Beginning in April, we experienced a significant deferral of care by our customers. The deferral of care moderated over the course of the second quarter with utilization levels eventually returning to nearly normal levels by the end of June. In the third quarter, we experienced increased medical utilization as we observed a reduction to the level of deferred care and our customers sought care for COVID-19 testing and treatment.
Our capital resources consist primarily of cash, cash equivalents and investments maintained at regulated subsidiaries required to underwrite insurance risks, cash flows from operating activities, our commercial paper program, credit agreements and the issuance of long-term debt and equity securities. Our businesses generate significant cash flow from operations, some of which is subject to regulatory restrictions relative to the amount and timing of dividend payments to parent. Dividends from U.S. regulated subsidiaries were $2.3 billion in 2020 and 2019. Nonregulated subsidiaries also generate significant cash flow from operating activities, which is typically available immediately to parent for general corporate purposes.
Pre-tax adjusted income from operations increased reflecting lower acquisition and loss ratios and business growth, primarily in Asia, partially offset by higher expense ratios. The ratios in 2020 reflect the costs of actions to support clients; additionally, the expense ratio reflects actions to support employees and investments in the business for future growth.
COVID-19 has negatively impacted commercial real estate fundamentals and capital market activity with concentrated weakness in hotels and regional malls. Our mortgage loan portfolio is well diversified by property type and geography with no material exposure to hotels and no exposure to regional shopping malls. We continue to monitor the long-term impacts on the office sector due to growing headwinds: expanded remote working flexibility, shorter term leases and corporate migration to lower cost states. Our mortgage loans secured by office properties are in good standing.
In the event of a hypothetical 100 basis point increase in interest rates, the fair value of the Company’s long-term debt would decrease approximately $3.0 billion at December 31, 2020 and $2.5 billion at December 31, 2019. Changes in the fair value of our long-term debt do not impact our financial position or operating results. See Note 7 to the Consolidated Financial Statements for additional information about the Company’s debt.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of the Evernorth and U.S. Medical reporting units is a critical audit matter are the significant judgment by management when determining the fair value measurement of the reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s estimate of the reporting units’ fair value related to the assumptions for the discount rate and projection of future cash flows. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
•Market risk benefits to be transitioned retrospectively and measured at fair value at the beginning of the earliest period presented. The difference between this fair value and carrying value to be recognized in the opening balance of retained earnings, excluding the effect of credit risk changes that are to be recognized in accumulated other comprehensive income.
•While not yet quantified, the cumulative effect of implementing this guidance may be material to the Company’s beginning shareholders' equity balance upon adoption.
•Supplemental health, life and accident insurance products (primarily individual products) that comprise the majority of the Company’s deferred policy acquisition costs and group health and accident insurance products are deferred and amortized, generally in proportion to the ratio of periodic revenue to the estimated total revenues over the contract periods.
Pharmacy costs. Pharmacy costs include the cost of prescriptions sold, network pharmacy claim costs and copayments. Also included are direct costs of dispensing prescriptions including supplies, shipping and handling and direct costs associated with clinical programs, such as drug utilization management and medication adherence counseling. Home delivery and specialty pharmacy costs are recognized when the drug is shipped and retail network costs are recognized when the drug is processed and approved for payment. Rebates and other vendor consideration received when providing pharmacy benefit management services are recorded as a reduction of pharmacy costs. Rebates are recognized as prescriptions are shipped or processed and approved for payment. Historically, the effect of adjustments resulting from the reconciliation of rebates recognized to the amounts billed and collected has not been material. The Company maintains reimbursement guarantees with certain retail network pharmacies. For each such guarantee, the Company records a pharmacy and other service costs payable or prepaid asset for applicable retail network claims based on our actual performance throughout the period against the contractual reimbursement rate. The Company’s contracts with certain retail pharmacies give the Company the right to adjust reimbursement rates during the annual guarantee period.
The revolving credit agreements contain customary covenants and restrictions including a financial covenant that the Company’s leverage ratio may not exceed 60%. As of December 31, 2020, there were no outstanding balances under the revolving credit agreements.
Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies and GMDB contracts represent benefits expected to be paid to policyholders, net of future premiums expected to be received. Management estimates these obligations based on assumptions as to premiums, interest rates, mortality or morbidity, future claim adjudication expenses and surrenders, allowing for adverse deviation as appropriate. Mortality, morbidity and surrender assumptions are based on the Company’s own experience and published actuarial tables. Interest rate assumptions are based on management’s judgment considering the Company’s experience and future expectations, and range from 1% to 9%. Obligations for the direct and assumed run-off settlement annuity business include adjustments for realized and unrealized investment returns consistent with GAAP when a premium deficiency exists. As of December 31, 2020, approximately 20% of the liability for future policy benefits was supported by assets held in trust for the benefit of the ceding company under reinsurance agreements.
The total of incurred but not reported liabilities plus expected development on reported claims, including reported claims in process, was $2.9 billion at December 31, 2020 and $2.7 billion at December 31, 2019.
•Fair value hedges of the foreign exchange-related changes in fair values of certain foreign-denominated bonds: Swap fair values are reported in Long-term investments or Other non-current liabilities. Changes in fair values attributable to foreign exchange risk of the swap contracts and the hedged bonds are reported in Realized investment gains and losses. The portion of the swap contracts’ changes in fair value excluded from the assessment of hedge effectiveness is recorded in Other comprehensive income and recognized in Net investment income as swap coupon payments are accrued, offsetting the foreign-denominated coupons received on the designated bonds. Net cash flows are reported in Operating activities, while exchanges of notional principal amounts are reported in Investing activities.
The Company is responsible for determining fair value and for assigning 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. An annual due-diligence review of the most significant pricing service is conducted to review their processes, methodologies and controls. This review includes a walk-through of inputs for a sample of securities held across various asset types to validate the documented pricing process.
The Company is involved in other types of variable interest entities, including real estate joint ventures that develop properties for residential and commercial use, independent physician associations (IPAs) that provide care management services and international healthcare joint ventures. The carrying values and maximum exposures for each of these types of unconsolidated variable interest entities was not material as of December 31, 2020.
We fund our qualified pension plans at least at the minimum amount required by the Employee Retirement Income Security Act of 1974 and the Pension Protection Act of 2006. The Company made immaterial contributions to the qualified pension plans in 2020. For 2021, contributions to the qualified pension plans are expected to be immaterial. Future years’ contributions will ultimately be based on a wide range of factors including but not limited to asset returns, discount rates and funding targets. Non-qualified pension and other postretirement benefit plans are generally funded on a pay-as-you-go basis as there are no plan assets for these plans.
(1)A pooled separate account has several participating benefit plans and each owns a share of the total pool of investments.
Black-Scholes option-pricing model assumptions and the resulting fair value of options are presented in the following table. The average fair value of options and the expected option life exclude the rollover options granted to Express Scripts employees in connection with the acquisition.
Accounting policy. Compensation expense for SPSs is recorded over the performance period. Fair value is determined at the grant date for “market condition” SPSs using a Monte Carlo simulation model and not subsequently adjusted regardless of the final outcome. Expense is initially accrued for “performance condition” SPSs based on the most likely outcome, but evaluated for adjustment each period for updates in the expected outcome. Expense is adjusted to the actual outcome (number of shares awarded times the share price at the grant date) at the end of the performance period.
Rental expense under operating lease agreements was $162 million for the year ended December 31, 2018.
Permitted practices used by the Company’s insurance subsidiaries in 2020 that differed from prescribed regulatory accounting had an immaterial impact on statutory surplus.
Reconciliations of unrecognized tax benefits for the years ended December 31 follow: