Our principal, domestic office locations, including staff support operations, along with CIGNA Disability and Life Insurance, the domestic office of CIGNA International, and CIGNA HealthCare, are the Wilde Building located at 900 Cottage Grove Road in Bloomfield, Connecticut and Two Liberty Place located at 1601 Chestnut Street in Philadelphia, Pennsylvania. The Wilde Building is owned with approximately 825,000 square feet and Two Liberty Place contains approximately 460,000 square feet of leased office space.
Beginning in 2010, the Company began reporting the expense associated with its frozen pension plans in Corporate. Prior periods were not restated. The effect on prior periods was not material.
In 2008, the Company recorded significant charges related to the guaranteed minimum income benefits and guaranteed minimum death benefits businesses as well as an after-tax litigation charge of $52 million in Corporate related to the CIGNA pension plan. For additional information, see the Run-off Reinsurance section of the Management’s Discussion and Analysis beginning on page 75 and Note 24 to the Consolidated Financial Statements.
During 2007, CIGNA completed a three-for-one stock split of CIGNA’s common shares. Per share figures for 2006 reflect the stock split. Pro forma common shares outstanding, calculated as if the stock split had occurred at the beginning of 2006, were 295,963 in 2006.
Adjusted income from operations increased significantly in 2010, reflecting focused execution of the Company’s business strategy, which includes a growing global customer base.
During 2010, the Company entered into several transactions to position itself to execute on its strategy as well as to strengthen its liquidity and financial condition.
The recent acquisition of Vanbreda International in the third quarter of 2010 positions the Company to be a global leader in the delivery of expatriate benefits.
The Company retired portions of its long-term debt through a tender offer process, and issued replacement debt at a significantly lower interest rate.
Shareholders’ equity increased substantially during 2010, reflecting strong shareholders’ net income as well as increased invested asset values (primarily fixed maturities) reflecting lower market yields. Those favorable impacts were partially offset by the unfavorable effects of the pension plan liability on shareholders’ equity due to changes in the discount rate and mortality assumptions. The Company’s commercial mortgage loan portfolio continued to perform well, with minimal write-downs and stabilizing real estate valuations.
As a global health service organization, CIGNA’s mission is to help the people it serves improve their health, well-being and sense of security. As part of this mission, the Company remains committed to health advocacy as a means of creating sustainable solutions for employers, improving the health of the individuals that the Company serves, and lowering the costs of health care for all constituencies.
“Go deep” with growth in targeted customer segments, geographies, buying segments and distribution channels;
“Go individual” by delivering high quality products and services which improve health, wellness and insurance needs that are helpful and easy to use; and
In the Disability and Life segment, CIGNA’s strategy is to grow its Disability business by fully leveraging the key components of its industry-leading disability management model to reduce costs for its clients and return their employees to work sooner through: (1) effective customer engagement and early outreach; (2) a full suite of clinical and return-to-work resources to support the employer’s ability to manage disability and work related events; and (3) specialized case management services that address an individual’s unique needs.
See the “Run-off operations” section below for further discussion of the Company’s actions to manage its balance sheet exposures. The Company’s operational strategies are discussed further in the Health Care segment section of the MD&A beginning on page 63.
The Company’s ability to increase revenue, shareholders’ net income and operating cash flows from ongoing operations is directly related to progress on the execution of its strategy as described above as well as other key factors, including the Company’s ability to:
developments in the political environment both domestically and internationally, including U.S. health care reform;
The Company’s run-off reinsurance operations have significant exposures, primarily for its guaranteed minimum death benefits (“GMDB”, also known as “VADBe”) and guaranteed minimum income benefits (“GMIB”) products. As part of its strategy to effectively manage these exposures, the Company operates an equity hedge program to substantially reduce the impact of equity market movements on the liability for the GMDB business. The Company actively monitors the performance of the hedge program, and evaluates the cost/benefit of hedging other risks, including interest rate risk.
These products are also influenced by a range of economic and behavioral factors that were not hedged as of December 31, 2010, including:
actively studies policyholder behavior experience and adjusts future expectations based on the results of the studies, as warranted;
implemented a partial hedge in February 2011 for a portion of the equity market risk for GMIB contracts and a portion of the interest rate risk for GMDB and GMIB contracts, and will continue to evaluate further adjustments to the hedging program;
In the first quarter of 2010, the Patient Protection and Affordable Care Act, including the Reconciliation Act of 2010, (“Health Care Reform”) was signed into law. Health Care Reform mandates broad changes in the delivery of health care benefits that may impact the Company’s current business model, including its relationship with current and future customers, producers and health care providers, products, services, processes and technology. Health Care Reform includes, among others, provisions for mandatory coverage of benefits, a minimum medical loss ratio for insured business, eliminates lifetime and annual benefit limits and creates health insurance exchanges. The provisions of the law take effect over the next several years from 2010 to 2018. Many provisions of Health Care Reform have become effective during 2010, and interim final regulations have been issued, however there are still many provisions which have yet to become effective, and it is possible that the ultimate impact of Health Care Reform could have a material impact on the Company’s results of operations. The Company is evaluating potential business opportunities resulting from Health Care Reform that will enable it to leverage the strengths and capabilities of its broad health and wellness portfolio.
During 2010, the Company incurred total after-tax costs of approximately $25 million related to Health Care Reform comprised of:
$10 million of additional income tax related to the impact of the tax law changes as described previously, and
$15 million of costs related to building the infrastructure necessary to comply with the provisions of Health Care Reform which were effective in 2010 and 2011 of which $7 million were incremental costs. The remaining $8 million reflected the estimated cost of internal staff redeployed to work on Health Care Reform initiatives.
Management is currently unable to estimate the full impact of Health Care Reform on the Company’s future results of operations, and its financial condition and liquidity due to uncertainties related to interpretation, implementation and timing of its many provisions. It is possible; however, that this impact could be material to future results of operations. Management, through its internal task force, continues to closely monitor implementation of the law, report on the Company’s compliance with Health Care Reform, actively engage with regulators to assist with the ongoing conversion of legislation to regulation and assess potential opportunities arising from Health Care Reform.
In line with its growth strategy, the Company has strengthened its market position and reduced balance sheet exposures through the following acquisition and disposition transactions.
On April 1, 2008, the Company acquired the Health care division of Great-West Life and Annuity, Inc. (“Great-West Healthcare”). See Note 3 to the Consolidated Financial Statements for additional information.
As part of its strategy, the Company has undertaken several initiatives to realign its organization and consolidate support functions in an effort to increase efficiency and responsiveness to customers and to reduce costs.
The Company measures the financial results of its segments using “segment earnings (loss)”, which is defined as shareholders’ income (loss) from continuing operations before after-tax realized investment results. Adjusted income from operations is defined as consolidated segment earnings (loss) excluding special items (defined below) and the results of the GMIB business. Adjusted income from operations is another measure of profitability used by the Company’s management because it presents the underlying results of operations of the Company’s businesses and permits analysis of trends in underlying revenue, expenses and shareholders’ net income. This measure is not determined in accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP measure, which is shareholders’ income from continuing operations.
Summarized below is a reconciliation between shareholders’ income from continuing operations and adjusted income from operations.
the favorable year over year impact of the following special items as detailed in the table above: completion of the IRS examination; the curtailment gain on the pension plan; and the absence of litigation charges in 2009.
a gain resulting from the resolution of a federal income tax matter, consisting of a $97 million release of a deferred tax valuation allowance and $4 million of accrued interest. See Note 20 for further information;
Special items for 2009 included a curtailment gain resulting from the decision to freeze the pension plan (see Note 10 to the Consolidated Financial Statements for additional information), cost reduction charges related to the 2008 cost reduction program (see the Introduction section of the MD&A beginning on page 47 of this Form 10-K), and benefits resulting from the completion of the 2005 and 2006 IRS examinations (see Note 20 to the Consolidated Financial Statements for additional information).
The Company expects 2011 adjusted income from operations to be approximately level with 2010. This outlook includes an assumption that GMDB (also known as “VADBe”) results will be approximately break-even for 2011, which assumes that actual experience, including capital market performance, will be consistent with long-term reserve assumptions. See Note 7 to the Consolidated Financial Statements and the Critical Accounting Estimates section of this MD&A beginning on page 57 for more information on the potential effect of capital market and other assumption changes on shareholders’ net income.
Information is not available for management to reasonably estimate the future results of the GMIB business or realized investment results due in part to interest rate and stock market volatility and other internal and external factors. In addition, the Company is not able to identify or reasonably estimate the financial impact of special items in 2011 however they may include potential adjustments associated with cost reduction, litigation, tax and assessment-related matters.
Net investment income increased by 9% in 2010, compared with 2009, primarily reflecting improved results from security partnerships and real estate investments and higher assets due to business growth, partially offset by lower reinvestment yields.
Net investment income decreased by 5% in 2009, compared with 2008, primarily reflecting lower income from real estate investments and security partnerships, unfavorable foreign exchange rates and lower investment yields, partially offset by higher invested assets due to business growth.
gains on sales of real estate held in joint ventures and other investments in 2010.
These favorable effects were partially offset by an increase in commercial mortgage loan impairments recorded in 2010, reflecting continued weakness in the commercial real estate market.
lower asset write-downs on fixed maturities largely reflecting improved market conditions;
gains on hybrid securities in 2009 compared with losses in 2008 (changes in fair value for these securities are reported in realized investment results).
Management has discussed the development and selection of its critical accounting estimates with the Audit Committee of the Company’s Board of Directors and the Audit Committee has reviewed the disclosures presented below.
See Note 2 to the Consolidated Financial Statements for further information on significant accounting policies that impact the Company.
Future policy benefits - Guaranteed minimum death benefits (“GMDB” also known as “VADBe”)
Interest rates: include both: (a) the mean investment performance assumption, and (b) the liability discount rate assumption. The mean investment performance for underlying equity mutual funds considers the Company’s GMDB equity hedge program which reflects the average short-term interest rate to be earned over the life of the program and considers the current low level of interest rates. The mean investment performance for underlying fixed income mutual funds considers the expected market return over the life of the contracts.
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.
Despite reflecting both historical and emerging trends in setting reserves, it is possible that the actual medical trend for the current period will develop differently from the expected, which could have a material impact on the Company’s medical claims payable and shareholders’ net income.
Accounts payable, accrued expenses and other liabilities, and Other assets, including other intangibles - Guaranteed minimum income benefits
Capital market inputs include market returns and discount rates, claim interest rates and market volatility. This group of assumptions is largely based on market-observable inputs.
Annuity election rates: the proportion of annuitants who elect to receive their income benefit as an annuity.
Lapse: the full surrender of an annuity prior to annuitization of the policy.
Risk and profit charge: the amount that a hypothetical market participant would include in the valuation to cover the uncertainty of outcomes and the desired return on capital.
If credit default swap spreads used to evaluate the nonperformance risk of the Company were to narrow or the credit rating of its principal life insurance subsidiary were to improve, it would cause a decrease in the discount rate of the GMIB liability, resulting in an unfavorable impact to earnings. If the discount rate decreased by 25 bps due to this, the decrease in shareholders’ net income would be approximately $10 million.
All of these estimated impacts due to unfavorable changes in assumptions could vary from quarter to quarter depending on actual reserve levels, the actual market conditions or changes in the anticipated view of a hypothetical market participant as of any future valuation date.
Using past experience, the Company expects that it is reasonably possible that a favorable or unfavorable change in these key assumptions of 50 basis points could occur. An unfavorable change is a decrease in these key assumptions with resulting impacts as discussed below.
the accrued pension benefit liability would increase by approximately $225 million as of December 31, 2010 resulting in an after-tax decrease to shareholders’ equity of approximately $145 million as of December 31, 2010.
If the December 31, 2010 fair values of domestic qualified plan assets decreased by 10%, the accrued pension benefit liability would increase by approximately $315 million as of December 31, 2010 resulting in an after-tax decrease to shareholders’ equity of approximately $205 million.
The Company’s evaluation of the likelihood of collecting all contractual payments and the collateral fair value for commercial mortgage loans is a qualitative and quantitative process which is subject to uncertainties. The Company carefully evaluates all facts and circumstances for each loan and its supporting collateral.
When evaluating the likelihood of collecting the contractual payments of a commercial mortgage loan, the Company considers factors including:
conditions and factors pertinent to the property and its local market.
The Company recognized impairment losses from commercial mortgage loan valuation reserves as follows (in millions, after-tax):
If property values declined by 10% across the commercial mortgage loan portfolio as of December 31, 2010, approximately 18% of the portfolio’s loans would have carrying values in excess of their underlying properties’ fair values totaling approximately $80 million. And if each of these loans were considered impaired as of December 31, 2010, shareholders’ net income would decrease by approximately $52 million after-tax.
If underlying property values declined by 10% for impaired commercial mortgage loans with valuation reserves as of December 31, 2010, shareholders’ net income would decrease by approximately $2 million after-tax.
a lower guaranteed cost medical care ratio driven by lower medical cost trend, reflecting lower utilization levels, as well as favorable prior year development; and
higher stop loss earnings largely from the Great-West Healthcare acquisition (effective April 1, 2008), tempered by lower margins on the remaining book; and
lower guaranteed cost earnings primarily reflecting a higher medical care ratio driven by unfavorable prior year development, as well as higher in-year claims due, in part to H1N1 flu-related claims; and
lower investment income primarily reflecting lower income from real estate funds.
Premiums and fees increased by 17% in 2010 (10% excluding the Medicare PFFS Individual business, which the Company has exited beginning in 2011), compared with 2009, primarily reflecting membership growth in most risk-based products, including Medicare, and to a lesser extent rate increases. The membership growth was driven by strong retention and new sales in targeted market segments. The increase in fees primarily reflects growth in specialty products. These increases reflect the success of the Company’s efforts to enhance customer access, improve the quality of care and provide cost effective products and services.
Premiums and fees decreased 2% in 2009, compared with 2008, primarily reflecting lower membership largely due to disenrollment resulting from higher unemployment. This impact was partially offset by:
the impact of the Great-West Healthcare acquisition (effective April 1, 2008).
Other revenues for the Health Care segment consist of revenues earned on direct channel sales of certain specialty products, including behavioral health and disease management.
Medical claims expense increased by 24% in 2010 (13% excluding the Medicare PFFS Individual business, which the Company has exited beginning in 2011), compared with 2009 largely due to higher medical membership, particularly in the commercial risk and Medicare PFFS Individual business, the latter resulted in an increase of approximately $725 million for the year ended December 31, 2010 compared with last year. The increase also reflects medical cost inflation.
is covered under an insurance policy that is (i) marketed by the Company, and (ii) for which the Company assumes reinsurance of at least 50%.
The Health Care segment’s medical membership increased 3.6% as of December 31, 2010 when compared with December 31, 2009. The increase was primarily driven by new business sales in targeted market segments: middle market, select and individual, as well as improved persistency in the risk businesses and lower disenrollment across all funding arrangements. The net decrease in the Health Care segment’s medical membership was 5.5% as of December 31, 2009 when compared with December 31, 2008. The decrease was primarily driven by disenrollment across all funding arrangements as a result of higher unemployment.
The Company is focused on delivering consistent, reliable and superior service to customers, health care professionals and clients. The Company believes that further enhancing service can improve customer retention and, when combined with useful health information and tools, can help motivate customers to become more engaged in their personal health. This will help to promote healthy outcomes thereby removing cost from the health care system. The evolution of the consumer-driven health care market is driving increased product and service complexity and is raising customers’ expectations with respect to service levels, which is expected to require significant investment, management attention and heightened interaction with customers.
The Health Care segment is focused on market segment and product expansion. With respect to market segment expansion, the focus is predominantly in the “Middle Market” (employers with generally more than 250 but fewer than 5,000 employees), “Select” (employers with generally more than 50 but fewer than 250 employees), and “Individual” market segments. The Health Care segment is focusing on several strategic growth industries and targeting key geographic markets within the Select and Middle Market segments that align with our competitive strengths. The Health Care segment expects to grow its presence in these market segments by leveraging its customer knowledge, differentiated service model, product portfolio and distribution model. The Health Care segment continues to increase its penetration into the Individual market segment and will refine its strategy for this market segment based on the evolution of health care reform. In the “National” market segment (multi-site, multi-state commercial employers with generally more than 5,000 employees), the Company will selectively focus on clients that value its differentiated product offering. These clients include those seeking engagement and incentive based programs designed to improve health, and those that purchase multiple products and services from a single company.
The Health Care segment operates under a centralized medical management model, which helps improve the health, well being and sense of security of its members, while reducing infrastructure expenses and driving productivity.
The Company operates in an intensely competitive marketplace. The Company continues to be focused on improving its operating expense efficiency while balancing strategic investments to achieve its enterprise strategy. Within the Health care segment, the Company is focused on driving operating efficiency within its primary operating functions while investing prudently in technology, segment expansion and specialty products expense.
The specialty and market segment expansion and the premium tax/commission expense components would increase over time as revenues grow. Specialty includes disease management, pharmacy, dental, behavioral, and seniors coverages.
The Health Care segment expects to drive efficiencies and competitively manage its operating expenses while remaining focused on its other business strategies including investing in areas that are critical to the Company’s growth initiatives and segment expansions, ensuring continued excellence in customer service and clinical programs, and leveraging technology to drive further operating efficiencies.
The Disability and Life segment includes group disability, life, accident and specialty insurance.
less favorable claims experience in the disability insurance business, primarily related to lower short-term disability underwriting margins. These results include the favorable after-tax impact of disability reserve studies of $29 million in 2010 compared with $20 million in 2009, which reflect continued strong disability claims management programs;
improved claims experience in the accident business including the more favorable after-tax impact of reserve studies of $5 million in 2009 compared with $3 million in 2008; and
Benefits and expenses increased 2% in 2010 compared with 2009, primarily reflecting:
the Company’s exit from two large, non-strategic assumed government life insurance programs and the sale of the renewal rights for the student and participant accident business.
more favorable accident claim experience, driven by lower new claims; and
Excluding the impact of the tax adjustments discussed below and foreign currency movements (presented in the table above), the International segment’s adjusted income from operations increased 25% for 2010, compared with 2009. The increase was primarily due to strong revenue growth and higher persistency in the supplemental health, life and accident insurance business, particularly in South Korea, as well as favorable loss ratios and membership growth in the expatriate employee benefits business and higher net investment income, partially offset by higher administrative expenses. Both businesses continue to deliver attractive margins.
Loss ratios were higher in the supplemental health, life and accident insurance business in 2010, compared with 2009, reflecting less favorable claims experience. Loss ratios were lower in the expatriate benefits business in 2010, compared with 2009, reflecting favorable claim experience and rate increases on renewal business.
Expense ratios increased in 2010, compared with 2009, reflecting the acquisition costs associated with the purchase of Vanbreda International as well as the impact of the higher expense ratios associated with the acquired business. Expense ratios decreased in 2009, compared with 2008, reflecting effective expense management.
The Company’s reinsurance operations were discontinued and are now an inactive business in run-off mode since the sale of the U.S. individual life, group life and accidental death reinsurance business in 2000. This segment is predominantly comprised of GMDB, GMIB, workers’ compensation and personal accident reinsurance products. On December 31, 2010, the Company essentially exited from its workers compensation and personal accident reinsurance business by purchasing retrocessional coverage from a Bermuda subsidiary of Enstar Group Limited and transferring the ongoing administration of this business to the reinsurer. The 2010 special item loss reflects the after-tax costs of this transaction.
The determination of liabilities for GMDB and GMIB requires the Company to make critical accounting estimates. In 2008, the Company updated the assumptions for GMIB and the effects of hypothetical changes in those assumptions in connection with the implementation of the FASB’s fair value disclosure and measurement guidance (ASC 820). The Company describes the assumptions used to develop the reserves for GMDB in Note 7 to the Consolidated Financial Statements and for the assets and liabilities associated with GMIB in Note 11 to the Consolidated Financial Statements. The Company also provides the effects of hypothetical changes in those assumptions in the Critical Accounting Estimates section of the MD&A beginning on page 57 of this Form 10-K.
Segment earnings declined significantly in 2010 compared with 2009, primarily due to the reduction in earnings from the GMIB business, partially offset by the gain resulting from the resolution of a federal tax matter.
Adjusted income from operations for Run-off Reinsurance improved significantly in 2009 compared with 2008 due to significantly reduced charges in the GMDB business to strengthen reserves ($47 million after-tax for 2009, compared with $263 million for 2008) resulting from a substantially lower amount of reserve strengthening. The improvement in GMDB results in 2009 primarily reflected the recovery and stabilization of the financial markets. Adjusted income from operations also included the favorable after-tax impact of reserve studies for the workers compensation and personal accident business of $16 million in 2009 and $30 million in 2008.
GMIB fair value (gain) loss. Under the GAAP guidance for fair value measurements, the Company’s results of operations are expected to be volatile in future periods because capital market assumptions needed to estimate the assets and liabilities for the GMIB business are based largely on market-observable inputs at the close of each reporting period including interest rates (LIBOR swap curve) and market-implied volatilities. See Note 11 to the Consolidated Financial Statements for additional information about assumptions and asset and liability balances related to GMIB.
GMIB fair value gains of $304 million for 2009, were primarily due to increases in interest rates and increases in underlying account values in the period resulting from favorable equity market and bond fund returns, resulting in reduced exposures. These favorable effects were partially offset by increases to the annuitization assumption and updates to the lapse assumptions.
The reduction in benefits expense in 2010 and 2009 reflects favorable equity market performance, while the increase in 2008 reflects the significant decline in equity markets. As explained in Other revenues above, these changes do not affect shareholders’ net income because they are offset by gains or losses on futures contracts used to hedge equity market performance.
The increases were due to the reduced favorable impacts of reserve studies in each successive year, and additionally for 2010, the reduced impact of favorable settlements and commutations.
COLI has contributed the majority of earnings in Other Operations for the periods presented and management expects this trend to continue in future periods as deferred gain amortization continues to decline from the sold businesses. The COLI regulatory environment continues to evolve, with various federal budget related proposals recommending changes in policyholder tax treatment. In addition, provisions of the Dodd-Frank financial reform legislation may limit the ability of some financial institutions to hold certain types of COLI contracts. Although regulatory and legislative activity could adversely impact our business and policyholders, management does not expect the impact to materially affect the Company’s results of operations, liquidity or financial condition.
Adjusted income from operations for Other Operations was flat in 2010 compared with 2009, reflecting an increase in COLI earnings driven by higher investment income and favorable mortality, primarily offset by the continued decline in deferred gain amortization associated with the sold businesses.
Net investment income decreased 1% in 2010 compared with 2009, primarily reflecting lower yields, offset by higher average invested assets of the COLI business and improved income from real estate and security partnerships. Net investment income decreased 2% in 2009 compared with 2008 primarily reflecting lower average invested assets and lower real estate income.
Corporate’s adjusted loss from operations was higher in 2010, compared with 2009, primarily reflecting:
pension expense related to the Company’s frozen pension plans which was reported in Corporate beginning in 2010.
These unfavorable effects were partially offset by lower spending on strategic initiatives and lower directors’ deferred compensation expense.
Corporate’s adjusted loss from operations was higher in 2009, compared with 2008, primarily reflecting:
higher net interest expense attributable to lower average invested assets and increased debt used for general corporate purposes, including the repayment of some of the Company’s outstanding commercial paper issued to finance the acquisition of Great West Healthcare;
For the year ended December 31, 2010, cash flows from operating activities were greater than net income by $394 million. Net income contains certain income and expense items which neither provide nor use operating cash flow, including:
tax benefits related to resolution of a federal tax matter of $101 million;
Cash flows from operating activities were greater than net income excluding the items noted above by $192 million. Excluding cash outflows of $157 million associated with the GMDB equity hedge program, (which did not affect shareholders’ net income) cash flows from operating activities were higher than net income by $349 million. This result primarily reflects premium growth in the Health Care segment’s risk businesses due to significant new business in 2010 and tax payments lower than expense due to favorable effects of benefit plans (primarily pension) and deferred foreign earnings, partially offset by pension contributions of $212 million.
Cash flows from operating activities were lower than net income excluding the non-cash items noted above by $545 million. This decrease was primarily due to pre-tax cash outflows of $282 million associated with the GMDB equity hedge program which did not affect shareholders’ net income and pre-tax contributions to the domestic pension plans of approximately $410 million, partially offset by the favorable effect of the pension contributions on tax payments.
The increase in interest expense in 2010 was primarily due to higher long-term debt (including current maturities) outstanding in 2010, resulting from the issuance of debt in May 2010 and May 2009 used for general corporate purposes.
On March 4, 2008, the Company issued $300 million of 6.35% Notes (with an effective interest rate of 6.68% per year). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. Interest is payable on March 15 and September 15 of each year beginning September 15, 2008. The proceeds of this debt were used for general corporate purposes, including financing the acquisition of Great-West Healthcare. These Notes will mature on March 15, 2018. As explained further under Uses of Capital below, the Company repurchased a portion of these Notes under a tender offer dated December 9, 2010.
the present value of the remaining principal and interest payments on the Notes being redeemed discounted at the applicable Treasury Rate plus 25 basis points for the 4.375% and 5.125% Notes due 2020, 50 basis points for the 8.5% Notes due 2019, or 40 basis points for the 6.35% Notes due 2018.
On March 14, 2008, the Company entered into a commercial paper program (“the Program”). Under the Program, the Company is authorized to sell short-term unsecured commercial paper notes from time to time up to a maximum of $500 million. The proceeds are used for general corporate purposes, including working capital, capital expenditures, acquisitions and share repurchases. The Company uses the credit facility described below as back-up liquidity to support the outstanding commercial paper. If at any time funds are not available on favorable terms under the Program, the Company may use the Credit Agreement (see below) for funding. In October 2008, the Company added an additional dealer to its Program. As of December 31, 2010, the Company had $100 million in commercial paper outstanding, at a weighted average interest rate of 0.38% and remaining maturities ranging from 11 to 35 days.
In June 2007, the Company amended and restated its five-year committed revolving credit and letter of credit agreement for $1.75 billion, which permits up to $1.25 billion to be used for letters of credit. This agreement is diversified among 22 banks, with three banks each having 11% of the commitment and the other 19 banks having the remaining 67% of the commitment. The credit agreement includes options, which are subject to consent by the administrative agent and the committing banks, to increase the commitment amount up to $2.0 billion and to extend the term of the agreement. The Company entered into the agreement for general corporate purposes, including support for the issuance of commercial paper and to obtain statutory reserve credit for certain reinsurance arrangements. There were letters of credit in the amount of $82 million issued as of December 31, 2010.
The Company contributed $212 million to the domestic qualified pension plans, of which $69 million was required and $143 million was voluntary.
On December 1, 2010 the Company offered to settle its 8.5% Notes due 2019, including accrued interest from November 1 through the settlement date. The tender price equaled the present value of the remaining principal and interest payments on the Notes being redeemed, discounted at a rate equal to the 10 year treasury rate plus a fixed spread of 100 basis points. The tender offer priced at a yield of 4.128% and principal of $99 million was tendered, with $251 million remaining outstanding. The Company paid $130 million, including accrued interest and expenses, to settle the Notes, resulting in an after-tax loss on early debt extinguishment of $21 million.
On December 9, 2010 the Company offered to settle its 6.35% Notes due 2018, including accrued interest from September 16 through the settlement date. The tender price equaled the present value of the remaining principal and interest payments on the Notes being redeemed, discounted at a rate equal to the 10 year treasury rate plus a fixed spread of 45 basis points. The tender offer priced at a yield of 3.923% and principal of $169 million was tendered, with $131 million remaining outstanding. The Company paid $198 million, including accrued interest and expenses, to settle the Notes, resulting in an after-tax loss on early debt extinguishment of $18 million.
The Company repurchased 6.2 million shares for $201 million during 2010, and an additional 1.8 million shares for $73 million through February 25, 2011. On February 23, 2011, the Board of Directors increased share repurchase authority by $500 million. The total remaining share repurchase authorization as of February 25, 2011 was $674 million.
At December 31, 2010, there was approximately $810 million in cash available at the parent company level. In 2011, the parent company’s cash obligations are expected to consist of the following:
contributions to the domestic qualified pension plan of $250 million, of which approximately 50% are expected to be required; and
However, the Company’s cash projections may not be realized and the demand for funds could exceed available cash if:
a substantial increase in funding over current projections is required for the Company’s pension plan; or
Though the Company believes it has adequate sources of liquidity, significant disruption or volatility in the capital and credit markets could affect the Company’s ability to access those markets for additional borrowings or increase costs associated with borrowing funds.
In addition, various non-U.S. jurisdictions prescribe minimum surplus requirements that are based upon solvency, liquidity and reserve coverage measures. During 2010, the Company’s HMOs and life and health insurance subsidiaries, as well as non-U.S. insurance subsidiaries, were compliant with applicable RBC and non-U.S. surplus rules.
As of December 31, 2010, the unfunded pension liability was $1.5 billion, substantially unchanged from December 31, 2009, reflecting a decline in the discount rate of approximately 50 basis points as well as an update to mortality assumptions during 2010 to better reflect recent experience, entirely offset by contributions of $212 million during 2010 and favorable investment asset performance in 2010. Although the GAAP funded status did not decline as a result of the contributions made in 2010, required pension contributions in 2011 under the Pension Protection Act of 2006 are not expected to significantly change from previous estimates, since discount rates used for funding purposes are based on a 24-month moving average which is less susceptible to volatility than the rate required to be used to compute the liability for the financial statements.
The Company is contingently liable for various contractual obligations entered into in the ordinary course of business. The maturities of the Company’s primary contractual cash obligations, as of December 31, 2010, are estimated to be as follows:
Estimated payments of $113 million for deferred compensation, non-qualified and International pension plans and other postretirement and postemployment benefit plans are expected to be paid in less than one year. The Company’s best estimate is that contributions to the qualified domestic pension plan during 2011 will be approximately $250 million. The Company expects to make payments subsequent to 2011 for these obligations, however subsequent payments have been excluded from the table as their timing is based on plan assumptions which may materially differ from actual activities (see Note 10 to the Consolidated Financial Statements for further information on pension and other postretirement benefit obligations).
The above table also does not contain $177 million of gross liabilities for uncertain tax positions because the Company cannot reasonably estimate the timing of their resolution with the respective taxing authorities. See Note 20 to the Consolidated Financial Statements for the year ended December 31, 2010 for further information.
The Company had commitments to invest in limited liability entities that hold real estate, loans to real estate entities or securities. See Note 12(D) to the Consolidated Financial Statements for additional information.
Future service commitments include an agreement with IBM for various information technology (IT) infrastructure services. The Company’s remaining commitment under this contract is approximately $268 million over the next 3 years. The Company has the ability to terminate this agreement with 90 days notice, subject to termination fees.
The Company’s remaining estimated future service commitments primarily represent contracts for certain outsourced business processes and IT maintenance and support. The Company generally has the ability to terminate these agreements, but does not anticipate doing so at this time. Purchase obligations exclude contracts that are cancelable without penalty and those that do not specify minimum levels of goods or services to be purchased.
The Company, through its subsidiaries, is contingently liable for various financial and other guarantees provided in the ordinary course of business. See Note 24 to the Consolidated Financial Statements for additional information on guarantees.
The Company’s investment assets do not include separate account assets. Additional information regarding the Company’s investment assets and related accounting policies is included in Notes 2, 11, 12, 13, 14, 15 and 18 to the Consolidated Financial Statements.
Investments in fixed maturities include publicly-traded and privately placed debt securities, mortgage and other asset-backed securities, preferred stocks redeemable by the investor, hybrid and trading securities. Fair values are based on quoted market prices when available. When market prices are not available, fair value is generally estimated using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality. In instances where there is little or no market activity for the same or similar instruments, the Company estimates fair value using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price.
The Company’s investment in state and local government securities is diversified by issuer and geography with no single exposure greater than $30 million. The Company focuses on the underlying issuer’s credit quality with 94% rated A3 or better excluding guarantees by monoline bond insurers, consistent with the prior year. As of December 31, 2010, 63%, or $1,542 million, of the Company’s total investments in state and local government securities were guaranteed by monoline bond insurers, providing additional credit quality support. The quality ratings of these investments with and without this guaranteed support as of December 31, 2010 were as follows:
As of December 31, 2010, the Company had no direct investments in monoline bond insurers. Guarantees provided by various monoline bond insurers for certain of the Company’s investments in state and local governments and other asset-backed securities as of December 31, 2010 were:
AMBAC filed for bankruptcy during the fourth quarter of 2010. However, the Company does not expect this action to materially impact valuations of guaranteed securities given the high quality of underlying issuer credit without this guaranteed support.
The Company’s commercial mortgage loans are fixed rate loans, diversified by property type, location and borrower to reduce exposure to potential losses. Loans are secured by high quality commercial property and are generally made at less than 75% of the property’s value at origination of the loan. In addition to property value, debt service coverage, which is the ratio of the estimated cash flows from the property to the required loan payments (principal and interest), is an important underwriting consideration. The Company holds no direct residential mortgage loans and does not securitize or service mortgage loans.
The Company completed its annual in depth review of its commercial mortgage loan portfolio in July, 2010. This review included an analysis of each property’s most recent annual financial statements, rent rolls and operating plans and budgets for 2010, a physical inspection of the property and other pertinent factors. Based on property values and cash flows estimated as part of this review, along with updates for portfolio activity subsequent to the review, the portfolio’s average loan-to-value ratio improved to 74% as of December 31, 2010 from 77% as of December 31, 2009. The portfolio’s debt service coverage was estimated to be 1.38 as of December 31, 2010, down from 1.48 as of December 31, 2009.
As summarized above, $344 million or 10% of the commercial mortgage loan portfolio is comprised of subordinated notes and loans, including $310 million of loans secured by first mortgages, which were fully underwritten and originated by the Company using its standard underwriting procedures. Senior interests in these first mortgage loans were then sold to other institutional investors. This strategy allowed the Company to effectively utilize its origination capabilities to underwrite high quality loans with strong borrower sponsorship, limit individual loan exposures, and achieve attractive risk adjusted yields. In the event of a default, the Company would pursue remedies up to and including foreclosure jointly with the holders of the senior interests, but would receive repayment only after satisfaction of the senior interest.
The Company recognizes interest income on problem bonds and commercial mortgage loans only when payment is actually received because of the risk profile of the underlying investment. The amount that would have been reflected in net income if interest on non-accrual investments had been recognized in accordance with the original terms was not significant for 2010 or 2009.
$26 million of additions related to two new problem mortgage loans.
Additionally, two mortgage loans totaling $53 million were identified as problem loans in 2010 and subsequently disposed of through a direct sale and a partial sale subsequent to foreclosure.
$34 million reduction for commercial mortgage loans that were reclassified to loans in good standing; and
Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the original loan agreement. Problem and potential problem commercial mortgage loans totaling $95 million (net of valuation reserves), presented in the above table, are considered impaired. During 2010, the Company recorded a $24 million pre-tax ($15 million after-tax) charge to increase valuation reserves on impaired commercial mortgage loans. See Note 12 to the Consolidated Financial Statements and the Critical Accounting Estimates section of the MD&A beginning on page 57 of this Form 10-K for additional information regarding impaired commercial mortgage loans.
The Company recorded after-tax realized investment losses for investment asset write-downs and changes in valuation reserves as follows:
While management believes the commercial mortgage loan portfolio is positioned to perform well due to its solid aggregate loan-to-value ratio (including minimal loans with carrying values exceeding the fair value of collateral) and strong debt service coverage, the commercial real estate market continues to exhibit significant signs of distress and if these conditions remain for an extended period or worsen substantially, it could result in an increase in problem and potential problem loans. Given the current economic environment, future impairments could have a material adverse effect on results of operations; however, management does not expect those losses to have a material adverse effect on the Company’s financial condition or liquidity.
Use of derivatives. The Company generally uses derivative financial instruments to minimize certain market risks.
The examples that follow illustrate the effect of hypothetical changes in market rates or prices on the fair value of certain financial instruments including:
hypothetical changes in market interest rates, primarily for fixed maturities and commercial mortgage loans, partially offset by liabilities for long-term debt and GMIB contracts;
The Company’s foreign operations hold investment assets, such as fixed maturities, that are generally invested in the currency of the related liabilities. Due to the increase in the fair value of these investments in 2010, which are primarily denominated in the South Korean won, the effect of a hypothetical 10% strengthening in U.S. dollar to foreign currencies at December 31, 2010 was greater than that effect at December 31, 2009.
risks and exposures associated with GMDB (see Note 7 to the Consolidated Financial Statements) and GMIB contracts (see Note 11 to the Consolidated Financial Statements); and
pension liabilities since equity securities comprise a significant portion of the assets of the Company’s employee pension plans.
Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
heightened competition, particularly price competition, which could reduce product margins and constrain growth in the Company’s businesses, primarily the Health Care business;
risks associated with the Company’s mail order pharmacy business which, among other things, includes any potential operational deficiencies or service issues as well as loss or suspension of state pharmacy licenses;
adjustments to the reserve assumptions (including lapse, partial surrender, mortality, interest rates and volatility) used in estimating the Company’s liabilities for reinsurance contracts covering guaranteed minimum death benefits under certain variable annuities;
significant stock market declines, which could, among other things, result in increased expenses for guaranteed minimum income benefit contracts, guaranteed minimum death benefit contracts and the Company’s pension plans in future periods as well as the recognition of additional pension obligations;
significant deterioration in economic conditions and significant market volatility, which could have an adverse effect on the businesses of our customers (including the amount and type of health care services provided to their workforce, loss in workforce and our customers’ ability to pay receivables) and our vendors (including their ability to provide services);
amendments to income tax laws, which could affect the taxation of employer provided benefits, the taxation of certain insurance products such as corporate-owned life insurance, or the financial decisions of individuals whose variable annuities are covered under reinsurance contracts issued by the Company;
potential public health epidemics, pandemics and bio-terrorist activity, which could, among other things, cause the Company’s covered medical and disability expenses, pharmacy costs and mortality experience to rise significantly, and cause operational disruption, depending on the severity of the event and number of individuals affected;
the ability to successfully complete the integration of acquired businesses; and
Management assessed the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2010. In making this assessment, Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on management’s assessment and the criteria set forth by COSO, it was determined that the Company’s internal controls over financial reporting are effective as of December 31, 2010.
The Company’s independent registered public accounting firm, PricewaterhouseCoopers, has audited the effectiveness of the Company’s internal control over financial reporting, as stated in their report located on page 165 in this Form 10-K.
As used in this document, “CIGNA” and the “Company” may refer to CIGNA Corporation itself, one or more of its subsidiaries, or CIGNA Corporation and its consolidated subsidiaries. CIGNA Corporation is a holding company and is not an insurance company. Its subsidiaries conduct various businesses, which are described in this Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (“Form 10-K”).
In October 2010, the Financial Accounting Standards Board (“FASB”) amended guidance (ASU 2010-26) for the accounting of costs related to the acquisition or renewal of insurance contracts to require costs such as certain sales compensation or telemarketing costs that are related to unsuccessful efforts and any indirect costs to be expensed as incurred. This new guidance must be implemented on January 1, 2012 or may be implemented earlier and any changes to the Company’s Consolidated Financial Statements may be recognized prospectively for acquisition costs incurred beginning in 2012 or through retrospective adjustment of comparative prior periods. The Company’s deferred acquisition costs arise from sales and renewal activities primarily in its International segment and, to a lesser extent, the Health Care and corporate-owned life insurance businesses. Because the new requirements further restrict the types of costs that are deferrable, the Company expects more of its acquisition costs to be expensed when incurred under the new guidance. The Company continues to evaluate these new requirements to determine the timing, method and estimated effects of their implementation.
Effective December 31, 2010, the Company adopted the FASB’s updated guidance (ASU 2010-20) that requires disclosures about the credit quality and risks inherent in financing receivables, including how credit risk is analyzed and assessed on a disaggregated basis (by portfolio segment and class). The Company determined it has one portfolio segment and one class of mortgage loans because all loans are subject to the same monitoring and risk assessment process, and are made exclusively to commercial borrowers. Financing receivables other than mortgage loans are immaterial. See Note 12 (B) for additional information.
Effective January 1, 2010, the Company adopted the FASB’s amended guidance that requires ongoing qualitative analysis to determine whether a variable interest entity must be consolidated based on the entity’s purpose and design, the Company’s ability to direct the entity’s activities that most significantly impact its economic performance, and the Company’s right or obligation to participate in that performance (ASC 810). A variable interest entity is insufficiently capitalized or is not controlled by its equity owners through voting or similar rights. These amendments must be applied to qualifying special-purpose entities and troubled debt restructures formerly excluded from such analysis. On adoption and through December 31, 2010, the Company was not required to consolidate any variable interest entities and there were no effects to its results of operations or financial condition. Although consolidation was not required, disclosures about the Company’s involvement with variable interest entities have been provided in Note 14.
Effective January 1, 2010, the Company adopted the FASB’s guidance for accounting for transfers of financial assets (ASC 860) that changes the requirements for recognizing the transfer of financial assets and requires additional disclosures about a transferor’s continuing involvement in transferred assets. The guidance also eliminates the concept of a “qualifying special purpose entity” when assessing transfers of financial instruments. On adoption, there were no effects to the Company’s results of operations or financial condition.
The Company adopted the FASB’s updated guidance on fair value measurements (ASU 2010-06) in the first quarter of 2010, which requires separate disclosures of significant transfers between levels in the fair value hierarchy. See Note 11 for additional information.
Effective January 1, 2008, the Company adopted the FASB’s fair value disclosure and measurement guidance (ASC 820) that expands disclosures about fair value measurements and clarifies how to measure fair value by focusing on the price that would be received when selling an asset or paid to transfer a liability (exit price). At adoption, the Company was required to change certain assumptions used to estimate the fair values of GMIB assets and liabilities. Because there is no market for these contracts, the assumptions used to estimate their fair values at adoption were determined using a hypothetical market participant’s view of exit price, rather than using historical market data and actual experience to establish the Company’s future expectations. Certain of these assumptions (primarily related to annuitant behavior) have limited or no observable market data so determining an exit price requires the Company to exercise significant judgment and make critical accounting estimates. On adoption, the Company recorded a charge of $131 million after-tax, net of reinsurance ($202 million pre-tax), in Run-off Reinsurance. The Company’s results of operations related to this business are expected to continue to be volatile in future periods because several underlying assumptions (primarily interest rates) will be based on current market-observable inputs which will likely change each period.
The cumulative effect of adoption increased the Company’s retained earnings in 2009 with an offsetting decrease to accumulated other comprehensive income of $18 million, with no overall change to shareholders’ equity. See Note 12 (A) for information on the Company’s other-than-temporary impairments including additional required disclosures.
Effective January 1, 2009, the Company adopted the FASB’s updated earnings per share guidance (ASC 260) for determining participating securities that requires unvested restricted stock awards containing rights to nonforfeitable dividends to be included in the denominator of both basic and diluted earnings per share (“EPS”) calculations. Prior period EPS data were restated in 2009 to reflect the adoption of this guidance. As part of this restatement, basic EPS for the full year 2008 was adjusted to $1.04 per share (originally reported as $1.05 per share).
Mortgage loans held by the Company are made exclusively to commercial borrowers. Generally, commercial mortgage loans are carried at unpaid principal balances and are issued at a fixed rate of interest. Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the original loan agreement. The Company assesses the impairment of loans individually for all loans in the portfolio. Impaired loans are carried at the lower of unpaid principal or fair value of the underlying collateral. Valuation reserves reflect any changes in fair value. The Company estimates the fair value of the underlying collateral using internal valuations generally based on discounted cash flow analyses.
Investments with maturities of greater than 90 days but less than one year from time of purchase are classified as short-term, available for sale and carried at fair value, which approximates cost.
When interest and principal payments on investments are current, the Company recognizes interest income when it is earned. The Company stops recognizing interest income when interest payments are delinquent based on contractual terms or when certain terms (interest rate or maturity date) of the investment have been restructured. Net investment income on these investments is only recognized when interest payments are actually received. Interest and dividends on trading and hybrid securities are included in net investment income when they are earned.
Realized investment gains and losses result from sales, investment asset write-downs, changes in the fair values of trading and hybrid securities and certain derivatives and changes in valuation reserves, based on specifically identified assets. Realized investment gains and losses on the disposition of certain directly owned real estate investments are eliminated from ongoing operations and reported in discontinued operations when the operations and cash flows of the underlying assets are clearly distinguishable and the Company has no significant continuing involvement in their operations.
For universal life and other individual products, management estimates the present value of future revenues less expected payments. For group health and accident insurance products, management estimates the sum of unearned premiums and anticipated net investment income less future expected claims and related costs. If management’s estimates of these sums are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. The Company recorded amortization for policy acquisition costs of $312 million in 2010, $299 million in 2009 and $314 million in 2008 in other operating expenses. There are no deferred policy acquisition costs attributable to the sold individual life insurance and annuity and retirement businesses or the run-off reinsurance operations.
The Company calculates depreciation and amortization principally using the straight-line method generally based on the estimated useful life of each asset as follows: buildings and improvements, 10 to 40 years; purchased software, one to five years; internally developed software; three to seven years and furniture and equipment (including computer equipment); three to 10 years. Improvements to leased facilities are depreciated over the remaining lease term or the estimated life of the improvement. If the Company determines the carrying value of a long-lived asset is not recoverable, an impairment charge is recorded. See Note 9 for additional information.
Goodwill represents the excess of the cost of businesses acquired over the fair value of their net assets. Goodwill primarily relates to the Health Care segment ($2.9 billion) and, to a lesser extent, the International segment ($240 million). The Company evaluates goodwill for impairment at least annually during the third quarter at the reporting unit level, based on discounted cash flow analyses and writes it down through results of operations if impaired. Consistent with prior years, the Company’s evaluations of goodwill associated with the Health Care segment used the best information available at the time, including reasonable assumptions and projections consistent with those used in its annual planning process. The discounted cash flow analyses used a range of discount rates that correspond with the Company’s weighted average cost of capital, consistent with that used for investment decisions considering the specific and detailed operating plans and strategies within the Health Care segment. The resulting discounted cash flow analysis indicated an estimated fair value for the Health Care segment exceeding its carrying value, including goodwill and other intangibles. Finally, the Company determined that no events or circumstances occurred subsequent to the annual evaluation of goodwill that would more likely than not reduce the fair value of its reporting units below their carrying values. See Note 9 for additional information.
Other assets consist of various insurance-related assets and the gain position of certain derivatives, primarily GMIB assets. The Company’s other intangible assets include purchased customer and producer relationships, provider networks, and trademarks. The Company amortizes other intangibles on an accelerated or straight-line basis over periods from 1 to 30 years. Management revises amortization periods if it believes there has been a change in the length of time that an intangible asset will continue to have value. Costs incurred to renew or extend the terms of these intangible assets are generally expensed as incurred. See Note 9 for additional information.
Liabilities for unpaid claims and claim expenses are estimates of payments to be made under insurance coverages (primarily long-term disability, workers’ compensation and life and health) for reported claims and for losses incurred but not yet reported.
The Company discounts certain claim liabilities related to group long-term disability and workers’ compensation because benefit payments may be made over extended periods. Discount rate assumptions are based on projected investment returns for the asset portfolios that support these liabilities and range from 3.80% to 7.25%. When estimates change, the Company records the adjustment in benefits and expenses in the period in which the change in estimate is identified. Discounted liabilities associated with the long-term disability and certain workers’ compensation businesses were $3.1 billion at December 31, 2010 and December 31, 2009.
The liability is primarily calculated using “completion factors” (a measure of the time to process claims), which are developed by comparing the date claims were incurred, generally the date services were provided, to the date claims were paid. 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. It is possible that the actual completion rates for the current period will develop differently from historical patterns, which could have a material impact on the Company’s medical claims payable and shareholders’ net income.
Despite reflecting both historical and emerging trends in setting reserves, it is possible that the actual medical trend for the current period will develop differently from expectations, which could have a material impact on the Company’s medical claims payable and shareholders’ net income.
Premiums for group life, accident and health insurance and managed care coverages are recognized as revenue on a pro rata basis over the contract period. Benefits and expenses are recognized when incurred. Premiums and fees include revenue from experience-rated contracts where revenue is based on the estimated ultimate claim, and in some cases, administrative cost experience of the contract. For these contracts, premium revenue includes an adjustment for experience-rated refunds which is calculated according to contract terms and using the customer’s experience (including estimates of incurred but not reported claims).
Contract fees, which are based upon related administrative expenses, are recognized in premiums and fees as they are earned ratably over the contract period.
The Company’s participating life insurance policies entitle policyholders to earn dividends that represent a portion of the earnings of the Company’s life insurance subsidiaries. Participating insurance accounted for approximately 1% of the Company’s total life insurance in force at the end of 2010 and 2009, and approximately 2% of the Company’s total life insurance in force at the end of 2008.
The Company recognizes interim period income taxes by estimating an annual effective tax rate and applying it to year-to-date results. The estimated annual effective tax rate is periodically updated throughout the year based on actual results to date and an updated projection of full year income. Although the effective tax rate approach is generally used for interim periods, taxes on significant, unusual and infrequent items are recognized at the statutory tax rate entirely in the period the amounts are realized.
Goodwill is allocated to the International segment. For foreign tax purposes, the acquisition of Vanbreda International is being treated as a stock purchase. Accordingly, goodwill and other intangible assets will not be amortized for foreign tax purposes but may reduce the taxability of earnings repatriated to the U.S. by Vanbreda International.
In accordance with the FASB’s guidance on accounting for business combinations, the Company completed its allocation of the total purchase price to the tangible and intangible net assets acquired based on management’s estimates of their fair values. Accordingly, approximately $290 million was allocated to intangible assets, primarily customer relationships and internal-use software. The weighted average amortization period was 9 years for customer relationships and 6 years for internal-use software. The remainder, net of tangible net assets acquired, was goodwill which approximated $1.1 billion and was allocated entirely to the Health Care segment. Substantially all of the goodwill is tax deductible and is being amortized over 15 years for federal income tax purposes.
The following outstanding employee stock options were not included in the computation of diluted earnings per share because their effect would have increased diluted earnings per share (antidilutive) as their exercise price was greater than the average share price of the Company’s common stock for the period.
Reinsurance and other amounts recoverable reflect amounts due from reinsurers and policyholders to cover incurred but not reported and pending claims for minimum premium products and certain administrative services only business where the right of offset does not exist. See Note 8 for additional information on reinsurance. For the year ended December 31, 2010, actual experience differed from the Company’s key assumptions resulting in favorable incurred claims related to prior years’ medical claims payable of $93 million, or 1.3% of the current year incurred claims as reported for the year ended December 31, 2009. Actual completion factors resulted in a reduction in medical claims payable of $51 million, or 0.7% of the current year incurred claims as reported for the year ended December 31, 2009 for the insured book of business. Actual medical cost trend resulted in a reduction in medical claims payable of $42 million, or 0.6% of the current year incurred claims as reported for the year ended December 31, 2009 for the insured book of business.
For the year ended December 31, 2009, actual experience differed from the Company’s key assumptions, resulting in favorable incurred claims related to prior years’ medical claims payable of $43 million, or 0.6% of the current year incurred claims as reported for the year ended December 31, 2008. Actual completion factors resulted in a reduction of the medical claims payable of $21 million, or 0.3% of the current year incurred claims as reported for the year ended December 31, 2008 for the insured book of business. Actual medical cost trend resulted in a reduction of the medical claims payable of $22 million, or 0.3% of the current year incurred claims as reported for the year ended December 31, 2008 for the insured book of business.
The corresponding impact of prior year development was an increase to shareholders’ net income of $26 million after-tax ($39 million pre-tax) for the year ended December 31, 2010 and was not material to shareholders’ net income for the year ended December 31, 2009. The change in the amount of the incurred claims related to prior years in the medical claims payable liability does not directly correspond to an increase or decrease in the Company’s shareholders’ net income recognized for the following reasons:
The reserves include an estimate for partial surrenders that essentially lock in the death benefit for a particular policy based on annual election rates that vary from 0 to 15% depending on the net amount at risk for each policy and whether surrender charges apply.
The assumed mean investment performance for the underlying equity mutual funds considers the Company’s GMDB equity hedge program using futures contracts, and is based on the Company’s view that short-term interest rates will average 5% over future periods, but considers that current short-term rates are less than 5%. The mean investment performance assumption for the underlying fixed income mutual funds (bonds and money market) is 5% based on a review of historical returns. The investment performance for underlying equity and fixed income mutual funds is reduced by fund fees ranging from 1 to 3% across all funds.
The volatility assumption is based on a review of historical monthly returns for each key index (e.g. S&P 500) over a period of at least ten years. Volatility represents the dispersion of historical returns compared to the average historical return (standard deviation) for each index. The assumption is 16% to 26%, varying by equity fund type; 4% to 10%, varying by bond fund type; and 2% for money market funds. These volatility assumptions are used along with the mean investment performance assumption to project future return scenarios.
Activity in future policy benefit reserves for these GMDB contracts was as follows:
no less than net deposits paid into the contract accumulated at a specified rate or net deposits paid into the contract.
The Company has also written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees related to minimum income benefits. All reinsured GMIB policies also have a GMDB benefit reinsured by the Company. See Note 11 for further information.
The Company had reinsurance recoverables totaling $4.3 billion as of December 31, 2010 and $4.4 billion as of December 31, 2009 from The Lincoln National Life Insurance Company and Lincoln Life & Annuity of New York resulting from the 1998 sale of the Company’s individual life insurance and annuity business through indemnity reinsurance arrangements. At December 31, 2010, the $3.9 billion reinsurance recoverable from The Lincoln National Life Insurance Company was secured by assets held in a trust established for the benefit of the Company, and was less than the market value of the trust assets. The remaining recoverable from Lincoln Life & Annuity of New York of $402 million is currently unsecured, however if this reinsurer does not maintain a specified minimum credit or claims paying rating, it is required to fully secure the outstanding balance. As of December 31, 2010 both companies had ratings sufficient to avoid triggering a contractual obligation.
The Company’s insurance subsidiaries have reinsurance recoverables from various reinsurance arrangements in the ordinary course of business for its Health Care, Disability and Life, and International segments as well as the corporate-owned life insurance business. Reinsurance recoverables of $282 million as of December 31, 2010 are expected to be collected from more than 70 reinsurers.
The Company reviews its reinsurance arrangements and establishes reserves against the recoverables in the event that recovery is not considered probable. As of December 31, 2010, the Company’s recoverables related to these segments were net of a reserve of $9 million.
Liabilities related to GMDB, workers’ compensation and personal accident are included in future policy benefits and unpaid claims. Because the GMIB contracts are treated as derivatives under GAAP, the asset related to GMIB is recorded in the Other assets, including other intangibles caption and the liability related to GMIB is recorded in Accounts payable, accrued expenses, and other liabilities on the Company’s Consolidated Balance Sheets (see Notes 11 and 24 for additional discussion of the GMIB assets and liabilities).
The reinsurance recoverables for GMDB, workers’ compensation, and personal accident total $261 million as of December 31, 2010. Of this amount, approximately 77% are secured by assets in trust or letters of credit.
The Company reviews its reinsurance arrangements and establishes reserves against the recoverables in the event that recovery is not considered probable. As of December 31, 2010, the Company’s recoverables related to this segment were net of a reserve of $1 million.
The Company’s payment obligations for underlying reinsurance exposures assumed by the Company under these contracts are based on the ceding companies’ claim payments. For GMDB, claim payments vary because of changes in equity markets and interest rates, as well as mortality and contractholder behavior. Any of these claim payments can extend many years into the future, and the amount of the ceding companies’ ultimate claims, and therefore the amount of the Company’s ultimate payment obligations and corresponding ultimate collection from retrocessionaires, may not be known with certainty for some time.
The decrease in assumed premiums in 2010 primarily reflects the effect of the Company’s exit from two large, non-strategic assumed government life insurance programs as well as the transfer of policies assumed in the acquisition of Great-West Healthcare directly to one of the Company’s insurance subsidiaries in 2010. The effects of reinsurance on written premiums and fees for short-duration contracts were not materially different from the recognized premium and fee amounts shown in the above table.
Goodwill primarily relates to the Health Care segment ($2.9 billion) and, to a lesser extent, the International segment ($240 million) and increased by approximately $230 million during 2010 as a result of the acquisition of Vanbreda International and foreign currency translation after the acquisition. The fair value of the Company’s reporting units is substantially in excess of their carrying value therefore the risk for future impairment is unlikely.
The Company estimates annual pre-tax amortization for intangible assets, including internal-use software, over the next five calendar years to be as follows: $214 million in 2011, $179 million in 2012, $139 million in 2013, $84 million in 2014, and $53 million in 2015.
The Company measures the assets and liabilities of its domestic pension and other postretirement benefit plans as of December 31. The following table summarizes the projected benefit obligations and assets related to the Company’s domestic and international pension and other postretirement benefit plans as of, and for the year ended, December 31:
The Company funds its 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. For 2011, the Company expects to make minimum required and voluntary contributions totaling approximately $250 million. 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.
Unfunded retiree health benefit plans had accumulated benefit obligations of $296 million at December 31, 2010, and $268 million at December 31, 2009. Retiree life insurance plans had accumulated benefit obligations of $148 million as of December 31, 2010 and $150 million as of December 31, 2009.
The Company expects to recognize in 2011 pre-tax gains of $16 million related to amortization of prior service cost and no pre-tax losses from amortization of past experience. The original amortization period is based on an average remaining service period of active employees associated with the other postretirement benefit plans of approximately 9 years. The weighted average remaining amortization period for prior service cost is approximately 3 years.
The fair values of plan assets by category and by hierarchy as defined by GAAP are as follows. See Note 11 for a definition of the levels within the fair value hierarchy.
fixed maturities valued using recent trades of similar securities or pricing models as described below.
The assets related to other postretirement benefit plans are invested in deposit funds with interest credited based on fixed income investments in the general account of CGLIC. As there are significant unobservable inputs used in determining the fair value of these assets, they are classified as Level 3. During 2010, these assets earned a return of $1 million, offset by a net withdrawal from the fund of $2 million, while during 2009, they earned a return of $2 million, offset by a net withdrawal of $2 million.
Expected long-term rates of return on plan assets were developed considering actual long-term historical returns, expected long-term market conditions, plan asset mix and management’s investment strategy, which includes a significant allocation of domestic and foreign equity securities. Expected long-term market conditions take into consideration certain key macroeconomic trends including expected domestic and foreign GDP growth, employment levels and inflation. Based on the Company’s current outlook, the expected return assumption is considered reasonable. Actual and target investment allocations are very similar at December 31, 2010.
The Company sponsors a 401(k) plan in which the Company matches a portion of employees’ pre-tax contributions. Another 401(k) plan with an employer match was frozen in 1999. Participants in the active plan may invest in a fund that invests in the Company’s common stock, several diversified stock funds, a bond fund and a fixed-income fund. In conjunction with the action to freeze the domestic defined benefit pension plans, effective January 1, 2010, the Company increased its matching contributions to 401(k) plan participants.
The Company may elect to increase its matching contributions if the Company’s annual performance meets certain targets. A substantial amount of the Company’s matching contributions are invested in the Company’s common stock. The Company’s expense for these plans was $69 million for 2010, $36 million for 2009 and $34 million for 2008.
The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, equity securities, short-term investments and derivatives. Other financial instruments are measured at fair value under certain conditions, such as when impaired.
Fair values are based on quoted market prices when available. When market prices are not available, fair value is generally estimated using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality. In instances where there is little or no market activity for the same or similar instruments, the Company estimates fair value using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. These valuation techniques involve some level of estimation and judgment by the Company which becomes significant with increasingly complex instruments or pricing models.
The following tables provide information as of December 31, 2010 and December 31, 2009 about the Company’s financial assets and liabilities carried at fair value. Similar disclosures for separate account assets, which are also recorded at fair value on the Company’s Consolidated Balance Sheets, are provided separately as gains and losses related to these assets generally accrue directly to policyholders. In addition, Note 10 contains similar disclosures for the Company’s pension plan assets.
that the most likely transfer of these assets and liabilities would be through a reinsurance transaction with an independent insurer having a market capitalization and credit rating similar to that of the Company; and
The market volatility assumptions for annuitants’ underlying mutual fund investments that are modeled based on the S&P 500, Russell 2000 and NASDAQ Composite are based on the market-implied volatility for these indices for three to seven years grading to historical volatility levels thereafter. For the remaining 54% of underlying mutual fund investments modeled based on other indices (with insufficient market-observable data), volatility is based on the average historical level for each index over the past 10 years. Using this approach, volatility ranges from 17% to 31% for equity funds, 4% to 12% for bond funds, and 1% to 2% for money market funds.
GMIB liabilities are reported in the Company’s Consolidated Balance Sheets in Accounts payable, accrued expenses and other liabilities. GMIB assets associated with these contracts represent net receivables in connection with reinsurance that the Company has purchased from two external reinsurers and are reported in the Company’s Consolidated Balance Sheets in Other assets, including other intangibles.
GMIB fair value (gain) loss for amounts related to GMIB assets and liabilities.
Reclassifications impacting Level 3 financial instruments are reported as transfers in or out of the Level 3 category as of the beginning of the quarter in which the transfer occurs. Therefore gains and losses in income only reflect activity for the quarters the instrument was classified in Level 3.
Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company’s best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement. For the years ended December 31, 2010 and 2009, transfer activity between Level 3 and Level 2 primarily reflects changes in the level of unobservable inputs used to value certain private corporate bonds, principally related to credit risk of the issuers.
The Company provided reinsurance for other insurance companies that offer a guaranteed minimum income benefit, and then retroceded a portion of the risk to other insurance companies. These arrangements with third-party insurers are the instruments still held at the reporting date for GMIB assets and liabilities in the table above. Because these reinsurance arrangements remain in effect at the reporting date, the Company has reflected the total gain or loss for the period as the total gain or loss included in income attributable to instruments still held at the reporting date. However, the Company reduces the GMIB assets and liabilities resulting from these reinsurance arrangements when annuitants lapse, die, elect their benefit, or reach the age after which the right to elect their benefit expires.
GMIB fair value losses of $55 million for 2010, were primarily due to declining interest rates, partially offset by increases in underlying account values resulting from favorable equity and bond fund returns, which resulted in decreased exposures.
Fair values and changes in the fair values of separate account assets generally accrue directly to the policyholders and are excluded from the Company’s revenues and expenses. As of December 31, 2010 and December 31, 2009 separate account assets were as follows:
Separate account assets in Level 1 include exchange-listed equity securities. Level 2 assets primarily include:
For the year ended December 31, 2009, transfers into Level 3 primarily represented fixed income funds that are priced using the net asset value where restrictions were placed on withdrawal.
Some financial assets and liabilities are not carried at fair value each reporting period, but may be measured using fair value only under certain conditions, such as investments in commercial mortgage loans and real estate entities when they become impaired. During 2010, impaired commercial mortgage loans with carrying values of $158 million were written down to their fair values of $134 million, resulting in pre-tax realized investment losses of $24 million. Also during 2010, impaired real estate entities carried at cost of $35 million were written down to their fair values of $21 million, resulting in pre-tax realized investment losses of $14 million.
During 2009, impaired commercial mortgage loans with carrying values of $143 million were written down to their fair values of $126 million, resulting in pre-tax realized investment losses of $17 million. Also during 2009, impaired real estate entities with carrying values of $48 million were written down to their fair values of $12 million, resulting in pre-tax realized investment losses of $36 million.
These fair values were calculated by discounting the expected future cash flows at estimated market interest rates. Such market rates were derived by calculating the appropriate spread over comparable U.S. Treasury rates, based on the characteristics of the underlying collateral, including the type, quality and location of the assets. The fair value measurements were classified in Level 3 because these cash flow models incorporate significant unobservable inputs.
Contractholder deposit funds, excluding universal life products. Generally, these funds do not have stated maturities. Approximately 45% of these balances can be withdrawn by the customer at any time without prior notice or penalty. The fair value for these contracts is the amount estimated to be payable to the customer as of the reporting date, which is generally the carrying value. Most of the remaining contractholder deposit funds are reinsured by the buyers of the individual life insurance and annuity and retirement benefits businesses. The fair value for these contracts is determined using the fair value of these buyers’ assets supporting these reinsured contracts. The Company had a reinsurance recoverable equal to the carrying value of these reinsured contracts.
Long-term debt, including current maturities, excluding capital leases. The fair value of long-term debt is based on quoted market prices for recent trades. When quoted market prices are not available, fair value is estimated using a discounted cash flow analysis and the Company’s estimated current borrowing rate for debt of similar terms and remaining maturities.
Securities in the following table are included in fixed maturities and equity securities on the Company’s Consolidated Balance Sheets. These securities are carried at fair value with changes in fair value reported in other realized investment gains (losses) and interest and dividends reported in net investment income. The Company’s hybrid investments include certain preferred stock or debt securities with call or conversion features.
Fixed maturities included $98 million at December 31, 2010 and $197 million at December 31, 2009, which were pledged as collateral to brokers as required under certain futures contracts. These fixed maturities were primarily corporate securities.
Gross unrealized appreciation (depreciation) on fixed maturities by type of issuer is shown below (excluding trading securities and hybrid securities with a fair value of $55 million at December 31, 2010 and $51 million at December 31, 2009).
Excluding trading and hybrid securities, as of December 31, 2010, fixed maturities with a decline in fair value from amortized cost (which were primarily investment grade corporate bonds) were as follows, including the length of time of such decline:
As of December 31, 2010, the unrealized depreciation of investment grade fixed maturities is primarily due to increases in market yields since purchase.
Mortgage loans held by the Company are made exclusively to commercial borrowers and are diversified by property type, location and borrower. Loans are secured by high quality, primarily completed and substantially leased operating properties and are generally carried at unpaid principal balances and are issued at a fixed rate of interest.
At December 31, 2010, scheduled commercial mortgage loan maturities were as follows (in millions): $518 in 2011, $547 in 2012, $612 in 2013, $274 in 2014 and $1,535 thereafter. Actual maturities could differ from contractual maturities for several reasons: borrowers may have the right to prepay obligations, with or without prepayment penalties: the maturity date may be extended; and loans may be refinanced.
As of December 31, 2010, the Company had commitments to extend credit under commercial mortgage loan agreements of $63 million that were diversified by property type and geographic region.
A commercial mortgage loan is considered impaired when it is probable that the Company will not collect all amounts due (principal and interest) according to the terms of the original loan agreement. The Company assesses each loan individually for impairment, utilizing the information obtained from the quality review process discussed above. Impaired loans are carried at the lower of unpaid principal balance or the fair value of the underlying collateral. Certain commercial mortgage loans without valuation reserves are considered impaired because the Company will not collect all interest due according to the terms of the original agreements; however, the Company does expect to recover their remaining carrying value primarily because it is less than the fair value of the underlying property.
$297 million to entities that hold securities diversified by issuer and maturity date.
The Company expects to disburse approximately 55% of the committed amounts in 2011.
Short-term investments and cash equivalents included corporate securities of $1.1 billion, federal government securities of $137 million and money market funds of $40 million as of December 31, 2010. The Company’s short-term investments and cash equivalents as of December 31, 2009 included corporate securities of $624 million, federal government securities of $402 million and money market funds of $104 million.
As of December 31, 2010 and 2009, the Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders’ equity.
The Company uses derivative financial instruments primarily as part of a strategy to reduce the equity market exposures relating to guaranteed minimum death benefit contracts. Derivative financial instruments are also used by the Company as a part of its investment strategy to manage the characteristics of investment assets (such as duration, yield, currency and liquidity) to meet the varying demands of the related insurance and contractholder liabilities (such as paying claims, investment returns and withdrawals). Derivatives are typically used under this strategy to minimize interest rate and foreign currency risks. The Company routinely monitors exposure to credit risk associated with derivatives and diversifies the portfolio among approved dealers of high credit quality to minimize this risk. In addition, the Company has written or sold contracts to guarantee minimum income benefits.
The following tables present information about the nature and accounting treatment of the Company’s primary derivative financial instruments including the Company’s purpose for entering into specific derivative transactions, and their locations in and effect on the financial statements as of and for the periods ended December 31, 2010 and 2009. Derivatives in the Company’s separate accounts are excluded from the tables because associated gains and losses generally accrue directly to policyholders.
In the normal course of its investing activities, the Company makes passive investments in securities that are issued by variable interest entities for which the Company is not the sponsor or manager. These investments are predominantly asset-backed securities primarily collateralized by foreign bank obligations and commercial mortgage-backed securities. The asset-backed securities largely represent fixed-rate debt securities issued by trusts which hold perpetual floating-rate subordinated notes issued by foreign banks. The commercial mortgage-backed securities represent senior interests in pools of commercial or residential mortgages created and held by special-purpose entities to provide investors with diversified exposure to these assets. The Company owns senior securities issued by several entities and receives fixed-rate cash flows from the underlying assets in the pools. The Company is not the primary beneficiary and does not consolidate any of these entities because either:
it had no right to receive benefits nor obligation to absorb losses that could be significant to these variable interest entities.
The Company has not provided, and does not intend to provide, financial support to these entities. The Company performs ongoing qualitative analyses of its involvement with these variable interest entities to determine if consolidation is required. The Company’s maximum potential exposure to loss related to these entities is limited to the carrying amount of its investment reported in fixed maturities and equity securities, and its aggregate ownership interest is insignificant relative to the total principal amount issued by these entities. See Note 12A for a discussion of the Company’s process for assessing fixed maturities and equity securities for impairment.
Realized investment losses in 2009 in other investments, including derivatives primarily represent impairments of real estate entities. In 2008, gains primarily represented gains on the sales of real estate properties held in joint ventures.
On December 9, 2010 the Company offered to settle its 6.35% Notes due 2018, including accrued interest from September 16 through the settlement date. The tender price equaled the present value of the remaining principal and interest payments on the Notes being redeemed, discounted at a rate equal to the 10-year treasury rate plus a fixed spread of 45 basis points. The tender offer priced at a yield of 3.923% and principal of $169 million was tendered, with $131 million remaining outstanding. The Company paid $198 million, including accrued interest and expenses, to settle the Notes, resulting in an after-tax loss on early debt extinguishment of $18 million.
On December 8, 2010, the Company issued $250 million of 4.375% Notes ($249 million net of debt discount, with an effective interest rate of 5.1%). The difference between the stated and effective interest rates primarily reflects the effect of treasury locks. See Note 13 to the Consolidated Financial Statements for further information. Interest is payable on June 15 and December 15 of each year beginning in 2010. These Notes will mature on December 15, 2020. The proceeds of this debt were used to fund the tender offer for the 8.5% Senior Notes due 2019 and the 6.35% Senior Notes due 2018 described above.
Maturities of debt and capital leases are as follows (in millions): $452 in 2011, $3 in 2012 and 2013, $23 in 2014 and the remainder in years after 2014. Interest expense on long-term debt, short-term debt and capital leases was $182 million in 2010, $166 million in 2009, and $146 million in 2008.
On March 14, 2008, the Company entered into a commercial paper program (“the Program”). Under the Program, the Company is authorized to sell from time to time short-term unsecured commercial paper notes up to a maximum of $500 million. The proceeds are used for general corporate purposes, including working capital, capital expenditures, acquisitions and share repurchases. The Company uses the credit facility entered into in June 2007, as back-up liquidity to support the outstanding commercial paper. If at any time funds are not available on favorable terms under the Program, the Company may use its credit facility for funding. In October 2008, the Company added an additional dealer to its Program. As of December 31, 2010, the Company had $100 million in commercial paper outstanding, at a weighted average interest rate of 0.38%.
The Company has authorized a total of 25 million shares of $1 par value preferred stock. No shares of preferred stock were outstanding at December 31, 2010 or 2009.
As a result, shareholders’ net income for the year ended December 31, 2010, increased by $31 million, which included $20 million relative to South Korea and $11 million relative to Hong Kong. The Hong Kong amount includes $6 million associated with first quarter transition. Shareholders’ net income for the year ended December 31, 2009 increased by $23 million, all attributable to South Korea. Permanent investment of foreign operation earnings has resulted in cumulative unrecognized deferred tax liabilities of $54 million though December 31, 2010.
A reconciliation of unrecognized tax benefits for the years ended December 31 is as follows:
The Company classifies net interest expense on uncertain tax positions and any applicable penalties as a component of income tax expense, but excludes these amounts from the liability for uncertain tax positions. The Company’s liability for net interest and penalties was $14 million at December 31, 2010, $13 million at December 31, 2009 and $19 million at December 31, 2008. The 2009 decline included $13 million associated with the completion of an IRS examination.
The recently enacted Patient Protection & Affordable Care Act, including the Reconciliation Act of 2010, included provisions limiting the tax deductibility of certain future retiree benefit and compensation related payments that were earned after 2009. The effect of these provisions reduced shareholders’ net income for the twelve months ended December 31, 2010 by $10 million. The Company will continue to evaluate the tax effect of these provisions.
At the end of 2010, approximately 3,000 employees held 4.3 million restricted stock grants and units with $65 million of related compensation expense to be recognized over the next three years (weighted average period).
Rental expenses for operating leases, principally for office space, amounted to $127 million in 2010, $138 million in 2009 and $131 million in 2008. As of December 31, 2010, future net minimum rental payments under non-cancelable operating leases were approximately $496 million, payable as follows (in millions): $105 in 2011, $93 in 2012, $70 in 2013, $56 in 2014, $48 in 2015 and $124 thereafter.
The Company also has several outsourced service arrangements with third parties, primarily for human resource and information technology support services. The initial service periods under these arrangements range from seven to eight years and their related costs are reported consistent with operating leases over the service period based on the pattern of use. The Company recorded in other operating expense $114 million in 2010, $115 million in 2009 and $113 million in 2008 for these arrangements.
Run-off Reinsurance includes accident, workers’ compensation, international life and health, GMDB and GMIB reinsurance businesses. The Company stopped underwriting new reinsurance business in 2000 and essentially exited the accident and workers’ compensation business in 2010.
Corporate reflects amounts such as interest expense on corporate debt and on uncertain tax positions, net investment income on investments not supporting segment operations, intersegment eliminations, compensation cost for stock options and certain corporate overhead expenses. Beginning in 2010, the Company began reporting the expense associated with its frozen pension plans in Corporate. Prior periods were not restated as the effect on prior periods was not material.
Separate account assets are contractholder funds maintained in accounts with specific investment objectives. The Company records separate account liabilities equal to separate account assets. In certain cases, primarily associated with the sold retirement benefits business (which was sold in April 2004), the Company guarantees a minimum level of benefits for retirement and insurance contracts, written in separate accounts. The Company establishes an additional liability if management believes that the Company will be required to make a payment under these guarantees.
The Company guarantees that separate account assets will be sufficient to pay certain retiree or life benefits. The sponsoring employers are primarily responsible for ensuring that assets are sufficient to pay these benefits and are required to maintain assets that exceed a certain percentage of benefit obligations. This percentage varies depending on the asset class within a sponsoring employer’s portfolio (for example, a bond fund would require a lower percentage than a riskier equity fund) and thus will vary as the composition of the portfolio changes. If employers do not maintain the required levels of separate account assets, the Company or an affiliate of the buyer has the right to redirect the management of the related assets to provide for benefit payments. As of December 31, 2010, employers maintained assets that exceeded the benefit obligations. Benefit obligations under these arrangements were $1.3 billion as of December 31, 2010. As of December 31, 2010, approximately 75% of these guarantees are reinsured by an affiliate of the buyer of the retirement benefits business. The remaining guarantees are provided by the Company with minimal reinsurance from third parties. There were no additional liabilities required for these guarantees as of December 31, 2010. Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the GAAP fair value hierarchy. See Note 11 for further information on the fair value hierarchy.
The maximum potential undiscounted payments that the Company would make under those assumptions would aggregate $1.1 billion before reinsurance recoveries. The Company expects the amount of actual payments to be significantly less than this hypothetical undiscounted aggregate amount. The Company has retrocessional coverage in place from two external reinsurers which covers 55% of the exposures on these contracts. The Company bears the risk of loss if its retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
As part of the reinsurance and administrative service arrangements, the Company pays claims for the group medical and long-term disability business of Great-West Healthcare and collects related amounts due from their third-party reinsurers. Any uncollected amounts will represent additional assumed liabilities of the Company and decrease its shareholders’ net income if and when these amounts are determined uncollectible. At December 31, 2010, there were no receivables recorded for paid claims due from third-party reinsurers for this business and unpaid claims related to this business were estimated at $19 million.
The Company contracts on an administrative services only basis with customers who fund their own claims. The Company charges these customers administrative fees based on the expected cost of administering their self-funded programs. In some cases, the Company provides performance guarantees associated with meeting certain service related and other performance standards. If these standards are not met, the Company may be financially at risk up to a stated percentage of the contracted fee or a stated dollar amount. The Company establishes liabilities for estimated payouts associated with these guarantees. Approximately 13% of these reported fees were at risk for the periods reported, with actual reimbursements of generally less than 1% of these reported fees in 2010, 2009, and 2008.
The Company does not expect that these certain other guarantees will have a material adverse effect on the Company’s consolidated results of operations, liquidity or financial condition.
Employee benefits regulation. The business of administering and insuring employee benefit programs, particularly health care programs, is heavily regulated by federal and state laws and administrative agencies, such as state departments of insurance and the Federal Departments of Health and Human Services, Labor and Justice, as well as the courts. Regulation and judicial decisions have resulted in changes to industry and the Company’s business practices and will continue to do so in the future. In addition, the Company’s subsidiaries are routinely involved with various claims, lawsuits and regulatory and IRS audits and investigations that could result in financial liability, changes in business practices, or both. Health care regulation in its various forms could have an adverse effect on the Company’s health care operations if it inhibits the Company’s ability to respond to market demands or results in increased medical or administrative costs without improving the quality of care or services.
The Company is routinely involved in numerous claims, lawsuits, regulatory and IRS audits, investigations and other legal matters arising, for the most part, in the ordinary course of the business of administering and insuring employee benefit programs including payments to providers and benefit level disputes. Litigation of income tax matters is accounted for under FASB’s accounting guidance for uncertainty in income taxes. Further information can be found in Note 20. The outcome of litigation and other legal matters is always uncertain, and outcomes that are not justified by the evidence can occur. The Company believes that it has valid defenses to the legal matters pending against it and is defending itself vigorously.
Broker compensation. Beginning in 2004, the Company, other insurance companies and certain insurance brokers received subpoenas and inquiries from various regulators, including the New York and Connecticut Attorneys General, the Florida Office of Insurance Regulation, the U.S. Attorney’s Office for the Southern District of California and the U.S. Department of Labor relating to their investigations of insurance broker compensation. CIGNA cooperated with the inquiries and investigations.
Ingenix. On February 13, 2008, State of New York Attorney General Andrew M. Cuomo announced an industry-wide investigation into the use of data provided by Ingenix, Inc., a subsidiary of UnitedHealthcare, used to calculate payments for services provided by out-of-network providers. The Company received four subpoenas from the New York Attorney General’s office in connection with this investigation and responded appropriately. On February 17, 2009, the Company entered into an Assurance of Discontinuance resolving the investigation. In connection with the industry-wide resolution, the Company contributed $10 million to the establishment of a new non-profit company that will compile and provide the data currently provided by Ingenix. In addition, on March 28, 2008, the Company received a voluntary request for production of documents from the Connecticut Attorney General’s office seeking certain out-of-network claim payment information. The Company has responded appropriately. Since January 2009, the Company has received and responded to inquiries regarding the use of Ingenix data from the Illinois and Texas Attorneys General and the Departments of Insurance in Illinois, Florida, Vermont, Georgia, Pennsylvania, Connecticut, and Alaska.
On June 9, 2009, CIGNA filed motions in the United States District Court for the Southern District of Florida to enforce a previous settlement, In re Managed Care Litigation, by enjoining the RICO and antitrust causes of action asserted by the provider and medical association plaintiffs in the Ingenix litigation on the ground that they arose prior to and were released in the prior settlement. On November 30, 2009, the Court granted the motions and ordered the provider and association plaintiffs to withdraw their RICO and antitrust claims from the Ingenix litigation by December 21, 2009. The plaintiffs filed notices of appeal with the United States Court of Appeals for the Eleventh Circuit on December 10 and 11, 2009. On April 21, 2010 and June 16, 2010, the appeals were dismissed for lack of appellate jurisdiction. Plaintiffs’ motion for reconsideration was denied on August 18, 2010.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income and changes in total equity and cash flows present fairly, in all material respects, the financial position of CIGNA Corporation and its subsidiaries («the Company») at December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.