(1) Beginning in 2014, we combined the results of our run-off reinsurance segment with Other Operations. Prior year segment information has been conformed to the current year presentation.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide information to assist you in better understanding and evaluating our financial condition and results of operations. We encourage you to read this MD&A in conjunction with our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K and the "Risk Factors" contained in Part I Item 1A of this Annual Report on Form 10-K ("Form 10-K").
Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as "Cigna," the "Company," "we," "our" or "us") is a global health services organization dedicated to a mission of helping individuals improve their health, well-being and sense of security. To execute on our mission, Cigna's strategy is to "Go Deep", "Go Global" and "Go Individual" with a differentiated set of medical, dental, disability, life and accident insurance and related products and services offered by our subsidiaries.
We present the remainder of our segment results in Other Operations, consisting of the corporate-owned life insurance business ("COLI"), run-off reinsurance and settlement annuity businesses and deferred gains associated with the sales of the individual life insurance and annuity and retirement benefits businesses.
Pharmacy Benefit Management ("PBM") Services Agreement. In June 2013, we entered into a 10-year pharmacy benefit management services agreement with Catamaran Corporation. Under this agreement, we utilize their technology and service platforms, retail network contracting and claims processing services. In the second quarter of 2013, we recorded one-time transaction costs of $37 million pre-tax ($24 million after-tax) that were reported as a special item. This arrangement has produced a positive contribution to earnings in 2014 through improved clinical management, purchasing and administrative efficiencies.
During the second quarter of 2013, we finalized an agreement with the Departments of Insurance for Maine, Massachusetts, Pennsylvania, Connecticut and California (together, the "monitoring states") related to our long-term disability claims handling practices. In connection with the terms of the agreement, the Company recorded a charge of $77 million before-tax ($51 million after-tax) in the first quarter of 2013. The charge was comprised of two elements: (1) $48 million of benefit costs and reserves from reassessed claims expected to be reopened, and (2) $29 million of additional costs for open claims as a result of the claims handling changes being implemented. This charge was reported in the Group Disability and Life segment. We are actively implementing the terms of the agreement and continue to communicate with the monitoring states on progress. If the monitoring states find material non-compliance
with the terms of the agreement upon re-examination, we may be subject to additional fines or penalties. In addition to the monitoring states, most other jurisdictions have joined the agreement as participating, non-monitoring states.
•Fees and other revenues. The increase in 2014 compared with 2013 largely resulted from growth in specialty contributions, including pharmacy and cost containment. For 2013, the growth in fees and other revenues over 2012 was due to customer growth as well as increased specialty contributions. Fees and other revenues also included pre-tax losses of $39 million in 2013 and $119 million in 2012 attributable to the hedge program associated with the GMDB and GMIB businesses prior to the reinsurance transaction with Berkshire in 2013.
•Net investment income. In 2014, net investment income was flat compared with 2013, reflecting higher average investment assets offset by lower yields. The slight increase in 2013, compared with 2012, was primarily due to higher yields driven in part by higher partnership income, partially offset by lower average investment assets primarily due to sales of assets to fund the reinsurance transaction with Berkshire.
•Mail order pharmacy revenues. Increases in each of 2014 and 2013 compared with the prior year, primarily reflected higher prescription volume for specialty medications (injectibles) and price increases to recover pharmacy cost trend.
•Realized investment results. In 2014, realized investment results decreased compared with 2013, primarily due to significantly lower gains on sales of fixed maturities that were partially offset by a gain on the sale of an equity interest in 2014. The significant increase in 2013, compared with 2012, primarily resulted from gains on the sales of real estate joint ventures and higher gains on sales of fixed maturities. In the first quarter of 2013, we realized large gains on sales of fixed maturities primarily to fund the reinsurance transaction with Berkshire. See Note 14 to the Consolidated Financial Statements for additional information.
•Other operating expenses. In 2014, the increase in other operating expenses over 2013 was largely driven by new taxes and fees assessed under Health Care Reform and business growth in all of our ongoing segments. The increase in 2013 compared with 2012 was due primarily to business growth in all of our ongoing segments. See the segment reporting section of this MD&A for additional discussion of operating expenses.
•Shareholders' net income. For 2014, the significant increase in shareholders' net income compared with 2013 is largely due to the absence of the $507 million after-tax charge associated with the reinsurance agreement with Berkshire recorded in the first quarter of 2013. The decrease in shareholders' net income in 2013, compared with 2012 was also driven by this after-tax charge, partially offset by an increase in adjusted income from operations.
•Consolidated effective tax rate. The increase in the consolidated effective tax rate in 2014, compared with 2013, was primarily driven by the non-deductible health insurance industry tax first assessed under Health Care Reform in 2014. The consolidated effective tax rate decreased in 2013, compared with 2012, primarily driven by favorable tax benefits reported in the third quarter of 2013. See Note 19 to the Consolidated Financial Statements for additional information.
•Global medical customers (excluding limited benefits). We exited the limited benefits business in 2014 as required by Health Care Reform. Excluding limited benefits customers, our medical customer base increased in both 2014 and 2013 compared with comparable prior years, primarily driven by continued growth in our targeted market segments.
Consolidated short-term investments decreased in 2014 compared with 2013 as a result of the Company reinvesting proceeds from maturities of short-term investments in longer-term holdings. The increase in short-term investments in 2013 compared with 2012 was driven by purchases of liquid commercial paper and United States Government obligations.
• pension plan funding. The parent company normally meets its liquidity requirements by:
• using proceeds from issuance of debt (including commercial paper) and equity securities; and
• borrowing from its subsidiaries. Cash flows for the years ended December 31, were as follows:
Cash flows from operating activities increased substantially in 2014 compared with 2013, primarily due to the absence of the 2013 reinsurance payments totaling $2.2 billion to Berkshire. Excluding those payments and tax benefits realized in connection with the Berkshire transaction, cash flows from operating activities in 2014 decreased by $0.6 billion, compared with 2013. This decrease was primarily related to the volume and timing of reimbursements prescribed by government programs.
Cash provided by operating activities declined by $1.6 billion in 2013 compared with 2012 primarily due to reinsurance payments totaling $2.2 billion made in 2013 to Berkshire.
Cash flows from investing activities decreased by $1.8 billion in 2014 compared with 2013, primarily due to higher net purchases of fixed maturities. In 2013, net purchases of fixed maturities were lower than 2014 primarily due to funding the Berkshire transaction. Cash flows from investing activities increased by $3.9 billion in 2013 compared with 2012 primarily driven by the absence of 2012 payments to acquire HealthSpring.
We maintain a share repurchase program that was authorized by our Board of Directors. The decision to repurchase shares depends on market conditions and alternate uses of capital. We have repurchased, and may continue to repurchase, shares on the open market through a Rule 10b5-1 plan that permits a company to repurchase its shares at times when it otherwise might be precluded from doing so under insider trading laws or because of self-imposed trading blackout periods. We suspend activity under this program from time to time and also remove such suspensions, generally without public announcement.
• provide the capital necessary to support growth and maintain or improve the financial strength ratings of subsidiaries;
Our cash projections may not be realized and the demand for funds could exceed available cash if our ongoing businesses experience unexpected shortfalls in earnings, or we experience material adverse effects from one or more risks or uncertainties described more fully in the Risk Factors section of this Form 10-K. In those cases, we expect to have the flexibility to satisfy liquidity needs through a variety of measures, including intercompany borrowings and sales of liquid investments. The parent company may borrow up to $1.3 billion from its insurance subsidiaries without additional state approval. As of December 31, 2014, the parent company had approximately $165 million of net intercompany loans receivable from its insurance subsidiaries. Alternatively, to satisfy parent company liquidity requirements we may use short-term borrowings, such as the commercial paper program, the committed revolving credit and letter of credit agreement of up to $1.5 billion subject to the maximum debt leverage covenant in its line of credit agreement. As of December 31, 2014, $1.5 billion of short-term borrowing capacity under the credit
Unfunded Pension Plan Liability. As of December 31, 2014, our unfunded pension liability was $1.1 billion, reflecting an increase of approximately $0.5 billion from December 31, 2013. The year over year increase in the unfunded liability reflected $0.6 billion in higher projected benefit obligations primarily as a result of a decrease of 75 basis points in the assumed discount rate, and changes to our mortality assumptions based on an updated pension mortality table. These impacts were partially offset by $0.1 billion in asset growth driven by pension contributions and strong asset returns. In 2015, we do not expect to make pension contributions in excess of the $5 million minimum required under the Pension Protection Act of 2006. See Note 9 for additional information regarding our pension plans.
Solvency II. Our businesses in the European Union will be subject to the directive on insurance regulation, solvency and governance requirements known as Solvency II. This directive will impose economic risk-based solvency and governance requirements and supervisory rules and becomes effective in 2016, although certain EU country regulators are requiring companies to demonstrate technical capability and comply with increased capital levels in advance of this effective date. Our European insurance companies are capitalized at levels consistent with projected Solvency II requirements and in compliance with anticipated governance and technical capability requirements.
contractholder liabilities exclude future interest crediting, charges and fees. We manage our investment portfolios to generate cash flows needed to satisfy contractual obligations. Any shortfall from expected investment yields could result in increases to recorded reserves and adversely impact results of operations. The amounts associated with the sold retirement benefits and individual life insurance and annuity businesses, as well as the reinsured workers' compensation, personal accident and supplemental benefits businesses, are excluded from the table above as net cash flows associated with them are not expected to impact us. The total amount of these reinsured reserves excluded is approximately $5 billion.
•Long-term debt includes scheduled interest payments. Capital leases are included in long-term debt and represent obligations for IT network storage, servers and equipment.
Estimated payments of $76 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. Our best estimate is that contributions to the qualified domestic pension plans during 2015 will be approximately $5 million. We expect to make payments subsequent to 2015 for these obligations, however subsequent payments have been excluded from the table as their timing is based on plan assumptions that 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 above table also does not contain $26 million of liabilities for uncertain tax positions because we cannot reasonably estimate the timing of their resolution with the respective taxing authorities. See Note 19 to the Consolidated Financial Statements for the year ended December 31, 2014 for further information.
Purchase obligations. As of December 31, 2014, purchase obligations consisted of estimated payments required under contractual arrangements for future services and investment commitments as follows:
We had commitments to invest in limited liability entities that hold real estate, loans to real estate entities or securities. See Note 11(C) to the Consolidated Financial Statements for additional information.
Goodwill At the acquisition date, goodwill represents the excess of the cost of businesses acquired over the fair value of their net assets.
The discount rate is typically the most significant assumption in measuring the pension liability. We develop the discount rate by applying actual annualized yields at various durations from a discount rate curve constructed from high quality corporate bonds. If discount rates for the qualified and nonqualified pension plans decreased by 50 basis points, the accrued pension benefit liability would increase by approximately $240 million as of December 31, 2014 resulting in an after-tax decrease to shareholders' equity of approximately $155 million.
If the December 31, 2014 fair values of domestic qualified plan assets decreased by 10%, the accrued pension benefit liability would increase by approximately $415 million as of December 31, 2014 resulting in an after-tax decrease to shareholders' equity of approximately $270 million.
In 2014, actual experience differed from our key assumptions as of December 31, 2013, resulting in $159 million of favorable incurred claims related to prior years' medical claims payable or 1.0% of the current year incurred claims as reported in 2013. In 2013, actual experience differed from our key assumptions as of December 31, 2012, resulting in $182 million of favorable incurred claims related to prior years' medical claims, or 1.3% of the current year incurred claims reported in 2012. Specifically, the favorable impact is due to faster than expected completion factors and lower than expected medical cost trends, both of which included an assumption for moderately adverse experience.
See Note 10 to the Consolidated Financial Statements for a discussion of our fair value measurements and the procedures performed by management to determine that the amounts represent appropriate estimates.
Typically, the most significant input in the measurement of fair value is the market interest rate used to discount the estimated future cash flows from the instrument. Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry and structure of the asset. If the interest rates used to calculate fair value increased by 100 basis points, the fair value of the total fixed maturity portfolio of $19.0 billion would decrease by approximately $1.2 billion.
The following section of this MD&A discusses the results of each of our reporting segments. We measure the financial results of our segments using "segment earnings (loss)", defined as shareholders' net income (loss) before after-tax realized investment results. In the following segment discussions, we also present information using "adjusted income (loss) from operations", defined as segment earnings (loss) excluding special items and results of the GMIB business. Adjusted income (loss) from operations is another measure of profitability used by our management because it presents the underlying results of operations of our businesses and permits analysis of trends in underlying revenue, expenses and shareholders' net income. This measure is not determined in accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP measure that is shareholders' net income. We exclude special items because management does not believe they are representative of our underlying results of operations. We also exclude
the results of the GMIB business because, prior to the reinsurance transaction with Berkshire on February 4, 2013, the changes in the fair value of GMIB assets and liabilities were volatile and unpredictable.
•operating expense as a percentage of segment revenues (operating expense ratio); and
Excluding the special items reported in 2013, segment earnings and adjusted income from operations increased in 2014, compared with 2013. This growth was primarily driven by increased specialty contributions, including strong pharmacy results, partially offset by lower earnings in our government segment primarily due to taxes and fees mandated by Health Care Reform and a higher medical care ratio in our Medicare Part D business. In addition, results include the impact of higher operating expenses reflecting investment spending to enhance our capabilities, and lower margins in our U.S. Commercial group risk business, including our exit from the limited benefits business. Results in the U.S. commercial individual business (after considering receivables from the government risk mitigation programs) were flat.
Premiums. The increase in 2014 compared with 2013 was primarily driven by rate increases on most products in the Commercial segment to recover underlying medical cost trends and taxes and fees mandated by Health Care Reform. In addition, premiums reflect customer growth in our U.S. commercial individual business, as well as in targeted markets for stop loss and Medicaid products. These increases were partially offset by a decline in group commercial risk customers including a shift from our insured to self-insured products and our exit from the limited benefits business.
Fees and other revenues. The increase in 2014, compared with 2013, largely resulted from growth in specialty contributions, including pharmacy and cost containment. In 2013, the growth in fees and other revenues compared to 2012 was due to customer growth as well as increased cost containment revenues.
Medical claims expense. The 5% increase in 2014 compared with 2013 primarily reflects medical cost inflation and customer growth, partially offset by our exit from the limited benefits business.
The guaranteed cost medical care ratio increased slightly in 2014, compared with 2013, due to a higher medical care ratio in the U.S. individual business and the exit from the limited benefits business, offset by rate increases to cover new taxes and fees mandated by Health Care Reform.
The operating expense ratios including and excluding special items decreased in 2013, compared with 2012, primarily driven by revenue growth and cost efficiencies partially offset by higher spending to enhance our capabilities, including 2013 costs associated with our new PBM arrangement.
As required by Health Care Reform, we exited the limited benefits business effective December 31, 2013. Excluding this impact, our medical customer base increased 3% in 2014, primarily driven by continued growth in the middle market, select, individual, and government market segments, partially offset by a decline in the national market segment.
• operating expense and acquisition expense as a percentage of segment revenues (expense ratio and acquisition cost ratio);
As described in Note 3 to the Consolidated Financial Statements, the Global Supplemental Benefits segment acquired two businesses during the second half of 2012: Great American Supplemental Benefits and Finans Emeklilik (also referred to as the "Turkey JV"). Collectively, throughout this discussion these two transactions are referred to as "the acquisitions."
The increase in segment earnings and adjusted income from operations was driven in part by a lower acquisition cost ratio and continuing business growth, primarily in South Korea, partially offset by a higher loss ratio driven by a business mix shift and higher incurred claims. 2014 results also included favorable tax-related items of $21 million recorded in the third quarter of 2014 (see effective tax rate discussion below).
Benefit expenses increased in both 2014 and 2013, compared with each prior year. Applying actual 2014 currency exchange rates to 2013 results, benefit expenses increased by 16%. These increases were primarily due to business growth and higher claims primarily in South Korea and the U.S. Applying actual 2014 currency exchange rates to prior year results, benefit expenses increased 28% in 2013, compared with 2012, primarily due to the acquisitions in the second half of 2012 and business growth.
Operating expenses. Included in operating expenses for the Global Supplemental Benefits segment are both policy acquisition costs and other operating expenses. Overall operating expenses were higher in 2014 and 2013 compared with each prior year, reflecting increases in both policy acquisition costs and other operating expenses. For 2014, the increase in policy acquisition costs reflects higher commissions in Hong Kong, the U.K. and the U.S., primarily driven by higher sales. For 2013, the increase in policy acquisition costs was largely attributable to the acquisitions and business growth, partially offset by lower acquisition costs in Europe reflecting a decision to cease selling activities in certain markets during 2012. The increases in other operating expenses in both 2014 and 2013 compared with each prior year were largely driven by strategic business investments.
Acquisition cost ratios decreased in both 2014 and 2013 compared with each prior year. For 2014, the decline in the ratio largely represents a shift toward higher premium products and more disciplined acquisition cost spending. The decrease in the ratio in 2013 was primarily driven by lower acquisition costs in Europe reflecting a decision to cease selling activities in certain markets during 2012 and, to a lesser extent, the impact of the lower acquisition cost ratios associated with our supplemental benefits business in the U.S.
• benefit expenses as a percentage of earned premium (loss ratio); and
Segment earnings decreased in 2013 compared with 2012 primarily due to the charge associated with the disability claims regulatory matter. Adjusted income from operations increased reflecting lower disability claim costs, a lower expense ratio and higher net investment income partially offset by unfavorable life claims experience. Lower disability claim costs included the $29 million favorable after-tax effect of a higher discount rate on claims incurred during 2013 as discussed above. Results included the favorable after-tax effect of reserve reviews of $60 million in 2013 and $43 million in 2012.
Premiums. The increases in both 2014 and in 2013 reflected new business growth due to disability and life sales and continued strong customer retention.
Net investment income. The increases in both 2014 and in 2013 were primarily due to higher assets partially offset by lower yields.
Benefit expenses. The increase in 2014 compared with 2013 was due primarily to premium growth and higher disability claims costs including the effect of a lower discount rate, partially offset by the absence of the $77 million before-tax charge for the disability claims regulatory matter and favorable life results. Disability claim costs in 2013 benefited from the $40 million before-tax impact of higher discount rates driven by the reallocation of higher yielding assets to the disability and life portfolio as noted above. The favorable life results reflected lower new claim incidence. Benefit expenses included the before-tax favorable impact of reserve reviews of $75 million in 2014 compared with $84 million in 2013.
The increase in benefit expenses in 2013 compared with 2012 was primarily due to the $77 million before-tax impact of the disability claims regulatory matter, premium growth and unfavorable life claims experience partially offset by lower disability claim costs. The unfavorable life claims experience was driven by higher new claim sizes and the lower disability claim costs were driven by discount rate changes in 2013 as discussed above and the favorable impact of reserve reviews. Benefit expenses in 2013 included the before-tax favorable impact of reserve reviews of $84 million compared with $60 million in 2012.
Operating expense ratio. The decrease in the operating expense ratio in both 2014 and 2013 reflected continued expense discipline.
Effective tax rate. The segment's effective tax rate is generally lower than the federal tax rate of 35%, primarily due to tax-exempt interest income on bonds. The increase in the effective tax rate in 2014 compared with 2013 resulted from a decline in the proportion of the segment's income that was attributable to tax-exempt interest and, to a lesser extent, the absence of the tax benefit reported in 2013 related to the completion of IRS tax audits. The decline in the effective tax rate in 2013 compared with 2012 was due to the tax benefit reported in 2013 related to the completion of IRS tax audits.
The decrease in segment results in 2013 compared with 2012 was driven largely by the 2013 charge related to the reinsurance transaction with Berkshire. The increase in adjusted income from operations in 2013, compared with 2012, primarily resulted from the absence of the 2012 reserve strengthening in the GMDB business of $27 million and the $14 million favorable impact of completing the 2009-2010 IRS examinations during the third quarter of 2013. See Note 19 to the Consolidated Financial Statements for additional information on the IRS examinations.
Fees and other revenues included losses of $39 million in 2013 and $119 million in 2012 associated with a dynamic hedge program for the run-off reinsurance business that was discontinued in 2013 with
the effective exit from the GMDB and GMIB businesses. Excluding this hedge activity, other revenues were slightly lower in both 2014 and 2013 compared with each prior year, primarily due to the continued decline in deferred gain amortization related to the sold retirement benefits and individual life insurance and annuity businesses.
Net investment income decreased in 2014 and, to a much more significant degree, in 2013 compared with each prior year. These decreases were primarily due to lower average yields and the selling or reallocating of investment assets in 2013 as a result of the reinsurance transaction with Berkshire.
Operating expenses decreased in 2014 compared with 2013 primarily due to the absence of expenses associated with the Berkshire transaction and lower ongoing expenses subsequent to the transaction. Operating expenses in 2012 included GMIB fair value gains of $(41) million. Excluding this GMIB activity, operating expenses increased in 2013 compared with 2012 primarily due to expenses associated with the Berkshire transaction.
The following table reflects our fixed maturity portfolio by type of issuer as of December 31, 2014 and 2013.
The fixed maturity portfolio increased approximately $2.5 billion during 2014, reflecting increased investment in fixed maturities and the impact of decreased market yields on asset valuations. Although overall asset values are well in excess of amortized cost, there are specific securities with amortized cost in excess of fair value by $42 million in aggregate as of December 31, 2014. See Note 11 to the Consolidated Financial Statements for further information.
Our investment in state and local government securities, with an average quality rating of Aa2 is diversified by issuer and geography with no single exposure greater than $28 million. We assess each issuer's credit quality based on a fundamental analysis of underlying financial information and do not rely solely on statistical rating organizations or monoline insurer guarantees.
Corporate fixed maturities include private placement investments of $5.2 billion that are generally less marketable than publicly-traded bonds. However, yields on these investments tend to be higher than yields on publicly-traded bonds with comparable credit risk. We perform a credit analysis of each issuer, diversify investments by industry and issuer and require financial and other covenants that allow us to monitor issuers for deteriorating financial strength and pursue remedial actions, if warranted. Corporate fixed maturities include $343 million of investments in companies that are domiciled or have significant business interests in Italy, Ireland, and Spain. These investments have an average quality rating of Baa2 and are diversified by industry sector, including approximately 2% invested in financial institutions. Corporate fixed maturities also include investments in the energy and natural gas sector of $1.4 billion that have an average quality rating of Baa and are diversified by issuer with no single exposure greater than $45 million.
Commercial real estate capital markets remain most active for well leased, quality commercial real estate located in strong institutional investment markets. The vast majority of properties securing the mortgages in our mortgage portfolio possess these characteristics. While commercial real estate fundamentals continued to improve, the improvement has varied across geographies and property types.
Other long-term investments of $1.5 billion primarily include investments in security partnership and real estate funds as well as direct investments in real estate joint ventures. The funds typically invest in mezzanine debt or equity of privately held companies (securities partnerships) and equity real estate. Given our subordinate position in the capital structure of these underlying entities, we assume a higher level of risk for higher expected returns. To mitigate risk, investments are diversified across approximately 110 separate partnerships, and approximately 65 general partners who manage one or more of these partnerships. Also, the funds' underlying investments are diversified by industry sector or property type, and geographic region. No single partnership investment exceeds 6% of our securities and real estate partnership portfolio.
Although the total fair values of investments exceeded their carrying values as of December 31, 2014, the fair value of our ownership interest in certain funds that are carried at cost was less than carrying value by $17 million. We expect to recover our carrying value over the average remaining life of these investments of approximately 5 years. Given the current economic environment, future impairments are possible; however, management does not expect those losses to have a material effect on our results of operations, financial condition or liquidity. See Note 11 to the Consolidated Financial Statements for further information regarding Other Long-term Investments.
•principal or interest payments past due by more than 30 but fewer than 60 days;
•for commercial mortgages, deterioration of debt service coverage below 1.0 or value declines resulting in estimated loan-to-value ratios increasing to 100% or more. We recognize interest income on problem bonds and commercial mortgage loans only when payment is actually received because of the risk profile of the underlying investment. The amount that would have been reflected in net income if interest on non-accrual investments had been recognized in accordance with the original terms was not significant for 2014 or 2013.
(1)Other long-term investments included $7 million at December 31, 2013 of restructured loans that were previously reported in commercial mortgage loans.
Included in realized investment gains (losses) were increases in valuation reserves related to commercial mortgage loans and other-than-temporary impairments on fixed maturities and partnership investments of $52 million. See Note 11 to the Consolidated Financial Statements for further information.
Our assets and liabilities include financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. Our primary market risk exposures are:
•Foreign currency exchange rate risk of the U.S. dollar primarily to the South Korean won, Euro, British pound, Chinese yuan renminbi and Taiwan dollar. An unfavorable change in exchange rates reduces the carrying value of net assets denominated in foreign currencies.
• Use of derivatives. We generally use derivative financial instruments to minimize certain market risks. In 2014, we entered into interest rate swap contracts to convert a portion of our interest rate exposure on long-term debt from fixed rates to variable rates to more closely align interest expense with interest income received on our cash equivalent and short-term investment balances. See Notes 2(C) and 12 to the Consolidated Financial Statements for additional information about financial instruments, including derivative financial instruments.
•a hypothetical increase in market interest rates, primarily for fixed maturities and commercial mortgage loans, partially offset by liabilities for long-term, fixed-rate debt; and
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in total equity and cash flows present fairly, in all material respects, the financial position of Cigna Corporation and its subsidiaries at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
products are offered through employers and other groups (e.g. governmental and non-governmental organizations, unions and associations). Cigna also offers commercial health and dental insurance, Medicare and Medicaid products and health, life and accident insurance coverages to individuals in the U.S. and selected international markets. In addition to its ongoing operations described above, Cigna also has certain run-off operations.
Variable interest entities. As of December 31, 2014 and 2013, the Company determined it was not a primary beneficiary in any material variable interest entities.
•A three-year (2014-2016) reinsurance program is designed to provide reimbursement to insurers for high cost individual business sold on or off the public exchanges. The reinsurance entity established by the U.S. Department of Health and Human Services ("HHS") is funded by a per-customer reinsurance fee assessed on all insurers, HMOs and self-insured group health plans, excluding certain products such as Medicare Advantage and Medicare Part D. Only non-grandfathered individual plans are eligible for recoveries if claims exceed a specified threshold, up to a reinsurance cap. Reinsurance contributions associated with non-grandfathered individual plans are reported as a reduction in premium revenue, and estimated reinsurance recoveries are established with an offsetting reduction in Global Health Care medical claims expense. Reinsurance fee contributions for other insured business are reported in other operating expenses. Final recoverable amounts are determined and settled with HHS in the year following the policy year.
Revenue from Contracts with Customers (Accounting Standards Update ("ASU") 2014-09). In May 2014, the Financial Accounting Standards Board ("FASB") issued new revenue recognition guidance that will apply to various contracts with customers to provide goods or services, including the Company's non-insurance, administrative services contracts. It will not apply to certain contracts within the
scope of other GAAP, such as insurance contracts. This new guidance introduces a model that requires companies to estimate and allocate the expected contract revenue among distinct goods or services in the contract based on relative standalone selling prices. Revenue is recognized as goods or services are delivered. This new method replaces the current GAAP approach of recognizing revenue that is fixed and determinable primarily based on contract terms. In addition, extensive new disclosures will be required including the presentation of additional categories of revenues and information about related contract assets and liabilities. This new guidance must be implemented on January 1, 2017; early adoption is not permitted. The Company may choose to adopt these changes through retrospective restatement with or without using certain practical expedients or with a cumulative effect adjustment on adoption. The Company continues to monitor developing implementation guidance and evaluate these new requirements for its non-insurance customer contracts to determine the method of implementation and any resulting estimated effects on the financial statements.
Fees Paid to the Federal Government by Health Insurers (ASU 2011-06). Effective January 1, 2014, the Company adopted the FASB's accounting guidance for the health insurance industry assessment (the "tax") mandated by Health Care Reform. This non-deductible tax is being levied based on a ratio of an insurer's net health insurance premiums written for the previous calendar year compared to the U.S. health insurance industry total. As required by the guidance, the Company reports a liability at the beginning of each year in accounts payable, accrued expenses and other liabilities and a corresponding deferred cost in other assets, including other intangibles based on a preliminary assessment of the full year. The Company recognizes the tax in operating expenses on a straight line basis and reduces the deferred cost correspondingly. For full-year 2014, the Company recognized $238 million in operating expenses for the tax. As of December 31, 2014, there were no such remaining balances in deferred costs or accounts payable, accrued expenses and other liabilities. This accounting will be reflected for the 2015 tax beginning in the first quarter of 2015.
Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("AOCI") (ASU 2013-02). Effective January 1, 2013, the Company adopted new requirements to disclose the effect of items reclassified out of AOCI into net income for each individual line item impacted in the statement of income. See Note 17 for the Company's disclosures.
Fixed maturities and equity securities. Fixed maturities (including bonds, mortgage and other asset-backed securities and preferred stocks redeemable by the investor) and most equity securities are classified as available for sale and are carried at fair value with changes in fair value recorded in accumulated other comprehensive income (loss) within shareholders' equity. The Company records impairment losses in net income for fixed maturities with fair value below amortized cost that meet either of the following conditions:
Other long-term investments also include investment real estate carried at depreciated cost less any impairment write downs to fair value when cash flows indicate that the carrying value may not be recoverable. Depreciation is generally recorded using the straight-line method based on the estimated useful life of each asset. Investment real estate as of December 31, 2014 and 2013 is expected to be held longer than one year and includes real estate acquired through the foreclosure of commercial mortgage loans.
Additionally, other long-term investments include interest rate and foreign currency swaps carried at fair value. See Note 12 for information on the Company's accounting policies for these derivative financial instruments.
• Changes in the fair value of derivatives that hedge market risk related to future cash flows and that qualify for hedge accounting are reported in accumulated other comprehensive income ("cash flow hedges").
• On early termination, the changes in fair value of derivatives that qualified for hedge accounting are reported in shareholders' net income (generally as part of realized investment gains and losses). Net investment income. When interest and principal payments on investments are current, the Company recognizes interest income when it is earned. The Company recognizes interest income on a cash basis when interest payments are delinquent based on contractual terms or when certain terms (interest rate or maturity date) of the investment have been restructured.
Investment gains and losses. Realized investment gains and losses are based on specifically identified assets and result from sales, investment asset write-downs, changes in the fair values of certain derivatives and changes in valuation reserves on commercial mortgage loans.
•Other products are expensed as incurred. Deferred policy acquisition costs also include the value of business acquired with the supplemental benefits business in 2012.
Each year, deferred policy acquisition costs are tested for recoverability. For universal life and other individual products, management estimates the present value of future revenues less expected payments. For group health and accident insurance products, management estimates the sum of unearned premiums and anticipated net investment income less future expected claims and related costs. If management's estimates of these sums are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. The Company recorded amortization for policy acquisition costs of $289 million in 2014, $255 million in 2013 and $218 million in 2012 in other operating expenses.
The Company calculates depreciation and amortization principally using the straight-line method generally based on the estimated useful life of each asset as follows: buildings and improvements, 10 to 40 years; purchased software, one to five years; internally developed software, three to seven years; and furniture and equipment (including computer equipment), three to 10 years. Improvements to leased facilities are depreciated over the lesser of the remaining lease term or the estimated life of the improvement. The Company considers events and circumstances that would indicate the carrying value of property, equipment or capitalized software might not be recoverable. If the Company determines the carrying value of any of these assets is not recoverable, an impairment charge is recorded. See Note 8 for additional information.
Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies and GMDB contracts represent benefits 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 or morbidity, future claim adjudication expenses and surrenders, allowing for adverse deviation as appropriate. Mortality, morbidity and surrender assumptions are based on the Company's own experience and/or published actuarial tables. Interest rate assumptions are based on management's judgment considering the Company's experience and future expectations, and range from 0.1% to 10.0%. Obligations for the run-off settlement annuity business include adjustments for realized and unrealized investment returns consistent with requirements of GAAP when a premium deficiency exists.
For the more recent months, the Company relies on medical cost trend analysis that reflects expected claim payment patterns and other relevant operational considerations. Medical cost trend is primarily impacted by medical service utilization and unit costs that are affected by changes in the level and mix of medical benefits offered, including inpatient, outpatient and pharmacy, the impact of copays and
Accounts payable, accrued expenses and other liabilities consist principally of liabilities for pension, other postretirement and postemployment benefits (see Note 9), GMIB contracts (see Note 10), self-insured exposures, management compensation, cash overdraft positions and various insurance-related liabilities, including experience-rated refunds, the minimum medical loss ratio rebate accrual under Health Care Reform and reinsurance contracts. Legal costs to defend the Company's litigation and arbitration matters are expensed when incurred in cases where the Company cannot reasonably estimate the ultimate cost to defend. In cases where the Company can reasonably estimate the cost to defend, a liability for these costs is accrued when the claim is reported.
Premiums for group life, accident and health insurance and managed care coverages are recognized as revenue on a pro rata basis over the contract period. Benefits and expenses are recognized when incurred, and for our Global Health Care business, medical claims expense is presented net of pharmaceutical manufacturer rebates. For experience-rated contracts, premium revenue includes an adjustment for experience-rated refunds which is calculated according to contract terms and using the customer's experience (including estimates of incurred but not reported claims).
Premiums received for the Company's Medicare Advantage Plans and Medicare Part D products from customers and the Centers for Medicare and Medicaid Services ("CMS") are recognized as revenue ratably over the contract period. CMS provides risk-adjusted premium payments for Medicare Advantage Plans and Medicare Part D products, based on the demographics and health severity of enrollees. The Company recognizes periodic changes to risk-adjusted premiums as revenue when the amounts are determinable and collection is reasonably assured. Additionally, Medicare Part D includes payments from CMS for risk sharing adjustments. The risk sharing adjustments that are estimated quarterly based on claim experience, compare actual incurred drug benefit costs to estimated costs submitted in original contracts and may result in more or less revenue from CMS. Final revenue adjustments are determined and settled with CMS in the year following the contract year. Premium revenue also includes an adjustment to reflect the estimated effect of rebates due to CMS under the Medicare Advantage and Medicare Part D minimum medical loss ratio provisions of Health Care Reform.
The unrecognized portion of premiums received is recorded as unearned premiums.
S. Fees, Related Expenses and Mail Order Pharmacy Revenues and Costs
• Net investment income on assets supporting investment-related products is recognized as earned.
Mail order pharmacy revenues and the cost of prescriptions are recognized as each prescription is shipped.
The Company's participating life insurance policies entitle policyholders to earn dividends that represent a portion of the earnings of the Company's life insurance subsidiaries. Participating insurance accounted for approximately 1% of the Company's total life insurance in force at the end of 2014, 2013 and 2012.
On November 9, 2012, the Company acquired 51% of the total shares of Finans Emeklilik ve Hayat A.S. ("Finans Emeklilik"), a Turkish insurance company for a cash purchase price of approximately $116 million. Finans Emeklilik operates in life insurance, accident insurance and pension product markets. Results of this business and the related goodwill and intangible assets (see Note 8 for additional information) are reported in the Global Supplemental Benefits segment. The redeemable noncontrolling interest is classified as temporary equity in the Company's Consolidated Balance Sheet because Finansbank has the right to require the Company to purchase its 49% interest for the value of its net assets and the inforce business in 15 years.
On August 31, 2012, the Company acquired Great American Supplemental Benefits Group, one of the largest providers of supplemental health insurance products in the U.S. for a cash purchase price of $326 million. Results of this business and the related goodwill and intangible assets (see Note 8 for additional information) are reported in the Global Supplemental Benefits segment.
During the three years ended December 31, 2014, the Company entered into other acquisition and divestiture transactions, the results of which were not material to the Company's results of operations, liquidity or financial condition.
First, the Company consistently recognizes the actuarial best estimate of the ultimate liability within a level of confidence, as required by actuarial standards of practice that require 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 relates to a release of the prior year's provision for moderately adverse conditions, the Company does not consider that amount as impacting shareholders' net income to the extent that it is offset by an increase determined appropriate to address moderately adverse conditions for the current year incurred claims.
The determination of liabilities for Global Health Care medical claims payable requires the Company to make critical accounting estimates. See Note 2(N) for further information about the assumptions and estimates used to establish this liability.
2012 Plan. During the third quarter of 2012, in connection with the execution of its strategy, the Company committed to a series of actions to further improve its organizational alignment, operational effectiveness, and efficiency. As a result, the Company recognized charges in other operating expenses of $77 million pre-tax ($50 million after-tax) in the third quarter of 2012 consisting primarily of severance costs. The costs associated with this plan were substantially paid as of March 31, 2014.
This transaction resulted in an after-tax charge to shareholders' net income in the first quarter of 2013 of $507 million ($781 million pre-tax reported as follows: $727 million in other benefit expenses; $45 million in GMIB fair value loss; and $9 million in other operating expenses). The payment to Berkshire under the agreement was $2.2 billion and was funded from the sale of investment assets, tax benefits related to the transaction and available parent cash.
Because this effective exit was accomplished via a reinsurance contract, the amounts related to the reinsured GMDB and GMIB contracts cannot be netted, so the gross assets and liabilities must continue to be measured and reported. The following disclosures provide further context to the methods and assumptions used to determine these assets and liabilities.
The Company estimates this liability with an internal model based on the Company's experience and future expectations over an extended period, consistent with the long-term nature of this product. Because the product is premium deficient, the Company records increases to the reserve if it is inadequate based on the model. Prior to the reinsurance transaction with Berkshire, any such reserve increases were recorded as a charge to shareholders' net income. Reserve increases after the reinsurance transaction are expected to have a corresponding
increase in the recorded reinsurance recoverable, provided the increased recoverable is not capped due to the overall Berkshire limit (including the GMIB assets).
Benefits paid and incurred are net of ceded amounts, including the impact of the 2013 reinsurance transaction with Berkshire. The ending net retained reserve as of December 31, 2014 and December 31, 2013 covers ongoing administrative expenses, as well as the few claims retained by the Company. Prior to 2013, incurred benefits reflected the favorable or unfavorable impact of a rising or falling equity market on the liability, and included reserve strengthening of $43 million in 2012.
The majority of the exposure arises under annuities that guarantee that the benefit received at death will be no less than the highest historical account value of the related mutual fund investments on a contractholder's anniversary date. Under this type of death benefit, the Company is liable to the extent the highest historical anniversary account value exceeds the fair value of the related mutual fund investments at the time of a contractholder's death.
The table below presents the account value, net amount at risk and average attained age of underlying contractholders for guarantees assumed by the Company in the event of death. The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date. Unless the Berkshire reinsurance limit is exceeded, the Company should be reimbursed in full for these payments.
The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
The Company estimates annual pre-tax amortization for intangible assets, including internal-use software, over the next five calendar years to be as follows: $425 million in 2015, $348 million in 2016, $237 million in 2017, $154 million in 2018, and $129 million in 2019.
In the first quarter of 2013, the Company also announced a change in the cost sharing arrangement with retirees for pharmacy subsidy payments received from the U.S. Government effective January 1, 2014, resulting in a reduced other postretirement benefit obligation of $57 million. This reduction was recorded in accumulated other comprehensive income, net of deferred taxes, resulting in an after-tax increase to shareholders' equity of $37 million.
During 2014, the Company's postretirement benefits liability adjustment increased by $656 million pre-tax ($426 million after-tax) resulting in a decrease to shareholders' equity. The increase in the liability was primarily due to a change in the mortality assumption (as discussed further in the assumptions section of this note) and a decrease in the discount rate.
The estimated rate of future increases in the per capita cost of health care benefits is 6.75% in 2015, decreasing by 0.25% per year to 4.75% in 2023 and beyond. This estimate reflects the Company's current claim experience and management's estimate that rates of growth will decline in the future. A 1% increase or decrease in the estimated rate in 2014 would have no impact on postretirement benefit costs, and $1 million on the postretirement benefit obligation.
Plan assets. The Company's current target investment allocation percentages (50% fixed income, 25% public equity securities, and 25% in other investments, including securities partnerships, hedge funds and real estate) 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 Company would expect to further reduce the allocation to equity securities and move further into fixed income investments as funding levels improve.
In measuring the benefit obligation, the Company sets discount rates by applying actual annualized yields at various durations from a discount rate curve to the expected cash flows of the pension and other postretirement benefits liabilities. The discount rate curve is constructed using an array of bonds in various industries throughout the domestic market for high quality bonds, but only selects those for the curve that have an above average return at each duration. The bond portfolio used to construct the curve is monitored to ensure that only high quality issues are included. The Company believes that this curve is representative of the yields that the Company is able to achieve in its plan asset investment strategy. As part of its discount rate setting process, the Company reviewed alternative indices and determined that they were not materially different than the result produced by the curve used.
The Company may elect to increase its matching contributions if the Company's annual performance meets certain targets. The Company's expense for these plans was $98 million for 2014, $91 million for 2013 and $78 million for 2012.
(1) Fixed maturities included $756 million of net appreciation required to adjust future policy benefits for the run-off settlement annuity business including $65 million of appreciation for securities classified in Level 3.
(3) Other derivative assets reflected interest rate and foreign currency swaps qualifying as cash flow hedges. Other derivative liabilities included $15 million of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million of interest rate and foreign currency swaps not designated as accounting hedges. See Note 12 for additional information.
Fair values of other asset and mortgage-backed securities, corporate and government fixed maturities are primarily determined using pricing models that incorporate the specific characteristics of each asset and related assumptions including the investment type and structure, credit quality, industry and maturity date in comparison to current market indices, spreads and liquidity of assets with similar characteristics. For other asset and mortgage-backed securities, inputs and assumptions for pricing may also include collateral attributes and prepayment speeds. Recent trades in the subject security or similar securities are assessed when available, and the Company may also review published research, as well as the issuer's financial statements, in its evaluation.
Other asset and mortgage-backed securities. The significant unobservable inputs used to value the following other asset and mortgage-backed securities are liquidity and weighting of credit spreads. When there is limited trading activity for the security, an adjustment for liquidity is made as of the measurement date that considers current market conditions, issuer circumstances and complexity of the security structure. An adjustment to weight credit spreads is needed to value a more complex bond structure with multiple underlying collateral and no standard market valuation technique. The weighting of credit spreads is primarily based on the underlying collateral's characteristics and their proportional cash flows supporting the bond obligations. The resulting wide range of unobservable adjustments in the table below is due to the varying liquidity and quality of the underlying collateral, ranging from high credit quality to below investment grade.
Equity securities. The significant unobservable input used to value the following equity securities is a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). These securities are comprised of private equity investments with limited trading activity and therefore a ratio of EBITDA is used to estimate value based on company circumstances and relative risk characteristics.
The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities. Significant decreases in assumed lapse rates or spreads used to calculate non-performance risk, or increases in assumed annuity election rates, would result in higher fair value measurements. A change in one of these assumptions is not necessarily accompanied by a change in another assumption.
The following tables summarize the changes in financial assets and financial liabilities classified in Level 3 for the years ended December 31, 2014 and 2013. Separate account asset changes are reported separately under the heading "Separate account assets" as the changes in fair values of these
• Realized investment gains (losses) and net investment income for amounts related to fixed maturities and equity securities and realized investment gains (losses) for the impact of changes in non-performance risk related to GMIB assets and liabilities beginning February 4, 2013, similar to hedge ineffectiveness; and
• Other operating expenses for amounts related to GMIB assets and liabilities (GMIB fair value gain/loss), except for the impact of changes in non-performance risk subsequent to February 4, 2013. In the tables above, gains and losses included in other comprehensive income are reflected in net unrealized appreciation (depreciation) on securities in the Consolidated Statements of Comprehensive Income.
Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company's best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement. For the years ended December 31, 2014 and 2013, transfers between Level 2 and Level 3 primarily reflect the change in significance of the unobservable inputs used to value certain public and private corporate bonds, principally related to liquidity of the securities and credit risk of the issuers.
(1) As of December 31, 2013, non-guaranteed separate accounts included $3.8 billion in assets supporting the Company's pension plans, including $983 million classified in Level 3.
• actively-traded institutional and retail mutual fund investments and separate accounts priced using the daily net asset value which is the exit price. Separate account assets classified in Level 3 include investments primarily in securities partnerships, real estate and hedge funds generally valued based on the separate account's ownership share of the equity of the investee including changes in the fair values of its underlying investments.
The following table summarizes the change in separate account assets reported in Level 3 for the years ended December 31, 2014 and 2013.
(1)Included in this amount were gains of $85 million attributable to instruments still held at December 31, 2014 and gains of $76 million attributable to instruments still held at December 31, 2013.
Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans generally by discounting the contractual cash flows at estimated market interest rates that reflect the Company's assessment of the credit quality of the loans. Market interest rates are derived by calculating the appropriate spread over comparable U.S. Treasury rates, based on the property type, quality rating and average life of the loan. The quality ratings reflect the relative risk of the loan, considering debt service coverage, the loan-to-value ratio and other factors. Fair values of impaired mortgage loans are based on the estimated fair value of the underlying collateral generally determined using an internal discounted cash flow model. The fair value measurements were classified in Level 3 because the cash flow models incorporate significant unobservable inputs.
Contractholder deposit funds, excluding universal life products. Generally, these funds do not have stated maturities. Approximately 60% of these balances can be withdrawn by the customer at any time without prior notice or penalty. The fair value for these contracts is the amount estimated to be payable to the customer as of the reporting date, which is generally the carrying value. Most of the remaining contractholder deposit funds are reinsured by the buyers of the individual life and annuity and retirement benefits businesses. The fair value for these contracts is determined using the fair value of these buyers' assets supporting these reinsured contracts. The Company had reinsurance recoverables equal to the carrying value of these reinsured contracts. These instruments were classified in Level 3 because certain inputs are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement.
Long-term debt, including current maturities, excluding capital leases. The fair value of long-term debt is based on quoted market prices for recent trades. When quoted market prices are not available, fair value is estimated using a discounted cash flow analysis and the Company's estimated current borrowing rate for debt of similar terms
and remaining maturities. These measurements were classified in Level 2 because the fair values are based on quoted market prices or other inputs that are market observable or can be corroborated by market data.
The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at December 31, 2014:
As of December 31, 2014, the Company had commitments to purchase $74 million of fixed maturities, all of which bear interest at a fixed market rate.
At December 31, 2014, scheduled commercial mortgage loan maturities were as follows (in millions): $247 in 2015, $533 in 2016, $229 in 2017, $179 in 2018 and $893 thereafter. Actual maturities could differ from contractual maturities for several reasons: borrowers may have the right to prepay obligations with or without prepayment penalties; the maturity date may be extended; and loans may be refinanced.
As of December 31, 2014, the Company had commitments to extend credit under commercial mortgage loan agreements of $65 million.
Credit quality. The Company regularly evaluates and monitors credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal credit quality rating system designed to evaluate the relative risk of the transaction at origination that is then updated each year as part of the annual
portfolio loan review. The Company evaluates and monitors credit quality on an ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.
Potential problem mortgage loans are considered current (no payment more than 59 days past due), but exhibit certain characteristics that increase the likelihood of future default such as the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and requests from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms, which could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.
The average recorded investment in impaired loans was $155 million during 2014 and $127 million during 2013. Because of the risk profile of the underlying investment, the Company recognizes interest income on problem mortgage loans only when payment is actually received. Interest income that would have been reflected in net income if interest on non-accrual commercial mortgage loans had been received in accordance with the original terms was not significant for 2014 or 2013. Interest income on impaired commercial mortgage loans was not significant for 2014 or 2013. See Note 2 for further information on impaired commercial mortgage loans.
The following table summarizes the changes in valuation reserves for commercial mortgage loans:
Real estate investments and securities partnerships with a carrying value of $264 million at December 31, 2014 and $217 million at December 31, 2013 were non-income producing during the preceding twelve months.
•$207 million to limited liability entities that hold either real estate or loans to real estate entities that are diversified by property type and geographic region; and
As of December 31, 2014 and 2013, the Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders' equity.
Cash flows. Under the terms of these various contracts, the Company periodically exchanges cash flows between variable and fixed interest rates and/or between two currencies for both principal and interest. Foreign currency and combination swaps are primarily Euros, Australian dollars, Canadian dollars, Japanese yen and British pounds and have terms for periods of up to seven years. Net interest cash flows are reported in operating activities.
Accounting Policy. Using fair value hedge accounting, the fair values of the swap contracts are reported in other assets or other liabilities. As the critical terms of these swaps match those of the long-term debt being hedged, the carrying value of the hedged debt is adjusted to reflect changes in its fair value driven by LIBOR. The effects of those adjustments on other operating expenses are offset by the effects of corresponding changes in the swaps' fair value, including interest expense for the difference between the variable and fixed interest rates.
Purpose. The Company's run-off reinsurance business has written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees of minimum income benefits resulting from the level of variable annuity account values compared with a contractually guaranteed amount ("GMIB liabilities"). According to the contractual terms of the written reinsurance contracts, payment by the Company depends on the actual account value in the underlying mutual funds and the level of interest rates when the contractholders elect to receive minimum income payments.
•the risks and rewards created by and shared through the entity; and
•the entity's participants' ability to direct its activities, receive its benefits and absorb its losses. Participants include the entity's sponsors, equity holders, guarantors, creditors and servicers. In the normal course of its investing activities, the Company makes passive investments in securities that are issued by variable interest entities for which the Company is not the sponsor or manager. These investments are predominantly asset-backed securities primarily collateralized by foreign bank obligations or mortgage-backed securities. The asset-backed securities are largely fixed-rate debt securities issued by trusts that hold perpetual floating-rate subordinated notes issued by foreign banks. The mortgage-backed securities are senior interests in pools of commercial or residential mortgages created and held by special-purpose entities to provide investors with diversified exposure to these assets. The Company owns senior securities issued by several entities and receives fixed-rate cash flows from the underlying assets in the pools.
•it has no power to direct the activities that most significantly impact the entities' economic performance; or
Net investment income for separate accounts that is excluded from the Company's revenues was $225 million for 2014, $232 million for 2013, and $181 million for 2012.
(1)Credit-related losses include other-than-temporary declines in fair value of equity securities, increases in valuation reserves on commercial mortgage loans and asset write-downs related to investments in real estate entities.
Maturities of long-term debt, excluding capital leases, are as follows (in millions): $25 in 2015, $600 in 2016, $250 in 2017, $131 in 2018, $251 in 2019 and the remainder in years after 2019. Maturities of debt under capital lease arrangements are as follows (in millions): $22 in 2015, $22 in 2016, $11 in 2017, $4 in 2018, none in 2019 and the remainder in years after 2019. Interest expense on long-term and short-term debt was $265 million in 2014, $270 million in 2013, and $268 million in 2012.
In 2014, the Company repurchased 18.5 million shares for $1.6 billion. The Company repurchased 13.6 million shares for $1.0 billion during 2013 and 4.4 million shares for $208 million during 2012.
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, 2014, 2013 or 2012.
Consolidated pre-tax income from the Company's foreign operations was approximately 10% in 2014, 12% in 2013 and 8% in 2012.
• Undistributed foreign earnings. As part of its global capital management strategy, the Company's foreign operations retain a significant portion of their earnings overseas. These undistributed earnings are deployed outside of the U.S. in support of the liquidity and capital needs of our foreign operations. The Company does not intend to repatriate these earnings to the U.S. and as a result, income taxes are provided using the respective foreign jurisdictions' tax rate. The Company has accumulated undistributed foreign earnings of $1.8 billion as of December 31, 2014. If the Company intended to repatriate these foreign earnings to the U.S., the Company's consolidated balance sheet would have included an additional $218 million of deferred tax liabilities as of December 31, 2014.
Deferred income tax assets and liabilities as of December 31 are as follows:
Management believes that future results will be sufficient to realize the Company's deferred tax assets. Substantially all of the Company's deferred tax benefits may be carried forward indefinitely. As of December 31, 2014, net operating loss related benefits were $71 million, the majority of which relate to foreign jurisdictions and do not expire. The Company establishes a valuation allowance when it determines that realization of a deferred tax asset does not meet the more likely than not standard. Valuation allowances have been established against certain federal, foreign and state deferred tax assets, generally due to the requirement to assess them on a separate entity basis.
In 2013, the IRS completed its examination of the Company's 2009 and 2010 tax years, resulting in two issues that could not be resolved at the examination level. The Company subsequently filed a formal protest challenging the IRS positions on the two disputed matters. The IRS previously withdrew its challenge relating to the first of these matters, and the parties have since agreed on a resolution of the second matter. The resolution of these matters did not materially impact shareholders' net income.
The IRS began its examination of the Company's 2011 and 2012 tax years in the third quarter of 2014 that is expected to continue through 2015.
The Company conducts business in numerous state and foreign jurisdictions, and may be engaged in multiple audit proceedings at any given time. Generally, no further state audit activity is expected for tax years prior to 2010, and prior to 2008 for foreign audit activity.
The Company had the following number of common stock shares available for award at December 31: 10.3 million in 2014, 13.2 million in 2013 and 8.4 million in 2012.
The weighted average fair value of options granted under employee incentive plans was $23.56 for 2014, $19.84 for 2013 and $14.99 for 2012 (excluding the HealthSpring rollover options issued in 2012) using the Black-Scholes option-pricing model and the assumptions presented in the following table.
At the end of 2014, approximately 3,400 employees held 2.1 million restricted stock grants and units with $54 million of related compensation expense to be recognized over the next three years (weighted average period).
The fair value of vested strategic performance shares was $57 million in 2014 and $42 million in 2013. No strategic performance shares vested in 2012.
Global Health Care aggregates the Commercial and Government operating segments due to their similar economic characteristics, products and services and regulatory environment:
• run-off settlement annuity business. Corporate reflects amounts not allocated to other segments, such as net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment operations), interest on uncertain tax positions, certain litigation matters, intersegment eliminations, compensation cost for stock options, expense associated with its frozen pension plans, and certain corporate project and overhead costs.
Revenue from external customers includes premiums, fees and other revenues, and mail order pharmacy revenues. The following table presents these revenues by product type for the years ended December 31:
Foreign and U.S. revenues from external customers for the 3 years ended December 31 are shown below. In the periods shown, no foreign country contributed more than 5% of consolidated revenues from external customers.
As a percentage of consolidated revenues, premiums from CMS were 21% in 2014 and 22% in both 2013 and 2012. These amounts were reported in the Global Health Care segment.
Under these guarantees, the future payment amounts are dependent on underlying mutual fund investment values and interest rate levels prior to and at the date of annuitization election that must occur within 30 days of a policy anniversary after the appropriate waiting period. Therefore, the future payments are not fixed and determinable under the terms of these contracts. Accordingly, the Company calculated exposure, without considering retrocessional coverage, using the following hypothetical assumptions as a proxy for maximum potential undiscounted future payments.
As of December 31, 2014, the Company guaranteed that it would compensate the lessors for a shortfall of up to $41 million in the market value of certain leased equipment at the end of the lease. Guarantees of $16 million expire in 2016 and $25 million expire in 2025. The Company had liabilities for these guarantees of $7 million as of December 31, 2014.
The Company had indemnification obligations as of December 31, 2014 in connection with acquisition, disposition and reinsurance transactions. These indemnification obligations are triggered by the breach of representations or covenants provided by the Company, such as representations for the presentation of financial statements, actuarial models, 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, because not all amounts due under these indemnification obligations are subject to limitation. There were no liabilities for these indemnification obligations as of December 31, 2014.
The Company is aware of an insurer that is in rehabilitation. In 2012, the state court denied the regulator's amended petitions for liquidation and set forth specific requirements and a deadline for the regulator to develop a plan of rehabilitation without liquidating the insurer. The regulator has appealed the court's decision. If the actions taken in the rehabilitation plan fail to improve this insurer's financial condition, or if the state court's ruling is overturned on appeal, this insurer may be forced into insolvency. In that event, the Company would be required to pay guaranty fund assessments related to this insurer. Due to the uncertainties surrounding this matter, the Company is unable to estimate the amount of any potential guaranty fund assessments and is monitoring the situation.
In addition, there is heightened review by federal and state regulators of the health care, disability and life insurance industry business and related reporting practices. Cigna is frequently the subject of regulatory market conduct reviews and other examinations of its business and reporting practices, audits and investigations by state insurance and health and welfare departments, state attorneys general, the CMS and the Office of Inspector General ("OIG"). With respect to Cigna's Medicare Advantage business, the CMS and OIG perform audits to determine a health plan's compliance with federal regulations and contractual obligations, including compliance with proper coding practices (sometimes referred to as Risk Adjustment Data Validation audits or RADV audits), that may result in retrospective adjustments to payments made to health plans. Regulatory actions can result in assessments, civil or criminal fines or penalties or other sanctions, including loss of licensing or exclusion from participating in government programs.
The outcome of litigation and other legal or regulatory matters is always uncertain, and unfavorable outcomes that are not justified by the evidence or existing law can occur. The Company believes that it has valid defenses to the matters pending against it and is defending itself vigorously. Except as otherwise noted, the Company believes
Amara cash balance pension plan litigation. In December 2001, Janice Amara filed a class action lawsuit in the U.S. District Court for the District of Connecticut against Cigna Corporation and the Cigna Pension Plan (the "Plan") on behalf of herself and other similarly situated participants in the Plan affected by the 1998 conversion to a cash balance formula. The plaintiffs allege various ERISA violations, including, that the Plan's cash balance formula discriminates against older employees; that the conversion resulted in a wear-away period (when the pre-conversion accrued benefit exceeded the post-conversion benefit); and that the Plan communications contained inaccurate or inadequate disclosures about these conditions.
In 2008, the District Court (1) found for plaintiffs on the disclosure claim only; (2) affirmed the Company's right to convert to a cash balance plan prospectively beginning in 1998; and (3) required the Company to pay pre-1998 benefits under the pre-conversion traditional annuity formula and post-1997 benefits under the post-conversion cash balance formula. The Second Circuit upheld this decision. In 2011, the Supreme Court reversed the lower court decisions in this matter and returned the case to the District Court, which ordered the Company to pay substantially the same benefits as had been ordered in 2008 and denied the Company's motion to decertify the class. The parties again appealed, with the plaintiffs challenging the District Court's denial of their request to return to the prior annuity benefit plan formula, and Cigna and the Plan appealing the District Court's order and the denial of a motion to decertify the class. In December 2014, the Second Circuit upheld the District Court ruling. In January 2015, the plaintiffs filed a petition for re-hearing with the Second Circuit. The Company will continue to vigorously defend its position.
Ingenix. In April 2004, the Company was sued in a number of putative nationwide class actions alleging that the Company improperly underpaid claims for out-of-network providers through the use of data provided by Ingenix, Inc., a subsidiary of one of the Company's competitors. These actions were consolidated into Franco v. Connecticut General Life Insurance Company, et al., pending in the U.S. District Court for the District of New Jersey. The consolidated amended complaint, filed in 2009 on behalf of subscribers, health care providers and various medical associations, asserted claims related to benefits and disclosure under ERISA, the Racketeer Influenced and Corrupt Organizations ("RICO") Act, the Sherman Antitrust Act and New Jersey state law and seeks recovery for alleged underpayments from 1998 through the present. Other major health insurers have been the subject of, or have settled, similar litigation.
In September 2011, the District Court (1) dismissed all claims by the health care provider and medical association plaintiffs for lack of standing; and (2) dismissed the antitrust claims, the New Jersey state law claims and the ERISA disclosure claim. In January 2013 and again in April 2014, the District Court denied separate motions by the plaintiffs to certify a nationwide class of subscriber plaintiffs. The Third Circuit denied plaintiff's request for an immediate appeal of the January 2013 ruling. As a result, the case is proceeding on behalf of the named plaintiffs only. In June 2014, the District Court granted the Company's motion for summary judgment to terminate all claims, and denied the plaintiffs' partial motion for summary judgment. In July 2014, the plaintiffs appealed all of the District Court's decisions in favor of the Company, including the class certification decision, to the Third Circuit. The Company will continue to vigorously defend its position.
In connection with the terms of the agreement, the Company recorded a charge of $77 million before-tax ($51 million after-tax) in the first quarter of 2013. The charge is comprised of two elements: (1) $48 million of benefit costs and reserves from reassessed claims expected to be reopened, and (2) $29 million in additional costs for open claims as a result of the claims handling changes being implemented. The Company is actively implementing the terms of the agreement and continues to communicate with the monitoring states on progress. If the monitoring states find material non-compliance with the agreement upon re-examination, the Company may be subject to additional costs and penalties. Most other jurisdictions have joined the agreement as participating, non-monitoring states.
(1)The first quarter of 2013 includes an after-tax gain of $25 million for the GMIB business, an after-tax charge of $507 million for the reinsurance transaction with Berkshire to effectively exit the Run-off Reinsurance business, and an after-tax charge of $51 million related to the disability claims regulatory matter in the Group Disability and Life segment.(2)The second quarter of 2013 includes an after-tax charge of $24 million for the Pharmacy Benefits Manager ("PBM") partnering agreement with Catamaran.(3)The fourth quarter of 2013 includes an after-tax charge of $40 million for an organizational efficiency plan.