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[May 01, 2014]
CIGNA CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) INDEX Cautionary Statement 37 Overview 38 Consolidated Results of Operations 42 Liquidity and Capital Resources 44 Critical Accounting Estimates 46 Segment Reporting 47 Global Health Care 48 Global Supplemental Benefits 51 Group Disability and Life 52 Other Operations 53 Corporate 54 Investment Assets 55 Market Risk 58 Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide information to assist you in better understanding and evaluating our financial condition as of March 31, 2014, compared with December 31, 2013 and our results of operations for the three months ended March 31, 2014 compared with the same period last year. We encourage you to read this MD&A in conjunction with our Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q and the "Risk Factors" contained in this Form 10-Q and Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K").
Unless otherwise indicated, financial information in the MD&A is presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). See Note 2 to the Consolidated Financial Statements in the 2013 Form 10-K for additional information regarding the Company's significant accounting policies. The preparation of interim consolidated financial statements necessarily relies heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the health care and related benefits business, as well as competitive and other market conditions, call for caution in estimating full year results based on interim results of operations.
In some of our financial tables in this MD&A, we present percentage changes or "N/M" when those changes are so large as to become not meaningful.
We measure the financial results of our segments using "segment earnings (loss)", defined as shareholders' net income (loss) before after-tax realized investment results. In this MD&A, we also present information using adjusted income from operations on both a consolidated and segment basis. Adjusted income (loss) from operations is another measure of profitability used by our management because it presents the underlying results of operations of our businesses and permits analysis of trends in underlying revenue, expenses and shareholders' net income. Adjusted income (loss) from operations is defined as segment earnings (loss) excluding special items (described in the table on page 42 of this Form 10-Q) and the results of the GMIB business. This measure is not determined in accordance with GAAP and should not be viewed as a substitute for the most directly comparable GAAP measures, which are shareholders' net income on a consolidated basis and segment earnings (loss) on a segment basis. We exclude special items because management does not believe they are representative of our underlying results of operations. We also exclude the results of the GMIB business because, prior to February 4, 2013, the changes in the fair value of GMIB assets and liabilities were volatile and unpredictable.
Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on Cigna's current expectations and projections about future trends, events and uncertainties. These statements are not historical facts.
Forward-looking statements may include, among others, statements concerning our business strategy and strategic or operational initiatives, including our ability to deliver improved health services outcomes and productivity for our customers and clients while lowering the costs of health care; future growth and expansion; future financial or operating performance; economic, regulatory or competitive environments; and our projected cash position, future pension funding and financing or capital deployment plans. You may identify forward-looking statements by the use of words such as "believe," "expect," "plan," "intend," "anticipate," "estimate," "predict," "potential," "may," "should," "will" or other words or expressions of similar meaning, although not all forward-looking statements contain such terms.
37 -------------------------------------------------------------------------------- Table of Contents Forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements. Such risks and uncertainties include, but are not limited to: our ability to achieve our financial, strategic and operational plans or initiatives; our ability to predict and manage medical costs and price effectively and develop and maintain good relationships with physicians, hospitals and other health care providers; our ability to realize the expected benefits of strategic transactions and/or acquisitions; the substantial level of government regulation over our business and the potential effects of new laws or regulations or changes in existing laws or regulations; the outcome of litigation, regulatory audits, investigations and actions and/or guaranty fund assessments; uncertainties surrounding participation in government-sponsored programs such as Medicare; and unfavorable industry, economic or political conditions, as well as more specific risks and uncertainties discussed in this MD&A, the "Risk Factors" contained in this Form 10-Q and Part I, Item 1A of our 2013 Form 10-K, and as described from time to time in our future reports filed with the Securities and Exchange Commission. You should not place undue reliance on forward-looking statements, which speak only as of the date they are made, are not guarantees of future performance or results, and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Cigna undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as may be required by law.
OVERVIEW We are a global health services organization with a mission to help our customers improve their health, well-being and sense of security. Our insurance subsidiaries are major providers of medical, dental, disability, life and accident insurance and related products and services, the majority of which are offered through employers and other groups (e.g., governmental and non-governmental organizations, unions and associations). We also offer Medicare and Medicaid products and health, life and accident insurance coverage primarily to individuals in selected international markets and the United States. In addition to these businesses, we also have certain run-off operations.
For further information on our business and strategy, please see Item 1, "Business" in our 2013 Form 10-K.
Our Segments As explained in Note 15 to the Consolidated Financial Statements, effective with the first quarter of 2014, we began combining the results of our run-off reinsurance business with Other Operations for segment reporting purposes.
Prior year segment information has been conformed to the current year presentation.
We present the financial results of our businesses in the following three reportable segments: Segment % of revenues Description Global Health 78% Aggregates the Commercial and Government operating Care segments: Commercial † Encompasses both our U.S. commercial and certain international health care businesses.
†††††††††††††††††† Serves employers and their employees, including globally mobile individuals, and other groups (e.g. governmental and non-governmental organizations, unions and associations). In addition, our U.S. commercial health care business also serves individuals.
†††††††††††††††††† Offers insured and self-insured medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services that may be integrated as part of a comprehensive global health care benefit program.
Government †††††††††††††††††† Offers Medicare Advantage, Medicare Part D and Medicaid plans.
Global 8% This segment offers supplemental health, life and Supplemental accident insurance products in selected Benefits international markets and the U.S.
Group 12% This segment offers group long-term and short-term Disability and disability, group life, accident and specialty Life insurance products and related services.
38 -------------------------------------------------------------------------------- Table of Contents We present the remainder of our segment results in Other Operations, consisting of corporate-owned life insurance business ("COLI"), run-off reinsurance and settlement annuity businesses and deferred gains associated with the sales of the individual life insurance and annuity and retirement benefits businesses.
Key Transactions and Other Significant Items The following is a summary of key transactions and other significant items since January 1, 2013 affecting period-to-period comparisons of our results.
Run-off Reinsurance Transaction. Prior to February 4, 2013, our run-off reinsurance business had significant exposures, primarily from our guaranteed minimum death benefits ("GMDB" also known as "VADBe") and guaranteed minimum income benefits ("GMIB") businesses. Effective February 4, 2013, we entered into an agreement with Berkshire to reinsure future exposures for this business, net of existing retrocessional arrangements, up to a specified limit, for a payment of $2.2 billion. The reinsurance transaction aligned with our strategy of increasing financial flexibility by accomplishing an effective exit from the GMDB and GMIB businesses. As a result of this transaction, we recorded an after-tax charge of $507 million in the first quarter of 2013 that was reported as a special item. See Note 5 to the Consolidated Financial Statements and the Other Operations section of this MD&A for additional information.
Pharmacy Benefit Management ("PBM") Services Agreement. In June 2013, we entered into a 10-year pharmacy benefit management services agreement with Catamaran Corporation. Under this agreement, we utilize their technology and service platforms, prescription drug procurement and inventory management capabilities, and order fulfillment services to lower costs and enhance our home-delivery pharmacy, retail network contracting and claims processing services. In the second quarter of 2013, we recorded one-time transaction costs of $37 million pre-tax ($24 million after-tax) that was reported as a special item. This arrangement produced a positive contribution to earnings in the first quarter of 2014 through improved clinical management, purchasing and administrative efficiencies, that we expect to continue for the remainder of 2014.
Organizational Efficiency Plans. We regularly evaluate ways to deliver our products and services more efficiently and at a lower cost. During 2013 and 2012, we adopted specific plans to increase our organizational efficiency as follows: † 2013 plan. During the fourth quarter of 2013, we committed to a plan to increase our organizational efficiency and reduce costs through a series of actions that includes employee headcount reductions. As a result, we recognized charges in other operating expenses of $60 million pre-tax ($40 million after-tax) in the fourth quarter of 2013, primarily for severance costs. We expect most of the severance to be paid by the end of 2015. We expect to realize annualized after-tax savings of approximately $45 million. A substantial portion of these savings will be realized in 2014.
† 2012 plan. During the third quarter of 2012, we committed to a series of actions to further improve our organizational alignment, operational effectiveness and efficiency. As a result, we recognized charges in other operating expenses of $77 million pre-tax ($50 million after-tax) in the third quarter of 2012, consisting primarily of severance costs that were paid as of March 31, 2014. We realized annualized after-tax savings of approximately $60 million during 2013, the majority of which was reinvested in the business to enhance our ability to provide superior service and affordable products to our customers.
Disability Claims Regulatory Matter During the second quarter of 2013, we finalized an agreement with the Departments of Insurance for Maine, Massachusetts, Pennsylvania, Connecticut and California (together, the "monitoring states") related to our long-term disability claims handling practices. In connection with the terms of the agreement, the Company recorded a charge of $77 million before-tax ($51 million after-tax) in the first quarter of 2013. The charge was comprised of two elements: (1) $48 million of benefit costs and reserves from reassessed claims expected to be reopened, and (2) $29 million in additional costs for open claims as a result of the claims handling changes being implemented. This charge was reported in the Group Disability and Life segment. We will be subject to re-examination 24 months after the execution date of the agreement. If the monitoring states find material non-compliance with the terms of the agreement upon re-examination, we may be subject to additional fines or penalties. In addition to the monitoring states, most other jurisdictions have joined the agreement as participating, non-monitoring states.
39 -------------------------------------------------------------------------------- Table of Contents Health Care Industry Developments Health Care Reform and other regulatory initiatives have resulted in broad changes that are meaningfully impacting the industry, including, but not limited to, relationships with customers and health care providers, the design of products and services, pricing and delivery systems. In 2013, the industry saw government-prescribed reductions to Medicare reimbursement rates (i.e., sequestration), ongoing payment reductions for Medicare Advantage plans by the Centers for Medicare and Medicaid Services ("CMS") and changes in requirements associated with operational and performance metrics used to determine Medicare Advantage payments and benefits. For 2014, there are further changes resulting from these regulatory initiatives including the advent of public exchanges, the non-tax deductible industry fee in addition to other fees and assessments, and the minimum medical loss ratio requirements for Medicare Advantage and Medicare Part D plans. Collectively, these changes have had a significant impact on our business and customers, requiring adjustments to our business model to mitigate the effects on our results of operations and cash flows.
Our 2013 Form 10-K provides a detailed description of Health Care Reform provisions and other legislative initiatives that impact our health care business, including regulations issued by CMS, and the U.S. Department of Health and Human Services ("HHS"). The table presented below provides an update of the impact of these items as of the first quarter of 2014.
Item Description Medicare Advantage ("MA") Sequestration: As a result of sequestration, federal and Part D Program government reimbursement rates for MA and Part D were Impacts lowered by 2% beginning April 1, 2013. This program is - Sequestration expected to run through 2023. The overall effect on net - MA Rates income and cash flows was immaterial in 2013 and is expected - Medical Loss to continue to be immaterial.
Ratio (MA and Part D) MA Rates: The 2014 federal government reimbursement rates established by CMS in April 2013 became effective January 1, 2014 and included a variety of payment reductions to Medicare plans. Overall, these rates were reduced by approximately 6% compared with 2013, which is expected to decrease full-year MA premiums by approximately $300 million. Actual impacts to annual revenue related to these rate reductions may vary from this estimate based on a variety of factors, including changes to member risk scores and membership enrollment (in total, and by geography). We expect these rate reductions to negatively impact margins for the Government operating segment in 2014. However, we cannot reliably estimate the effect on our 2014 net income and cash flows because it will depend on the impact of our benefit plan design changes instituted in 2014, and our ability to manage medical and administrative costs.
In April 2014, CMS published its notice of final federal government reimbursement rates for calendar year 2015. While we continue to assess this notice, our preliminary estimate is that overall rates will be reduced by approximately 2% compared with 2014. We expect to reflect the reduced 2015 rates in our proposed bids to CMS that will be submitted in the second quarter of 2014. Although we expect to adjust our programs and services and market participation in response to these 2015 rates, we cannot reliably estimate the impact on our revenues, results of operations, or cash flows in 2015 and beyond.
Medical Loss Ratio ("MLR"): Beginning in 2014, if our MLR for MA or Part D business is less than the required 85% minimum, we will be required to pay a rebate to CMS. For full-year 2014, we currently do not expect to pay a rebate for our MA and Part D plan offerings under these MLR requirements.
40 -------------------------------------------------------------------------------- Table of Contents Health Care Reform Fees Health Insurance Industry Fee: See Note 2 to the Consolidated Financial Statements for additional - Industry Fee information. We recognized $60 million in operating expenses in the first quarter of 2014 and now expect the full-year fee to be approximately $240 million. Because the fee is not tax deductible, our effective tax rate increased in 2014, both on a consolidated basis and for the Global Health Care segment. Approximately $135 million of the fee relates to our commercial business and $105 million to our Medicare business. For our commercial business, we expect to recover substantially all of the fee through rate increases. For our Medicare business, although we expect to partially mitigate the effect of the fee through benefit changes and price increases, we cannot reliably estimate the effect on our 2014 results of operations or cash flows because it will depend on the impact of our benefit plan design changes instituted in 2014, and our ability to manage medical and administrative costs. See the Consolidated Results of Operations and Global Health Care segment sections of this MD&A for further discussion.
Reinsurance Fee: This fee is a fixed dollar per customer levy that applies to both insured and self-insured major - Reinsurance Fee medical plans. Proceeds from the fee will be used to fund the reinsurance program for non-grandfathered individual business sold either on or off the public exchanges beginning in 2014. For our self-insured business, the fee is the responsibility of the employer group. For our insured business, the amount of the fee is approximately $110 million in 2014 and is tax deductible. We recorded approximately $27 million of the reinsurance fee in the first quarter of 2014. We expect to recover substantially all of the fee through rate increases. We expect this trend to continue for the remainder of 2014. See the Global Health Care section of this MD&A for further discussion.
Public Health Exchanges Public Health Exchanges: Beginning in 2014, we are offering coverage on five public health insurance exchanges (Arizona, Colorado, Florida, Tennessee and Texas). See the Global Risk Mitigation Programs Health Care segment section of this MD&A for further - Reinsurance discussion around the results from our individual business.
- Risk Adjustment - Risk Corridor Risk Mitigation Programs: See our 2013 Form 10-K for a description of each of these programs that commenced on January 1, 2014. The reported effect of these programs was not material to our results of operations or cash flows for the first quarter of 2014.
Commercial MLR Commercial MLR: The effect of the commercial MLR rebate accrual was not material to our results of operations or cash flows for the three months ended March 31, 2014.
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