Short-term investments

 

-

 

381

 

-

 

381

GMIB assets (2)

 

-

 

-

 

907

 

907

Other derivative assets (3)

 

-

 

16

 

-

 

16

Total financial assets at fair value, excluding separate accounts

 

$

283

 

$

19,033

 

$

1,633

 

$

20,949

Financial liabilities at fair value:

 

 

 

 

 

 

 

 

GMIB liabilities

 

$

-

 

$

-

 

$

885

 

$

885

Total financial liabilities at fair value

 

$

-

 

$

-

 

$

885

 

$

885

 

(1)

Fixed maturities included $622 million as of March 31, 2016 and $483 million as of December 31, 2015 of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $42 million as of March 31, 2016 and $30 million as of December 31, 2015 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 $10 million as of March 31, 2016 and $15 million as of December 31, 2015 of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million as of March 31, 2016 and December 31, 2015 of interest rate swaps qualifying as fair value 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.

 

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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 95% 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.

 

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, 2016 or December 31, 2015.  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.

 

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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 in its evaluation, as well as the issuer’s financial statements.

 

Quantitative Information about Unobservable Inputs

 

The following tables summarize the fair value and significant unobservable inputs used in pricing the following securities that were developed directly by the Company as of March 31, 2016 and December 31, 2015.  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 these 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.

 

(Fair value in millions)

 

Fair Value

 

Unobservable
Input

 

Unobservable Adjustment
Range (Weighted Average)

 

As of March 31, 2016

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Other asset and mortgage-backed securities

 

$

310

 

Liquidity

 

60 - 450 (190) bps

 

 

 

 

 

 

Weighting of credit spreads

 

180 - 680 (230) bps

 

Corporate and government fixed maturities

 

 

360

 

Liquidity

 

70 - 1,150 (360) bps

 

Total fixed maturities

 

 

670

 

 

 

 

 

Equity securities

 

 

72

 

Price-to-earnings multiples

 

4.2 - 11.6 (8.2)

 

Subtotal

 

 

742

 

 

 

 

 

Securities not priced by the Company(1)

 

 

50

 

 

 

 

 

Total Level 3 securities

 

$

792

 

 

 

 

 

As of December 31, 2015

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

Other asset and mortgage-backed securities

 

$

327

 

Liquidity

 

60 - 440 (200) bps

 

 

 

 

 

 

Weighting of credit spreads

 

170 - 630 (220) bps

 

Corporate and government fixed maturities

 

 

285

 

Liquidity

 

70 - 930 (280) bps

 

Total fixed maturities

 

 

612

 

 

 

 

 

Equity securities

 

 

69

 

Price-to-earnings multiples

 

4.2 - 11.6 (8.3)

 

Subtotal

 

 

681

 

 

 

 

 

Securities not priced by the Company(1)

 

 

45

 

 

 

 

 

Total Level 3 securities

 

$

726

 

 

 

 

 

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

 

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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.

 

GMIB contracts.  As discussed in Note 6, 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 a subsidiary 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, 2016, there were three reinsurers for GMIB, with collateral securing 68% of the balance.

 

The Company reports GMIB liabilities and assets as derivatives at fair value because the 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 contractholders elect 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 a subsidiary 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.

 

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, 2016 and 2015.  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.

 

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Table of Contents

 

 

 

Changes in Level 3 financial assets and financial liabilities

 

For the Three Months Ended March 31, 2016
(In millions)

 

Fixed Maturities &
Equity Securities

 

GMIB Assets

 

GMIB Liabilities

 

GMIB Net

 

Balance at January 1, 2016

 

$

726

 

$

907

 

$

(885)

 

$

22

 

Gains (losses) included in shareholders’ net income:

 

 

 

 

 

 

 

 

 

GMIB fair value gain/(loss)

 

-

 

61

 

(61)

 

-

 

Other

 

(25)

 

(1)

 

(5)

 

(6)

 

Total gains (losses) included in shareholders’ net income

 

(25)

 

60

 

(66)

 

(6)

 

Gains included in other comprehensive income

 

-

 

-

 

-

 

-

 

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

 

11

 

-

 

-

 

-

 

Purchases, sales and settlements:

 

 

 

 

 

 

 

 

 

Purchases

 

24

 

-

 

-

 

-

 

Sales

 

-

 

-

 

-

 

-

 

Settlements

 

(11)

 

(10

)

10

 

-

 

Total purchases, sales and settlements

 

13

 

(10

)

10

 

-

 

Transfers into/(out of) Level 3:

 

 

 

 

 

 

 

 

 

Transfers into Level 3

 

128

 

-

 

-

 

-

 

Transfers out of Level 3

 

(61)

 

-

 

-

 

-

 

Total transfers into/(out of) Level 3

 

67

 

-

 

-

 

-

 

Balance at March 31, 2016

 

$

792

 

$

957

 

$

(941)

 

$

16

 

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

 

$

(25)

 

$

60

 

$

(66)

 

$

(6)

 

 

 

 

Changes in Level 3 financial assets and financial liabilities

 

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