On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc. For additional information, see the Health Care section of the Management’s Discussion and Analysis beginning on page 54.
In 2008, the Company recorded an after-tax litigation charge of $52 million in Corporate related to the CIGNA pension plan. See Note 22 to the Consolidated Financial Statements for additional information.
During 2007, CIGNA completed a three-for-one stock split of CIGNA’s common shares. Per share figures have been adjusted to reflect the stock split.
Pro forma common shares outstanding, calculated as if the stock split had occurred at the beginning of the prior periods, were as follows: 295,963 in 2006; 363,573 in 2005; and 396,021 in 2004.
The Company generates revenues, net income and cash flow from ongoing operations by:
Effectively managing the various exposures of its run-off operations is important to the Company’s ongoing profitability, operating cash flows and available capital. The results are influenced by a range of economic factors, especially movements in equity markets and interest rates. Results are also influenced by behavioral factors, including partial surrender election rates for GMDB contracts and annuity election rates for GMIB contracts, as well as the collection of amounts recoverable from retrocessionaires. In order to manage these risks, the Company operates a GMDB equity hedge program to substantially reduce the impact of equity market movements. The Company actively monitors the performance of the hedge program, and evaluates the cost/benefit of hedging other risks. The Company also actively studies policyholder behavior experience and adjusts future expectations based on the results of the studies, as warranted. We also perform regular audits of the ceding companies to ensure treaty compliance that premiums received and claims paid are properly reflective of the underlying risks and to maximize the probability of subsequent collection of claims from retrocessionaires. Finally, the Company monitors the credit standing of the retrocessionaires.
The Company regularly monitors the trends impacting operating results from the above mentioned key factors and economic and other factors affecting its operations. The Company develops strategic and tactical plans designed to improve performance and maximize its competitive position in the markets it serves. The Company’s ability to achieve its financial objectives is dependent upon its ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.
On April 1, 2008, the Company acquired the Healthcare division of Great-West Life and Annuity, Inc. (“Great-West Healthcare” or the “acquired business”) through 100% indemnity reinsurance agreements and the acquisition of certain affiliates and other assets and liabilities of Great-West Healthcare. The purchase price was approximately $1.5 billion and consisted of a payment to the seller of approximately $1.4 billion for the net assets acquired and the assumption of net liabilities under the reinsurance agreement of approximately $0.1 billion. Great-West Healthcare primarily sells medical plans on a self-funded basis with stop-loss coverage to select and regional employer groups. Great-West Healthcare’s offerings also include the following specialty products: stop-loss, life, disability, medical, dental, vision, prescription drug coverage, and accidental death and dismemberment insurance. The acquisition, which was accounted for as a purchase, was financed through a combination of cash and the issuance of both short and long-term debt.
Special items for 2008 included a cost reduction charge (see the Introduction section of the MD&A beginning on page 43), a litigation matter related to the CIGNA Pension Plan (see Note 22 to the Consolidated Financial Statements for additional information) reported in Corporate and charges related to certain other litigation matters, which are reported in the Health Care segment.
The Company reported significant net realized investment losses in 2008 primarily due to impairments caused largely by the deterioration in the financial markets. These losses were partially offset by gains on the sale of real estate. See the Investment Assets section of the MD&A beginning on page 73 for more information.
These factors were partially offset by higher segment earnings in each of the Company’s ongoing operating segments (Health Care, Disability and Life, and International).
Excluding the special items discussed above, income from continuing operations decreased in 2007, compared with 2006, principally reflecting lower realized investment gains primarily due to lower gains from sales of equity interests in real estate limited liability entities of $145 million.
condition, and could reduce the capital of the Company’s insurance subsidiaries as well as their dividend paying capabilities.
Excluding the impact of the futures contracts associated with the GMDB equity hedge program, Other revenues increased 17% in 2008, compared with 2007, primarily reflecting the impact of the acquired business. In 2008, the Company reported gains of $333 million associated with the GMDB equity hedge program, compared with losses of $32 million in 2007. The gains in 2008 primarily reflect the decline in stock market values.
Excluding the impact of the GMDB equity hedge program, Other revenues decreased 10% in 2007, compared with 2006 primarily due to lower revenues from the disability and workers compensation case management business reported in the Disability and Life segment. The Company reported losses on futures contracts associated with the GMDB equity hedge program of $32 million in 2007, compared with losses of $96 million in 2006. The decline in losses in 2007 primarily reflects lower stock market appreciation compared with 2006.
Realized investment gains (losses) were lower in 2007, compared with 2006, primarily due to sales of equity interests in real estate limited liability entities in 2006.
The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect reported amounts and related disclosures in the consolidated financial statements. Management considers an accounting estimate to be critical if:
These liabilities are estimates of the present value of net amounts expected to be paid, less the present value of net future premiums expected to be received. The amounts to be paid represent the excess of the guaranteed death benefit over the values of contractholders’ accounts. The death benefit coverage in force at December 31, 2008 (representing the amount payable if all of approximately 650,000 contractholders had died as of that date) was approximately $11 billion.
Interest rates include both (a) the mean investment performance assumption considering 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 (b) the liability discount rate assumption.
• 10% increase in election rates for future partial surrenders - $10 million
Liabilities for medical claims payable as of December 31 were as follows (in millions):
For the year ended December 31, 2008, actual experience differed from the Company’s key assumptions, resulting in $60 million of favorable incurred claims related to prior years’ medical claims payable of 0.9% of the current year incurred claims as reported for the year ended December 31, 2007. For the year ended December 31, 2007, actual experience differed from the Company’s key assumptions, resulting in $80 million of favorable incurred claims related to prior years’ medical claims, or 1.3% of the current year incurred claims reported for the year ended December 31, 2006. Specifically, the favorable impact is due to faster than expected completion factors and lower than expected medical cost trends, both of which included an assumption for moderately adverse experience.
manage these factors through benefit design, underwriting, provider contracting and the Company’s medical management initiatives. These factors are affected by changes in the level and mix of medical benefits offered, including inpatient, outpatient and pharmacy, the impact of copays and deductibles, changes in provider practices and changes in consumer demographics and consumption behavior.
Accounts payable, accrued expenses and other liabilities, and Other assets -
With the adoption of SFAS No. 157, the Company updated assumptions to reflect those that the Company believes a hypothetical market participant would use to determine a current exit price. The Company estimates a hypothetical market participant’s view of these assumptions considering market observable information, the actual and expected experience of the Company, and other relevant and available industry sources. Resulting changes in fair value are reported in GMIB expense.
Current assumptions used to estimate these liabilities are detailed in Note 11 to the Consolidated Financial Statements. With the adoption of SFAS No. 157, the Company’s results of operations are expected to be more volatile in future periods because these assumptions will be based largely on market-observable inputs at the close of each period including interest rates and market implied volatilities.
If an unfavorable change were to occur in these assumptions, the approximate after-tax decrease in net income, net of estimated amounts receivable from reinsurers, would be as follows:
Credit risk refers to the ability of these reinsurers to pay.
• 10% decrease in amounts receivable from reinsurers (credit risk) - $60 million
Market declines which reduce annuitants’ account values expose the Company to higher potential claims which results in a larger net liability. If annuitants’ account values as of December 31, 2008 declined by 10% due to the performance of the underlying mutual funds, the approximate after-tax decrease in net income, net of estimated amounts receivable from reinsurers, would be approximately $25 million.
The amount of reinsurance recoverables in the Run-off Reinsurance segment, net of reserves, represents management’s best estimate of recoverability, including an assessment of the financial strength of reinsurers.
A 10% reduction of net reinsurance recoverables due to uncollectibility at December 31, 2008, would reduce net income by approximately $11 million after-tax.
See Note 10 to the Consolidated Financial Statements for additional information.
• annual pension costs for 2009 would increase by approximately $15 million, after-tax; and
• the accrued pension benefit liability would increase by approximately $180 million as of December 31, 2008 resulting in an after-tax decrease to shareholders’ equity of approximately $120 million as of December 31, 2008.
The significant decline in value of equity securities during 2008 has resulted in an accumulated unrecognized actuarial loss of $1.5 billion at December 31, 2008. The actuarial loss is adjusted for unrecognized changes in market-related asset values and amortized over the remaining service life of pension plan participants if the adjusted loss exceeds 10% of the market-related value of plan assets or 10% of the projected benefit obligation, whichever is greater. As of December 31, 2008, approximately $0.4 billion of the adjusted actuarial loss exceeded 10% of the projected benefit obligation. As a result, approximately $35 million after-tax will be expensed in 2009 net income. For the year ended December 31, 2008, $37 million after-tax was expensed in net income.
Recognition of losses from “other than temporary” impairments of public and private placement fixed maturities
Management estimates the amount of an “other than temporary” impairment when a decline in value is expected to persist, using quoted market prices for public securities with active markets and generally the present value of future cash flows for private placement bonds and other public securities. Expected future cash flows are based on historical experience of the issuer and management’s expectation of future performance. See “Quality Ratings” in the Investment Assets section of the MD&A beginning on page 73 for additional information.
The Company recognized “other than temporary” impairments of investments in fixed maturities as follows (in millions, after-tax):
For all fixed maturities with cost in excess of their fair value, if this excess was determined to be other-than-temporary, the Company’s net income for the year ended December 31, 2008 would have decreased by approximately $388 million after-tax.
Operating segments generally reflect groups of related products, but the International segment is generally based on geography. The Company measures the financial results of its segments using “segment earnings (loss),” which is defined as income (loss) from continuing operations excluding after-tax realized investment gains and losses.
Excluding the special items for cost reduction and litigation charges as well as the items mentioned above, segment earnings increased in 2008 compared with 2007 due to:
favorable specialty earnings due to increased sales to core medical customers as well as strong performance in the direct specialty
higher operating expenses reflecting spending on operational improvement initiatives, including segment expansion and investments in information technology, partially offset by expense reductions in certain areas, primarily service operations.
a lower medical cost ratio in the guaranteed cost business of 160 basis points due to strong renewal pricing increases in excess of medical cost trend; and
(1) Premiums and/or fees associated with certain specialty products are also included.
(2) Includes premiums associated with other risk-related products, primarily network and PPO plans.
Premiums and fees increased by 9% in 2008, compared with 2007, primarily reflecting:
higher other medical premiums due to increased sales to core medical customers and rate increases in specialty business; and
These factors were partially offset by a decrease in the guaranteed cost business which was due to membership declines largely in commercial HMO business partially offset by rate increases.
In addition, premiums and fees in 2007 reflect a change in the mix of products to more service-only products from guaranteed cost products.
(3) Represents members associated with the acquisition of Great-West Healthcare effective April 1, 2008.
Offering products that meet emerging customer and market trends. In order to meet emerging customer and market trends, the Company’s suite of products (CIGNATURE®, CareAllies®, and CIGNA Choice Fund®) offers various options to customers and employers and is key to our customer engagement strategy. Offerings include: choice of benefit, participating provider network, funding, medical management, and health advocacy options. Through the CIGNA Choice Fund®, the Company offers a set of customer-directed capabilities that includes options for health reimbursement arrangements and/or health savings accounts and enables customers to make effective health decisions using information tools provided by the Company.
Effectively managing medical costs. The Company operates under a centralized medical management model, which helps facilitate consistent levels of care for its members and reduces infrastructure expenses.
The Company is focused on continuing to effectively manage medical utilization and unit costs. The Company believes that by increasing the quality of medical care and improving access to care we can drive reductions in total medical cost. To help achieve this, the Company continues to focus on renegotiating contracts with providers and certain facilities to limit increases in medical reimbursement costs. In addition, the Company seeks to strengthen its network position in selected markets. In connection with the Great-West Healthcare acquisition in April 2008, the Company is converting and integrating these acquired members to its extensive preferred provider network which offers access to a broad range of utilization review and case management services. By directing members to the highest quality and most efficient network providers and leveraging their clinical engagement protocols we are realizing benefits from the increased utilization.
The Company is focused on the development and enhancement of a service model that is capable of meeting the challenges brought on by the increasing product and service complexity and the heightened expectations of health care customers. The Company continues to make significant investments in the development and implementation of systems and technology to improve the member and provider service experience, enhance its capabilities and improve its competitive position.
The Company’s health advocacy capabilities support its recent membership growth efforts. The Company must be able to deliver those capabilities efficiently and cost-effectively. The Company continues to identify additional cost savings to further improve its competitive cost position. Savings generated from the Company’s operating efficiency initiatives provide capital to make investments that will enhance its capabilities in the areas of customer engagement, particularly product development, the delivery of member service and health advocacy and related technology.
Segment earnings in 2008 include the favorable after-tax impact of reserve studies and a favorable reinsurance settlement which aggregated to $19 million, partially offset by a special item for a cost reduction charge of $2 million. Segment earnings in 2007 include the favorable after-tax impact of reserve studies of $12 million and a special item of $6 million of previously unrecognized tax benefits resulting from the completion of the IRS examination for the 2003 and 2004 tax years. Segment earnings in 2006 include the favorable after-tax impact of reserve studies of $28 million, partially offset by severance charges of $6 million. Excluding the impact
of the items noted above, segment earnings increased 8% in 2008, compared with 2007 reflecting:
a lower expense ratio driven by effective operating expense management and lower management incentive compensation; and
higher premiums and fees in the disability, life and accident businesses due to business growth.
Excluding the impact of reserve studies and the items noted above, segment earnings increased 16% in 2007, compared with 2006 reflecting:
Premiums and fees, excluding the effect of foreign currency movements, were (in millions): $1,971 in 2008, $1,745 in 2007 and $1,494 in 2006.
Benefits and expenses increased 4% in 2008, compared with 2007 and 16% in 2007 compared with 2006, primarily due to business growth in all lines of business, partially offset by foreign currency movements, primarily in South Korea.
Expense ratios increased slightly in 2008 in the life, accident and supplemental health business and the expatriate benefits business as a result of higher expenses to support growth initiatives and expansion. Expense ratios in the life, accident and health and expatriate benefits businesses continue to be strong due to effective expense management.
GMIB Expense. GMIB expense in 2008 includes a pre-tax charge of $202 million for the adoption of SFAS No. 157, which is discussed in Notes 2(B) and 11 to the Consolidated Financial Statements. GMIB expense in 2007 includes a pre-tax charge of $86 million related to updated assumptions for annuity election and lapse rates. With the adoption of SFAS No. 157 in 2008, the Company’s results of operations are expected to be more volatile in future periods both because the liabilities, net of receivables from reinsurers, are larger and because these assumptions will be based largely on market-observable inputs at the close of each reporting period including interest rates (LIBOR swap curve) and market-implied volatilities.
Excluding the charge on adoption of SFAS No. 157, the GMIB business generated additional pre-tax expense of $488 million in 2008 primarily as a result of:
the impact of declines in underlying account values in the period, driven by declines in equity markets and bond fund returns, resulting in increased exposure: $158 million;
Excluding the charge to update assumptions for annuity election and lapse rates, the GMIB business generated additional pre-tax expense of $61 million in 2007, primarily the result of unfavorable annuitization and lapse experience.
However, the significant decline in financial markets during 2008 has had an unfavorable impact on the GMIB business. Significant declines in mutual fund values that underlie the contracts (increasing the exposure to the Company) together with declines in the 7-year Treasury rate (used to determine claim payments) increased the expected amount of claims that will be paid out for contractholders who choose to annuitize while these conditions continue. It is also possible that these unfavorable market conditions will have an impact on the level of contractholder annuitizations, particularly if these unfavorable market conditions persist for an extended period.
Other Benefits and Expenses. During 2008, the Company recorded additional other benefits and expenses of $412 million ($267 million after-tax) primarily to strengthen GMDB reserves following an analysis of experience and reserve assumptions. These amounts were primarily due to:
adverse volatility-related impacts due to turbulent equity market conditions. Volatility risk is not covered by the GMDB equity
hedge program. Also, the equity market volatility, particularly during the second half of the year, impacted the effectiveness of the hedge program. In aggregate, these volatility-related impacts totaled $182 million ($118 million after-tax). The GMDB equity hedge program is designed so that changes in the value of a portfolio of actively managed futures contracts will offset changes in the liability resulting from equity market movements. In periods of equity market declines, the liability will increase; the program is designed to produce gains on the futures contracts to offset the increase in the liability. However, the program will not perfectly offset the change in the liability, in part because the market does not offer futures contracts that exactly match the diverse mix of equity fund investments held by contractholders, and because there is a time lag between changes in underlying contractholder mutual funds, and corresponding changes in the hedge position. In 2008, the impact of this mismatch was higher than most prior periods due to the relatively large changes in market indices from day to day. In addition, the number of futures contracts used in the program is adjusted only when certain tolerances are exceeded and in periods of highly volatile equity markets when actual volatility exceeds the expected volatility assumed in the liability calculation, losses will result. These conditions have had an adverse impact on earnings, and during 2008, the increase in the liability due to equity market movements was only partially offset by the results of the futures contracts; and
Other benefits and expenses were lower in 2007, compared with 2006, due to lower expense in the workers’ compensation and personal accident businesses, due to the impact of favorable claim experience and settlements and commutations that were favorable to the Company’s reserved position. This was partially offset by higher benefits expense for the guaranteed minimum death benefit business, as improvements in equity markets for 2007 were smaller than in 2006.
From April 1, 2004 through March 31, 2006, the Company had a modified coinsurance arrangement relating to the single premium annuity business sold to the buyer of the retirement benefits business. Under that arrangement, the Company retained the invested assets supporting the reinsured liabilities. These invested assets were held in a business trust established by the Company. Effective April 1, 2006, the buyer converted this modified coinsurance arrangement to an indemnity reinsurance structure and took ownership of the trust assets.
Excluding the special items noted in the table above, Corporate results in 2007, compared with 2006, were lower, reflecting higher net interest expense resulting from the issuance of additional debt combined with lower average assets due to share repurchase activity. In addition, the increase in segment loss also reflects the absence in 2007 of certain favorable expense items recorded in 2006.
impairment losses related to the dispositions in 2007 and 2006 of several Latin American insurance operations as discussed in Note 3 to the Consolidated Financial Statements; and
collecting pension contributions from subsidiaries in the amount of the GAAP expense charged; and
Because certain income and expense transactions do not generate cash, and because cash transactions related to revenue and expenses may occur in periods different from when those revenues and expenses are recognized in net income, cash flow from operating activities can be significantly different from net income. The Company assesses cash flows from operating activities by comparing it with adjusted income from operations, which is defined as income from continuing operations excluding the results of GMIB and special items, and further adjusted to exclude pre-tax realized investment results and depreciation and amortization charges.
Cash flows from investing activities generally consist of net investment purchases or sales and net purchases of property and equipment, which includes capitalized software, as well as cash used to acquire businesses.
Cash flows from financing activities is generally comprised of issuances and re-payment of debt at the parent level, proceeds on the issuance of common stock resulting from stock option exercises, and stock repurchases. In addition, the subsidiaries report net deposits/withdrawals to/from investment contract liabilities (which include universal life insurance liabilities) because such liabilities are considered financing activities with policyholders.
Cash flows from operating activities increased by $314 million in 2008 compared with 2007. Excluding the results of the GMDB equity hedge program (which did not affect net income), cash flows from operating activities decreased by $51 million. This decrease in 2008 primarily reflects higher payments for certain prepaid expenses in 2008.
The Company used net cash of $1.3 billion to fund the acquisition of Great-West Healthcare, consisting of a cash payment to Great-West Life and Annuity, Inc. of approximately $1.4 billion, partially offset by cash acquired from Great-West Healthcare of approximately $0.1 billion. Excluding this item, cash used in investing activities was $1.3 billion. This use of cash primarily consisted of net purchases of investments of $988 million and net purchases of property and equipment of $257 million.
financing of the acquisition of Great-West Healthcare. Financing activities also included net deposits from contractholder deposit funds of $91 million, proceeds from the issuance of common stock under the Company’s stock plans of $37 million and dividends on and repurchases of common stock of $392 million.
Solvency regulation Many states have adopted some form of the National Association of Insurance Commissioners (“NAIC”) model solvency-related laws and risk-based capital rules (“RBC rules”) for life and health insurance companies. The RBC rules recommend a minimum level of capital depending on the types and quality of investments held, the types of business written and the types of liabilities incurred. If the ratio of the insurer’s adjusted surplus to its risk-based capital falls below statutory required minimums, the insurer could be subject to regulatory actions ranging from increased scrutiny to conservatorship.
In addition, various non-U.S. jurisdictions prescribe minimum surplus requirements that are based upon solvency, liquidity and reserve coverage measures. During 2008, 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.
In 2008, the NAIC adopted Actuarial Guideline VACARVM, which will be effective December 31, 2009. VACARVM will impact statutory and tax reserves for CIGNA’s GMDB and GMIB contracts. Upon implementation, it is anticipated that statutory reserves for these contracts will increase and thus statutory surplus for Connecticut General Life Insurance Company will be reduced. The magnitude of any impact depends on equity market and interest rate levels at the time of implementation.
The above table also does not contain $164 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 18 to the Consolidated Financial Statements for the year ended December 31, 2008 for further information.
Purchase obligations. As of December 31, 2008, purchase obligations consisted of estimated payments required under contractual arrangements for future services and investment commitments as follows:
The Company had commitments to invest in limited liability entities that hold real estate or loans in real estate entities or securities. See Note 12(C) to the Consolidated Financial Statements for additional information.
Operating leases. For additional information, see Note 20 to the Consolidated Financial Statements.
As of December 31, 2008, $10.8 billion, or 92%, of the fixed maturities in the Company’s investment portfolio were investment grade (Baa and above, or equivalent), and the remaining $1.0 billion were below investment grade. Most of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum.
Because of the higher yields and the inherent risk associated with privately placed investments and below investment grade securities, gains or losses from such investments could affect future results of operations. However, since management matches the duration of assets to the duration of liabilities, it expects to hold a significant portion of these assets for the long term and therefore, does not expect such gains or losses to be material to the Company’s liquidity or financial condition.
“Problem” bonds and commercial mortgage loans are either delinquent by 60 days or more or have been restructured as to terms (interest rate or maturity date). “Potential problem” bonds and commercial mortgage loans are considered current (no payment more than 59 days past due), but management believes they have certain characteristics that increase the likelihood that they may become “problems.” These characteristics include, but are not limited to, the following:
(1) The Company sold its remaining foreclosed property and did not acquire any properties through foreclosure in 2008.
The market conditions described above resulted in a significant net increase in investment yields across the credit spectrum. While this increase is positive for new investments, it drove a significant decline in value for the Company’s existing investment portfolio. The Company’s corporate fixed maturity and commercial mortgage loan portfolios are well diversified by borrower, sector, and geographic region, limiting exposure. However, if broad economic conditions and/or illiquidity in the capital markets persist or worsen, this would likely result in an increase in the severity and duration of the decline in asset values, and may cause the Company to experience additional investment losses.
The Company’s assets and liabilities include financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. The Company’s primary market risk exposures are:
Equity price risk for domestic equity securities and for GMDB and GMIB contracts resulting from unfavorable changes in variable annuity account values based on underlying mutual fund investments.
The Company predominantly relies on three techniques to manage its exposure to market risk:
changes in the fair values of investments recorded using the equity method of accounting and liabilities for pension and other postretirement and postemployment benefit plans (and related assets) have been excluded, consistent with the disclosure guidance; and
CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company and its representatives may from time to time make written and oral forward-looking statements, including statements contained in press releases, in the Company’s filings with the Securities and Exchange Commission, in its reports to shareholders and in meetings with analysts and investors. Forward-looking statements may contain information about financial prospects, economic conditions, trends and other uncertainties. These forward-looking statements are based on management’s beliefs and assumptions and on information available to management at the time the statements are or were made. Forward-looking statements include but are not limited to the information concerning possible or assumed future business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, trends and, in particular, the Company’s productivity initiatives, litigation and other legal matters, operational improvement in the health care operations, and the outlook for the Company’s full year 2009 results. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believe”, “expect”, “plan”, “intend”, “anticipate”, “estimate”, “predict”, “potential”, “may”, “should” or similar expressions.
You should not place undue reliance on these forward-looking statements. The Company cautions that actual results could differ materially from those that management expects, depending on the outcome of certain factors. Some factors that could cause actual results to differ materially from the forward-looking statements include:
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;
inability of the program adopted by the Company to substantially reduce equity market risks for reinsurance contracts that guarantee minimum death benefits under certain variable annuities (including possible market difficulties in entering into appropriate futures contracts and in matching such contracts to the underlying equity risk);
adjustments to the assumptions (including annuity election rates and amounts collectible from reinsurers) used in estimating the Company’s assets and liabilities for reinsurance contracts covering guaranteed minimum income benefits under certain variable annuities;
unfavorable claims experience related to workers’ compensation and personal accident exposures of the run-off reinsurance business, including losses attributable to the inability to recover claims from retrocessionaires;
potential public health epidemics 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 of the Company to execute its growth plans by successfully managing Great-West Healthcare’s outsourcing projects and leveraging the Company’s capabilities and those of the business acquired from Great-West to further enhance the combined organization’s network access position, underwriting effectiveness, delivery of quality member and provider service, and increased penetration of its membership base with differentiated product offerings.
This list of important factors is not intended to be exhaustive. Other sections of the Company’s 2008 Annual Report on Form 10-K, including the “Risk Factors” section, and other documents filed with the Securities and Exchange Commission include both expanded discussion of these factors and additional risk factors and uncertainties that could preclude the Company from realizing the forward-looking statements. The Company does not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these statements.
CIGNA Corporation together with its subsidiaries (referred to collectively as “the Company”) constitutes one of the largest investor-owned health service organizations in the United States. Its subsidiaries are major providers of health care and related benefits, the majority of which are offered through the workplace, including health care products and services such as medical coverages, pharmacy, behavioral health, dental benefits, and disease management; group disability, life and accident insurance; and disability and workers’ compensation case management and related services. In addition, the Company has an international operation that offers life, accident and supplemental health insurance products and international health care products and services to businesses and individuals in selected markets. The Company also has certain inactive businesses, including a run-off reinsurance operation.
The consolidated financial statements include the accounts of CIGNA Corporation, its significant subsidiaries, and variable interest entities of which CIGNA Corporation is the primary beneficiary. Intercompany transactions and accounts have been eliminated in consolidation.
impairment losses related to the dispositions in 2007 and 2006 of several Latin American insurance operations as discussed in Note 3; and
realized gains on the disposition of certain directly-owned real estate investments in 2007 and 2006 as discussed in Note 13.
Variable interest entities. As of December 31, 2008 the Company is no longer a primary beneficiary in any variable interest entities. As of 2007, the Company consolidated $5 million in assets and $5 million in liabilities as the primary beneficiary of one real estate joint venture.
$20 million related to projecting the interest rate used to calculate the reinsured income benefits at the time of annuitization (claim interest rate) using the market-implied forward rate curve and volatility as of January 1, 2008. Claim payments are based on the 7-year Treasury Rate at the time the benefit is elected, and the Company believes that a hypothetical market participant would likely use the above market-implied approach rather than projecting the 7-year Treasury Rate grading from current levels to long-term average levels.
Assumptions Related to Future Annuitant and Retrocessionaire Behavior - $19 million of the $202 million pre-tax charge, net of estimated receivables for reinsurance, reflected the impact of the Company’s view of a hypothetical market participant’s assumptions for future annuitant and retrocessionaire behavior and primarily reflects an incremental risk and profit charge.
Fair value option. Effective January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose fair value measurement for many financial instruments, including insurance contracts, with subsequent changes in fair value to be reported in net income for the period. This choice is made for each individual financial instrument, is irrevocable and, after implementation, must be determined when the entity first commits to or recognizes the financial instrument. The adoption of SFAS No. 159 did not impact the Company’s consolidated financial statements, as no items were elected for fair value measurement. For financial assets and liabilities acquired after adoption, the Company determines whether to use the fair value election at the time of acquisition.
Deferred acquisition costs. Effective January 1, 2007, the Company implemented the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.” The SOP requires that deferred acquisition costs be expensed in full when the original contract is substantially changed by election or amendment of an existing contract feature or by replacement with a new contract. There were no material effects to the consolidated financial statements at implementation. Although substantial contract changes are not expected to occur, the effect of this SOP in future periods may vary based on the nature and volume of any such contract changes.
Liabilities for pension benefits and other postretirement benefits are recorded in accounts payable, accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets.
Earnings per share. In 2008, the FASB issued FASB Staff Position EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” to require outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends to be included in the denominator of both basic and diluted earnings per share calculations. These new requirements must be applied through restatement of prior-period earnings per share data beginning in the first quarter of 2009. On adoption, the Company does not expect material changes to either basic or diluted earnings per share data.
These instruments may change in value due to interest rate and market fluctuations, and most also have credit risk. The Company evaluates and monitors each financial instrument individually and, when management considers it appropriate, uses a derivative instrument or obtains collateral or another form of security to minimize risk of loss.
Fixed maturities and equity securities. Fixed maturities include bonds, mortgage- and other asset-backed securities and preferred stocks redeemable by the investor. Equity securities include common stocks and preferred stocks that are non-redeemable or redeemable only by the issuer. These investments are primarily classified as available for sale and are carried at fair value with changes in fair value recorded in accumulated other comprehensive income (loss) within shareholders’ equity. Fixed maturities and equity securities are considered impaired, and their cost basis is written down to fair value through earnings, when management expects a decline in value to persist (i.e. the decline is “other than temporary”). Fixed maturities and equity securities include certain trading and hybrid securities carried at fair value with changes in fair value reported in realized investment gains and losses, beginning after the implementation of SFAS No. 155 on January 1, 2007 for hybrid securities. The Company elected fair value accounting for certain hybrid securities to simplify accounting and mitigate volatility in results of operations and financial condition.
Real estate is “held for sale” when a buyer’s investigation is completed, a deposit has been received and the sale is expected to be completed within the next year. Real estate held for sale is carried at the lower of carrying value or current fair value, less estimated costs to sell, and is not depreciated. Valuation reserves reflect any changes in fair value.
The Company uses several methods to determine the fair value of real estate, but relies primarily on discounted cash flow
Other long-term investments. Other long-term investments include investments in unconsolidated entities. These entities include certain limited partnerships and limited liability companies holding real estate, securities or loans. These investments are carried at
Derivative financial instruments. Note 12(F) discusses the Company’s accounting policies for derivative financial instruments.
Net investment income. 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 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 earned on trading and hybrid securities are included in net investment income.
Investment gains and losses. 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.
amounts required to adjust future policy benefits for run-off settlement annuity business; and
Premiums, accounts and notes receivable are reported net of an allowance for doubtful accounts of $50 million as of December 31, 2008 and $54 million as of December 31, 2007. Reinsurance recoverables are estimates of amounts that the Company will receive from reinsurers and are recorded net of an allowance for unrecoverable reinsurance of $23 million as of December 31, 2008 and $27 million as of December 31, 2007.
Acquisition costs include sales compensation, commissions, premium taxes and other costs that the Company incurs in connection with new and renewal business. Depending on the product line they relate to, the Company records acquisition costs in different ways. Acquisition costs for:
For universal life, annuity and other individual products, management estimates the present value of future revenues less expected payments. For group health indemnity products, management estimates the sum of future expected claims and related costs less unearned premiums and anticipated net investment income. If management’s estimates are less than the deferred costs, the Company reduces deferred policy acquisition costs and records an expense. Anticipated investment income is considered in the calculation of
premium deficiency losses for short-duration contracts. The Company recorded in other operating expenses amortization for policy acquisition costs of $314 million in 2008, $242 million in 2007 and $202 million in 2006. 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.
Property and equipment is carried at cost less accumulated depreciation. When applicable, cost includes interest, real estate taxes and other costs incurred during construction. Also included in this category is internal-use software that is acquired, developed or modified solely to meet the Company’s internal needs, with no plan to market externally. Costs directly related to acquiring, developing or modifying internal-use software are capitalized. See Note 9 for additional information on internal-use software.
Future policy benefits are liabilities for the present value of estimated future obligations under long-term life and supplemental health insurance policies and annuity products currently in force. These obligations are estimated using actuarial methods and primarily
consist of reserves for annuity contracts, life insurance benefits, guaranteed minimum death benefit contracts and certain life, accident and health insurance products in our International operations.
Obligations for annuities represent specified periodic benefits to be paid to an individual or groups of individuals over their remaining lives. Obligations for life insurance policies represent benefits to be paid to policyholders, net of future premiums to be received. Management estimates these obligations based on assumptions as to premiums, interest rates, mortality and surrenders, allowing for adverse deviation. Mortality, morbidity, and surrender assumptions are based on either the Company’s own experience or actuarial tables. Interest rate assumptions are based on management’s judgment considering the Company’s experience and future expectations, and range from 1.5% to 10.0%. Obligations for the run-off settlement annuity business include adjustments for investment returns consistent with requirements of GAAP when a premium deficiency exists.
Certain reinsurance contracts guarantee a minimum death benefit (GMDB) under variable annuities issued by other insurance companies. These obligations represent the guaranteed death benefit in excess of the contractholder’s account values (based on underlying equity and bond mutual fund investments). These obligations are estimated based on assumptions regarding lapse, partial surrenders, mortality, interest rates (mean investment performance and discount rate), market volatility as well as investment returns and premiums, consistent with the requirements of GAAP when a premium deficiency exists. Lapse, partial surrenders, mortality, interest rates and volatility are based on management’s judgment considering the Company’s experience and future expectations. The results of futures contracts used in the GMDB equity hedge program are reflected in the liability calculation as a component of investment returns. See also Note 7 for additional information.
The Company develops these estimates using actuarial principles and assumptions based on historical and projected claim payment patterns, medical cost trends, which are impacted by the utilization of medical services and the related costs of the services provided (unit costs), benefit design, seasonality, and other relevant operational factors. The Company consistently applies these actuarial principles and assumptions each reporting period, with consideration given to the variability of these factors, and recognizes the
Benefits and expenses for universal life products consist of benefit claims in excess of policyholder account balances. Expenses are recognized when claims are submitted, and income is credited in accordance with contract provisions.
As part of the reinsurance and administrative service arrangements, the Company is responsible to pay claims for the group medical and long-term disability business of Great-West Healthcare and collect related amounts due from their third party reinsurers. Any such amounts not collected will represent additional assumed liabilities of the Company and decrease net income if and when these amounts are determined uncollectible. At December 31, 2008, receivables recorded for paid claims due from third party reinsurers for this business approximated $1 million and unpaid claims related to this business were estimated at $27 million.
The results of Great-West Healthcare are included in the Company’s Consolidated Financial Statements from the date of acquisition.
On August 10, 2007, the Company completed the sale of its Chilean insurance operations, which was classified as a discontinued operation in the second quarter of 2007. The Company recognized an impairment loss in the second quarter of 2007 for this business of $19 million after-tax primarily relating to the write-off of unrecoverable tax assets and foreign currency translation losses. As of
The Company’s reinsurance operations, which were discontinued in 2000 and are now an inactive business in run-off mode, reinsured a guaranteed minimum death benefit (GMDB), also known as variable annuity death benefits (VADBe), under certain variable annuities issued by other insurance companies. These variable annuities are essentially investments in mutual funds combined with a death benefit. The Company has equity and other market exposures as a result of this product. In periods of declining equity markets and in periods of flat equity markets following a decline, the Company’s liabilities for these guaranteed minimum death benefits increase. Conversely, in periods of rising equity markets, the Company’s liabilities for these guaranteed minimum death benefits decrease.
required hedge position on a real time basis. Although this hedge program does not qualify for GAAP hedge accounting, it is an economic hedge because it is designed to and is effective in reducing equity market exposures resulting from this product. The results of the futures contracts are included in other revenue and amounts reflecting corresponding changes in liabilities for these GMDB contracts are included in benefits and expenses, consistent with GAAP when a premium deficiency exists.
The Company had future policy benefit reserves for GMDB contracts of $1.6 billion as of December 31, 2008, and $848 million as of December 31, 2007. The increase in reserves is primarily due to declines in the equity market driving down the value of the underlying mutual fund investments.
During 2008, the Company recorded additional benefits and expenses of $412 million pre-tax ($267 million after-tax) primarily to strengthen GMDB reserves following an analysis of experience and reserve assumptions. The amounts were primarily due to:
Management estimates reserves for GMDB exposures based on assumptions regarding lapse, partial surrender, mortality, interest rates (mean investment performance and discount rate) and volatility. These assumptions are based on the Company’s experience and future expectations over the long-term period. The Company monitors actual experience to update these reserve estimates as necessary.
Lapse refers to the full surrender of an annuity prior to a contractholder’s death. Partial surrender refers to the fact that most contractholders have the ability to withdraw substantially all of their mutual fund investments while retaining the death benefit coverage in effect at the time of the withdrawal. Mean investment performance refers to market rates to be earned over the life of the GMDB equity hedge program and market volatility refers to market fluctuations.
The determination of liabilities for GMDB requires the Company to make critical accounting estimates. The Company regularly evaluates the assumptions used in establishing reserves and changes its estimates if actual experience or other evidence suggests that earlier assumptions should be revised. If actual experience differs from the assumptions (including lapse, partial surrender, mortality, interest rates and volatility) used in estimating these reserves, the resulting change could have a material adverse effect on the Company’s consolidated results of operations, and in certain situations, could have a material adverse effect on the Company’s financial condition.
The following provides information about the Company’s reserving methodology and assumptions for GMDB as of December 31, 2008:
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 0-24% depending on the net amount at risk for each policy and whether surrender charges apply.
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 16-30%, varying by equity fund type; 4-10%, 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.
As discussed above, the Company operates a GMDB equity hedge program to substantially reduce the equity market exposures of this business by selling exchange-traded futures contracts, which are expected to rise in value as the equity market declines and decline in value as the equity market rises. In addition, the Company uses foreign currency futures contracts to reduce the international equity market and foreign currency risks associated with this business. The notional amount of futures contract positions held by the Company at December 31, 2008 was $1.4 billion. The Company recorded in other revenues pre-tax gains of $333 million in 2008, compared with pre-tax losses of $32 million in 2007 and $96 million in 2006 from these futures contracts.
Ceded Reinsurance: Ongoing operations. The Company’s insurance subsidiaries have reinsurance recoverables of $298 million as of December 31, 2008 from various reinsurance arrangements in the ordinary course of business for its Health Care, Disability and Life, and International segments as well as the non-leveraged and leveraged corporate-owned life insurance business. These reinsurance arrangements are diversified among more than 90 reinsurers. One recoverable represents 14% of the total, and the reinsurer has been assigned an AA- insurer financial strength rating from S&P. No other single reinsurer represents more than 11% of the total.
Summary. The Company’s reserves for underlying reinsurance exposures assumed by the Company, as well as for amounts recoverable from reinsurers/retrocessionaires for both ongoing operations and the run-off reinsurance operation, are considered appropriate as of December 31, 2008, based on current information. However, it is possible that future developments could have a material adverse effect on the Company’s consolidated results of operations and, in certain situations, such as if actual experience differs from the assumptions used in estimating reserves for GMDB, could have a material adverse effect on the Company’s financial condition. The Company bears the risk of loss if its retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.
Substantially all goodwill relates to the Health Care segment. As a result of the acquisition of Great-West Healthcare in 2008, and other minor acquisition in 2007, changes in the carrying value of goodwill were as follows:
Other intangible assets were comprised of the following at December 31:
(1) As a result of the acquisition of Great-West Healthcare in 2008, customer relationships increased by $127 million, internal-use software increased by $142 million and other intangibles, including provider networks and producer relationships, increased by $21 million.
The Company estimates annual pre-tax amortization for these intangible assets over the next five calendar years to be as follows: $142 million in 2009, $86 million in 2010, $75 million in 2011, $66 million in 2012, and $42 million in 2013.
The Company measures the assets and obligations of its domestic pension and other postretirement benefit plans as of December 31. The following table summarizes the projected obligations and assets related to the Company’s domestic and international pension and other postretirement benefit plans as of, and for the years ended, December 31:
During 2008, the Company’s postretirement benefits liability adjustment increased by $1.1 billion pre-tax ($723 million after-tax) resulting in a decrease to shareholders’ equity. The increase in the liability was primarily due to the difference between expected and actual returns on pension plan assets. Those investments experienced significant losses in 2008 due to the decline in the equity markets, compared with the expected long-term returns of 8% assumed in the expense calculation. Partially offsetting these losses was the amortization of actuarial losses.
Other postretirement benefits. Unfunded retiree health benefit plans had accumulated benefit obligations of $235 million at December 31, 2008, and $283 million at December 31, 2007. Retiree life insurance plans had accumulated benefit obligations of $141 million as of December 31, 2008 and $143 million as of December 31, 2007.
Components of net other postretirement benefit cost for the years ended December 31 were as follows:
As of December 31, 2008, pension plan assets included $1.5 billion invested in the separate accounts of Connecticut General Life Insurance Company (CGLIC) and Life Insurance Company of North America, which are subsidiaries of the Company. Most of these separate accounts are reinsured and managed by the buyer of the retirement benefits business.
Discount rates are set by applying actual annualized yields at various durations from the Citigroup Pension Liability curve, without adjustment, to the expected cash flows of the pension liabilities. The Company believes that the Citigroup Pension Liability curve is the most representative curve to use because it is derived from a broad array of bonds in various industries throughout the domestic market for high quality bonds. Further, Citigroup monitors the bond portfolio to ensure that only high quality issues are included. Accordingly, the Company does not believe that any adjustment is required to the Citigroup curve. 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. Actual and target investment allocations are very similar at December 31, 2008.
To measure pension costs, the Company uses a market-related asset valuation for domestic pension plan assets invested in non-fixed income investments. The market-related value of pension assets recognizes the difference between actual and expected long-term returns in the portfolio over 5 years, a method that reduces the short-term impact of market fluctuations.
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 periodically measured at fair value, such as when impaired, or, for commercial mortgage loans, when classified as “held for sale.”
Financial Assets and Financial Liabilities Measured at Fair Value on a Recurring Basis
The following table provides information as of December 31, 2008 about the Company’s financial assets and liabilities measured at fair value on a recurring basis. SFAS No. 157 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.
(3) Derivatives other than GMIB assets and liabilities are presented net of $36 million in gross derivative liabilities.
Other derivatives. Amounts classified in Level 2 represent over-the-counter instruments such as swap contracts. Fair values for these instruments are determined using market observable inputs including forward currency and interest rate curves and widely published market observable indices. Credit risk related to the counterparty and the Company is considered when estimating the fair values of these derivatives. However, the Company is largely protected by collateral arrangements with counterparties, and determined that no
The Company classifies certain newly issued, privately placed, complex or illiquid securities, as well as assets and liabilities relating to guaranteed minimum income benefits in Level 3.
Fixed maturities and equity securities. Approximately 7% or $889 million of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category, including:
$101 million of subordinated loans and private equity investments valued at transaction price in the absence of market data indicating a change in the estimated fair values.
Fair values of mortgage and asset-backed securities and corporate bonds are determined using pricing models that incorporate the specific characteristics of each asset and related assumptions including the investment type and structure, credit quality, industry and maturity date in comparison to current market indices and spreads, liquidity and economic events. For mortgage and asset-backed securities, inputs and assumptions to pricing may also include collateral attributes and prepayment speeds. Recent trades in the subject security or similar securities are assessed when available, and the Company may also review published research as well as the issuer’s financial statements in its evaluation.
The risk and profit charge assumption is based on the Company’s estimate of the capital and return on capital that would be required by a hypothetical market participant.
Changes in Level 3 Financial Assets and Financial Liabilities Measured at Fair Value on a Recurring Basis
(1) Amounts do not accrue to shareholders and are not reflected in the Company’s revenues.
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.
Fair values and changes in the fair values of separate account assets generally accrue directly to the policyholders and are not included in the Company’s revenues and expenses. As of December 31, 2008 separate account assets were as follows:
equity securities and corporate and structured bonds valued using recent trades of similar securities or pricing models that discount future cash flows at estimated market interest rates as described above; and
Separate account assets classified in Level 3 include investments primarily in securities partnerships and real estate generally valued at transaction price in the absence of market data indicating a change in the estimated fair value. Values may be adjusted when evidence is available to support such adjustments. Evidence may include market data as well as changes in the financial results and condition of the investment.
Certain financial assets and liabilities are measured at fair value on a non-recurring basis, such as commercial mortgage loans held for sale. As of December 31, 2008, the amount required to adjust these assets and liabilities to their fair value was not significant.
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 realized investment gains (losses).
Fixed maturities and equity securities included $211 million at December 31, 2008 and $89 million at December 31, 2007, which were pledged as collateral to brokers as required under certain futures contracts. These fixed maturities and equities securities were primarily corporate securities.
The following information about fixed maturities excludes trading and hybrid securities. The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at December 31, 2008:
Mortgage-backed assets consist principally of commercial mortgage-backed securities and collateralized mortgage obligations of which $41 million were residential mortgages and home equity lines of credit, all of which were originated utilizing standard underwriting practices and are not considered sub-prime loans.
Gross unrealized appreciation (depreciation) on fixed maturities (excluding trading securities and hybrid securities) by type of issuer is shown below.
Federal agency mortgage-backed securities were first purchased in 2008 as part of the acquired business.
In connection with the Company’s investment strategy to enhance investment yields by selling senior participations, commercial mortgage loans include loans that were originated with the intent to sell of $75 million as of December 31, 2008 and $77 million as of December 31, 2007.
At December 31, 2008, scheduled commercial mortgage loan maturities were as follows (in millions): $266 in 2009, $255 in 2010, $397 in 2011, $654 in 2012 and $2,045 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.
$229 million to limited liability entities that hold either real estate or loans to real estate entities that are diversified by property type and geographic region; and
$241 million to entities that hold securities diversified by issuer and maturity date.
The Company expects to disburse approximately 35% of the committed amounts in 2009 and the remaining amounts by 2014.
Short-term investments and cash equivalents included corporate securities of $1.1 billion, federal government securities of $126 million and money market funds of $147 million at December 31, 2008. The Company’s short-term investments and cash equivalents at December 31, 2007 included corporate securities of $1.5 billion, federal government securities of $192 million and money market funds of $66 million.
As of December 31, 2008 and 2007, the Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders’ equity.
Changes in the fair value of derivatives that hedge market risk related to future cash flows - and that qualify for hedge accounting - are reported in a separate caption in accumulated other comprehensive income. These hedges are referred to as cash flow hedges.
A change in the fair value of a derivative instrument may not always equal the change in the fair value of the hedged item; this difference is referred to as hedge ineffectiveness. Where hedge accounting is used, the Company reflects hedge ineffectiveness in net income (generally as part of realized investment gains and losses).
The Company recorded pre-tax realized investment losses of $11 million in 2006 from terminating swaps hedging interest rate and foreign currency risk of fixed maturities. The Company recorded pre-tax realized investment gains from swaps on commercial loan pools of $7 million in 2006.
To hedge the interest or foreign currency cash flows of fixed maturities and commercial mortgage loans to match associated liabilities. Currency swaps are primarily Canadian dollars, euros, Australian dollars and British pounds for periods of up to 13 years.
Using cash flow hedge accounting, fair values are reported in other long-term investments or other liabilities and accumulated other comprehensive income. Net interest cash flows are reported in net investment income and included in operating activities. When hedge accounting does not apply, fair value changes and net interest cash flows are reported in realized investment gains and losses.
Fair values of the swaps are reported in other long-term investments or other liabilities, with changes in fair value reported in realized investment gains and losses. Quarterly fees and gains and losses on purchases and sales are also reported in realized investment gains and losses. These cash flows are reported in investing activities.
To hedge the variability of and fix at inception date, the benchmark Treasury rate component of future interest payments on debt to be issued in 2009.
The Company will receive (pay) the fair value of the contract at the earliest of expiration or debt issuance.
Using cash flow hedge accounting, fair values are reported in short-term investments or other liabilities, with changes in fair value reported in accumulated other comprehensive income and amortized to interest expense over the life of the debt issued. These cash flows are reported in operating activities.
Fair values of the swaps are reported in other long-term investments or other liabilities, with changes in fair value reported in realized investment gains and losses. These cash flows are reported in investing activities.
Net investment income for separate accounts (which is not reflected in the Company’s revenues) was $148 million for 2008, $215 million for 2007, and $140 million for 2006.
The following realized gains and losses on investments for the years ended December 31 exclude amounts required to adjust future policy benefits for run-off settlement annuity business.
In addition to these asset write-downs, in 2008, the Company recognized pre-tax losses of $14 million on hybrid securities (classified as equity securities) of certain quasi-federal government agencies where the Company believes that the decline in fair value is “other-than-temporary”.
Investment gains required to adjust future policy benefits for run-off settlement annuity business
Under a universal shelf registration statement filed with the Securities and Exchange Commission (SEC), the Company issued $300 million of 6.35% Notes on March 4, 2008 (with an effective interest rate of 6.68% per year). Interest is payable on March 15 and September 15 of each year beginning September 15, 2008. These Notes will mature on March 15, 2018.
Maturities of debt and capital leases are as follows (in millions): $2 in 2009, $3 in 2010, $452 in 2011, $3 in 2012, $2 in 2013 and the remainder in years after 2013. Interest expense on long-term debt, short-term debt and capital leases was $146 million in 2008, $122 million in 2007, and $104 million in 2006.
On March 14, 2008, the Company entered into a new 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 agreement for funding. In October 2008, the Company added an additional dealer to its Program. As of December 31, 2008, the Company had $299 million in commercial paper outstanding, at a weighted average interest rate of 6.31%, used to finance the Great-West Healthcare acquisition and for other corporate purposes.
In June 2007, the Company amended and restated its five-year 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. The credit agreement includes options, which are subject to consent by the administrative agent and the committing bank, 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 was a $25 million letter of credit issued as of December 31, 2008. As of December 31, 2008, the Company had an additional $750 million of borrowing capacity within the maximum debt leverage covenant in the line of credit agreement in addition to the $2.4 billion of debt outstanding.
The Company maintains a share repurchase program, which was authorized by its Board of Directors. Decisions to repurchase shares depend on market conditions and alternative uses of capital. The Company has, and may continue from time to time, to repurchase shares on the open market through a Rule 10b5-1 plan which permits a company to repurchase its shares at times when it otherwise might be precluded from doing so under insider trading laws or because of self-imposed trading blackout periods.
As of December 31, 2008, surplus for each of the Company’s life insurance and HMO subsidiaries is sufficient to meet the minimum required by regulators. As of December 31, 2008, the Company’s life insurance and HMO subsidiaries had $395 million of investments on deposit with state departments of insurance. The Company’s life insurance and HMO subsidiaries are also subject to regulatory restrictions that limit the amount of annual dividends or other distributions (such as loans or cash advances) insurance companies may extend to the parent company without prior approval of regulatory authorities. The maximum dividend distribution that the Company’s life insurance and HMO subsidiaries may make during 2009 without prior approval is approximately $530 million. The amount of net assets of the Company that could not be distributed without prior approval as of December 31, 2008, was approximately $2.9 billion. In addition, one of the Company’s life insurance subsidiaries is permitted to loan up to $400 million to the parent company without prior approval.
As discussed in Note 2(B), the Company implemented FIN No. 48 as of January 1, 2007. As a result, total unrecognized tax benefits at January 1, 2007 were $245 million, including $108 million that would impact net income if recognized. Total unrecognized tax benefits were $164 million at December 31, 2008 and $260 million at December 31, 2007, including $144 million at December 31, 2008 and $124 million at December 31, 2007 that would impact net income if recognized.
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. At January 1, 2008, the Company had $17 million of accrued interest and accrued an additional $2 million of interest and penalties through 2008.
The IRS is expected to examine the Company’s 2007 consolidated federal income tax return though the timing of this review is uncertain. The Company conducts business in numerous states and foreign jurisdictions, and may be engaged in multiple audit proceedings at any given time. Generally, no further state or foreign audit activity for years prior to 2001 is expected.
Management believes consolidated taxable income to be generated in the future will be sufficient in amount and character to support realization of the Company’s net deferred tax assets of $1.6 billion as of December 31, 2008 and $794 million as of December 31, 2007. This determination is based upon the Company’s consistent overall earnings history and future earnings expectations. Other than deferred tax benefits attributable to operating loss carry forwards, there are no constraints on the period of time within which the Company’s deferred tax assets must be realized.
Federal operating loss carryforwards in the amount of $283 million were available at December 31, 2008. These operating losses are available only to offset future taxable income of the generating company, and begin to expire in 2022.
Current income taxes payable included in accounts payable, accrued expenses and other liabilities in the consolidated balance sheet were $152 million as of December 31, 2008 and $236 million as of December 31, 2007.
Total income taxes for the years ended December 31 were different from the amount computed using the nominal federal income tax rate of 35% for the following reasons:
During 2007, the IRS completed its examination of the Company’s 2003 and 2004 tax years. As a result, the Company recorded net income of $25 million, primarily attributable to the recognition of previously unrecognized tax benefits, of which:
Compensation expense of $25 million related to unvested stock options at December 31, 2008 will be recognized over the next 2 years (weighted average period).
The following table summarizes information for outstanding common stock options at December 31, 2008:
At the end of 2008, approximately 2,500 employees held 2.3 million restricted shares with $49 million of related compensation expense to be recognized over the next 3 years (weighted average period).
Deferred Stock. In 2003, the Company made deferred stock unit grants with 100% vesting in three to six years, dependent on the Company’s consolidated earnings per share during this vesting period. Upon meeting the stated performance objectives in 2005, the Board of Directors determined that the vesting period for the deferred stock units would be three years. On vesting in 2006, stock issuance was deferred until January of the year following an employee’s termination from the Company.
Rental expenses for operating leases, principally for office space, amounted to $131 million in 2008, $114 million in 2007 and $104 million in 2006. As of December 31, 2008, future net minimum rental payments under non-cancelable operating leases were approximately $535 million, payable as follows (in millions): $121 in 2009, $111 in 2010, $89 in 2011, $63 in 2012, $44 in 2013 and $107 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 2 to 7 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 $113 million in 2008, $87 million in 2007 and $24 million in 2006 for these arrangements.
Consolidated pre-tax income from continuing operations is primarily attributable to domestic operations. Consolidated pre-tax income from continuing operations generated by the Company’s foreign operations was approximately 36% in 2008, and 11% in 2007 and 8% in 2006.
(2) Includes premiums associated with other risk-related products, primarily indemnity network and PPO plans.
A. Financial Guarantees Primarily Associated with the Sold Retirement Benefits Business
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, 2008, employers maintained assets that exceeded the benefit obligations. Benefit obligations under these arrangements were $1.8 billion as of December 31, 2008. As of December 31, 2008, approximately 76% 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, 2008. Separate account assets supporting these guarantees are classified in Levels 1 and 2 of the SFAS No. 157 fair value hierarchy. See Note 11 for further information on the fair value hierarchy.
In periods of declining equity markets or declining interest rates, the Company’s GMIB liabilities increase. Conversely, in periods of rising equity markets and rising interest rates, the Company’s liabilities for these benefits decrease.
The Company estimates the fair value of the GMIB assets and liabilities using assumptions for market returns and interest rates, volatility of the underlying equity and bond mutual fund investments, mortality, lapse, annuity election rates, non-performance risk, and risk and profit charges. Assumptions were updated effective January 1, 2008 to reflect the requirements of SFAS No. 157. See Note 11 for additional information on how fair values for these liabilities and related receivables for retrocessional coverage are determined.
The Company is required to disclose the maximum potential undiscounted future payments for guarantees related to minimum income benefits. Under these guarantees, the future payment amounts are dependent on equity and bond fund market and interest rate levels
prior to and at the date of annuitization election, which must occur within 30 days of a policy anniversary, after the appropriate waiting period. Therefore, the future payments are not fixed and determinable under the terms of the contract. Accordingly, the Company has estimated the maximum potential undiscounted future payments using hypothetical adverse assumptions, defined as follows:
All annuitants elected to receive their benefit on the next available date (2009 through 2014); and
All underlying mutual fund investment values remained at the December 31, 2008 value of $1.3 billion with no future returns.
The Company had indemnification obligations to lenders of up to $185 million as of December 31, 2008 related to borrowings by certain real estate joint ventures which the Company either records as an investment or consolidates. These borrowings, which are nonrecourse to the Company, are secured by the joint ventures’ real estate properties with fair values in excess of the loan amounts and mature at various dates beginning from 2009 through 2014. The Company’s indemnification obligations would require payment to lenders for any actual damages resulting from certain acts such as unauthorized ownership transfers, misappropriation of rental payments by others or environmental damages. Based on initial and ongoing reviews of property management and operations, the Company does not expect that payments will be required under these indemnification obligations. Any payments that might be required could be recovered through a refinancing or sale of the assets. In some cases, the Company also has recourse to partners for their proportionate share of amounts paid. There were no liabilities required for these indemnification obligations as of December 31, 2008.
As of December 31, 2008, the Company guaranteed that it would compensate the lessors for a shortfall of up to $44 million in the market value of certain leased equipment at the end of the lease. Guarantees of $28 million expire in 2012 and $16 million expire in 2016. The Company had additional liabilities for these guarantees of $4 million as of December 31, 2008.
The Company does not expect that these guarantees will have a material adverse effect on the Company’s consolidated results of operations, liquidity or financial condition.
changes in Employee Retirement Income Security Act (ERISA) regulations resulting in increased administrative burdens and costs;
Concentration of risk. For the Company’s International segment, South Korea is the single largest geographic market. South Korea generated 29% of the segment’s revenues for year ended December 31, 2008. South Korea generated 39% of the segment’s earnings for the year ended December 31, 2008. Due to the concentration of business in South Korea, the International segment is exposed to potential losses resulting from economic and geopolitical developments in that country, as well as foreign currency movements affecting the South Korean currency, which could have a significant impact on the segment’s results and the Company’s consolidated financial results.
On August 1, 2005, two CIGNA subsidiaries, Connecticut General Life Insurance Company and Life Insurance Company of North America, were named as defendants in a multi-district litigation proceeding, In re Insurance Brokerage Antitrust Litigation, consolidated in the United States District Court for the District of New Jersey. The complaint alleges that brokers and insurers conspired to hide commissions, increasing the cost of employee benefit plans, and seeks treble damages and injunctive relief. Numerous insurance brokers and other insurance companies are named as defendants. In 2008, the court ordered the clerk to enter judgment against plaintiffs and in favor of the defendants. Plaintiffs have filed an appeal. CIGNA denies the allegations and will continue to vigorously defend itself.
Amara cash balance pension plan litigation. On December 18, 2001, Janice Amara filed a class action lawsuit, now captioned Janice C. Amara, Gisela R. Broderick, Annette S. Glanz, individually and on behalf of all others similarly situated v. CIGNA Corporation and CIGNA Pension Plan, in the United States District Court for the District of Connecticut against CIGNA Corporation and the CIGNA Pension Plan on behalf of herself and other similarly situated participants in the CIGNA Pension Plan affected by the 1998 conversion to a cash balance formula. The plaintiffs allege various ERISA violations including, among other things, that the Plan’s cash balance formula discriminates against older employees; the conversion resulted in a wear away period (during which the pre-conversion accrued benefit exceeded the post-conversion benefit); and these conditions are not adequately disclosed in the Plan.
In 2008, the court issued a decision finding in favor of CIGNA Corporation and the CIGNA Pension Plan on the age discrimination and wear away claims. However, the court found in favor of the plaintiffs on many aspects of the disclosure claims and ordered an enhanced level of benefits from the existing cash balance formula for the majority of the class, requiring class members to receive their frozen benefits under the pre-conversion CIGNA Pension Plan and their accrued benefits under the post-conversion CIGNA Pension Plan. The court also ordered, among other things, pre-judgment and post-judgment interest. The court has stayed implementation of the decision until the parties’ appeals have been exhausted. Both parties have appealed the court’s decisions. In the second quarter of 2008, the Company recorded a charge of $80 million pre-tax ($52 million after-tax), which principally reflects the Company’s current best estimate of the liabilities related to the court order. The Company will continue to vigorously defend itself in this case.
The Company is also a defendant in two putative class actions (Franco et al. v. Connecticut General Life Insurance Co., CIGNA Corporation and CIGNA Health Corporation and Chazen et al. v. Connecticut General Life Insurance Co., CIGNA Corporation and CIGNA Health Corporation) brought on behalf of members and one putative class action brought on behalf of providers (AMA et al. v. Connecticut General Life Insurance Co.) asserting that due to the use of Ingenix data, the Company improperly underpaid claims, an industry-wide issue. The Franco putative class action filed on March 22, 2004 in federal district court in New Jersey asserts claims under ERISA and the RICO statute on behalf of members of CIGNA plans. Plaintiff seeks to recover alleged underpayments in relation to out-of-network claims for the period from 1998 to present. In 2008, the court denied the Company’s motion to dismiss for lack of standing while indicating that the named plaintiff’s unique situation might undermine her adequacy as a class representative. The parties are conducting significant discovery, and we expect the class certification hearing to occur in the second quarter of 2009. On August 15, 2008, the same counsel that filed the Franco case, filed a second putative class action in the same court as the Franco case on behalf of a different class representative, David Chazen, in order to address potential issues regarding Franco’s adequacy as a class representative. The alleged damages period in the Chazen case encompasses 2002 to present. On February 9, 2009, the same counsel that filed the Franco case, filed a third putative class action in the same court as the Franco case on behalf of providers. The alleged damages period in the AMA case encompasses 2005 to present. The Company denies the allegations asserted in the investigations and litigation and will vigorously defend itself in these matters.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income and changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of CIGNA Corporation and its subsidiaries (“the Company”) at December 31, 2008 and December 31, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 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, 2008, 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.
As discussed in Note 2(B) to the Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” effective January 1, 2008.
The following unaudited quarterly financial data is presented on a consolidated basis for each of the years ended December 31, 2008 and 2007. Quarterly financial results necessarily rely heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the insurance business, suggest the need to exercise caution in drawing specific conclusions from quarterly consolidated results.
The first quarter of 2008 includes an after-tax loss of $195 million for the GMIB business and an after-tax charge of $24 million associated with litigation matters.
The first quarter of 2007 includes an after-tax loss of $15 million for the GMIB business.
The second quarter of 2007 includes an after-tax loss of $61 million for the GMIB business.