Our global real estate portfolio consists of approximately 7.8 million square feet of owned and leased properties. Our domestic portfolio has approximately 5.9 million square feet in 40 states, the District of Columbia, Puerto Rico and the Virgin Islands. Our International properties contain approximately 1.9 million square feet located throughout the following countries: Bahrain, Belgium, Canada, China, Hong Kong, India, Indonesia, Kenya, Malaysia, New Zealand, Singapore, South Korea, Spain, Switzerland, Taiwan, Thailand, Turkey, United Arab Emirates, and the United Kingdom.
Our principal, domestic office locations, including various support operations, along with Group Disability and Life Insurance, Health Services, Core Medical and Service Operations and the domestic office of our Global Supplemental Benefits business are the Wilde Building located at 900 Cottage Grove Road in Bloomfield, Connecticut (our corporate headquarters) and Two Liberty Place located at 1601 Chestnut Street in Philadelphia, Pennsylvania. The Wilde Building measures approximately 893,000 square feet and is owned, while Two Liberty Place measures approximately 322,000 square feet and is leased office space.
(1) As explained in Note 2(B) to the Consolidated Financial Statements, in the fourth quarter of 2015, we retrospectively adopted Accounting Standards Update 2015-03 "Simplifying the Presentation of Debt Issuance Costs," that requires debt issuance costs to be netted against long-term debt. Amounts presented above for the years 2011 through 2014 for total assets, long-term debt, and total liabilities have been retrospectively adjusted to conform to the new guidance. The impact was not material.
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") .
In this MD&A, our consolidated measures "operating revenues" and "adjusted income from operations" are not determined in accordance with GAAP and should not be viewed as substitutes for the most directly comparable GAAP measures "total revenues" and "shareholders' net income."
We use adjusted income (loss) from operations as our principal financial measure of operating performance because management believes it best reflects the underlying results of our business operations and permits analysis of trends in underlying revenue, expenses and profitability. Beginning on January 1, 2015, we define adjusted income from operations as shareholders' net income (loss) excluding after-tax realized investment gains and losses, net amortization of other acquired intangible assets and special items. Prior period segment information has been restated to reflect these new performance metrics. Income or expense amounts are excluded from adjusted income from operations for the following reasons:
This section includes a discussion of our consolidated financial results over the past three years as well as key trends and transactions impacting our business.
Operating revenues increased in both 2015 and 2014 in each of our ongoing reporting segments (Global Health Care, Global Supplemental Benefits, and Group Disability and Life). These increases are primarily attributable to customer growth in our targeted market segments, rate actions in our commercial health care businesses to recover medical cost trend as well as amounts assessed under Health Care Reform (as defined on page 2 in this Form 10-K), and growth in our specialty businesses within our Global Health Care segment.
Total revenues. The increases in operating revenues in both 2015 and 2014 were partially offset by decreases in realized investment results. See additional discussion in our Consolidated financial results beginning on page 39 of this MD&A.
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 2013. See Note 7 to the Consolidated Financial Statements for further information.
Adjusted income from operations increased in both 2015 and 2014 reflecting higher earnings in each of our ongoing reporting segments. These favorable effects were driven by continued customer growth in our targeted market segments and improved contributions from our specialty health care businesses. Adjusted income from operations per share in 2015 and 2014 benefited from share repurchase.
• Run-off reinsurance transaction: See Note 7 to the Consolidated Financial Statements for further information.
• Disability claims regulatory matter: See Note 23 to the Consolidated Financial Statements for further information.
• Organizational efficiency plan: See Note 6 to the Consolidated Financial Statements for further information.
The "Regulation" section of this Form 10-K provides a detailed description of Health Care Reform provisions and other legislative initiatives that impact our domestic health care business, including regulations issued by CMS and the Departments of the Treasury and Health and Human Services ("HHS"). The discussion below provides a summary of the financial impacts of key provisions of Health Care Reform and certain other regulatory matters in 2015 and beyond.
(1) After-tax impacts reported in 2015 included an increase for the 2014 coverage year of approximately $20 million based on CMS data received in June 2015. For the 2015 coverage year, we have accrued reinsurance recoveries at the 50% coinsurance rate prescribed by Health Care Reform.
In 2015, we received approximately $300 million related to the 2014 risk mitigation programs. CMS paid substantially all amounts due under the 2014 reinsurance and risk adjustment programs. In addition, CMS paid approximately 13% of insurers' 2014 coverage year risk corridor receivables. CMS has acknowledged its legal obligation to pay insurers under the risk corridor program for the balance of the 2014 coverage year as well as the 2015 coverage year, as required by Health Care Reform. If CMS' risk corridor program collections, including carryovers from prior years, are insufficient to satisfy its payment obligations, CMS has stated that it will explore other funding sources subject to the availability of appropriations that may require congressional approval. We are continuing to monitor developments related to the risk corridor program.
Consolidated Results of Operations: 2015 Compared to 2014 and 2014 Compared to 2013
•Premiums. The increase in 2015 compared with 2014 reflects premium growth in each of our ongoing reporting segments: Global Health Care, Global Supplemental Benefits and Group Disability and Life. These results are primarily attributable to customer growth in our targeted market segments and rate actions in our commercial health care businesses consistent with medical cost trend. The increase in 2014 compared with 2013 was driven primarily by rate increases to recover both medical cost trend and new taxes and fees assessed under Health Care Reform. Business growth in certain of our market segments also contributed to the increase in 2014.
•Fees and other revenues. The increases in both 2015 and 2014 largely reflected growth from specialty products offered through our Global Health Care segment and an increased customer base for our administrative services only business. Fees and other revenues also included pre-tax losses of $39 million in early 2013 attributable to the hedge program associated with the guaranteed minimum death benefit ("GMDB") and GMIB business prior to the reinsurance transaction with Berkshire.
•Amortization of other acquired intangible assets, net. The decreases in both 2015 and 2014 reflect the expected continuing decline in amortization from our 2012 acquisition of HealthSpring, Inc. The decrease in 2015 also includes the one-time $23 million benefit of an acquisition in which the fair value of acquired net assets exceeded the purchase price.
(1) As explained in Note 2 (B) to the Consolidated Financial Statements, in the fourth quarter of 2015, the Company retrospectively adopted Accounting Standards Update 2015-03 that requires debt issuance costs to be netted against the carrying value of the debt. Amounts presented above for 2014 and 2013 have been retrospectively adjusted to conform to the new guidance. The impact was not material.
• medical costs and benefit payments to policyholders; and • operating expense requirements, primarily for employee compensation and benefits.
Cash flows from operating activities consist of cash receipts and disbursements for premiums and fees, mail order pharmacy, other revenues, investment income, taxes, benefits and expenses. Because certain income and expense transactions do not generate cash, and because cash transactions related to revenues and expenses may occur in periods different from when those revenues and expenses are recognized in shareholders' net income, cash flows from operating activities can be significantly different from shareholders' net income.
Cash flows from financing activities are generally comprised of issuances and re-payment of debt at the parent company level, proceeds on the issuance of common stock resulting from stock option exercises, and stock repurchases. In addition, the subsidiaries report deposits to and withdrawals from investment contract liabilities (including universal life insurance liabilities) because such liabilities are considered financing activities with policyholders.
Net cash used in investing activities decreased in 2015 compared with 2014, due to lower net purchases of fixed maturities. 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.
In 2015, we repurchased 5.5 million shares for $683 million. From January 1, 2016 through February 25, 2016 we repurchased 0.8 million shares for $110 million. The total remaining share repurchase authorization as of February 25, 2016 was $390 million. We repurchased 18.5 million shares for $1.6 billion in 2014 and repurchased 13.6 million shares for $1.0 billion in 2013.
Management, guided by regulatory requirements and rating agency capital guidelines, determines the amount of capital resources that we maintain. Management allocates resources to new long-term business commitments when returns, considering the risks, look promising and when the resources available to support existing business are adequate.
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, 2015, the parent company had $63 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, 2015, $1.5 billion of short-term borrowing capacity under the credit agreement was available to us. Within the maximum debt leverage covenant in the line of credit agreement as described in Note 15, we have $7.9 billion of borrowing capacity in addition to the $5.2 billion of debt outstanding. This additional borrowing capacity includes the $1.5 billion available under the credit agreement.
Estimated payments of $75 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 there will be no contributions to the qualified domestic pension plans during 2016. We expect to make payments subsequent to 2016 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.
See Note 11 to the Consolidated Financial Statements for additional information.
Our estimated future service commitments primarily represent contracts for certain outsourced business processes and IT maintenance and support. We generally have the ability to terminate these agreements, but do not anticipate doing so at this time. Purchase obligations exclude contracts that are cancelable without penalty and those that do not specify minimum levels of goods or services to be purchased.
In addition to the estimates presented in the following table, there are other accounting estimates used in the preparation of our Consolidated Financial Statements, including estimates of liabilities for future policy benefits, 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.
We completed our annual evaluations of goodwill for impairment during the third quarter of 2015. These evaluations were performed at the reporting unit level, based on discounted cash flow analyses and market data. The evaluations indicated that no impairment was required.
The estimated fair value of our remaining reporting units exceeded their carrying values by a substantial margin based on our annual evaluations of goodwill for impairment during the third quarter of 2015.
Accounts payable, accrued expenses and other liabilities - pension liabilities 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 (in millions):
An increase in these key assumptions would result in impacts to, the accrued pension liability and shareholders' equity in an opposite direction, but similar amounts.
The impact of this favorable prior year development was an increase to shareholders' net income of $60 million in 2015. The change in the amount of the incurred costs related to prior years in the medical costs payable liability does not directly correspond to an increase or decrease in shareholders' net income as explained in Note 5 to the Consolidated Financial Statements.
Typically, the most significant input in the measurement of fair value is the market interest rate used to discount the estimated future cash flows of 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 billion would decrease by approximately $1.2 billion.
For all fixed maturities with cost in excess of their fair value, if this excess was determined to be other-than-temporary, shareholders' net income for the year ended December 31, 2015 would have decreased by approximately $142 million after-tax.
income from operations as shareholders' net income (loss) excluding after-tax realized investment gains and losses, net amortization of other acquired intangible assets and special items. Prior period segment information has been restated to reflect these new performance metrics. Ratios presented in this segment discussion exclude the same items as adjusted income from operations. Income or expense amounts are excluded from adjusted income from operations for the following reasons:
•Net amortization of other intangible assets is excluded because it relates to costs incurred for acquisitions and, as a result, it does not relate to the core performance of the Company's business operations. The amortization amount is net of one-time benefits of acquisitions in which the fair value of net assets acquired exceeds the purchase price.
•Special items, if any, are excluded because management believes they are not representative of the underlying results of operations. See Note 22 to the Consolidated Financial Statements for descriptions of special items. In 2013, adjusted income from operations also excluded the results of the guaranteed minimum income benefit ("GMIB") business prior to the reinsurance transaction with Berkshire.
See MD&A Overview on page 35 for summarized financial results of each of our reporting segments.
Adjusted income from operations increased in 2014 compared with 2013. This growth was primarily driven by increased specialty contributions, partially offset by lower earnings in our government segment. In addition, results included the impact of higher operating expenses and lower margins in our U.S. commercial group risk business.
The increase in 2014 compared with 2013 was primarily driven by growth in specialty businesses, higher premiums in the U.S. commercial segment reflecting rate actions on most risk products to recover underlying medical cost trends and taxes and fees mandated by Health Care Reform, and a higher customer base in our individual and Medicaid business. These increases were partially offset by lower revenue due to our exit from the limited benefits business.
The Government medical care ratio increased in 2015 compared with 2014 due to an increase in Medicare Part D utilization. In 2014, the Government medical care ratio increased slightly compared with 2013 due to higher Medicare Part D pharmacy costs offset by improved per-member revenues in the Medicare Advantage business.
Operating expense ratio. The operating expense ratio was flat in 2015 compared with 2014, reflecting business-initiative investments offset by higher revenue and disciplined expense management. The operating expense ratio increased in 2014 compared with 2013 primarily due to the impact of Health Care Reform taxes and fees that became effective in 2014.
As described in the Segment Reporting introduction on page 48, the performance of the Global Supplemental Benefits segment is measured using adjusted income from operations. See Note 22 to the Consolidated Financial Statements for the calculation of adjusted income from operations for each segment. The key factors affecting adjusted income from operations for this segment are:
• the impact of foreign currency movements. Throughout this discussion and the table presented below, prior period currency adjusted income from operations and operating revenues are calculated by applying the current period's exchange rates to reported results in the prior period. A strengthening U.S. Dollar against foreign currencies will decrease segment earnings, while a weakening U.S. Dollar produces the opposite effect.
As described in the Segment Reporting introduction on page 48, the performance of the Group Disability and Life segment is measured using adjusted income from operations. See Note 22 to the Consolidated Financial Statements for the calculation of adjusted income from operations for each segment. The key factors affecting adjusted income from operations for this segment are:
Adjusted income from operations increased in 2015 compared with 2014 due primarily to favorable life claims experience. Results also included the favorable after-tax effects of reserve reviews of $55 million in 2015 compared with $52 million in 2014.
Adjusted income from operations increased in 2015 compared with 2014, reflecting favorable mortality experience in COLI. In 2014, adjusted income from operations decreased compared with 2013, primarily reflecting the absence of the $14 million favorable impact of the Internal Revenue Service ("IRS") examinations of our 2009-2010 federal tax returns completed during the third quarter of 2013 and unfavorable COLI mortality experience in 2014.
Corporate's adjusted loss from operations decreased in 2015 compared with 2014, primarily due to lower pension and interest expenses.
Corporate's adjusted loss from operations increased in 2014 compared with 2013, primarily due to increased taxes related to certain employee stock compensation costs that are not deductible for income tax purposes under Health Care Reform.
The following table presents our invested asset portfolio, excluding separate account assets, as of December 31, 2015 and 2014. Additional information regarding our investment assets and related accounting policies is included in Notes 2, 10, 11, 12, 13, 14 and 17 to the Consolidated Financial Statements.
Investments in fixed maturities include publicly traded and privately placed debt securities, mortgage and other asset-backed securities, and preferred stocks redeemable by the investor. These investments are classified as available for sale and are carried at fair value on our balance sheet. Additional information regarding valuation methodologies, key inputs and controls is included in Note 10 of the Consolidated Financial Statements.
We invest in high quality foreign government obligations, with an average quality rating of Aa3 as of December 31, 2015. These investments are primarily concentrated in Asia consistent with the geographic distribution of our international business operations. Foreign government obligations also include $205 million of investments in European sovereign debt, none of which are in countries with significant political or economic concerns (Portugal, Italy, Ireland, Greece, and Spain).
natural gas sector of $1.5 billion with gross unrealized losses of $59 million. These investments have an average quality rating of Baa1 and are diversified by issuer with no single exposure greater than $35 million.
We have approximately $25 million of aggregate corporate fixed maturity investments in China-based companies. In addition to amounts classified in fixed maturities on our Consolidated Balance Sheet, we operate a joint venture in China in which we have a 50% ownership interest. We account for this joint venture on the equity basis of accounting and report it in other assets, including other intangibles. This entity has an investment portfolio of approximately $2 billion that is primarily invested in diversified corporate fixed maturities and has no investments with a material unrealized loss as of December 31, 2015.
Commercial real estate capital markets remain very 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.
Other long-term investments of $1.4 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 105 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.
Net problem and potential problem investments representing less than 1% of total investments, excluding policy loans at December 31, 2015, decreased by $72 million from December 31, 2014, primarily due to the payoffs of four potential problem mortgage loans and the sale of the remaining foreclosed property.
Global financial markets have exhibited continued volatility, including modest depreciation of fixed income asset values. This volatility reflects increasing global economic uncertainty, led by concerns about China's decelerating economic growth as well as the negative and potentially destabilizing impacts from cyclically low and falling energy prices. Future realized and unrealized investment results will be driven largely by market conditions that exist when a transaction occurs or at the reporting date. These future conditions are not reasonably predictable. We believe that the vast majority of our fixed maturity investments will continue to perform under their contractual terms and that the commercial mortgage loan portfolio is positioned to perform well due to its solid aggregate loan-to-value ratio and strong debt service coverage. Based on our strategy to match the duration of invested assets to the duration of insurance and contractholder liabilities, we expect to hold a significant portion of these assets for the long term. Although future impairment losses resulting from interest rate movements and credit deterioration due to both company-specific and the global economic uncertainties discussed above remain possible, we do not expect these losses to have a material adverse effect on our financial condition or liquidity.
•changes in the fair values of all insurance-related assets and liabilities have been excluded because their primary risks are insurance rather than market risk;
•changes in the fair values of investments recorded using the equity method of accounting and liabilities for pension and other postretirement and postemployment benefit plans (and related assets) have been excluded, consistent with the disclosure guidance; 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, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 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, 2015, 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.
Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). In January 2016 the FASB issued guidance that will require entities to measure equity securities at fair value in net income if they are not consolidated or accounted for under the equity method. The new guidance also changes the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance for assessing the valuation allowance when recognizing deferred tax assets from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities was left largely unchanged. The new standard will be effective beginning January 1, 2018 and will be recognized as a cumulative adjustment to the beginning balance of retained earnings. If adopted as of December 31, 2015, the impact of this new guidance would have resulted in a cumulative effect adjustment to retained earnings of less than $10 million representing unrealized gains on equity securities that would be reclassified from accumulated other comprehensive income. The actual cumulative effect adjustment will depend on the portfolio and market conditions as of the date of implementation.
Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03). In the fourth quarter of 2015, the Company implemented the FASB's April 2015 amended guidance to simplify the presentation of debt issuance costs by reclassifying debt issuance costs from other assets, including other intangibles, to long-term debt. Amounts
Amendments to the Consolidation Analysis (ASU 2015-02). In February 2015, the FASB issued guidance to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability companies and securitization structures. Among other provisions, the consolidation guidance specific to limited partnerships is eliminated and consolidation by a general partner is no longer presumed. The new guidance applies retrospectively, with a cumulative effect adjustment to beginning Retained earnings at the date of adoption or through restatement of financial statements of comparative periods presented. Effective on January 1, 2016 this guidance is expected to have no material effect on the Company's financial statements at adoption. Additional disclosures will be provided beginning in 2016 about various real estate and security limited partnerships to be newly identified as variable interest entities for which the Company is not the primary beneficiary.
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 the Patient Protection and Affordable Care Act (referred to as "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 (accounts payable, accrued expenses and other liabilities) and a corresponding deferred cost (other assets, including other intangibles) based on a preliminary assessment of the full year tax. The Company recognizes the tax in operating expenses on a straight line basis over the year, reduces the deferred cost correspondingly and pays the tax during the third quarter of each year. The Company recognized operating expenses of $311 million in 2015 and $238 million in 2014 for the tax.
Other long-term investments. Other long-term investments include investments in unconsolidated entities. These entities include certain limited partnerships and limited liability companies holding real estate, securities or loans. These investments are carried at cost plus the Company's ownership percentage of reported income or loss in cases where the Company has significant influence; otherwise the investment is carried at cost. Income from certain entities is reported on a one quarter lag depending on when their financial information is received. Other long-term investments are considered impaired, and written down to their fair value, when cash flows indicate that the carrying value may not be recoverable. Fair value is generally determined based on a discounted cash flow analysis.
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, 2015 and 2014 is expected to be held longer than one year and includes real estate acquired through the foreclosure of commercial mortgage loans.
Cash and cash equivalents are carried at cost that approximates fair value. Cash equivalents consist of short-term investments with maturities of three months or less from the time of purchase. The Company reclassifies cash overdraft positions to accounts payable, accrued expenses and other liabilities when the legal right of offset does not exist.
Goodwill represents the excess of the cost of businesses acquired over the fair value of their net assets. The resulting goodwill is assigned to those reporting units expected to realize cash flows from the acquisition, allocated to reporting units based on relative fair values and reported in the Global Health Care segment ($5.7 billion) and the Global Supplemental Benefits segment ($0.3 billion). The Company evaluates goodwill for impairment at least annually during the third quarter at the reporting unit level and writes it down through results of operations if impaired. Fair value of a reporting unit is generally estimated based on either market data or a discounted cash flow analysis using assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. The significant assumptions and estimates used in determining fair value include the discount rate and future cash flows. A range of discount rates is used that corresponds with the reporting unit's weighted average cost of capital, consistent with that used for investment decisions considering the specific and detailed operating plans and strategies within the reporting units. Projections of future cash flows for the reporting units are consistent with our annual planning process for revenues, claims, operating expenses, taxes, capital levels and long-term growth rates. See Note 8 for additional information.
Separate account assets and liabilities are contractholder funds maintained in accounts with specific investment objectives. The assets of these accounts are legally segregated and are not subject to claims that arise out of any of the Company's other businesses. These separate account assets are carried at fair value with equal amounts for related separate account liabilities. The investment income, gains and losses of these accounts generally accrue to the contractholders and, together with their deposits and withdrawals, are excluded from the Company's Consolidated Statements of Income and Cash Flows. Fees and charges earned for mortality risks, asset management or administrative services are reported in either premiums or fees and other revenues.
liabilities are adjusted to reflect administrative charges and, for universal life fund balances, mortality charges. In addition, this caption includes: 1) premium stabilization reserves under group insurance contracts representing experience refunds left with the Company to pay future premiums; 2) deposit administration funds used to fund non-pension retiree insurance programs; 3) retained asset accounts; and 4) annuities or supplementary contracts without significant life contingencies. Interest credited on these funds is accrued ratably over the contract period.
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 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 9%. 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.
Medical costs payable for the Global Health Care segment include reported claims, estimates for losses incurred but not yet reported and liabilities for services rendered by providers, as well as liabilities under risk-sharing and quality management arrangements with providers. The Company uses actuarial principles and assumptions consistently applied each reporting period and recognizes the actuarial best estimate of the ultimate liability within a level of confidence. This approach is consistent with actuarial standards of practice that the liabilities be adequate under moderately adverse conditions.
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 deductibles, changes in provider practices and changes in consumer demographics and consumption behavior.
For each reporting period, the Company compares key assumptions used to establish the medical costs payable to actual experience. When actual experience differs from these assumptions, medical costs payable are adjusted through current period shareholders' net income. Additionally, the Company evaluates expected future developments
Products and services are offered in Turkey and India through joint venture entities for which the Company is the primary beneficiary. Accordingly, these entities are consolidated. The redeemable noncontrolling interests on our consolidated balance sheet represent our joint venture partners' preferred and common stock interests in these entities. Our joint venture partners may, at their election, require the Company to purchase their redeemable noncontrolling interests. We also have the right to require our joint venture partners to sell their redeemable noncontrolling interests to us. The redeemable noncontrolling interests were recorded at fair value as of the dates of purchase. When the estimated redemption value for a redeemable noncontrolling interest exceeds its carrying value, an adjustment to increase the redeemable noncontrolling interest is recorded with an offsetting reduction to additional paid-in capital. When an adjustment is made to the carrying value of the redeemable noncontrolling interest, the calculation of shareholders' net income per share will be adjusted if the redemption value exceeds the greater of the carrying value or fair value.
Accounts payable, accrued expenses and other liabilities include liabilities for pension, other postretirement and postemployment benefits (see Note 9), GMIB contract liabilities (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 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 premiums include 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.
Accounting for Health Care Reform's Risk Mitigation Programs. Beginning in 2014, as prescribed by Health Care Reform, programs went into effect to reduce the risk for participating health insurance companies selling coverage on the public exchanges.
For the premium stabilization program, the Company records receivables or payables as adjustments to premium revenue based on our year-to-date experience when the amounts are reasonably estimable and collection is reasonably assured. Final revenue adjustments are determined by HHS in the year following the policy year. Premiums for individual life, accident and supplemental health insurance and annuity products, excluding universal life and investment-related products, are recognized as revenue when due. Benefits and expenses are matched with premiums.
Contract fees for administrative services only ("ASO") programs and pharmacy programs and services are recognized in fees and other revenues as services are provided, net of pharmaceutical manufacturer rebates payable to clients and estimated refunds under performance guarantees. Expenses associated with these programs and services are recognized in other operating expenses as incurred, net of pharmaceutical rebates from manufacturers. In some cases, the Company provides performance guarantees associated with meeting certain service standards, clinical outcomes or financial metrics. If these service standards, clinical outcomes or financial metrics are not met, the Company may be financially at risk up to a stated percentage of the contracted fee or a stated dollar amount. The Company establishes deferred revenues for estimated payouts associated with these performance guarantees. Approximately 12% of ASO fees reported for the year ended December 31, 2015 were at risk, with reimbursements estimated to be approximately 1%.
Mail order pharmacy revenues and the cost of prescriptions are recognized as each prescription is shipped. Mail order pharmacy revenues are presented net of pharmaceutical manufacturer rebates payable to clients. Mail order pharmacy costs include the cost of prescriptions sold and other costs to operate this business including supplies, shipping and handling, net of pharmaceutical rebates from manufacturers.
The Company records compensation expense for stock awards and options over their vesting periods primarily based on the estimated fair value at the grant date. For stock options, fair value is estimated using an option-pricing model, whereas for restricted stock grants and units, fair value is equal to the market price of the Company's common stock on the date of grant. Compensation expense for strategic performance shares is recorded over the performance period. For strategic performance shares with payment dependent on a market condition, fair value is determined at the grant date using a Monte Carlo simulation model and not subsequently adjusted regardless of the final outcome. For strategic performance shares with payment dependent on performance conditions, expense is initially accrued based on the most likely outcome, but evaluated for adjustment each period for updates in the expected outcome. At the end of the performance period, expense is adjusted to the actual outcome (number of shares awarded times the share price at the grant date). See Note 20 for additional information on the Company's stock compensation plans.
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 2015, 2014 and 2013.
Deferred income tax assets and liabilities are recognized for differences between the financial and income tax reporting bases of the underlying assets and liabilities and established based upon enacted tax rates and laws. Deferred income tax assets are recognized when available evidence indicates that realization is more likely than not.
At special shareholders' meetings held in December 2015, Cigna shareholders approved the merger and Anthem shareholders approved the issuance of shares of Anthem common stock in connection with the merger. Completing the merger remains subject to certain customary conditions, including the receipt of certain necessary governmental and regulatory approvals and the absence of a legal restraint prohibiting the merger. Completing the merger is not subject to a financing condition.
If the merger agreement is terminated under certain circumstances, Anthem will be required to pay Cigna a termination fee of $1.85 billion. Anthem's obligation to pay the termination fee arises if the merger agreement is terminated because: (1) a governmental entity, such as the Department of Justice or a state Department of Insurance, has prevented the merger for regulatory reasons and that decision is final and non-appealable; or (2) the merger has not closed by January 31, 2017 (subject to extension to April 30, 2017 under certain circumstances) only because all necessary regulatory approvals have not been received.
The merger agreement contains customary covenants, including covenants that Cigna conduct its business in the ordinary course during the period between entering into the merger agreement and closing. In addition, Cigna's ability to take certain actions prior to closing without Anthem's consent is subject to certain limitations. These limitations relate to, among other matters, the payment of dividends, capital expenditures, the payment or retirement of indebtedness or the incurrence of new indebtedness, settlement of material claims or proceedings, mergers or acquisitions, and certain employment-related matters.
The following table presents direct, assumed and ceded premiums for both short-duration and long-duration insurance contracts. It also presents reinsurance recoveries that have been netted against benefits and expenses in the Company's Consolidated Statements of Income.
The majority of the Company's reinsurance recoverables balance resulted from acquisition and disposition transactions in which the underwriting company was not acquired. Components of the Company's reinsurance recoverables are presented below:
Over 90% of the Company's reinsurance recoverables were from companies that are rated A or higher by Standard & Poors at December 31, 2015. The Company reviews its reinsurance arrangements and establishes reserves against the recoverables in the event that recovery is not considered probable. As of December 31, 2015, the Company's recoverables were net of a reserve of $3 million.
Property and equipment was comprised of the following as of December 31:
Other property and equipment includes assets recorded under capital leases with a cost of $90 million, accumulated amortization of $44 million, and a net carrying value of $46 million as of December 31, 2015. Other property and equipment includes assets recorded under capital leases with a cost of $84 million, accumulated amortization of $36 million, and a net carrying value of $48 million as of December 31, 2014. Current capital lease agreements are for equipment and generally have a term of 48 months with the equipment returned to the lessor at the end of the term.
The Company estimates annual pre-tax amortization for intangible assets, including internal-use software, over the next five calendar years to be as follows: $432 million in 2016, $313 million in 2017, $216 million in 2018, $151 million in 2019, and $82 million in 2020.
The Company and certain of its subsidiaries provide pension, health care and life insurance defined benefits to eligible retired employees, spouses and other eligible dependents through various domestic and foreign plans. The effect of its foreign pension and other postretirement benefit plans is immaterial to the Company's results of operations, liquidity and financial position. The Company froze its defined benefit postretirement medical plan in 2013 and its primary domestic pension plans in 2009.
During 2015, the unfunded liability for the Company's pension and other postretirement benefit plans decreased by $182 million. In addition, the postretirement benefits liability adjustment (recorded in accumulated other comprehensive income) decreased by $131 million pre-tax ($85 million after-tax) resulting in an increase to shareholders' equity. These decreases were primarily due to an increase in the discount rate and a change in the mortality assumption (as discussed further in the assumptions section of this note).
Components of net pension cost for the years ended December 31 were as follows:
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 increase the allocation to fixed income investments as funding levels improve.
The fair values of plan assets by category and by the fair value hierarchy as defined by GAAP are as follows. See Note 10 for further details regarding how the Company determines fair value, including the level within the fair value hierarchy and the procedures the Company uses to validate fair value measurements.
• fixed maturities valued using recent trades of similar securities or pricing models as described in Note 10. Plan assets classified in Level 3 include investments primarily in securities partnerships, equity real estate and hedge funds generally valued based on the pension plan's ownership share of the equity of the investee including changes in the fair values of its underlying investments.
Expected long-term rates of return on plan assets were developed considering actual long-term historical returns, expected long-term market conditions, plan asset mix and management's investment strategy that continues a significant allocation to domestic and foreign equity securities as well as real estate, securities partnerships and hedge funds. Expected long-term market conditions take into consideration certain key macroeconomic trends including expected domestic and foreign GDP growth, employment levels and inflation.
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 these pension assets recognizes the difference between actual and expected long-term returns in the portfolio over 5 years, a method that reduces the short-term impact of market fluctuations on pension cost. At December 31, 2015, the market-related asset value was approximately $3.9 billion compared with a market value of approximately $4.0 billion.
Benefit payments. The following benefit payments are expected to be paid in:
The Company is responsible for determining fair value, as well as the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs. The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates. The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value. The controls executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations. The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates. The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations. Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls. This on-site review includes a walk-through of inputs of a sample of securities held across various asset types to validate the documented pricing process.
(3) Other derivative assets included $15 million of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million of interest rate swaps qualifying as fair value hedges. See Note 12 for additional information.
(1) Fixed maturities included $756 million of net cumulative 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. See Note 11 for additional information.
(3) Other derivative assets included $5 million of interest rate and foreign currency swaps qualifying as cash flow hedges and $1 million of interest rate swaps qualifying as fair value 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 in its evaluation, as well as the issuer's financial statements.
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.
GMIB contracts. As discussed in Note 7, the Company effectively exited the GMIB business in 2013. Although these GMIB assets and liabilities must continue to be reported as derivatives at fair value, the only assumption that is expected to impact future shareholders' net income is the risk of non-performance. This assumption reflects a market participant's view of (a) the risk of the Company not fulfilling its GMIB obligations (GMIB liabilities) and (b) the credit risk that the reinsurers do not pay their obligations (GMIB assets). As of December 31, 2015, there were three reinsurers for GMIB, with collateral securing 70% of the balance.
The Company reports GMIB liabilities and assets as derivatives at fair value because cash flows of these liabilities and assets are affected by equity markets and interest rates, but are without significant life insurance risk and are settled in lump sum payments. Under the terms of these written and purchased contracts, the Company periodically receives and pays fees based on either contractholders' account values or deposits increased at a contractual rate. The Company will also pay and receive cash depending on account values and interest rates when contractholders elect to begin to receive minimum income payments. The Company estimates the fair value of the assets and liabilities for GMIB contracts by calculating the results for many scenarios run through a model utilizing various assumptions that include non-performance risk, among other things.
assets accrue directly to the policyholders. Gains and losses reported in these tables may include net changes in fair value that are attributable to both observable and unobservable inputs.
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, 2015 and 2014, 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.
The following table includes the Company's financial instruments not recorded at fair value that are subject to fair value disclosure requirements at December 31, 2015 and 2014. Financial instruments that are carried in the Company's Consolidated Financial Statements at amounts that approximate fair value are excluded from the following table.
As explained in Note 2(B), in the fourth quarter of 2015, the Company retrospectively adopted ASU 2015-03 that requires debt issuance costs to be netted against the carrying value of the debt. The carrying value presented above for 2014 has been retrospectively adjusted to conform to the new guidance. The fair values for all financial instruments presented in the table above have been estimated using market information when available. The following valuation methodologies and inputs are used by the Company to determine fair value.
Fair values of off-balance-sheet financial instruments were not material as of December 31, 2015 and 2014.
The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at December 31, 2015:
The above table includes investments with a fair value of $2.7 billion at December 31, 2015 and $3.1 billion at December 31, 2014 supporting liabilities of the Company's run-off settlement annuity business. These investments had gross unrealized appreciation of $521 million and gross unrealized depreciation of $38 million at December 31, 2015, compared with gross unrealized appreciation of $758 million and gross unrealized depreciation of $2 million at December 31, 2014. Such unrealized amounts are reported in future policy benefit liabilities rather than accumulated other comprehensive income.
• $184 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
Short-term investments and cash equivalents included corporate securities of $925 million, federal government securities of $220 million and money market funds of $55 million as of December 31, 2015. The Company's short-term investments and cash equivalents as of December 31, 2014 included corporate securities of $509 million, federal government securities of $274 million and money market funds of $33 million.
As of December 31, 2015 and 2014, the Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders' equity.
Collateral and termination features. The Company routinely monitors exposure to credit risk associated with derivatives and diversifies the portfolio among approved dealers of high credit quality to minimize this risk. As of December 31, 2015, the Company had $16 million in cash on deposit representing the upfront margin required for the Company's centrally-cleared derivative instruments. Certain of the Company's over-the-counter derivative instruments contain provisions requiring either the Company or the counterparty to post collateral or demand immediate payment depending on the amount of the net liability position and predefined financial strength or credit rating thresholds. Collateral posting requirements vary by counterparty. The net asset or liability positions of these derivatives were not material as of December 31, 2015 or 2014.
The Company uses interest rate, foreign currency, and combination (interest rate and foreign currency) swap contracts to hedge the interest and foreign currency cash flows of its fixed maturity bonds to match associated insurance liabilities.
Under the terms of these various contracts, the Company periodically exchanges cash flows between variable and fixed interest rates 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 six years. Net interest cash flows are reported in operating activities.
The notional values of these cash flow swaps were $131 million as of December 31, 2015 and $145 million as of December 31, 2014.
As of and for the years ended December 31, 2015 and 2014, the effects of these derivative instruments on the Consolidated Financial Statements were not material. No amounts were excluded from the assessment of hedge effectiveness and no gains or losses were recognized due to hedge ineffectiveness.
The Company entered into centrally-cleared interest rate swap contracts to convert a portion of the interest rate exposure on its long-term debt from fixed to variable rates to more closely align interest expense with interest income received on its cash equivalent and short-term investment balances. The variable rates are benchmarked to LIBOR.
The Company's run-off reinsurance business has written reinsurance contracts with issuers of variable annuities 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 Company has purchased retrocessional coverage ("GMIB assets") for these contracts, including the agreement with Berkshire in 2013, effectively exiting this business. See Note 7 for further details.
To provide certain services to its Medicare Advantage customers, the Company contracts with independent physician associations ("IPAs") that are variable interest entities. Physicians provide health care services to Medicare Advantage customers and the Company provides medical management and administrative services to the IPAs.
• 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 $262 million for 2015, $225 million for 2014, and $232 million for 2013.
(2)Other credit-related losses include other-than-temporary declines in the fair values of equity securities, increases in valuation reserves on commercial mortgage loans, and asset write-downs related to security partnerships and real estate investments.
Realized investment gains in other investments, including derivatives, represented primarily gains on sale of real estate properties held in joint ventures.
• the present value of the remaining principal and interest payments on the Notes being redeemed discounted at the applicable Treasury rate plus 17.5 basis points. The following debt transactions occurred in April 2015:
The Company has a five-year revolving credit and letter of credit agreement for $1.5 billion that permits up to $500 million to be used for letters of credit. This agreement extends through December 2019 and is diversified among 16 banks with three banks each having 12% of the commitment and the remainder spread among 13 banks. The credit agreement includes options to increase the commitment amount to $2 billion and to extend the term past December 2019, subject to consent by the administrative agent and the committing banks. The credit agreement is available for general corporate purposes including for the issuance of letters of credit. The credit agreement contains customary covenants and restrictions, including a financial covenant that the Company may not permit its leverage ratio to be greater than 0.50. The leverage ratio is total consolidated debt to total consolidated capitalization (each as defined in the credit agreement) and excludes net unrealized appreciation in fixed maturities and the portion of the post-retirement benefits liability adjustment attributable to pension that is included in accumulated other comprehensive loss on the Company's consolidated balance sheet.
The Company had $7.9 billion of borrowing capacity within the maximum debt coverage covenant in the letter of credit agreement, in addition to the $5.2 billion of debt outstanding as of December 31, 2015. This additional borrowing capacity includes the $1.5 billion available under the credit agreement. Letters of credit outstanding as of December 31, 2015 totaled $19 million.
The Company was in compliance with its debt covenants as of December 31, 2015.
The Company's HMO and life subsidiaries are subject to minimum statutory surplus requirements and may be required to maintain investments on deposit with state departments of insurance or other regulatory bodies. Additionally, these subsidiaries may be subject to regulatory restrictions on the amount of annual dividends or other distributions (such as loans or cash advances) that insurance companies may extend to the parent company without prior approval. As of December 31, 2015, these amounts, including restricted net assets of the Company, were as follows:
Statutory surplus for each of the Company's life insurance and HMO subsidiaries is sufficient to meet the minimum required by regulators. For one of the Company's foreign insurance subsidiaries, the regulatory authority has permitted deferral of certain policy acquisition costs that increased statutory capital and surplus by approximately $0.2 billion as of December 31, 2015. There were no other permitted practices for the Company's insurance subsidiaries that significantly differed from prescribed regulatory accounting practices.
• 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 $2.2 billion as of December 31, 2015. If the Company intended to repatriate these foreign earnings to the U.S., the Company's consolidated balance sheet would have included an additional $290 million of deferred tax liabilities as of December 31, 2015.
Management believes that future results will be sufficient to realize the Company's deferred tax assets. With the exception of certain net operating loss related tax benefits, the Company's deferred tax benefits may be carried forward indefinitely. Net operating loss benefits are primarily attributable to foreign jurisdictions. 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 when there is a requirement to assess them on a separate entity basis. The increased valuation allowance for 2015 is primarily attributable to tax benefits of certain overseas start-up operations.
The Company conducts business in a number of 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 2011, and prior to 2009 for foreign audit activity.
The People Resources Committee ("the Committee") of the Board of Directors awards stock options, restricted stock, deferred stock and strategic performance shares to certain employees. The Committee has issued common stock instead of cash compensation and dividend equivalent rights to a very limited extent, as part of restricted and deferred stock units. The Company issues shares from Treasury stock for option exercises, awards of restricted stock grants and payment of strategic performance shares, deferred stock units and restricted stock units.
Compensation cost and related tax benefits for these awards were as follows:
The Company had the following number of common stock shares available for award at December 31: 8.6 million in 2015, 10.3 million in 2014 and 13.2 million in 2013.
Compensation expense of $36 million related to unvested stock options at December 31, 2015 will be recognized over the next two years (weighted average period).
At the end of 2015, approximately 3,900 employees held 1.6 million restricted stock grants and units with $56 million of related compensation expense to be recognized over the next two years (weighted average period).
At the end of 2015, approximately 1,300 employees held 1.2 million strategic performance shares and $37 million of related compensation expense is expected to be recognized over the next two years. For strategic performance shares subject to a performance condition, the amount of expense may vary based on actual performance in 2016 and 2017.
The Company's operating leases are primarily for office space. Some of these leases include renewal options and other incentives that are amortized over the life of the lease. Office space leases active in 2015 had terms ranging from one month to 18 years. Net rental expenses for operating leases amounted to approximately $165 million in 2015, $150 million in 2014 and $140 million in 2013. As of December 31, 2015, future net minimum rental payments under non-cancelable operating leases were approximately $700 million, payable as follows:
options, expense associated with frozen pension plans and certain costs for corporate projects, including overhead.
The Company uses adjusted income (loss) from operations as its principal financial measure of segment operating performance because management believes it best reflects the underlying results of business operations and permits analysis of trends in underlying revenue, expenses and profitability. Beginning on January 1, 2015, adjusted income from operations was newly defined as shareholders' net income (loss) excluding after-tax realized investment gains and losses, net amortization of other acquired intangible assets and special items. Prior period segment information has been restated to reflect these new performance metrics. Income or expense amounts are excluded from adjusted income from operations for the following reasons:
(2)Under this agreement, the Company utilizes a vendor's technology and service platforms, retail network contracting and claims processing services.
The Company guarantees that separate account assets will be sufficient to pay certain life insurance or retiree 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 of the retirement benefits business (Prudential Retirement Insurance and Annuity Company) has the right to redirect the management of the related assets to provide for benefit payments. As of December 31, 2015, employers maintained assets that exceeded the benefit obligations. Benefit obligations under these arrangements were $495 million as of December 31, 2015 and approximately 13% of these are reinsured by an affiliate of the buyer of the retirement benefits business. The remaining guarantees are provided by the Company with minimal reinsurance from third parties. There were no additional liabilities required for these guarantees as of December 31, 2015. Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the GAAP fair value hierarchy. See Note 10 for further information on the fair value hierarchy.
Under these guarantees, 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 any reinsurance coverage, using the following hypothetical assumptions:
• all annuitants elected to receive their benefit on the next available date (2016 through 2021); and
As of December 31, 2015, 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 2022. The Company had liabilities for these guarantees of $14 million as of December 31, 2015.
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, 2015.
The business of administering and insuring health services programs, particularly health care and group insurance programs, is heavily regulated by federal and state laws and administrative agencies, such as state departments of insurance, HHS and the U.S. Departments of Treasury, Labor and Justice, as well as the courts. Health care regulation and legislation in its various forms, including the implementation of Health Care Reform, other regulatory reform initiatives, such as those relating to Medicare programs, or additional changes in existing laws or regulations or their interpretations, could have a material adverse effect on the Company's business, results of operations and financial condition.
As a global company, Cigna is also subject to the laws, regulations and rules of the foreign jurisdictions in which it conducts business. Foreign laws and rules and regulatory audit and investigation practices may differ from, or be more stringent than, similar requirements in the U.S.
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 that the legal actions, regulatory matters, proceedings and investigations currently pending against it should not have a material adverse effect on the Company's results of operations, financial condition or liquidity based upon current knowledge and taking into consideration current accruals. The Company had pre-tax reserves as of December 31, 2015 of $190 million ($125 million after-tax) for the matters discussed below. Due to numerous uncertain factors presented in these cases, it is not possible to estimate an aggregate range of loss (if any) for these matters at this time. In light of the uncertainties involved in these matters, there is no assurance that their ultimate resolution will not exceed the amounts currently accrued by the Company. An adverse outcome in one or more of these matters could be material to the Company's results of operations, financial condition or liquidity for any particular period.
In 2008, the District Court (1) affirmed the Company's right to convert to a cash balance plan prospectively beginning in 1998; (2) found for plaintiffs on the disclosure claim only; 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. From 2008 through the present, this case has undergone a series of court proceedings that resulted in the original District Court order being largely upheld. In 2015, the Company submitted to the District Court its proposed method for calculating the additional pension benefits due to class members and plaintiffs responded in August 2015. In January 2016, the District Court ordered the method of calculating the additional pension benefits due to class members. Accordingly, management expects this lawsuit to be resolved, and the Plan to be amended to comply with the District Court's order, in 2016. The Company's reserve for this litigation remains reasonable at December 31, 2015 based on a calculation compliant with the court order.
CMS imposed sanctions based on its finding of deficiencies with the Company's operations of its Parts C and D appeals and grievances, Part D formulary and benefit administration, and compliance program. The Company is working to resolve these matters as quickly as possible and is cooperating fully with CMS on its review. Based on management's current expectations, the Company does not expect the impact to its 2016 consolidated results of operations, financial condition or cash flows to be material.
Disability claims regulatory matter. During the second quarter of 2013, the Company finalized an agreement with the Departments of Insurance for Maine, Massachusetts, Pennsylvania, Connecticut and California (together, the "monitoring states") related to the Company's long-term disability claims handling practices. Most other jurisdictions have joined the agreement as participating, non-monitoring states. The agreement requires, among other things: (1) enhanced procedures related to documentation and disposition; (2) a two-year monitoring period; and (3) reassessment of claims denied or closed during a two-year prior period, except California that has a three-year reassessment period. As previously disclosed, the
Company recorded a charge of $77 million before-tax ($51 million after-tax) in the first quarter of 2013 related to this matter. The Company is actively addressing the requirements of the agreement. If the monitoring states find material non-compliance with the agreement upon re-examination, the Company may be subject to additional costs and penalties.
Following announcement of the Company's merger agreement with Anthem as discussed in Note 3, six putative class action complaints (collectively the "complaints" or "Cigna Merger Litigation") were filed by purported Cigna shareholders on behalf of a purported class of Cigna shareholders. Five of the complaints were filed in the Court of Chancery of the State of Delaware. The sixth complaint was filed in the Connecticut Superior Court, Judicial District of Hartford. Additional lawsuits arising out of or relating to the merger agreement or the merger may be filed in the future.
(1)Shareholders' net income includes an after-tax charge of $65 million for the early extinguishment of debt in the second quarter of 2015. See Note 15 to the Consolidated Financial Statements for additional details.(2)Shareholders' net income includes after-tax charges of $29 million in the third quarter of 2015 and $28 million in the fourth quarter of 2015 for advisory, legal and other transactions costs directly related to the Company's proposed merger with Anthem. See Note 3 to the Consolidated Financial Statements for additional details.