OVERVIEW
We are one of the nation's leading diversified health care benefits companies,
serving approximately 36.7 million people with information and resources to help
them make better informed decisions about their health care. We offer a broad
range of traditional and consumer-directed health insurance products and related
services, including medical, pharmacy, dental, behavioral health, group life and
disability plans, medical management capabilities, Medicaid health care
management services and health information technology services. Our customers
include employer groups, individuals, college students, part-time and hourly
workers, health plans, health care providers, governmental units,
government-sponsored plans, labor groups and expatriates. Our operations are
conducted in three business segments: Health Care, Group Insurance and Large
Case Pensions.
The following MD&A provides a review of our financial condition at June 30, 2012
and December 31, 2011 and operating results for the three and six months ended
June 30, 2012 and 2011. This Overview should be read in conjunction with the
entire MD&A, which contains detailed information that is important to
understanding our operating results and financial condition, the consolidated
financial statements and other data presented in this Quarterly Report on Form
10-Q as well as the MD&A contained in our 2011 Annual Report on Form 10-K (the
"2011 Annual Report"). This Overview is qualified in its entirety by the full
MD&A.
Summarized Results for the Three and Six Months Ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Revenue:
Health Care $ 8,188.8 $ 7,706.4 $ 16,431.5 $ 15,449.8
Group Insurance 523.7 503.9 1,067.9 1,014.8
Large Case Pensions 122.6 134.1 251.5 267.6
Total revenue 8,835.1 8,344.4 17,750.9 16,732.2
Net income 457.6 536.7 968.6 1,122.7
Operating earnings: (1)
Health Care 443.5 512.9 912.4 1,068.2
Group Insurance 46.0 44.4 86.9 87.3
Large Case Pensions 3.9 6.2 9.7 12.0
Cash flows from operations 1,110.0 896.5
(1) Our discussion of operating results for our reportable business segments is
based on operating earnings, which is a non-GAAP measure of net income (the
term "GAAP" refers to U.S. generally accepted accounting principles). Refer
to "Segment Results and Use of Non-GAAP Measures" in this document beginning
on page 30 for a discussion of non-GAAP measures. Refer to pages 31, 34 and
35 for a reconciliation of operating earnings to net income for Health Care,
Group Insurance and Large Case Pensions, respectively.
Our business segment operating earnings included $24.1 million after-tax and
$121.3 million after-tax of favorable development of prior-period health care
cost estimates in the three months ended June 30, 2012 and 2011, respectively.
Excluding the impact of reserve development, our aggregate business segment
operating earnings increased for the three months ended June 30, 2012 compared
to the corresponding period in 2011, primarily due to higher underwriting
margins and increased membership in the Medicare business in the Health Care
segment, partially as a result of the Medicare Supplement business and related
blocks of in-force business acquired from Genworth Financial, Inc. ("Genworth's
Medicare Supplement business") in the second half of 2011. For the six months
ended June 30, 2012 our aggregate business segment operating earnings excluding
the impact of reserve development decreased compared to the corresponding period
in 2011 as lower Commercial underwriting margins were largely offset by the
favorable impact of higher underwriting margins and increased membership in the
Medicare business, partially as a result of our 2011 acquisition of Genworth's
Medicare Supplement business.
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Total revenue increased during the three and six months ended June 30, 2012
compared to the corresponding periods in 2011 primarily due to an increase in
Health Care premium and higher fees and other revenue as a result of our 2011
acquisitions.
At June 30, 2012, we served approximately 18.0 million medical members
(consisting of approximately 32% Insured members and 68% administrative services
contract ("ASC") members), 13.6 million dental members and 8.7 million pharmacy
benefit management services members. At June 30, 2011, we served approximately
18.2 million medical members (consisting of approximately 31% Insured members
and 69% ASC members), 13.8 million dental members and 8.8 million pharmacy
benefit management services members.
We continued to generate strong cash flows from operations in 2012 and 2011,
generating $1.2 billion and $1.0 billion of cash flows from operations in our
Health Care and Group Insurance businesses during the six months ended June 30,
2012 and 2011, respectively. During 2012, these cash flows contributed to
funding our ordinary course operating activities, the payment of cash dividends
to shareholders and repurchases of shares of our common stock. We paid dividends
to our shareholders of $122 million during the six months ended June 30, 2012.
In addition we repurchased 21 million and 18 million shares of common stock
under our share repurchase programs at a cost of approximately $925 million and
$735 million during the six months ended June 30, 2012 and 2011,
respectively. Refer to "Liquidity and Capital Resources" beginning on page 38
and Note 9 of Condensed Notes to Consolidated Financial Statements on page 19
for additional information.
Management Update
On February 20, 2012, we announced that Kristi Ann Matus was joining Aetna as
Executive Vice President, Government Services and will lead our government
services businesses and that we would consolidate and realign our Commercial ASC
and insurance businesses under Frank G. McCauley, who assumed the role of
Executive Vice President, Commercial Businesses.
On June 7, 2012, we announced that Karen S. Rohan will be joining Aetna as
Executive Vice President, Head of Specialty Products and also will lead our
distribution strategy.
Health Care Reform
The Patient Protection and Affordable Care Act and the Health Care and Education
Reconciliation Act of 2010 (collectively, "Health Care Reform") makes
broad-based changes to the U.S. health care system which could significantly
affect the U.S. economy and will continue to significantly impact our business
operations and financial results, including our pricing and medical benefit
ratios. Health Care Reform presents us with new business opportunities, but also
with new financial and other challenges. It is reasonably possible that Health
Care Reform, in the aggregate, could have a material adverse effect on our
business operations and financial results.
Components of the legislation will be phased in over the next six years. We are
dedicating and will continue to be required to dedicate material resources and
incur material expenses during that time to implement and comply with Health
Care Reform as well as state level health care reform. While the federal
government has issued a number of regulations implementing Health Care Reform,
many significant parts of the legislation, including health insurance exchanges
("Insurance Exchanges"), Medicaid expansion, the scope of "essential health
benefits", employer penalties and the implementation of minimum medical loss
ratios ("MLRs"), require further guidance and clarification at the federal level
and/or in the form of regulations and actions by state legislatures to implement
the law. As a result, many of the impacts of Health Care Reform will not be
known for several years.
On June 28, 2012, the U.S. Supreme Court issued a decision that generally upheld
the constitutionality of Health Care Reform. However, pending efforts in the
U.S. Congress to repeal, amend, or restrict funding for various aspects of
Health Care Reform, the 2012 presidential and congressional elections, and the
possibility of additional litigation challenging aspects of the law continue to
create additional uncertainty about the ultimate impact of the legislation.
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The Supreme Court decision also permits states to opt out of the elements of
Health Care Reform requiring expansion of Medicaid coverage in January 2014
without losing their current federal Medicaid funding, and governors in some
states already have indicated that they will not support Medicaid expansion. The
ruling also creates uncertainty regarding the effectiveness of Health Care
Reform's "maintenance of effort" ("MOE") provision. If states are not subject to
the MOE provision and allow certain programs to expire or choose to opt out of
Medicaid expansion, we could experience reduced Medicaid enrollment or reduced
Medicaid enrollment growth. We cannot predict whether pending or future federal
or state legislation or court proceedings will change various aspects of Health
Care Reform or state level health care reform, nor can we predict the impact
those changes will have on our business operations or financial results, but the
effects could be materially adverse.
Most state legislatures have adjourned for the year, and they generally have not
enacted legislation related to Health Care Reform. To date, approximately a
dozen states have indicated that they will establish Insurance Exchanges.
Following the Supreme Court decision, we expect most states to begin working
more actively to develop their Insurance Exchanges, although a few state
governors have indicated they will not establish Insurance Exchanges.
For additional information on Health Care Reform refer to "MD&A-Overview-Health
Care Reform Legislation," "Regulatory Environment" and "Forward-Looking
Information/Risk Factors" in our 2011 Annual Report.
Segment Results and Use of Non-GAAP Measures in this Document
The following discussion of operating results is presented based on our
reportable segments in accordance with the accounting guidance for segment
reporting and consistent with our segment disclosure included in Note 13 of
Condensed Notes to Consolidated Financial Statements beginning on page 24. Our
operations are conducted in three business segments: Health Care, Group
Insurance and Large Case Pensions. Our Corporate Financing segment is not a
business segment; it is added to our business segments to reconcile to our
consolidated results. The Corporate Financing segment includes interest expense
on our outstanding debt and the financing components of our pension and other
postretirement benefit ("OPEB") plan expense (the service cost and prior service
cost components of this expense are allocated to our business segments).
Our discussion of our operating results is based on operating earnings, which is
the measure reported to our Chief Executive Officer for purposes of assessing
financial performance and making operating decisions, such as allocating
resources to each segment. Operating earnings exclude net realized capital gains
or losses as well as other items that neither relate to the ordinary course of
our business nor reflect our underlying business performance, if any, from net
income reported in accordance with GAAP. We believe excluding net realized
capital gains or losses from net income to arrive at operating earnings provides
more meaningful information about our underlying business performance. Net
realized capital gains and losses arise from various types of transactions,
primarily in the course of managing a portfolio of assets that support the
payment of liabilities; however, these transactions do not directly relate to
the underwriting or servicing of products for our customers and are not directly
related to the core performance of our business operations. In each segment
discussion in this MD&A, we provide a table that reconciles operating earnings
to net income. Each table details the net realized capital gains or losses and
any other items excluded from net income, and the footnotes to each table
describe the nature of each other item and why we believe it is appropriate to
exclude that item from net income.
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HEALTH CARE
Health Care consists of medical, pharmacy benefit management services, dental,
behavioral health and vision plans offered on both an Insured basis and an ASC
basis. Medical products include point-of-service ("POS"), preferred provider
organization ("PPO"), health maintenance organization ("HMO") and indemnity
benefit plans. Medical products also include health savings accounts ("HSAs")
and Aetna HealthFund®, consumer-directed health plans that combine traditional
POS or PPO and/or dental coverage, subject to a deductible, with an accumulating
benefit account. We also offer Medicare and Medicaid products and services, as
well as specialty products, such as health information technology services,
medical management and data analytics services, medical stop loss insurance and
products that provide access to our provider networks in select geographies. We
separately track premiums and health care costs for Medicare and Medicaid
products; all other medical, dental and other Health Care products are referred
to as Commercial. We refer to insurance products (where we assume all or a
majority of the risk for medical and dental care costs) as "Insured" and
administrative services contract products (where the plan sponsor assumes all or
a majority of the risk for medical and dental care costs) as "ASC."
Operating Summary for the Three and Six Months Ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Premiums:
Commercial $ 5,202.6 $ 5,031.4 $ 10,379.7 $ 10,045.0
Medicare 1,554.3 1,358.3 3,205.9 2,767.1
Medicaid 411.0 343.7 769.7 671.9
Total premiums 7,167.9 6,733.4 14,355.3 13,484.0
Fees and other revenue 938.3 869.2 1,870.4 1,739.2
Net investment income 76.9 88.8 158.5 177.9
Net realized capital gains 5.7 15.0 47.3 48.7
Total revenue 8,188.8 7,706.4 16,431.5 15,449.8
Health care costs 5,908.3 5,366.8 11,765.8 10,714.8
Operating expenses:
Selling expenses 250.2 250.9 506.0 522.4
General and administrative expenses 1,302.1 1,253.8 2,620.1 2,458.3
Total operating expenses 1,552.3 1,504.7 3,126.1 2,980.7
Amortization of other acquired
intangible assets 35.9 24.5 72.6 49.1
Total benefits and expenses 7,496.5 6,896.0 14,964.5 13,744.6
Income before income taxes 692.3 810.4 1,467.0 1,705.2
Income taxes 245.0 287.8 523.8 605.4
Net income $ 447.3 $ 522.6 $ 943.2 $ 1,099.8
The table presented below reconciles net income to operating earnings for the
three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Net income $ 447.3 $ 522.6 $ 943.2 $ 1,099.8
Net realized capital gains, net of tax (3.8 ) (9.7 ) (30.8 ) (31.6 )
Operating earnings $ 443.5 $ 512.9 $ 912.4 $ 1,068.2
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Included in operating earnings for the three months ended June 30, 2012 and 2011
was $24.1 million and $121.3 million of favorable after-tax development of
prior-period health care costs estimates, respectively, primarily from first
quarter 2012 and first quarter 2011 incurred health care costs, respectively.
Excluding the impact of favorable prior-period reserve development, operating
earnings increased by $28 million for the three months ended June 30, 2012
compared to the corresponding period in 2011, primarily due to higher
underwriting margins and increased membership in our Medicare business,
partially as a result of our 2011 acquisition of Genworth's Medicare Supplement
business. For the six months ended June 30, 2012 operating earnings excluding
prior-years reserve development were lower than the corresponding period in
2011, as lower underwriting margins in our Commercial business were largely
offset by the favorable impact of higher underwriting margins and increased
membership in our Medicare business, partially as a result of our 2011
acquisition of Genworth's Medicare Supplement business.
We calculate our medical benefit ratio ("MBR") by dividing health care costs by
premiums. For the three and six months ended June 30, 2012 and 2011, our MBRs by
product were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Commercial 81.7 % 77.9 % 80.8 % 77.4 %
Medicare 82.9 % 84.6 % 83.7 % 84.8 %
Medicaid 90.1 % 87.2 % 90.8 % 87.8 %
Total 82.4 % 79.7 % 82.0 % 79.5 %
Refer to our discussion of Commercial and Medicare results below for an
explanation of the changes in our MBRs.
Commercial operating results reflect lower underwriting margins and lower
Insured membership in 2012 compared to 2011.
Commercial premiums increased approximately $171 million and $335 million for
the three and six months ended June 30, 2012, respectively, when compared to the
corresponding periods in 2011, due primarily to higher Commercial premium rates
partially offset by lower Commercial Insured membership in 2012.
Our Commercial MBRs were 81.7% and 80.8% for the three and six months ended
June 30, 2012, respectively, compared to 77.9% and 77.4% for the corresponding
periods in 2011. Our Commercial MBR was higher in the three and six months ended
June 30, 2012 compared to the corresponding periods in 2011 primarily due to the
impact of favorable development of prior-period health care cost estimates in
2011 and consideration of our 2011 experience in our 2012 pricing. The 2011
development was primarily caused by lower than projected utilization of most
categories of medical services. Refer to "Critical Accounting Estimates - Health
Care Costs Payable" in our 2011 Annual Report for a discussion of Health Care
Costs Payable at December 31, 2011.
Medicare results for the three and six months ended June 30, 2012 reflect higher
underwriting margins and an increase in membership from the corresponding
periods in 2011.
Medicare premiums increased approximately $196 million and $439 million for the
three and six months ended June 30, 2012, respectively, when compared to the
corresponding periods in 2011, primarily due to membership growth in Medicare
Advantage and the addition of Genworth's Medicare Supplement business.
Our Medicare MBRs were 82.9% and 83.7% for the three and six months ended
June 30, 2012, respectively, compared to 84.6% and 84.8% for the corresponding
periods in 2011. For the three months ended June 30, 2012 the decrease was
primarily due to an increase in the proportion of Medicare Supplement business
as well as greater favorable development of prior-period health care cost
estimates in 2012. For the six months ended June 30, 2012 the decrease was
primarily due to premium revenue growth that outpaced health care cost growth in
2012 and an increase in the proportion of Medicare Supplement business.
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Other Sources of Revenue
Medicaid revenues for the three and six months ended June 30, 2012 increased
$67.3 million and $97.8 million compared to the corresponding periods in 2011
primarily from membership increases in certain high acuity Medicaid contracts
with greater per-member premium rates which more than offset the decline in
premium from other membership losses. Health Care fees and other revenue for the
three and six months ended June 30, 2012 increased $69 million and $131 million
compared to the corresponding periods in 2011 as a result of the inclusion of
revenues from our 2011 acquisitions.
General and Administrative Expenses
General and administrative expenses increased during the three and six months
ended June 30, 2012 compared with the corresponding periods of 2011, due
primarily to the inclusion of expenses associated with our 2011 acquisitions and
increased investments in growth initiatives, partially offset by continued
execution of our expense initiatives.
Membership
Health Care's membership at June 30, 2012 and 2011 was as follows:
2012 2011
(Thousands) Insured ASC Total Insured ASC Total
Medical:
Commercial 4,745 11,476 16,221 4,784 11,810 16,594
Medicare Advantage 437 - 437 393 - 393
Medicaid 345 843 1,188 403 839 1,242
Medicare Supplement 183 - 183 12 - 12
Total Medical Membership 5,710 12,319 18,029 5,592 12,649 18,241
Consumer-Directed Health Plans (1) 2,552 2,405
Dental:
Commercial 4,688 7,286 11,974 4,744 7,437 12,181
Medicare and Medicaid 186 451 637 167 468 635
Network Access (2) - 979 979 - 970 970
Total Dental Membership 4,874 8,716 13,590 4,911 8,875 13,786
Pharmacy:
Commercial 7,882 8,131
Medicare PDP (stand-alone) 471 432
Medicare Advantage PDP 200 188
Medicaid 108 27
Total Pharmacy Benefit Management Services 8,661 8,778
(1) Represents members in consumer-directed health plans who also are included
in Commercial medical membership above.
(2) Represents members in products that allow these members access to our dental
provider network for a nominal fee.
Total medical membership at June 30, 2012 decreased compared to June 30, 2011,
reflecting a decline in Commercial ASC membership due to lapsed customers and
in-group attrition that exceeded new sales. This decrease was partially offset
by the addition of more than 165 thousand Medicare Supplement members from the
2011 acquisition and subsequent growth of Genworth's Medicare Supplement
business and related blocks of in-force business and growth in Medicare
Advantage membership.
Total dental membership at June 30, 2012 decreased compared to June 30, 2011
primarily due to lapsed customers that exceeded new sales in the Commercial ASC
business.
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Total pharmacy benefit management services membership decreased at June 30, 2012
compared to June 30, 2011 primarily due to a decrease in Commercial medical
enrollment partially offset by growth in other businesses.
GROUP INSURANCE
Group Insurance primarily includes group life insurance products offered on an
Insured basis, including basic and supplemental group term life, group universal
life, supplemental or voluntary programs and accidental death and dismemberment
coverage. Group Insurance also includes: (i) group disability products offered
to employers on both an Insured and an ASC basis, which consist primarily of
short-term and long-term disability insurance (and products which combine both),
(ii) absence management services offered to employers, which include short-term
and long-term disability administration and leave management, and (iii)
long-term care products that were offered primarily on an Insured basis, which
provide benefits covering the cost of care in private home settings, adult day
care, assisted living or nursing facilities. We no longer solicit or accept new
long-term care customers.
Operating Summary for the Three and Six Months Ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Premiums:
Life $ 264.9 $ 263.1 $ 528.7 $ 521.0
Disability 155.0 132.0 309.5 266.1
Long-term care 11.6 11.3 23.2 22.8
Total premiums 431.5 406.4 861.4 809.9
Fees and other revenue 26.2 24.8 50.9 51.6
Net investment income 68.0 68.3 145.4 142.4
Net realized capital (losses) gains (2.0 ) 4.4 10.2 10.9
Total revenue 523.7 503.9 1,067.9 1,014.8
Current and future benefits 371.8 355.6 759.0 717.4
Operating expenses:
Selling expenses 21.2 16.3 41.7 35.5
General and administrative expenses 70.6 65.9 139.6 129.3
Total operating expenses 91.8 82.2 181.3 164.8
Amortization of other acquired
intangible assets 1.1 1.1 2.2 2.8
Total benefits and expenses 464.7 438.9 942.5 885.0
Income before income taxes 59.0 65.0 125.4 129.8
Income taxes 14.3 17.7 31.9 35.4
Net income $ 44.7 $ 47.3 $ 93.5 $ 94.4
The table presented below reconciles net income to operating earnings for the
three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Net income $ 44.7 $ 47.3 $ 93.5 $ 94.4
Net realized capital losses (gains),
net of tax 1.3 (2.9 ) (6.6 ) (7.1 )
Operating earnings $ 46.0 $ 44.4 $ 86.9 $ 87.3
Operating earnings for the three and six months ended June 30, 2012 were
relatively flat when compared to the corresponding periods in 2011.
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The group benefit ratio (which represents current and future benefits divided by
premiums) was 86.2% and 88.1% for the three and six months ended June 30, 2012
compared to 87.5% and 88.6% for corresponding periods in 2011. The group benefit
ratios improved for the three and six months ended June 30, 2012 primarily due
to higher underwriting margins in our life products.
LARGE CASE PENSIONS
Large Case Pensions manages a variety of retirement products (including pension
and annuity products) primarily for tax qualified pension plans. These products
provide a variety of funding and benefit payment distribution options and other
services. The Large Case Pensions segment includes certain discontinued
products.
Operating Summary for the Three and Six Months Ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Premiums $ 37.2 $ 45.4 $ 83.7 $ 87.2
Net investment income 77.9 84.2 159.5 173.6
Other revenue 2.6 2.5 5.5 5.3
Net realized capital gains 4.9 2.0 2.8 1.5
Total revenue 122.6 134.1 251.5 267.6
Current and future benefits 111.5 122.1 235.2 245.8
General and administrative expenses 3.0 3.6 6.3 7.3
Total benefits and expenses 114.5 125.7 241.5 253.1
Income before income taxes 8.1 8.4 10.0 14.5
Income taxes (benefits), net of tax 1.1 .9 (1.5 ) 1.5
Net income $ 7.0 $ 7.5 $ 11.5 $ 13.0
The table presented below reconciles net income to operating earnings for the
three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Net income $ 7.0 $ 7.5 $ 11.5 $ 13.0
Net realized capital gains, net of tax (3.1 ) (1.3 ) (1.8 ) (1.0 )
Operating earnings $ 3.9 $ 6.2 $ 9.7 $ 12.0
Operating earnings in the three and six months ended June 30, 2012 declined
compared to the corresponding periods in 2011, which is consistent with the
run-off nature of this segment.
Discontinued Products
Prior to 1993, we sold single-premium annuities ("SPAs") and guaranteed
investment contracts ("GICs"), primarily to employer sponsored pension plans. In
1993, we discontinued selling these products to Large Case Pensions customers,
and now we refer to these products as discontinued products.
We discontinued selling these products because they were generating losses for
us, and we projected that they would continue to generate future losses over
their life (which is currently greater than 30 years for SPAs and less than 3
years for GICs); so we established a reserve for anticipated future losses at
the time of discontinuance. We provide additional information on this reserve,
including key assumptions and other important information, in Note 15 of
Condensed Notes to Consolidated Financial Statements beginning on page 25.
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The operating summary for Large Case Pensions on page 35 includes revenues and
expenses related to our discontinued products, with the exception of net
realized capital gains and losses which are recorded as part of current and
future benefits. Since we established a reserve for future losses on
discontinued products, as long as our expectation of future losses remains
consistent with prior projections, the results of our discontinued products are
applied against the reserve and do not impact operating earnings or net income
for Large Case Pensions. However, if actual or expected future losses are
greater than we currently estimate, we may increase the reserve, which could
adversely impact net income. If actual or expected future losses are less than
we currently estimate, we may decrease the reserve, which could favorably impact
net income. In those cases, we disclose such adjustment separately in the
operating summary. Management reviews the adequacy of the discontinued products
reserve quarterly. The current reserve reflects management's best estimate of
anticipated future losses.
The activity in the reserve for anticipated future losses on discontinued
products for the six months ended June 30, 2012 and 2011 was as follows
(pretax):
(Millions)
2012 2011
Reserve, beginning of period $ 896.3 $ 884.8
Operating (losses) income (6.2 ) 1.5
Net realized capital gains 32.6 19.7
Reserve, end of period $ 922.7 $ 906.0
During the six months ended June 30, 2012, our discontinued products reflected
net realized capital gains (primarily attributable to gains from the sale of
debt securities, partially offset by losses from other investments) and
operating losses. We evaluated these results against our expectations of future
cash flows assumed in estimating the reserve and concluded that no adjustment to
the reserve was required at June 30, 2012.
INVESTMENTS
At June 30, 2012 and December 31, 2011 our investment portfolio consisted of the
following:
June 30, December 31,
(Millions) 2012 2011
Debt and equity securities available for sale $ 17,686.7 $ 17,390.8
Mortgage loans 1,623.9 1,648.5
Other investments 1,367.4 1,255.7
Total investments $ 20,678.0 $ 20,295.0
The risks associated with investments supporting experience-rated pension and
annuity products in our Large Case Pensions business are assumed by the contract
holders and not by us (subject to, among other things, certain minimum
guarantees). Anticipated future losses associated with the discontinued
fully-guaranteed Large Case Pensions products are provided for in the reserve
for anticipated future losses on discontinued products.
As a result of the foregoing, investment risks associated with our
experience-rated and discontinued products generally do not impact our operating
results. Our investment portfolio supported the following products at June 30,
2012 and December 31, 2011:
June 30, December 31,
(Millions) 2012 2011
Experience-rated products $ 1,642.2 $ 1,645.0
Discontinued products 3,631.4 3,646.0
Remaining products 15,404.4 15,004.0
Total investments $ 20,678.0 $ 20,295.0
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Assets supporting experience-rated products may be subject to contract holder or
participant withdrawals. Experience-rated contract holder and
participant-directed withdrawals for the three and six months ended June 30,
2012 and 2011 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
(Millions) 2012 2011 2012 2011
Scheduled contract maturities and
benefit payments (1) $ 58.7 $ 61.9 $ 117.9 $ 123.7
Contract holder withdrawals other than
scheduled contract
maturities and benefit payments .9 7.3 3.1 7.8
Participant-directed withdrawals .3 .7 1.1 2.4
(1) Includes payments made upon contract maturity and other amounts distributed
in accordance with contract schedules.
Debt and Equity Securities
The debt securities in our investment portfolio had an average credit quality
rating of A+ and A at June 30, 2012 and December 31, 2011, respectively, with
approximately $4.7 billion at June 30, 2012 and $4.4 billion at December 31,
2011 rated AAA. The debt securities that were rated below investment grade (that
is, having a quality rating below BBB-/Baa3) were $1.1 billion at June 30, 2012
and $1.2 billion at December 31, 2011 (of which 19% and 20% at June 30, 2012 and
December 31, 2011, respectively, supported our discontinued and experience-rated
products).
At June 30, 2012 and December 31, 2011, we held approximately $723 million and
$733 million, respectively, of municipal debt securities that were guaranteed by
third parties, representing approximately 3% and 4% of our total investments,
respectively. These securities had an average credit quality rating of A+ at
both June 30, 2012 and December 31, 2011 with and without the guarantee. We do
not have any significant concentration of investments with third party
guarantors (either direct or indirect).
At both June 30, 2012 and December 31, 2011, approximately 2% of our investment
portfolio was comprised of investments that were either European sovereign,
agency, or local government debt or European corporate issuers of countries
which, in our judgment based on an analysis of market-yields, are experiencing
economic, fiscal or political strains such that the likelihood of default may be
higher than if those factors did not exist.
We classify our debt and equity securities as available for sale, and carry them
at fair value on our balance sheet. Approximately 1% of our debt and equity
securities at both June 30, 2012 and December 31, 2011 were valued using inputs
that reflect our own assumptions (categorized as Level 3 inputs in accordance
with GAAP). Refer to Note 7 of Condensed Notes to Consolidated Financial
Statements beginning on page 14 for additional information on the methodologies
and key assumptions we use to determine the fair value of investments.
At June 30, 2012 and December 31, 2011, our debt and equity securities had net
unrealized capital gains of $1.7 billion and $1.5 billion, respectively, of
which $494 million and $457 million, respectively, related to our
experience-rated and discontinued products.
Refer to Note 5 of Condensed Notes to Consolidated Financial Statements
beginning on page 8 for details of net unrealized capital gains and losses by
major security type, as well as details on our debt securities with unrealized
capital losses at June 30, 2012 and December 31, 2011. We regularly review our
debt securities to determine if a decline in fair value below the carrying value
is other-than-temporary. If we determine a decline in fair value is
other-than-temporary, we will write down the carrying value of the security. The
amount of the credit-related impairment is included in our operating results,
and the non-credit component is included in other comprehensive income if we do
not intend to sell the security. Accounting for other-than-temporary impairments
of our debt securities is considered a critical accounting estimate. Refer to
"Critical Accounting Estimates - Other-Than-Temporary Impairment of Debt
Securities" in our 2011 Annual Report for more information.
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Net Realized Capital Gains and Losses
Net realized capital gains were $6 million ($9 million pretax) and $39 million
($60 million pretax) for the three and six months ended June 30, 2012,
respectively, and $14 million ($21 million pretax) and $40 million ($61 million
pretax) for the corresponding periods in 2011, respectively. We had no
individual realized capital losses on debt or equity securities that materially
impacted our operating results during the three or six months ended June 30,
2012 or 2011.
Mortgage Loans
Our mortgage loan portfolio (which is collateralized by commercial real estate)
represented 8% of our total invested assets at both June 30, 2012 and
December 31, 2011. There were no material impairment reserves on these loans at
June 30, 2012 or December 31, 2011. Refer to Note 5 of Condensed Notes to
Consolidated Financial Statements on page 8 for additional information on our
mortgage loan portfolio.
Risk Management and Market-Sensitive Instruments
We manage interest rate risk by seeking to maintain a tight match between the
durations of our assets and liabilities where appropriate. We manage credit risk
by seeking to maintain high average quality ratings and diversified sector
exposure within our debt securities portfolio. In connection with our investment
and risk management objectives, we also use derivative financial instruments
whose market value is at least partially determined by, among other things,
levels of or changes in interest rates (short-term or long-term), duration,
prepayment rates, equity markets or credit ratings/spreads. Our use of these
derivatives is generally limited to hedging risk and has principally consisted
of using interest rate swap agreements, forward contracts, futures contracts,
put options and credit default swaps. Additionally, from time to time, we
receive warrants from our vendors. These instruments, viewed separately, subject
us to varying degrees of interest rate, equity price and credit risk. However,
when used for hedging, we expect these instruments to reduce overall risk.
We regularly evaluate our risk from market-sensitive instruments by examining,
among other things, levels of or changes in interest rates (short-term or
long-term), duration, prepayment rates, equity markets or credit
ratings/spreads. We also regularly evaluate the appropriateness of investments
relative to our management-approved investment guidelines (and operate within
those guidelines) and the business objectives of our portfolios.
On a quarterly basis, we review the impact of hypothetical net losses in our
investment portfolio for the risk factors noted above on our consolidated
near-term financial position, operating results and cash flows assuming the
occurrence of certain reasonably possible changes in near-term market rates and
prices. Based upon this analysis, there have been no material changes in our
exposure to these risks since December 31, 2011. Refer to the MD&A in our 2011
Annual Report for a more complete discussion of risk management and
market-sensitive instruments.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
We meet our operating cash requirements by maintaining liquidity in our
investment portfolio, using overall cash flows from premiums, fees and other
revenue, deposits and income received on investments, and issuing commercial
paper from time to time. We monitor the duration of our investment portfolio of
highly marketable debt securities and mortgage loans, and execute purchases and
sales of these investments with the objective of having adequate funds available
to satisfy our maturing liabilities. Overall cash flows are used primarily for
claim and benefit payments, contract withdrawals, operating expenses, share
repurchases and shareholder dividends. We have a committed short-term borrowing
capacity of $1.5 billion through the five-year revolving credit facility
agreement which we entered into on March 27, 2012 to replace our $1.5 billion
credit facility which was due to expire in March 2013.
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Presented below is a condensed statement of cash flows for the six months ended
June 30, 2012 and 2011. We present net cash flows used for operating activities
and net cash flows provided by investing activities separately for our Large
Case Pensions segment because changes in the insurance reserves for the Large
Case Pensions segment (which are reported as cash used for operating activities)
are funded from the sale of investments (which are reported as cash provided by
investing activities). Refer to the Consolidated Statements of Cash Flows on
page 5 for additional information.
