CIGNA’s global real estate portfolio consists of approximately 6.6 million square feet of owned and leased properties. Our domestic portfolio has approximately 5.8 million square feet in 37 states, District of Columbia, and Puerto Rico. Our International properties contain approximately 800,000 square feet located throughout the following countries:
Belgium, Canada, China, France, Germany, Hong Kong, Indonesia, Ireland, Italy, Netherlands, New Zealand, Portugal, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, United Arab Emirates, United Kingdom, and Vietnam.
CIGNA believes its properties are adequate and suitable for our business as presently conducted. The foregoing does not include information on investment properties.
The following discussion addresses the financial condition of the Company as of December 31, 2010, compared with December 31, 2009, and a comparison of results of operations for the years ended December 31, 2010, 2009 and 2008.
CIGNA is a global health service organization with subsidiaries that are major providers of medical, dental, disability, life and accident insurance and related products and services. In the U.S., the majority of these products and services are offered through employers and other groups (e.g. unions and associations) and in selected international markets, CIGNA offers supplemental health, life and accident insurance products, expatriate benefits and international health care coverage and services to businesses, governmental and non-governmental organizations and individuals. In addition to its ongoing operations described above, the Company also has certain run-off operations, including a Run-off Reinsurance segment.
Unless otherwise indicated, financial information in the MD&A is presented in accordance with accounting principles generally accepted in the United States (“GAAP”). Certain reclassifications have been made to prior period amounts to conform to the presentation of 2010 amounts. See Note 2 to the Consolidated Financial Statements for additional information.
Summarized below are the key highlights for 2010. For additional information, see the remaining sections of this MD&A, which discuss both consolidated and segment results in more detail.
Revenues rose significantly in 2010, reflecting strong premium growth in the Company’s ongoing operating segments due to solid growth in each of the Company’s targeted markets. Net investment income and realized investment results also improved significantly primarily reflecting improving economic conditions.
Medical membership increased, reflecting the acquisition of Vanbreda International as well as the strength of the Company’s value proposition centered around health advocacy and its focus on growth in targeted markets, primarily the middle market and select segments.
Shareholders’ income from continuing operations also increased, but at a lower rate than adjusted income from operations. This is primarily due to significantly lower results in the Company’s run-off GMIB business. Results from this business are volatile, as key market inputs to the valuation of these assets and liabilities, such as interest rates, are adjusted each quarter.
Cash flows from operating activities remain strong, reflecting solid underlying earnings as well as business growth. Strong operating cash flows enabled the Company to contribute $212 million to its pension plan as well as to repurchase 6.2 million shares of stock for $201 million.
CIGNA’s long-term growth strategy is based on: (1) growth in targeted geographies, product lines, buying segments and distribution channels; (2) improving its strategic and financial flexibility; and (3) pursuing additional opportunities in high-growth markets with particular focus on individuals. Our strategy can be summarized as follows:
“Go global” by pursuing additional opportunities in high-growth markets across the globe and serving individuals regardless of where they live and work.
To achieve these goals, CIGNA expects to focus on the following which have the most potential for profitable growth:
Domestic Health Care segment. In this market, CIGNA is focused on expanding and deepening client and customer relationships across each segment. Specifically: (1) within key geographic segments, growing the “Select” market, which generally includes employers with more than 50 but fewer than 250 employees and the “Middle Market” segment which generally includes employers with more than 250 but less than 5,000 employees, by leveraging the Company’s customer knowledge, differentiated service model, product portfolio and distribution model; (2) engaging those national account employers who share and will benefit from the Company’s value proposition of using health advocacy and employee engagement to increase productivity, performance and the health outcomes of their employees; and (3) targeting sub-markets including industry, government and municipal entities and individuals that align closest to the Company’s stated strategy.
The Company plans to improve its strategic and financial flexibility by driving further reductions in its Health Care operating expenses, improving its medical cost competitiveness in targeted markets and effectively managing balance sheet exposures.
In addition to the Company-specific factors cited above, overall results are influenced by a range of economic and other factors, especially:
The Company regularly monitors the trends impacting operating results from the above mentioned key factors to appropriately respond to economic and other factors affecting its operations, both in its ongoing and run-off operations.
Health Care Reform will require the assessment of fees and excise taxes on health services companies such as CIGNA and others in the health care industry to help fund the additional insurance benefits and coverages provided by this legislation. The amount which the Company will be required to pay starting in 2013 and 2014 for these fees and excise taxes will result in charges to the Company’s financial statements in future periods. In addition, since these fees and excise taxes will not be tax deductible, the Company’s effective tax rate is expected to increase in future periods. However, the Company is unable to estimate the amount of these fees and excise taxes or the increase in the effective tax rate because guidance for the calculation has not been finalized.
Health Care Reform also changes certain tax laws which affected the Company’s 2010 financial statements. Although these provisions do not become effective until 2013, they are expected to limit the tax deductibility of certain future retiree benefit and compensation-related payments earned after 2009. The Company recorded after-tax charges of approximately $10 million for the twelve months ended December 31, 2010 related to these changes. The Company will continue to evaluate the impact of these tax laws as further guidance is made available.
Many provisions of Health Care Reform are not effective until future years and the Company will continue to implement these provisions. On January 1, 2011, the minimum loss ratio became effective and will require payment of premium rebates beginning in 2012 to employers and customers covered under the Company’s comprehensive medical insurance if certain minimum medical loss ratios are not met. Management estimates charges for rebates to approximate $25 million after-tax for the year ending December 31, 2011. This estimate followed the most current regulatory guidance for the calculation of rebates and was developed using assumptions about the amount and distribution for claim experience, enrollment and premiums earned by state and market segment. Actual rebates could differ substantially from management’s estimates if actual experience differs from the assumptions.
On December 1, 2010 the Company completed the sale of its workers’ compensation and case management business to GENEX Holdings, Inc. The Company recognized an after-tax gain on sale of $11 million ($18 million before tax) which was reported in other revenues in the Disability and Life segment. See Note 3 to the Consolidated Financial Statements for additional information.
On August 31, 2010, the Company acquired 100% of the voting stock of Vanbreda International NV (“Vanbreda International”), based in Antwerp, Belgium for a cash purchase price of $412 million. See Note 3 to the Consolidated Financial Statements for additional information about the acquisition of Vanbreda International.
During 2008 and 2009, the Company conducted a comprehensive review to reduce certain operating expenses of its ongoing businesses (“cost reduction program”). As a result, the Company recognized severance-related and real estate charges in other operating expenses.
Severance charges in 2008 and 2009 resulted from reductions of approximately 2,350 positions in the Company’s workforce. Cost reduction activities associated with these charges are substantially complete as of December 31, 2010 with severance expected to be paid by the end of the second quarter of 2011. In 2010, the Company recorded an incremental pre-tax charge of $6 million ($4 million after-tax) to reflect actual severance experience differing from prior assumptions.
Cost reduction activity for 2008, 2009 and 2010 was as follows:
The Health Care segment reported substantially all of the 2010 charge, $37 million pre-tax ($24 million after-tax) of the 2009 charges and $44 million pre-tax ($27 million after-tax) of the 2008 charge. The remainder of the 2009 and 2008 charges were reported as follows: Disability and Life: $5 million pre-tax ($4 million after-tax) in 2009 and $3 million pre-tax ($2 million after-tax) in 2008; and International: $2 million pre-tax ($1 million after-tax) in 2009 and $8 million pre-tax ($6 million after-tax) in 2008.
The Company expects annualized after-tax savings from this cost reduction program to be approximately $130 million in 2011 and beyond. A portion of the savings was realized in 2009 while most was realized in 2010.
Adjusted income from operations increased 16% in 2010 compared with 2009 primarily due to strong earnings growth in the ongoing business segments (Health Care, Disability and Life and International), reflecting focused execution of the Company’s strategy, which includes a growing global customer base as well as higher net investment income reflecting improved economic conditions and asset growth. See the individual segment sections of this MD&A for further discussion.
Shareholders’ income from continuing operations increased 3% in 2010 compared with 2009, reflecting strong growth in adjusted income from operations as explained above as well as significant improvement in realized investment results, partially offset by a loss in the GMIB business in 2010 compared with a significant gain in 2009. See the Run-off Reinsurance section of the MD&A beginning on page 75 for additional information on GMIB results.
Adjusted income from operations increased 16% in 2009 compared with 2008 primarily reflecting significantly improved results in the Run-off Reinsurance segment due to a lower amount of reserve strengthening required for the GMDB business in 2009 compared with 2008. This result was primarily due to improved equity market conditions in 2009. Also, in the aggregate, adjusted income from operations from the Company’s ongoing operating segments (Health Care, Disability and Life, and International) improved slightly in 2009 over 2008. These favorable effects were partially offset by higher unallocated costs (including interest) reported in Corporate.
Shareholders’ income from continuing operations for the year ended December 31, 2009 was significantly higher than 2008, reflecting improved adjusted income from operations, as explained above, as well as the following:
Management does not believe that the special items noted in the table above are representative of the Company’s underlying results of operations. Accordingly, the Company excluded these special items from adjusted income from operations in order to facilitate an understanding and comparison of results of operations and permit analysis of trends in underlying revenue, expenses and shareholders’ income from continuing operations.
a loss on the extinguishment of debt resulting from the decision of certain holders of the Company’s 8.5% Notes due 2019 and 6.35% Notes due 2018 to accept the Company’s tender offer to redeem these Notes for cash. See Note 16 for further information; and
a loss on reinsurance of the run-off workers’ compensation and personal accident reinsurance businesses to Enstar. See Note 3 for further information.
Special items for 2008 included a cost reduction charge related to the 2008 cost reduction program (see the Introduction section of the MD&A beginning on page 47 of this Form 10-K), a litigation matter related to the CIGNA Pension Plan (see Note 24 to the Consolidated Financial Statements for additional information) reported in Corporate and charges related to certain other litigation matters, which are reported in the Health Care segment.
The Company also excludes the results of the GMIB business from adjusted income from operations because the fair value of GMIB assets and liabilities must be recalculated each quarter using updated capital market assumptions. The resulting changes in fair value, which are reported in shareholders’ net income, are volatile and unpredictable. See the Critical Accounting Estimates section of the MD&A beginning on page 57 of this Form 10-K for more information on the effect of capital market assumption changes on shareholders’ net income. Because of this volatility, and since the GMIB business is in run-off, management does not believe that its results are meaningful in assessing underlying results of operations. The loss for the GMIB business in 2010 primarily reflects the impact of declining interest rates, partially offset by favorable equity market performance, whereas the gain in 2009 primarily reflected increases in interest rates combined with favorable equity market performance. See the Run-off Reinsurance section of the MD&A beginning on page 75 for further information on the GMIB business.
The Company’s outlook for 2011 is subject to the factors cited above and in the Cautionary Statement beginning on page 95 of this Form 10-K and the sensitivities discussed in the Critical Accounting Estimates section of the MD&A beginning on page 57 of this Form 10-K. If unfavorable equity market and interest rate movements occur, the Company could experience losses related to investment impairments and the GMIB and GMDB businesses. These losses could adversely impact the Company’s consolidated results of operations and financial condition by potentially reducing the capital of the Company’s insurance subsidiaries and reducing their dividend-paying capabilities.
Total revenues increased by 15% in 2010, compared with 2009, and decreased by 4% in 2009 compared with 2008. Changes in the components of total revenue are described in more detail below.
Premiums and fees increased by 15% in 2010, compared with 2009, primarily reflecting membership growth in the Health Care segment’s risk businesses as well as growth in the International segment. Premiums and fees increased by 10% in 2010 compared with 2009 after excluding the Medicare Private Fee for Service (“Medicare PFFS”) Individual business, from which the Company has exited beginning in 2011.
Premiums and fees decreased by 1% in 2009, compared with 2008, primarily reflecting membership declines in Health Care resulting from higher unemployment and the unfavorable effect of foreign currency translation in International, offset by the absence of premium and fees from Great West Healthcare in the first quarter of 2008 since this business was acquired April 1, 2008.
Mail order pharmacy revenues increased by 11% in 2010, compared with 2009, primarily reflecting increases in volume and, to a lesser extent, price increases and by 6% in 2009, compared with 2008, primarily due to price increases.
Other revenues include the impact of futures contracts associated with the GMDB equity hedge program. Losses on futures contracts reflect stock market gains, whereas gains reflect stock market losses. The Company reported losses associated with the GMDB equity hedge program of $157 million in 2010 and $282 million in 2009 compared with gains of $333 million in 2008. Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues increased 4% in 2010, compared with 2009 primarily reflecting the pre-tax gain on the sale of the workers’ compensation and case management business of $18 million.
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues decreased 4% in 2009, compared with 2008, primarily reflecting declines in amortization of deferred gains on the sales of the retirement benefits and individual life insurance and annuity business.
Realized investment results in 2009 were significantly improved compared to 2008, primarily due to:
changes in the estimate or different estimates that could have been selected could have a material effect on the Company’s consolidated results of operations or financial condition.
These liabilities are estimates of the present value of net amounts expected to be paid, less the present value of net future premiums expected to be received. The amounts to be paid represent the excess of the guaranteed death benefit over the values of contractholders’ accounts. The death benefit coverage in force at December 31, 2010 (representing the amount payable if all of approximately 530,000 contractholders had submitted death claims as of that date) was approximately $5 billion.
The Company estimates these liabilities based on assumptions for lapse, partial surrender, claim mortality (deaths that result in claims), interest rates (mean investment performance and discount rate), and volatility. These assumptions are based on the Company’s experience and future expectations over the long-term period. The Company monitors actual experience to update these estimates as necessary.
Lapse: the full surrender of an annuity prior to a contractholder’s death.
Partial surrender: most contractholders have the ability to withdraw substantially all of their mutual fund investments while retaining death benefit coverage in effect at withdrawal. A partial surrender causes the value of the reinsured liability to increase reflecting lower future assumed premiums, a lower likelihood of lapse, and a lower likelihood that account values will recover sufficiently to reduce the death benefit exposure in the future. These effects are not covered by the Company’s GMDB equity hedge program. Market declines expose the Company to higher death benefit exposure and higher anticipated election rates of future partial surrenders. Thus, if equity markets decline, the Company’s liability for partial surrenders increases and there is no corresponding offset from the hedge program. The election rate for expected future partial surrenders is updated quarterly based on emerging experience.
10% increase in election rates for future partial surrenders - $5 million;
As of December 31, 2010, if contractholder account values invested in underlying equity mutual funds declined by 10% due to equity market performance, the after-tax decrease in shareholders’ net income resulting from an increase in the provision for partial surrenders would be approximately $10 million.
Medical claims payable for the Health Care segment include both reported claims and estimates for losses incurred but not yet reported.
For the year ended December 31, 2010, actual experience differed from the Company’s key assumptions as of December 31, 2009, resulting in $93 million of favorable incurred claims related to prior years’ medical claims payable or 1.3% of the current year incurred claims as reported for the year ended December 31, 2009. For the year ended December 31, 2009, actual experience differed from the Company’s key assumptions as of December 31, 2008, resulting in $43 million of favorable incurred claims related to prior years’ medical claims, or 0.6% of the current year incurred claims reported for the year ended December 31, 2008. Specifically, the favorable impact is due to faster than expected completion factors and lower than expected medical cost trends, both of which included an assumption for moderately adverse experience.
The impact of this favorable prior year development was an increase to shareholders’ net income of $26 million after-tax ($39 million pre-tax) for the year ended December 31, 2010. The change in the amount of the incurred claims related to prior years in the medical claims payable liability does not directly correspond to an increase or decrease in shareholders’ net income as explained in Note 5 to the Consolidated Financial Statements.
The assets associated with these contracts represent receivables in connection with reinsurance that the Company has purchased from two external reinsurers, which covers 55% of the exposures on these contracts.
Liabilities related to these contracts as of December 31, were as follows (in millions):
Future annuitant behavior and other inputs: these assumptions include annuity election rates, lapse, mortality, nonperformance risk (for both the Company and its retrocessionaires), and a risk and profit charge. This group of assumptions is based on the Company’s experience, industry data, and management’s judgment.
Nonperformance risk: the market’s perception that either the Company will not fulfill its GMIB liability (own credit) or the Company will not collect on its GMIB retrocessional coverage (reinsurer credit risk).
Based on current and historical market, industry and Company-specific experience and management’s judgment, the Company believes that it is reasonably likely that the unfavorable changes in the key assumptions and/or conditions described below could occur. If these unfavorable assumption changes were to occur, the approximate after-tax decrease in shareholders’ net income, net of estimated amounts receivable from reinsurers, would be as follows:
50 basis point decrease in interest rates (which are aligned with LIBOR) used for projecting market returns and discounting - $15 million;
50 basis point decrease in interest rates used for projecting claim exposure (7-year Treasury rates) - $25 million;
10% increase to the risk and profit charge - $2 million.
Market declines expose the Company to a larger net liability. Decreases in annuitants’ account values resulting from a 10% equity market decline could decrease shareholders’ net income by approximately $20 million. Decreases in annuitants’ account values resulting from a 3% decline due to bond/money market performance could decrease shareholders’ net income by approximately $2 million.
Accounts payable, accrued expenses and other liabilities, and Other assets including other intangibles - Guaranteed minimum income benefits (continued)
The amounts would be reflected in the Run-off Reinsurance segment in GMIB expense.
The Company estimates these liabilities and the related expense with actuarial models using various assumptions including discount rates and an expected long-term return on plan assets.
Discount rates are set by applying actual annualized yields at various durations from the Citigroup Pension Liability curve, without adjustment, to the expected cash flows of the pension liabilities.
The expected long-term return on plan assets for the domestic qualified pension plan is developed considering actual historical returns, expected long-term market conditions, plan asset mix and management’s investment strategy. In addition, to measure pension costs the Company uses a market-related asset value method for domestic qualified pension plan assets invested in non-fixed income investments, which are approximately 80% of total plan assets. This method recognizes the difference between actual and expected returns in the non-fixed income portfolio over 5 years, a method that reduces the short-term impact of market fluctuations on pension cost. At December 31, 2010, the market-related asset value was approximately $3.4 billion compared with a market value of $3.2 billion.
The accumulated unrecognized actuarial loss of $1.8 billion at December 31, 2010 primarily reflects the significant decline in the value of equity securities during 2008 and, to a lesser extent, a decline in the discount rate and change in mortality assumption during 2010. The actuarial loss is adjusted for unrecognized changes in market-related asset values and amortized over the average remaining life expectancy of plan participants if the adjusted loss exceeds 10% of the market-related value of plan assets or 10% of the projected benefit obligation, whichever is greater. As of December 31, 2010, approximately $1.1 billion of the adjusted actuarial loss exceeded 10% of the projected benefit obligation. As a result, approximately $25 million after-tax of the unrecognized loss will be expensed in 2011 shareholders’ net income. For the year ended December 31, 2010, $18 million after-tax of the unrecognized loss was expensed in shareholders’ net income.
If discount rates for the qualified and nonqualified pension plans decreased by 50 basis points:
annual pension costs for 2011 would decrease by approximately $3 million, after-tax; and
If the expected long-term return on domestic qualified pension plan assets decreased by 50 basis points, annual pension costs for 2011 would increase by approximately $10 million after-tax.
Recognition of losses from “other- than-temporary” impairments of public and private placement fixed maturities
To assess whether a fixed maturity’s decline in fair value below its amortized cost is other than temporary, the Company evaluates the expected recovery in value and its intent to sell or the likelihood of a required sale of the fixed maturity prior to an expected recovery.
When the Company does not expect to recover a fixed maturity’s amortized cost, its fair value and expected future cash flows must be estimated by management to record an impairment loss. The credit portion of an impairment loss is recognized in shareholders’ net income and measured as the difference between a fixed maturity’s amortized cost and the net present value of its projected future cash flows. The non-credit portion, if any, is recognized in a separate component of shareholders’ equity.
When evaluating whether a loss is other than temporary, the Company considers factors including:
Management estimates other-than-temporary impairments based on fair values using quoted market prices for public securities with active markets and generally the present value of future cash flows for private placement bonds and other public securities. Expected future cash flows for each fixed maturity are based on the Company’s assessment of qualitative and quantitative factors, including the probability of default, and the estimated timing and amount of any recovery in value. See Note 11 to the Consolidated Financial Statements for a discussion of the Company’s fair value measurements.
The Company recognized other -than- temporary impairments of investments in fixed maturities as follows (in millions, after-tax):
For all fixed maturities with cost in excess of their fair value, if this excess was determined to be other-than-temporary, shareholders’ net income for the year ended December 31, 2010 would have decreased by approximately $51 million after-tax.
For private placement bonds considered impaired, a decrease of 10% of all expected future cash flows for the impaired bonds would reduce shareholders’ net income by less than $1 million after-tax.
Recognition of losses from valuation reserves for impaired commercial mortgage loans
See Note 2 (C) to the Consolidated Financial Statements for additional information regarding the Company’s accounting policies for commercial mortgage loans.
rental and growth rates for the property and its local market;
These evaluations are based primarily on an in-depth review of the commercial mortgage loan portfolio which is completed annually in the third quarter. The Company updates this annual review as material changes in these factors are identified.
See the Investment Assets section of the MD&A beginning on page 88 for discussion of the Company’s problem and potential problem mortgage loans and Note 12 to the Consolidated Financial Statements for further information surrounding impaired commercial mortgage loans.
If loans with carrying values in excess of the fair value of their underlying property were considered impaired as of December 31, 2010, shareholders’ net income would decrease by approximately $11 million after-tax.
Beginning in 2010, the Company began reporting the expense associated with its frozen pension plans in Corporate. Prior periods were not restated; the effect on prior periods is not material.
The Health Care segment offers insured and self-insured medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services that may be integrated to provide comprehensive health care benefit programs. CIGNA HealthCare companies offer these products and services in all 50 states, the District of Columbia and the U.S. Virgin Islands. These products and services are offered through a variety of funding arrangements such as guaranteed cost, retrospectively experience-rated and administrative services only arrangements.
The Company measures the operating effectiveness of the Health Care segment using the following key factors:
revenue growth in the commercial risk businesses, particularly in the targeted market segments, as evidenced by a 15% increase in commercial risk membership. In addition, adjusted income from operations was favorably impacted by increased penetration of our specialty products;
Operating expense efficiencies were achieved by successful execution of cost reduction initiatives including staffing, real estate and pension changes, resulting in an approximately 3% decrease in the operating expense ratio. Despite this decline in the expense ratio, adjusted income from operations was reduced in 2010 by increased expenses related to business growth, investment in segment expansion, compliance and higher management incentive compensation.
The Health Care segment’s adjusted income from operations in 2009, as compared with 2008, was favorably impacted by the absence of a $7 million after-tax adjustment related to a large experience-rated life and non-medical account in run-out recorded in the first quarter of 2008.
lower operating expenses, excluding the impact of an additional quarter from the Great-West Healthcare acquisition (effective April 1, 2008), primarily driven by cost reduction initiatives and pension plan changes, partially offset by higher management incentive compensation and higher information technology spend;
membership growth in the Medicare private fee for service and Voluntary products; and
Net investment income increased by 34% in 2010 compared with 2009 primarily reflecting higher security partnership results, higher real estate income and increased invested assets driven by business growth. Net investment income decreased by 10% in 2009 compared with 2008 primarily reflecting lower income from real estate funds partially offset by higher invested assets.
Other operating expenses increased in 2010, compared with 2009, primarily due to increased membership in risk products, investment in segment expansion, compliance and higher management incentive compensation, partially offset by cost reduction initiatives including staffing, real estate and pension changes.
Excluding special items, other operating expenses increased slightly in 2009 compared with 2008, primarily due to expenses related to the Great-West Healthcare acquisition (effective April 1, 2008), higher management incentive compensation and higher information technology spend, mostly offset by cost reduction initiatives and pension plan changes as a result of the comprehensive review of ongoing expenses, as well as lower volume-related expenses.
Medical claims payable increased $325 million for the year ended December 31, 2010 largely driven by medical membership growth, particularly in the Medicare PFFS and commercial risk businesses as noted above (see Note 5 to the Consolidated Financial Statements for additional information). The Medicare PFFS reserve balance was $167 million as of December 31, 2010. It is expected that a substantial portion of this reserve will be settled by December 31, 2011.
A medical member reported within the Health Care segment (excluding members in the International and Disability and Life segments) is defined as a person who falls within one of the following categories:
The Health Care segment is focused on several operational strategies including improving the efficiency of its operations, while growing its customer base in targeted markets and focusing on the needs of its customers. Savings generated from the reduction of operating expenses will provide the financial flexibility and capital to make investments that will enable the Company to enhance its capabilities, particularly in product development and the delivery of customer service, health advocacy and related technology. These capabilities are critical to enabling the Health Care segment to execute on its strategies to achieve profitable growth and retain customers. Successful execution of these operational strategies is critical to maintaining and improving its competitive position in the health care marketplace.
The Company continues to focus on the development and enhancement of its service model that is capable of meeting the challenges brought on by the increasing product and service complexity and the heightened expectations of health care customers. The Company continues to make significant investments in the development and implementation of systems and technology to improve the provider service experience for customers and health care professionals (e.g. opening its Call Center 24/7), thereby enhancing its capabilities and improving its competitive position.
targeted geographic regions where the Company already has a strong market presence and competitive networks;
increasing penetration of our specialty health care programs and services and cross-selling products sold primarily by other segments of the Company.
Driving additional cross-selling is also key to the Company’s integrated benefits value proposition. The Company is expanding network access for its dental product and improving network flexibility to drive better alignment with customers’ needs including increasing disability and pharmacy penetration across the entire book.
In addition to designing lower cost plan offerings to meet emerging customer and market trends, enhancements to the Company’s suite of products (CIGNA Choice Fund® CIGNA Health Advisor, CIGNA Incentive Points Program, CIGNA Choicelinx) offer various options to customers and employers that are key to our customer engagement strategy. By providing tools to our customers which will facilitate access and greater understanding of their health care choices, customers are better equipped to make effective health related decisions. CIGNA’s Cost of Care Estimator, Quicken Health and improvements to customer Explanation of Benefits and Health Statements are a part of the Company’s strategy to engage the individual by making information more available and easier to understand. In addition to operating clinics at employer sites, the Company has expanded their onsite health services to include onsite pharmacies, dedicated health advocates, hourly coaching services and onsite biometric screenings through the acquisition of Kronos.
The Health Care segment is focused on continuing to effectively manage medical utilization and unit costs. The Company believes that by increasing the quality of medical care and improving access to care it can drive reductions in total medical cost and better outcomes, resulting in healthier members. To help achieve this, the Company continues to focus on contracting with health care professionals to strengthen its networks in targeted markets, enhancing clinical capabilities and engaging its customers and clients/employers.
The Health Care segment’s operating expenses are comprised of three components and are approximately allocated as follows: health care (70%), specialty and market segment expansion (20%), and premium taxes and commissions (10%).
The Disability and Life segment’s adjusted income from operations increased 4% in 2010 compared to 2009 reflecting:
the $11 million after-tax gain on the sale of the workers’ compensation and case management business.
slightly less favorable accident claims experience including the less favorable after-tax impact of reserve studies of $3 million in 2010 compared with $5 million in 2009; and
a higher operating expense ratio, including a litigation expense charge of $4 million;
Premiums and fees increased 1% in 2010 compared with 2009. The segment’s revenue growth was somewhat tempered by the Company’s exit from two large, non-strategic assumed government life insurance programs and the sale of the renewal rights for the student and participant accident business. Excluding the impact of these items, premiums and fees increased 7% as a result of disability and life sales growth combined with solid persistency.
Premiums and fees increased by 3% in 2009 compared with 2008 reflecting disability and life sales growth and solid persistency, partially offset by lower employment levels at the customers we serve, the Company’s exit from a large, low-margin assumed government life reinsurance program and the sale of the renewal rights for the student and participant accident business.
Net investment income increased by 7% in 2010 reflecting higher income from security and real estate partnerships and higher assets. Net investment income decreased by 5% in 2009 reflecting lower yields and lower security and real estate partnership income.
Other revenues include the $18 million pre-tax gain on the sale of the workers’ compensation and case management business in 2010.
less favorable claims experience in the short-term disability insurance business. These results reflect the favorable pre-tax impact of disability reserve studies of $43 million in 2010 compared with $29 million in 2009, largely driven by continued strong disability claims management programs.
Benefits and expenses increased 2% in 2009 compared with 2008, primarily reflecting:
more favorable disability claims experience including the favorable pre-tax impact of disability reserve studies of $29 million in 2009 compared with $15 million in 2008 resulting from higher resolutions driven by strong disability management programs partially offset by higher new claims;
the Company’s exit from a government life insurance program and sale of the renewal rights for the student and participant accident business.
The International segment includes supplemental health, life and accident insurance products and international health care products and services, including those offered to expatriate employees of multinational corporations and other organizations.
Excluding the impact of the tax adjustments discussed below and foreign currency movements (presented in the table above), the International segment’s adjusted income from operations decreased 7% for 2009, compared with 2008. The decrease was primarily driven by unfavorable claims experience in the supplemental health, life and accident insurance business and the expatriate employee benefits business. The unfavorable effects were partially offset by revenue growth and competitively strong margins in both businesses.
Throughout this discussion, the impact of foreign currency movements was calculated by comparing the reported results to what the results would have been had the exchange rates remained constant with the prior year’s comparable period exchange rates. The favorable impact in 2010 using 2009 rates, as well as the unfavorable change in 2009 using 2008 rates, primarily reflects the movement between the U.S. dollar and the South Korean won.
Premiums and fees. Excluding the effect of foreign currency movements, premiums and fees were $2.2 billion in 2010, compared with reported premiums and fees of $1.9 billion in 2009, an increase of 16%. The increase was primarily attributable to new sales growth in the supplemental health, life and accident insurance operations, particularly in South Korea, and rate increases and membership growth in the expatriate employee benefits business. Excluding the effect of foreign currency movements, premiums and fees were $2.0 billion in 2009, compared with reported premiums and fees of $1.9 billion in 2008, an increase of 9%. The increase was primarily attributable to new sales growth in the supplemental health, life and accident insurance operations, particularly in Taiwan and South Korea, and rate actions in the expatriate employee benefits business.
Net investment income increased by 19% in 2010, compared with 2009. The increase was primarily due to favorable foreign currency movements and asset growth, particularly in South Korea. Net investment income decreased by 13% in 2009, compared with 2008. The decrease was primarily due to unfavorable foreign currency movements, primarily in South Korea.
Excluding the impact of foreign currency movements, benefits and expenses were $2.0 billion in 2010, compared with reported benefits and expenses of $1.7 billion in 2009, an increase of 15%. These increases were primarily due to business growth and higher claims in the supplemental health, life and accident insurance business, particularly in South Korea. Excluding the impact of foreign currency movements, benefits and expenses were $1.8 billion in 2009, compared with reported benefits and expenses of $1.7 billion in 2008, an increase of 9%. The increase was primarily driven by higher loss ratios, business growth, and increased amortization of deferred acquisition costs.
For the Company’s International segment, South Korea is the single largest geographic market. South Korea generated 32% of the segment’s revenues and 49% of the segment’s earnings in 2010. South Korea generated 29% of the segment’s revenues and 49% of the segment’s earnings in 2009. Due to the concentration of business in South Korea, the International segment is exposed to potential losses resulting from economic and geopolitical developments in that country, as well as foreign currency movements affecting the South Korean currency, which could have a significant impact on the segment’s results and the Company’s consolidated financial results.
As discussed in Note 3 to the Consolidated Financial Statements, the Company acquired Vanbreda International in August of 2010. This acquisition further strengthens CIGNA International’s position in the expatriate benefits market. Since the acquisition, earnings from Vanbreda International have been immaterial to results of operations. The Company expects Vanbreda International’s earnings to be accretive in 2011.
In China, CIGNA International owns a 50% interest in a joint venture through which its products and services are offered. The Company accounts for this joint venture using the equity method, recording its share of the joint venture’s net income in other revenues.
The adjusted loss from operations for Run-off Reinsurance was larger in 2010 compared with 2009 due to reduced favorable after-tax impact of reserve studies ($6 million for 2010 compared to $16 million for 2009) and settlements and commutations ($3 million for 2010 compared to $11 million in 2009) for workers compensation and personal accident businesses, partially offset by reduced charges in 2010 to strengthen GMDB reserves ($34 million after-tax for 2010, compared to $47 million after-tax for 2009).
Segment earnings were significantly higher in 2009, compared with 2008, due in part to the improvement in adjusted income from operations as discussed above and the significant improvement in GMIB results in 2009 (significant gains) compared with 2008 (significant losses).
Other revenues included pre-tax losses from futures contracts used in the GMDB equity hedge program (see Note 7 to the Consolidated Financial Statements) of $157 million in 2010 and $282 million in 2009 compared with pre-tax gains of $333 million in 2008. Amounts reflecting corresponding changes in liabilities for GMDB contracts were included in benefits and expenses consistent with GAAP when a premium deficiency exists (see below “Other Benefits and Expenses”). The Company held futures contract positions related to this program with a notional amount of $0.9 billion at December 31, 2010.
GMIB fair value losses of $55 million for 2010, were primarily due to declining interest rates, partially offset by increases in underlying account values resulting from favorable equity and bond fund returns, which result in decreased exposures.
GMIB fair value losses of $690 million for 2008 include a pre-tax charge of $202 million for the adoption of the FASB’s fair value disclosure and measurement guidance, which is discussed in Notes 2(B) and 11 to the Consolidated Financial Statements. Excluding the charge on adoption, the GMIB fair value losses of $488 million were primarily due to declines in interest rates, the impact of declines in underlying account values driven by declines in equity markets and bond fund returns, resulting in increased exposures, and unfavorable annuitization and lapse experience.
However, significant declines in mutual fund values that underlie the contracts (increasing the exposure to the Company) together with declines in the 7-year treasury rates (used to determine claim payments) similar to what occurred periodically during the last few years would increase the expected amount of claims that would be paid out for contractholders who choose to annuitize. It is also possible that such unfavorable market conditions would have an impact on the level of contractholder annuitizations, particularly if these unfavorable market conditions persisted for an extended period.
2010: Primarily reflects management’s consideration of the anticipated impact of the continued low level of current short-term interest rates and, to a lesser extent, a reduction in assumed lapse rates for policies that have taken or are assumed to take significant partial withdrawals.
2009: Primarily due to an increase in the provision for future partial surrenders due to overall market declines, adverse volatility-related impacts due to turbulent equity market conditions and adverse interest rate impacts.
2008: Primarily due to the adverse impacts of overall market declines, volatility related impacts due to turbulent equity market conditions, and to a lesser extent, adverse interest rate impacts.
CIGNA’s Other Operations segment includes the results of the following businesses:
Other revenues decreased 6% in 2010 compared with 2009 and decreased 10% in 2009 compared with 2008 primarily due to lower deferred gain amortization related to the sold retirement benefits and individual life insurance and annuity businesses.
For more information regarding the sale of these businesses see Note 8 of the Consolidated Financial Statements beginning on page 119 of this Form 10-K.
Corporate reflects amounts not allocated to other segments, such as net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment operations), interest on uncertain tax positions, certain litigation matters, intersegment eliminations, compensation cost for stock options and certain corporate overhead expenses such as directors’ expenses and, beginning in 2010, pension expense related to the Company’s frozen pension plans.
tax adjustments related to postretirement benefits and compensation resulting from health care reform; and
Cash flows from operating activities increased by $998 million in 2010 compared with 2009. Excluding the results of the GMDB equity hedge program (which did not affect net income), cash flows from operating activities increased by $873 million. This increase in 2010 primarily reflects premium growth in the Health Care segment’s risk businesses as noted above and earnings growth in the Health Care, Disability and Life and International segments as well as lower contributions to the qualified domestic pension plan ($212 million in 2010, compared with $410 million in 2009). These favorable effects were partially offset by higher management compensation and income tax payments in 2010 compared with 2009.
Cash used in investing activities was $1.3 billion. This use of cash primarily consisted of net purchases of investments of $503 million, cash used to fund acquisitions (net of cash acquired) of $344 million, net cash used to transfer the run-off workers’ compensation and personal accident assumed reinsurance business via a reinsurance transaction of $190 million, and net purchases of property and equipment of $300 million.
For the year ended December 31, 2009, cash flows from operating activities were less than net income by $560 million. Net income contains certain non-cash income and expense items, which neither provide nor use operating cash flow, including:
Cash used in investing activities was $1.5 billion. This use of cash primarily consisted of net purchases of investments of $1.2 billion and net purchases of property and equipment of $307 million.
The increase in interest expense in 2009 was primarily due to the issuance of debt used for general corporate purposes, including the repayment of some of the Company’s outstanding commercial paper issued to finance the Great-West Healthcare acquisition.
On December 8, 2010, the Company issued $250 million of 4.375% Notes ($249 net of debt discount, with an effective interest rate of 5.1%). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. See Note 13 to the Consolidated Financial Statements for further information. Interest is payable on June 15 and December 15 of each year beginning December 15, 2010. These Notes will mature on December 15, 2020. The proceeds of this debt were used to fund the tender offer for the Company’s 8.5% Senior Notes due 2019 and the 6.35% Senior Notes due 2018 (described further below under uses of capital).
On May 12, 2010, the Company issued $300 million of 5.125% Notes ($299 million, net of debt discount, with an effective interest rate of 5.36% per year). Interest is payable on June 15 and December 15 of each year beginning December 15, 2010. These Notes will mature on June 15, 2020. The proceeds of this debt were used for general corporate purposes.
On May 4, 2009, the Company issued $350 million of 8.5% Notes ($349 million, net of debt discount, with an effective interest rate of 9.90% per year). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. See Note 13 to the Consolidated Financial Statements for further information. Interest is payable on May 1 and November 1 of each year beginning November 1, 2009. The proceeds of this debt were used for general corporate purposes, including the repayment of some of the Company’s outstanding commercial paper. These Notes will mature on May 1, 2019. As explained further under Uses of Capital below, the Company repurchased a portion of these Notes under a tender offer dated December 1, 2010.
The Company maintains a share repurchase program, which was authorized by its Board of Directors. The decision to repurchase shares depends on market conditions and alternate uses of capital. The Company has, and may continue from time to time, to repurchase shares on the open market through a Rule 10b5-1 plan which permits a company to repurchase its shares at times when it otherwise might be precluded from doing so under insider trading laws or because of self-imposed trading blackout periods. The Company suspends activity under this program from time to time and also removes such suspensions, generally without public announcement.
The Company did not repurchase any shares during 2009 and repurchased 10.0 million shares for $378 million in 2008.
scheduled interest payments of $167 million on outstanding short-term and long-term debt of $2.8 billion at December 31, 2010;
approximately $100 million of commercial paper that will mature over the next three months. The Company expects to either repay the commercial paper or refinance it either by issuing long-term debt or re-issuing commercial paper.
The Company expects, based on cash on hand, current projections for dividends from the Company’s subsidiaries, as well as its ability to issue debt or equity securities in the capital markets to have sufficient liquidity to meet its obligations.
Many states have adopted some form of the National Association of Insurance Commissioners (“NAIC”) model solvency-related laws and risk-based capital rules (“RBC rules”) for life and health insurance companies. The RBC rules recommend a minimum level of capital depending on the types and quality of investments held, the types of business written and the types of liabilities incurred. If the ratio of the insurer’s adjusted surplus to its risk-based capital falls below statutory required minimums, the insurer could be subject to regulatory actions ranging from increased scrutiny to conservatorship.
Effective December 31, 2009 the Company’s principal life insurance subsidiary, CGLIC, implemented the NAIC’s Actuarial Guideline XLIII (also known as AG 43 or VACARVM), which is applicable to CGLIC’s statutory reserves for GMDB and GMIB contracts totaling $1.5 billion as of December 31, 2010. As provided under this guidance, CGLIC received approval from the State of Connecticut to grade-in the full effect of the guideline over a 3-year period beginning in 2009. At December 31, 2010, statutory reserves for CGLIC were higher than the pre-AG 43 reserves by $123 million. If the guidance had been fully implemented at December 31, 2010, statutory reserves would have been higher by an additional $62 million. Management does not anticipate that VACARVM will have a material impact on the amount of dividends expected to be paid by CGLIC to the parent company in 2011. In addition, VACARVM has no impact on measurement of the Company’s results of operations or financial condition as determined under GAAP.
Insurance liabilities. Contractual cash obligations for insurance liabilities, excluding unearned premiums and fees, represent estimated net benefit payments for health, life and disability insurance policies and annuity contracts. Recorded contractholder deposit funds reflect current fund balances primarily from universal life customers. Contractual cash obligations for these universal life contracts are estimated by projecting future payments using assumptions for lapse, withdrawal and mortality. These projected future payments include estimated future interest crediting on current fund balances based on current investment yields less the estimated cost of insurance charges and mortality and administrative fees. Actual obligations in any single year will vary based on actual morbidity, mortality, lapse, withdrawal, investment and premium experience. The sum of the obligations presented above exceeds the corresponding insurance and contractholder liabilities of $16 billion recorded on the balance sheet because the recorded insurance liabilities reflect discounting for interest and the recorded contractholder liabilities exclude future interest crediting, charges and fees. The Company manages its investment portfolios to generate cash flows needed to satisfy contractual obligations. Any shortfall from expected investment yields could result in increases to recorded reserves and adversely impact results of operations. The amounts associated with the sold retirement benefits and individual life insurance and annuity businesses, as well as the reinsured workers’ compensation and personal accident businesses are excluded from the table above as net cash flows associated with them are not expected to impact the Company. The total amount of these reinsured reserves excluded is approximately $6 billion.
Operating leases. For additional information, see Note 22 to the Consolidated Financial Statements.
The Company’s fixed maturity portfolio continues to be diversified by issuer and industry type, with no single industry constituting more than 10% of total invested assets as of December 31, 2010.
As of December 31, 2010, $13.5 billion, or 92%, of the fixed maturities in the Company’s investment portfolio were investment grade (Baa and above, or equivalent), and the remaining $1.2 billion were below investment grade. The majority of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum. These quality characteristics have not materially changed during the year.
The net appreciation of the Company’s fixed maturity portfolio increased nearly $400 million during 2010, driven by a decline in market yields. Although asset values are well in excess of amortized cost, there are specific securities with amortized cost in excess of fair value by approximately $80 million as of December 31, 2010.
Corporate fixed maturities includes private placement investments of $4.7 billion, which are generally less marketable than publicly-traded bonds, but yields on these investments tend to be higher than yields on publicly-traded bonds with comparable credit risk. The Company performs a credit analysis of each issuer, diversifies investments by industry and issuer and requires financial and other covenants that allow the Company to monitor issuers for deteriorating financial strength and pursue remedial actions, if warranted.
The Company invests in high quality foreign government obligations, with an average quality rating of AA as of December 31, 2010. The diversification of these investments was consistent with the geographic distribution of the international business operations.
As of December 31, 2010, the Company’s investments in other asset and mortgage-backed securities totaling $754 million included $477 million of investment grade private placement securities guaranteed by monoline bond insurers. Quality ratings without considering the guarantees for these other asset-backed securities were not available.
Values estimated for the properties in CIGNA’s mortgage portfolio reflect improving commercial real estate capital markets, with stabilizing, and in some instances, increasing values, for well leased, quality commercial real estate located in strong institutional markets, the quality reflected by the vast majority of properties securing the mortgages. The deterioration in property cash flows (and resulting debt service coverage levels) estimated as part of the review reflects generally weak fundamentals (higher vacancy and reduced rental rates) across property types and markets. While commercial real estate capital markets improved during 2010 and there are some signs of improvement in fundamentals, a sustained recovery will be dependent on continued improvement in local markets and the broader national economy.
The following table reflects the commercial mortgage loan portfolio as of December 31, 2010 summarized by loan-to-value ratio based on the annual loan review completed in July, 2010.
There are seven loans where the aggregate carrying value of the mortgage loans exceeds the value of the underlying properties by $17 million. Five of these loans have current debt service coverage of 1.0 or greater and two with debt service coverage below 1.0 have other risk mitigating factors including strong borrower sponsorship. As of December 31, 2010, the mortgage portfolio contains approximately 170 loans and all but four of these loans (totaling $86 million and considered problem commercial mortgage loans) continue to perform under their contractual terms, resulting in an aggregate default rate of 2.5%. The Company has $518 million of loans maturing in the next twelve months. Given the quality and diversity of the underlying real estate, positive debt service coverage and significant borrower cash investment averaging nearly 30%, the Company remains confident that the vast majority of borrowers will continue to perform as required. While considered unlikely, if property values were to decrease 10% from those levels estimated during the annual in-depth loan review, this would cause approximately 18% of the portfolio’s carrying values to exceed the fair values of their underlying properties, totaling $80 million.
The Company’s other long-term investments include $682 million in securities 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. Because these investments have a subordinate position in the capital structure, the Company assumes a higher level of risk for higher expected returns. Although the total fair values of these investments exceeded their carrying values as of December 31, 2010, the fair value of the Company’s ownership interest in certain funds (those carried at cost) was less than its carrying value by $50 million. During 2010 these investment values improved, but remained at depressed levels reflecting the impact of declines in value experienced predominantly during 2008 and 2009 due to economic weakness and disruption in the capital markets, particularly in the commercial real estate market. The Company believes these declines in value are temporary and expects to recover its carrying value over the remaining lives of the funds. To mitigate risk, these investments are diversified across approximately 65 separate partnerships, and approximately 40 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 investment exceeds 6% of the Company’s securities and real estate partnership portfolio. Given the current economic environment, future impairments are possible; however, management does not expect those losses to have a material effect on the Company’s results of operations, financial condition or liquidity.
“Problem” bonds and commercial mortgage loans are either delinquent by 60 days or more or have been restructured as to terms, which could include concessions by the Company for modification of interest rate, principal payment or maturity date. “Potential problem” bonds and commercial mortgage loans are considered current (no payment more than 59 days past due), but management believes they have certain characteristics that increase the likelihood that they may become problems. The characteristics management considers include, but are not limited to, the following:
$7 million reduction to problem bonds due to redemption activity; and
Realized investment gains and losses from the disposal of problem assets were not material to the Company’s results of operations.
Net potential problem investments represent 1.7% of total investments excluding policy loans. Net potential problem investments increased $4 million during 2010 reflecting:
$188 million increase due to the addition of eight commercial mortgage loans, five of which were identified as a result of management’s in-depth portfolio loan review completed in July 2010. These loans were exhibiting signs of distress such as an elevated loan-to-value ratio or a low or negative debt service coverage. Seven of the loans continue to perform according to their original contractual terms as of December 31, 2010, while one of the loans was reclassified to problem status;
$96 million reduction for commercial mortgage loans that were sold, foreclosed, reclassified to problem commercial mortgage loans or paid down;
The financial credit markets improved during 2010, with appreciation in asset values reflecting lower market yields. In the current economic environment, risks in the Company’s investment portfolio, while declining, remain elevated. Continued economic weakness for an extended period could cause default rates to increase and recoveries to decline resulting in additional impairment losses for the Company. Future realized and unrealized investment results will be impacted largely by future market conditions that are not reasonably predictable. Management believes that the vast majority of the Company’s fixed maturity investments will continue to perform under their contractual terms, and that declines in their fair values below carrying value are temporary. Based on the strategy to match the duration of invested assets to the duration of insurance and contractholder liabilities, the Company expects to hold a significant portion of these assets for the long term. While future credit-related losses could have a material adverse impact on results of operations, such losses are not expected to have a material adverse effect on the Company’s financial condition or liquidity.
Interest-rate risk on fixed-rate, domestic, medium-term instruments. Changes in market interest rates affect the value of instruments that promise a fixed return and impact the value of liabilities for reinsured GMDB and GMIB contracts.
Foreign currency exchange rate risk of the U.S. dollar primarily to the South Korean won, euro, Taiwan dollar, British pound, New Zealand dollar, and Hong Kong dollar. An unfavorable change in exchange rates reduces the carrying value of net assets denominated in foreign currencies.
Equity price risk for domestic equity securities and for the value of reinsured GMDB and GMIB contracts resulting from unfavorable changes in variable annuity account values based on underlying mutual fund investments.
Investment/liability matching. The Company generally selects investment assets with characteristics (such as duration, yield, currency and liquidity) that correspond to the underlying characteristics of its related insurance and contractholder liabilities so that the Company can match the investments to its obligations. Shorter-term investments support generally shorter-term life and health liabilities. Medium-term, fixed-rate investments support interest-sensitive and health liabilities. Longer-term investments generally support products with longer pay out periods such as annuities and long-term disability liabilities.
In addition, hypothetical effects of changes in equity indices and foreign exchange rates are presented separately for futures contracts used in the GMDB equity hedge program.
By their nature, forward-looking statements: (i) speak only as of the date they are made, (ii) are not guarantees of future performance or results and (iii) are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from those forward-looking statements as a result of a variety of factors. Some factors that could cause actual results to differ materially from the forward-looking statements include:
increased medical costs that are higher than anticipated in establishing premium rates in the Company’s Health Care operations, including increased use and costs of medical services;
challenges and risks associated with implementing operational improvement initiatives and strategic actions in the ongoing operations of the businesses, including those related to: (i) growth in targeted geographies, product lines, buying segments and distribution channels, (ii) offering products that meet emerging market needs, (iii) strengthening underwriting and pricing effectiveness, (iv) strengthening medical cost and medical membership results, (v) delivering quality member and provider service using effective technology solutions, (vi) lowering administrative costs and (vii) transitioning to an integrated operating company model, including operating efficiencies related to the transition;
downgrades in the financial strength ratings of the Company’s insurance subsidiaries, which could, among other things, adversely affect new sales, retention of current business as well as a downgrade in financial strength ratings of reinsurers which could result in increased statutory reserve or capital requirements;
adjustments to the assumptions (including annuity election rates and amounts collectible from reinsurers) used in estimating the Company’s assets and liabilities for reinsurance contracts covering guaranteed minimum income benefits under certain variable annuities;
significant deterioration in economic conditions and significant market volatility, which could have an adverse effect on the Company’s operations, investments, liquidity and access to capital markets;
adverse changes in state, federal and international laws and regulations, including health care reform legislation and regulation which could, among other items, affect the way the Company does business, increase cost, limit the ability to effectively estimate, price for and manage medical costs, and affect the Company’s products, services, market segments, technology and processes;
This list of important factors is not intended to be exhaustive. Other sections of the Form 10-K, including the “Risk Factors” section, and other documents filed with the Securities and Exchange Commission include both expanded discussion of these factors and additional risk factors and uncertainties that could preclude the Company from realizing the forward-looking statements. The Company does not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets and liabilities of the Company;
The Consolidated Financial Statements include the accounts of CIGNA Corporation and its significant 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.
In preparing these Consolidated Financial Statements, the Company has evaluated events that occurred between the balance sheet date and February 25, 2011 and determined there were no other items to disclose.
Certain reclassifications have been made to prior period amounts to conform to the current presentation. In addition, certain amounts have been restated as a result of the adoption of new accounting pronouncements.
Amendments to this guidance in 2008 and 2009 had no effect on the Company’s Consolidated Financial Statements. See Note 11 for additional information.
Effective January 1, 2009, the Company adopted the FASB’s updated guidance on accounting for noncontrolling interests (ASC 810) through retroactive restatement of prior financial statements and reclassified $3 million of noncontrolling interest as of January 1, 2007 from Accounts payable, accrued expenses and other liabilities to Noncontrolling interest in total equity. In addition, net income attributable to the noncontrolling interest of $2 million in 2008 and $3 million in 2007 has been reclassified to be included in net income, with a reduction to net income to determine net income attributable to the Company’s shareholders (“shareholders’ net income”).
At the time of foreclosure, properties are reclassified from commercial mortgage loans to real estate or other long-term investments depending on the ownership of the underlying assets. The Company rehabilitates, re-leases and sells foreclosed properties. This process usually takes from three to five years unless management considers a near-term sale preferable. When foreclosed real estate is recapitalized through a joint venture including a contribution of new equity from a third-party investor, the asset is accounted for as a partnership investment in good standing reported in other long-term investments.
Note 13 discusses the Company’s accounting policies for derivative financial instruments.
Premiums, accounts and notes receivable are reported net of an allowance for doubtful accounts of $49 million as of December 31, 2010 and $43 million as of December 31, 2009. Reinsurance recoverables are estimates of amounts that the Company will receive from reinsurers and are recorded net of an allowance for unrecoverable reinsurance of $10 million as of December 31, 2010 and $15 million as of December 31, 2009. The Company estimates these allowances for doubtful accounts for premiums, accounts and notes receivable, as well as for reinsurance recoverables, using management’s best estimate of collectibility, taking into consideration the aging of these amounts, historical collection patterns and other economic factors.
Supplemental health, life and accident insurance (primarily individual international products) 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.
Separate account assets and liabilities are contractholder funds maintained in accounts with specific investment objectives. The assets of these accounts are legally segregated and are not subject to claims that arise out of any of the Company’s other businesses. These separate account assets are carried at fair value with equal amounts for related separate account liabilities. The investment income, gains and losses of these accounts generally accrue to the contractholders and are not included in the Company’s revenues and expenses. Fees earned for asset management services are reported in premiums and fees.
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 contracts used in the GMDB equity hedge program are reflected in the liability calculation as a component of investment returns. See also Note 7 for additional information.
The Company’s estimate of the liability for disability claims reported but not yet paid is primarily calculated as the present value of expected benefit payments to be made over the estimated time period that a policyholder remains disabled. The Company estimates the expected time period that a policyholder may be disabled by analyzing the rate at which an open claim is expected to close (claim resolution rate). Claim resolution rates may vary based upon the length of time a policyholder is disabled, the covered benefit period, cause of disability, benefit design and the policyholder’s age, gender and income level. The Company uses historical resolution rates combined with an analysis of current trends and operational factors to develop current estimates of resolution rates. The reserve for the gross monthly disability benefits due to a policyholder is reduced (offset) by the income that the policyholder receives under other benefit programs, such as Social Security Disability Income, worker’s compensation, statutory disability or other group disability benefit plans. For awards of such offsets that have not been finalized, the Company estimates the probability and amount of the offset based on the Company’s experience over the past three to five years.
The Company develops estimates for Health Care medical claims payable using actuarial principles and assumptions consistently applied each reporting period, and recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice, which require that the liabilities be adequate under moderately adverse conditions.
Accounts payable, accrued expenses and other liabilities consist principally of liabilities for pension, other postretirement and postemployment benefits (see Note 10), self-insured exposures, incentive compensation and various insurance-related items, including amounts related to reinsurance contracts and insurance-related assessments that management can reasonably estimate. Accounts payable, accrued expenses and other liabilities also include certain overdraft positions and the loss position of certain derivatives, primarily for GMIB contracts (see Note 13). Legal costs to defend the Company’s litigation and arbitration matters are expensed when incurred in cases for which the Company cannot reasonably estimate the ultimate cost to defend. In cases for which the Company can reasonably estimate the cost to defend, these costs are recognized when the claim is reported.
Premiums and fees received for CIGNA’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, which are estimated quarterly based on claim experience, compare actual incurred drug benefit costs to estimated costs submitted in original contracts and may result in more or less revenue from CMS. Final revenue adjustments are determined through an annual settlement with CMS that occurs after the contract year.
Contract fees and expenses for administrative services only programs and pharmacy programs and services are recognized as services are provided. Mail order pharmacy revenues and cost of goods sold are recognized as each prescription is shipped.
The Company records compensation expense for stock awards and options over their vesting periods primarily based on the estimated fair value at the grant date. Compensation expense is recorded for stock options over their vesting period based on fair value at the grant date which is calculated using an option-pricing model. Compensation expense is recorded for restricted stock grants and units over their vesting periods based on fair value, which is equal to the market price of the Company’s common stock on the date of grant. Compensation expense for strategic performance shares is recorded over the performance period. For strategic performance shares with payment dependent on market condition, fair value is determined at the grant date using a Monte Carlo simulation model and not subsequently adjusted regardless of the final outcome. For strategic performance shares with payment dependent on performance conditions, expense is initially accrued based on the most likely outcome, but evaluated for adjustment each period for updates in the expected outcome. At the end of the performance period, expense is trued up to the actual outcome (number of shares awarded times the share price at the grant date).
The Company recognizes deferred income taxes when the financial statement and tax-based carrying values of assets and liabilities are different and recognizes deferred income tax liabilities on the unremitted earnings of foreign subsidiaries that are not permanently invested overseas. For subsidiaries whose earnings are considered permanently invested overseas, income taxes are accrued at the local foreign tax rate. The Company establishes valuation allowances against deferred tax assets if it is more likely than not that the deferred tax asset will not be realized. The need for a valuation allowance is determined based on the evaluation of various factors, including expectations of future earnings and management’s judgment. Note 20 contains detailed information about the Company’s income taxes.
On December 1, 2010 the Company completed the sale of its workers’ compensation and case management business to GENEX Holdings, Inc. The Company recognized an after-tax gain on sale of $11 million ($18 million pre-tax) which was reported in other revenues in the Disability and Life segment. Proceeds of the sale were received in preferred stock of GENEX Holdings, Inc., resulting in the Company becoming a minority shareholder in GENEX Holdings, Inc. This investment is classified in other long-term investments and accounted for using the equity method of accounting.
On August 31, 2010, the Company acquired 100% of the voting stock of Vanbreda International NV (Vanbreda International), based in Antwerp, Belgium for a cash purchase price of $412 million. Vanbreda International specializes in providing worldwide medical insurance and employee benefits to intergovernmental and non-governmental organizations, including international humanitarian operations, as well as corporate clients. Vanbreda International’s strong presence in Europe complements the Company’s position in providing expatriate benefits primarily to corporate clients in North America, as well as in Europe and Asia.
The results of Vanbreda International are included in the Company’s Consolidated Financial Statements from the date of acquisition. The pro forma effect on total revenues and net income assuming the acquisition had occurred as of January 1, 2009 was not material to the Company’s total revenues and shareholders’ net income for the years ended December 31, 2010 or 2009.
As described in Note 2, effective in 2009, the Company adopted the FASB’s new guidance for determining participating securities which requires the Company’s unvested restricted stock awards to be included in weighted average shares instead of being considered a common stock equivalent and restated 2008 EPS.
The favorable impact in 2010 is primarily due to lower utilization levels that occurred in late 2009 and the release of the provision for moderately adverse conditions. This provision is a component of the assumptions for both completion factors and medical cost trend, established for claims incurred related to prior years. The release was substantially offset by the provision for moderately adverse conditions established for claims incurred related to the current year. The favorable impact in 2009 was primarily due to the release of the provision for moderately adverse conditions.
Second, while changes in reserves for the Company’s guaranteed cost products do directly affect shareholders’ net income, changes in reserves for the Company’s retrospectively experience-rated business do not always impact shareholders’ net income. For the Company’s retrospectively experience-rated business only adjustments to medical claims payable on accounts in deficit affect shareholders’ net income. An increase or decrease to medical claims payable on accounts in deficit, in effect, accrues to the Company and directly impacts shareholders’ net income. An account is in deficit when the accumulated medical costs and administrative charges, including profit charges, exceed the accumulated premium received. Adjustments to medical claims payable on accounts in surplus accrue directly to the policyholder with no impact on the Company’s shareholders’ net income. An account is in surplus when the accumulated premium received exceeds the accumulated medical costs and administrative charges, including profit charges.
During 2008 and 2009, the Company conducted a comprehensive review to reduce the operating expenses of its ongoing businesses (“cost reduction program”). As a result, the Company recognized severance-related and real estate charges in other operating expenses.
Severance charges in 2008 and 2009 resulted from reductions of approximately 2,350 positions in the Company’s workforce. Cost reduction activities associated with these charges are substantially complete as of December 31, 2010. In 2010, the Company recorded an incremental pre-tax charge of $6 million ($4 million after-tax) to reflect actual severance experience differing from prior assumptions.
The Health Care segment recorded substantially all of the 2010 charge, $37 million pre-tax ($24 million after-tax) of the 2009 charges and $44 million pre-tax ($27 million after-tax) of the 2008 charge. The remainder of the 2009 and 2008 charges were reported as follows: Disability and Life: $5 million pre-tax ($4 million after-tax) in 2009 and $3 million pre-tax ($2 million after-tax) in 2008; and International: $2 million pre-tax ($1 million after-tax) in 2009 and $8 million pre-tax ($6 million after-tax) in 2008. Substantially all severance is expected to be paid by the end of the second quarter of 2011.
In 2000, the Company determined that the GMDB reinsurance business was premium deficient because the recorded future policy benefit reserve was less than the expected present value of future claims and expenses less the expected present value of future premiums and investment income using revised assumptions based on actual and expected experience. The Company tests for premium deficiency by reviewing its reserve each quarter using current market conditions and its long-term assumptions. Under premium deficiency accounting, if the recorded reserve is determined insufficient, an increase to the reserve is reflected as a charge to current period income. Consistent with GAAP, the Company does not recognize gains on premium deficient long duration products.
The Company had future policy benefit reserves for GMDB contracts of $1.1 billion as of December 31, 2010, and $1.3 billion as of December 31, 2009. The determination of liabilities for GMDB requires the Company to make critical accounting estimates. The Company estimates its liabilities for GMDB exposures using a complex internal model run using many scenarios and based on assumptions regarding lapse, future partial surrenders, claim mortality (deaths that result in claims), interest rates (mean investment performance and discount rate) and volatility. Lapse refers to the full surrender of an annuity prior to a contractholder’s death. Future partial surrender refers to the fact that most contractholders have the ability to withdraw substantially all of their mutual fund investments while retaining the death benefit coverage in effect at the time of the withdrawal. Mean investment performance for underlying equity mutual funds refers to market rates expected to be earned on the hedging instruments over the life of the GMDB equity hedge program, and for underlying fixed income mutual funds refers to the expected market return over the life of the contracts. Market volatility refers to market fluctuation. These assumptions are based on the Company’s experience and future expectations over the long-term period, consistent with the long-term nature of this product. The Company regularly evaluates these assumptions and changes its estimates if actual experience or other evidence suggests that assumptions should be revised. If actual experience differs from the assumptions (including lapse, future partial surrenders, claim mortality, interest rates and volatility) used in estimating these liabilities, the result could have a material adverse effect on the Company’s consolidated results of operations, and in certain situations, could have a material adverse effect on the Company’s financial condition.
The claim mortality assumption is 65% to 89% of the 1994 Group Annuity Mortality table, with 1% annual improvement beginning January 1, 2000. The assumption reflects that for certain contracts, a spousal beneficiary is allowed to elect to continue a contract by becoming its new owner, thereby postponing the death claim rather than receiving the death benefit currently. For certain issuers of these contracts, the claim mortality assumption depends on age, gender, and net amount at risk for the policy.
The lapse rate assumption is 0% to 24%, depending on contract type, policy duration and the ratio of the net amount at risk to account value.
During 2010, the Company performed its periodic review of assumptions resulting in a charge of $52 million pre-tax ($34 million after-tax) to strengthen GMDB reserves. During 2010, current short-term interest rates had declined from the level anticipated at December 31, 2009, leading the Company to increase reserves. Interest rate risk is not covered by the GMDB equity hedge program discussed above. The Company also updated the lapse assumption for policies that have already taken or may take a significant partial withdrawal, which had a lesser reserve impact.
During 2008, the Company recorded additional benefits expenses of $406 million pre-tax ($263 million after-tax) to strengthen GMDB reserves following an analysis of experience and reserve assumptions. The amounts were primarily due to adverse impacts of overall market declines of $210 million pre-tax ($136 million after-tax), adverse volatility-related impacts due to turbulent equity market conditions totaling $182 million pre-tax ($118 million after-tax) and adverse interest rate impacts of $14 million pre-tax ($9 million after-tax).
The Company had reinsurance recoverables of $1.7 billion as of December 31, 2010, and December 31, 2009 from Prudential Retirement Insurance and Annuity Company resulting from the 2004 sale of the retirement benefits business, which was primarily in the form of a reinsurance arrangement. The reinsurance recoverable, which is reduced as the Company’s reinsured liabilities are paid or directly assumed by the reinsurer, is secured primarily by fixed maturities equal to or greater than 100% of the reinsured liabilities. These fixed maturities are held in a trust established for the benefit of the Company. As of December 31, 2010, the fair value of trust assets exceeded the reinsurance recoverable.
The Company’s Run-off Reinsurance operations assumed risks related to GMDB contracts, GMIB contracts, workers’ compensation, and personal accident business. The Company’s Run-off Reinsurance operations also purchased retrocessional coverage to reduce the risk of loss on these contracts. In December 2010, the Company entered into reinsurance arrangements to transfer the remaining liabilities and administration of the workers’ compensation and personal accident businesses to a subsidiary of Enstar Group Limited. Under this arrangement, the new reinsurer also assumes the future risk of collection from prior reinsurers. See Note 3 for further details regarding this arrangement.
The Company’s reserves for underlying reinsurance exposures assumed by the Company, as well as for amounts recoverable from reinsurers/retrocessionaires for both ongoing operations and the run-off reinsurance operation, are considered appropriate as of December 31, 2010, based on current information. However, it is possible that future developments could have a material adverse effect on the Company’s consolidated results of operations and, in certain situations, such as if actual experience differs from the assumptions used in estimating reserves for GMDB, could have a material adverse effect on the Company’s financial condition. The Company bears the risk of loss if its retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
The Company and certain of its subsidiaries provide pension, health care and life insurance defined benefits to eligible retired employees, spouses and other eligible dependents through various domestic and foreign plans. The effect of its foreign pension and other post retirement benefit plans is immaterial to the Company’s results of operations, liquidity and financial position. Effective July 1, 2009, the Company froze its primary domestic defined benefit pension plans. A curtailment of benefits occurred as a result of this action since it eliminated the accrual of benefits for the future service of active employees enrolled in these domestic pension plans. Accordingly, the Company recognized a pre-tax curtailment gain of $46 million ($30 million after-tax) in 2009.
The Company’s pension plans were underfunded by $1.5 billion in 2010 and 2009 and had related accumulated benefit obligations of $4.7 billion as of December 31, 2010 and $4.3 billion as of December 31, 2009.
The Company expects to recognize pre-tax losses of $38 million in 2011 from amortization of past experience. This estimate is based on a weighted average amortization period for the frozen and inactive plans of approximately 30 years, as this period is now based on the average expected remaining life of plan participants.
The estimated rate of future increases in the per capita cost of health care benefits is 8.5% in 2011, decreasing by 0.50% per year to 5% in 2018 and beyond. This estimate reflects the Company’s current claim experience and management’s estimate that rates of growth will decline in the future. A 1% increase or decrease in the estimated rate would change 2010 reported amounts as follows:
The target investment allocation percentages (57% equity securities, 20% fixed income, 8% real estate and 15% other) are developed by management as guidelines, although the fair values of each asset category are expected to vary as a result of changes in market conditions. The pension plan asset portfolio has been most heavily weighted towards equity securities, consisting of domestic and international investments, in an effort to earn a higher rate of return on pension plan investments over the long-term payout period of the pension benefit obligations. The diversification of the pension plan assets into other investments is intended to mitigate the volatility in returns, while also providing adequate liquidity to fund benefit distributions.
As of December 31, 2010, pension plan assets included $2.8 billion invested in the separate accounts of Connecticut General Life Insurance Company (“CGLIC”) and Life Insurance Company of North America, which are subsidiaries of the Company, as well as an additional $0.4 billion invested directly in funds offered by the buyer of the retirement benefits business.
Plan assets classified in Level 3 include securities partnerships and equity real estate generally valued based on the pension plan’s ownership share of the equity of the investee including changes in the fair values of its underlying investments. In addition, as of December 31, 2009, investments in pooled separate accounts principally invested in equity real estate and fixed income funds that are priced using the net asset value are classified in Level 3 due to restrictions on withdrawal.
The following table summarizes the changes in pension plan assets classified in Level 3 for the years ended December 31, 2010 and December 31, 2009. Actual return on plan assets in this table may include changes in fair value that are attributable to both observable and unobservable inputs.
To measure pension costs, the Company uses a market-related asset valuation for domestic pension plan assets invested in non-fixed income investments. The market-related value of pension assets recognizes the difference between actual and expected long-term returns in the portfolio over 5 years , a method that reduces the short-term impact of market fluctuations. At December 31, 2010, the market-related asset value was approximately $3.4 billion compared with a market value of approximately $3.2 billion.
The Company performs ongoing analyses of prices used to value the Company’s invested assets to determine that they represent appropriate estimates of fair value. This process involves quantitative and qualitative analysis including reviews of pricing methodologies, judgments of valuation inputs, the significance of any unobservable inputs, pricing statistics and trends. The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates.
Fixed maturities and equity securities. Approximately 93% 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 asset and mortgage-backed securities and preferred stocks. Because many fixed maturities and preferred stocks do not trade daily, fair values are often derived using recent trades of securities with similar features and characteristics. When recent trades are not available, pricing models are used to determine these prices. These models calculate fair values by discounting future cash flows at estimated market interest rates. Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry and structure of the asset. Typical inputs and assumptions to pricing models include, but are not limited to, 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.
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 December 31, 2010 or December 31, 2009. The nature and use of these other derivatives are described in Note 13.
The Company classifies certain newly issued, privately placed, complex or illiquid securities, as well as assets and liabilities relating to GMIB, in Level 3.
Fixed maturities and equity securities. Approximately 6% of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category, including:
Guaranteed minimum income benefit contracts. Because cash flows of the GMIB liabilities and assets are affected by equity markets and interest rates but are without significant life insurance risk and are settled in lump sum payments, the Company reports these liabilities and assets as derivatives at fair value. The Company estimates the fair value of the assets and liabilities for GMIB contracts using assumptions regarding capital markets (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments), future annuitant behavior (including mortality, lapse, and annuity election rates), and non-performance risk, as well as risk and profit charges. As certain assumptions (primarily related to future annuitant behavior) used to estimate fair values for these contracts are largely unobservable, the Company classifies GMIB assets and liabilities in Level 3. The Company considered the following in determining the view of a hypothetical market participant:
These GMIB assets and liabilities are calculated with a complex internal model using many scenarios to determine the fair value of net amounts estimated to be paid, less the fair value of net future premiums estimated to be received, adjusted for risk and profit charges that the Company anticipates a hypothetical market participant would require to assume this business. Net amounts estimated to be paid represent the excess of the anticipated value of the income benefits over the values of the annuitants’ accounts at the time of annuitization. Generally, market return, interest rate and volatility assumptions are based on market observable information. Assumptions related to annuitant behavior reflect the Company’s belief that a hypothetical market participant would consider the actual and expected experience of the Company as well as other relevant and available industry resources in setting policyholder behavior assumptions. The significant assumptions used to value the GMIB assets and liabilities as of December 31, 2010 were as follows:
The market return and discount rate assumptions are based on the market-observable LIBOR swap curve.
The projected interest rate used to calculate the reinsured income benefits is indexed to the 7-year Treasury Rate at the time of annuitization (claim interest rate) based on contractual terms. That rate was 2.71% at December 31, 2010 and must be projected for future time periods. These projected rates vary by economic scenario and are determined by an interest rate model using current interest rate curves and the prices of instruments available in the market including various interest rate caps and zero-coupon bonds. For a subset of the business, there is a contractually guaranteed floor of 3% for the claim interest rate.
The annual lapse rate assumption reflects experience that differs by the company issuing the underlying variable annuity contracts, ranges from 2% to 17% at December 31, 2010, and depends on the time since contract issue and the relative value of the guarantee.
The nonperformance risk adjustment is incorporated by adding an additional spread to the discount rate in the calculation of both (1) the GMIB liability to reflect a hypothetical market participant’s view of the risk of the Company not fulfilling its GMIB obligations, and (2) the GMIB asset to reflect a hypothetical market participant’s view of the reinsurers’ credit risk, after considering collateral. The estimated market-implied spread is company-specific for each party involved to the extent that company-specific market data is available and is based on industry averages for similarly rated companies when company-specific data is not available. The spread is impacted by the credit default swap spreads of the specific parent companies, adjusted to reflect subsidiaries’ credit ratings relative to their parent company and any available collateral. The additional spread over LIBOR incorporated into the discount rate ranged from 5 to 110 basis points for the GMIB liability and from 10 to 85 basis points for the GMIB reinsurance asset for that portion of the interest rate curve most relevant to these policies.
The following tables summarize the changes in financial assets and financial liabilities classified in Level 3 for the years ended December 31, 2010 and 2009. 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 changes in fair value that are attributable to both observable and unobservable inputs.
As noted in the tables above, total gains and losses included in net income are reflected in the following captions in the Consolidated Statements of Income:
GMIB fair value gains of $304 million for 2009, were primarily due to increases in interest rates and increases in underlying account values in the period resulting from favorable equity market and bond fund returns, resulting in reduced exposures. These favorable effects were partially offset by updates to the annuitization assumption (to assume that a greater percentage of contractholders will annuitize) and updates to the lapse assumption.
The following tables summarize the change in separate account assets reported in Level 3 for the years ended December 31, 2010 and 2009.
Most financial instruments that are subject to fair value disclosure requirements are carried in the Company’s Consolidated Financial Statements at amounts that approximate fair value. The following table provides the fair values and carrying values of the Company’s financial instruments not recorded at fair value that are subject to fair value disclosure requirements at December 31, 2010 and December 31, 2009.
Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans generally by discounting the contractual cash flows at estimated market interest rates that reflect the Company’s assessment of the credit quality of the loans. Market interest rates are derived by calculating the appropriate spread over comparable U.S. Treasury rates, based on the property type, quality rating and average life of the loan. The quality ratings reflect the relative risk of the loan, considering debt service coverage, the loan-to-value ratio and other factors. Fair values of impaired mortgage loans are based on the estimated fair value of the underlying collateral generally determined using an internal discounted cash flow model.
The following information about fixed maturities excludes trading and hybrid securities. The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at December 31, 2010:
The above table includes investments with a fair value of $2.5 billion supporting the Company’s run-off settlement annuity business, with gross unrealized appreciation of $476 million and gross unrealized depreciation of $33 million at December 31, 2010. Such unrealized amounts are required to support future policy benefit liabilities of this business and, as such, are not included in accumulated other comprehensive income. At December 31, 2009, investments supporting this business had a fair value of $2.3 billion, gross unrealized appreciation of $326 million and gross unrealized depreciation of $52 million.
As of December 31, 2010, the Company had commitments to purchase $14 million of fixed maturities bearing interest at a fixed market rate.
the Company’s intent to sell or the likelihood of a required sale prior to recovery.
The Company applies a consistent and disciplined approach to evaluating and monitoring credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal rating system developed from the Company’s experience in real estate investing and mortgage lending. A quality rating, designed to evaluate the relative risk of the transaction, is assigned at each loan’s origination and is updated each year as part of the annual portfolio loan review. The Company monitors credit quality on an ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.
The following table summarizes the credit risk profile of the Company’s commercial mortgage loan portfolio based on loan-to-value and debt service coverage ratios, as of December 31, 2010:
Potential problem mortgage loans are considered current (no payment more than 59 days past due), but exhibit certain characteristics that increase the likelihood of future default. The characteristics management considers include, but are not limited to, the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and request from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms, which could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.
Problem and potential problem mortgage loans totaled $383 million at December 31, 2010 and $397 million at December 31, 2009, with no significant concentrations by property type or geographic region in either year.
As of December 31, the carrying value of the Company’s impaired commercial mortgage loans and related valuation reserves were as follows:
During 2010, the Company recorded a $24 million pre-tax ($15 million after-tax) increase in valuation reserves on impaired commercial mortgage loans primarily due to decreased valuations of certain office properties collateralizing the loans. The average recorded investment in impaired loans was $169 million during 2010 and $116 million during 2009. The Company recognizes interest income on problem mortgage loans only when payment is actually received because of the risk profile of the underlying investment. Interest income that would have been reflected in net income if interest on non-accrual commercial mortgage loans had been received in accordance with the original terms was not significant for 2010 or 2009. Interest income on impaired commercial mortgage loans was not significant for 2010 or 2009.
As of December 31, 2010 and 2009, real estate investments consisted primarily of office and industrial buildings in California. Investments with a carrying value of $49 million as of December 31, 2010 and $55 million as of December 31, 2009 were non-income producing during the preceding twelve months. As of December 31, 2010, the Company had commitments to contribute additional equity of $11 million to real estate investments.
Investments in real estate entities and securities partnerships with a carrying value of $169 million at December 31, 2010 and $121 million at December 31, 2009 were non-income producing during the preceding twelve months.
As of December 31, 2010, the Company had commitments to contribute:
$224 million to limited liability entities that hold either real estate or loans to real estate entities that are diversified by property type and geographic region; and
A change in the fair value of a derivative instrument may not always equal the change in the fair value of the hedged item; this difference is referred to as hedge ineffectiveness. Where hedge accounting is used, the Company reflects hedge ineffectiveness in shareholders’ net income (generally as part of realized investment gains and losses).
Certain of the Company’s over-the-counter derivative instruments contain provisions requiring either the Company or the counterparty to post collateral depending on the amount of the net liability position and predefined financial strength or credit rating thresholds. The collateral posting requirements vary by counterparty. The aggregate fair value of derivative instruments with such credit-risk-related contingent features where the Company was in a net liability position was $25 million at December 31, 2010 and $29 million at December 31, 2009 for which the Company was not required to post collateral with its counterparties. If the various contingent features underlying the agreements were triggered as of the balance sheet date, the Company would be required to post collateral equal to the total net liability. The Company is a party to certain other derivative instruments that contain termination provisions for which the counterparties could demand immediate payment of the total net liability position if the financial strength rating of the Company were to decline below specified levels. As of December 31, 2010 and 2009, there was no net liability position under such derivative instruments.
See Note 7 for a discussion of derivatives associated with GMDB contracts and Note 11 for a discussion of derivatives arising from GMIB contracts. The effects of other derivatives were not material to the Company’s consolidated results of operations, liquidity or financial condition for the years ended December 31, 2010 and 2009.
the entity’s participants’ ability to direct the activities, receive its benefits and absorb its losses. Participants include the entity’s sponsors, equity holders, guarantors, creditors and servicers.
Net investment income for separate accounts (which is not reflected in the Company’s revenues) was $163 million for 2010, $22 million for 2009, and $148 million for 2008.
The Company recognized pre-tax gains of $7 million in 2010 and $13 million in 2009, compared with pre-tax losses of $31 million in 2008 on hybrid securities.
During 2010, the 7% Notes and 6.375% Notes due 2011 were reclassified into current maturities of long-term debt since they will mature in less than one year.
The Company may redeem the Notes issued in 2010 and 2009 at any time, in whole or in part, at a redemption price equal to the greater of:
the present value of the remaining principal and interest payments on the Notes being redeemed discounted at the applicable Treasury Rate plus 25 basis points for the 4.375% and 5.125% Notes due 2020 and 50 basis points for the 8.5% Notes due 2019.
In June 2007, the Company amended and restated its five-year revolving credit and letter of credit agreement for $1.75 billion, which permits up to $1.25 billion to be used for letters of credit. The agreement includes options, which are subject to consent by the administrative agent and the committing bank, to increase the commitment amount up to $2.0 billion and to extend the term of the agreement. The Company entered into the agreement for general corporate purposes, including the support for the issuance of commercial paper and to obtain statutory reserve credit for certain reinsurance arrangements. There were letters of credit issued in the amount of $82 million as of December 31, 2010. As of December 31, 2010, the Company had an additional $1.7 billion of borrowing capacity within the maximum debt leverage covenant in the line of credit agreement in addition to the $2.8 billion of short-term and long-term debt outstanding.
As of December 31, 2010, statutory surplus for each of the Company’s life insurance and HMO subsidiaries is sufficient to meet the minimum required by regulators. As of December 31, 2010, the Company’s life insurance and HMO subsidiaries had investments on deposit with state departments of insurance with statutory carrying values of $319 million. The Company’s life insurance and HMO subsidiaries are also subject to regulatory restrictions that limit the amount of annual dividends or other distributions (such as loans or cash advances) insurance companies may extend to the parent company without prior approval of regulatory authorities. The maximum dividend distribution that the Company’s life insurance and HMO subsidiaries may make during 2011 without prior approval is approximately $1.5 billion. Restricted net assets of the Company as of December 31, 2010, were approximately $5 billion. One of the Company’s life insurance subsidiaries is permitted to loan up to $600 million to the parent company without prior approval.
The Company has historically accrued U. S. income taxes on the undistributed earnings of its foreign subsidiaries. However, the Company recently began computing income taxes attributable to the South Korea and Hong Kong operations using the tax rates of the foreign jurisdictions, as compared to the higher U. S. statutory tax rate. This change, adopted in 2009 for South Korea and earlier in 2010 for Hong Kong, was based upon a determination that the prospective earnings of these operations would be permanently invested overseas.
The decline in the valuation allowance primarily reflects the resolution of a disputed federal income tax matter. See the “Deferred Income Taxes” section of this footnote for further discussion.
Management believes consolidated taxable income expected to be generated in the future will be sufficient to support realization of the Company’s net deferred tax assets. This determination is based upon the Company’s consistent overall earnings history and future earnings expectations. Other than deferred tax benefits attributable to operating loss carryforwards, there are no time constraints within which the Company’s deferred tax assets must be realized. Federal operating losses of $205 million were available to offset taxable income of the generating companies, and begin to expire in 2022. As of December 31, 2010, the Company had no foreign tax credit carryforwards.
The December 31, 2010 balance included $29 million that would increase shareholders’ net income if recognized. The Company has determined it is reasonably possible that within the next twelve months the level of unrecognized tax benefits could change significantly, subject to the development of IRS specific matters. These changes are not expected to have a material impact on shareholders’ net income.
One disputed matter remains unresolved related to the IRS examination of the 2003 and 2004 consolidated federal income tax returns and on June 4, 2009 the Company initiated litigation of this matter by filing a petition in the United States Tax Court. Due to the nature of the litigation process, timing of the resolution of this matter is uncertain. This same issue also remains unresolved in the IRS examination of the 2005 and 2006 consolidated federal income tax returns. Though the Company expects to prevail, unfavorable resolution of this litigation would result in a charge to shareholders’ net income of up to $22 million, representing net interest expense on the cumulative incremental tax for all affected years.
The IRS is currently in the latter stages of its examination of the Company’s 2007 and 2008 consolidated federal income tax returns, which is expected to be completed in the first quarter of 2011. The Company conducts business in numerous states and foreign jurisdictions, and may be engaged in multiple audit proceedings at any given time. Generally, no further state or foreign audit activity for years prior to 2002 is expected.
The Company had the following number of shares of common stock available for award at December 31: 7.5 million in 2010, 23.3 million in 2009 and 28.5 million in 2008.
Compensation expense of $18 million related to unvested stock options at December 31, 2010 will be recognized over the next two years (weighted average period).
The table below summarizes information for stock options exercised during the last three years :
The following table summarizes information for outstanding common stock options at December 31, 2010:
The weighted average fair value of options granted under employee incentive plans was $11.56 for 2010, $4.60 for 2009 and $14.33 for 2008, using the Black-Scholes option-pricing model and the following assumptions:
Restricted stock. The Company awards restricted stock to its employees or directors with vesting periods ranging from two to five years. These awards are generally in one of two forms: restricted stock grants or restricted stock units. Restricted stock grants are the most widely used form of restricted stock awards and are used for substantially all U.S.-based employees receiving such awards. Recipients of restricted stock grants are entitled to earn dividends and to vote during the vesting period, but forfeit their awards if their employment terminates before the vesting date. Awards of restricted stock units are generally limited to international employees. A restricted stock unit represents a right to receive a common share of stock when the unit vests. Recipients of restricted stock units are entitled to receive hypothetical dividends, but cannot vote during the vesting period. They forfeit their units if their employment terminates before the vesting date.
The fair value of vested restricted stock was: $18 million in 2010, $10 million in 2009 and $35 million in 2008.
Strategic Performance Shares. The Company awards strategic performance shares to its executives generally with a performance period of three years. Strategic performance shares are divided into two broad groups: 50% are subject to a market condition (total shareholder return relative to industry peer companies) and 50% are subject to a performance conditions (revenue growth and cumulative adjusted net income). These targets are set by the Committee. At the end of the performance period, holders of strategic performance shares will be awarded anywhere from 0 to 200% of the original grant of strategic performance shares in CIGNA common stock.
The table below shows the status of, and changes in, strategic performance shares during 2010:
Consolidated pre-tax income from continuing operations is primarily attributable to domestic operations. Consolidated pre-tax income from continuing operations generated by the Company’s foreign operations was approximately 13% in 2010, 9% in 2009 and 36% in 2008.
deferred gains recognized from the 1998 sale of the individual life insurance and annuity business and the 2004 sale of the retirement benefits business; and
Concentration of risk. For the Company’s International segment, South Korea is the single largest geographic market. South Korea generated 32% of the segment’s revenues and 49% of the segment’s earnings in 2010. South Korea generated 29% of the segment’s revenues and 49% of the segment’s earnings in 2009. Due to the concentration of business in South Korea, the International segment is exposed to potential losses resulting from economic and geopolitical developments in that country, as well as foreign currency movements affecting the South Korean currency, which could have a significant impact on the segment’s results and the Company’s consolidated financial results.
all underlying mutual fund investment values remained at the December 31, 2010 value of $1.3 billion with no future returns.
The Company had indemnification obligations as of December 31, 2010 in connection with acquisition and disposition transactions. These indemnification obligations are triggered by the breach of representations or covenants provided by the Company, such as representations for the presentation of financial statements, the filing of tax returns, compliance with law or the identification of outstanding litigation. These obligations are typically subject to various time limitations, defined by the contract or by operation of law, such as statutes of limitation. In some cases, the maximum potential amount due is subject to contractual limitations based on a percentage of the transaction purchase price, while in other cases limitations are not specified or applicable. The Company does not believe that it is possible to determine the maximum potential amount due under these obligations, since not all amounts due under these indemnification obligations are subject to limitation. There were no liabilities required for these indemnification obligations as of December 31, 2010.
The Company has agreements with certain banks that provide banking services to settle claim checks processed by the Company for administrative services only and certain minimum premium customers. The customers are responsible for adequately funding their accounts as claim checks are presented for payment. Under these agreements, the Company guarantees that the banks will not incur a loss if a customer fails to properly fund its account. The amount of the guarantee fluctuates daily. As of December 31, 2010, the aggregate maximum exposure under these guarantees was approximately $366 million and there were no liabilities required. After-tax charges related to these guarantees were approximately $3 million for the year ended December 31, 2010 and there were no charges in 2009. Through February 1, 2011, the exposure that existed at December 31, 2010 has been reduced by approximately 92% through customers’ funding of claim checks when presented for payment. In addition, the Company can limit its exposure under these guarantees by suspending claim payments for any customer who has not adequately funded their bank account.
additional privacy legislation and regulations that interfere with the proper use of medical information for research, coordination of medical care and disease and disability management;
Guaranty fund assessments. The Company operates in a regulatory environment that may require the Company to participate in assessments under state insurance guaranty association laws. The Company’s exposure to assessments is based on its share of business it writes in the relevant jurisdictions for certain obligations of insolvent insurance companies to policyholders and claimants. For the years ended December 31, 2010, 2009 and 2008, charges related to guaranty fund assessments were not material to the Company’s results of operations.
The Company is aware of an insurer that is in rehabilitation, an intermediate action before insolvency. As of December 31, 2010, the regulator had petitioned the state court for liquidation and the Company believes it is likely that the state court will rule on insolvency for this insurer within the next twelve months. If the insurer is declared insolvent and placed in liquidation, the Company and other insurers may be required to pay a portion of policyholder claims through guaranty fund assessments from various states in which the Company’s insurance subsidiaries write premiums. Based on current information available, which is subject to change, the Company has estimated that potential future assessments could decrease its future results of operations by up to $40 million after-tax. The ultimate amount and timing of any future charges for this potential insolvency will depend on several factors, including the declaration of insolvency and the amount of the potential insolvency, the basis, amount and timing of associated estimated future guaranty fund assessments and the availability and amount of any potential premium tax and other offsets. Cash payments, if any, by the Company’s insurance subsidiaries are likely to extend over several years. The Company will continue to monitor the outcome of the court’s deliberations and may record a liability and expense in a future reporting period.
Based upon its current knowledge, and taking into consideration its current accruals, the Company believes that the legal actions, proceedings and investigations currently pending against it should not have a material adverse effect on the Company’s results of operation, financial condition or liquidity other than possibly the matters referred to in the following paragraphs. However, in light of the uncertainties involved in these matters, there is no assurance that their ultimate resolution will not exceed the amounts currently accrued by the Company and that an adverse outcome in one or more of these matters could be material to the Company’s financial statements, results of operation, financial condition or liquidity for any particular period.
On August 1, 2005, two CIGNA subsidiaries, Connecticut General Life Insurance Company and Life Insurance Company of North America, were named as defendants in a multi-district litigation proceeding, In re Insurance Brokerage Antitrust Litigation, consolidated in the United States District Court for the District of New Jersey. The complaint alleges that brokers and insurers conspired to hide commissions, thus increasing the cost of employee benefit plans, and seeks treble damages and injunctive relief. Numerous insurance brokers and other insurance companies are named as defendants. In 2008, the court ordered the clerk to enter judgment against plaintiffs and in favor of the defendants. Plaintiffs appealed. On August 16, 2010, the Third Circuit Court of Appeals affirmed that decision as to employee benefit companies. No appeal was taken. On September 27, 2010, the District Court entered final judgment against plaintiffs consistent with the Third Circuit Court of Appeals’ opinion. Accordingly, the risk of loss is immaterial. This matter is closed and will no longer be reported.
Amara cash balance pension plan litigation. On December 18, 2001, Janice Amara filed a class action lawsuit, captioned Janice C. Amara, Gisela R. Broderick, Annette S. Glanz, individually and on behalf of all others similarly situated v. CIGNA Corporation and CIGNA Pension Plan, in the United States District Court for the District of Connecticut against CIGNA Corporation and the CIGNA Pension Plan on behalf of herself and other similarly situated participants in the CIGNA Pension Plan affected by the 1998 conversion to a cash balance formula. The plaintiffs allege various ERISA violations including, among other things, that the Plan’s cash balance formula discriminates against older employees; the conversion resulted in a wear away period (during which the pre-conversion accrued benefit exceeded the post-conversion benefit); and these conditions are not adequately disclosed in the Plan.
In 2008, the court issued a decision finding in favor of CIGNA Corporation and the CIGNA Pension Plan on the age discrimination and wear away claims. However, the court found in favor of the plaintiffs on many aspects of the disclosure claims and ordered an enhanced level of benefits from the existing cash balance formula for the majority of the class, requiring class members to receive their frozen benefits under the pre-conversion CIGNA Pension Plan and their accrued benefits under the post-conversion CIGNA Pension Plan. The court also ordered, among other things, pre-judgment and post-judgment interest. Both parties appealed the court’s decisions to the United States Court of Appeals for the Second Circuit which issued a decision on October 6, 2009 affirming the District Court’s judgment and order on all issues. On January 4, 2010, the Company and the plaintiffs filed separate petitions for a writ of certiorari to the United States Supreme Court. CIGNA’s petition was granted on June 28, 2010 and was argued on November 30, 2010. The United States Supreme Court held the plaintiffs’ petition for writ of certiorari and the Company expects it to be disposed of when an opinion is issued. The implementation of the judgment is currently stayed. The Company will continue to vigorously defend itself in this case. As of December 31, 2010, the Company is carrying a liability of $82 million pre-tax ($53 million after-tax), which principally reflects the Company’s best estimate of the liabilities related to the court order.
The Company was named as a defendant in a number of putative nationwide class actions asserting that due to the use of data from Ingenix, Inc., the Company improperly underpaid claims, an industry-wide issue. Three actions were brought on behalf of members, (Franco v. CIGNA Corp. et al., Chazen v. CIGNA Corp. et al. and Nelson v. Connecticut General Life Insurance Co. et al.), and three remaining actions were brought on behalf of providers, (American Medical Association et al. v. CIGNA Corp. et al., Shiring et al. v. CIGNA Corp. et al.; and North Peninsula Surgical Center v. Connecticut General Life Insurance Co. et al.), all of which were consolidated into the Franco case pending in the United States District Court for the District of New Jersey. The consolidated amended complaint, filed on August 7, 2009, asserts claims under ERISA, the RICO statute, the Sherman Antitrust Act and New Jersey state law. CIGNA filed a motion to dismiss the consolidated amended complaint on September 9, 2009, which is fully briefed and pending. Plaintiffs filed a motion for class certification on May 28, 2010, which is also fully briefed and pending. Fact and expert discovery have been completed.
Due to numerous uncertain and unpredictable factors presented in these cases, including the lack of any clear basis to determine whether and to what extent the claimants have been injured, it is not possible to estimate a range of loss at this time.
In its Form 10-Q for the quarter ended September 30, 2010, CIGNA described the Managed Care cases. The Company believes that any remaining liabilities related to the unresolved Managed Care cases are immaterial to the Company’s results of operation, financial condition or liquidity.
The following unaudited quarterly financial data is presented on a consolidated basis for each of the years ended December 31, 2010 and 2009. Quarterly financial results necessarily rely heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the insurance business, suggest the need to exercise caution in drawing specific conclusions from quarterly consolidated results.