The Run-off Reinsurance segment reported substantial losses in 2008, primarily due to losses in the guaranteed minimum income benefits (GMIB) and guaranteed minimum death benefits (GMDB) businesses, reflecting the deterioration in the financial markets and also, for GMIB, the effect of adopting Statement of Financial Accounting Standards No. (SFAS No.) 157. See the Run-off Reinsurance section of the MD&A beginning on page 62 for additional information.
Delivering quality member and provider service. The Company is focused on delivering competitive service to members, providers and customers. The Company believes that further enhancing quality service can improve member retention and, when combined with useful health information and tools, can help motivate members to become more engaged in their personal health, and will help promote healthy outcomes thereby removing cost from the system. The evolution of the consumer-driven healthcare market is driving increased product and service complexity and is raising customers’ expectations with respect to service levels, which is expected to require significant investment, management attention and heightened interaction with customers.
Excluding the pre-tax impact of the reserve studies and severance charge noted above, benefits and expenses increased 9% in 2007 compared with 2006, reflecting overall business growth, continued strong disability claims management and unfavorable life claims experience largely offset by favorable accident and specialty claims experience. In addition, lower expenses were driven by continued focus on operating expense management and lower disability and workers’ compensation case management expenses.
For the Company’s International segment, South Korea is the single largest geographic market. South Korea generated 29% of the segment’s revenues and 39% of the segment’s earnings in 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
The Company’s reinsurance operations were discontinued and are now an inactive business in run-off mode since the sale of the U.S. individual life, group life and accidental death reinsurance business in 2000. This segment is predominantly comprised of guaranteed minimum death benefit (GMDB, also known as VADBe), guaranteed minimum income benefit (GMIB), workers’ compensation and personal accident reinsurance products.
Other revenues included pre-tax gains from futures contracts used in the GMDB equity hedge program (see Note 7 to the Consolidated Financial Statements) of $333 million in 2008, compared with pre-tax losses of $32 million in 2007 and $96 million in 2006. Amounts reflecting corresponding changes in liabilities for GMDB contracts were included in benefits and expenses consistent with GAAP when a premium deficiency exists (see below “Other Benefits and Expenses”). The notional amount of the futures contract positions held by the Company at December 31, 2008 related to this program was $1.4 billion.
Other revenues. Other revenues decreased 13% in 2008 compared with 2007, and 20% in 2007 compared with 2006 primarily due to lower deferred gain amortization related to the sold retirement benefits and individual life insurance and annuity businesses. The amount of the deferred gain amortization recorded was $38 million in 2008, $47 million in 2007 and $62 million in 2006.
The availability of capital resources will be impacted by equity and credit market conditions. Extreme volatility in credit or equity market conditions may reduce the Company’s ability to issue debt or equity securities. Significant volatility and deterioration of the equity markets during 2008 has resulted in reduced retained earnings and has reduced the capital available for growth, acquisitions, and share repurchase.
In June 2007, the Company amended and restated its five-year committed revolving credit and letter of credit agreement for $1.75 billion, which permits up to $1.25 billion to be used for letters of credit. This agreement is diversified among 22 banks, with three banks each having 11% of the commitment and the other 21 banks having the remaining 67% of the commitment. The credit agreement includes options, which are subject to consent by the administrative agent and the committing banks, to increase the commitment amount up to $2.0 billion and to extend the term of the agreement. The Company entered into the agreement for general corporate purposes, including support for the issuance of commercial paper and to obtain statutory reserve credit for certain reinsurance arrangements. There was a $25 million letter of credit issued as of December 31, 2008.
The Company’s best estimate is that contributions to the qualified pension plan will be approximately $410 million pre-tax during 2009. The parent company expects to fund the $410 million pre-tax contribution with subsidiary contributions equal to GAAP expense and parent company tax benefits. However, this amount could change based on final valuation amounts and the level at which the Company decides to fund the plan. The parent company would fund the estimated remaining $130 million net after-tax contribution with ongoing parent company cash sources including, but not limited to, subsidiary dividends. These estimates do not include funding requirements related to the litigation matter discussed in Note 22 to the Consolidated Financial Statements, as management does not expect this matter to be resolved in 2009. Future years’ contributions will ultimately be based on a wide range of factors including but not limited to asset returns, discount rates, and funding targets.
Estimated payments of $85 million for deferred compensation, non-qualified and International pension plans and other postretirement and postemployment benefit plans are expected to be paid in less than one year. The Company’s best estimate is that contributions to the qualified domestic pension plan during 2009 will be approximately $410 million. This amount could change based on final valuation amounts and the level at which the Company decides to fund the plan. The Company expects to make payments subsequent to 2009 for these obligations, however subsequent payments have been excluded from the table as their timing is based on plan assumptions which may materially differ from actual activities (see Note 10 to the Consolidated Financial Statements for further information on pension and other postretirement benefit obligations).
Foreign currency exchange rate risk of the U.S. dollar to the South Korean won, Taiwan dollar, euro, Hong Kong dollar, British pound, and Thai Bhat. An unfavorable change in exchange rates reduces the carrying value of net assets denominated in foreign currencies.
challenges and risks associated with implementing operational improvement initiatives and strategic actions in the ongoing operations of the businesses, including those related to: (i) offering products that meet emerging market needs, (ii) strengthening underwriting and pricing effectiveness, (iii) strengthening medical cost and medical membership results, (iv) delivering quality member and provider service using effective technology solutions, (v) lowering administrative costs and (vi) transitioning to an integrated operating company model, including operating efficiencies related to the transition;
Management assessed the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2008. In making this assessment, Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on Management’s assessment and the criteria set forth by COSO, it was determined that the Company’s internal controls over financial reporting are effective as of December 31, 2008.
$9 million related to using market-observable interest rates as of January 1, 2008 to discount the liability. The Company believes that a hypothetical market participant would use market-observable interest rates for discounting rather than a rate anticipated to be earned on the assets invested to settle the liability. The impact of using market-observable interest rates to discount the liability is significantly less than the impact of using these rates to project the growth in contractholders’ underlying investment accounts because market-observable interest rates as of January 1, 2008 were much closer to the discount rate assumption of
Commercial mortgage loans. Mortgage loans held by the Company are made exclusively to commercial borrowers, therefore there is no exposure to either prime or sub-prime residential mortgages. Generally, commercial mortgage loans are carried at unpaid principal balances and are issued at a fixed rate of interest. Commercial mortgage loans held for sale are carried at the lower of unpaid principal balance or fair value with any resulting valuation allowance reported in realized investment gains and losses. Commercial mortgage loans are considered impaired when it is probable that the Company will not collect amounts due according to the terms of the loan agreement. Impaired loans are carried at the lower of unpaid principal or fair value of the underlying collateral. The Company estimates the fair value of the underlying collateral using internal valuations generally based on discounted cash flow analyses.
The Company calculates depreciation and amortization principally using the straight-line method based on the estimated useful life of each asset as follows: buildings and improvements, 1 year to 40 years; equipment and software, 1 year to 10 years. Depreciation and amortization expense on property and equipment, including internal-use software, was $219 million in 2008, $185 million in 2007 and $187 million in 2006. Accumulated depreciation and amortization on property and equipment, including internal-use software was $1.5 billion at December 31, 2008 and $1.4 billion at December 31, 2007.
Pension benefits. The Company’s pension plans were underfunded by $1.9 billion in 2008 and $628 million in 2007 and had related accumulated benefit obligations of $4.1 billion as of December 31, 2008 and $4.0 billion as of December 31, 2007.
Level 1 - Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date. Active markets provide pricing data for trades occurring at least weekly and include exchanges and dealer markets.
adjustment for credit risk was required as of December 31, 2008. The nature and use of these other derivatives are described in Note 12(F).
The projected interest rate used to calculate the reinsured income benefits is indexed to the 7-year Treasury Rate at the time of annuitization (claim interest rate) based on contractual terms. That rate was 1.87% at December 31, 2008 and must be projected for future time periods. These projected rates vary by economic scenario and are determined by an interest rate model using current interest rate curves and the prices of instruments available in the market including various interest rate caps and zero-coupon bonds. For a subset of the business, there is a contractually guaranteed floor of 3% for the claim interest rate.
As of December 31, 2008, the Company had commitments to contribute: