See Note 2 to the Consolidated Financial Statements for additional information.
Health Care Reform also impacts Cigna's Medicare Advantage and Medicare Part D prescription drug plan businesses acquired with HealthSpring in a variety of additional ways, including reduced Medicare premium rates (that began with the 2011 contract year), mandated minimum reductions to risk scores (beginning in 2014), transition of Medicare Advantage "benchmark" rates to Medicare fee-for-service parity, reduced enrollment periods and limitations on disenrollment, providing "quality bonuses" for Medicare Advantage plans with a rating of four or five stars from CMS, and mandated consumer discounts on brand name and generic prescription drugs for Medicare Part D plan participants in the coverage gap. Beginning in 2014, Health Care Reform requires Medicare Advantage and Medicare Part D plans to meet a minimum MLR of 85%. Under the rules proposed by HHS, if the MLR for a CMS contract is less than 85%, the contractor is required to pay a penalty to CMS and could be subject to additional sanctions if the MLR continues to be less than 85% for successive years.
Global medical customers increased 11% primarily attributable to growth in strategically targeted global markets reflecting solid customer persistency and strong new sales as well as the acquisition of HealthSpring.
If the December 31, 2012 fair values of domestic qualified plan assets decreased by 10%, the accrued pension benefit liability would increase by approximately $365 million as of December 31, 2012 resulting in an after-tax decrease to shareholders' equity of approximately $235 million.
a lower guaranteed cost medical care ratio and higher experience-rated margins in the commercial business driven by low medical services utilization trend, as well as favorable prior year claim development. These favorable effects were partially offset by the estimated cost of premium rebates calculated under the minimum medical loss ratio requirements of Health Care Reform; and
Includes fees related to the U.S. and international health care businesses. Fees related to Medicare Part D of $61 million in 2011 and $57 million in 2010 have been reclassified to premiums to conform to current presentation.
Offsetting these factors were more favorable life and accident claims experience and higher net investment income driven largely by higher invested assets and partnership income.
Excluding the impact of foreign currency movements, benefits and expenses were $1.9 billion in 2012, compared to reported benefits and expenses of $1.5 billion in 2011, an increase of 30%. These increases were primarily due to the acquisitions and business growth.
Excluding the impact of foreign currency movements, benefits and expenses were $1.4 billion in 2011, compared with reported benefits and expenses of $1.2 billion in 2010, an increase of 20%. The increase was primarily due to business growth.
Segment earnings decreased 8% in 2012 compared with 2011, primarily reflecting lower COLI interest margins and mortality gains and the continued decline in deferred gain amortization associated with the sold businesses.
The Company maintains a capital management strategy to permanently invest the earnings for certain of its foreign operations overseas. During the first quarter of 2012 the Company expanded this strategy to its China and Indonesia operations. As of December 31, 2012 the Company's cash and cash equivalents in its foreign operations were $768 million, and permanently reinvested earnings were approximately $628 million. Repatriation of foreign cash via a dividend of these permanently reinvested earnings would result in a charge for the incremental U.S. taxes due on the repatriation. Because of the size, strength and diversity of earnings from domestic sources, management does not believe this global capital management strategy materially limits the Company's ability to meet its liquidity and capital needs in the United States.
Solvency II. Cigna's businesses in the European Union will be subject to the directive on insurance regulation and solvency requirements known as Solvency II. This directive will impose economic risk-based solvency requirements and supervisory rules and is expected to become effective in January 2014, although certain regulators are requiring companies to demonstrate technical capability and comply with increased capital levels in advance of the effective date. Cigna's European insurance companies are capitalized at levels consistent with projected Solvency II requirements and in compliance with anticipated technical capability requirements.
The Company's fixed maturity portfolio continues to be diversified by issuer and industry type with the consumer sector representing the largest single industry concentration of approximately 10% of total invested assets as of December 31, 2012.
The Company's other long-term investments include $1,166 million in security partnership and real estate funds as well as direct investments in real estate joint ventures. The funds typically invest in mezzanine debt or equity of privately held companies (securities partnerships) and equity real estate. Given its subordinate position in the capital structure of these underlying entities, the Company assumes a higher level of risk for higher expected returns. To mitigate risk, investments are diversified across approximately 80 separate partnerships, and approximately 50 general partners who manage one or more of these partnerships. Also, the funds' underlying investments are diversified by industry sector or property type, and geographic region. No single partnership investment exceeds 7% of the Company's securities and real estate partnership portfolio.
The Company's assets and liabilities include financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. Subsequent to the reinsurance transaction entered into on February 4, 2013 as further discussed in Note 25 to the Consolidated Financial Statements, the Company's primary market risk exposures are:
a hypothetical increase in market interest rates, primarily for fixed maturities and commercial mortgage loans, partially offset by liabilities for long-term debt and, in 2011, GMIB contracts;
16.downgrades in the financial strength ratings of the Company's insurance subsidiaries, that could, among other things, adversely affect new sales and retention of current business or limit the subsidiaries' ability to dividend capital to the parent company, resulting in changes in statutory reserve or capital requirements or other financial constraints;
17.significant deterioration in global market economic conditions and market volatility, that could have an adverse effect on the Company's investments, liquidity and access to capital markets;
Policy loans. Policy loans are carried at unpaid principal balances plus accumulated interest. The loans are collateralized by insurance policy cash values and therefore have no exposure to credit loss.
Certain reinsurance contracts contain GMDB under variable annuities issued by other insurance companies. These obligations represent the guaranteed death benefit in excess of the contractholder's account values (based on underlying equity and bond mutual fund investments). These obligations are estimated based on assumptions regarding lapse, partial surrenders, mortality, interest rates (mean investment performance and discount rate), market volatility as well as investment returns and premiums, consistent with the requirements of GAAP when a premium deficiency exists. Lapse, partial surrenders, mortality, interest rates and volatility are based on management's judgment considering the Company's experience and future expectations. The results of futures and swap contracts used in the GMDB equity and growth interest rate hedge programs are reflected in the liability calculation as a component of investment returns. See also Note 7 for additional information.
Premiums and fees received for the Company's Medicare Advantage Plans and Medicare Part D products from customers and the Centers for Medicare and Medicaid Services (CMS) are recognized as revenue ratably over the contract period. CMS provides risk adjusted premium payments for the Medicare Advantage Plans and Medicare Part D products, based on the demographics and health severity of enrollees. The Company recognizes periodic changes to risk adjusted premiums as revenue when the amounts are determinable and collection is reasonably assured. Additionally, Medicare Part D includes payments from CMS for risk sharing adjustments. The risk sharing adjustments,
The results of FirstAssist are included in the Company's Consolidated Financial Statements from the date of acquisition. The pro forma effects on total revenues and net income assuming the acquisition had occurred as of January 1, 2011 were not material to the Company for the year ended December 31, 2011.
Subsequent to the segment reporting changes in 2012, goodwill has been allocated to the Commercial operating segment. For foreign tax purposes, the acquisition of Vanbreda International was treated as a stock purchase. Accordingly, goodwill and other intangible assets will not be amortized for foreign tax purposes but may reduce the taxability of earnings repatriated to the U.S. by Vanbreda International.
The severance costs are expected to be substantially paid in 2013.
As discussed in Note 25, the Company reinsured the guaranteed minimum death benefit ("GMDB") business on February 4, 2013.
The Company's reinsurance operations, that were discontinued in 2000 and are now an inactive business in run-off mode, reinsured a GMDB, also known as variable annuity death benefits ("VADBe"), under certain variable annuities issued by other insurance companies. These variable annuities are essentially investments in mutual funds combined with a death benefit. The Company has equity and other market exposures as a result of this product. In periods of declining equity markets and in periods of flat equity markets following a decline, the Company's liabilities for these guaranteed minimum death benefits increase. Conversely, in periods of rising equity markets, the Company's liabilities for these guaranteed minimum death benefits decrease.
In the Company's Consolidated Income Statements, Premiums and fees were presented net of ceded premiums, and Total benefits and expenses were presented net of reinsurance recoveries, in the following amounts:
During 2012, the Company's postretirement benefits liability adjustment increased by $129 million pre-tax ($92 million after-tax) resulting in a decrease to shareholders' equity. The increase in the liability was primarily due to a decrease in the discount rate, partially offset by actual investment returns greater than expected in 2012.
Fixed maturities included $826 million of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $115 million of appreciation for securities classified in Level 3.
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. An adjustment for liquidity is made as of the measurement date when there is limited trading activity for the security 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 with 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.
The market volatility assumptions for annuitants' underlying mutual fund investments that are modeled based on the S&P 500, Russell 2000 and NASDAQ Composite are based on the market-implied volatility for these indices for three to seven years grading to historical volatility levels thereafter. For the remaining 50% of underlying mutual fund investments modeled using other indices (with insufficient market-observable data), volatility is based on the average historical level for each index over the past 10 years. Using this approach, volatility ranges from 18% to 28% for equity funds, 6% to 8% for bond funds, and 0% to 1% for money market funds.
The following tables summarize the changes in financial assets and financial liabilities classified in Level 3 for the years ended December 31, 2012 and 2011. These tables exclude separate account assets as changes in fair values of these assets accrue directly to policyholders. Gains and losses reported in this table may include net changes in fair value that are attributable to both observable and unobservable inputs.
(1)Included in this amount are gains of $96 million attributable to instruments still held at the reporting date.
Excluding trading and hybrid securities, as of December 31, 2012, fixed maturities with a decline in fair value from amortized cost (primarily corporate, and other asset and mortgage-backed securities) were as follows, including the length of time of such decline:
The IRS continues to be engaged in its examination of the Company's 2009 and 2010 consolidated federal income tax returns. This review is expected to be competed in 2013, and is not expected to have a material impact on shareholder's net income. The Company conducts business in numerous state and foreign jurisdictions, and may be engaged in multiple audit proceedings at any given time. Generally, no further state audit activity is expected for tax years prior to 2008, and prior to 2001 for foreign audit activity.
The Company does not expect that these financial guarantees will have a material effect on the Company's consolidated results of operations, liquidity or financial condition.
Both parties appealed the court's decisions to the United States Court of Appeals for the Second Circuit that issued a decision on October 6, 2009 affirming the District Court's judgment and order on all issues. On January 4, 2010, both parties filed separate petitions for a writ of certiorari to the United States Supreme Court. Cigna's petition was granted, and on May 16, 2011, the Supreme Court issued its Opinion in which it reversed the lower courts' decisions and remanded the case to the trial judge for reconsideration of the remedy. The Court unanimously agreed with the Company's position that the lower courts erred in granting a remedy for an inaccurate plan description under an ERISA provision that allows only recovery of plan benefits. However, the decision identified possible avenues of "appropriate equitable relief" that plaintiffs may pursue as an alternative remedy. The case was returned to the trial court and hearings took place on December 9, 2011 and March 29-30, 2012. Over the summer, the trial judge passed away after a long illness and the case was re-assigned.