Our global real estate portfolio consists of approximately 12.9 million square feet of owned and leased properties. Our domestic portfolio has approximately 10.9 million square feet in 43 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. Our international properties contain approximately 2.0 million square feet located throughout the following countries: Australia, Bahrain, Belgium, Canada, China, France, Germany, Hong Kong, India, Indonesia, Kenya, Kuwait, Lebanon, Malaysia, New Zealand, Oman, Singapore, South Korea, Spain, Switzerland, Taiwan, Thailand, Turkey, United Arab Emirates, and the United Kingdom.
The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying notes included elsewhere herein.
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 as of December 31, 2019 compared with December 31, 2018 and our results of operations for the year ended December 31, 2019 compared with 2018 and 2017. 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 (“Form 10-K”) and the Risk Factors contained in Part 1A of this Form 10-K. For comparisons of our results of operations for the year ended December 31, 2018 with 2017 please refer to the previously filed MD&A included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
In this MD&A, our consolidated measures “adjusted income from operations,” earnings per share on that same basis, and “adjusted revenues” are not determined in accordance with GAAP and should not be viewed as substitutes for the most directly comparable GAAP measures of “shareholders’ net income,” “earnings per share” and “total revenues.” We also use pre-tax adjusted income from operations and adjusted revenues to measure the results of our segments.
We use adjusted income 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. We define adjusted income from operations as shareholders’ net income (or income before taxes for the segment metric) excluding realized investment gains and losses, amortization of acquired intangible assets, results of Anthem and Coventry Health Care Inc. (“Coventry”) (collectively, the “transitioning clients”) (see the “Key Transactions and Developments” section of the MD&A for further discussion of transitioning clients) and special items. Cigna’s share of certain realized investment results of its joint ventures reported in the International Markets segment using the equity method of accounting are also excluded. Income or expense amounts excluded from adjusted income from operations because they are not indicative of underlying performance or the responsibility of operating segment management include:
Realized investment gains (losses) including changes in market values of certain financial instruments between balance sheet dates, as well as gains and losses associated with invested asset sales.
The term “Adjusted revenues” is defined as total revenues excluding the following adjustments: revenue contributions from transitioning clients, special items and Cigna’s share of certain realized investment results of its joint ventures reported in the International Markets segment using the equity method of accounting. We exclude these items from this measure because management believes they are not indicative of past or future underlying performance of the business.
Unless indicated otherwise, the commentary presented below, and in the segment discussions that follow, compare results for the year ended December 31, 2019 with results for the year ended December 31, 2018.
Medical customers increased, primarily attributable to growth in the Select and Middle Market segments, partially offset by a decline in the National Accounts and Individual market segments.
Revenue growth primarily reflected the addition of Express Scripts and, to a lesser extent, business growth in the Integrated Medical segment. Detailed revenue items are discussed further below.
oPharmacy revenues in 2019 reflected the Express Scripts pharmacy benefit management business. In 2018, we reported pharmacy revenues from Express Scripts for the period following the acquisition on December 20, 2018. See the Health Services Segment section of this MD&A for further discussion of pharmacy revenues.
Pharmacy and other service costs. In 2019, this amount was primarily comprised of the Express Scripts’ pharmacy benefits and health management businesses reported in the Health Services segment. In 2018, we reported activity from Express Scripts for the period following the acquisition on December 20, 2018.
Medical costs and other benefit expenses increased, primarily due to medical cost inflation in Integrated Medical, customer growth in the insured business and the addition of Express Scripts’ Medicare Part D business.
Selling, general and administrative expenses increased, primarily due to the addition of Express Scripts and, to a lesser extent, volume-related expenses in Integrated Medical. These increases were partially offset by suspension of the health insurance industry tax in 2019.
As discussed in Note 4 to the Consolidated Financial Statements, Cigna acquired Express Scripts on December 20, 2018 in a cash and stock transaction valued at $52.8 billion. The “Liquidity” section of this MD&A provides further discussion of the impact of the acquisition on our liquidity and capital resources.
We continue to incur costs related to this transaction, including costs to integrate the Cigna and Express Scripts operations. These costs are being reported in “integration and transaction-related costs” as a special item and excluded from adjusted income from operations because they are not indicative of future underlying performance of the business.
On January 30, 2019, Anthem exercised its early termination right and terminated their pharmacy benefit management services agreement with us, effective March 1, 2019. There is a twelve-month transition period ending March 1, 2020. The transition of Anthem’s customers occurred at various dates, as informed by Anthem’s technology platform migration schedule. In 2019 and 2018, we excluded the results of Express Scripts’ contract with Anthem (and also Coventry) from our non-GAAP reporting metrics “adjusted revenues” and “adjusted income from operations” and referred to these clients as “transitioning clients.” As of December 31, 2019, the transition of customers was substantially complete; therefore, beginning in 2020, we will no longer exclude results of transitioning clients from our reported adjusted revenues and adjusted income from operations.
As discussed in Note 15 to the Consolidated Financial Statements, during the fourth quarter of 2019 the Company committed to a plan to increase our organizational alignment and operational efficiency and reduce costs. As a result we recognized a charge in selling, general and administrative expenses of $207 million, pre-tax ($162 million, after-tax) in the fourth quarter of 2019. We expect to realize annualized after-tax savings of approximately $180 million. A substantial portion of the savings is expected to be realized in 2020.
The “Business - Regulation” section of this Form 10-K provides a detailed description of The Patient Protection and Affordable Care Act (“ACA”) provisions and other legislative initiatives that impact our health care and pharmacy services businesses, including regulations issued by the Centers for Medicare & Medicaid Services (“CMS”) and the Departments of the Treasury and Health and Human Services (“HHS”). The health care and pharmacy services businesses continue to operate in a dynamic environment, and the laws and regulations applicable to these businesses, including the ACA, continue to be subject to legislative, regulatory and judicial challenges. The table presented below provides an update on the expected impact of these items and other matters as of December 31, 2019.
Risk adjustment balances are subject to audit adjustment by CMS following each program year. In April 2019, CMS published the final Notice of Benefit and Payment Parameters for the 2020 plan year that clarified the 2017 benefit year RADV program. CMS released the 2017 benefit year data validation error rates in May and published the preliminary RADV transfers in August 2019. Based on the information currently available, we adjusted our risk adjustment balance to reflect the expected outcome of the RADV program.
·expense requirements, primarily for employee compensation and benefits, information technology and facilities costs;
·maintaining appropriate levels of cash and various types of marketable investments;
Dividends from our insurance, Health Maintenance Organization (“HMO”) and foreign subsidiaries are subject to regulatory restrictions. See Note 20 to the Consolidated Financial Statements for additional discussion of these restrictions. Most of Express Scripts’ subsidiaries provide significant financial flexibility to Cigna because they are not subject to regulatory restrictions on paying dividends.
Cash flows from operating activities consist principally of cash receipts and disbursements for pharmacy revenues and costs, premiums, fees, investment income, taxes, benefit costs and other expenses.
Our most significant investing and financing activities in 2018 related to acquiring Express Scripts. See Note 4 to the Consolidated Financial Statements for additional information on the acquisition. Cigna financed a portion of the acquisition in cash, primarily with debt financing as shown above and described more fully in Note 7 to the Consolidated Financial Statements, with the remaining required cash coming from cash on hand. In 2018, Cigna also acquired OnePath Life for approximately $480 million, largely with cash held in our foreign operations.
We maintain a share repurchase program authorized by our Board of Directors. Under this program, we may repurchase shares from time to time, depending on market conditions and alternate uses of capital. The timing and actual number of shares repurchased will depend on a variety of factors including price, general business and market conditions and alternate uses of capital. The share repurchase program may be effected through open market purchases or privately negotiated transactions in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended, including through Rule 10b5-1 trading plans. The program may be suspended or discontinued at any time.
In 2019, we repurchased 11.8 million shares for approximately $2.0 billion. From January 1, 2020 through February 26, 2020 we repurchased 2.0 million shares for approximately $425 million. Share repurchase authority was $3.5 billion as of February 26, 2020.
Our capital resources (primarily cash flows from operating activities and proceeds from the issuance of debt and equity securities) provide protection for policyholders, furnish the financial strength to underwrite insurance risks and facilitate continued business growth.
Our acquisition of Express Scripts increased our debt and shareholders’ equity in 2018 as follows:
Debt. See Note 7 to the Consolidated Financial Statements for further description of the debt issued to finance the acquisition.
Assumption of Express Scripts’ Senior Notes. See Note 7 to the Consolidated Financial Statements for further description of the notes assumed in the acquisition of Express Scripts.
In December 2019, Cigna entered into a definitive agreement to sell the Group Disability and Life business to New York Life Insurance Company for $6.3 billion. The sale is expected to close by the third quarter of 2020 subject to applicable regulatory approvals and other customary closing conditions. Cigna estimates to receive approximately $5.3 billion of net after-tax proceeds from this transaction and expects to use these proceeds for share repurchase and repayment of debt in 2020.
In 2018, Cigna entered into a new Revolving Credit Agreement and Term Loan Credit Agreement in financing the Express Scripts acquisition. Cigna had $10 million of letters of credit outstanding under the Revolving Credit Agreement as of December 31, 2019. In 2019, Cigna entered into an additional 364-day revolving credit agreement that matures in October 2020. See Note 7 to the Consolidated Financial Statements for further information on our revolving credit agreements.
Insurance liabilities. Excluded from the table above are $4 billion of insurance liabilities ($3 billion in contractholder deposit funds; $1 billion in future policy benefits) 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 as their related net cash flows are not expected to impact our cash flows. Excluding these amounts, the sum of the obligations presented above exceeds the corresponding insurance and contractholder liabilities of $23 billion recorded on the balance sheet (including $6 billion reported in liabilities held for sale) because some of the recorded insurance liabilities reflect discounting for interest and the recorded contractholder liabilities exclude future interest crediting, charges and fees. The timing and amount of actual future cash flows may differ from those presented above.
oFuture policy benefits and unpaid claims and claim expenses: see Note 9 to the Consolidated Financial Statements for our accounting policies for these liabilities. Expected future cash flows for these liabilities presented in the table above are undiscounted. The expected future cash flows for guaranteed minimum death benefit (“GMDB,” reported in future policy benefits) do not consider any of the related reinsurance arrangements.
Long-term debt includes scheduled interest payments and current maturities of long-term debt. See Note 7 to the Consolidated Financial Statements for information regarding long-term debt. Finance leases are included in long-term debt and primarily represent obligations for information technology network storage, servers and equipment. See Note 19 to the Consolidated Financial Statements for information regarding finance leases.
Operating leases: See Note 19 to the Consolidated Financial Statements for additional information.
The table above excludes the liabilities for uncertain tax positions because we cannot reasonably estimate the timing of such future payments. In the event we are unable to sustain all of our $1 billion of uncertain tax positions it could result in future tax payments of approximately $760 million. See Note 21 to the Consolidated Financial Statements for additional information on uncertain tax positions.
Purchase obligations. As of December 31, 2019, purchase obligations consisted of estimated payments required under contractual arrangements for future services and investment commitments as follows:
it requires assumptions to be made that were uncertain at the time the estimate was made; and
Management believes the current assumptions used to estimate amounts reflected in our Consolidated Financial Statements are appropriate. However, if actual experience significantly differs from the assumptions used in estimating amounts reflected in our Consolidated Financial Statements, the resulting changes could have a material adverse effect on our consolidated results of operations and in certain situations, could have a material adverse effect on liquidity and our financial condition. The tables below present the adverse impacts of certain possible changes in assumptions. The effect of assumption changes in the opposite direction would be a positive impact to our consolidated results of operations, liquidity or financial condition, except for assessing impairment of goodwill and debt securities carried at fair value below cost.
We completed our normal annual evaluations for impairment of goodwill and intangible assets during the third quarter of 2019. The evaluations indicated that the fair value estimates of our reporting units exceed their carrying values by sufficient margins and no impairments were required.
Goodwill and other intangibles as of December 31 were as follows (in millions):
If we do not achieve our earnings and cash flow projections or our cost of capital rises significantly, the assumptions and estimates underlying the goodwill and intangible asset impairment evaluations could be adversely affected and result in future impairment charges that would negatively impact our operating results and financial position.
The factors that could impact our estimates of uncertain tax positions include the likelihood of being sustained upon audit based on the technical merits of the tax position and related assumed interest and penalties. If our positions are upheld upon audit, our net income would increase.
Unpaid claims and claim expenses in Integrated Medical are primarily impacted by assumptions related to completion factors and medical cost trend. Variation of actual results from either assumption could impact the unpaid claims balance as noted below. A large number of factors may cause the medical cost trend to vary from the Company’s estimates, including: changes in health management practices, changes in the level and mix of benefits offered and services utilized, and changes in medical practices. Completion factors may be affected if actual claims submission rates from providers differ from estimates (that can be influenced by a number of factors, including provider mix and electronic versus manual submissions), or if changes to the Company’s internal claims processing patterns occur.
Unpaid claims and claim expenses for the Integrated Medical segment as of December 31 were as follows (in millions):
See Note 9 to the Consolidated Financial Statements for additional information regarding assumptions and methods used to estimate this liability.
These liabilities are presented above both gross and net of reinsurance recoverables and are included in liabilities held for sale in the Consolidated Balance Sheet.
See Note 9C. to the Consolidated Financial Statements for additional information regarding assumptions and methods used to estimate this liability.
A five percent decrease in the claim resolution rate would increase long-term disability reserves by approximately $95 million and decrease net income by approximately $75 million after-tax.
A 25 basis point decrease in the discount rate would increase long-term disability reserves by approximately $45 million and decrease net income by approximately $35 million after-tax.
Most debt 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.
If the derived interest rates used to calculate fair value increased by 100 basis points, the fair value of the total debt security portfolio of $24 billion would decrease by approximately $1.5 billion, resulting in an after-tax decrease to shareholders’ equity of approximately $0.9 billion.
If we subsequently determine that the excess of amortized cost over fair value is other-than-temporary for any or all of these debt securities, the amount recorded in accumulated other comprehensive income would be reclassified to shareholders’ net income as an impairment loss.
In segment discussions, we present adjusted revenues and “pre-tax adjusted income from operations,” defined as income before taxes excluding realized investment gains (losses), amortization of acquired intangible assets, results of transitioning clients, (income) loss attributable to noncontrolling interests and special items. Ratios presented in this segment discussion exclude the same items as pre-tax adjusted income from operations. See Note 23 to the Consolidated Financial Statements for additional discussion of these metrics and a reconciliation of income before income taxes to pre-tax adjusted income from operations, as well as a reconciliation of total revenues to adjusted revenues. Note 23 to the Consolidated Financial Statements also explains two additional items that are important in understanding our segment results: 1) segment revenues include both external revenues and sales between segments that are eliminated in Corporate and 2) beginning in the first quarter of 2019, compensation cost for stock options is recorded by the segments. Prior year segment information was not restated for this change in stock option reporting.
See the MD&A Executive Overview for summarized financial results of each of our segments.
The Health Services segment includes pharmacy benefits management, specialty pharmacy services, clinical solutions, home delivery and health management services. This segment includes Express Scripts’ business from the December 20, 2018 date of acquisition except for Express Scripts’ Medicare Part D business that is reported in the Government operating segment of our Integrated Medical segment. This segment also includes Cigna’s legacy home delivery pharmacy business. Due to the timing of the acquisition, results of operations in 2018 only included results from the Express Scripts’ business for the period following the acquisition on December 20, 2018. The main driver of period over period increases in the financial information presented below was the results from the Express Scripts’ business in 2019. As described in the introduction to Segment Reporting, performance of the Health Services segment is measured using pre-tax adjusted income from operations.
The key factors that impact Health Services revenues and costs of revenues are volume, mix and price. These key factors are discussed further below. See Note 2 to the Consolidated Financial Statements for additional information on revenue and cost recognition policies for this segment.
The mix of claims generally considers the type of drug and distribution method used for dispensing and fulfilling. As our mix of drugs changes, our resulting pharmacy revenues and cost of revenues correspondingly may increase or decrease. The primary driver of fluctuations within our mix of claims is the generic fill rate. Generally, higher generic fill rates reduce revenues, as generic drugs are typically priced lower than the branded drugs they replace. However, as ingredient cost paid to pharmacies on generic drugs is incrementally lower than the price charged to our clients, higher generic fill rates generally have a favorable impact on our gross profit. The home delivery generic fill rate is currently lower than the network generic fill rate as fewer generic substitutions are available among maintenance medications (such as therapies for chronic conditions) commonly dispensed from home delivery pharmacies as compared to acute medications that are primarily dispensed by pharmacies in our retail networks.
Our client contract pricing is impacted by our ability to negotiate supply chain contracts for pharmacy network, pharmaceutical and wholesaler purchasing and manufacturer rebates. As we seek to improve the effectiveness of our integrated solutions for the benefit of our clients, we are continuously innovating and optimizing the supply chain. Our gross profit could also increase or decrease as a result of supply chain initiatives implemented. Inflation also impacts our pricing because most of our contracts provide that we bill clients and pay pharmacies based on a generally recognized price index for pharmaceuticals. Therefore, the rate of inflation for prescription drugs and our efforts to manage this inflation for our clients can affect our revenues and cost of revenues.
clients. See the “Key Transactions and Business Developments” section of this MD&A for further discussion of transitioning clients and why we present this information.
Adjusted revenues. The increase reflected a full year of results from the Express Scripts’ business in 2019. Adjusted revenues in 2019 for the Health Services segment reflected strong performance, including customer growth, adjusted pharmacy scripts volume, specialty pharmacy care and management of supply chain.
Pre-tax adjusted income from operations. The increase reflected a full year of results from the Express Scripts’ business in 2019. Results in the Health Services segment in 2019 reflected strong performance, including customer growth, adjusted pharmacy scripts volumes and benefits from the effective management of the supply chain.
percentage of Medicare Advantage customers in plans eligible for quality bonus payments;
benefit expenses as a percentage of premiums (medical care ratio or “MCR”) for our insured commercial and government businesses; and
selling, general and administrative expense as a percentage of adjusted revenues (expense ratio).
Adjusted revenues. The increase reflected Commercial customer growth in our insured business as well as higher premium rates due to underlying medical cost trend and the addition of Express Scripts’ Medicare Part D business.
Expense ratio. The expense ratio decreased primarily reflecting higher revenues in our insurance business and the suspension of the health insurance industry tax in 2019.
Our unpaid claims and claim expenses liability was higher as of December 31, 2019 compared with December 31, 2018, primarily due to customer growth.
As described in the introduction to Segment Reporting, performance of the International Markets segment is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations for this segment are:
selling, general and administrative expense and acquisition expense as a percentage of revenues (expense ratio and acquisition cost ratio); and
Adjusted revenues. The increase reflected business growth in Asia, Europe, and the Middle East and the acquisition of OnePath Life in New Zealand in the fourth quarter of 2018. These increases were partially offset by unfavorable foreign currency movements.
Pre-tax adjusted income from operations. The increase reflected business growth in Asia and the acquisition of OnePath Life, partially offset by unfavorable foreign currency movements.
The acquisition cost ratio decreased due to lower spending in certain markets and the acquisition of OnePath Life, partially offset by higher acquisition expenses in South Korea and Taiwan.
South Korea is the single largest geographic market for our International Markets segment. In 2019, South Korea generated 37% of the segment’s adjusted revenues and 63% of the segment’s pre-tax adjusted income from operations.
As described in the introduction of Segment Reporting, performance of Group Disability and Other is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations are:
selling, general and administrative expense as a percentage of revenues excluding net investment income (expense ratio).
Adjusted revenues. The increase reflected business growth in the group disability, life and voluntary businesses, partially offset by the continued run-off of international business and lower investment income.
Pre-tax adjusted income from operations and Pre-tax adjusted margin. The decreases resulted from unfavorable disability claims experience.
Pre-tax adjusted loss from operations. The increase reflected higher interest expense on debt issued in the third quarter of 2018 to finance the Express Scripts acquisition and debt assumed from Express Scripts.
Our debt securities portfolio increased during 2019 reflecting increased valuations due to decreases in market yields, partially offset by net sales and maturities. As of December 31, 2019, $21.2 billion, or 90% of the debt securities in our investment portfolio were investment grade (Baa and above, or equivalent) and the remaining $2.5 billion were below investment grade. The majority of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum. These quality characteristics have not materially changed from the prior year and are consistent with our investment strategy. Investments in debt securities are diversified by issuer, geography and industry as appropriate.
In addition to amounts classified as debt securities in our Consolidated Balance Sheets, we participate in an insurance joint venture in China with a 50% ownership interest. This entity had an investment portfolio of approximately $8.1 billion supporting its business that is primarily invested in Chinese corporate and government debt securities. We account for this joint venture on the equity method of accounting and report it in other assets. There were no investments with a material unrealized loss as of December 31, 2019.
Our commercial mortgage loans are fixed rate loans, diversified by property type, location and borrower. Loans are secured by high quality commercial properties and are generally made at less than 70% of the property’s value at origination of the loan. Property value, debt service coverage, quality, building tenancy and stability of cash flows are all important financial underwriting considerations. We hold no direct residential mortgage loans and do not originate or service securitized mortgage loans.
As of December 31, 2019, the $1.9 billion commercial mortgage loan portfolio consisted of approximately 65 loans that are in good standing. Given the quality and diversity of the underlying real estate, positive debt service coverage and significant borrower cash investment generally ranging between 30 and 40%, we remain confident that borrowers will continue to perform as expected under their contract terms.
“Problem” bonds and commercial mortgage loans are either delinquent by 60 days or more or have been restructured as to terms, including concessions by us for modification of interest rate, principal payment or maturity date. “Potential problem” bonds and commercial mortgage loans are considered current (no payment is more than 59 days past due), but management believes they have certain characteristics that increase the likelihood that they may become problems.
Interest-rate risk on fixed-rate, medium-term instruments. Changes in market interest rates affect the value of instruments that promise a fixed return.
Investment/liability matching. We generally select investment assets with characteristics (such as duration, yield, currency and liquidity) that correspond to the underlying characteristics of our related insurance and contractholder liabilities so that we can match the investments to our obligations. Shorter-term investments generally support shorter-term life and health liabilities. Medium-term, fixed-rate investments support interest-sensitive and health liabilities. Longer-term investments generally support products with longer pay out periods such as annuities and long-term disability liabilities.
Use of local currencies for foreign operations. We generally conduct our international business through foreign operating entities that maintain assets and liabilities in local currencies. This technique limits exchange rate risk to our net assets.
Use of derivatives. We use derivative financial instruments to reduce our primary market risks. See Note 11 to the Consolidated Financial Statements for additional information about derivative financial instruments.
The effect of a hypothetical strengthening of the U.S. dollar relative to the foreign currencies of certain financial instruments held by us was estimated to be 10% of the U.S. dollar equivalent fair value. Our foreign operations hold investment assets, such as debt securities, cash, and cash equivalents that are generally invested in the currency of the related liabilities.
The Company's management is responsible for these consolidated 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 the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment is a critical audit matter are there was significant judgment by management when determining the fair value measurement of the reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s estimate of the reporting units’ fair value including the assumptions for the discount rate and projection of future cash flows. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over management’s methodology, inputs and assumptions used in its goodwill impairment assessment. These procedures also included, among others, testing management’s process for determining the fair value estimate of the reporting units; evaluating the appropriateness of the discounted cash flow analysis; testing the completeness and accuracy of underlying data used in the discounted cash flow analysis; and evaluating the key inputs and significant assumptions, including the discount rate and the projections of future cash flows. The underlying inputs and assumptions used in the development of the discount rate and the projections of future cash flows that were evaluated included the weighted average cost of capital, revenues, pharmacy costs, benefits expenses, operating expenses, capital levels and long-term growth rates. Evaluating the reasonableness of management’s inputs and assumptions involved considering (i) the current and past performance of the reporting unit, (ii) the consistency of the discount rate and long-term growth rates with external market and industry data, and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of certain significant assumptions, including the discount rate.
estimates the probability and amount of future offset awards and lapses based on management’s experience for certain offsets not yet finalized.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of long-term disability disabled life reserves, including controls over management’s actuarial methodologies and the development of significant assumptions including the discount rate, resolution rates, offset awards, and adequacy. These procedures also included, among others, the involvement of professionals with specialized skill and knowledge to assist in testing management’s process for determining the reserves which included evaluating the appropriateness of management’s actuarial methodologies and the reasonableness of the aforementioned assumptions utilized in determining the reserves balances and recalculating the reserves for a sample of long-term disability disabled life reserves utilizing management’s actuarial methodologies and assumptions. The professionals with specialized skill and knowledge also recalculated a sample of long-term disability disabled life reserves utilizing an independent model and management’s assumptions. Performing these procedures involved testing the completeness and accuracy of the data provided by management.
Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”) is a global health service organization dedicated to a mission of helping those we serve improve their health, well-being and peace of mind. Our evolved strategy in support of our mission is Go Deeper, Go Local, Go Beyond using a differentiated set of pharmacy, medical, dental, disability, life and accident insurance and related products and services offered by our subsidiaries.
Health Services includes pharmacy benefits management, specialty pharmacy services, clinical solutions, home delivery and health management services.
Corporate-Owned Life Insurance (“COLI”) offers permanent insurance contracts sold to corporations to provide coverage on the lives of certain employees for financing employer-paid future benefit obligations.
Reinsurance: predominantly comprised of guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) business effectively exited through reinsurance with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) in 2013.
The Consolidated Financial Statements include the accounts of Cigna Corporation and its consolidated subsidiaries. Intercompany transactions and accounts have been eliminated in consolidation. These Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
The Company has completed its evaluation of this new standard and its expected effects on our financial statements and disclosures. We will adopt the standard as of January 1, 2020.
Changes in measuring our future policy benefits liability for traditional and limited-pay insurance contracts:
Assumptions used to measure cash flows (such as mortality, morbidity and lapse assumptions) to be updated at least annually with the effect of changes in those assumptions remeasured retrospectively and reflected in current period net income.
Discount rate assumptions to be updated quarterly based on an upper-medium grade fixed-income instrument yield that maximizes the use of observable market inputs with any changes reflected in other comprehensive income.
Market risk benefits (defined as protecting the contractholder from other-than-nominal capital market risk and exposing the insurer to that risk) to be measured at fair value with changes in fair value recognized in net income each period, except for the effect of changes in the insurance entity’s credit risk to be recognized in other comprehensive income.
Changes to the liability for future policy benefits to use a modified retrospective approach applied to all outstanding contracts on the basis of their carrying amounts as of the beginning of the earliest period presented, with an option to elect a full retrospective transition under certain criteria. Remeasuring the future policy benefits liability for the discount rate to be recorded through accumulated other comprehensive income at transition.
Although we continue to evaluate the new requirements and model their impacts across various products, we are not yet able to project or estimate the magnitude or frequency of expected changes to our financial results. However, it is possible that the Company's income recognition pattern could change for several reasons:
Amortizing DAC on a constant-level basis over the expected term of the related contracts, versus being tied to the emergence of profit for such contracts.
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 liabilities when the legal right of offset does not exist.
Supplemental health, life and accident insurance products (primarily individual products) that comprise the majority of the Company’s deferred policy acquisition costs and group health and accident insurance products are deferred and amortized, generally in proportion to the ratio of periodic revenue to the estimated total revenues over the contract periods.
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 additional expense.
Products and services are offered in Turkey through our joint venture. The Company is the majority equity holder of this joint venture, owning 51%, and accordingly, it is consolidated.
The Company accrues for legal and regulatory matters when a loss contingency is both probable and estimable. The estimated loss is generally recorded in selling, general and administrative expenses and represents the Company’s best estimate of the loss contingency. If the loss estimate is a range, the Company accrues the minimum amount in the range if no amount is better than any other estimated amount in the range. Legal costs to defend the Company’s litigation and arbitration matters are expensed as incurred in cases that the Company cannot reasonably estimate the ultimate cost to defend. If the Company can reasonably estimate the cost to defend, a liability for these costs is accrued when the claim is reported. Litigation and legal or regulatory matters that the Company has identified with a reasonable possibility of material loss are described in Note 22 to the Consolidated Financial Statements.
The Company generally conducts its international business through foreign operating entities that maintain assets and liabilities in local currencies that are their functional currencies. The Company uses exchange rates as of the balance sheet date to translate assets and liabilities into U.S. dollars. Translation gains or losses on functional currencies, net of applicable taxes, are recorded in accumulated other comprehensive income (loss). The Company uses average monthly exchange rates during the year to translate revenues and expenses into U.S. dollars.
We may also provide certain financial and performance guarantees, including a minimum level of discounts a client may receive, generic utilization rates and various service levels. Clients may be entitled to receive compensation if we fail to meet the guarantees. Actual performance is compared to the contractual guarantee for each measure throughout the period and the Company defers revenue for any estimated payouts within accrued expenses and other liabilities (current). These estimates are adjusted at the end of the guarantee period. Historically, adjustments to original estimates have not been material. The performance guarantee liability was $1.0 billion as of December 31, 2019 and $895 million as of December 31, 2018.
The Company administers programs through which we may receive rebates and other vendor consideration from pharmaceutical manufacturers. The amounts of such rebates or other vendor consideration shared with pharmacy benefit management services clients vary based on the contractual arrangement with the client and in some cases the type of consideration received from the pharmaceutical manufacturer. Rebates and other vendor consideration payable to pharmacy benefit management services clients are recorded as a reduction of pharmacy revenues. Estimated amounts payable to clients are based on sharing percentages in contractual arrangements between the Company and the client, and are typically adjusted when amounts are collected from pharmaceutical manufacturers. Historically, these adjustments have not been material.
the estimated effect of rebates due to CMS under the Medicare Advantage and Medicare Part D minimum medical loss ratio provisions of the ACA.
Investment income on assets supporting universal life products is recognized in net investment income as earned.
In return for fees from these clients, the Company provides access to our participating provider networks and other services supporting benefit management, including claims administration, behavioral health services, disease management, utilization management and cost containment programs. In general, the Company considers these services to be a combined performance obligation to provide cost effective administration of plan benefits over the contract period. Fees are billed, due and recognized monthly at contracted rates based on current membership or utilization. This recognition pattern aligns with the benefits from services provided to clients. These revenues are reported in fees and other revenues in the Consolidated Statements of Income.
The Company may also provide performance guarantees that provide potential refunds to clients if certain service standards, clinical outcomes or financial metrics are not met. If these standards, outcomes and 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 defers revenue by recording a liability for estimated payouts associated with these guarantees within accrued expenses and other liabilities. The amount of revenue deferred is estimated for each type of guarantee using either a most likely amount or expected value method depending on the nature of the guarantee and the information available to estimate refunds. Estimates are refined each reporting period as additional information on the Company’s performance becomes available and upon final reconciliation and settlement at the end of the guarantee period. Amounts accrued and paid for these performance guarantees during the reporting periods were not material.
Rebates from pharmaceutical manufacturers for ASO client purchases at retail pharmacies, net of amounts payable to ASO clients, were considered compensation for use of the manufacturer’s products and recorded in fees and other revenues prior to transitioning
Integrated Medical’s Commercial customers to Express Scripts’ retail pharmacy network in the third quarter of 2019. After this transition, these rebates are reflected as a reduction to pharmacy costs (See “Pharmacy Costs” above).
The Company also earns revenue, as part of its integrated pharmacy benefits performance obligation, by offering fee-for-service clinical solutions to our clients, such as drug utilization management and medication adherence counseling. These clinical programs help clients to drive better health outcomes at a lower cost by identifying and addressing potentially unsafe or wasteful prescribing, dispensing and utilization of prescription drugs, and communicating with, or supporting communications with physicians, pharmacies and patients. Fees are billed, due and recognized at contracted rates either on a periodic basis or as services are provided. This recognition pattern aligns with the benefits from services provided. These revenues are reported in fees and other revenues in the Consolidated Statements of Income. Direct costs associated with these programs are recognized in pharmacy and other service costs, and other related expenses are recorded as incurred in selling, general and administrative expenses.
The Company also earns fees by providing health benefit management solutions that drive cost reductions and improve quality outcomes. Clients are primarily sponsors of health benefit plans and fees may be stated as a per-member-per-month fee or as a per-claim fee. The Company considers the services to be a single performance obligation to stand ready to provide utilization management services over the contract period (generally three years). In certain arrangements, the Company assumes the financial obligation for third-party provider costs for medical services provided to the health plan’s customers. Fees are recorded gross in fees and other revenues in the Consolidated Statements of Income because the Company is acting as a principal in arranging for and controlling the services provided by third-party network providers. Contractual fees vary based on enrollment and provider costs and are billed, due and recognized monthly. Direct costs associated with these programs are recognized in pharmacy and other service costs, and other related expenses are recorded in selling, general and administrative expenses as incurred.
Certain health benefit management contracts require the Company to share the results of medical cost experience that differ from specified targets. This variable consideration is estimated at contract inception and adjusted through the contract period. The estimated profits and costs are recognized net in fees and other revenues.
Accounting policy. The Company’s accounts receivable balances primarily include amounts due from clients, third-party payors, customers and pharmaceutical manufacturers, and are presented net of allowances. Allowances for doubtful accounts are based on the current status of each customer’s receivable balance as well as current economic and market conditions and a variety of other factors including the length of time the receivables are past due, the financial health of customers and our past experience. We bill pharmaceutical manufacturers based on management’s interpretation of contractual terms and estimate a contractual allowance at the time a claim is processed based on the best information available. Contractual allowances for certain rebates receivable from pharmaceutical manufacturers are determined by reviewing payment experience and specific known items that could be adjusted under contract terms. The Company’s estimation process for contractual allowances for pharmaceutical manufacturer receivables generally results in an allowance for balances outstanding greater than 90 days. Contractual allowances for certain receivables from third-party payors are based on the contractual terms and are estimated based on the Company’s best information available at the time revenue is recognized. Receivables are written off against allowances only when such amounts are determined unrecoverable and all collection attempts have failed. We regularly review the adequacy of these allowances based on a variety of factors, including age of the outstanding receivable and collection history. When circumstances related to specific collection patterns change, estimates of the recoverability of receivables are adjusted.
As part of purchase accounting, Express Scripts’ receivables were recorded at their estimated fair values with no allowances as of December 31, 2018.
Fair value of share-based compensation award. Express Scripts employees’ awards of options and restricted stock units of Express Scripts stock were rolled over to Cigna stock options and restricted stock units on the date of the acquisition. Each holder of an Express Scripts stock option or restricted stock unit received 0.4802 of a Cigna stock option or restricted stock award. The Cigna stock option exercise price was determined using this same conversion ratio. Vesting periods and the remaining life of the options remained consistent with the original Express Scripts awards.
The fair value of these options and restricted stock unit awards was included in the purchase price for services that had been provided prior to the acquisition based on the grant date of the original Express Scripts award and vesting period. The remaining fair value not included in the purchase price will be recorded as compensation expense in future periods over the remaining vesting periods. Most of the expense was recognized in 2019 with the balance expected in 2020.
Most of the goodwill ($33.7 billion) is assigned to the Health Services segment, with the remainder to the Integrated Medical segment and is not deductible for federal income tax purposes. In addition, a portion of the purchase price has been allocated to intangible assets that are presented and discussed below.
The results of Express Scripts have been included in the Company’s Consolidated Financial Statements from the date of the acquisition. Revenues of Express Scripts included in the Company’s results for 2018 approximated $2.6 billion and Express Scripts’ results of operations were immaterial to Cigna's net income.
Unaudited pro forma information. The following table presents selected unaudited pro forma information for the Company assuming the acquisition of Express Scripts had occurred on January 1, 2017. The primary adjustments reflected in the pro forma results relate to the interest expense on the debt issued to fund the Merger, the amortization of the acquired intangible assets and the presentation of transaction related costs. Transaction related costs incurred by the Company and Express Scripts in 2018 have been presented as if they had been incurred on January 1, 2017. The pro forma information does not purport to represent what the Company’s actual results would have been if the acquisition had occurred as of the date indicated or what such results would be for any future periods.
Pro forma shareholders’ net income for the year ended December 31, 2017 includes $1.2 billion in integration and transaction-related costs incurred in connection with the acquisition.
The Company has incurred costs detailed in the table below related to the acquisition and integration of Express Scripts, the terminated merger with Anthem, Inc. (“Anthem”) and other transactions. These costs consisted primarily of certain projects to integrate the Company’s systems, products and services, fees for legal, advisory and other professional services and certain employment-related costs. Costs in 2018 also included charitable contributions and amortization of certain financing fees and interest expense on the debt issued in the third quarter of 2018 to fund the Express Scripts merger, net of investment income earned on proceeds of the debt issuance.
Note 5 - Assets and Liabilities of Business Held for Sale
Accounting Policy. The Company classifies assets and liabilities as held for sale (“disposal group”) when management commits to a plan to sell the disposal group, the sale is probable within one year and the disposal group is available for immediate sale in its present condition. The Company considers various factors, particularly whether actions required to complete the plan indicate it is unlikely that significant changes to the plan will be made or the plan will be withdrawn. Assets held for sale are measured at the lower of carrying value or fair value less costs to sell. Any loss resulting from the measurement is recognized in the period the held-for-sale criteria are met. Conversely, gains are not recognized until the date of the sale. When the disposal group is classified as held for sale, depreciation and amortization ceases and the Company tests the assets for impairment.
Debt repayment. During 2019, the Company repaid approximately $5.2 billion of outstanding obligations, including the $3.0 billion term loan, $1.3 billion in current maturities of long-term debt, $0.7 billion in short term debt and $151 million for the early redemption of the Medco Notes.
Exchange of Legacy Notes for Cigna Notes and Redemption of Medco Notes. In the fourth quarter of 2019, the Company completed an exchange of $12.7 billion of legacy Notes issued by Express Scripts, Medco and Old Cigna for new Notes issued by Cigna with the same interest rates, maturities and other comparable terms. The Company entered into this exchange primarily to simplify its capital structure and reporting obligations. Additionally, in the fourth quarter of 2019, the Company fully redeemed all of the remaining outstanding Medco Notes. As a result of the exchange and redemption, guarantees of obligations under the remaining legacy Notes not exchanged, as well as under Notes issued by Cigna in September 2018 to finance its acquisition of Express Scripts, were released and Cigna is no longer required to separately present Condensed Consolidated Financial Information under Rule 3-10 of Regulation S-X.
The revolving credit agreements contain customary covenants and restrictions including a financial covenant that the Company’s leverage ratio may not exceed 60%.
Commercial Paper outstanding as of December 31, 2019 had an average interest rate of 2.11%.
The Company was in compliance with its debt covenants as of December 31, 2019.
Insurance and contractholder liabilities expected to be paid within one year are classified as current.
Accounting Policy - Future Policy Benefits. Future policy benefits represent the present value of estimated future obligations under long-term life and supplemental health insurance policies and annuity products currently in force. These obligations are estimated using actuarial methods and consist primarily of reserves for annuity contracts, life insurance benefits, GMDB contracts (see Note 10 for additional information) and certain health, life and accident insurance products of our International Markets segment.
The Company compares key assumptions used to establish the medical costs payable to actual experience for each reporting period. The unpaid claims liability is adjusted through current period shareholders’ net income when actual experience differs from these assumptions. Additionally, the Company evaluates expected future developments and emerging trends that may impact key assumptions. The process used to determine this liability requires the Company to make critical accounting estimates that involve considerable judgment, reflecting the variability inherent in forecasting future claim payments. These estimates are highly sensitive to changes in the Company’s key assumptions, specifically completion factors and medical cost trend.
The liability is primarily calculated using “completion factors” developed by comparing the claim incurral date to the date claims were paid. Completion factors are impacted by several key items including changes in: 1) electronic (auto-adjudication) versus manual claim processing; 2) provider claims submission rates; 3) membership and 4) the mix of products. The Company uses historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. The Company estimates the liability for claims incurred in each month by applying the current estimates of completion factors to the current paid claims data. This approach implicitly assumes that historical completion rates will be a useful indicator for the current period.
Variances in incurred costs related to prior years’ unpaid claims and claims expenses that resulted from the differences between actual experience and the Company’s key assumptions were as follows:
Prior year development increased shareholders’ net income by $67 million ($85 million before-tax) for the year ended December 31, 2019, compared with $77 million ($97 million before-tax) for the year ended December 31, 2018. Favorable prior year development in both years reflects lower than expected utilization of medical services.
C. Unpaid Claims and Claim Expenses - Group Disability and Other and International Markets
Liabilities for unpaid claims and claim expenses within the group disability and life business reflect the following primary products: long-term and short-term disability, life insurance and accident coverages. The majority of the Company’s liability for disability claims consists of “disabled life reserves”, measured as the present value of estimated future benefit payments, including expected development, for each reported claim that is currently receiving benefit payments over the expected disability period or pending a decision on eligibility for benefits. The Company projects the expected disability period by using historical resolution rates combined with an analysis of current trends and operational factors to develop current estimates of resolution rates. Expected claim resolution rates may vary based upon the Company’s experience for the anticipated disability period, the covered benefit period, the cause of disability, the benefit design and the claimant’s age, gender and income level. The gross monthly benefit is reduced (offset) by disability income received under other benefit programs, most commonly Social Security Disability Income, workers’ compensation, statutory disability or other group benefit plans. The Company estimates the probability and amount of future offset awards and lapses based on the Company’s experience for certain offsets not yet finalized.
Long-term disability development tables. The table below presents information about incurred and paid claims development as of December 31, 2019 (net of reinsurance), total incurred but not reported liabilities and cumulative claims frequency for the Company’s long-term disability book of business. The information about incurred and paid claims development for the years ended 2012 through 2018 is presented as supplementary information and is unaudited. As permitted under GAAP, the Company presents development table information beginning in 2012 because obtaining information beyond this period was impracticable as historical data was not maintained in such detail
The following table reconciles the long-term disability net incurred and paid claims development table to the liability for unpaid claims and claim expenses in the Company’s Consolidated Balance Sheets as of December 31, 2019.
The following table presents the account value, net amount at risk and the number of 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 in excess of the contractholders’ account value if all contractholders died as of the specified date. The Company should be reimbursed in full for these payments unless the Berkshire reinsurance limit is exceeded.
Assumptions used in fair value measurement. GMIB assets and liabilities are established using capital market assumptions and assumptions related to future annuitant behavior (including mortality, lapse, and annuity election rates). The Company classifies GMIB assets and liabilities in Level 3 of the fair value hierarchy described in Note 12 because assumptions related to future annuitant behavior are largely unobservable.
Cigna’s investment portfolio consists of a broad range of investments including debt securities, equity securities, commercial mortgage loans, policy loans, other long-term investments, short-term investments and derivative financial instruments. The sections below provide more detail regarding our accounting policies, investment balances, net investment income and realized investment gains and losses. See Note 12 for information about valuing the Company’s investment portfolio. Debt securities, commercial mortgage loans, derivative financial instruments and short-term investments with contractual maturities during the next twelve months are classified on the balance sheet as current investments, unless they are held as statutory deposits or restricted for other purposes and then they are classified in long-term investments. Equity securities may include exchange traded funds that are used in our cash management strategy and classified as current investments. All other investments are classified as long-term investments. The following table summarizes the Company’s investments by category and current or long-term classification.
The Company records impairment losses in net income for debt securities with fair value below amortized cost that meet either of the following conditions:
If the Company intends to sell or determines that it is more likely than not to be required to sell these debt securities before their fair values recover, an impairment loss is recognized for the excess of the amortized cost over fair value.
If the net present value of projected future cash flows of a debt security (based on qualitative and quantitative factors, including the probability of default, and the estimated timing and amount of recovery) is below the amortized cost basis, that difference is recognized as an impairment loss. For mortgage and asset-backed securities, estimated future cash flows are also based on assumptions about the collateral attributes including prepayment speeds, default rates and changes in value.
The amortized cost and fair value by contractual maturity periods for debt securities were as follows at December 31, 2019:
Gross unrealized appreciation (depreciation) on debt securities by type of issuer is shown below.
The Company had commitments to purchase $98 million of debt securities as of December 31, 2019, bearing interest at a fixed market rate.
the Company’s intent to sell or the likelihood of a required sale prior to recovery.
Accounting policy. Changes in the fair values of equity securities that have a readily determinable fair value are reported in net realized investment gains (losses). As of December 31, 2019, the fair values of these securities were $64 million and cost was $61 million, compared with fair value of $415 million and cost of $433 million as of December 31, 2018. Private equity securities of $192 million as of December 31, 2019, and $89 million as of December 31, 2018, without a readily determinable fair value are carried at cost minus impairment, if any, plus or minus changes resulting from observable price changes. The amount of impairments or value changes resulting from observable price changes was not material.
Equity securities also include hybrid investments consisting of preferred stock with call features that are carried at fair value with changes in fair value reported in net realized investment gains (losses) and dividends reported in net investment income.As of December 31, 2019, fair values of these securities were $47 million and cost was $58 million, compared with fair value of $44 million and cost of $58 million as of December 31, 2018.
As of December 31, 2019, virtually all of the Company’s commercial mortgage loan portfolio is scheduled to mature in 2022 or thereafter. Actual maturities could differ from contractual maturities for several reasons, including that borrowers may have the right to prepay their obligations with or without prepayment penalties, the maturity date may be extended or loans may be refinanced.
Quality ratings are based on our evaluation of a number of key inputs related to the loan, including real estate market-related factors such as rental rates and vacancies, and property-specific inputs such as growth rate assumptions and lease rollover statistics. However, the two most significant contributors to the credit quality rating are the debt service coverage and loan-to-value ratios. The debt service coverage ratio measures the estimated amount of property cash flow available to meet annual interest and principal payments on debt, with a ratio below 1.0 indicating that there is not enough cash flow to cover the required loan payments. The loan-to-value ratio, commonly expressed as a percentage, compares the amount of the loan to the fair value of the underlying property
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, 2019 and 2018 is expected to be held longer than one year and may include real estate acquired through the foreclosure of commercial mortgage loans.
Additionally, other long-term investments include foreign currency swaps carried at fair value. See discussion below for information on the Company’s accounting policies for these derivative financial instruments.
Other long-term investments and related commitments are diversified by issuer, property type and geographic regions. The following table provides unfunded commitment and carrying value information for these investments. The Company expects to disburse approximately 30% of the committed amounts in 2020.
The Company uses derivative financial instruments to manage the characteristics of investment assets (such as duration, yield, currency and liquidity) to meet the varying demands of the related insurance and contract holder liabilities. The Company also uses derivative financial instruments to hedge the risk of changes in the net assets of certain of its foreign subsidiaries due to changes in foreign currency exchange rates. The Company has written and purchased GMIB reinsurance contracts in its run-off reinsurance business that are accounted for as freestanding derivatives as discussed in Note 10. Derivatives in the Company’s separate accounts are excluded from the following discussion because associated gains and losses generally accrue directly to separate account policyholders.
Derivative instruments used by the Company typically include foreign currency swap contracts and foreign currency forward contracts. Foreign currency swap contracts periodically exchange cash flows between two currencies for principal and interest. Foreign currency forward contracts require the Company to purchase a foreign currency in exchange for the functional currency of its operating unit at a future date, generally within three months from the contracts’ trade dates.
Gross fair values of our derivative financial instruments are presented in Note 12. As of December 31, 2019 and 2018, and for the years then ended, the effects of derivative instruments on the Consolidated Financial Statements were not material, including gains or losses reclassified from accumulated other comprehensive income into shareholders’ net income, as well as amounts excluded from the assessment of hedge effectiveness. The following table summarizes the types and notional quantity of derivative instruments held by the Company.
Net investment hedges of certain foreign subsidiaries that conduct their business principally in currencies other than the U.S. dollar: The fair values of the foreign currency swap and forward contracts are reported in other assets or other liabilities. The changes in fair values of these instruments are reported in other comprehensive income, specifically in translation of foreign currencies. The portion of the change in fair values relating to foreign exchange spot rates will be recognized in earnings upon deconsolidation of the hedged foreign subsidiaries. The remaining changes in fair value of these instruments are excluded from our effectiveness assessment and recognized in interest expense when coupon payments are accrued or ratably over the term of the instrument. The notional value of hedging instruments matches the hedged amount of subsidiary net assets. Cash flows relating to these contracts are reported in investing activities.
The Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders’ equity as of December 31, 2019 or 2018.
Net realized investment gains, excluding investment asset write-downs in 2019 and 2017 primarily represent gains on the sales of real estate partnerships and debt securities. Additionally, 2019 included mark-to-market gains and 2017 included gains on sales of equity securities. Net realized investment losses, excluding investment asset write-downs in 2018 represented mark-to-market losses on equity securities and derivatives, partially offset by gains on the sales of real estate partnerships. Realized gains or losses on equity securities still held at December 31, 2019 and 2018 were not material.
The Company’s financial assets and liabilities carried at fair value have been classified based upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). An asset’s or a liability’s classification is based on the lowest level of input that is significant to its measurement. For example, a financial asset or liability carried at fair value would be classified in Level 3 if unobservable inputs were significant to the instrument’s fair value, even though the measurement may be derived using inputs that are both observable (Levels 1 and 2) and unobservable (Level 3).
Debt and equity securities. Approximately 97% of the Company’s investments in debt and equity securities are classified in Level 2 including most public and private corporate debt and hybrid equity securities, federal agency and municipal bonds, non-government mortgage-backed securities and preferred stocks. Third-party pricing services and internal methods often use recent trades of securities with similar features and characteristics because many debt securities do not trade daily. Pricing models are used to determine these prices when recent trades are not available. These models calculate fair values by discounting future cash flows at estimated market interest rates. Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities based on the credit quality, industry and structure of the asset. Typical inputs and assumptions to pricing models include, but are not limited to, a combination of benchmark yields, reported trades, issuer spreads, liquidity, benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit rating.
Gains and losses included in other comprehensive income in the tables above 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. Transfers between Level 2 and Level 3 during 2019 and 2018 primarily reflected changes in liquidity and credit risk estimates for certain private placement issuers across several sectors.
Accounting policy. 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 recorded for related separate account liabilities. The investment income and fair value gains and losses of these accounts generally accrue directly 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. Investments that are measured using the practical expedient of NAV are excluded from the fair value hierarchy.
Separate account investments in securities partnerships, real estate, and hedge funds are generally valued based on the separate account’s ownership share of the equity of the investee (NAV as a practical expedient) including changes in the fair values of its underlying investments. Substantially all of these assets support the Cigna Pension Plans. The following table provides additional information on these investments.
Fair values of off-balance sheet financial instruments were not material as of December 31, 2019 or 2018.
When the Company becomes involved with a variable interest entity and when there is a change in the Company’s involvement with an entity, the Company must determine if it is the primary beneficiary and must consolidate the entity. The Company is considered the primary beneficiary if it has the power to direct the entity’s most significant economic activities and has the right to receive benefits or obligation to absorb losses that could be significant to the entity. The Company evaluates the following criteria:
the risks and rewards created by, and shared through, the entity; and
The Company determined it was not a primary beneficiary in any material variable interest entities as of December 31, 2019 or 2018. The Company’s involvement in variable interest entities for which it is not the primary beneficiary is described below.
Securities limited partnerships and real estate limited partnerships. The Company owns interests in securities limited partnerships and real estate limited partnerships that are defined as variable interest entities. These partnerships invest in the equity or mezzanine debt of privately-held companies and real estate properties. General partners unaffiliated with the Company control decisions that most significantly impact the partnership’s operations and the limited partners do not have substantive kick-out or participating rights. The Company’s maximum exposure to loss from these entities of $3.4 billion across approximately 140 limited partnerships as of December 31, 2019 includes $1.8 billion reported in long-term investments and commitments to contribute an additional $1.6 billion. The Company’s noncontrolling interest in each of these limited partnerships is generally less than 15% of the partnership ownership interests.
The Company is involved with various other variable interest entities with immaterial carrying values and maximum exposures to loss.
The Company has not provided, and does not intend to provide, financial support to any of the above entities that it is not contractually required to provide. The Company performs ongoing qualitative analyses of its involvement with these variable interest entities to determine if consolidation is required.
AOCI includes unrealized appreciation on securities and derivatives (excluding appreciation on investments supporting future policy benefit liabilities of the run-off settlement annuity business), foreign currency translation and the net postretirement benefits liability adjustment (see Note 16). AOCI includes the Company’s share from unconsolidated entities reported on the equity method. Generally, tax effects in AOCI are established at the currently enacted tax rate and reclassified to net income in the same period that the related pre-tax AOCI reclassifications are recognized. Changes in the components of AOCI were as follows:
The Company is continuously evaluating ways to deliver our products and services more efficiently and at a lower cost. During the fourth quarter of 2019, we committed to a plan to increase our organizational alignment, operational efficiency and reduce costs. As a result, we recognized a charge in selling, general and administrative expenses of $207 million pre-tax ($162 million after-tax) in the fourth quarter of 2019 primarily for severance costs related to headcount reductions. We expect most of the severance to be paid by the end of 2021.
For balance sheet purposes, we measure plan assets at fair value. When the actual return differs from the expected return, those differences are reflected in the net unrealized actuarial gain (loss) discussed above. However, to measure pension benefit costs, we use a “market-related” asset valuation that differs from the actual fair value for domestic pension plan assets invested in non-fixed income investments. The “market-related” value recognizes the difference between actual and expected long-term returns in the portfolio over five years, a method that reduces the short-term impact of market fluctuations on pension costs. The market-related asset value was approximately $4.2 billion, compared with a fair value of approximately $4.4 billion at December 31, 2019.
The following table summarizes the projected benefit obligations and assets related to our U.S. and non-U.S. pension plans as of, and for the years ended, December 31.
We fund our qualified pension plans at least at the minimum amount required by the Employee Retirement Income Security Act of 1974 and the Pension Protection Act of 2006. The Company made immaterial contributions to the qualified pension plans in 2019. For 2020, contributions to the qualified pension plans are expected to be immaterial. Future years’ contributions will ultimately be based on a wide range of factors including but not limited to asset returns, discount rates and funding targets. There are no plan assets for our non-qualified pension plans as they are generally funded on a pay-as-you-go basis.
As further discussed in Note 22, Old Cigna and the Cigna Pension Plan (the “Plan”) are defendants in a class action lawsuit related to the Plan’s conversion of certain employees from an annuity to a cash balance benefit in 1997. In the fourth quarter of 2018, the Plan was ordered to pay $32 million representing the attorney fee portion of the settlement. This payment was recognized as an expense in 2018. In the first quarter of 2019, the Plan implemented the court order described in Note 22 resulting in an increase to the pension liability of $142 million. The Company reversed a litigation reserve for the expenses recognized for this matter in both 2019 and 2018 aggregating to the same amount resulting in no impact on net income.
In 2019, to better align with our mortality experience, the Company adopted the “White Collar mortality table with MP 2019 projection scale” to value our benefit obligations.
The fair values of pension assets by category are as follows as of December 31, 2019 and 2018.
The Company’s current target investment allocation percentages (60% fixed income, 25% public equity securities and 15% in other investments, including private equity (securities partnerships) 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 other investments and increase the allocation to fixed income investments as funding levels improve.
The Company sponsors a 401(k) plan in which the Company matches a portion of employees’ pre-tax contributions. Participants in the plan may invest in various funds that invest in the Company’s common stock, several diversified stock funds, a bond fund or a fixed-income fund.
The Company may elect to increase its matching contributions if the Company’s annual performance meets certain targets. The Company’s annual expense for these plans was as follows:
Accounting policy. The Company awards options to purchase Cigna common stock at the market price of the stock on the grant date except for rollover option awards issued to Express Scripts employees in connection with the acquisition. Options vest over periods ranging from one year to three years and expire no later than 10 years from grant date. Fair value is estimated using the Black-Scholes option-pricing model by applying the assumptions presented below. That fair value is reduced by options expected to be forfeited during the vesting period. The Company estimates forfeitures at the grant date based on our experience and adjusts the expense to reflect actual forfeitures over the vesting period. The fair value of options, net of forfeitures, is recognized in selling, general and administrative expenses on a straight-line basis over the vesting period.
Black-Scholes option-pricing model assumptions and the resulting fair value of options are presented in the following table. The average fair value of options and the expected option life exclude the rollover options granted to Express Scripts employees in connection with the acquisition. See Note 4 for further information.
The expected volatility reflects the past daily stock price volatility of Cigna stock. The Company does not consider volatility implied in the market prices of traded options to be a good indicator of future volatility because remaining traded options will expire within one year. The risk-free interest rate is derived using the four-year U.S. Treasury bond yield rate as of the award date for the primary annual grant. Expected option life reflects the Company’s historical experience.
Compensation expense of $64 million related to unvested stock options at December 31, 2019 will be recognized over the next two years (weighted average period).
The Company awards SPSs to executives and certain other key employees generally with a performance period of three years. Half of these shares are subject to a market condition (total shareholder return relative to industry peer companies) and half are subject to a performance condition (cumulative adjusted net income). These targets are set by the Committee at the beginning of the performance period. Holders of these awards receive shares of Cigna common stock at the end of the performance period ranging anywhere from 0 to 200% of the original awards.
Approximately 1,600 employees held 818,000 SPSs at the end of 2019 and $58 million of related compensation expense is expected to be recognized over the next two years. The amount of expense for “performance condition” SPSs will vary based on actual performance in 2020 and 2021.
Accounting policy. 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, based on those reporting units’ relative fair values. As a result, goodwill is primarily reported in the Health Services segment ($33.7 billion), the Integrated Medical segment ($10.5 billion) and, to a lesser extent, the International Markets segment ($0.4 billion).
Goodwill activity. Goodwill activity during 2019 and 2018 was as follows:
The significant increase in goodwill during 2018 reflects the Company’s acquisition of Express Scripts as further discussed in Note 4.
The Company’s amortized intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the total of the expected future undiscounted cash flows generated by the underlying asset group is less than the carrying amount of the asset group, the Company recognizes an impairment charge equal to the difference between the carrying value of the asset group and its estimated fair value. The Company’s indefinite-lived intangible assets are each reviewed for impairment at least annually by comparing their fair value with their carrying value. If the carrying value exceeds fair value, that excess is recognized as an impairment loss.
The Company has indefinite-lived intangible assets totaling $8.4 billion at December 31, 2019 and 2018, largely consisting of trade names and licenses.
Accounting policy. Property and equipment is carried at cost less accumulated depreciation. Cost includes interest, real estate taxes and other costs incurred during construction when applicable. Internal-use software that is acquired, developed or modified solely to meet the Company’s internal needs, with no plan to market externally, is also included in this category. Costs directly related to acquiring, developing or modifying internal-use software are capitalized.
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, three 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. An impairment charge is recorded if the Company determines the carrying value of any of these assets is not recoverable. The Company also reviews and shortens the estimated useful lives of these assets, if necessary.
These lease assets and liabilities are recognized at the lease commencement date based on the present value of the lease payments over the lease term. Most of the Company’s leases do not provide an implicit rate, so the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The ROU asset also includes any lease pre-payments made and excludes lease incentives for operating leases. The Company’s expected life of a lease may consider options to extend or terminate a lease when it is reasonably certain that the Company will exercise that option.
Rental expense under operating lease agreements was $162 million for the years ended December 31, 2018 and 2017.
The non-cash impact of adopting the new lease guidance was an increase of Other assets of $615 million and an increase to Accrued expenses and other liabilities of $630 million.
The Company’s HMO and life, accident and health insurance subsidiaries are also 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 their parent companies without prior approval. As of December 31, 2019, these amounts, including restricted GAAP net assets of the Company’s subsidiaries, were as follows:
Consolidated pre-tax income from the Company’s foreign operations was approximately 12% of the Company’s pre-tax income in 2019. The comparable amounts in prior years were 15% in 2018 and 14% in 2017. South Korean operations produced a majority of the Company’s foreign pre-tax earnings.
Substantially all unrecognized tax benefits would impact shareholders’ net income if recognized. The increase in the liability for uncertain tax positions from 2017 to 2018 was largely due to matters related to Health Services.
The Company classifies net interest expense on uncertain tax positions as a component of income tax expense, but excludes this amount from the disclosed liability for uncertain tax positions. The liability for net interest expense on uncertain tax positions was approximately $100 million as of December 31, 2019, and immaterial for the prior two years.
The Company guarantees that separate account assets will be sufficient to pay certain life insurance or retiree benefits. For the majority of these 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. If employers fail to do so, the Company or an affiliate of the buyer of the retirement benefits business (Prudential Retirement Insurance and Annuity Company or “Prudential”) has the right to redirect the management of the related assets to provide for benefit payments. As of December 31, 2019, employers maintained assets that exceeded the benefit obligations under these arrangements of approximately $450 million. These guarantees are generally provided by the Company with minimal reinsurance from third parties. An additional liability is established if management believes that the Company will be required to make payments under the guarantees; there were no additional liabilities required for these guarantees, net of reinsurance, as of December 31, 2019. Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the GAAP fair value hierarchy (see Note 12).
these indemnification obligations are subject to limitation. There were no liabilities for these indemnification obligations as of December 31, 2019.
The Company operates in a regulatory environment that may require its participation in assessments under state insurance guaranty association laws. The Company’s exposure to assessments for certain obligations of insolvent insurance companies to policyholders and claimants is based on its share of business written in the relevant jurisdictions.
Pending litigation and legal or regulatory matters that the Company has identified with a reasonable possibility of material loss are described below. For material pending litigation and legal or regulatory matters discussed below, the Company provides disclosure in the aggregate of accruals and range of loss, or a statement that such information cannot be estimated. The Company’s accruals for the matters discussed below under “Litigation Matters” and “Regulatory Matters” are immaterial. 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. The outcomes of lawsuits are inherently unpredictable, and we may be unsuccessful in these ongoing litigation matters or any future claims or litigation.
Cigna Litigation with Anthem. In February 2017, the Company delivered a notice to Anthem terminating the 2015 merger agreement, and notifying Anthem that it must pay the Company the $1.85 billion reverse termination fee pursuant to the terms of the merger agreement. Also in February 2017, the Company filed suit against Anthem in the Delaware Court of Chancery (the “Chancery Court”) seeking declaratory judgments that the Company’s termination of the merger agreement was valid and that Anthem was not permitted to extend the termination date. The complaint also sought payment of the reverse termination fee and additional damages in an amount exceeding $13 billion, including the lost premium value to the Company’s shareholders caused by Anthem’s willful breaches of the merger agreement. Anthem countersued, alleging its own claims for damages.
The litigation between the parties remains pending. A trial was held during the first quarter of 2019. Oral arguments on post-trial briefs were held on November 26, 2019. In February 2020, the Chancery Court issued a letter requesting certain supplemental briefing. The supplemental briefs are due March 6, 2020. We believe in the merits of our claims and dispute Anthem’s claims, and we intend to vigorously defend ourselves and pursue our claims.
See Note 1 for a description of our segments. Effective with the first quarter of 2019, the Company began allocating compensation cost for stock options to the segments. Prior year segment information was not restated for this change. A description of our basis for reporting segment operating results is outlined below. Intersegment transactions primarily reflect pharmacy sales to insured customers of the Integrated Medical segment. These and other transactions are eliminated in consolidation.
Results of transitioning clients because those results are not indicative of ongoing results
Special items, if any, that management believes are not representative of the underlying results of operations due to the nature or size of these matters.
The Company does not report total assets by segment since this is not a metric used to allocate resources or evaluate segment performance.
The following tables present the special items recorded by the Company in 2019, 2018 and 2017.
Revenue from external customers includes pharmacy revenues, premiums and fees and other revenues. The following table presents these revenues by product, premium and service type for the twelve months ended December 31:
The following unaudited quarterly financial data is presented on a consolidated basis for each of the years ended December 31, 2019 and December 31, 2018. Quarterly financial results necessarily rely heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the insurance business, suggest the need to exercise caution in drawing specific conclusions from quarterly consolidated results.