During 2007, CIGNA completed a three-for-one stock split of CIGNA's common shares. All per share figures have been adjusted to reflect the stock
Pro forma common shares outstanding, calculated as if the stock split had occurred at the beginning of the prior periods, were as follows: 295,963 in 2006;
Certain insignificant reclassifications have been made to prior years' amounts to conform to the presentation of 2007 amounts.
The Company constitutes one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace, including health care products and services such as: medical coverages, pharmacy, behavioral health, dental benefits, and disease management, group disability, life and accident insurance; and disability and workers’ compensation case management and related services. In addition, the Company has an international operation that offers life, accident and supplemental health insurance products and international health care products and services to businesses and individuals in selected markets. The Company also has certain inactive businesses, including a run-off reinsurance operation. See “Business - Item 1” in the Company’s Form 10-K for additional information on its segments.
The Company generates revenues, net income and cash flow from operations by:
investing available cash at attractive rates of return for appropriate durations; and
The Company’s ability to increase revenue, net income and operating cash flow is directly related to its ability to address broad economic and industry factors and execute its strategic initiatives, the success of which is measured by certain key factors as discussed below.
the volume of customers served and the mix of products and services purchased by those customers;
The Company’s 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 and economic and other factors. The Company develops strategic and tactical plans designed to improve performance and maximize its competitive position in the markets it serves. The Company’s ability to achieve its financial objectives is dependent upon its ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.
The Company believes that the health care business model is evolving to one that focuses more directly on the role and needs of the health care consumer. The consumer-directed environment presents particular challenges by requiring a more complex service model and products specifically designed to meet the emerging market needs of the consumer. In order to meet the emerging market challenges, the Company is investing in product development, service, technology, educational resources and customer support tools to assist consumers in making more informed choices regarding their health care and to achieve better health outcomes. These investments and execution of related initiatives are critical to respond to increasing consumer demands. The Company believes that its investments in these areas will position it to more effectively meet emerging market needs and better position the Company to be a leader in the health care industry.
The Company’s consolidated results of operations include results from discontinued operations, which are discussed on page 56.
a charge for changes in the long-term assumptions for annuitization and lapse rates for guaranteed minimum income benefit contracts.
accelerated amortization of deferred gain on the sale of the retirement benefits business;
a charge for severance costs associated with streamlining the operations of the Health Care operations and supporting areas. The Company substantially completed this program in 2006;
improved realized investment results primarily due to sales of equity interests in real estate limited liability entities of $165 million after-tax;
These factors were partially offset by lower segment earnings in the Health Care segment (see page 48).
Management is not able to estimate 2008 income from continuing operations under generally accepted accounting principles because it includes realized investment gains (losses), the results of the GMIB business and special items. Information is not available for management to reasonably estimate future realized investment gains (losses), the results of the GMIB business under a new accounting standard (see Note 2(B) to the Consolidated Financial Statements) or special (non-recurring) items, due, in part, to interest rate and stock market volatility and other internal and external factors.
Premiums and fees increased 10% in 2007, compared to 2006, primarily attributable to higher specialty revenues and growth in medical membership as well as strong renewal pricing on existing business in the Health Care segment (see page 48) and strong business growth in the Disability and Life (see page 52) and International segments (see page 53).
Premiums and fees decreased marginally in 2006 reflecting the loss of a large prescription drug contract of $1.1 billion. Excluding the loss of this contract, premiums and fees increased 9% in 2006, compared with 2005 primarily due to membership growth and rate increases in the Health Care, Disability and Life and International segments (see pages 48-53).
Net investment income decreased 12% in 2006 as a result of the 2006 conversion of the single premium annuity business to indemnity reinsurance (see page 55 for additional information) and share repurchase activity.
In addition to the estimates presented in the following table, there are other accounting estimates used in the preparation of the Company’s consolidated financial statements, including estimates of liabilities for future policy benefits other than those identified in the following table, as well as estimates with respect to unpaid claims and claim expenses, postemployment and postretirement benefits other than pensions, certain compensation accruals, and income taxes.
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, 2007 (representing the amount payable if all approximately 750,000 contractholders had died as of that date) was approximately $4.2 billion.
Liabilities for future policy benefits for these contracts as of December 31 were as follows:
Interest rates include both (a) the mean investment performance assumption considering the Company's program to reduce equity market exposures using futures contracts, and (b) the liability discount rate assumption.
Volatility refers to market fluctuations that affect the costs of the program adopted by the Company to reduce equity market risks associated with these liabilities.
The Company's estimate of the liability for medical claims incurred but not yet reported is primarily calculated using historical claim payment patterns and expected medical cost trends. The Company analyzes the historical claim payment patterns by comparing the dates claims were incurred, generally the dates services were provided, to the dates claims were paid to determine “completion factors”, which are a measure of the time to process claims. A completion factor is calculated for each month of incurred claims. The Company uses historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. The Company estimates the ultimate liability for claims incurred in each month by applying the current estimates of completion factors to the current paid claim data. The difference between this estimate of the ultimate liability and the current paid claim data is the estimate of the remaining claims to be paid for each incurral month. These monthly estimates are aggregated and included in the Company's Health Care medical claims payable at the end of each
Recent variances were 1.3% for the year ended December 31, 2007 and 2.6% for the year ended December 31, 2006 related to the impact of the prior year medical claims payable; and 0.1% for the year ended December 31, 2007 and 0.8% for the year
reporting period. Completion factors are used to estimate the health care medical claims payable for all months where claims have not been completely resolved and paid, except for the most recent month as described below.
Completion factors are impacted by several key items including changes in the level of claims processed electronically versus manually (auto-adjudication), changes in provider claims submission rates, membership changes and the mix of products. As noted, the Company uses historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. This approach implicitly assumes that historical completion rates will be a useful indicator for the current period. It is possible that the actual completion rates for the current period will develop differently from historical patterns, which could have a material impact on the Company's medical claims payable and net income.
ended December 31, 2006 related to the impact on net income. The Company believes that based on the current mix of business as of December 31, 2007, relative to the health care medical claims payable, the annual impact of each 1% variance between the actual and expected incurred medical claims on the Company’s net income would be approximately $35 million, favorable or unfavorable dependent on the direction of the actual versus expected variance.
As discussed in Note 2(B) to the Consolidated Financial Statements, the Company will implement SFAS No. 157, “Fair Value Measurements,” on January 1, 2008. The new requirements that focus on exit price to measure fair value will impact the current assumptions and resulting estimated fair value of assets and liabilities for guaranteed minimum income benefits and are expected to reduce the Company's net income at implementation between $125 million to $150 million, net of estimated reinsurance recoverable.
Interest rates include both (a) the liability discount rate assumption and (b) the projected interest rates used to calculate the reinsured income benefit at the time of annuitization (claim interest rate).
After implementation of SFAS 157, the Company will consider the various assumptions used to estimate fair values of assets and liabilities associated with these contracts in two categories. The first group of assumptions consists of future annuitant behavior including annuity election rates, lapse, and mortality as well as retrocessionnaire credit risk. Current assumptions used to estimate these liabilities are detailed in Note 20 to the Consolidated Financial Statements. The Company will estimate a hypothetical market participant's view of these assumptions considering the actual and expected experience of the Company and other relevant and available industry sources. If an unfavorable change were to occur in these assumptions before the implementation of SFAS No. 157, the approximate after-tax decrease in net income, net of estimated reinsurance recoverable, would be as follows:
· 10% decrease in amounts recoverable from reinsurers (credit risk) - $10 million
The second group of assumptions used to estimate these fair values consist of capital markets inputs including market returns and discount rates, claim interest rates and market volatility. After the implementation of SFAS No. 157, the Company's results of operations are expected to be more volatile in future periods because these assumptions will be based largely on market-observable inputs at the close of each period including risk free interest rates and market implied volatilities. If the following unfavorable changes were to occur after the implementation of SFAS No. 157 on January 1, 2008, the approximate after-tax decrease in net income, net of estimated reinsurance recoverable, would be as follows:
· basis point decrease in risk free interest rates (which are aligned with LIBOR) used for projecting market returns and discounting - $15 to $20 million
All of these estimated impacts due to unfavorable changes could vary from quarter to quarter depending on actual reserve levels, the actual market conditions or changes in the anticipated view of a hypothetical market participant as of any future valuation date.
The amounts would be reflected in the Run-off Reinsurance segment. See Note 2(B) to the Consolidated Financial Statements for further information.
These liabilities are estimates of the present value of the qualified and nonqualified pension benefits to be paid (attributed to employee service to date) net of the fair value of plan assets. The accrued pension benefit liability as of December 31 was as follows:
Changes to the Company's assumptions for discount rates and the expected return on domestic qualified plan assets will not change required cash contributions to the pension plan, as the Company funds at least the minimum amount required by ERISA. Using past experience, the Company expects that it is reasonably possible that a favorable or unfavorable change in these key assumptions of 50 basis points could occur. An unfavorable change is a decrease in these key assumptions with resulting impacts as discussed below.
· annual pension costs for 2008 would increase by approximately $15 million, after-tax; and
Losses for “other than temporary” impairments of fixed maturities must be recognized in net income based on an estimate of fair value by management.
Management estimates the amount of an “other than temporary” impairment when a decline in value is expected to persist, 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 are based on historical experience of the issuer and management’s expectation of future performance. See “Quality Ratings” on page 60 for additional information.
Operating segments generally reflect groups of related products, but the International segment is generally based on geography. The Company measures the financial results of its segments using “segment earnings (loss),” which is defined as income (loss) from continuing operations excluding realized investment gains (losses). Beginning in 2007, the Company reports the results of the run-off retirement business in Other Operations. Prior periods have been restated to conform to this presentation. See Note 19 to the Consolidated Financial Statements for additional segment information and a reconciliation of segment earnings (loss) to the Company’s consolidated income from continuing operations.
These products and services are offered through guaranteed cost, retrospectively experience-rated and service funding arrangements. For a description of funding arrangements, see page 5 in this Form 10-K.
The amount of prior year claim development recorded in 2007, compared with 2006, is lower due to actual medical cost trends and completion factors being more in line with initial assumptions.
improved cost productivity from expense reduction initiatives reflected in lower operating costs per member; and
4 Includes minimum premium members, who have a risk profile similar to experience-rated funding arrangements. The risk portion of minimum premium revenue is reported in experience-rated medical premium whereas the self funding portion of minimum premium revenue is recorded in fees.
Premiums and fees. Premiums and fees increased 9% in 2007, compared with 2006, primarily reflecting:
strong renewal pricing on existing business, particularly in the guaranteed cost business;
Excluding the loss of this contract, premiums and fees increased by 9% in 2006, compared with 2005, primarily due to increased guaranteed cost membership and rate increases, as well as premiums and fees associated with the Medicare Part D and voluntary/limited benefits businesses.
Medical claims expense. Medical claims expense included favorable prior year claim development of $12 million in 2007, $83 million in 2006 and $211 million in 2005. Excluding the prior year claim development, medical claims expense increased 10% in 2007 compared to 2006 primarily due to medical trend, increased Medicare Part D membership and the impact of the Star HRG operations. The increase in medical claims expense for the guaranteed cost business was more than offset by the increase in premiums as demonstrated by the improvement in the medical cost ratio to 84.2% from 85.8%.
See Note 5 to the Consolidated Financial Statements for additional information about medical claims payable and medical claims expense.
Other operating expenses for 2006 include the favorable impact of a $22 million pre-tax ($14 million after-tax) insurance recovery resulting from a litigation matter. Other operating expenses increased in 2006 reflecting costs associated with certain revenue growth initiatives and amortization of software development. Excluding these items, other operating expenses for 2006 reflect productivity improvements.
The Company's medical membership includes any individual for whom the Company retains medical underwriting risk, who uses the Company’s network for services covered under their medical coverage or for whom the Company administers medical claims.
1 Includes membership associated with other risk-related products, primarily open access products.
During 2006, the Company's medical membership increased by 3% including approximately 164,000 members with voluntary or other limited health care benefits coverage as a result of the Star HRG acquisition in 2006. Excluding this acquisition, medical membership increased 1.5% reflecting growth in service and other guaranteed cost, partially offset by lower experience-rated membership.
In addition, in 2006, approximately 84,000 members were reclassified from experience-rated to administrative service only. This change had no impact on reported revenues or segment earnings.
Offering products that meet emerging consumer and market trends. The CIGNATURE®, CareAlliesSM, and CIGNA Choice Fund® suite of products offers various options to consumers and employers and are key to our consumer engagement strategy. Offerings include: choice of benefit, participating provider network, funding, medical management, and health advocacy options. Through the CIGNA Choice Fund®, the Company offers a set of consumer-directed capabilities that includes options for health reimbursement arrangements and/or health savings accounts and enables consumers to make effective health decisions using information tools provided by the Company.
guaranteed cost business as demonstrated in the improvement in the guaranteed cost medical cost ratio by 160 basis points in 2007 excluding prior year claim development.
Growing medical membership results. The Company continues to focus on growing its medical membership by:
The Company is focused on segment expansion most notably in the voluntary, individual and small employer (less than 200 employees) and senior segments. In an effort to achieve these objectives, the Company took the following strategic actions:
In November 2007, the Company announced its agreement to acquire Great-West Healthcare of Denver, Colorado. This acquisition will enable the Company to broaden its distribution reach and provider network, particularly in the western regions of the United States, and expand the range of health benefits and products it offers. The Company is targeting an April 1, 2008 closing date. See “Liquidity and Capital Resources Outlook” on page 58 for more information about funding this acquisition.
Additionally, the Company acquired Memphis-based Mid-South Administrative Group, LLC in January 2007 to give the Company an expanded local presence in Memphis and western Tennessee.
The Company is focused on continuing to effectively manage medical utilization and unit costs. To help achieve this, the Company continues to focus on renegotiating contracts with providers and certain facilities to limit increases in medical reimbursement costs. In addition, the Company seeks to strengthen its network position in selected markets and, on August 1, 2007, acquired Sagamore Health Network, Inc. in Indiana. Sagamore provides access to an extensive preferred provider network and offers access to a broad range of utilization review and case management services to health claim payer organizations, self-insured employers and third-party administrators. In the future, the Company may pursue additional acquisitions and strategic alliances.
Delivering quality member and provider service. The Company is focused on delivering competitive service to members, providers and customers. The Company believes that further enhancing quality service can improve member retention and, when combined with useful health information and tools, can help motivate members to become more engaged in their personal health, and will promote healthy outcomes thereby removing cost from the system. The evolution of the consumer-driven healthcare market is driving increased product and service complexity and is raising consumers’ expectations with respect to service levels, which is expected to require significant investment, management attention and heightened interaction with customers.
Maintaining and upgrading information technology systems. The Company’s current business model and long-term strategy require effective and reliable information technology systems. The Company’s current systems architecture will require continuing investment to meet the challenges of increasing consumer demands from both our existing and emerging customer base to support its business growth and strategies, improve its competitive position and provide appropriate levels of service to consumers. The Company is focused on providing these enhanced strategic capabilities in response to increasing consumer expectations, while continuing to provide a consistent, high quality consumer service experience with respect to the Company’s current programs. Further integration of the Company’s multiple administrative and customer facing platforms is required to support the Company's internal needs and growth strategies, and to ensure reliable, efficient and effective customer service both in today’s employer focused model as well as in a consumer directed model. The Company’s ability to obtain and effectively deploy capital to make these investments will influence the timing and the impact these initiatives will have on its operations.
Reducing other operating expenses. The Company operates in an intensely competitive marketplace and its ability to establish a meaningful cost advantage is key to achieving its initiatives. Accordingly, the Company continues to focus on initiatives that will increase its operating efficiency and responsiveness to customers.
For a description of Disability and Life’s products and services, see page 11 in the “Business” section of this Form 10-K.
other operating expense as a percentage of earned premiums (expense ratio).
Premiums and fees. Premiums and fees increased 13% in 2007 and 2% in 2006 primarily reflecting business growth from new and existing customers and strong customer retention primarily in the disability and life insurance business while maintaining competitively strong margins.
Excluding the special item noted in the table above, International segment earnings increased in 2007 and 2006 primarily due to substantial earnings growth in the life, accident and health insurance business, particularly in South Korea, and in the expatriate employee benefits business.
Premiums and fees. The increases in premiums and fees of 18% in 2007 and 23% in 2006, were primarily attributable to new sales growth and strong customer retention in the life, accident and health insurance operations, particularly in South Korea, and in the expatriate employee benefits business. These increases also reflect appropriate renewal pricing on existing business.
Premiums and fees, excluding the effect of foreign currency changes, were $1,745 million in 2007, $1,494 million in 2006 and $1,202 million in 2005.
South Korea represents the single largest geographic market for the Company’s international businesses. In 2007, South Korea generated 31% of International’s revenues and 41% of its segment earnings. Due to the concentration of business in this region, the Company’s International business in South Korea could be exposed to potential losses resulting from adverse consumer credit conditions and geopolitical and economic conditions in that country, which could have a significant impact on the Company’s consolidated results.
The Company’s reinsurance operations were discontinued and are now an inactive business in run-off mode since the sale of the U.S. individual life, group life and accidental death reinsurance business in 2000. This segment is predominantly comprised of guaranteed minimum death benefit, guaranteed minimum income benefit, workers’ compensation and personal accident reinsurance products.
The determination of liabilities for GMIB requires the Company to make critical accounting estimates. The Company describes the assumptions used to develop the liabilities for these benefits and provides the effects of hypothetical changes in those assumptions on page 45. See Note 20(B) to the Consolidated Financial Statements for additional information about these assumptions and the liability balances.
The Company's payment obligations under these contracts are based on ceding companies’ claim payments relating to accidents and injuries. These claim payments can in some cases extend many years into the future, and the amount of the ceding companies’ ultimate claims, and therefore the amount of the Company's ultimate payment obligations and ultimate collection from retrocessionaires may not be known with certainty for some time.
The segment loss for Run-off Reinsurance was lower in 2006 as compared to 2005 due to more favorable results in the workers’ compensation and personal accident lines of business due to lower reserve increases related to retrocessional credit risk as well as more favorable claims experience. The GMDB and GMIB businesses also reported a more favorable result as compared to 2005 reflecting lower reserve increases related to GMDB and GMIB contracts.
The Company maintains a program to substantially reduce the equity market exposures relating to guaranteed minimum death benefit contracts by entering into exchange-traded futures contracts. Other revenues include pre-tax losses of $32 million in 2007, $96 million in 2006 and $48 million in 2005 from these contracts. Expense offsets reflecting corresponding changes in liabilities for these guaranteed minimum death benefit contracts were included in benefits and expenses. The notional amount of the futures contract positions held by the Company at December 31, 2007 related to this program was $625 million.
annuitization and lapse experience (see Note 20(B) to the Consolidated Financial Statements), and higher annuitization experience prior to the assumption change. In addition, improvements in equity markets for 2007 were smaller than in 2006, leading to higher benefits expense for the guaranteed minimum death benefit business. These factors were partially offset by lower expense in the workers’ compensation and personal accident businesses, due to the impact of favorable claim experience and settlements and commutations that were favorable to the Company’s reserved position.
Excluding the special item noted above, segment earnings decreased for Other Operations in 2007, primarily reflecting expected lower deferred gain amortization associated with the sales of the individual life insurance and annuity and retirement benefits businesses. This decrease was partially offset by higher COLI earnings primarily reflecting favorable mortality experience.
impairment losses related to the dispositions in 2007 and 2006 of several Latin American insurance operations as discussed in Note 3 to the Consolidated Financial Statements;
realized gains on the disposition of certain directly-owned real estate investments in 2007 and 2006 as discussed in Note 11 to the Consolidated Financial Statements; and
tax benefits recognized in connection with past divestitures as discussed in Note 16 to the Consolidated Financial Statements.
Cash flows from operating activities consist of cash receipts and disbursements for premiums and fees, gains (losses) recognized in connection with the Company's program to manage equity market risk related to reinsured guaranteed minimum death benefit contracts, investment income, taxes, and benefits and expenses.
Cash flows from operating activities increased by $700 million in 2007 from 2006 and were affected by the following significant items:
lower net cash outflows of $212 million to originate commercial mortgage loans held for sale (see Note 10 to the Consolidated Financial Statements for additional information);
lower net cash outflows of $64 million associated with futures contracts related to the Run-off Reinsurance segment (see Note 7 to the Consolidated Financial Statements for additional information);
net cash outflows in 2006 of $171 million for experience-rated refunds due to the loss of a large prescription drug contract; and
settlement in 2006 of certain liabilities associated with the single premium annuity business of $44 million.
Excluding these items, cash flows from operating activities in 2007 increased by $209 million compared with 2006. The increase was primarily due to higher cash revenues of $1.2 billion resulting from business growth in all of the Company’s ongoing operating segments, partially offset by higher paid claims of $536 million and higher operating expenses of $498 million (including higher tax payments of $138 million).
settlement in 2006 of certain liabilities associated with the single premium annuity business of $44 million;
net cash outflows in 2006 of $171 million for experience-rated refunds due to the loss of a large prescription drug contract, compared with net receipts of $107 million in 2005 from that contract;
voluntary pension contributions of $440 million (see Note 9 to the Consolidated Financial Statements for additional information); and
Cash provided by investing activities primarily consisted of net proceeds from investments of $1.8 billion, partially offset by net purchases of property and equipment of $136 million, net cash transferred of $45 million in connection with the conversion of the single premium annuity business to indemnity reinsurance and net cash used in acquisitions of $38 million.
million, partially offset by net proceeds of $246 million on issuance of long-term debt and proceeds of $251 million from issuances of common stock to employees under the Company's stock plans.
The Company’s capital resources (primarily retained earnings and the proceeds from the issuance of long-term debt and equity securities) provide protection for policyholders, furnish the financial strength to underwrite insurance risks and facilitate continued business growth.
provide capital necessary to support growth and maintain or improve the financial strength ratings of subsidiaries;
a substantial insurance or contractholder liability becomes due before related investment assets mature;
In November 2007, the Company announced its plan to acquire Great West Healthcare. The acquisition will require $1.5 billion in cash. The Company is targeting an April 1, 2008 closing date and expects to finance the acquisition with $1.0 billion in parent company cash and $500 million in new debt issuances. As of December 31, 2007, cash at the parent company was approximately $885 million.
In addition, the Company intends to retain approximately $400 million of surplus in the subsidiaries during 2008 to support the transaction.
The NAIC is considering changing statutory reserving rules for variable annuities. Any changes would apply to the Company’s reinsurance contracts covering guaranteed minimum death benefits and guaranteed minimum income benefits, and would impact the Company’s overall surplus level.
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. Actual obligations in any single year will vary based on actual morbidity, mortality, lapse, withdrawal and premium experience. The sum of the obligations presented above exceeds the corresponding insurance liabilities of $15.0 billion recorded on the balance sheet because these recorded liabilities reflect discounting for interest. The Company manages its investment portfolios to generate cash flows needed to satisfy contractual obligations. Any shortfall from expected 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 are excluded from the table above as net cash flow associated with them are not expected to impact the Company. The total amount of these reinsured reserves excluded is approximately $6.8 billion.
Non-recourse obligations represent principal and interest payments due which may be limited to the value of specified assets, such as real estate properties held in joint ventures.
Other long-term liabilities. These items are presented in accounts payable, accrued expenses and other liabilities in the Company's consolidated balance sheet. This table includes estimated payments for pension and other postretirement and postemployment benefit obligations, supplemental and deferred compensation plans, interest rate and foreign currency swap contracts and certain tax and reinsurance liabilities. Estimated payments of $90 million for deferred compensation, non-qualified and International pension plans and other postretirement and postemployment benefit plans are expected to be paid in less than one year. The Company does not expect to make, nor is the Company required to make, contributions to its primary qualified domestic pension plan in 2008. The Company expects to make additional payments subsequent to 2008 for these obligations, however subsequent payments have been excluded from the table as their timing is based on plan assumptions which may materially differ from actual activities (see Note 9 to the Consolidated Financial Statements for further information on pension and other postretirement benefit obligations). The Company expects to make additional payments subsequent to 2008 for tax obligations, however,
Purchase obligations. As of December 31, 2007, purchase obligations consisted of estimated payments required under contractual arrangements for future services and investment commitments as follows:
The Company had commitments to purchase investments in limited liability entities that hold real estate or loans in real estate entities or securities. See Note 10(C) to the Consolidated Financial Statements for additional information.
Future service commitments include an agreement with IBM for various information technology (IT) infrastructure services. The Company's commitment under this contract is approximately $640 million over a 6-year period. The Company has the ability to terminate this agreement with 90 days notice, subject to termination fees.
The Company's remaining estimated future service commitments primarily represent contracts for certain outsourced business processes and IT maintenance and support. The Company generally has the ability to terminate these agreements, but does not anticipate doing so at this time. Purchase obligations exclude contracts that are cancelable without penalty or those that do not specify minimum levels of goods or services to be purchased.
The Company repurchased 23.7 million shares in 2007 for $1.2 billion, and 75.9 million shares in 2006 for $2.8 billion. Shares repurchased have been adjusted to reflect the three-for-one stock split effective June 2007. See Note 4 to the Consolidated Financial Statements for additional information. The total remaining share repurchase authorization as of February 26, 2008, was $327 million.
During 2007, the Company suspended its repurchase program due to the capital requirements to fund the pending Great-West acquisition. In 2008, following the closing of the Great-West acquisition, the Company expects to have the capacity to resume the share repurchase program or consider additional acquisitions during the fourth quarter of 2008.
Additional information regarding the Company’s investment assets and related accounting policies is included in Notes 2, 10, 11 and 14 to the Consolidated Financial Statements in this 2007 Form 10-K.
Investments in fixed maturities (bonds) include publicly traded and privately placed debt securities, mortgage and other asset-backed securities and preferred stocks redeemable by the investor. Fixed maturities, as presented on the balance sheet, also include trading and hybrid securities.
As of December 31, 2007, $11.3 billion, or 93%, of the fixed maturities in the Company’s investment portfolio were
investment grade (Baa and above, or equivalent), and the remaining $0.8 billion were below investment grade. Most of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum.
Because of the higher yields and the inherent risk associated with privately placed investments and below investment grade securities, gains or losses from such investments could affect future results of operations. However, management does not expect such gains or losses to be material to the Company’s liquidity or financial condition.
significant vacancy in commercial rental mortgage property, or a decline in sales for commercial retail mortgage property.
The following table shows problem and potential problem investments at amortized cost as of December 31:
The effect of investment asset write-downs and changes in valuation reserves on the Company’s net income are shown below. Other includes amounts attributable to future policy benefits for certain annuities and a modified coinsurance arrangement associated with the sold retirement benefits business prior to its conversion to indemnity reinsurance in April 2006.
The Company’s portion of these losses is a component of realized investment results.
changes in market rates and prices. The Company’s primary market risk exposures are:
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 guaranteed minimum death and income benefit contracts.
Foreign currency exchange rate risk of the U.S. dollar to the South Korean won, Taiwan dollar, British pound, euro, Hong Kong dollar and New Zealand 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 reinsurance contracts that guarantee minimum death or income benefits resulting from unfavorable changes in variable annuity account values based on underlying mutual fund investments.
Use of local currencies for foreign operations. The Company generally conducts its international business through foreign operating entities that maintain assets and liabilities in local currencies. This substantially limits exchange rate risk to net assets denominated in foreign currencies.
See Notes 2(C) and 10(F) to the Consolidated Financial Statements for additional information about financial instruments, including derivative financial instruments.
Management believes that actual results could differ materially from these examples because:
The effect of a hypothetical increase in interest rates on the fair value of certain of the Company’s financial instruments decreased in 2007 as a result of declining investments in commercial mortgage loans and shortening durations of fixed maturity investments supporting certain annuities and
increased long-term debt. The effect of a hypothetical decrease in market prices for equity exposures increased in 2007 as a result of increased net liabilities related to guaranteed minimum income benefits reinsured by the Company based on higher assumed annuity election rates. See “Critical Accounting Estimates” for guaranteed minimum income benefit benefits on page 45 for further discussion.
The Company uses futures contracts as part of a program to substantially reduce the effect of equity market changes on certain reinsurance contracts that guarantee minimum death benefits based on unfavorable changes in variable annuity account values. The hypothetical effect of a 10% increase in the S&P 500, S&P 400, Russell 2000, NASDAQ, TOPIX (Japanese), EUROSTOXX and FTSE (British) equity indices and a 10% weakening in the U.S. dollar to the Japanese yen, British pound and euro would have been a decrease of approximately $60 million in the fair value of the futures contracts outstanding under this program as of December 31, 2007. A corresponding decrease in liabilities for guaranteed minimum death benefit contracts would result from the hypothetical 10% increase in these equity indices and 10% weakening in the U.S. dollar. See Note 7 to the Consolidated Financial Statements for further discussion of this program and related guaranteed minimum death benefit contracts.
As noted above, the Company manages its exposure to market risk by matching investment characteristics to its obligations.
The performance of equity markets can have a significant effect on the Company's businesses, including on:
pension liabilities since equity securities comprise a significant portion of the assets of the Company’s employee pension plans (see page 46).
The Company and its representatives may from time to time make written and oral forward-looking statements, including statements contained in press releases, in the Company’s filings with the Securities and Exchange Commission, in its reports to shareholders and in meetings with analysts and investors. Forward-looking statements may contain information about financial prospects, economic conditions, trends and other uncertainties. These forward-looking statements are based on management’s beliefs and assumptions and on information available to management at the time the statements are or were made. Forward-looking statements include but are not limited to the information concerning possible or assumed future business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, trends and, in particular, the Company’s productivity initiatives, litigation and other legal matters, operational improvement in the health care operations, and the outlook for the Company’s full year 2008 results. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believe”, “expect”, “plan”, “intend”, “anticipate”, “estimate”, “predict”, “potential”, “may”, “should” or similar expressions.
risks associated with pending and potential state and federal class action lawsuits, disputes regarding reinsurance arrangements, other litigation and regulatory actions challenging the Company’s businesses and the outcome of pending government proceedings and tax audits;
downgrades in the financial strength ratings of the Company’s insurance subsidiaries, which could, among other things, adversely affect new sales and retention of current business;
significant deterioration in economic conditions, which could have an adverse effect on the Company’s operations and investments;
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of the company’s assets that could have a material effect on the financial statements.
CIGNA constitutes one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace, including health care products and services such as medical coverages, pharmacy, behavioral health, dental benefits, and disease management; group disability, life and accident insurance; and disability and workers’ compensation case management and related services. In addition, CIGNA has an international operation that offers life, accident and supplemental health insurance products and international health care products and services to businesses and individuals in selected markets. CIGNA also has certain inactive businesses, including a run-off reinsurance operation.
The consolidated financial statements include the accounts of CIGNA, its significant subsidiaries, and variable interest entities of which CIGNA is the primary beneficiary, which are referred to collectively as “the Company.” 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 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.
impairment losses related to the dispositions in 2007 and 2006 of several Latin American insurance operations as discussed in Note 3;
Unless otherwise indicated, amounts in these Notes exclude the effects of discontinued operations.
Uncertain tax positions. Effective January 1, 2007, the Company implemented Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48, "Accounting for Uncertainty in Income Taxes." This interpretation provides guidance for recognizing and measuring uncertain tax positions that are "more likely than not" to result in a benefit if challenged by the Internal Revenue Service (IRS). The guidance clarifies that the amount of tax benefit recognized should be measured using management's best estimate based on the most favorable expected benefit with greater than fifty percent likelihood of being realized. The interpretation also requires that interest expense and penalties be recognized for any reserved portion of an uncertain tax position beginning when the effect of that position is reported to tax authorities. The cumulative effect of implementing the interpretation for unrecognized tax benefits decreased opening retained earnings by $29 million. See Note 16 for additional information.
Certain financial instruments. Effective January 1, 2007, the Company implemented Statement of Financial Accounting Standards (SFAS) No. 155, "Accounting for Certain Hybrid Financial Instruments,” an amendment of FASB Statements No. 133 and 140. This standard clarifies when certain financial instruments and features of financial instruments must be treated as derivatives and reported on the balance sheet at fair value with changes in fair value reported in net income. At
adoption, the Company elected to fair value certain existing investments in preferred stock and debt securities with call or conversion features (hybrid securities) and future changes in the fair value of these investments will be reported in net income. As a result, the Company reclassified $12 million after-tax of unrealized appreciation from the opening balance of accumulated other comprehensive loss to retained earnings with no net change to total shareholders' equity. In addition, this standard may affect future income recognition for certain future financial instruments if the fair value election is used or if additional derivatives are identified because any changes in their fair values will be recognized in net income each period. See Note 10(A) for a review of instruments that the Company has elected to fair value.
Pension and other postretirement benefit plans. Effective December 31, 2006, the Company implemented SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Benefits Plans." This standard requires that the overfunded or underfunded status of all defined benefit postretirement plans be measured as the difference between the fair value of plan assets and the benefit obligation and recognized in the balance sheet. Changes in actuarial gains and losses and prior service costs are required to be recognized in accumulated other comprehensive income, net of tax, each period. The effects on the consolidated financial statements were as follows:
The implementation of SFAS No. 158 did not impact the Company's pension expense, funding requirements or financial covenants. See Note 9 for further information on pension and other postretirement benefit plans.
Other-than-temporary impairment. Effective January 1, 2006, the Company implemented guidance provided by the FASB on evaluating fixed maturities and equity securities for other-than-temporary impairment. Because this guidance is largely a summary of existing accounting principles generally accepted in the United States of America, there was no material effect in accounting for fixed maturities and equity securities with other-than-temporary impairments at implementation. See Note 10(A) for a review of declines in fair value of fixed maturities and equity securities.
Fair value measurements. In 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," to expand disclosures about fair value measurements and to clarify how to measure fair value by focusing on the price that would be received when selling an asset or paid to transfer a liability (exit price). Except for certain nonfinancial instruments, implementation is required in the first quarter of 2008 with any changes to the fair values of assets or liabilities to be reported generally in net income. For fixed maturities and equity securities held for sale and derivatives that hedge future cash flows, changes in fair value will be reported in accumulated other comprehensive income (loss) for the period. The FASB voted to defer the effective date of SFAS No. 157 until first quarter 2009 for nonfinancial assets and liabilities (such as intangible assets, property and equipment and goodwill) that are required to be measured at fair value on a periodic basis (such as at acquisition or impairment).
Estimates of the fair values of the assets and liabilities for reinsurance contracts covering guaranteed minimum income benefits under certain variable annuity contracts issued by other insurance companies, including related retrocessional coverage from two external reinsurers, will be impacted by these new requirements. The assumptions used to estimate the fair value of these contracts will be determined using a market-based view of an exit price rather than using historical market data and actual experience to establish the Company’s future expectations. These assumptions include market returns and volatilities of the underlying equity and bond mutual fund investments, interest rates, mortality, lapse and annuity election rates, retrocessional credit, and risk and profit charges. For many of these assumptions, there is limited or no observable market data so determining an exit price under SFAS No. 157 requires significant judgment. The impact to the Company’s net income of implementing SFAS No. 157 on January 1, 2008 is expected to be a non-cash loss of $125-$150 million after-tax, net of estimated reinsurance recoverable, in the Run-off Reinsurance segment. In addition, the Company’s results of operations related to this business are expected to be more volatile in future periods as changes in the underlying assumptions will be based on current market inputs each period rather than on longer term expectations.
various investments (such as fixed maturities, commercial mortgage loans and equity securities);
off-balance-sheet instruments (such as investment and certain loan commitments and financial guarantees).
Commercial mortgage loans. Mortgage loans held by the Company are made exclusively to commercial borrowers, therefore there is no exposure to either prime or sub-prime residential mortgages. Generally, commercial mortgage loans are carried at unpaid principal balances and are issued at a fixed rate of interest. Commercial mortgage loans held for sale are carried at the lower of unpaid principal balance or market with any resulting valuation allowance reported in realized investment gains and losses. Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the loan agreement. Impaired loans are carried at the lower of unpaid principal or fair value of the underlying collateral. The Company estimates the fair value of the underlying collateral using internal valuations generally based on discounted cash flow analyses.
real estate "held and used" is expected to be held longer than one year and includes real estate acquired through the foreclosure of commercial mortgage loans. The Company carries real estate held and used at depreciated cost less any write-downs to fair value due to impairment and assesses impairment when cash flows indicate that the carrying value may not be recoverable. Depreciation is generally calculated using the straight-line method based on the estimated useful life of the particular real estate asset.
the Company uses several methods to determine the fair value of real estate, but relies primarily on discounted cash flow analyses and, in some cases, third party appraisals.
At the time of foreclosure, properties are reclassified from commercial mortgage loans to real estate. The Company rehabilitates, re-leases and sells foreclosed properties. This process usually takes from 2 to 4 years unless management considers a near-term sale preferable.
Short-term investments. Investments with maturities of less than one year from time of purchase are classified as short-term, available for sale and carried at fair value, which approximates cost.
Derivative financial instruments. Note 10(F) discusses the Company’s accounting policies for derivative financial instruments.
Investment gains and losses. Realized investment gains and losses result from sales, investment asset write-downs, changes in the fair values of hybrid securities and certain derivatives and changes in valuation reserves based on specifically identified assets. Realized investment gains and losses on the disposition of certain directly owned real estate investments are eliminated from ongoing operations and reported in discontinued operations when the operations and cash flows of the underlying assets are clearly distinguishable and the Company has no significant continuing involvement in the operations.
Reinsurance recoverables are estimates of amounts that the Company will receive from reinsurers and are recorded net of amounts management believes will not be received.
For universal life, annuity and other individual products, management estimates the present value of future revenues less expected payments. For group health indemnity products, management estimates the sum of future expected claims and related costs less unearned premiums and anticipated net investment income. If management’s estimates are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. Anticipated investment income is considered in the calculation of premium deficiency losses for short-duration contracts. The Company recorded in other operating expenses amortization for policy acquisition costs of $242 million in 2007, $202 million in 2006 and $149 million in 2005. There are no deferred policy acquisition costs attributable to the run-off retirement or run-off reinsurance operations.
Accumulated depreciation and amortization on property and equipment was $1.4 billion at December 31, 2007 and 2006.
Other assets consist primarily of various insurance-related assets. The Company’s other intangible assets include purchased customer relationships, provider networks, and trademarks. The Company amortizes other intangibles on a straight-line basis over periods from 1 to 11 years. Management revises amortization periods if it believes there has been a change in the length of time that an intangible asset will continue to have value. Other assets also include the gain position of certain derivatives (see Note 10(F)).
The gross carrying value of the Company’s other intangible assets was $275 million at December 31, 2007 and $266 million at December 31, 2006. The accumulated amortization was $211 million at December 31, 2007 and $202 million at December 31, 2006.
Future policy benefits are liabilities for the present value of estimated future obligations under long-term life and supplemental health insurance policies and annuity products currently in force. These obligations are estimated using actuarial methods and primarily consist of reserves for annuity contracts, life insurance benefits, guaranteed minimum death benefit contracts and certain life, accident and health insurance products in our International operations.
Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies represent benefits to be paid to policyholders, net of future premiums to be received. Management estimates these obligations based on assumptions as to premiums, interest rates, mortality and surrenders, allowing for adverse deviation. Mortality, morbidity, and surrender assumptions are based on either the Company’s own experience or actuarial tables. Interest rate assumptions are based on management’s judgment considering the Company’s experience and future expectations, and range from 1.25% to 10.0%. Obligations for certain annuities include adjustments for amounts that would be required had related investments been sold at their current fair values.
Certain reinsurance contracts guarantee a minimum death benefit 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 generally accepted accounting principles when a premium deficiency exists. Lapse, partial surrenders, mortality, interest rates and volatility are based on management’s judgment considering the Company’s experience and future expectations. The results of futures and forward contracts are reflected in the liability calculation as a component of investment returns. See also Note 7 for additional information.
Liabilities for unpaid claims and claim expenses are estimates of payments to be made under insurance coverages, (primarily long-term disability, workers’ compensation and life and health), for reported claims and for losses incurred but not yet reported.
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.
Because historical trend factors are often not representative of current claim trends, the trend experienced for the most recent history along with an analysis of emerging trends, have been taken into consideration in establishing the liability for Health Care medical claims payable at December 31, 2007 and 2006. It is possible that the actual medical trend for the current period will develop differently from that expected, which could have a material impact on the Company's medical claims payable and net income.
Accounts payable, accrued expenses and other liabilities consist principally of pension, other postretirement and postemployment benefits and various insurance-related liabilities, 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 (see Note 10(F)). Legal costs to defend the Company’s litigation and arbitration matters are expensed when incurred.
net investment income on assets supporting investment-related products is recognized as earned.
contract fees, which are based upon related administrative expenses, are recognized in premiums and fees as they are earned ratably over the contract period.
fees for mortality are recognized as assessed, which is as earned.
During 2006, the Company acquired the operating assets of Star HRG, a leading provider of low cost health plans and other employee benefits coverage for hourly and part-time workers and their families, for $156 million, including assumed liabilities. The acquisition was accounted for as a purchase, and was financed through the issuance of a note payable to the seller (see Note 12). The purchase price was allocated as follows: $57 million to identifiable intangible assets and the remaining $99 million to goodwill.
As of December 31, 2007, the remaining deferred gain of $36 million after-tax will be recognized in the Company’s results of operations through 2032.
In 1998, the Company sold its individual life insurance and annuity business for cash proceeds of $1.4 billion. The sale generated an after-tax gain of approximately $800 million, the majority of which was deferred and is recognized at the rate that earnings from the sold business would have been expected to emerge (primarily over 15 years on a declining basis). The Company recognized deferred gains of $25 million after-tax in 2007, $28 million after-tax in 2006 and $32 million after-tax in 2005. The remaining deferred gain as of December 31, 2007, was $130 million after-tax.
On April 25, 2007, the Company's Board of Directors approved a three-for-one stock split (in the form of a stock dividend) of the Company's common shares. The stock split was effective on June 4, 2007 for shareholders of record as of the close of business on May 21, 2007. All weighted average shares, per share amounts and references to stock compensation data for all periods presented have been adjusted to reflect the effect of the stock split.
Medical claims payable for the Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not yet reported, those which have been reported but not yet paid (reported claims in process) and other medical expense payable, which primarily comprises accruals for provider incentives and other amounts payable to providers. Incurred but not yet reported comprises the majority of the reserve balance at December 31 as follows:
Reinsurance and other amounts recoverable reflect amounts due from policyholders to cover incurred but not reported and pended claims for minimum premium products and certain administrative services only business where the right of offset does not exist.
For the year ended December 31, 2007, actual experience differed from the Company's key assumptions, resulting in favorable incurred claims related to prior years’ medical claims payable of $80 million, or 1.3% of the current year incurred claims as reported for the year ended December 31, 2006. Actual completion factors resulted in a reduction in medical claims payable of $46 million, or 0.7% of the current year incurred claims as reported for the year ended December 31, 2006 for the insured book of business. Actual medical cost trend resulted in a reduction in medical claims payable of $34 million, or 0.6% of the current year incurred claims as reported for the year ended December 31, 2006 for the insured book of business. The favorable impact in 2007 relating to completion factors and medical cost trend variances is primarily due to the release of the provision for moderately adverse conditions, which is a component of the assumptions for both completion factors and medical cost trend, established for claims incurred related to 2006. This release was substantially offset by the provision for moderately adverse conditions established for claims incurred related to 2007.
For the year ended December 31, 2006, actual completion factors resulted in a reduction of the medical claims payable of $99 million or 1.5% of the current year incurred claims as reported for the year ended December 31, 2005 for the insured book of business. Completion factors in 2006 reflected better than expected time to process claims, driven by higher auto-adjudication rates, the impact of claim recoveries and more timely submissions of provider claims. For the year ended December 31, 2006, actual medical cost trend resulted in a reduction of the medical claims payable of $74 million or 1.1% of the current year incurred claims as reported for the year ended December 31, 2005 for the insured book of business. The better than expected medical cost trend in 2006 was driven by lower inpatient, outpatient and pharmacy service utilization and lower than expected unit cost trends. The lower than expected unit cost trends reflected provider contracting initiatives and the mix of services provided.
The corresponding impact of favorable prior year development on net income was $8 million for the year ended December 31, 2007 and $54 million for the year ended December 31, 2006, or 0.1% in 2007 and 0.8% in 2006 of the current year incurred claims as reported for the years ended December 31, 2006 and 2005, respectively. 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 the Company's net income recognized for the following reasons:
First, due to the nature of the Company's retrospectively experience-rated business, only adjustments to medical claims payable on accounts in deficit affect net income. An increase or decrease to medical claims payable on accounts in deficit, in effect, accrue to the Company and directly impact 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 net income. An account is in surplus when the accumulated premium received exceeds the accumulated medical costs and administrative charges, including profit charges.
Second, the Company consistently 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. As the Company establishes the liability for each incurral year, the Company ensures that its assumptions appropriately consider moderately adverse conditions. When a portion of the development related to the prior year incurred claims is offset by an increase deemed appropriate to address moderately adverse conditions for the current year incurred claims, the Company does not consider that offset amount as having any impact on net income.
In periods of declining equity markets and in periods of flat equity markets following a decline, the Company's liabilities for these guaranteed minimum death benefits increase. Conversely, in periods of rising equity markets, the Company's liabilities for these guaranteed minimum death benefits decrease. As a result of the implementation of the program to reduce equity market exposures discussed below, the favorable and unfavorable effects of the equity market on the reserve are largely offset in other revenues as a result of the related futures contracts gains or losses.
Activity in future policy benefit reserves for these guaranteed minimum death benefit contracts was as follows:
Lapse refers to the full surrender of an annuity prior to a contractholder’s death. 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 and market volatility refer to the market return and market fluctuations respectively, that affect the costs of the program adopted by the Company to reduce equity market risks associated with these liabilities.
The Company regularly evaluates the assumptions used in establishing reserves and changes its estimates if actual experience or other evidence suggests that earlier assumptions should be revised. If actual experience differs from the assumptions used in estimating these reserves, the resulting differences 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 volatility assumption is 15-30%, varying by equity fund type; 3-8%, varying by bond fund type; and 2% for money market funds.
The Company has a program to substantially reduce the equity market exposures of this business by selling exchange-traded futures contracts, which are expected to rise in value as the equity market declines and decline in value as the equity market rises. In addition, the Company uses foreign currency futures contracts to reduce the international equity market and foreign currency risks associated with this business.
The Company recorded in other revenues pre-tax losses of $32 million in 2007, $96 million in 2006, and $48 million in 2005 from the futures contracts. Expense offsets reflecting
corresponding changes in liabilities for these guaranteed minimum death benefit contracts were included in benefits and expenses. The notional amount of the futures contract positions held by the Company at December 31, 2007 was $625 million.
The Company has also written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees related to minimum income benefits. See Note 20(B) for further information.
In addition to the exposures for guaranteed minimum death benefit contracts discussed above and for guaranteed minimum income benefit contracts discussed in Note 20(B), the Company’s insurance subsidiaries enter into agreements with other insurance companies to assume and cede reinsurance. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses. Reinsurance does not relieve the originating insurer of liability. The Company evaluates the financial condition of its reinsurers and monitors its concentrations of credit risk.
The Company purchased retrocessional coverage in these markets to substantially reduce the risk of loss on these contracts. Disputes involving a number of these reinsurance and retrocessional contracts have been substantially resolved and some of the disputed contracts have been commuted. See Note 20(E) “Litigation and Other Legal Matters” for more information.
The Company's payment obligations for underlying reinsurance exposures assumed by the Company under these contracts are based on ceding companies’ claim payments relating to accidents and injuries. These claim payments can in some cases extend many years into the future, and the amount of the ceding companies’ ultimate claims, and therefore the amount of the Company's ultimate payment obligations and ultimate collection from retrocessionaires may not be known with certainty for some time.
The Company could have losses if reinsurers fail to indemnify the Company on other reinsurance arrangements, either because of reinsurer insolvencies or contract disputes. However, management does not expect charges for other unrecoverable reinsurance to have a material adverse effect on the Company’s consolidated results of operations, liquidity or financial condition.
The effects of reinsurance on written premiums and fees for short-duration contracts were not materially different from the recognized premium and fee amounts shown in the above table.
The Company measures the assets and obligations of its domestic pension and other postretirement benefit plans as of December 31. The following table summarizes the projected obligations and assets related to the Company's domestic and international pension and other postretirement benefit plans as of, and for the years ended, December 31:
During 2007, the Company’s postretirement benefits liability adjustment decreased by $396 million pre-tax ($258 million after-tax) resulting in an increase to shareholders’ equity. The decrease in the liability was primarily due to:
an increase in the interest rate used to discount pension and other postretirement benefit liabilities;
adoption of a pension plan amendment, which, as of April 1, 2008, will change the benefit formula for employees hired prior to 1989 to one similar to all other employees; and
the annual update of census data, favorable medical claim experience, and lower actual than expected election rates in the Company’s postretirement medical plan.
These favorable effects were partially offset by certain assumption changes primarily related to expected retirement ages.
Effective December 31, 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans”. The overall effect was an after-tax increase to shareholders’ equity of $36 million. This increase occurred because prior service cost and net gains from past experience for other postretirement benefits plans more than offset the unrecognized underfunded pension liability. See Note 2(B) for further information.
The Company expects to recognize in 2008 $17 million of pre-tax gain related to amortization of prior service cost and $6 million of pre-tax gain from amortization of past experience.
The target investment allocation percentages 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 synchronize the expected higher rate of return on equities over the long-term with the overall long-term nature 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.
The assets related to other postretirement benefit plans are invested in fixed income investments in the general account of CGLIC.
The discount rates were developed considering actual annualized yields as of the measurement date for high quality, long-term corporate bonds adjusted to reflect the durations of the pension and other postretirement benefit obligations. Expected rates of return on plan assets were developed considering actual historical returns, current and expected market conditions, plan asset mix and management’s investment strategy.
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 market appreciation or depreciation in the portfolio over 5 years, a method that reduces the short-term impact of market fluctuations.
Changes to the Company's assumptions for the discount rates and expected rate of return on domestic qualified plan assets will not change required cash contributions to the pension plan as the Company funds at least the minimum amount required by ERISA.
Fixed maturities and equity securities included $89 million at December 31, 2007 and $88 million at December 31, 2006, which were pledged as collateral to brokers as required under certain futures contracts. These fixed maturities and equities securities were primarily corporate securities.
Gross unrealized appreciation (depreciation) on fixed maturities (excluding trading securities and hybrid securities beginning after the implementation of SFAS No. 155 on January 1, 2007) by type of issuer is shown below.
changes in the regulatory, economic or general market environment of the issuer’s industry or geographic region; and
As of December 31, 2007, fixed maturities (excluding trading and hybrid securities) which were primarily investment grade corporate bonds with a decline in fair value from cost were as follows, including the length of time of such decline:
The unrealized depreciation of investment grade fixed maturities is primarily due to increases in interest rates since purchase. There were no equity securities with a material decline in fair value from cost as of December 31, 2007. See Note 11(B) for discussion of impairments included in realized investment gains and losses.
At December 31, commercial mortgage loans and real estate investments were distributed among the following property types and geographic regions:
$224 million to entities that hold securities diversified by issuer and maturity date.
The Company expects to disburse approximately 40% of the committed amounts in 2008 and the remaining amounts by 2012.
Short-term investments and cash equivalents included corporate securities of $1.5 billion, federal government securities of $192 million and money market funds of $66 million at December 31, 2007. The Company’s short-term investments and cash equivalents at December 31, 2006, included corporate securities of $973 million, money market funds of $101 million and federal government securities of $117 million.
The Company’s investment strategy is to manage the characteristics of investment assets (such as duration, yield, currency and liquidity) to meet the varying demands of the related insurance and contractholder liabilities (such as paying claims, investment returns and withdrawals). As part of this investment strategy, the Company typically uses derivatives to minimize interest rate, foreign currency and equity price risks. The Company routinely monitors exposure to credit risk associated with derivatives and diversifies the portfolio among approved dealers of high credit quality to minimize credit risk. In addition, the Company has written or sold contracts to guarantee minimum income benefits and to enhance investment returns.
The Company recorded pre-tax realized investment losses of $11 million in 2006 from terminating swaps hedging interest rate and foreign currency risk of fixed maturities. The Company recorded pre-tax realized investment gains from swaps on commercial loan pools of $7 million in 2006 and 2005.
For futures, the Company receives (pays) cash daily in the amount of the change in fair value of the futures contracts.
To enhance investment returns, the Company sells Dow Jones indexed credit default swaps on a basket of primarily investment grade corporate bonds.
The Company receives quarterly fees and will make future payments if an issuer of an underlying corporate bond defaults on scheduled payments or files for bankruptcy. If an issuer defaults or files for bankruptcy, the Company will make payment for the par value of the underlying corporate bond and may subsequently sell or hold that bond as an invested asset. If the most current indexed swaps are determined desirable for liquidity, credit risk or other reasons, the Company also pays or receives cash to settle purchases and sales.
To hedge the variability of and fix at inception date, the benchmark Treasury rate component of future interest payments on debt to be issued in 2008.
Using cash flow hedge accounting, fair values are reported in short-term investment or other liabilities, with changes to fair value reported in accumulated other comprehensive income and amortized to interest expense over the life of the debt issued. These cash flows will be reported in operating activities.
To obtain returns based on the performance of underlying commercial loan pools.
The Company receives cash based on the performance of underlying commercial loan pools.
Fair values of the swaps are reported in other long-term investments or other liabilities, with changes reported in realized investment gains and losses. These cash flows are reported in investing activities.
Fair values are reported in other liabilities and other assets. Changes in fair value are reported in other operating expenses. These cash flows are reported in operating activities.
To hedge the possibility of early policyholder cash surrender when the amortized cost of underlying invested assets is greater than their fair values.
gains from other investments on sales of equity interests in real estate limited liability entities;
gains on sale of commercial mortgage loans in 2007 versus losses in 2006 on sales and asset write downs;
losses on fixed maturities largely due to asset write downs; and
Realized investment gains and losses that are not reflected in the Company’s revenues for the years ended December 31 were as follows:
$250 million of Notes bearing interest at the rate of 6.150% per year, which is payable on May 15 and November 15 of each year, beginning May 15, 2007. The Notes will mature on November 15, 2036.
The Company may redeem the Notes, at any time, in whole or in part, at a redemption price equal to the greater of:
100% of the principal amount of the Notes to be redeemed; or
the present value of the remaining principal and interest payments on the Notes being redeemed discounted at the applicable Treasury Rate plus 15 basis points for the 5.375% Notes and 25 basis points for the 6.150% Notes.
Also, in connection with the Star HRG acquisition in 2006, the Company issued to the seller a note payable of $151 million. Of that amount, $73 million was repaid during 2006 and the remaining $78 million is due in 2021.
In addition, as of December 31, 2007, the Company had $500 million remaining under an effective shelf registration statement filed with the SEC, which may be issued as debt securities, equity securities or both.
The Company has authorized a total of 25 million shares of $1 par value preferred stock. No shares of preferred stock were outstanding at December 31, 2007 or 2006.
State insurance departments and foreign jurisdictions that regulate certain of the Company’s subsidiaries prescribe accounting practices (which differ in some respects from generally accepted accounting principles) to determine statutory net income and surplus. The Company’s life insurance and HMO company subsidiaries are regulated by such statutory requirements. The statutory net income for the years ended, and surplus as of, December 31 of the Company’s life insurance and HMO subsidiaries were as follows:
As of December 31, 2007, surplus for each of the Company’s life insurance and HMO subsidiaries is sufficient to meet the minimum required by regulators. 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 2008 without prior approval is approximately $1.0 billion. The amount of net assets of the Company that could not be distributed without prior approval as of December 31, 2007, was approximately $3.6 billion.
During 2007, the IRS completed its examination of the Company’s 2003 and 2004 federal income tax returns. There remain two unresolved issues which will proceed to the appeals level. The timing for resolution of these matters remains uncertain due to the nature of the appeals process. The Company, however, anticipates that the appeals process could be completed in the next 12 months, but does not expect this to result in a significant change to the level of unrecognized tax benefits over the next 12 months.
The Company’s deferred tax asset is net of a federal and state valuation allowance (see table above). The valuation allowance reflects management’s assessment as to whether certain deferred tax assets will be realizable. These assessments could be revised in the near term if underlying circumstances change. The $24 million decrease in the valuation allowance during 2007 relates primarily to the run-off reinsurance operations, and was attributable to the recognition of pretax operating income. The valuation allowance at December 31, 2007 relates primarily to operating losses, and other deferred tax benefits, in the run-off reinsurance operations.
Federal operating loss carryforwards in the amount of $312 million were available at December 31, 2007. These operating losses are available to only offset future taxable income of the generating company, and begin to expire in 2022. The Company has no unused capital losses as of December 31, 2007.
Current income taxes payable included in accounts payable, accrued expenses and other liabilities in the consolidated balance sheet was $236 million as of December 31, 2007 and $193 million as of December 31, 2006.
$150 million resulting primarily from the release of tax reserves and valuation allowances. This amount consists of:
$88 million reported as income from continuing operations. This amount includes $4 million of interest income; and
In management’s opinion, adequate tax liabilities, including related interest charges should the IRS prevail, have been established to address exposures involving tax positions the Company has taken that may be challenged by the IRS. These liabilities could be revised in the near term if estimates of the Company's ultimate liability change as a result of new developments or a change in circumstances.
The Company had the following number of shares of common stock available for award at December 31: 31.1 million in 2007, 33.0 million in 2006 and 34.5 million in 2005.
Compensation expense of $19 million related to unvested stock options at December 31, 2007 will be recognized over the next 2 years (weighted average period).
Restricted stock. The Company makes restricted stock grants to its employees or directors with vesting periods ranging from 1 to 5 years. Recipients are entitled to receive dividends and to vote during the vesting period, but forfeit their awards if their employment terminates before the vesting date.
The table below shows the status of, and changes in, restricted stock grants during the last three years:
The Company also has several outsourced service arrangements with third parties, primarily for human resource and information technology support services. The initial service periods under these arrangements range from 2 to 7 years and they are reported primarily as operating leases under SFAS No. 13, “Accounting for Leases.” The Company recorded in other operating expense $87 million in 2007 and $24 million in 2006 for these arrangements.
Consolidated pre-tax income from continuing operations is primarily attributable to domestic operations. Consolidated pre-tax income from continuing operations generated by the
Corporate reflects amounts not allocated to segments, such as interest expense on corporate debt and on uncertain tax positions, net investment income on unallocated corporate investments, intersegment eliminations, compensation cost for stock options and certain corporate overhead expenses.
Summarized segment financial information for the years ended December 31 was as follows:
3 Includes premiums associated with other risk-related products primarily open access products.
6Represent administrative service fees for medical members and related specialty product fees for non-medical members as well as fees related to Medicare Part D.
The Company guarantees that separate account assets will be sufficient to pay certain retiree or life benefits. The sponsoring employers are primarily responsible for ensuring that assets are sufficient to pay these benefits and are required to maintain assets that exceed a certain percentage of benefit obligations. This percentage varies depending on the asset class within a sponsoring employer’s portfolio (for example, a bond fund would require a lower percentage than a riskier equity fund) and thus will vary as the composition of the portfolio changes. If employers do not maintain the required levels of separate account assets, the Company or an affiliate of the buyer has the right to redirect the management of the related assets to provide for benefit payments. As of December 31, 2007, employers maintained assets that exceeded the benefit obligations. Benefit obligations under these arrangements were $1.8 billion as of December 31, 2007. As of December 31, 2007 approximately 75% of these guarantees are reinsured by an affiliate of the buyer of the retirement benefits business. The remaining guarantees were provided by the Company with minimal reinsurance from third parties. There were no additional liabilities required for these guarantees as of December 31, 2007.
The Company estimates the fair value of the assets and liabilities associated with these contracts using assumptions as to market returns and volatility of the underlying equity and bond mutual fund investments, interest rates, mortality, lapse, annuity election rates, and retrocessional credit risk.
The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities by monitoring actual experience as it emerges over time and may change its estimates if actual experience or other evidence suggests that assumptions should be revised. If actual experience differs from the assumptions used in estimating these assets and liabilities, the resulting change 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 following provides information about the assumptions used in calculating the assets and liabilities for guaranteed minimum income benefits:
The gross market return assumption is 8-11% varying by equity fund type; 6-7% varying by bond fund type; and 5-6% for money market funds, reduced by fund fees ranging 2-3% across all funds.
The mortality assumption is 70% of the 1994 Group Annuity Mortality table, with 1% annual improvement beginning January 1, 2000.
The lapse rate assumption varies by contract from 2% to 17% and depends on the time since contract issue, the relative value of the guarantee and the differing experience by issuing company of the underlying variable annuity contracts.
The Company will implement SFAS No. 157 on January 1, 2008. The assumptions described above will be updated to reflect a market-based view of exit price. See Note 2(B) for further information.
also had an additional liability of $47 million associated with the future cost of reinsurance as of December 31, 2006. Management believes the current assumptions used to estimate reserves for these liabilities are appropriate.
All underlying mutual fund investment values remained at the December 31, 2007 value of $2.6 billion, with no future returns.
As of December 31, 2007 the Company guaranteed that it would compensate the lessors for a shortfall of up to $44 million in the market value of certain leased equipment at the end of the lease. Guarantees of $28 million expire in 2012 and $16 million expire in 2016. The Company had no additional liabilities for these guarantees as of December 31, 2007.
The Company had indemnification obligations as of December 31, 2007, 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 consolidated 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, 2007.
changes in federal tax laws, such as amendments that could affect the taxation of employer provided benefits.
Insurance-related assessments. Many states maintain funds to pay for the operating expenses of insurance regulatory agencies and pay the obligations of insolvent insurance companies. Regulators finance these funds by imposing assessments against insurance companies operating in the state. In some states, insurance companies can recover a portion of these assessments through reduced premium taxes.
As of December 31, 2007, the Company’s insurance and HMO subsidiaries have recorded $17 million in liabilities and $10 million in assets for insolvency fund and other insurance-related assessments.
The Company is routinely involved in numerous claims, lawsuits, regulatory and IRS examinations, investigations and other legal matters arising, for the most part, in the ordinary course of the business of administering and insuring employee benefit programs. An increasing number of claims are being made for substantial non-economic, extra-contractual or punitive damages. The outcome of litigation and other legal matters is always uncertain, and outcomes that are not justified by the evidence can occur. The Company believes that it has valid defenses to the legal matters pending against it and is defending itself vigorously. Nevertheless, it is possible that resolution of one or more of the legal matters currently pending or threatened could result in losses material to the Company’s consolidated results of operations, liquidity or financial condition.
Managed care litigation. On April 7, 2000, several pending actions were consolidated in the United States District Court for the Southern District of Florida in a multi-district litigation proceeding captioned In re Managed Care Litigation. The consolidated cases include Shane v. Humana, Inc., et al. (The Company’s subsidiaries added as defendants in August 2000), Mangieri v. CIGNA Corporation (filed December 7, 1999 in the United States District Court for the Northern District of Alabama), Kaiser and Corrigan v. CIGNA Corporation, et al. (class of health care providers certified on March 29, 2001) and Amer. Dental Ass’n v. CIGNA Corp. et. al. (a putative class of dental providers).
In 2004, the Court approved a settlement agreement between the physician class and the Company. A dispute over disallowed claims under the settlement submitted by a representative of certain class member physicians is proceeding to arbitration. Separately, in April 2005, the Court approved a settlement between the Company and a class of non-physician health care providers. Only the Amer. Dental Ass’n case remains unresolved. The Company’s motion to dismiss the case is pending.
In the fourth quarter of 2006, pursuant to a settlement, the Company received a $22 million pre-tax ($14 million after-tax) insurance recovery related to this litigation. In the first quarter of 2007, the Company received an additional $5 million pre-tax ($3 million after-tax) insurance recovery related to this litigation. The Company is pursuing recovery from two additional insurers.
On November 18, 2004, The People of the State of California by and through John Garamendi, Insurance Commissioner of the State of California v. Universal Life Resources, et al. was filed in the Superior Court of the State of California for the County of San Diego alleging that defendants (including the Company and several other insurance holding companies) failed to disclose compensation paid to ULR and that, in return for the compensation, ULR steered clients to defendants. The plaintiff sought injunctive relief only. On July 9, 2007, the parties to this lawsuit entered into a non-monetary settlement in which some of the Company’s subsidiaries agreed to maintain certain disclosure practices regarding contingent compensation. This settlement does not resolve the regulator’s claim for recovery of attorneys’ fees and costs.
On February 13, 2008, the court entered an order dismissing plaintiffs' state law claims and the complaint in its entirety. The court ordered the clerk to enter judgment against plaintiffs and in favor of the defendants. Plaintiffs have filed a notice of appeal. The Company denies the allegations and will continue to vigorously defend itself.
Boon Insurance Agency. On February 14, 2007, the Boon Insurance Agency and an affiliated company filed a complaint in Texas state court against two CIGNA subsidiaries and a co-defendant alleging breach of contract and fraudulent inducement in regard to several agreements with plaintiffs in connection with the marketing, production and servicing of voluntary health insurance policies. Plaintiffs seek compensatory damages, punitive damages and declaratory relief against the Company. Discovery is ongoing, and is scheduled to be completed by June 23, 2008. The case is set for jury trial on September 22, 2008. The Company denies the allegations and will vigorously defend itself in this case.
Run-off reinsurance litigation. In connection with the Company’s run-off reinsurance operations described in Note 8, the Company purchased extensive retrocessional reinsurance for its Unicover contracts and also for some other segments of its non-Unicover business. During 2007, CIGNA entered into a settlement that resolved the appeal of an adverse court award in a retrocessional enforcement arbitration. That appeal, captioned CIGNA EUROPE INSURANCE COMPANY SA-NV v. John Hancock Life Insurance Company, was pending in the High Court of Justice, Queen’s Bench Division, Commercial Court and the case was dismissed in the fourth quarter of 2007. Other disputes concerning retrocessional contracts have been substantially resolved or settled.
All weighted average shares and per share amounts for all periods presented have been adjusted to reflect the three-for-one stock split effective June 4, 2007 (see Note 4 to the Financial Statements).