AETNA INC /PA/ – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

OVERVIEW

  We are one of the nation's leading diversified health care benefits companies, serving an estimated 44 million people with information and resources to help them in consultation with their health care professionals make better informed decisions about their health care. We offer a broad range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, group life and disability plans and medical management capabilities, Medicaid health care management services, workers' compensation administrative services and health information technology products and services, including emerging businesses products and services, such as Accountable Care Solutions. On May 7, 2013 (the "Effective Date"), we completed the acquisition of Coventry Health Care, Inc. ("Coventry"). The acquisition enhances the scope and geographic breadth of our Health Care products. Our customers include employer groups, individuals, college students, part-time and hourly workers, health plans, health care providers ("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, 2013 and December 31, 2012 and operating results for the three and six months ended June 30, 2013 and 2012. We completed our acquisition of Coventry on May 7, 2013. As a result, Coventry's results after that date are reflected in our results for the three and six months ended June 30, 2013, which significantly affects the comparability of those results to the three and six months ended June 30, 2012. 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 2012 Annual Report on Form 10-K (the "2012 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, 2013 and 2012:                                     Three Months Ended          Six Months Ended                                          June 30,                   June 30, (Millions)                             2013         2012          2013          2012 Revenue: Health Care                      $ 10,847.5$ 8,189.0$ 19,670.4$ 16,431.8 Group Insurance                       587.1        523.9       1,173.9       1,068.6 Large Case Pensions                   102.8        123.0         232.0         252.5 Total revenue                      11,537.4      8,835.9      21,076.3      17,752.9

Net income attributable to Aetna 536.0 457.6 1,026.1

   968.6 Operating earnings: (1) Health Care                           559.2        443.5       1,052.0         912.4 Group Insurance                        29.9         46.0          61.1          86.9 Large Case Pensions                     3.8          3.9          10.0           9.7 Cash flows from operations                                       583.5       1,117.8   

(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

attributable to Aetna (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 41 for a discussion of non-GAAP

measures. Refer to pages 42, 46 and 47 for a reconciliation of operating

     earnings to net income attributable to Aetna for Health Care, Group      Insurance and Large Case Pensions, respectively.    Our business segment operating earnings in aggregate increased for the three and six months ended June 30, 2013 compared to the corresponding periods in 2012. The increase in our business segment operating earnings is primarily due to the acquisition of Coventry in May 2013 as well as higher underwriting margins in our underlying Commercial Health Care business.                                      Page 38 --------------------------------------------------------------------------------    Total revenue increased during the three and six months ended June 30, 2013 compared to the corresponding periods in 2012 primarily due to higher Health Care premiums in each of our Commercial, Medicare and Medicaid businesses from the acquisition of Coventry as well as growth in our underlying Medicare membership.  As a result of the acquisition of Coventry, we acquired approximately 3.7 million medical members. At June 30, 2013, we served approximately 22.0 million medical members (consisting of approximately 38% Insured members and 62% administrative services contract ("ASC") members), 14.3 million dental members and 13.8 million pharmacy benefit management services members.  At June 30, 2012, we served approximately 18.0 million medical members (consisting of approximately 32% Insured members and 68% ASC members), 13.6 million dental members and 8.7 million pharmacy benefit management services members.  We continued to generate strong cash flows from operations in 2013 and 2012, generating $759 million and $1.2 billion of cash flows from operations in our Health Care and Group Insurance businesses during the six months ended June 30, 2013 and 2012, respectively. During 2013, these cash flows contributed to funding the acquisition of Coventry, 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 $131 million and $122 million during the six months ended June 30, 2013 and 2012, respectively. In addition, we repurchased 11 million and 21 million shares of common stock under our share repurchase programs at a cost of approximately $625 million and $925 million during the six months ended June 30, 2013 and 2012, respectively. On the Effective Date, we issued an aggregate of approximately 52.2 million shares of common stock to holders of Coventry common stock in connection with our acquisition of Coventry. Refer to "Liquidity and Capital Resources" beginning on page 51 and Note 12 of Condensed Notes to Consolidated Financial Statements on page 29 for additional information.  Acquisition of Coventry Health Care, Inc. On August 19, 2012, we entered into a definitive agreement (as amended, the "Merger Agreement") to acquire Coventry. On the Effective Date, we completed the acquisition of Coventry in a transaction valued at approximately $8.7 billion, including $1.8 billion fair value of Coventry's outstanding long-term debt. Coventry is a diversified managed health care company that offers a full portfolio of risk and fee-based products, including Medicare Advantage and Medicare Part D programs, Medicaid managed care plans, group and individual health insurance, coverage for specialty services such as workers' compensation administrative services, and network rental services.  Pursuant to the terms of the Merger Agreement, by and among Aetna, Jaguar Merger Subsidiary, Inc., a wholly owned subsidiary of Aetna ("Merger Sub"), and Coventry, Merger Sub merged with and into Coventry (the "Merger"), with Coventry continuing as the surviving corporation and a wholly owned subsidiary of Aetna.  Under the terms of the Merger Agreement, Coventry stockholders received $27.30 in cash and 0.3885 of an Aetna common share for each share of Coventry common stock (including restricted shares but excluding shares held by Coventry as treasury stock) outstanding at the effective time of the Merger. As a result, on the Effective Date, we issued approximately 52.2 million common shares with a fair value of approximately $3.1 billion and paid approximately $3.8 billion in cash in exchange for all of the outstanding shares of Coventry common stock and outstanding awards. Substantially all of Coventry's outstanding equity awards vested and were paid out in cash and canceled in connection with the Merger. We funded the cash portion of the purchase price with a combination of $2.0 billion of long-term debt issued in November 2012, approximately $700 million of commercial paper issued in March and April 2013 and approximately $1.1 billion of available cash on hand.  The Coventry acquisition adds medical membership, which we expect will enhance our diversified portfolio, increases our presence in government programs, which is an important element of our growth strategy, and improves our positioning and reach in health insurance exchange-based businesses.                                       Page 39 --------------------------------------------------------------------------------

In connection with the acquisition of Coventry, on March 31, 2013, we completed the sale of our Missouri Medicaid business, Missouri Care, Incorporated ("Missouri Care"), to WellCare Health Plans, Inc. The sale price was not material and did not have a material impact on our financial position or operating results.

  Management Updates On June 14, 2013, we announced that Francis S. Soistman would succeed Kristi Ann Matus as Executive Vice President, Government Services, and Ms. Matus would be leaving the Company effective July 5, 2013. On July 25, 2013, in connection with her departure, Ms. Matus and the Company entered into a separation agreement, the principal terms of which are described in Part II, Item 5 of this Quarterly Report on Form 10-Q.  Health Care Reform The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, "Health Care Reform") has changed and will continue to make broad-based changes to the U.S. health care system which could significantly affect the U.S. economy and we expect 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 regulatory 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.  Key components of the legislation will continue to be phased in over the next several years, with the most significant changes during that time due to occur in 2014, including health insurance exchanges (also known as health insurance marketplaces) ("Insurance Exchanges"), Medicare minimum medical loss ratios ("MLRs"), the individual coverage mandate, guaranteed issue, rating limits in the individual and small group markets, and new industry-wide fees, assessments and taxes. 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 aspects of Insurance Exchanges, Medicaid expansion, employer penalties, assessments, fees and taxes, community rating, reinsurance, risk transfer, risk adjustment and the implementation of Medicare Advantage and Part D minimum MLRs have not yet been fully implemented and may 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, and given the inherent difficulty of foreseeing how individuals and businesses will respond to the choices afforded them by Health Care Reform, we cannot predict the full effect Health Care Reform will have on us.  On June 28, 2012, the U.S. Supreme Court issued a decision that generally upheld the constitutionality of Health Care Reform. However, federal budget negotiations, pending efforts in the U.S. Congress to amend or restrict funding for various aspects of Health Care Reform and the possibility of additional litigation challenging aspects of the law continue to create additional uncertainty about the ultimate impact of Health Care Reform.  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 over a dozen states have indicated that they oppose Medicaid expansion in their states. 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.  

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 2012 Annual Report.

                                    Page 40 --------------------------------------------------------------------------------   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 15 of Condensed Notes to Consolidated Financial Statements beginning on page 33. Our operations are conducted in three business segments: Health Care, Group Insurance and Large Case Pensions. The acquired Coventry operations after the Effective Date are reflected in our Health Care segment for the three and six months ended June 30, 2013. 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 plans ("OPEB") 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 among our businesses. Operating earnings exclude from net income attributable to Aetna reported in accordance with GAAP, net realized capital gains or losses as well as other items, if any, that neither relate to the ordinary course of our business nor reflect our underlying business performance. Although the excluded items may recur, we believe excluding them 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 business segment discussion in this MD&A, we provide a table that reconciles operating earnings to net income attributable to Aetna. 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.  

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 and emerging businesses products and services, such as ACS, that complement and enhance our medical products. 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 (which may be funded by the plan sponsor and/or the member in the case of HSAs). We also offer Medicare and Medicaid products and services, and other medical products, such as medical management and data analytics services, medical stop loss insurance, workers' compensation administrative services and products that provide access to our provider networks in select markets.  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."                                       Page 41 --------------------------------------------------------------------------------   Operating Summary for the Three and Six Months Ended June 30, 2013 and 2012:                                              Three Months Ended            Six Months Ended                                                   June 30,                     June 30, (Millions)                                     2013          2012           2013           2012 Premiums: Commercial                                $ 6,068.0$ 5,202.6$ 11,282.0$ 10,379.7 Medicare                                    2,787.2       1,554.3        4,894.5        3,205.9 Medicaid                                      846.1         411.0        1,310.6          769.7 Total premiums                              9,701.3       7,167.9       17,487.1       14,355.3 Fees and other revenue                      1,089.8         938.3        2,027.2        1,870.4 Net investment income                          80.2          77.1          153.6          158.8 Net realized capital (losses) gains           (23.8 )         5.7            2.5           47.3 Total revenue                              10,847.5       8,189.0       19,670.4       16,431.8 Health care costs                           8,006.9       5,908.3       14,386.4       11,765.8 Operating expenses: Selling expenses                              305.9         250.2          575.9          506.0 General and administrative expenses         1,735.7       1,302.1        3,109.6        2,620.1 Total operating expenses                    2,041.6       1,552.3        3,685.5        3,126.1 Amortization of other acquired intangible assets                                         50.7          35.9           82.0           72.6 Total benefits and expenses                10,099.2       7,496.5       18,153.9       14,964.5 Income before income taxes                    748.3         692.5        1,516.5        1,467.3 Income taxes                                  285.0         245.0          558.9          523.8 Net income including non-controlling interests                                     463.3         447.5          957.6          943.5 Less: Net (loss) income attributable to non-controlling interests                      (3.0 )          .2           (3.4 )           .3 

Net income attributable to Aetna $ 466.3$ 447.3$ 961.0$ 943.2

     The table presented below reconciles net income attributable to Aetna to operating earnings for the three and six months ended June 30, 2013 and 2012:                                                Three Months Ended             Six Months Ended                                                     June 30,                      June 30, (Millions)                                      2013             2012          2013          2012 Net income attributable to Aetna          $    466.3$   447.3$   961.0$   943.2 Transaction and integration-related costs, net of tax (1)                           77.2                -          92.0             - Net realized capital losses (gains), net of tax                                          15.7             (3.8 )        (1.0 )       (30.8 ) Operating earnings                        $    559.2$   443.5$ 1,052.0$   912.4

(1) During the three and six months ended June 30, 2013, we incurred transaction

     and integration-related costs of $81.4 million ($101.3 million pretax) and      $106 million ($138.4 million pretax), respectively, related to the      acquisition of Coventry, of which $77.2 million ($94.9 million pretax) and      $92.0 million ($116.9 million pretax), respectively, were recorded in the

Health Care segment. Transaction costs include advisory, legal and other

professional fees which are not deductible for tax purposes and are

reflected in our GAAP Consolidated Statements of Income in general and

administrative expenses. Transaction costs also include transaction-related

payments as well as expenses related to the negative cost of carry

associated with the permanent financing that we obtained in November 2012

for the Coventry acquisition. Prior to the Effective Date, the negative cost

of carry associated with the permanent financing is excluded from operating

earnings. The components of the negative cost of carry are reflected in our

GAAP Consolidated Statements of Income in interest expense, net investment

income, and general and administrative expenses. On and after the Effective

     Date, the interest expense and general and administrative expenses      associated with the permanent financing are no longer excluded from      operating earnings.   

Operating earnings increased for the three and six months ended June 30, 2013 compared to the corresponding periods in 2012. The increase in operating earnings is primarily due to the acquisition of Coventry as well as higher underwriting margins in our underlying Commercial business.

                                    Page 42 --------------------------------------------------------------------------------   We calculate our medical benefit ratio ("MBR") by dividing health care costs by health care premiums. For the three and six months ended June 30, 2013 and 2012, our MBRs by product were as follows:              Three Months Ended        Six Months Ended                   June 30,                 June 30,               2013          2012       2013         2012 Commercial    79.1 %        81.7 %     79.0 %       80.8 % Medicare      89.1 %        82.9 %     88.5 %       83.7 % Medicaid      85.9 %        90.1 %     87.1 %       90.8 % Total         82.5 %        82.4 %     82.3 %       82.0 %   

Refer to our discussion of Commercial and Medicare results below for an explanation of the changes in our MBRs.

  Commercial operating results for the three and six months ended June 30, 2013 reflect the Coventry acquisition and an increase in premiums and higher underwriting margins in our underlying business compared to the corresponding periods in 2012. Commercial premiums increased approximately $865 million and $902 million for the three and six months ended June 30, 2013, respectively, compared to the corresponding periods in 2012, as a result of the acquisition of Coventry as well as higher premium rates in our underlying business.  Our Commercial MBR was 79.1% and 79.0% for the three and six months ended June 30, 2013, respectively, compared to 81.7% and 80.8% for the corresponding periods in 2012. For the three months ended June 30, 2013 the improvement in our Commercial MBR is primarily due to lower than projected medical cost trends driven primarily by lower than projected utilization of medical services, which resulted in favorable development of prior period health care cost estimates, primarily attributable to 2013 performance. The improvement in our Commercial MBR for the six months ended June 30, 2013 is due to the impact of increased favorable development of prior-years' health care cost estimates in 2013. Refer to "Critical Accounting Estimates - Health Care Costs Payable" in our 2012 Annual Report for a discussion of Health Care Costs Payable at December 31, 2012.  Medicare operating results for the three and six months ended June 30, 2013 reflect an increase in membership from the Coventry acquisition, offset by lower underwriting margins in our underlying business compared to the corresponding periods in 2012. Medicare premiums increased approximately $1.2 billion and $1.7 billion for the three and six months ended June 30, 2013, respectively, compared to the corresponding periods in 2012. For the three months ended June 30, 2013, the increase is primarily due to the addition of Coventry membership and higher premium from underlying Medicare membership growth. The increase for the six months ended June 30, 2013 is primarily driven by underlying Medicare membership growth and the addition of Coventry membership.  Our Medicare MBR was 89.1% and 88.5% for the three and six months ended June 30, 2013, respectively, compared to 82.9% and 83.7% for the corresponding periods in 2012. The increase in our Medicare MBR for both the three and six month periods is due to favorable 2012 experience being reflected in establishing customer premiums upon renewal as well as the impact of sequestration on Medicare reimbursement rates and underperformance in two specific Medicare product offerings, largely driven by new member claim experience.  Medicaid operating results for the three and six months ended June 30, 2013 primarily reflect an increase in membership from the Coventry acquisition compared to the corresponding periods in 2012. Medicaid premiums increased approximately $435 million and $541 million for the three and six months ended June 30, 2013, respectively, compared to the corresponding periods in 2012, as a result of the addition of Coventry membership as well as, in the six months ended June 30, 2013, the favorable impact of in-state expansions and growth in high acuity populations in our underlying business.  Our Medicaid MBR was 85.9% and 87.1% for the three and six months ended June 30, 2013, respectively, compared to 90.1% and 90.8% for the corresponding periods in 2012. The improvement in our Medicaid MBR for                                      Page 43 --------------------------------------------------------------------------------   the three months ended June 30, 2013 is primarily due to the inclusion of Coventry, which added geographies carrying relatively lower MBRs and favorable development of prior period health care cost estimates. The improvement in our Medicaid MBR for the six months ended June 30, 2013 is primarily due to the impact of increased favorable development of prior-years' health care cost estimates in 2013 and the inclusion of Coventry.  Fees and Other Revenue Health Care fees and other revenue increased approximately $152 million and $157 million for the three and six months ended June 30, 2013, respectively compared to the corresponding periods in 2012. The increase in both the three and six month periods is due to the acquisition of Coventry's service businesses.  General and Administrative Expenses General and administrative expenses increased $434 million and $490 million for the three and six months ended June 30, 2013, respectively, compared with the corresponding periods of 2012, due primarily to the inclusion of general and administrative costs relating to Coventry and higher business volume from underlying membership growth as well as transaction and integration-related costs incurred for the Coventry acquisition which were partially offset by continued execution of our expense initiatives.  

Membership

Health Care's membership at June 30, 2013 and 2012 was as follows:

                                                2013                           2012 (Thousands)                         Insured      ASC      Total    Insured      ASC      Total Medical: Commercial                            5,937    12,697    18,634      4,745    11,476    16,221 Medicare Advantage                      948         -       948        437         -       437 Medicare Supplement                     341         -       341        183         -       183 Medicaid                              1,169       876     2,045        345       843     1,188 Total Medical Membership              8,395    13,573    21,968      5,710    12,319    18,029   Consumer-Directed Health Plans (1)                        3,253                          2,552  Dental: Total Dental Membership               5,466     8,788    14,254      4,874     8,716    13,590  Pharmacy: Commercial                                               10,062                          7,882 Medicare PDP (stand-alone)                                2,084                            471 Medicare Advantage PDP                                      572                            200 Medicaid                                                  1,128                            108 Total Pharmacy Benefit Management Services               13,846                          8,661    

(1) Represents members in consumer-directed health plans who also are included in Commercial medical membership above.

  Total medical membership at June 30, 2013 increased compared to June 30, 2012, reflecting an increase of 3.7 million medical members from the acquisition of Coventry as well as growth in our underlying Medicare and Commercial ASC businesses.  Total dental membership at June 30, 2013 increased compared to June 30, 2012 primarily reflecting an increase of 848 thousand members from the acquisition of Coventry which was partially offset by lapsed customers that exceeded new sales in our underlying Commercial Insured and ASC businesses.                                       Page 44 --------------------------------------------------------------------------------   Total pharmacy benefit management services membership increased at June 30, 2013 compared to June 30, 2012 primarily reflecting an increase of 3.9 million members from the acquisition of Coventry as well as growth across all lines of our underlying business, primarily our Commercial ASC and Medicaid businesses.  

Health Care Costs Payable The following table shows the components of the change in health care costs payable during the six months ended June 30, 2013, 2012 and 2011: (Millions)

                                       2013              2012     

2011

 Health care costs payable, beginning of period                                  $     2,992.5$     2,675.5$     2,630.9 Less: reinsurance recoverables                    3.8               3.3     

1.7

 Health care costs payable, beginning of period, net                                   2,988.7           2,672.2           2,629.2  Acquisition of businesses                     1,440.1                 -                 -  Add: Components of incurred health care costs: Current year                                 14,756.0          11,929.3          11,098.4 Prior years (1)                                (369.6 )          (163.5 )          (383.6 ) Total incurred health care costs             14,386.4          11,765.8          10,714.8  Less: Claims paid Current year                                 11,800.9           9,326.1           8,804.6 Prior years                                   2,437.0           2,231.5           1,970.3 Total claims paid                            14,237.9          11,557.6          10,774.9  Disposition of business                         (42.3 )               -                 -  Health care costs payable, end of period, net                                   4,535.0           2,880.4     

2,569.1

 Add: reinsurance recoverables                     5.5               3.1     

1.6

 Health care costs payable, end of period                                  $     4,540.5$     2,883.5$     2,570.7

(1) Negative amounts reported for incurred health care costs related to prior

years result from claims being settled for less than originally estimated.

The acquisition of Coventry resulted in a $1.4 billion increase in health care costs payable at June 30, 2013 (refer to Note 3 of Condensed Notes to Consolidated Financial Statements beginning on page 7 for additional information).

  Favorable development of prior years' health care costs payable estimates was approximately $370 million and $164 million during the six months ended June 30, 2013 and 2012, respectively, and in 2013 includes Coventry favorable prior years' development since the closing of the acquisition. The favorable development in estimated prior years' health care costs payable in each period primarily resulted from lower health care cost trends than we assumed in establishing our health care costs payable in the prior year. This development does not directly correspond to an increase in our current year operating results.  

GROUP INSURANCE

Group Insurance primarily includes group life insurance and group disability products. Group life products are offered on an Insured basis and include basic and supplemental group term life, group universal life, supplemental or voluntary programs and accidental death and dismemberment coverage. Group disability products primarily consist of short-term and long-term disability insurance (and products which combine both), which are offered to employers on both an Insured and an ASC basis, and absence management services offered to employers, which include short-term and long-term disability administration and leave management. Group Insurance also includes 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.                                       Page 45 --------------------------------------------------------------------------------     Operating Summary for the Three and Six Months Ended June 30, 2013 and 2012:                                               Three Months Ended             Six Months Ended                                                    June 30,                      June 30, (Millions)                                      2013           2012           2013           2012 Premiums: Life                                      $    290.0$   264.9$    577.0$    528.7 Disability                                     185.2          155.0          365.4          309.5 Long-term care                                  11.2           11.6           22.6           23.2 Total premiums                                 486.4          431.5          965.0          861.4 Fees and other revenue                          34.4           26.2           61.1           50.9 Net investment income                           68.8           68.2          144.8          146.1 Net realized capital (losses) gains             (2.5 )         (2.0 )          3.0           10.2 Total revenue                                  587.1          523.9        1,173.9        1,068.6 Current and future benefits                    440.0          371.8          876.3          759.0 Operating expenses: Selling expenses                                26.3           21.2           53.5           41.7 General and administrative expenses             75.0           70.6          149.1          139.6 Reversal of allowance on reinsurance recoverable                                    (42.2 )            -          (42.2 )            - Total operating expenses                        59.1           91.8          160.4          181.3 Amortization of other acquired intangible assets                                           1.1            1.1            2.2            2.2 Total benefits and expenses                    500.2          464.7        1,038.9          942.5 Income before income taxes                      86.9           59.2          135.0          126.1 Income taxes                                    26.4           14.3           38.5           31.9 Net income including non-controlling interests                                       60.5           44.9           96.5           94.2 Less: Net income attributable to non-controlling interests                         .2             .2            1.4             .7 

Net income attributable to Aetna $ 60.3$ 44.7 $

  95.1     $     93.5     The table presented below reconciles net income attributable to Aetna to operating earnings for the three and six months ended June 30, 2013 and 2012:                                                   Three Months Ended            Six Months Ended                                                        June 30,                     June 30, (Millions)                                         2013            2012          2013          2012 Net income attributable to Aetna              $    60.3$    44.7$    95.1$   93.5 Reversal of allowance and gain on sale of reinsurance recoverable, net of tax (1)           (32.1 )             -         (32.1 )           - Net realized capital losses (gains), net of tax                                                 1.7             1.3          (1.9 )        (6.6 ) Operating earnings                            $    29.9$    46.0$    61.1$   86.9

(1) In 2008, as a result of the liquidation proceedings of Lehman Re Ltd.

("Lehman Re"), a subsidiary of Lehman Brothers Holdings Inc., we recorded an

allowance against our reinsurance recoverable from Lehman Re of $27.4 million

($42.2 million pretax). This reinsurance was placed in 1999 and was on a

closed book of paid-up group whole life insurance business. In the second

quarter of 2013, we sold our claim against Lehman Re to an unrelated third

party including the reinsurance recoverable and terminated the reinsurance

arrangement. Upon the sale of the claim and termination of the arrangement,

we released the related allowance thereby reducing second quarter 2013 other

general and administrative expenses by $27.4 million ($42.2 million pretax)

and recognized a $4.7 million ($7.2 million pretax) gain on the sale in fees

    and other revenue. These are other items in the second quarter of 2013     because they do not reflect underlying 2013 business performance.    Operating earnings for the three and six months ended June 30, 2013 declined when compared to the corresponding periods in 2012, primarily reflecting lower underwriting margins in our life products.                                       Page 46 --------------------------------------------------------------------------------   The group benefit ratio, which represents current and future benefits divided by premiums, was 90.5% and 90.8% for the three and six months ended June 30, 2013, respectively, and 86.2% and 88.1%, respectively for the three and six months ended June 30, 2012. The increase in our group benefit ratio in each period is primarily due to higher claims 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, 2013 and 2012:                                                Three Months Ended              Six Months Ended                                                     June 30,                       June 30, (Millions)                                      2013             2012           2013           2012 Premiums                                  $     27.9$     37.2$     70.6$    83.7 Net investment income                           76.0             78.3          161.7          160.5 Other revenue                                    2.4              2.6            4.7            5.5 Net realized capital (losses) gains             (3.5 )            4.9           (5.0 )          2.8 Total revenue                                  102.8            123.0          232.0          252.5 Current and future benefits                     99.1            111.9          222.1          236.2 General and administrative expenses              3.2              3.0            6.4            6.3 Reduction of reserve for anticipated future losses on discontinued products         (86.0 )              -          (86.0 )            - Total benefits and expenses                     16.3            114.9          142.5          242.5 Income before income taxes                      86.5              8.1           89.5           10.0 Income tax benefits                             29.0              1.1           26.8           (1.5 )

Net income attributable to Aetna $ 57.5$ 7.0 $

    62.7      $    11.5     The table presented below reconciles net income attributable to Aetna to operating earnings for the three and six months ended June 30, 2013 and 2012:                                                        Three Months Ended          Six Months Ended                                                             June 30,                   June 30, (Millions)                                              2013           2012         2013        2012 Net income attributable to Aetna                   $    57.5$    7.0

$ 62.7$ 11.5 Reduction of reserve for anticipated future losses on discontinued products, net of tax (1)

               (55.9 )            -        (55.9 )         - Net realized capital losses (gains), net of tax          2.2           (3.1 )        3.2        (1.8 ) Operating earnings                                 $     3.8$    3.9

$ 10.0$ 9.7

     (1) In 1993, we discontinued the sale of our fully guaranteed large case pension products and established a reserve for anticipated future losses on these products, which we review quarterly. Changes in this reserve are recognized when deemed appropriate. In the three and six months ended June 30, 2013, we reduced the reserve for anticipated future losses on discontinued products by $55.9 million ($86.0 million pretax). We believe excluding any changes in the reserve for anticipated future losses on discontinued products from operating earnings provides more useful information as to our continuing products and is consistent with the treatment of the operating results of these discontinued products, which are credited or charged to the reserve and do not affect our operating results.  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.                                       Page 47 --------------------------------------------------------------------------------   We discontinued selling these products because they were generating losses for us, and we projected that they would continue to generate losses over their life (which is currently greater than 30 years for SPAs and less than 1 year 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 17 of Condensed Notes to Consolidated Financial Statements beginning on page 35.  The operating summary for Large Case Pensions above 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 expected future losses remain consistent with prior projections, the results of our discontinued products are applied against the reserve and do not impact net income for Large Case Pensions. 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. As a result of this review $55.9 million ($86.0 million pretax) of the reserve was released in the three and six months ended June 30, 2013. This reserve release was primarily due to favorable investment performance as well as favorable retirement experience compared to assumptions we previously made in estimating the reserve.  The current reserve reflects management's best estimate of anticipated future losses, and is included in future policy benefits on our balance sheet.  

The activity in the reserve for anticipated future losses on discontinued products for the six months ended June 30, 2013 and 2012 (pretax) was as follows: (Millions)

                      2013        2012 Reserve, beginning of period $ 978.5$ 896.3 Operating income (loss)          1.1        (6.2 ) Net realized capital gains      78.7        32.6 Reserve reduction              (86.0 )         - Reserve, end of period       $ 972.3$ 922.7    During the six months ended June 30, 2013, our discontinued products reflected net realized capital gains, primarily attributable to gains from other invested assets and from the sale of debt securities.  

INVESTMENTS

At June 30, 2013 and December 31, 2012 our investment portfolio consisted of the following:

                                                 June 30,      December 31, (Millions)                                          2013              2012 Debt and equity securities available for sale $ 19,144.6$     18,827.8 Mortgage loans                                   1,555.6           1,643.6 Other investments                                1,609.5           1,448.7 Total investments                             $ 22,309.7$     21,920.1    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).                                       Page 48 --------------------------------------------------------------------------------

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, 2013 and December 31, 2012:

                             June 30,      December 31, (Millions)                      2013              2012 Experience-rated products $  1,551.2$      1,660.3 Discontinued products        3,357.4           3,675.5 Remaining products          17,401.1          16,584.3 Total investments         $ 22,309.7$     21,920.1    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, 2013 and 2012 were as follows:                                               Three Months Ended            Six Months Ended                                                    June 30,                     June 30, (Millions)                                      2013          2012           2013          2012 Scheduled contract maturities and benefit payments (1)                              $     59.4$    58.7$    118.5$   117.9 Contract holder withdrawals other than scheduled contract maturities and benefit payments                  1.8            .9            3.9           3.1 Participant-directed withdrawals                  .6            .3            1.5           1.1    

(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 at both June 30, 2013 and December 31, 2012, with approximately $4.6 billion rated AAA at both June 30, 2013 and December 31, 2012. The debt securities that were rated below investment grade (that is, having a credit quality rating below BBB-/Baa3) were $1.2 billion and $1.1 billion at June 30, 2013 and December 31, 2012, respectively, (of which 16% and 19% at June 30, 2013 and December 31, 2012, respectively, supported our experience-rated and discontinued products).  At June 30, 2013 and December 31, 2012, we held approximately $832 million and $694 million, respectively, of municipal debt securities that were guaranteed by third parties, representing approximately 4% and 3% of our total investments, respectively. These securities had an average credit quality rating of A+ at both June 30, 2013 and December 31, 2012 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, 2013 and December 31, 2012, approximately 1% 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, 2013 and December 31, 2012 were valued using inputs that reflect our own assumptions (categorized as Level 3 inputs in accordance with GAAP). Refer to Note 9 of Condensed Notes to Consolidated Financial Statements beginning on page 21 for additional information on the methodologies and key assumptions we use to determine the fair value of investments.  

At June 30, 2013 and December 31, 2012, our debt and equity securities had net unrealized capital gains of $855 million and $1.9 billion, respectively, of which $268 million and $540 million, respectively, related to our experience-rated and discontinued products.

                                    Page 49 --------------------------------------------------------------------------------   Refer to Note 7 of Condensed Notes to Consolidated Financial Statements beginning on page 14 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, 2013 and December 31, 2012. 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 impairment of our debt securities is considered a critical accounting estimate. Refer to "Critical Accounting Estimates - Other-Than-Temporary Impairment of Debt Securities" in our 2012 Annual Report for additional information.  Net Realized Capital Gains and Losses Net realized capital losses were $20 million ($30 million pretax) for the three months ended June 30, 2013. During the six months ended June 30, 2013, we did not have any material net realized capital gains. 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. We had no individually material realized capital losses on debt or equity securities that impacted our operating results during the three and six months ended June 30, 2013 or 2012.  Mortgage Loans Our mortgage loan portfolio (which is collateralized by commercial real estate) represented approximately 7% of our total invested assets at both June 30, 2013 and December 31, 2012. There were no material impairment reserves on these loans at June 30, 2013 or December 31, 2012. Refer to Note 7 of Condensed Notes to Consolidated Financial Statements on page 14 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 when appropriate. We manage credit risk by seeking to maintain high average credit 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 swaps, forward contracts, futures contracts, warrants, put options and credit default swaps. 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 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. Interest rate changes (whether resulting from changes in treasury yields or credit spreads) represent the most material risk exposure category for us. During 2013, we acquired Coventry which held approximately $2.2 billion of interest-sensitive investments and had issued $1.8 billion of long-term debt. Although the acquisition has increased our total exposure to changes in interest rates, we do not believe there has been a material change to the composition of these market risks since December 31, 2012. We have estimated the impact on fair value based on the net present value of cash flows using a representative set of likely future interest rate scenarios. The assumptions used were as follows: an immediate increase of 100 basis points in interest rates (which we believe represents a moderately adverse scenario and is approximately equal to the historical annual volatility of interest rate movements for our intermediate-term available-for-sale debt securities) and an immediate decrease of 15% in prices for domestic equity securities.                                       Page 50 --------------------------------------------------------------------------------   Assuming an immediate 100 basis point increase in interest rates and immediate decrease of 15% in the prices for domestic equity securities, the theoretical decline in the fair values of our market sensitive instruments was $656 million ($1.0 billion pretax) at June 30, 2013.  

• Approximately $421 million ($646 million pretax) was the result of the

theoretical reduction of the fair value of our long-term debt. Changes in

the fair value of our long-term debt do not impact our financial position

       or operating results.   

• The remaining $235 million ($362 million pretax) was from the theoretical

reduction in the fair value of our investment securities partially offset

by the theoretical reduction in the value of interest rate sensitive

liabilities. Reductions in the fair value of our investment securities

would be reflected as an unrealized loss in equity, as we classify these

securities as available for sale. We do not record our liabilities at fair

        value.    Based on our overall exposure to interest rate risk and equity price risk, we believe that these changes in market rates and prices would not materially affect our consolidated near-term financial position, operating results or cash flows as of June 30, 2013.  

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 and debt repurchases, shareholder dividends and to fund acquisitions. We have committed short-term borrowing capacity of $2.0 billion through a revolving credit facility agreement that expires in March 2018.  Presented below is a condensed statement of cash flows for the six months ended June 30, 2013 and 2012. On May 7, 2013, we completed the acquisition of Coventry, which is reflected in our cash flows for the six months ended June 30, 2013</chron>. 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.