HIGHLIGHTS
----------------------------------------------------------------------------------------------------------------------------------
(Dollars in millions, except per share amounts) 1998 1997 1996 1995 1994
----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums and fees and other revenues $17,576 $15,626 $14,526 $14,426 $14,404
Net investment income 3,705 4,245 4,333 4,296 3,946
Realized investment gains 156 167 91 233 42
----------------------------------------------------------------------------------------------------------------------------------
Total revenues $21,437 $20,038 $18,950 $18,955 $18,392
-----------------------------------------------------------=======================================================================
Net Income:
Operating Income (Loss):
Employee Health Care, Life and Disability Benefits $617 $425 $497 $489 $529
Employee Retirement Benefits and Investment
Services 248 230 210 197 184
International Life, Health and Employee Benefits 17 21 5 (4) (23)
Property and Casualty 70 205 208 (718) (210)
Other Operations 313 180 155 146 135
Corporate (75) (90) (73) (77) (89)
----------------------------------------------------------------------------------------------------------------------------------
Total operating income 1,190 971 1,002 33 526
Realized investment gains, net of taxes 102 115 54 178 28
----------------------------------------------------------------------------------------------------------------------------------
Net Income $1,292 $1,086 $1,056 $211 $554
-----------------------------------------------------------=======================================================================
Earnings per share:
Basic $6.12 $4.93 $4.68 $0.97 $2.58
Diluted $6.05 $4.88 $4.64 $0.96 $2.50
Common dividends declared per share $1.15 $1.11 $1.07 $1.01 $1.01
Total assets $114,612 $108,199 $98,932 $95,903 $86,102
Long-term debt $1,431 $1,465 $1,021 $1,066 $1,389
Shareholders' equity $8,277 $7,932 $7,208 $7,157 $5,811
Per share $40.25 $36.55 $32.38 $31.25 $26.82
Common shares outstanding (thousands) 205,650 216,996 222,594 228,996 216,675
Shareholders of record 12,441 12,953 14,027 15,131 16,408
Employees 49,900 47,700 42,800 44,700 48,600
----------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) is defined as net income (loss) excluding after-tax
realized investment results.
Operating income (loss) by segment for years 1994-1997 has been restated to
reflect the adoption of Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information." For more
information regarding the effect of adopting accounting pronouncements, see the
Notes to Financial Statements.
Share and per share data for years 1994-1997 reflect the three-for-one stock
split approved by shareholders on April 22, 1998.
As discussed in Note 3, CIGNA entered into an agreement in January 1999 to sell
the businesses included in the Property and Casualty segment. Completion of the
transaction is subject to U.S. and international regulatory approval and other
conditions to closing.
1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CONSOLIDATED RESULTS OF OPERATIONS
(In millions)
----------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
----------------------------------------------------------------
Premiums and fees $16,413 $14,935 $13,916
Net investment income 3,705 4,245 4,333
Other revenues 1,163 691 610
Realized investment gains 156 167 91
---------------------------------
Total revenues 21,437 20,038 18,950
Benefits and expenses 19,427 18,388 17,349
---------------------------------
Income before taxes 2,010 1,650 1,601
Income taxes 718 564 545
---------------------------------
Net income 1,292 1,086 1,056
Realized investment gains,
net of taxes 102 115 54
----------------------------------------------------------------
Operating income* $1,190 $971 $1,002
-------------------------------=================================
CIGNA's consolidated operating income increased 23% in 1998, primarily
reflecting the $202 million after-tax gain recognized on the sale of CIGNA's
individual life insurance and annuity business, 1997 after-tax charges of $58
million for integration costs associated with the acquisition of Healthsource,
Inc. (Healthsource) and $22 million for health care restructuring costs
(discussed below) and improved results in the Employee Health Care, Life and
Disability Benefits (excluding the 1997 charges) and Employee Retirement
Benefits and Investment Services segments.** These increases were partially
offset by lower operating income in the Property and Casualty segment
(principally due to catastrophe losses) and Other Operations (excluding the
gain).
Excluding the 1997 charges mentioned above, operating income increased 5% in
1997 reflecting improved results in all segments except Property and Casualty.
Net realized investment gains decreased 11% in 1998 reflecting higher
impairment losses on equity securities, partially offset by lower impairments of
fixed maturities and mortgage loans. Net realized investment gains increased
113% in 1997, reflecting sales of real estate and fixed maturities. For
additional information on net realized investment gains, see Note 5(B) to the
Financial Statements.
Consolidated revenues, excluding realized investment gains, were $21.3
billion, $19.9 billion and $18.9 billion for 1998, 1997 and 1996, respectively.
The 1998 and 1997 increases primarily reflect growth in the Employee Health
Care, Life and Disability Benefits segment (principally from Healthsource),
partially offset in 1998 by the absence of revenues for the individual life
insurance and annuity business. Revenue growth for all years was constrained by
continued price competition and strict underwriting standards.
Excluding the $202 million after-tax gain recognized on the sale of CIGNA's
individual life insurance and annuity business, the anticipated gain on the sale
of CIGNA's property and casualty operations and the effect of the adoption of a
new accounting pronouncement (SOP 97-3, discussed below), operating income is
expected to improve in 1999; however, such improvement could be adversely
affected by the factors noted in the cautionary statement on page 24.
OTHER MATTERS
Acquisitions and Dispositions
In January 1999, CIGNA entered into an agreement to sell its domestic and
international property and casualty businesses (which comprise the Property and
Casualty segment described in Note 16 to the Financial Statements) to ACE
Limited for cash proceeds of $3.45 billion. The sale, which is subject to U.S.
and international regulatory approval and other conditions to closing, is
expected to be completed by mid-1999. Net assets of the businesses to be sold
were approximately $2.3 billion as of December 31, 1998. The determination of
the gain on sale will be affected by changes to net assets through closing for
results of operations and dividends from the businesses to be sold, as well as
transaction costs and other adjustments. CIGNA's priorities for the use of
capital, including proceeds from the sale are, in order, internal growth,
acquisitions, and share repurchases.
As of January 1, 1998, CIGNA sold its individual life insurance and annuity
business for cash proceeds of $1.4 billion. The sale resulted in an after-tax
gain of $773 million of which $202 million was recognized upon closing of the
sale. Since the principal agreement to sell this business is in the form of an
indemnity reinsurance arrangement, the remaining $571 million of the gain was
deferred and is being recognized at the rate that earnings from the business
sold would have been expected to emerge, primarily over fifteen years on a
declining basis. CIGNA recognized $66 million of the deferred gain in 1998.
Revenues for this business were $972 million and $926 million for the years
ended December 31, 1997 and 1996, respectively, and net income was $102 million
and $67 million for the same periods. Also, as part of the transaction, CIGNA
recorded a reinsurance recoverable from the purchaser of $5.8 billion for
insurance liabilities retained, and transferred invested assets of $5.4 billion
along with other assets and liabilities associated with the business. The sales
agreement provides for the possibility of certain
--------
*Operating income (loss) is defined as net income (loss) excluding after-tax
realized investment results.
**CIGNA adopted new segment reporting requirements as of December 31, 1998 as
discussed in Note 16 to the Financial Statements.
10
adjustments; however, any future adjustments are not expected to be material to
results of operations, liquidity or financial condition.
CIGNA acquired the outstanding common stock of Healthsource on June 25,
1997. The cost of the acquisition was $1.7 billion, reflecting the purchase of
Healthsource common stock for $1.4 billion and the retirement of Healthsource
debt of $250 million. The acquisition was accounted for as a purchase, and was
financed through the issuance of long-term debt of $600 million and a
combination of internally generated funds and short-term debt.
In the fourth quarter of 1997, CIGNA recorded a pre-tax integration charge
of $87 million ($58 million after-tax) in connection with its review of
Healthsource operations. The charge primarily resulted from an analysis of
Healthsource HMO medical reserves, receivable balances and contractual
obligations. During 1998, adjustments to these items were recorded, resulting in
an increase to net income of $10 million.
In addition, Healthsource goodwill and other intangibles of $1.5 billion,
recorded at the time of acquisition, were increased by $24 million in the fourth
quarter of 1997. This increase primarily reflects severance of Healthsource
employees, vacated Healthsource lease space and adjustments to Healthsource net
assets to conform to CIGNA's accounting policies. These initiatives are expected
to result in annual after-tax expense savings of $35 million with approximately
two-thirds having emerged in 1998 and the full amount in 1999.
CIGNA has invested in certain entities in connection with the expansion
(principally in emerging markets) of its international operations for
approximately $350 million in 1998 and $125 million in 1997. Most of these
investments relate to the expansion of CIGNA's health care operations in Brazil.
They include the acquisition of a managed health care business, which is being
consolidated, and investments in another health care operation, which are being
accounted for under the equity method. These investments also included equity
securities of a Brazilian financial services company. In 1998, CIGNA recognized
realized investment losses of $31 million after-tax on the Brazilian equity
securities and losses of approximately $17 million after-tax from Brazilian
health care operations. The effect on CIGNA's results of operations in 1997 and
1996 from this expansion of international operations was not material.
CIGNA expects that additional losses and start-up costs will be incurred,
and additional investments may be required in order for these entities to
achieve profitable operations. Certain risks are inherent in expanding
operations in foreign countries, particularly in emerging markets. The
investments in recent international expansion are routinely monitored for
potential impairment, and management currently believes that such investments
are recoverable.
CIGNA continues to conduct strategic and financial reviews of its businesses
in order to deploy its capital most effectively. See Note 3 to the Financial
Statements for additional information on acquisitions and dispositions.
Cost Reduction Initiatives
In the fourth quarter of 1998, CIGNA adopted a cost reduction plan to
restructure certain operations which resulted in a pre-tax charge of $29 million
($19 million after-tax), including $18 million after-tax for restructuring
certain of its domestic and international operations included in the Property
and Casualty segment and $1 million after-tax for certain operations included in
the International Life, Health and Employee Benefits segment. The charge
consisted primarily of costs related to severance and vacated lease space. The
majority of the cash outlays for these initiatives are expected to be made in
1999. These initiatives are expected to result in annual after-tax savings of
$20 million in the Property and Casualty segment. As noted above, CIGNA has
entered into an agreement to sell the businesses that comprise this segment.
In the fourth quarter of 1997, CIGNA adopted a cost reduction plan to
restructure its health care operations, which resulted in a pre-tax charge of
$32 million ($22 million after-tax) in the Employee Health Care, Life and
Disability Benefits segment. The charge consisted primarily of costs related to
severance, real estate and other costs for office closings. Cash outlays
associated with this initiative are expected to be completed in 1999 with most
having occurred in 1998. These initiatives are expected to result in annual
after-tax expense savings of $50 million with approximately two-thirds having
emerged in 1998 and the full amount in 1999.
See Note 17 to the Financial Statements for additional information on cost
reduction initiatives.
11
Other
Effective December 31, 1995, CIGNA restructured its domestic property and
casualty businesses into two separate operations, ongoing and run-off. The
ongoing operations are actively engaged in selling insurance products and
related services. The run-off operations, which do not actively sell insurance
products, manage run-off policies and related claims, including those for
asbestos and environmental (A&E) exposures. Insurance products that were
actively sold in 1995 by subsidiaries that are now in run-off continue to be
sold by the ongoing operations. The restructuring is being contested in the
courts by certain competitors and policyholders. Although CIGNA expects the
matter to be in litigation for some time, it expects to ultimately prevail.
CIGNA's businesses are subject to a changing social, economic, legal,
legislative and regulatory environment that could affect them. Some of the
changes include initiatives to:
o increase health care regulation;
o revise the system of funding cleanup of environmental damages;
o reinterpret insurance contracts long after the policies
were written to provide coverage unanticipated by
CIGNA;
o restrict insurance pricing and the application of
underwriting standards; and
o revise federal tax laws.
In early 1999, the Administration proposed a federal budget that would
eliminate the deferral of taxation of certain statutory income of life insurance
companies. As discussed in Note 9 to the Financial Statements, CIGNA has not
provided taxes on $450 million of such income. If the budget provision is
enacted, CIGNA will record additional income tax expense of $158 million to
reflect this liability. The proposed federal budget also would limit the
deduction of interest expense on the general indebtedness of corporations owning
non-leveraged corporate life insurance policies covering the lives of officers,
employees or directors. If this latter provision is enacted as proposed, CIGNA
does not anticipate that it will have a material effect on its consolidated
results of operations, liquidity, or financial condition, although it could have
a material adverse effect on the results of operations of the Employee
Retirement Benefits and Investment Services segment.
The eventual effect on CIGNA of the changing environment in which it
operates remains uncertain. For additional information, see Note 19 to the
Financial Statements.
ACCOUNTING PRONOUNCEMENTS
CIGNA adopted Statement of Financial Accounting Standards (SFAS) No. 131,
"Disclosures about Segments of an Enterprise and Related Information," as of
December 31, 1998. SFAS No. 131 changes the way segments are structured and
requires additional segment disclosures. Prior period information has been
restated based on the new requirements. See Note 16 to the Financial Statements
for additional information.
In 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that derivatives be reported on the balance sheet at fair value.
Changes in fair value are recognized in net income or, for derivatives that are
hedging market risk related to future cash flows, in the accumulated other
comprehensive income section of shareholders' equity. Implementation is required
by the first quarter of 2000, with the cumulative effect of adoption reflected
in net income and accumulated other comprehensive income, as appropriate. CIGNA
has not determined the effect or timing of implementation of this pronouncement.
The American Institute of Certified Public Accountants (AICPA) issued
Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments," in 1997. SOP 97-3 provides guidance on the
recognition and measurement of liabilities for guaranty fund and other
insurance-related assessments. Implementation is required by the first quarter
of 1999, with the cumulative effect of adopting the SOP reflected in net income
in the year of adoption. The estimated reduction of net income from
implementation of this pronouncement is expected to be approximately $95
million, and is primarily related to the property and casualty operations.
In 1998, the AICPA issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." SOP
98-7 provides guidance on the deposit method of accounting for insurance and
reinsurance contracts that do not transfer insurance risk, except for
long-duration life and health contracts. Implementation is required by the first
quarter of 2000, with the cumulative effect of adopting the SOP reflected in net
income in the year of adoption. CIGNA has not determined the effect or timing of
implementation of this pronouncement.
See Note 2(B) to the Financial Statements for additional information
regarding accounting pronouncements.
12
EMPLOYEE HEALTH CARE, LIFE AND DISABILITY BENEFITS
(In millions)
----------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
----------------------------------------------------------------
Premiums and fees $11,421 $9,546 $8,375
Net investment income 589 563 567
Other revenues 542 454 404
---------------------------------
Segment revenues 12,552 10,563 9,346
Benefits and expenses 11,574 9,906 8,588
---------------------------------
Income before taxes 978 657 758
Income taxes 361 232 261
---------------------------------
Operating income $617 $425 $497
-------------------------------=================================
Realized investment gains,
net of taxes $54 $17 $3
-------------------------------=================================
Operating income for the Employee Health Care, Life and Disability Benefits
segment increased 45% in 1998 and decreased 14% in 1997. Results for 1997
included after-tax charges of $58 million for Healthsource integration and $22
million related to cost reduction initiatives to restructure the health care
operations. See pages 10 and 11 for additional information. Excluding the above
charges, operating income was as follows:
-------------------------------------------------
(In millions) 1998 1997 1996
-------------------------------------------------
Indemnity operations $314 $302 $286
HMO operations 303 203 211
-------------------------------------------------
Total $617 $505 $497
------------------------=========================
The increase in the indemnity operations in 1998 primarily reflects
favorable claim experience from guaranteed cost medical, long-term disability
and life businesses. Partially offsetting this increase were lower earnings from
experience-rated medical business.
The increase in the indemnity operations in 1997 reflects improved claim
experience from guaranteed cost medical and group life businesses. Partially
offsetting this increase were higher medical costs, and lower earnings from
Administrative Services Only (ASO) business resulting from higher operating
expenses due to customer service initiatives.
The 1998 increase in HMO results reflects membership growth and rate
increases, improved results in health care services operations and lower
operating expenses per member due to expense savings initiatives. These
improvements were partially offset by increased HMO medical costs reflecting
higher pharmacy and outpatient costs and higher amortization of goodwill and
other intangibles associated with the acquisition of Healthsource. The effect of
account reviews on operating income in 1998 compared with 1997 was not material.
HMO operating income for 1997 and 1996 includes the favorable after-tax
effect of tax and other account reviews of $6 million and $17 million in 1997
and 1996, respectively, and a net gain from sales of subsidiaries of $8 million
in 1996. Excluding these amounts, operating income for 1997 and 1996 was $197
million and $186 million, respectively. The 1997 improvement reflects rate
increases, membership growth and lower dental costs. Partially offsetting these
improvements were increased HMO medical costs, higher operating expenses
associated with growth and customer service initiatives, and amortization of
Healthsource goodwill and other intangibles.
Premiums and fees increased 20% in 1998 and 14% in 1997. These increases
primarily reflect the addition of Healthsource premiums and fees and, to a
lesser extent, rate increases and non-Healthsource membership growth.
The 5% increase in net investment income in 1998 reflects higher assets due
to the Healthsource acquisition, partially offset by lower yields.
Total medical HMO membership increased 11% in 1998 and 36% in 1997. The 1998
increase primarily reflects membership growth in medical HMO alternative funding
programs. The 1997 increase reflects the Healthsource acquisition and, to a
lesser extent, growth in medical HMO alternative funding programs.
Management believes that adding premium equivalents to premiums and fees
(adjusted premiums and fees) produces a more meaningful measure of business
volume. Premium equivalents generally represent paid claims under alternative
funding programs, such as minimum premium and ASO plans, and are additional
premiums that would have been earned if these coverages had been written as
traditional indemnity and HMO programs. Under alternative funding programs, the
customer assumes all or a portion of the responsibility for funding claims, and
CIGNA generally earns a lower margin than under traditional programs.
Premium equivalents were approximately $13 billion in 1998 compared with
$10.8 billion in 1997 and $9.6 billion in 1996. The 1998 increase of 21%
primarily reflects the Healthsource acquisition and growth in HMOs. The 1997
increase of 13% reflects the Healthsource acquisition. Excluding Healthsource,
1997 premium equivalents were level with 1996, with both years reflecting growth
in HMOs offset by cancellations and conversions of medical indemnity business to
HMOs. Premium equivalents were approximately 55% of total adjusted premiums and
fees in 1998, 1997 and 1996. ASO plans accounted for approximately 50% of total
adjusted premiums and fees in 1998, 1997 and 1996.
Business mix in 1998, measured by adjusted premiums and fees, was
approximately 44% HMO medical and dental care, 38% medical indemnity, 8% dental
indemnity, 7% life insurance, 2% long-term disability insurance and 1% other
insurance coverages.
13
Indemnity claims paid for insured plans and claims paid for all alternative
funding programs, including ASOs, for the year ended December 31 were as
follows:
------------------------------------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------------------------
Insured plans $3,880 $3,842 $3,814
Alternative funding programs 13,063 11,052 19,759
------------------------------------------------------------------
Total $16,943 $14,894 $13,573
--------------------------------==================================
The 1998 and 1997 increases in alternative funding programs primarily
reflect the Healthsource acquisition and membership growth.
Growth in premiums and fees and premium equivalents may be constrained by
competitive pressures in both the medical indemnity and HMO markets.
EMPLOYEE RETIREMENT BENEFITS AND INVESTMENT SERVICES
(In millions)
-------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
-------------------------------------------------------------
Premiums and fees $257 $221 $272
Net investment income 1,613 1,655 1,716
------------------------------
Segment revenues 1,870 1,876 1,988
Benefits and expenses 1,505 1,545 1,680
------------------------------
Income before taxes 365 331 308
Income taxes 117 101 98
------------------------------
Operating income $248 $230 $210
-------------------------------==============================
Realized investment gains,
net of taxes $25 $15 $21
-------------------------------==============================
Operating income for the Employee Retirement Benefits and Investment
Services segment increased 8% in 1998 and 10% in 1997. Results for 1997 include
a favorable tax adjustment of $5 million and, for 1996, an after-tax charge of
$8 million for state guarantee fund assessments.
Operating income, excluding the items noted above, was $248 million, $225
million and $218 million in 1998, 1997 and 1996, respectively. The increases for
1998 and 1997 reflect higher earnings from an increased asset base, partially
offset by a shift to lower margin products (separate account equity funds) and
by higher operating expenses related to growth initiatives. The 1998 increase
also reflects higher earnings from non-leveraged corporate life insurance
business resulting from an increased asset base and favorable mortality
experience.
Premiums and fees increased 16% in 1998 and decreased 19% in 1997. The 1998
increase reflects higher non-leveraged corporate life insurance premiums and
fees, higher fees from separate accounts and higher annuity sales. The 1997
decrease primarily reflects a decline in annuity sales.
Net investment income decreased 3% in 1998 and 4% in 1997. These decreases
primarily reflect customers' continued redirection of a portion of their
investments from the general account to separate accounts and lower investment
yields, partially offset by higher investment income from an increased
non-leveraged corporate life insurance asset base.
Assets under management are generally a key determinant of earnings for this
segment. For the year ended December 31, assets under management and related
activity, including amounts attributable to separate accounts, were as follows:
-------------------------------------------------------------
(In millions) 1998 1997
-------------------------------------------------------------
Balance -- January 1 $48,231 $41,663
Premiums and deposits 8,048 7,796
Investment results 3,432 3,244
Increase in fair value of assets 2,704 2,613
Customer withdrawals (3,573) (2,428)
Other, including participant
withdrawals and benefit payments (5,913) (4,657)
-------------------------------------------------------------
Balance -- December 31 $52,929 $48,231
------------------------------------=========================
Premiums and deposits increased slightly in 1998 compared with 1997.
Recurring deposits from existing customers were approximately 55% and 52% of the
premiums and deposits for 1998 and 1997, respectively, while the remaining
amounts represent sales to new customers. The increase in investment results
reflects higher realized capital gains, partially offset by lower investment
yields. The increase in the fair value of assets primarily reflects market value
appreciation of equity securities in separate accounts. The increase in customer
withdrawals is primarily due to the effect of one customer withdrawal in 1998.
The increase in Other reflects larger participant withdrawals and benefit
payments due to a higher level of assets under management.
Assets under management will continue to be affected by market value
fluctuations for equity securities and fixed maturities.
See Other Matters for additional information regarding corporate life
insurance.
14
INTERNATIONAL LIFE, HEALTH AND EMPLOYEE BENEFITS
(In millions)
-------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
-------------------------------------------------------------
Premiums and fees $1,227 $1,076 $981
Net investment income 115 122 125
Other revenues 4 2 --
-------------------------------
Segment revenues 1,346 1,200 1,106
Benefits and expenses 1,309 1,167 1,098
-------------------------------
Income before taxes 37 33 8
Income taxes 20 12 3
-------------------------------
Operating income $17 $21 $5
------------------------------===============================
Realized investment gains,
net of taxes $-- $2 $1
------------------------------===============================
Operating income for the International Life, Health and Employee Benefits
segment decreased 19% in 1998 and increased substantially in 1997. The decrease
in 1998 reflects losses of $17 million after-tax in Brazilian health care
operations, unfavorable economic conditions in Asia, and expenses incurred in
connection with expansion of operations, primarily in Poland. Partially
offsetting these decreases were an $18 million after-tax improvement in the
results of Japanese life insurance operations reflecting higher business volume
and favorable product mix, and growth in the health care business related to
expatriate employees of multinational companies.
Premiums and fees increased 14% and 10% for 1998 and 1997, respectively.
Excluding the effects of foreign currency changes, premiums and fees increased
25% and 17% for the same periods. These increases reflect growth in the Japanese
life insurance operations and the health care business related to expatriate
employees of multinational companies and, for 1998, the acquisition of a
Brazilian managed health care business.
Net investment income declined 6% and 2% in 1998 and 1997, respectively.
Excluding the unfavorable effects of foreign currency changes, net investment
income increased 5% for both 1998 and 1997, reflecting higher average assets due
to business growth.
CIGNA is undertaking efforts to improve the results of its Brazilian
operations, including initiatives to improve the pricing of medical products and
services and to provide for enhanced medical cost controls. Additional losses
are expected while these initiatives are in progress. See page 11 for additional
discussion regarding the expansion of CIGNA's international operations.
The devaluation of the Brazilian currency in early 1999 is not expected to
have a material effect on CIGNA's consolidated results of operations, liquidity
or financial condition.
PROPERTY AND CASUALTY
(In millions)
-------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
-------------------------------------------------------------
Premiums and fees $2,957 $3,154 $3,417
Net investment income 583 639 679
Other revenues 297 302 244
-------------------------------
Segment revenues 3,837 4,095 4,340
Benefits and expenses 3,748 3,788 4,045
-------------------------------
Income before taxes 89 307 295
Income taxes 19 102 87
-------------------------------
Operating income $70 $205 $208
------------------------------===============================
Realized investment gains,
net of taxes $11 $47 $26
------------------------------===============================
In January 1999, CIGNA entered into an agreement to sell the businesses
included in this segment. See page 10 for additional information. Operating
income (loss) was as follows:
(In millions) 1998 1997 1996
--------------------------------------------------------
International $(13) $106 $130
Domestic 85 98 76
---------------------------
Total ongoing operations 72 204 206
Run-off operations (2) 1 2
--------------------------------------------------------
Total $70 $205 $208
-----------------------------===========================
The decline in the international operations for 1998 includes catastrophe
losses of $72 million after-tax for Hurricane Georges, Hurricane ▇▇▇▇▇ and
Canadian winter storms as well as restructuring costs (primarily severance) of
approximately $7 million after-tax. These results also reflect unfavorable claim
experience, primarily from large property losses, the competitive pricing
environment, and lower investment income. The decline in 1997 primarily reflects
unfavorable claim experience in both the fire and casualty lines and charges for
severance costs.
The decline in the domestic operations for 1998 reflects higher catastrophe
losses, including $9 million after-tax relating to Hurricane ▇▇▇▇▇▇▇,
restructuring charges of $9 million after-tax, lower net investment income and
unfavorable workers' compensation experience, partially offset by favorable
prior year development on selected lines of business and improvement in results
from insurance-related service businesses. The improvement in the domestic
operations for 1997 primarily reflects lower catastrophe losses partially offset
by lower premiums and fees, lower investment income and an unfavorable tax
adjustment of $7 million.
Results for the run-off operations primarily reflect prior year development
on claim and claim adjustment expense reserves and investment activity and for
1998 include $2 million after-tax for restructuring costs.
15
Premiums and fees for the segment decreased 6% in 1998. This decline
primarily reflects 1) the unfavorable effect of approximately $104 million from
foreign currency translation, 2) lower premiums of approximately $92 million for
run-off and certain personal lines that are no longer being actively sold , 3)
strict underwriting standards, and 4) the highly competitive pricing environment
in certain domestic and international property and casualty lines of business.
These declines were partially offset by increases in workers' compensation
premiums and growth in international accident and health business.
Premiums and fees decreased 8% in 1997. This decline primarily reflects 1)
lower premiums of approximately $153 million for run-off and personal automobile
products that are no longer being actively sold, 2) the unfavorable effect of
approximately $73 million from foreign currency translation, 3) strict
underwriting standards, and 4) the highly competitive pricing environment in
certain domestic and international property and casualty lines of business.
These declines were partially offset by increases in domestic specialty lines of
business including marine and aviation coverages as well as growth in
international accident and health business.
Net investment income for 1998 decreased 9% reflecting a lower asset base
(primarily for run-off operations), a shift in the investment portfolio mix from
fixed maturities to equity securities, and the unfavorable effect of $6 million
from currency translation. Net investment income for 1997 decreased 6% from
1996, primarily reflecting a lower asset base and an unfavorable effect from
currency translation of $2 million.
Pre-tax catastrophe losses, net of reinsurance, were $141 million, $17
million and $87 million in 1998, 1997 and 1996, respectively. Net catastrophe
losses in 1998 included $82 million for Hurricane ▇▇▇▇▇▇▇, $21 million for
Hurricane ▇▇▇▇▇, and $29 million for Canadian and East Coast winter storms. Net
catastrophe losses in 1996 included $21 million for Hurricane ▇▇▇▇ and $22
million for East Coast winter storms.
Effective July 1, 1998, CIGNA revised its reinsurance programs. CIGNA's
domestic reinsurance programs provide approximately 60% recovery for property
catastrophe losses between $45 million and $260 million. Other reinsurance
programs are in place which could provide for the recovery of up to an
additional $300 million on certain losses, including property catastrophes,
depending on the aggregate annual level of losses incurred. CIGNA's
international catastrophe program provides approximately 95% recovery of losses
between $100 million and $400 million. Other reinsurance programs are in place
which could provide for the recovery of additional property losses including
coverage between $15 million and $150 million on a per risk basis. CIGNA's
results of operations could be volatile, depending on the frequency and severity
of catastrophes.
Loss Reserves and Reinsurance Recoverables
CIGNA's property and casualty loss reserves of $14.6 billion and $14.9
billion as of December 31, 1998 and 1997, respectively, are estimates of future
payments for reported and unreported claims for losses and related expenses with
respect to insured events that have occurred. The basic assumption underlying
the many traditional actuarial and other methods used in the estimation of
property and casualty loss reserves is that past experience is an appropriate
basis for predicting future events. However, current trends and other factors
that would modify past experience are also considered. The process of
establishing loss reserves is subject to uncertainties that are normal,
recurring and inherent in the property and casualty business.
CIGNA continually attempts to improve its loss estimation process by
refining its analysis of loss development patterns, claims payments and other
information, but there remain many reasons for adverse development of estimated
ultimate liabilities. For example, unanticipated changes in workers'
compensation and product liability laws have at times significantly affected the
ability of insurers to estimate liabilities for unpaid losses and related
expenses.
Reserving for property and casualty claims continues to be a complex and
uncertain process, requiring the use of informed estimates and judgments.
CIGNA's estimates and judgments may be revised as additional experience and
other data become available and are reviewed, as new or improved methodologies
are developed or as current law changes. Any such revisions could result in
future changes in estimates of losses or reinsurance recoverables, and would be
reflected in CIGNA's results of operations for the period in which the estimates
are changed. While the effect of any such changes in estimates of losses or
reinsurance recoverables could be material to future results of operations,
CIGNA does not expect such changes to have a material effect on its liquidity or
financial condition.
CIGNA manages its loss exposure through the use of reinsurance. While
reinsurance arrangements are designed to limit losses from large exposures and
to permit recovery of a portion of direct losses, reinsurance does not relieve
CIGNA of liability to its insureds. Accordingly, CIGNA's loss reserves represent
total gross losses, and reinsurance recoverables represent anticipated
recoveries of a portion of those losses.
16
CIGNA's reinsurance recoverables were approximately $6.3 billion and $6.2
billion as of December 31, 1998 and 1997, net of allowances for unrecoverable
reinsurance of $705 million and $720 million, respectively.
CIGNA recognized significant recoveries in 1998, 1997 and 1996 from
reinsurance arrangements, as shown in the table below. Reinsurance recoveries
for the periods presented increased or decreased as a result of comparable
changes in gross losses. Reinsurance recoveries are also affected by the factors
noted below for "unrecoverable reinsurance."
CIGNA expects to continue to have significant recoveries from its
reinsurance arrangements, including recoveries of A&E losses. However, the
extent of recoveries in the aggregate will depend on future gross loss
experience and the particular reinsurance arrangements to which future losses
relate.
At December 31, 1998 and 1997, approximately 16% of CIGNA's reinsurance
recoverables related to paid claims. The timing and collectibility of such
recoverables have not had, and are not expected to have, a material adverse
effect on CIGNA's liquidity.
In management's judgment, information currently available has been
appropriately considered in estimating CIGNA's loss reserves and reinsurance
recoverables.
See CIGNA's Form 10-K for additional information on CIGNA's loss reserves
and reinsurance recoverables.
The following table shows CIGNA's gross losses for incurred claims and claim
adjustment expenses (Gross), amounts ceded to reinsurers (Reinsurance) and net
losses for incurred claims and claim adjustment expenses (Net) for the year
ended December 31. The table also categorizes those amounts as they relate to
insured events of the current year and of prior years (prior year development).
===========================================================================================================================
1998 1997 1996
---------------------------------------------------------------------------------------------------------------------------
(In millions) Gross Reinsurance Net Gross Reinsurance Net Gross Reinsurance Net
---------------------------------------------------------------------------------------------------------------------------
Current year $3,241 $(1,192) $2,049 $2,831 $(841) $1,990 $3,419 $(1,162) $2,257
---------------------------------------------------------------------------------------------------------------------------
Prior year development:
Asbestos-related 202 (109) 93 170 (78) 92 115 (53) 62
Environmental pollution 51 (11) 40 94 (61) 33 58 (26) 32
Assumed reinsurance
exposures 59 (37) 22 16 (9) 7 114 (74) 40
Unrecoverable
reinsurance -- 27 27 -- 23 23 -- 23 23
Other 130 (135) (5) (71) 134 63 (26) 46 20
---------------------------------------------------------------------------------------------------------------------------
Total prior year
development 442 (265) 177 209 9 218 261 (84) 177
---------------------------------------------------------------------------------------------------------------------------
Total incurred claims
and claim adjustment
expenses $3,683 $(1,457) $2,226 $3,040 $(832) $2,208 $3,680 $(1,246) $2,434
===========================================================================================================================
Losses for "assumed reinsurance exposures" resulted from a review of
reserves for certain reinsurance lines of business, including London reinsurance
exposures.
Losses for "unrecoverable reinsurance" are principally due to the failure of
reinsurers to indemnify CIGNA, primarily because of disputes under reinsurance
contracts. Reinsurance disputes continue to be significant, particularly on
larger and more complex claims, such as those related to asbestos, environmental
pollution and London reinsurance market exposures. Allowances have been
established for amounts deemed uncollectible.
"Other" prior year development in 1998 reflects favorable development on
shorter-tail property, marine and aviation business, partially offset by
unfavorable development on workers' compensation and long-term exposures. Losses
for "other" prior year development in 1997 and 1996 reflect unfavorable
development on workers' compensation and long-term exposures, partially offset
by favorable loss reserve development on commercial packages and, for 1996, the
commercial fire line of business.
17
OTHER OPERATIONS
(In millions)
-----------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
-----------------------------------------------------------------
Premium and fees $551 $938 $871
Net investment income 771 1,235 1,217
Other revenues 514 151 156
-----------------------------
Segment revenues 1,836 2,324 2,244
Benefits and expenses 1,356 2,056 2,007
-----------------------------
Income before taxes 480 268 237
Income taxes 167 88 82
-----------------------------
Operating income $313 $180 $155
------------------------------------=============================
Realized investment gains,
net of taxes $9 $35 $12
------------------------------------=============================
Other Operations consist of gain recognition related to the sale of the
individual life insurance and annuity business, corporate life insurance on
which policy loans are outstanding (also called leveraged corporate life
insurance), life, accident and health reinsurance operations, settlement annuity
business, and certain new business initiatives.
Operating income for the Other Operations segment increased substantially in
1998 and by 16% in 1997. Results for 1998 include an after-tax gain of $202
million recognized on the sale of the individual life and annuity business.
Results for 1998 also include $66 million from recognizing a portion of the
deferred gain associated with the sale (as discussed on page 10). Excluding
these amounts, operating income for 1998 was $45 million, compared with
operating income of $82 million in 1997 and $91 million in 1996 (excluding, in
those years, results from the sold business). The 1998 decrease primarily
reflects unfavorable claim experience in the health and accident reinsurance
operations and increased operating expenses for new business initiatives,
partially offset by growth in specialty life reinsurance products. The 1997
decrease primarily reflects the expenses related to new business initiatives,
partially offset by growth in specialty life reinsurance products.
Premiums and fees decreased 41% in 1998 and increased 8% in 1997. Excluding
premiums and fees for the sold business, premiums and fees increased 11% and 8%
in 1998 and 1997, respectively. These increases reflect growth in specialty life
reinsurance, partially offset by lower renewal premiums for leveraged corporate
life insurance.
Net investment income decreased 38% in 1998 and was about level in 1997 with
1996. Excluding net investment income from the business sold, 1998 and 1997
decreased slightly, primarily reflecting lower yields and lower assets from
leveraged corporate life insurance, partially offset by higher assets from
specialty life reinsurance products.
The increase in other revenues in 1998 is primarily attributable to
recognition of gains on the sale of the individual life insurance and annuity
business.
In 1996, Congress passed legislation that phases out over a three-year
period the tax deductibility of policy loan interest for most leveraged
corporate life insurance products. Revenues of $556 million and operating income
of $42 million for 1998 were from leveraged corporate life insurance products
that are affected by this legislation. CIGNA does not expect this legislation to
have a material effect on its consolidated results of operations, liquidity or
financial condition.
The specialty life reinsurance products of this segment include contracts
that guarantee payments for specified unfavorable changes in variable annuity
account values based on underlying mutual fund investments if account holders
expire or elect to receive periodic income payments. Although these guarantees
may adversely affect CIGNA's results of operations in future periods, they are
not expected to have a material adverse effect on CIGNA's liquidity or financial
condition.
CORPORATE
(In millions)
------------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
------------------------------------------------------------------
Operating loss $(75) $(90) $(73)
---------------------------------------===========================
Realized investment gains (losses),
net of taxes $3 $(1) $(9)
---------------------------------------===========================
The Corporate caption is used to report amounts not allocated to segments,
such as interest expense, certain goodwill amortization and intersegment
eliminations. The reduction in the operating loss in 1998 is primarily
attributed to a decrease in unallocated corporate expenses. The increase in the
operating loss in 1997 primarily reflects higher interest expense.
LIQUIDITY AND CAPITAL RESOURCES
(In millions)
------------------------------------------------------------
FINANCIAL SUMMARY 1998 1997 1996
------------------------------------------------------------
Short-term investments $308 $212 $847
Cash and cash equivalents 3,028 2,625 1,760
Short-term debt 272 690 289
Long-term debt 1,431 1,465 1,021
Shareholders' equity 8,277 7,932 7,208
------------------------------------------------------------
CIGNA's operations have liquidity requirements that vary among the principal
product lines. Life insurance and pension plan reserves are primarily
longer-term liabilities. Property and casualty, as well as accident and health
reserves, including long-term disability, consist of both short-term and
long-term liabilities. Life insurance and
18
pension plan reserve requirements are usually stable and predictable, and are
supported primarily by medium-term, fixed-income investments. Property and
casualty claim demands are less predictable in nature, requiring greater
liquidity in the investment portfolio. Accident and health claim demands are
stable and predictable, but generally shorter term, requiring greater liquidity.
Generally, CIGNA has met its operating requirements by maintaining
appropriate levels of liquidity in its investment portfolio and utilizing
overall cash flows. Overall cash flows have been constrained by negative cash
flows in the property and casualty business, resulting from claim payments
related to insurance reserves established in prior periods. Liquidity for CIGNA
and its insurance subsidiaries has remained strong, as evidenced by significant
amounts of short-term investments and cash and cash equivalents.
During 1998, cash and cash equivalents increased $403 million. This increase
primarily reflects net proceeds on the sale of the individual life insurance and
annuity business ($1.3 billion), cash provided by operating activities ($627
million) reflecting earnings and the timing of cash receipts and cash
disbursements, and net investment sales (approximately $300 million). These
increases were partially offset by repurchases of, and payments of dividends on,
common stock ($1.1 billion), repayment of debt ($456 million) and investments in
international growth initiatives (approximately $350 million).
During 1997, cash and cash equivalents increased $865 million. This increase
primarily reflects cash flows from operating activities ($1.2 billion)
reflecting earnings and the timing of cash receipts and cash disbursements;
proceeds on the issuance of long-term debt ($600 million); net proceeds on
short-term debt ($358 million); and deposits and interest credited, net of
withdrawals, to contractholder deposit funds ($579 million). The increase was
partially offset by cash used in investing activities ($966 million, which
reflects $1.3 billion used to acquire Healthsource), repayment of Healthsource
debt ($250 million), and payments of dividends on and repurchases of CIGNA
common stock ($580 million).
Funds provided from premiums and fees, investment income and maturities of
investment assets are reasonably predictable and normally exceed liquidity
requirements for payments of claims, benefits and expenses. However, since the
timing of available funds cannot always be matched precisely to commitments,
imbalances may arise when demand for funds exceeds those on hand. Also, a demand
for funds may arise as a result of CIGNA taking advantage of current investment
opportunities.
CIGNA's insurance subsidiaries are subject to various regulatory
restrictions that can limit the amount of internal dividends and other
distributions, including loans, that can be utilized to manage liquidity needs.
However, CIGNA's size and diversity generally provide the flexibility to manage
liquidity needs, either internally or externally, through short-term borrowings.
At December 31, 1998, CIGNA had available approximately $655 million of
committed and uncommitted lines of credit with banks.
CIGNA's financial strength provides the capacity and flexibility to enable
it to raise funds in the capital markets through the issuance of long-term debt
and equity securities. CIGNA continues to be well capitalized, with sufficient
borrowing capacity to meet the anticipated needs of its businesses.
CIGNA's capital resources represent funds available for long-term business
commitments. They primarily consist of retained earnings and proceeds from the
issuance of long-term debt and equity securities. Capital resources provide
protection for policyholders and the financial strength to support the
underwriting of insurance risks, and allow for continued business growth. The
amount of capital resources that may be needed is determined by CIGNA's senior
management and Board of Directors, as well as by regulatory requirements. The
allocation of resources to new long-term business commitments is designed to
achieve an attractive return, tempered by considerations of risk and the need to
support CIGNA's existing businesses.
CIGNA had $1.4 billion of long-term debt outstanding at December 31, 1998,
compared with $1.5 billion at December 31, 1997. At December 31, 1998, CIGNA had
$1 billion remaining under effective shelf registration statements filed with
the Securities and Exchange Commission that may be issued as debt securities,
equity securities or both, depending upon market conditions and CIGNA's capital
requirements.
CIGNA repurchased 12.4 million shares of its common stock for $822 million
during 1998. From January 1, 1999 through February 24, 1999, an additional
673,700 shares were repurchased for $53 million. The remaining authorization of
CIGNA's Board of Directors for share repurchases as of February 24, 1999 was
$737 million. Decisions regarding share repurchases are subject to prevailing
market conditions and alternative uses for capital.
19
INVESTMENT ASSETS
Information regarding investment assets held by CIGNA is presented below.
Additional information regarding CIGNA's investment assets and related
accounting policies is included in Notes 2, 4 and 5 to the Financial Statements,
and in CIGNA's Form 10-K.
(In millions)
-------------------------------------------------------
As of December 31,
FINANCIAL SUMMARY 1998 1997
-------------------------------------------------------
Fixed maturities $32,634 $36,358
Equity securities 1,043 854
Mortgage loans 9,599 10,859
Real estate 733 769
Other, primarily policy loans 6,698 7,738
-------------------------------------------------------
Total investment assets $50,707 $56,578
--------------------------------=======================
The decrease in investment assets in 1998 is primarily related to
investments which were included in the sale of the individual life insurance and
annuity business.
Significant amounts of CIGNA's investment assets are attributable to
experience-rated contracts with policyholders (policyholder contracts).
Approximate percentages of investments attributable to policyholder contracts as
of December 31 were as follows:
---------------------------------------------
1998 1997
---------------------------------------------
Fixed maturities 27% 29%
Mortgage loans 57% 53%
Real estate 63% 64%
---------------------------------------------
Under the experience-rating process, net investment income and gains and
losses on assets related to policyholder contracts generally accrue to the
policyholders. Consequently, write-downs, changes in valuation reserves and
non-accruals on investments attributable to policyholder contracts do not affect
CIGNA's net income, except under unusual circumstances.
Fixed Maturities
Investments in fixed maturities (bonds) include publicly traded and private
placement debt securities; asset-backed securities, including collateralized
mortgage obligations (CMOs); and redeemable preferred stocks.
As of December 31, 1998, the fair value of fixed maturities, including
policyholder share, was greater than amortized cost by $2.0 billion, compared
with $2.1 billion as of December 31, 1997.
Quality Ratings
As of December 31, 1998, $31.0 billion, or 95%, of bonds were investment
grade, and $1.6 billion, or 5%, were below investment grade (BA and below, or
equivalent).
The quality ratings of CIGNA's below investment grade bonds are concentrated
toward the higher end of the below investment grade spectrum. Approximately 17%
of below investment grade securities relate to policyholder contracts.
Private placement investments are made after credit analysis and are
diversified by industry and issuer. Private placement investments are generally
less marketable than public bonds, and yields are generally higher for
comparable credit risk. Further, private placement investments generally contain
financial and other covenants that allow CIGNA to monitor the debtor for early
signs of deteriorating financial strength so it can take remedial actions, if
warranted.
As a result of the higher yields and the inherent risk associated with below
investment grade securities and private placement investments, gains or losses
could significantly affect future results of operations, although such effects
are not expected to be material to CIGNA's liquidity or financial condition.
Potential Problem and Problem Bonds
Potential problem bonds are fully current but judged by management to have
certain characteristics that increase the likelihood of problem classification.
CIGNA had $69 million of potential problem bonds, including amounts attributable
to policyholder contracts, as of December 31, 1998, compared with $63 million as
of December 31, 1997. These amounts are net of $14 million and $10 million of
cumulative write-downs, respectively. Potential problem bonds attributable to
policyholder contracts represented 35% and 45% of total potential problem bonds
at December 31, 1998 and 1997, respectively.
CIGNA considers bonds that are delinquent or restructured as to terms,
typically interest rate and, in certain cases, maturity date, problem bonds. As
of December 31, 1998 and 1997, CIGNA had problem bonds, including amounts
attributable to policyholder contracts, of $119 million and $137 million, net of
related cumulative write-downs of $19 million and $30 million, respectively.
Problem bonds attributable to policyholder contracts represented 29% and 24% of
total problem bonds at December 31, 1998 and 1997, respectively.
CIGNA recognizes interest income on problem bonds only when payment is
received. See the Summary on page 22 for the adverse effect of non-accruals and
write-downs for bonds on policyholder contracts and on CIGNA's net income.
20
Mortgage Loans
---------------------------------------------------------------------------
As of December 31,
1998 1997
---------------------------------------------------------------------------
Mortgage loans (in millions) $9,599 $10,859
Property type:
Retail facilities 34% 40%
Office buildings 37 34
Apartment buildings 15 13
Industrial 7 5
Hotels 5 5
Other 2 3
---------------------------------------------------------------------------
Total 100% 100%
----------------------------------------------=============================
CIGNA's investment strategy requires diversification of the mortgage loan
portfolio. This strategy includes guidelines relative to property type, location
and borrower to reduce its exposure to potential losses. CIGNA routinely
monitors and evaluates the status of its mortgage loans through the review of
loan and property-related information, including cash flows, expiring leases,
financial health of the borrower and major tenants, loan payment history,
occupancy and room rates for hotels and, for all commercial properties,
significant new competition. CIGNA evaluates this information in light of
current economic conditions as well as geographic and property type
considerations.
Potential Problem and Problem Mortgage Loans
Potential problem mortgage loans include:
o fully current loans that are judged by management to have certain
characteristics that increase the likelihood of problem classification;
o fully current loans for which the borrower has requested restructuring; and
o loans that are 30 to 59 days delinquent with respect to interest or
principal payments.
CIGNA had potential problem mortgage loans, including amounts attributable
to policyholder contracts, of $55 million and $191 million as of December 31,
1998 and 1997, respectively. These amounts were net of related valuation
reserves of $41 million as of December 31, 1997. There were no such reserves as
of December 31, 1998. Potential problem mortgage loans attributable to
policyholder contracts represented 58% and 61% of total potential problem
mortgage loans at December 31, 1998 and 1997, respectively.
CIGNA's problem mortgage loans include delinquent and restructured mortgage
loans. Delinquent mortgage loans include those on which payment is overdue 60
days or more. Restructured mortgage loans are those whose basic financial terms
have been modified, typically to reduce the interest rate or extend the maturity
date.
CIGNA had problem mortgage loans, including amounts attributable to
policyholder contracts, of $98 million and $152 million, net of valuation
reserves of $6 million and $9 million, as of December 31, 1998 and 1997,
respectively. Problem mortgage loans attributable to policyholder contracts
represented 62% and 51% of total problem mortgage loans at December 31, 1998 and
1997, respectively.
For 1998 and 1997, the majority of problem mortgage loans related to office
buildings in the Middle Atlantic region.
CIGNA recognizes interest income on problem mortgage loans only when payment
is received. See the Summary on page 22 for the effect of non-accruals and
valuation reserves for mortgage loans on policyholder contracts and on CIGNA's
net income.
Real Estate
Investment real estate includes real estate held for the production of
income and real estate held for sale, primarily properties acquired as a result
of foreclosure of mortgage loans (foreclosure properties).
As of December 31, investment real estate, including amounts attributable to
policyholder contracts, and related cumulative write-downs and valuation
reserves, were as follows:
----------------------------------------------------------------------
(In millions) 1998 1997
----------------------------------------------------------------------
Real estate held for sale (primarily
foreclosure properties) $511 $513
Less cumulative write-downs 132 129
Less valuation reserves 36 29
-----------------------
343 355
-----------------------
Real estate held for the production
of income 435 462
Less cumulative write-downs 45 48
-----------------------
390 414
----------------------------------------------------------------------
Investment real estate $733 $769
-----------------------------------------------=======================
Foreclosure properties attributable to policyholder contracts represented
60% of total foreclosure properties at December 31, 1998 and 1997.
For 1998 and 1997, the majority of real estate held for sale related to
office buildings and retail facilities in the Central and Middle Atlantic
regions.
See the Summary on page 22 for the effect of real estate write-downs and
valuation reserves on policyholder contracts and on CIGNA's net income.
21
Summary
The adverse (favorable) effects of write-downs and changes in valuation
reserves as well as of non-accruals on policyholder contracts and on CIGNA's net
income for the year ended December 31 were as follows:
---------------------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------- -----------------------------
Policyholder Policyholder Policyholder
(In millions) Contracts CIGNA Contracts CIGNA Contracts CIGNA
---------------------------------------------------------------------------------------------------------------
Write-downs and
valuation reserves:
Bonds $4 $10 $15 $23 $18 $24
Mortgage loans (7) (1) 15 10 37 16
Real estate 7 2 (5) 1 1 1
---------------------------------------------------------------------------------------------------------------
Total $4 $11 $25 $34 $56 $41
-------------------------======================================================================================
Non-accruals:
Bonds $3 $6 $2 $9 $8 $15
Mortgage loans (2) (2) (5) (1) 1 --
---------------------------------------------------------------------------------------------------------------
Total $1 $4 $(3) $8 $9 $15
-------------------------======================================================================================
CIGNA also recognized losses in connection with Brazilian equity securities,
as discussed on page 11. Additional losses from problem investments are expected
to occur for specific investments in the normal course of business. Assuming no
significant deterioration in economic conditions, including further significant
deterioration in Latin American and Asian economies, CIGNA does not expect
additional non-accruals, write-downs and reserves to materially affect future
results of operations, liquidity or financial condition, or to result in a
significant decline in the aggregate carrying value of its assets.
MARKET RISK OF FINANCIAL INSTRUMENTS
CIGNA's principal assets and liabilities are financial instruments, which
are subject to the market risk of potential losses from adverse changes in
market rates and prices. CIGNA's primary market risk exposures are: interest
rate risk on fixed rate domestic medium-term instruments and, to a lesser
extent, international medium-term and domestic and international short- and
long-term instruments; foreign currency exchange rate risk, in particular the
U.S. dollar to the Brazilian real, Japanese yen, Canadian dollar and certain
European currencies; and equity price risk for domestic and international stocks
and for contract guarantees linked to variable annuity account values with
underlying mutual fund investments. CIGNA uses a variety of techniques to manage
its exposure to market risk, as follows:
o CIGNA generally selects investment assets with characteristics such as
duration, yield, currency and liquidity to reflect the underlying
characteristics of related insurance and contractholder liabilities. CIGNA
selects medium-term, fixed rate investments to support interest-sensitive,
experience-rated and health liabilities subject to liquidity requirements,
shorter- and longer-term investments to support generally shorter- and
longer-term property and casualty and other life and health claim
liabilities, and longer-term fully guaranteed products, primarily annuities.
o CIGNA generally conducts its international businesses through foreign
operating entities that maintain assets and liabilities in local currencies,
substantially limiting exchange rate risk to net assets denominated in
foreign currencies.
o CIGNA generally uses derivative financial instruments to minimize market
risk. Derivative instruments written to minimize market risks of insurance
customers are not material.
See Notes 2(C) and 4(F) to the Financial Statements for additional
information about financial instruments, including derivative financial
instruments.
Caution should be used in evaluating CIGNA's overall market risk from the
information on page 23, since actual results could differ materially because the
information was developed using estimates and assumptions as described on page
23, and because insurance contract liabilities and reinsurance recoverables on
unpaid losses are not included in the hypothetical effects (insurance contract
liabilities represent 62% and 61% of total liabilities and reinsurance
recoverables on unpaid losses represent 13% and 7% of the total assets,
excluding separate accounts at December 31, 1998 and 1997, respectively).
22
The hypothetical effects of changes in market rates or prices on the fair
values of financial instruments, excluding separate account assets and
liabilities (because gains and losses of these accounts generally accrue to the
policyholders), insurance contract liabilities and reinsurance recoverables on
unpaid losses (because insurance contracts are excluded from requirements for
these disclosures of hypothetical effects), would have been as follows as of
December 31:
----------------------------------------------------------------------------
Market scenario for certain Loss in fair value
noninsurance financial instruments 1998 1997
----------------------------------------------------------------------------
100 basis point increase in
interest rate $1.3 billion $1.3 billion
10% strengthening in U.S. dollar
to each foreign currency $495 million $450 million
10% decrease in market prices for
equity exposures $110 million $85 million
----------------------------------------------------------------------------
The decrease in fair values based on an increase in interest rates was
determined by estimating the present value of future cash flows using various
models, primarily duration modeling.
The decrease in fair value based on a strengthening of the U.S. dollar in
comparison with each of the foreign currencies held by CIGNA was estimated as
10% of the U.S. dollar equivalent fair value.
The decrease in fair value of equity securities based on a decrease in the
market prices of all equity securities was estimated as 10% of the fair value.
The decrease in fair value of contract guarantees for minimum annuity benefits
was estimated for amounts expected to be paid assuming a 10% decrease in the
market prices of underlying mutual funds. Equity securities at December 31, 1998
and 1997, included domestic securities of $737 million and $564 million,
respectively, which are primarily managed to reflect the S&P 500, and
international securities of $306 million and $290 million, respectively,
substantially all of which relate to issuers that are based in developed
countries (primarily certain European countries, Japan and Australia). Contract
guarantees are linked to variable annuity account values invested primarily in
domestic stock and bond mutual funds.
YEAR 2000
CIGNA is highly dependent on automated systems and systems applications in
conducting its operations. These systems include information technology (IT)
systems that are used for, among other things, processing claims, billing,
collecting premiums from customers and managing investment activities. If these
systems were unable to function because of failing to be Year 2000 ready,
CIGNA's business operations would be interrupted, which could have a material
adverse effect on CIGNA's results of operations.
CIGNA's Year 2000 efforts include: 1) identifying systems requiring
remediation; 2) assessing what is required to remediate those systems; 3)
remediating systems to be ready for the Year 2000 (by either modifying or
replacing them); and 4) testing systems for Year 2000 readiness, including that
they properly interface with systems of external parties such as customers and
third-party administrators. CIGNA has completed the identification and
assessment phases with respect to its IT systems that are critical to
maintaining operations or the failure of which would result in significant costs
or disruption of operations ("mission critical systems"). As of December 31,
1998, remediation and testing procedures had been completed for 90% of its
mission critical systems. CIGNA expects to substantially complete the
remediation and testing of its mission critical systems by the middle of 1999.
In certain cases, CIGNA will perform additional testing to ensure that these
systems appropriately interact with other systems.
CIGNA's systems also include non-IT systems, such as telephone, facility
management and other systems using embedded chips. The majority of non-IT
systems are believed to be Year 2000 ready and the remaining non-IT systems are
expected to be ready by mid-1999.
CIGNA is using both internal and external resources to meet the timetable
established for completion of its Year 2000 efforts. The after-tax costs of Year
2000 efforts were approximately $100 million in 1998, and are expected to be $50
million in 1999. Approximately 60% of total Year 2000 costs are attributable to
existing systems resources that have been redirected to the Year 2000 efforts.
The remaining amounts represent incremental costs for Year 2000 efforts.
Although certain systems development efforts have been deferred in order to
address Year 2000 issues, CIGNA does not expect that this deferral will have a
significant adverse effect on its results of operations or financial condition.
23
CIGNA has relationships with various third-party entities in the ordinary
course of business. For example, CIGNA receives data from clients; depends on
others, such as third-party administrators and banks, for services; and bears
credit risk on others, such as entities in which it invests. CIGNA has
identified third-party entities critical to its operations, and it is assessing
and attempting to mitigate its risks with respect to the potential failure of
these entities to be Year 2000 ready by, among other things, reviewing, where
possible, their formal Year 2000 plans and obtaining Year 2000 readiness
affirmations from certain third-party entities. The effect, if any, on CIGNA's
results of operations from the failure of these entities (including entities on
which CIGNA bears credit risk) to be Year 2000 ready is not reasonably
estimable.
While CIGNA expects that its Year 2000 efforts will be successful, it has
begun, but not yet completed, a comprehensive analysis of the operational
problems that would be reasonably likely to result from the failure by CIGNA and
certain third parties to complete efforts necessary to achieve Year 2000
compliance on a timely basis. CIGNA has made substantial progress in completing
this analysis and expects to complete it by the end of the second quarter of
1999. CIGNA has historically had security and backup policies and procedures for
safeguarding critical corporate data. It is supplementing these policies by
developing Year 2000 contingency plans to provide for the resumption of
operations in the event of Year 2000 systems failures or the failure of
third-party entities to be Year 2000 ready. These plans are expected to be
completed and tested prior to the fourth quarter of 1999.
The costs of CIGNA's Year 2000 efforts and the dates on which CIGNA believes
it will complete such efforts are based on management's best estimates, which
were derived using numerous assumptions regarding future events, including the
continued availability of certain resources, third-party remediation plans, and
other factors. There can be no assurance that these estimates will prove to be
accurate, and actual results could differ materially from those currently
anticipated. Specific factors that could cause such material differences
include, but are not limited to, the availability and costs of personnel trained
in Year 2000 issues, the ability to identify, assess, remediate and test all
relevant computer codes and embedded technology, the risk that reasonable
testing will not uncover all Year 2000 problems, and similar uncertainties.
Property and casualty indemnity losses for Year 2000 claims and litigation costs
to defend or deny such claims are not reasonably estimable at this time.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Except for historical information provided in this Management's Discussion
and Analysis of Financial Condition and Results of Operations, statements made
throughout this document are forward-looking and contain information about
financial results, economic conditions, trends and known uncertainties. CIGNA
cautions the reader that actual results could differ materially from those
expected by CIGNA, depending on the outcome of certain factors (some of which
are described with the forward-looking statements) including: 1) adverse
catastrophe experience in CIGNA's property and casualty businesses; 2) adverse
property and casualty loss development for events that CIGNA insured in prior
years; 3) an increase in medical costs in CIGNA's health care operations,
including increases in utilization and costs of medical services; 4) heightened
competition, particularly price competition, reducing product margins and
constraining growth in CIGNA's businesses; 5) significant changes in interest
rates; 6) significant stock market declines resulting in payments contingent on
certain variable annuity account values; 7) the effect on CIGNA's international
operations and investments from further significant deterioration in Latin
American and Asian economies; and 8) proposals to change federal corporate
income taxes.
24
CONSOLIDATED STATEMENTS OF INCOME
----------------------------------------------------------------------------------
(In millions, except per share amounts)
----------------------------------------------------------------------------------
For the years ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------
REVENUES
Premiums and fees $16,413 $14,935 $13,916
Net investment income 3,705 4,245 4,333
Other revenues 1,163 691 610
Realized investment gains 156 167 91
--------------------------------------
Total revenues 21,437 20,038 18,950
--------------------------------------
BENEFITS, LOSSES AND EXPENSES
Benefits, losses and settlement expenses 13,861 13,029 12,473
Policy acquisition expenses 954 1,046 1,138
Other operating expenses 4,612 4,313 3,738
--------------------------------------
Total benefits, losses and expenses 19,427 18,388 17,349
--------------------------------------
INCOME BEFORE INCOME TAXES 2,010 1,650 1,601
--------------------------------------
Income taxes (benefits):
Current 841 493 419
Deferred (123) 71 126
--------------------------------------
Total taxes 718 564 545
----------------------------------------------------------------------------------
NET INCOME $1,292 $1,086 $1,056
--------------------------------------------======================================
EARNINGS PER SHARE:
Basic $6.12 $4.93 $4.68
--------------------------------------------======================================
Diluted $6.05 $4.88 $4.64
--------------------------------------------======================================
The Notes to Financial Statements are an integral part of these statements.
25
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------------------------------------------------
(In millions, except per share amounts)
-------------------------------------------------------------------------------------------------------------------------
As of December 31, 1998 1997
-------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturities, at fair value (amortized cost, $30,614; $34,284) $32,634 $36,358
Equity securities, at fair value (cost, $746; $648) 1,043 854
Mortgage loans 9,599 10,859
Policy loans 6,185 7,253
Real estate 733 769
Other long-term investments 205 273
Short-term investments 308 212
----------------------------------------
Total investments 50,707 56,578
Cash and cash equivalents 3,028 2,625
Accrued investment income 769 868
Premiums, accounts and notes receivable 4,469 4,265
Reinsurance recoverables 12,925 6,753
Deferred policy acquisition costs 1,069 1,542
Property and equipment 938 857
Deferred income taxes 1,861 1,788
Other assets 1,543 1,033
Goodwill and other intangibles 2,495 2,542
Separate account assets 34,808 29,348
-------------------------------------------------------------------------------------------------------------------------
Total assets $114,612 $108,199
--------------------------------------------------------------------------------========================================
LIABILITIES
Contractholder deposit funds $30,864 $30,682
Unpaid claims and claim expenses 18,017 17,906
Future policy benefits 12,510 11,976
Unearned premiums 1,990 1,774
----------------------------------------
Total insurance and contractholder liabilities 63,381 62,338
Accounts payable, accrued expenses and other liabilities 6,765 6,562
Current income taxes 56 60
Short-term debt 272 690
Long-term debt 1,431 1,465
Separate account liabilities 34,430 29,152
-------------------------------------------------------------------------------------------------------------------------
Total liabilities 106,335 100,267
-------------------------------------------------------------------------------------------------------------------------
CONTINGENCIES - NOTE 19
SHAREHOLDERS' EQUITY
Common stock (shares issued, 265; 264) 66 66
Additional paid-in capital 2,719 2,655
Net unrealized appreciation, fixed maturities $750 $752
Net unrealized appreciation, equity securities 206 132
Net translation of foreign currencies (114) (126)
---------- ---------
Accumulated other comprehensive income 842 758
Retained earnings 6,746 5,696
Less treasury stock, at cost (2,096) (1,243)
-------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 8,277 7,932
-------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $114,612 $108,199
--------------------------------------------------------------------------------========================================
SHAREHOLDERS' EQUITY PER SHARE $40.25 $36.55
--------------------------------------------------------------------------------========================================
The Notes to Financial Statements are an integral part of these statements.
26
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND CHANGES IN
SHAREHOLDERS' EQUITY
------------------------------------------------------------------------------------------------------------------------------------
(In millions)
------------------------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 1998 1997 1996
------------------------------------------------------------------------------------------------------------------------------------
Compre- Share- Compre- Share- Compre- Share-
hensive holders' hensive holders' hensive holders'
Income Equity Income Equity Income Equity
------------------------------------------------------------------------------------------------------------------------------------
Common stock $66 $66 $66
------------------------------------------------------------------------------------------------------------------------------------
Additional paid-in capital, beginning of year 2,655 2,594 2,558
Issuance of common stock for employee benefits plans 64 61 36
------------------------------------------------------------------------------------------------------------------------------------
Additional paid-in capital, end of year 2,719 2,655 2,594
------------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income,
beginning of year 758 582 1,071
Net unrealized appreciation (depreciation), fixed
maturities $(2) (2) $213 213 $(486) (486)
Net unrealized appreciation, equity securities 74 74 44 44 15 15
----------- ----------- -----------
Net unrealized appreciation (depreciation) on
investments 72 257 (471)
Net translation of foreign currencies 12 12 (81) (81) (18) (18)
----------- ----------- -----------
Other comprehensive income (loss) 84 176 (489)
------------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income, end of year 842 758 582
------------------------------------------------------------------------------------------------------------------------------------
Retained earnings, beginning of year 5,696 4,855 4,041
Net income 1,292 1,292 1,086 1,086 1,056 1,056
Common dividends declared (242) (245) (242)
------------------------------------------------------------------------------------------------------------------------------------
Retained earnings, end of year 6,746 5,696 4,855
------------------------------------------------------------------------------------------------------------------------------------
Treasury stock, beginning of year (1,243) (889) (578)
Repurchase of common stock (822) (340) (298)
Other treasury stock transactions, net (31) (14) (13)
------------------------------------------------------------------------------------------------------------------------------------
Treasury stock, end of year (2,096) (1,243) (889)
------------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME AND
SHAREHOLDERS' EQUITY $1,376 $8,277 $1,262 $7,932 $567 $7,208
-------------------------------------------------------=============================================================================
The Notes to Financial Statements are an integral part of these statements.
27
CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------------------------------------------------------------------------
(In millions)
----------------------------------------------------------------------------------------------------------------
For the years ended December 31, 1998 1997 1996
----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,292 $1,086 $1,056
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Insurance liabilities 530 (665) (351)
Reinsurance recoverables (239) 565 (140)
Premiums, accounts and notes receivable (248) 85 23
Deferred policy acquisition costs (126) (217) (89)
Accounts payable, accrued expenses, other liabilities
and current income taxes 31 328 23
Deferred income taxes (123) 71 126
Realized investment gains (156) (167) (91)
Depreciation and goodwill amortization 318 255 227
Gain on sale of businesses (418) -- (18)
Other, net (234) (110) (66)
---------------------------------------
Net cash provided by operating activities 627 1,231 700
---------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from investments sold:
Fixed maturities 6,776 5,902 6,076
Equity securities 439 304 368
Mortgage loans 1,278 861 676
Other (primarily short-term investments) 2,692 4,305 4,222
Investment maturities and repayments:
Fixed maturities 4,015 3,588 3,867
Mortgage loans 470 634 672
Investments purchased:
Fixed maturities (9,567) (10,309) (9,842)
Equity securities (466) (383) (348)
Mortgage loans (1,851) (1,527) (1,375)
Other (primarily short-term investments) (3,013) (2,731) (4,659)
Sale of individual life insurance and annuity business, net proceeds 1,296 -- --
Healthsource acquisition, net cash used -- (1,305) --
Other acquisitions and dispositions, net cash provided (used) (336) (111) 65
Other, net (441) (194) (209)
---------------------------------------
Net cash provided by (used in) investing activities 1,292 (966) (487)
---------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to contractholder deposit funds 7,064 7,622 7,261
Withdrawals and benefit payments from contractholder deposit funds (7,097) (7,043) (7,168)
Net change in short-term debt (348) 358 (6)
Issuance of long-term debt -- 600 --
Repayment of long-term debt (108) (318) (158)
Repurchase of common stock (833) (335) (292)
Issuance of common stock 26 19 12
Common dividends paid (243) (245) (242)
---------------------------------------
Net cash provided by (used in) financing activities (1,539) 658 (593)
---------------------------------------
Effect of foreign currency rate changes on cash and cash equivalents 23 (58) (22)
----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 403 865 (402)
Cash and cash equivalents, beginning of year 2,625 1,760 2,162
----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $3,028 $2,625 $1,760
-------------------------------------------------------------------------=======================================
Supplemental Disclosure of Cash Information:
Income taxes paid, net of refunds $843 $620 $360
Interest paid $128 $123 $106
----------------------------------------------------------------------------------------------------------------
The Notes to Financial Statements are an integral part of these statements.
28
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- DESCRIPTION OF BUSINESS
CIGNA Corporation's subsidiaries provide group health and life insurance,
managed care products and related services, retirement and investment products
and services, and property and casualty insurance throughout the United States
and in many locations worldwide, as well as individual life and health insurance
and annuity products in selected international locations.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A) Basis of Presentation: The consolidated financial statements include the
accounts of CIGNA Corporation and all significant subsidiaries (CIGNA). These
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles, and reflect management's estimates and
assumptions, such as those regarding medical costs and interest rates, that
affect the recorded amounts. Significant estimates used in determining insurance
and contractholder liabilities and related reinsurance recoverables, and
valuation allowances for investment assets and deferred tax assets, are
discussed throughout the Notes to Financial Statements.
All share and per share data presented have been restated to reflect the
three-for-one stock split approved by shareholders on April 22, 1998 (see Note
7). Certain reclassifications have been made to prior years' amounts to
conform with the 1998 presentation.
B) Recent Accounting Pronouncements: CIGNA adopted Statement of Financial
Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an
Enterprise and Related Information," as of December 31, 1998. SFAS No. 131
changes the way segments are structured and requires additional segment
disclosures. Prior period information has been restated based on the new
requirements. See Note 16 for additional information.
In 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that derivatives be reported on the balance sheet at fair value.
Changes in fair value are recognized in net income or, for derivatives that are
hedging market risk related to future cash flows, in the accumulated other
comprehensive income section of shareholders' equity. Implementation is required
by the first quarter of 2000, with the cumulative effect of adoption reflected
in net income and accumulated other comprehensive income, as appropriate. CIGNA
has not determined the effect or timing of implementation of this pronouncement.
The American Institute of Certified Public Accountants (AICPA) issued
Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments," in 1997. SOP 97-3 provides guidance on the
recognition and measurement of liabilities for guaranty fund and other
insurance-related assessments. Implementation is required by the first quarter
of 1999, with the cumulative effect of adopting the SOP reflected in net income
in the year of adoption. The estimated reduction of net income from
implementation of this pronouncement is expected to be approximately $95
million, and is primarily related to the property and casualty operations.
In 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 specifies the types
of costs that must be capitalized and amortized over the software's expected
useful life and the types of costs which must be immediately recognized as
expense. Implementation of this pronouncement is required by the first quarter
of 1999 and is not expected to have a material effect on results of operations,
liquidity or financial condition.
In 1998, the AICPA issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." SOP
98-7 provides guidance on the deposit method of accounting for insurance and
reinsurance contracts that do not transfer insurance risk, except for
long-duration life and health contracts. Implementation is required by the first
quarter of 2000, with the cumulative effect of adopting the SOP reflected in net
income in the year of adoption. CIGNA has not determined the effect or timing of
implementation of this pronouncement.
C) Financial Instruments: In the normal course of business, CIGNA enters
into transactions involving various types of financial instruments, including
investments such as fixed maturities and equity securities, debt, and off-
balance-sheet financial instruments such as investment and loan commitments and
financial guarantees. These instruments are subject to risk of loss due to
interest rate and market fluctuations and most have credit risk. CIGNA evaluates
and monitors each financial instrument individually and, where appropriate, uses
certain derivative instruments or obtains collateral or other forms of security
to minimize risk of loss.
Financial instruments that are subject to fair value disclosure requirements
(insurance contracts, real estate, goodwill and taxes are excluded) are carried
in the financial statements at amounts that approximate fair value, except for
mortgage loans, contractholder deposit funds (non-insurance products) and
long-term debt. For these financial instruments, the fair value was not
materially different from the carrying amount as of December 31, 1998 and 1997.
Fair values of off-balance-sheet financial instruments as of December 31, 1998
and 1997 were not material.
29
Fair values for financial instruments are estimates that, in many cases, may
differ significantly from the amounts that could be realized upon immediate
liquidation. In cases where market prices are not available, estimates of fair
value are based on discounted cash flow analyses which utilize current interest
rates for similar financial instruments with comparable terms and credit
quality. The fair value of liabilities for contractholder deposit funds was
estimated using the amount payable on demand and, for those not payable on
demand, discounted cash flow analyses.
D) Investments: Investments in fixed maturities, which are classified as
available-for-sale and carried at fair value, include bonds; asset-backed
securities, including collateralized mortgage obligations (CMOs); and redeemable
preferred stocks. Fixed maturities are considered impaired and written down to
fair value when a decline in value is considered to be other than temporary.
Mortgage loans are carried principally at unpaid principal balances, net of
valuation reserves. Mortgage loans are considered impaired when it is probable
that CIGNA will not collect all amounts according to the contractual terms of
the loan agreement. If impaired, a valuation reserve is utilized to record any
change in the fair value of the underlying collateral below the carrying value
of the mortgage loan.
Fixed maturities and mortgage loans that are delinquent or restructured to
modify basic financial terms, typically to reduce the interest rate and, in
certain cases, extend the term, are placed on non-accrual status. Net investment
income on such investments is recognized only when payment is received.
Real estate investments are either held for the production of income or held
for sale. Real estate investments held for the production of income are carried
at depreciated cost less any write-downs to fair value. Depreciation is
generally calculated using the straight-line method based on the estimated
useful lives of these assets.
Real estate investments held for sale are generally those which are acquired
through the foreclosure of mortgage loans. CIGNA's policy is to rehabilitate,
re-lease and sell foreclosed properties, which generally takes two to four years
or less if circumstances indicate that an immediate sale is in the best
interests of CIGNA or policyholders. At the time of foreclosure, properties are
valued at fair value less estimated costs to sell and are reclassified from
mortgage loans to real estate held for sale. Subsequent to foreclosure, these
investments are carried at the lower of cost or current fair value less
estimated costs to sell and are no longer depreciated. Adjustments to the
carrying value as a result of changes in fair value subsequent to foreclosure
are recorded as valuation reserves. CIGNA considers several methods in
determining fair value for real estate, with emphasis placed on the use of
discounted cash flow analyses and, in some cases, the use of third-party
appraisals.
Equity securities and short-term investments are classified as
available-for-sale. Equity securities, which include common and non-redeemable
preferred stocks, are carried at fair value. Short-term investments are carried
at fair value, which approximates cost.
Policy loans generally are carried at unpaid principal balances.
Realized investment gains and losses result from sales, investment asset
write-downs and changes in valuation reserves. Realized investment gains and
losses do not include amounts attributable to experience-rated pension
policyholders' contracts and participating life policies (policyholder share).
Realized investment gains and losses are based upon specific identification of
the investment assets.
Unrealized investment gains and losses for investments carried at fair value
are included in shareholders' equity net of policyholder-related amounts and
deferred income taxes.
See Note 4(F) for a discussion of CIGNA's accounting policies for derivative
financial instruments.
E) Cash and Cash Equivalents: Short-term investments with a maturity of
three months or less at the time of purchase are reported as cash equivalents.
F) Reinsurance Recoverables: Reinsurance
recoverables are estimates of amounts to be received from
reinsurers. Allowances are established for amounts
estimated to be uncollectible.
G) Deferred Policy Acquisition Costs: Acquisition costs consist of
commissions, premium taxes and other costs, which vary with, and are primarily
related to, the production of revenues. Acquisition costs for:
o property and casualty products are deferred and amortized over the terms of
the insurance policies;
o universal life products and contractholder deposit funds are deferred and
amortized in proportion to the present value of total estimated gross
profits over the expected lives of the contracts;
o annuity and other individual life insurance products are deferred and
amortized, generally in proportion to the ratio of annual revenue to the
estimated total revenues over the contract periods; and
o other products are expensed as incurred.
Deferred policy acquisition costs are reviewed to determine if they are
recoverable from future income, including investment income. If such costs are
estimated to be unrecoverable, they are expensed unless such costs are estimated
to be unrecoverable as a result of treating unrealized investment gains and
losses as though they had been realized. If so, a deferred acquisition cost
valuation allowance may be established or adjusted, with a comparable offset in
net unrealized appreciation (depreciation).
30
H) Property and Equipment: Property and equipment are carried at cost less
accumulated depreciation. When applicable, cost includes interest and real
estate taxes incurred during construction and other construction-related costs.
Depreciation is calculated principally on the straight-line method based on the
estimated useful lives of the assets. Accumulated depreciation was $1.3 billion
and $1.2 billion at December 31, 1998 and 1997, respectively.
I) Other Assets: Other assets consists of various insurance-related assets,
principally ceded unearned premiums and reinsurance deposits, and investments
accounted for under the equity method.
J) Goodwill and Other Intangibles: Goodwill represents the excess of the
cost of businesses acquired over the fair value of their net assets. Other
intangible assets primarily represent purchased customer lists and provider
contracts. Goodwill and other intangibles are amortized over periods ranging
from five to 40 years. Goodwill and other intangibles are written down when not
recoverable based on analysis of historical and estimated future income or
undiscounted estimated cash flows of the related businesses. Amortization
periods are revised if it is estimated that the remaining period of benefit of
the goodwill and other intangibles has changed. Accumulated amortization was
$1.2 billion and $1.0 billion at December 31, 1998 and 1997, respectively.
K) Separate Accounts: Separate account assets and liabilities are carried at
market value and represent policyholder funds maintained in accounts having
specific investment objectives. The investment income, gains and losses of these
accounts generally accrue to the policyholders and, therefore, are not included
in CIGNA's revenues and expenses.
L) Contractholder Deposit Funds: Liabilities for contractholder deposit
funds consist of deposits received from customers and investment earnings on
their fund balances, less administrative charges and, for universal life fund
balances, mortality charges.
M) Unpaid Claims and Claim Expenses: Liabilities for unpaid claims and claim
expenses are estimates of payments to be made on reported claims and incurred
but not reported claims on property, casualty, health and dental coverages.
Estimated amounts of salvage and subrogation are deducted from the liability for
unpaid claims.
N) Future Policy Benefits: Future policy benefits are liabilities for life,
health and annuity products. Such liabilities are established in amounts
adequate to meet the estimated future obligations of policies in force. These
liabilities are computed using premium assumptions for group annuity policies
and the net level premium method for individual life policies, and are based
upon estimates as to future investment yield, mortality and withdrawals that
include provisions for adverse deviation. Future policy benefits for individual
life insurance and annuity policies are computed using interest rates ranging
from approximately 2.0% to 10.8%, generally graded down from one to 20 years.
Mortality, morbidity and withdrawal assumptions are based on either CIGNA's own
experience or various actuarial tables.
O) Unearned Premiums: Premiums for property and casualty and group life,
accident and health insurance are reported as earned on a pro-rata basis over
the contract period. The unexpired portion of these premiums is recorded as
unearned premiums.
P) Other Liabilities: Other liabilities consists principally of
postretirement and postemployment benefits and various insurance-related
liabilities, including amounts related to reinsurance contracts and guaranty
fund assessments that can be reasonably estimated.
Q) Translation of Foreign Currencies: Foreign operations primarily utilize
the local currencies as their functional currencies, and assets and liabilities
are translated at the rates of exchange as of the balance sheet date. The
translation gain or loss on such functional currencies, net of applicable taxes,
is generally reflected in shareholders' equity. Revenues and expenses are
translated at average rates of exchange prevailing during the year.
R) Premiums and Fees, Revenues and Related Expenses: Premiums for property
and casualty insurance, group life, accident and health insurance, and prepaid
health and dental coverages are recognized as revenue on a pro-rata basis over
their contract periods. Benefits, losses and settlement expenses are recognized
when incurred.
Revenues for investment-related products consist of net investment income
and contract fees assessed against the fund balances during the period. Net
investment income represents investment income on assets supporting
investment-related products and is recognized as earned. Contract fees are based
upon related administrative expenses and are assessed ratably over the contract
year. Benefit expenses for investment-related products primarily consist of
amounts credited in accordance with contract provisions.
Premiums for individual life insurance as well as individual and group
annuity products, excluding universal life and investment-related products, are
recognized as revenue when due. Benefits, losses and settlement expenses are
matched with premiums.
31
Revenues for universal life products consist of net investment income and
mortality, administration and surrender fees assessed against the fund balances
during the period. Net investment income represents investment income on assets
supporting universal life products and is recognized as earned. Fees for
mortality are recognized ratably over the policy year. Administration fees are
recognized as services are provided, and surrender charges are recognized as
earned. Benefit expenses for universal life products consist of benefit claims
in excess of fund balances, which are recognized when claims are filed, and
amounts credited in accordance with contract provisions.
S) Participating Business: Certain life insurance policies contain dividend
payment provisions that enable the policyholder to participate in a portion of
the earnings of the life insurance subsidiaries of CIGNA. The participating
insurance in force accounted for approximately 6% of total life insurance in
force at December 31, 1998, 1997 and 1996.
T) Income Taxes: CIGNA and its domestic subsidiaries file a consolidated
United States federal income tax return; foreign subsidiaries file tax returns
in accordance with applicable foreign regulations. Included in tax returns for
domestic subsidiaries are the taxable income and credits for taxes paid for
certain foreign subsidiaries. Entities included within the consolidated group
are segregated into either a life insurance or non-life insurance company
subgroup. The consolidation of these subgroups is subject to certain statutory
restrictions on the percentage of eligible non-life tax losses that can be
applied to offset life company taxable income.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes. See
Note 9 for additional information.
NOTE 3 -- ACQUISITIONS AND DISPOSITIONS
In January 1999, CIGNA entered into an agreement to sell its domestic and
international property and casualty businesses (which comprise the Property and
Casualty segment described in Note 16) to ACE Limited for cash proceeds of $3.45
billion. The sale, which is subject to U.S. and international regulatory
approval and other conditions to closing, is expected to be completed by mid-
1999. Net assets of the businesses to be sold were approximately $2.3 billion as
of December 31, 1998. The determination of the gain on sale will be affected by
changes to net assets through closing for results of operations and dividends
from the businesses to be sold, as well as transaction costs and other
adjustments.
As of January 1, 1998, CIGNA sold its individual life insurance and annuity
business for cash proceeds of $1.4 billion. The sale resulted in an after-tax
gain of $773 million of which $202 million was recognized upon closing of the
sale. Since the principal agreement to sell this business is in the form of an
indemnity reinsurance arrangement, the remaining $571 million of the gain was
deferred and is being recognized at the rate that earnings from the business
sold would have been expected to emerge, primarily over fifteen years on a
declining basis. CIGNA recognized $66 million of the deferred gain in 1998.
Revenues for this business were $972 million and $926 million for the years
ended December 31, 1997 and 1996, respectively, and net income was $102 million
and $67 million for the same periods. Also, as part of the transaction, CIGNA
recorded a reinsurance recoverable from the purchaser of $5.8 billion for
insurance liabilities retained, and transferred invested assets of $5.4 billion
along with other assets and liabilities associated with the business. The sales
agreement provides for the possibility of certain adjustments; however, any
future adjustments are not expected to be material to results of operations,
liquidity or financial condition.
CIGNA acquired the outstanding common stock of Healthsource, Inc.
(Healthsource) on June 25, 1997. The cost of the acquisition was $1.7 billion,
reflecting the purchase of Healthsource common stock for $1.4 billion and the
retirement of Healthsource debt of $250 million. The acquisition was accounted
for as a purchase, and was financed through the issuance of long-term debt of
$600 million and a combination of internally generated funds and short-term
debt. The results of operations of Healthsource are included in the accompanying
consolidated financial statements from the date of acquisition. Healthsource
revenues that are not included in CIGNA's results of operations were $971
million and $1.7 billion for the first six months of 1997 and for the full year
1996, respectively. The pro forma effect on CIGNA's net income was not material.
Goodwill and other intangible assets associated with the Healthsource
acquisition were $1.5 billion, including $24 million recorded in the fourth
quarter of 1997 for severance of Healthsource employees, vacated Healthsource
lease space and adjustments to Healthsource net assets to conform to CIGNA's
accounting policies. As of December 31, 1998, approximately $8 million of
severance had been paid to approximately 530 employees. Goodwill and other
intangible assets are being amortized on a straight-line basis over periods
ranging from eight to 40 years.
32
CIGNA has invested in certain entities in connection with the expansion
(principally in emerging markets) of its international operations for
approximately $350 million in 1998 and $125 million in 1997. Most of these
investments relate to expansion of CIGNA's health care operations in Brazil.
They include the acquisition of a managed health care business, which is being
consolidated, and investments in another health care operation, which are being
accounted for under the equity method. These investments also included equity
securities of a Brazilian financial services company. In 1998, CIGNA recognized
realized investment losses of $31 million after-tax on the Brazilian equity
securities and losses of approximately $17 million after-tax from Brazilian
health care operations. The effect on CIGNA's results of operations in 1997 and
1996 from this expansion of international operations was not material.
CIGNA had other acquisitions and dispositions during 1998, 1997 and 1996,
the effects of which were not material to the financial statements.
NOTE 4 -- INVESTMENTS
A) Fixed Maturities: Fixed maturities are net of cumulative write-downs of
$33 million and $43 million, including policyholder share, as of December 31,
1998 and 1997, respectively.
The amortized cost and fair value by contractual maturity periods for fixed
maturities, including policyholder share, as of December 31, 1998 were as
follows:
-----------------------------------------------------------------
Amortized Fair
(In millions) Cost Value
-----------------------------------------------------------------
Due in one year or less $1,898 $1,930
Due after one year through five years 8,120 8,447
Due after five years through ten years 7,952 8,367
Due after ten years 4,854 5,822
Asset-backed securities 7,790 8,068
----------------------------------------------------------------
Total $30,614 $32,634
---------------------------------------=========================
Actual maturities could differ from contractual maturities because issuers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Also, CIGNA may extend maturities in some cases.
Gross unrealized appreciation (depreciation) for fixed maturities, including
policyholder share, by type of issuer was as follows:
--------------------------------------------------------------------------
December 31, 1998
--------------------------------------------------------------------------
Unrealized Unrealized
Amortized Apprec- Deprec- Fair
(In millions) Cost iation iation Value
--------------------------------------------------------------------------
Federal government
bonds $972 $467 $(1) $1,438
State and local
government bonds 2,212 175 (1) 2,386
Foreign government
bonds 2,707 238 (78) 2,867
Corporate securities 16,933 1,178 (236) 17,875
Asset-backed securities 7,790 320 (42) 8,068
--------------------------------------------------------------------------
Total $30,614 $2,378 $(358) $32,634
--------------------------================================================
December 31, 1997
--------------------------------------------------------------------------
Federal government
bonds $1,816 $336 $-- $2,152
State and local
government bonds 1,835 190 (2) 2,023
Foreign government
bonds 2,507 178 (45) 2,640
Corporate securities 19,532 1,185 (165) 20,552
Asset-backed securities 8,594 418 (21) 8,991
--------------------------------------------------------------------------
Total $34,284 $2,307 $(233) $36,358
--------------------------================================================
Asset-backed securities include investments in CMOs as of December 31, 1998
of $2.9 billion carried at fair value (amortized cost, $2.8 billion), compared
with $3.5 billion carried at fair value (amortized cost, $3.4 billion) as of
December 31, 1997. Certain of these securities are backed by Aaa/AAA-rated
government agencies. All other CMO securities have high quality ratings through
use of credit enhancements provided by subordinated securities or mortgage
insurance from Aaa/AAA-rated insurance companies. CMO holdings are concentrated
in securities with limited prepayment, extension and default risk, such as
planned amortization class bonds. CIGNA's investments in interest-only and
principal-only CMOs, which are subject to interest rate risk due to accelerated
prepayments, represented less than 1% of total CMO investments at December 31,
1998 and 1997, respectively.
At December 31, 1998, contractual fixed maturity investment commitments were
$39 million. The majority of investment commitments are for the purchase of
investment grade fixed maturities, bearing interest at a fixed market rate, and
require no collateral. These commitments are diversified by issuer and maturity
date, and it is estimated that approximately 65% will be disbursed in 1999.
33
B) Mortgage Loans and Real Estate: CIGNA's mortgage loans and real estate
investments are diversified by property type and location and, for mortgage
loans, by borrower. Mortgage loans are collateralized by the related property
and generally are less than 75% of the property's value at the time the original
loan is made.
At December 31, the carrying values of mortgage loans and real estate
investments, including policyholder share, were as follows:
-------------------------------------------------------------------
(In millions) 1998 1997
-------------------------------------------------------------------
Mortgage loans $9,599 $10,859
--------------------------
Real estate:
Held for sale 343 355
Held for the production of income 390 414
--------------------------
Total real estate 733 769
-------------------------------------------------------------------
Total $10,332 $11,628
----------------------------------------===========================
At December 31, mortgage loans and real estate investments comprised the
following property types and geographic regions:
----------------------------------------------------------------
(In millions) 1998 1997
----------------------------------------------------------------
Property type:
Retail facilities $3,412 $4,579
Office buildings 4,049 4,191
Apartment buildings 1,434 1,460
Industrial 692 601
Hotels 468 513
Other 277 284
----------------------------------------------------------------
Total $10,332 $11,628
-------------------------------------===========================
Geographic region:
Central $3,279 $3,744
Pacific 2,273 2,473
Middle Atlantic 1,590 1,918
South Atlantic 1,516 1,618
New England 1,065 1,180
Other 609 695
----------------------------------------------------------------
Total $10,332 $11,628
-------------------------------------===========================
Mortgage Loans
At December 31, 1998, scheduled mortgage loan maturities were as follows:
1999 -- $924 million; 2000 -- $1.0 billion; 2001 -- $903 million; 2002 -- $1.2
billion; 2003 -- $1.7 billion; and $3.9 billion thereafter. Actual maturities
could differ from contractual maturities because borrowers may have the right to
prepay obligations, with or without prepayment penalties; the maturity date may
be extended; and loans may be refinanced. During 1998 and 1997, CIGNA refinanced
at current market rates approximately $135 million and $139 million,
respectively, of its mortgage loans relating to borrowers that were unable to
obtain alternative financing.
At December 31, 1998, contractual commitments to extend credit under
commercial mortgage loan agreements amounted to approximately $542 million, most
of which were at a fixed market rate of interest. These commitments expire
within three months, and are diversified by property type and geographic region.
At December 31, 1998, CIGNA's impaired mortgage loans were $159 million,
including $26 million before valuation reserves totaling $6 million, and $133
million, which had no valuation reserves. At December 31, 1997, CIGNA's impaired
mortgage loans were $393 million, including $170 million before valuation
reserves totaling $50 million, and $223 million, which had no valuation
reserves.
During the year ended December 31, changes in reserves for impaired mortgage
loans, including policyholder share, were as follows:
--------------------------------------------------------------------
(In millions) 1998 1997
--------------------------------------------------------------------
Reserve balance -- January 1 $50 $101
Transfers to foreclosed real estate (26) (30)
Charge-offs upon sales (9) (52)
Net change in valuation reserves (9) 31
--------------------------------------------------------------------
Reserve balance -- December 31 $6 $50
------------------------------------------==========================
During 1998 and 1997, impaired mortgage loans, before valuation reserves,
averaged approximately $294 million and $624 million, respectively, and interest
income recorded and cash received on these loans were approximately $12 million
and $35 million in each year.
Real Estate
During 1998, 1997 and 1996, non-cash investing activities included real
estate acquired through foreclosure of mortgage loans, which totaled $37
million, $85 million and $114 million, respectively.
Valuation reserves and cumulative write-downs related to real estate,
including policyholder share, were $213 million and $206 million as of December
31, 1998 and 1997, respectively.
Net income for 1998 and 1997 included net investment income of $9 million
and $10 million, respectively, for real estate held for sale. Write-downs upon
foreclosure and changes in valuation reserves were not material for 1998 and
1997.
C) Short-Term Investments and Cash Equivalents: At December 31, 1998 and
1997, short-term investments and cash equivalents, in the aggregate, primarily
included debt securities, principally federal government bonds of $144 million
and $682 million, respectively, and corporate securities of $1.8 billion and
$985 million, respectively.
34
D) Net Unrealized Appreciation (Depreciation) of Investments: Unrealized
appreciation (depreciation) for investments carried at fair value as of December
31 were as follows:
----------------------------------------------------------------
(In millions) 1998 1997
----------------------------------------------------------------
Unrealized appreciation:
Fixed maturities $2,378 $2,307
Equity securities 349 284
----------------------------
2,727 2,591
----------------------------
Unrealized depreciation:
Fixed maturities (358) (233)
Equity securities (52) (78)
----------------------------
(410) (311)
----------------------------
2,317 2,280
Less policyholder-related
amounts 871 946
----------------------------
Shareholder net unrealized
appreciation 1,446 1,334
Less deferred income taxes 490 450
----------------------------------------------------------------
Net unrealized appreciation $956 $884
------------------------------------============================
The components of net unrealized appreciation (depreciation) on investments
for the year ended December 31 were as follows:
----------------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------------
Unrealized appreciation
(depreciation) on investments
held, net of taxes of $129,
$176 and $(228), respectively $237 $319 $(431)
Less gains realized in net
income, net of taxes of $89,
$33 and $21, respectively 165 62 40
----------------------------------------------------------------------------
Net unrealized appreciation
(depreciation) $72 $257 $(471)
--------------------------------------=======================================
E) Non-Income Producing Investments: At December 31, the carrying values of
investments, including policyholder share, that were non-income producing during
the preceding 12 months were as follows:
---------------------------------------------------------
(In millions) 1998 1997
---------------------------------------------------------
Fixed maturities $27 $34
Mortgage loans 2 --
Real estate 68 141
Other long-term investments 6 8
---------------------------------------------------------
Total $103 $183
---------------------------------========================
F) Derivative Financial Instruments: CIGNA's investment strategy is to
manage the characteristics of investment assets, such as duration, yield,
currency and liquidity, to reflect the underlying characteristics of the related
insurance and contractholder liabilities, which vary among CIGNA's principal
product lines. In connection with this investment strategy, CIGNA's use of
derivative instruments, including interest rate and currency swaps, purchased
options and futures contracts, is generally limited to hedging applications to
minimize market risk.
Hedge accounting treatment requires a probability of high correlation
between the changes in the market value or cash flows of the derivatives and the
hedged assets or liabilities. Under hedge accounting, the changes in market
value or cash flows of the derivatives and the hedged assets or liabilities are
recognized in net income in the same period. If CIGNA's use of derivatives does
not qualify for hedge accounting treatment, the derivative is recorded at fair
value and changes in its fair value are recognized in net income without
considering changes in the hedged asset or liability.
CIGNA routinely monitors, by individual counterparty, exposure to credit
risk associated with swap and option contracts and diversifies the portfolio
among approved dealers of high credit quality. Futures contracts are
exchange-traded and, therefore, credit risk is limited since the exchange
assumes the obligations. CIGNA manages legal risks by following industry
standardized documentation procedures and by monitoring legal developments.
Underlying contract, notional or principal amounts associated with
derivatives at December 31 were as follows:
=====================================================
(In millions) 1998 1997
-----------------------------------------------------
Interest rate swaps $182 $316
Currency swaps $213 $276
Purchased options $897 $833
Written options $1,105 $--
Futures $249 $80
-----------------------------------------------------
Under interest rate swaps, CIGNA agrees with other parties to periodically
exchange the difference between variable rate and fixed rate asset cash flows to
provide stable returns for related liabilities. CIGNA uses currency swaps
(primarily Canadian dollars, pounds sterling and Swiss francs) to match the
currency of investments to that of the associated liabilities. Under currency
swaps, the parties exchange principal and interest amounts in two relevant
currencies using agreed-upon exchange amounts.
The net interest cash flows from interest rate and currency swaps are
recognized currently as an adjustment to net investment income, and the fair
value of these swaps is reported as an adjustment to the related investments.
35
Using purchased options to reduce the effect of changes in interest rates or
equity indexes on liabilities, CIGNA pays an up-front fee to receive cash flows
from third parties when interest rates or equity indexes vary from specified
levels. Purchased options that qualify for hedge accounting are recorded
consistent with the related liabilities, at amortized cost plus adjustments
based on current equity indexes, and income is reported as an adjustment to
benefit expense. Purchased options that qualify for hedge accounting are
reported in other assets, and fees paid are amortized to benefit expense over
their contractual periods. Purchased options with underlying notional amounts of
$82 million at December 31, 1997 that are designated as ▇▇▇▇▇▇, but do not
qualify for hedge accounting, are reported in other long-term investments at
fair value with changes in fair value recognized as realized investment gains
and losses. There were no such options at December 31, 1998.
CIGNA also writes reinsurance contracts that are accounted for as written
options. CIGNA receives fees to pay for specified unfavorable changes in
variable annuity account values based on underlying mutual fund investments when
account holders elect to receive periodic income payments. These written
options, along with options purchased to minimize the risk assumed, are reported
at fair value in other liabilities and other assets, respectively. Changes in
fair value are recognized in other revenues, or other operating expenses if
there is a net loss. Fair values of written and related purchased options during
1998 and as of December 31, 1998 were not material.
Interest rate futures are used to temporarily hedge against the changes in
market values of bonds and mortgage loans to be purchased or sold. Under futures
contracts, changes in the contract values are settled in cash daily with the
exchange on which the instrument is traded. These changes in contract values are
deferred and recorded as adjustments to the carrying value of the related bond
or mortgage loan. Deferred gains and losses are amortized into net investment
income over the life of the investments purchased or are recognized in full as
realized investment gains and losses if investments are sold. Gains and losses
on futures contracts deferred in anticipation of investment purchases were
immaterial at December 31, 1998 and 1997.
The effects of interest rate and currency swaps, purchased and written
options and futures on the components of net income for 1998, 1997 and 1996 were
not material.
As of December 31, 1998 and 1997, CIGNA's variable interest rate investments
consisted of approximately $788 million and $828 million of fixed maturities,
respectively. As of December 31, 1998 and 1997, CIGNA's fixed interest rate
investments consisted of $31.8 billion and $35.6 billion, respectively, of fixed
maturities, and $9.6 billion and $10.9 billion, respectively, of mortgage loans.
G) Other: As of December 31, 1998 and 1997, CIGNA had no concentration of
investments in a single investee exceeding 10% of shareholders' equity.
NOTE 5 -- INVESTMENT INCOME AND GAINS AND LOSSES
A) Net Investment Income: The components of net investment income, including
policyholder share, for the year ended December 31 were as follows:
--------------------------------------------------------------------------------
(In millions) 1998 1997 1996
--------------------------------------------------------------------------------
Fixed maturities $2,268 $2,566 $2,613
Equity securities 17 20 20
Mortgage loans 800 948 982
Policy loans 466 542 561
Real estate 159 213 223
Other long-term investments 45 48 65
Short-term investments 130 141 110
-------------------------------------------
3,885 4,478 4,574
Less investment expenses 180 233 241
--------------------------------------------------------------------------------
Net investment income $3,705 $4,245 $4,333
-------------------------------------===========================================
Net investment income attributable to policyholder contracts, which is
included in CIGNA's revenues and is primarily offset by amounts included in
benefits, losses and settlement expenses, was approximately $1.6 billion for
1998, compared with $1.7 billion for 1997 and $1.8 billion for 1996. Net
investment income for separate accounts, which is not reflected in CIGNA's
revenues, was $1.5 billion, $1.4 billion and $1.1 billion for 1998, 1997 and
1996, respectively.
As of December 31, 1998, fixed maturities and mortgage loans on non-accrual
status, including policyholder share, were $122 million and $98 million,
including restructured investments of $96 million for both fixed maturities and
mortgage loans. As of December 31, 1997, fixed maturities and mortgage loans on
non-accrual status, including policyholder share, were $141 million and $176
million, including restructured investments of $90 million and $137 million,
respectively. If interest on these investments had been recognized in accordance
with their original terms, net income would have been increased by $4 million,
$8 million and $15 million in 1998, 1997 and 1996, respectively.
36
B) Realized Investment Gains and Losses: Realized gains (losses) on
investments, excluding policyholder share, for the year ended December 31 were
as follows:
------------------------------------------------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------------------------------------
Fixed maturities $98 $57 $37
Equity securities (2) 38 24
Mortgage loans 15 (15) (23)
Real estate 13 73 29
Other 32 14 24
-----------------------------------------
156 167 91
Less income taxes 54 52 37
------------------------------------------------------------------------------
Net realized investment gains $102 $115 $54
-------------------------------------=========================================
Realized investment gains and losses include impairments in the value of
investments, net of recoveries, of $49 million, $33 million and $51 million in
1998, 1997 and 1996, respectively.
Realized investment gains for separate accounts, which are not reflected in
CIGNA's revenues, were $493 million, $484 million and $305 million for 1998,
1997 and 1996, respectively. Realized investment gains attributable to
policyholder contracts, which also are not reflected in CIGNA's revenues, were
$98 million, $45 million and $82 million for 1998, 1997 and 1996, respectively.
Sales of available-for-sale fixed maturities and equity securities,
including policyholder share, for the year ended December 31 were as follows:
----------------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------------
Proceeds from sales $7,215 $6,206 $6,444
Gross gains on sales $322 $191 $239
Gross losses on sales $(84) $(127) $(158)
----------------------------------------------------------------------------
NOTE 6 -- DEBT
Short-term and long-term debt consisted of the following at December 31:
------------------------------------------------------------------------
(In millions) 1998 1997
------------------------------------------------------------------------
Short-term
Commercial paper $257 $605
Current maturities of long-term debt 15 85
------------------------------------------------------------------------
Total short-term debt $272 $690
--------------------------------------------============================
Long-term
Unsecured Debt:
8.16% Notes due 2000 $25 $25
8 3/4% Notes due 2001 100 100
7.17% Notes due 2002 25 25
7.4% Notes due 2003 100 100
6 3/8% Notes due 2006 100 100
7.4% Notes due 2007 300 300
8 1/4% Notes due 2007 100 100
7.65% Notes due 2023 100 100
8.3% Notes due 2023 17 100
7 7/8% Debentures due 2027 300 300
8.3% Step Down Notes due 2033 83 --
Medium-term Notes 111 121
Secured Debt (principally by real
estate) 70 94
------------------------------------------------------------------------
Total long-term debt $1,431 $1,465
--------------------------------------------============================
CIGNA issues commercial paper primarily to manage imbalances between
operating cash flows and existing commitments, to meet working capital needs and
to take advantage of current investment opportunities. Commercial paper
borrowing arrangements are supported by various lines of credit. As of December
31, 1998 and 1997, the weighted average interest rate on commercial paper was
5.5% and 5.9%, respectively.
Medium-term notes have original maturity dates ranging from approximately
five to ten years and interest rates ranging from 6 1/4% to 9 1/2%. As of
December 31, 1998 and 1997, the weighted average interest rate on medium-term
notes was 8.0% and 8.3%, respectively.
In July 1998, CIGNA completed an offer to exchange its 8.3% Step Down Notes
due 2033 (New Notes) for 8.3% Notes due 2023 (Old Notes). Old Notes with
principal amounts aggregating approximately $83 million were tendered in
connection with the exchange offer. The New Notes bear interest at 8.3% through
January 14, 2023 and 8.08% to January 15, 2033. The New Notes may be redeemed at
CIGNA's option, at any time, at par plus a possible additional redemption
payment. Expenses incurred in connection with the exchange were not material.
In 1997, CIGNA issued $300 million of unsecured 7.4% Notes due in 2007 and
$300 million of unsecured 7 7/8% Debentures due in 2027. The proceeds from these
issues were used for the purchase of Healthsource.
37
As of December 31, 1998, CIGNA had available approximately $655 million in
committed and uncommitted lines of credit provided by U.S. and foreign banks.
These lines of credit generally have terms ranging from one to three years and
are paid for by using a combination of fees and bank balances. Interest that
CIGNA would be charged for usage of these lines of credit is based upon
negotiated arrangements.
As of December 31, 1998, CIGNA had $1 billion remaining under effective
shelf registration statements filed with the Securities and Exchange Commission
that may be issued as debt securities, equity securities or both, depending upon
market conditions and CIGNA's capital requirements.
Maturities of long-term debt for each of the next five years are as follows:
1999 -- $15 million; 2000 -- $57 million; 2001 -- $148 million; 2002 -- $39
million; and 2003 -- $129 million.
Interest expense was $126 million, $127 million and $102 million in 1998,
1997 and 1996, respectively.
NOTE 7 -- COMMON AND PREFERRED STOCK
On April 22, 1998, CIGNA's shareholders approved a three-for-one common
stock split, an increase in the number of common shares authorized for issuance
from 200 million to 600 million and a decrease in the par value of common stock
from $1 per share to $0.25 per share. These actions resulted in a reduction in
common stock and corresponding increase in additional paid-in capital of $22
million. Share and per share data have been retroactively adjusted for the stock
split as though it had occurred at the beginning of the periods presented.
-----------------------------------------------------------------------------
(Shares in thousands) 1998 1997 1996
-----------------------------------------------------------------------------
Common: Par value $0.25
600,000 shares authorized
Outstanding -- January 1 216,996 222,594 228,996
Issued for stock option
and other benefit plans 1,055 687 882
Repurchase of common stock (12,401) (6,285) (7,284)
-----------------------------------------
Outstanding -- December 31 205,650 216,996 222,594
Treasury shares 59,530 46,875 40,296
-----------------------------------------------------------------------------
Issued -- December 31 265,180 263,871 262,890
------------------------------------=========================================
In 1997, CIGNA's Board of Directors adopted a shareholder rights plan which
will expire on August 4, 2007. The rights attach to all outstanding shares of
common stock and become exercisable upon an acquisition of (or announcement to
acquire) 10% or more of CIGNA's outstanding common stock unless CIGNA's Board of
Directors approves the acquisition. When exercisable, each right entitles its
holder to purchase securities of CIGNA at a substantial discount or, at the
discretion of the Board of Directors, to exchange the rights for CIGNA common
stock on a one-for-one basis. In certain other circumstances, the rights also
entitle the holders to purchase securities of an acquirer at a substantial
discount. CIGNA's Board of Directors may redeem the rights for $.0033 each prior
to an acquisition of 10% or more of its common stock, and thereafter under
certain circumstances.
CIGNA has authorized a total of 25 million shares of $1 par value preferred
stock. No shares of preferred stock were outstanding at December 31, 1998, 1997
and 1996.
NOTE 8 -- SHAREHOLDERS' EQUITY AND DIVIDEND RESTRICTIONS
The insurance departments of various jurisdictions in which CIGNA's
insurance subsidiaries are domiciled recognize as net income and surplus
(shareholders' equity) those amounts determined in conformity with statutory
accounting practices prescribed or permitted by the departments, which may
differ from generally accepted accounting principles. As permitted by a state
insurance department, certain of CIGNA's insurance subsidiaries discount certain
asbestos-related and environmental pollution liabilities, which increased
statutory surplus by approximately $197 million and $217 million as of December
31, 1998 and 1997, respectively.
The amounts of statutory net income (loss) for the year ended, and surplus
as of, December 31 were as follows:
---------------------------------------------------------------
(In millions) 1998 1997 1996
---------------------------------------------------------------
Life Insurance Companies:
Net income $947 $634 $680
Surplus $2,858 $3,021 $2,683
Property and Casualty
Insurance Companies:
Net income $160 $192 $164
Surplus $1,673 $1,542 $1,655
---------------------------------------------------------------
CIGNA's insurance subsidiaries are subject to various regulatory
restrictions that limit the amount of annual dividends or other distributions,
such as loans or cash advances, available to shareholders without prior approval
of the insurance regulatory authorities. The maximum dividend distribution that
may be made by CIGNA's insurance subsidiaries during 1999 without prior approval
is approximately $1.2 billion. The amount of restricted net assets as of
December 31, 1998 was approximately $6.8 billion.
38
NOTE 9 -- INCOME TAXES
CIGNA's net deferred tax asset of $1.9 billion and $1.8 billion as of
December 31, 1998 and 1997, respectively, reflects management's belief that
CIGNA's taxable income in future years will be sufficient to realize the net
deferred tax asset based on CIGNA's earnings history and its future
expectations. In determining the adequacy of future taxable income, management
considered the future reversal of its existing taxable temporary differences and
available tax planning strategies that could be implemented, if necessary.
CIGNA's deferred tax asset is net of valuation allowances of $53 million as
of December 31, 1998 and 1997. The valuation allowance reflects management's
assessment, based on available information, that it is more likely than not that
a portion of the deferred tax asset will not be realized. Adjustments to the
valuation allowance will be made if there is a change in management's assessment
of the amount of the deferred tax asset that is realizable. Adjustments made to
the valuation allowance for 1998, 1997 and 1996 were immaterial.
As of December 31, 1998 and 1997, CIGNA did not have any tax basis net
operating loss carryforwards.
In accordance with the Life Insurance Company Income Tax Act of 1959, a
portion of CIGNA's life insurance companies' statutory income was not subject to
current income taxation but was accumulated in an account designated
Policyholders' Surplus Account. Under the Tax Reform Act of 1984, no further
additions may be made to the Policyholders' Surplus Account for tax years ending
after December 31, 1983. The balance in the account of approximately $450
million at December 31, 1998 would result in a tax liability of $158 million
only if distributed to shareholders or if the account balance exceeded a
prescribed maximum. No income taxes have been provided on this amount because,
in management's opinion, the likelihood that these conditions will be met is
remote. See Note 19 for a discussion of potential legislation regarding this
matter.
CIGNA's federal income tax returns are routinely audited by the Internal
Revenue Service (IRS), and provisions are made in the financial statements in
anticipation of the results of these audits. The IRS completed its audits for
the years 1982 through 1993, and challenged CIGNA on one issue related to years
prior to 1989. During the third quarter of 1997, the U.S. Tax Court ruled
against CIGNA in connection with this issue. The decision did not have an effect
on results of operations, as liabilities had been previously established. As a
result of this ruling, CIGNA made payments of approximately $115 million and
$250 million during 1998 and 1997, respectively. CIGNA has appealed the U.S. Tax
Court decision to the U.S. Court of Appeals.
In management's opinion, adequate tax liabilities have been established for
all years.
The tax effect of temporary differences which give rise to deferred income
tax assets and liabilities as of December 31 was as follows:
----------------------------------------------------------------------
(In millions) 1998 1997
----------------------------------------------------------------------
Deferred tax assets:
Loss reserve discounting $679 $705
Other insurance and contractholder
liabilities 341 689
Employee and retiree benefit plans 493 455
Deferred gain on sale of business 290 --
Investments, net 282 287
Policy acquisition expenses 144 --
Bad debt expense 155 152
Other 189 194
-------------------------
Deferred tax assets before valuation
allowance 2,573 2,482
Valuation allowance for deferred tax
assets (53) (53)
-------------------------
Deferred tax assets, net of valuation
allowance 2,520 2,429
-------------------------
Deferred tax liabilities:
Unrealized appreciation on investments 490 450
Depreciation and amortization 168 183
Policy acquisition expenses -- 4
Other 1 4
-------------------------
Total deferred tax liabilities 659 641
----------------------------------------------------------------------
Net deferred income tax asset $1,861 $1,788
---------------------------------------------=========================
The components of income taxes for the year ended December 31 were as
follows:
--------------------------------------------------------------
(In millions) 1998 1997 1996
--------------------------------------------------------------
Current taxes:
U.S. income $753 $424 $339
Foreign income 48 69 80
State income 40 -- --
--------------------------------
841 493 419
--------------------------------
Deferred taxes (benefits):
U.S. income (36) 68 108
Foreign income (76) 3 18
State income (11) -- --
--------------------------------
(123) 71 126
--------------------------------------------------------------
Total income taxes $718 $564 $545
------------------------------================================
State income taxes were not material in years prior to 1998.
39
Total income taxes for the year ended December 31 differs from the amount
computed using the nominal federal income tax rate of 35% for the following
reasons:
----------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------
Tax expense at nominal rate $704 $577 $560
Tax-exempt interest income (33) (30) (31)
Realized investment results 1 (1) 1
Dividends received deduction (12) (8) (7)
Amortization of goodwill 30 26 17
State income tax (net of
federal income tax benefit) 18 -- --
Interest on provisions 8 15 7
Resolved federal tax audit issues -- (13) --
Other 2 (2) (2)
----------------------------------------------------------------------
Total income taxes $718 $564 $545
-------------------------------------=================================
NOTE 10 -- PENSION AND OTHER POSTRETIREMENT BENEFITS PLANS
A) Pension and Other Postretirement Benefits Plans: CIGNA and certain of its
subsidiaries provide pension and certain health care and life insurance benefits
to eligible retired employees and agents, spouses and other eligible dependents
through various plans.
The following tables summarize the obligations, costs and significant
assumptions related to these plans as of and for the year ended December 31:
-----------------------------------------------------------------------------
Other
Postretirement
Pension Benefits Benefits
-----------------------------------------------------------------------------
(In millions) 1998 1997 1998 1997
-----------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation, January 1 $2,925 $2,540 $478 $462
Service cost 106 96 4 6
Interest cost 191 188 31 32
(Gain) loss from past 9
experience 32 279 (7)
Benefits paid - from plan assets (137) (117) (1) (2)
Benefits paid - other (20) (7) (32) (29)
Amendments -- (45) -- --
Other (11) (9) (4) --
-----------------------------------------------------------------------------
Benefit obligation,
December 31 3,086 2,925 469 478
-----------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets,
January 1 2,631 2,337 59 54
Actual return on plan assets 361 390 6 7
Employer contributions 67 31 -- --
Benefits paid (137) (117) (1) (2)
Other -- (10) -- --
-----------------------------------------------------------------------------
Fair value of plan assets,
December 31 2,922 2,631 64 59
-----------------------------------------------------------------------------
Net benefit obligation 164 294 405 419
Unrecognized net gain (loss)
from past experience 67 (68) 214 216
Unrecognized prior service cost (23) (26) 213 236
Unamortized SFAS 87
transition asset 24 34 -- --
-----------------------------------------------------------------------------
Net amount recognized in the
balance sheet $232 $234 $832 $871
-----------------------------------==========================================
Prepaid benefit cost $(14) $(8) $-- $--
Accrued benefit liability 290 290 832 871
Intangible asset (44) (48) -- --
-----------------------------------------------------------------------------
Net amount recognized in the
balance sheet $232 $234 $832 $871
-----------------------------------==========================================
At December 31, 1998 and 1997, pension plans under which accumulated
benefits exceeded assets had projected benefit obligations of $318 million and
$293 million, respectively, and related assets at fair value of $29 million and
$34 million, respectively. The accumulated benefit obligation related to these
plans was $238 million and $221 million at December 31, 1998 and 1997,
respectively.
CIGNA funds the pension plans at least at the minimum amount required by the
Employee Retirement Income Security Act of 1974 (ERISA). Substantially all
pension plan assets are invested in either the separate accounts
40
of Connecticut General Life Insurance Company (CGLIC), which is a CIGNA
subsidiary, or immediate participation guaranteed investment contracts issued by
CGLIC. Plan assets also include 292,500 shares of CIGNA common stock at December
31, 1998 and 1997, with a market value of $23 million and $17 million at
December 31, 1998 and 1997, respectively.
Components of net pension cost for the year ended December 31 were as
follows:
-----------------------------------------------------------------
(In millions) 1998 1997 1996
-----------------------------------------------------------------
Service cost $106 $96 $100
Interest cost 191 188 174
Expected return on plan assets (208) (185) (171)
Gain on curtailments -- (3) --
Amortization of:
Net loss from past experience 4 3 11
Prior service cost 4 7 7
SFAS 87 transition asset (10) (10) (10)
-----------------------------------------------------------------
Net pension cost $87 $96 $111
---------------------------------================================
Determination of the projected benefit obligation was based on the following
weighted average assumptions at December 31:
----------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------
Discount rate 6.75% 7% 7.5%
Expected return on plan assets 9% 9% 9%
Expected rate of compensation
increase 5.1% 5.1% 5.1%
----------------------------------------------------------------------
Retiree health benefit plans with accumulated benefit obligations of $327
million and $337 million at December 31, 1998 and 1997, respectively, are
unfunded. At December 31, 1998 and 1997, plan assets of $64 million and $59
million, respectively, represented partial funding for retiree life insurance
plans with accumulated benefit obligations of $142 million and $141 million,
respectively, and such plan assets were invested in the general account assets
of CGLIC.
Components of net other postretirement benefit cost for the year ended
December 31 were as follows:
--------------------------------------------------------------
(In millions) 1998 1997 1996
--------------------------------------------------------------
Service cost $4 $6 $10
Interest cost 31 32 38
Expected return on plan assets (4) (4) (4)
Amortization of:
Net gain from past experience (10) (11) (9)
Prior service cost (17) (17) (14)
--------------------------------------------------------------
Net other postretirement
benefit cost $4 $6 $21
--------------------------------==============================
Determination of the accumulated other postretirement benefit obligation was
based on the following weighted average assumptions at December 31:
----------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------
Discount rate 6.75% 7% 7.5%
Expected return on plan assets 7% 7% 7%
Expected rate of compensation
increase 4.5% 4.5% 4.5%
----------------------------------------------------------------------------
The estimated rate of future increases in per capita cost of health care
benefits (the health care cost trend rate) was 7% decreasing to 5% over three
years, which reflects CIGNA's current claim experience and management's estimate
that future rates of growth will decline. A one percentage point change in
assumed health care cost trend rate would have the following effects on amounts
reported for 1998:
------------------------------------------------------------------
(In millions) Increase Decrease
------------------------------------------------------------------
Effect on total service and interest cost $4 $3
Effect on postretirement benefit obligation $39 $33
------------------------------------------------------------------
B) Capital Accumulation Plans: CIGNA sponsors various capital accumulation
plans (401(k)) in which employee contributions on a pre-tax basis are
supplemented by CIGNA matching contributions. These contributions are invested,
at the election of the employee, in one or more of the following investments:
CIGNA common stock fund, several CIGNA and non-CIGNA mutual funds, and a
fixed-income fund. In addition, beginning in 1999, CIGNA may provide additional
matching contributions, depending on its annual performance, which would be
invested in the CIGNA common stock fund. CIGNA's expense for such plans totaled
$51 million, $42 million and $39 million for 1998, 1997 and 1996, respectively.
41
NOTE 11 -- EMPLOYEE INCENTIVE PLANS
The People Resources Committee of the Board of Directors can award to
employees stock options, stock appreciation rights (SARs) only in tandem with
stock options, restricted stock, dividend equivalent rights or common stock in
lieu of cash payable under other incentive plans or arrangements. As of December
31, 1998, 1997 and 1996, stock available for award aggregated 10,783,561 shares,
15,008,850 shares and 15,286,245 shares, respectively.
Grants of restricted stock are awarded annually, with vesting periods
ranging from three to five years. Although recipients are entitled to receive
dividends and vote restricted stock during the vesting period, termination of
employment prior to vesting results in forfeiture of the stock. Grants of
restricted shares of CIGNA common stock during 1998, 1997 and 1996 totaled
456,635 shares, 427,884 shares and 429,834 shares, respectively, at a weighted
average fair value per share of $62.91, $52.34 and $39.47, respectively.
Restricted stock grants of 1,923,278 shares for 2,343 employees were outstanding
at December 31, 1998. Compensation cost related to restricted stock grants was
not material to CIGNA's results of operations, liquidity or financial condition.
Options to purchase CIGNA common stock are awarded at market price on the
date of grant, vest over periods ranging from one to five years and expire no
later than 10 years after the date of grant. Certain outstanding options have a
replacement option feature providing that when the underlying option is
exercised by tendering stock a new option is granted covering shares equal to
the number tendered. These options are exercisable at the market price on the
date of the new grant and expire on the expiration date of the original option.
The following table summarizes the status of, and changes in, common stock
options outstanding for the year ended December 31 and includes approximately
three million options granted in connection with the 1997 Healthsource
acquisition:
----------------------------------------------------------------------------------------------------------------------------------
(Shares in thousands) 1998 1997 1996
----------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
----------------------------------------------------------------------------------------------------------------------------------
Outstanding -- January 1 10,035 $50.70 4,884 $32.42 4,826 $23.72
Granted 4,213 64.01 8,410 54.83 2,614 40.38
Exercised (2,939) 46.12 (3,204) 33.87 (2,409) 23.78
Expired or canceled (330) 61.80 (55) 39.14 (147) 29.91
----------- ---------- ----------
Outstanding -- December 31 10,979 56.70 10,035 50.70 4,884 32.42
-------------------------------------=============================================================================================
Options exercisable at year-end 4,397 $53.35 4,370 $46.41 1,994 $25.21
-------------------------------------=============================================================================================
The following table summarizes the range of exercise prices for outstanding
common stock options at December 31, 1998:
====================================================================
Range of Exercise Prices
--------------------------------------------------------------------
$5.57 to $70.00 to
(Shares in thousands) $69.94 $106.11
--------------------------------------------------------------------
Options outstanding 9,981 998
Weighted average remaining
contractual life 7.6 years 7.2 years
Weighted average exercise price $53.80 $85.75
Options exercisable 3,933 464
Weighted average exercise price $48.22 $96.83
--------------------------------------------------------------------
The weighted average fair value of options granted under employee incentive
plans during 1998, 1997 and 1996 was $13.87, $12.94 and $9.99, respectively.
Fair value of each option grant in 1998, 1997 and 1996 was estimated using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
---------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------
Dividend yield 1.7% 2.4% 3.5%
Expected volatility 25.9% 23.7% 26.2%
Risk-free interest rate 5.5% 6.1% 5.9%
Expected option life 3 years 4 years 6 years
---------------------------------------------------------------
CIGNA awards stock options under employee incentive plans with exercise
prices equal to the market price at the date of grant and, therefore, does not
record compensation expense related to stock options. Had CIGNA recorded
compensation expense for stock options based on their fair value at the grant
date using the Black- Scholes option-pricing model, CIGNA's net income would
have been reduced by $30 million, $22 million and $10 million in 1998, 1997 and
1996, respectively. Also, basic and diluted earnings per share would have been
reduced by $0.14, $0.10 and $0.04 in 1998, 1997 and 1996, respectively.
42
NOTE 12 -- EARNINGS PER SHARE
Basic and Diluted earnings per share (EPS) are computed as follows for the
year ended December 31 (see Note 2 regarding stock split):
-------------------------------------------------------------------
(Dollars in millions,
except per share Effect of
amounts) Basic Dilution Diluted
-------------------------------------------------------------------
1998
-------------------------------------------------------------------
Net income $1,292 -- $1,292
--------------------------=========================================
Shares (in thousands):
Weighted average 210,948 -- 210,948
Options and restricted
stock grants 2,499 2,499
-------------------------------------------------------------------
Total shares 210,948 2,499 213,447
--------------------------=========================================
EPS $6.12 $(0.07) $6.05
--------------------------=========================================
1997
-------------------------------------------------------------------
Net income $1,086 -- $1,086
--------------------------=========================================
Shares (in thousands):
Weighted average 220,263 -- 220,263
Options and restricted
stock grants 2,250 2,250
-------------------------------------------------------------------
Total shares 220,263 2,250 222,513
--------------------------=========================================
EPS $4.93 $(0.05) $4.88
--------------------------=========================================
1996
-------------------------------------------------------------------
Net income $1,056 -- $1,056
--------------------------=========================================
Shares (in thousands):
Weighted average 225,495 -- 225,495
Options and restricted
stock grants 2,259 2,259
-------------------------------------------------------------------
Total shares 225,495 2,259 227,754
--------------------------=========================================
EPS $4.68 $(0.04) $4.64
--------------------------=========================================
NOTE 13 -- REINSURANCE
In the normal course of business, CIGNA's insurance subsidiaries enter into
agreements, primarily short-duration contracts, to assume and cede reinsurance
with other insurance companies. Reinsurance is ceded primarily to limit losses
from large exposures and to permit recovery of a portion of direct losses,
although ceded reinsurance does not relieve the originating insurer of primary
liability. CIGNA evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk arising from similar geographic regions,
activities or economic characteristics of its reinsurers. In connection with the
sale of CIGNA's individual life insurance and annuity business (as discussed in
Note 3), the reinsurance recoverable from Lincoln National Corporation at
December 31, 1998 was $6.0 billion. As of December 31, 1998 and 1997,
approximately 3% and 7% respectively, of reinsurance recoverables were due from
certain syndicates affiliated with Lloyd's of London.
Failure of reinsurers to indemnify CIGNA, as a result of reinsurer
insolvencies and disputes, could result in losses. Allowances for uncollectible
amounts were $705 million and $720 million as of December 31, 1998 and 1997,
respectively.
Future charges for unrecoverable reinsurance may materially affect results
of operations in future periods, however, such amounts are not expected to have
a material adverse effect on CIGNA's liquidity or financial condition.
The effects of reinsurance on net earned premiums and fees for the year
ended December 31 were as follows:
-----------------------------------------------------------------------
(In millions) 1998 1997 1996
-----------------------------------------------------------------------
Short-duration contracts
Premiums and fees:
Direct $14,700 $12,585 $11,577
Assumed 909 1,143 1,099
Ceded (1,803) (1,790) (1,904)
-----------------------------------------------------------------------
Net earned premiums and fees $13,806 $11,938 $10,772
--------------------------------=======================================
Long-duration contracts
Premiums and fees:
Direct $2,736 $2,707 $2,728
Assumed 594 544 634
Ceded (723) (254) (218)
-----------------------------------------------------------------------
Net earned premiums and fees $2,607 $2,997 $3,144
--------------------------------=======================================
The effects of reinsurance on written premiums and fees for short-duration
contracts were not materially different from the amounts shown in the above
table.
Benefits, losses and settlement expenses for 1998, 1997 and 1996 were net of
reinsurance recoveries of $2.2 billion, $1.3 billion and $1.6 billion,
respectively. For the year ended December 31, 1998, ceded premiums and
reinsurance recoveries associated with the individual life insurance and annuity
business sold were $557 million and $424 million, respectively.
43
NOTE 14 -- PROPERTY AND CASUALTY UNPAID
CLAIMS AND CLAIM EXPENSE RESERVES AND
REINSURANCE RECOVERABLES
As described in Note 2(M), CIGNA establishes loss reserves, which are
estimates of future payments of reported and unreported claims for losses and
related expenses, with respect to insured events that have occurred.
Activity in the reserve for unpaid claims and claim adjustment expenses for
the year ended December 31 was as follows:
--------------------------------------------------------------------------
(In millions) 1998 1997 1996
--------------------------------------------------------------------------
Gross reserve -- January 1 $14,930 $16,324 $16,877
Less reinsurance recoverable 5,168 5,835 5,864
-----------------------------------
Net reserve -- January 1 9,762 10,489 11,013
-----------------------------------
Plus incurred claims and claim
adjustment expenses:
Provision for insured events of
the current year 2,049 1,990 2,257
Increase in provision for insured
events of prior years 177 218 177
-----------------------------------
Total incurred claims and claim
adjustment expenses 2,226 2,208 2,434
-----------------------------------
Less payments for claims and
claim adjustment expenses
attributable to:
Insured events of the current
year 910 871 793
Insured events of prior years 1,745 2,064 2,165
-----------------------------------
Total payments for claims and
claim adjustment expenses 2,655 2,935 2,958
-----------------------------------
Net reserve -- December 31 9,333 9,762 10,489
Plus reinsurance recoverable 5,293 5,168 5,835
--------------------------------------------------------------------------
Gross reserve -- December 31 $14,626 $14,930 $16,324
---------------------------------------===================================
The basic assumption underlying the many traditional actuarial and other
methods used in the estimation of property and casualty loss reserves is that
past experience is an appropriate basis for predicting future events. However,
current trends and other factors that would modify past experience are also
considered. The process of establishing loss reserves is subject to
uncertainties that are normal, recurring and inherent in the property and
casualty business.
Reserving for property and casualty claims continues to be a complex and
uncertain process, requiring the use of informed estimates and judgments.
CIGNA's estimates and judgments may be revised as additional experience and
other data become available and are reviewed, as new or improved methodologies
are developed or as current law changes. Any such revisions could result in
future changes in estimates of losses or reinsurance recoverables, and would be
reflected in CIGNA's results of operations for the period in which the estimates
are changed. While the effect of any such changes in estimates of losses or
reinsurance recoverables could be material to future results of operations,
CIGNA does not expect such changes to have a material effect on its liquidity or
financial condition.
In management's judgment, information currently available has been
appropriately considered in estimating CIGNA's loss reserves and reinsurance
recoverables.
CIGNA's reserves for asbestos-related and environmental pollution (A&E)
exposures as of December 31 were as follows:
------------------------------------------------------------------
1998 1997
------------------------------------------------------------------
(In millions) Gross Net Gross Net
------------------------------------------------------------------
Asbestos $841 $523 $846 $509
Environmental $1,212 $941 $1,404 $1,059
------------------------------------------------------------------
CIGNA's reserves for A&E claims are a reasonable estimate of its liability
for these claims, based on currently known facts, reasonable assumptions where
the facts are not known, current law and methodologies currently available.
Charges to income for increases in the Property and Casualty segment's
liability for insured events of prior years (prior year development) for A&E
losses and charges for unrecoverable reinsurance in the aggregate were $160
million, $148 million and $117 million for 1998, 1997 and 1996, respectively.
Prior year development, other than for A&E claims and charges for
unrecoverable reinsurance, was $17 million, $70 million and $60 million for
1998, 1997 and 1996, respectively.
CIGNA's property and casualty operations routinely insure various forms of
property, including large property risks. A major catastrophe could have a
material adverse effect on CIGNA's results of operations. However, because CIGNA
monitors writings to avoid significant concentrations, it is not likely that
such adverse effect would be material to CIGNA's liquidity or financial
condition.
NOTE 15 -- LEASES AND RENTALS
Rental expenses for operating leases, principally with respect to buildings,
amounted to $192 million, $234 million and $214 million in 1998, 1997 and 1996,
respectively.
As of December 31, 1998, future net minimum rental payments under
non-cancelable operating leases were approximately $704 million, payable as
follows: 1999 -- $143 million; 2000 -- $116 million; 2001 -- $101 million; 2002
-- $82 million; 2003 -- $70 million; and $192 million thereafter.
44
NOTE 16 -- SEGMENT INFORMATION
Operating segments are based on CIGNA's internal reporting structure and
generally reflect differences in products except that the International Life,
Health and Employee Benefits segment is based on geography. CIGNA presents
segment information as follows:
o Employee Health Care, Life and Disability Benefits which combines CIGNA's
Health Care and Group Insurance segments, offers traditional indemnity,
managed care and cost containment products and services as well as
alternative funding arrangements, such as administrative services only and
minimum premium plans.
o Employee Retirement Benefits and Investment Services provides investment
products and professional services primarily to sponsors of qualified
pension, profit-sharing and retirement saving plans. This segment also
provides certain corporate and variable life insurance products.
o International Life, Health and Employee Benefits provides life, accident and
health and employee benefits (group life, health and pensions) coverages and
services primarily outside the United States.
o Property and Casualty is comprised of two operations, ongoing and run-off.
Ongoing operations provide global commercial insurance and risk management
services. The run-off operations, which do not actively sell insurance
products, manage run-off policies and related claims, including those for
A&E exposures. As discussed in Note 3, CIGNA has entered into an agreement
to sell the businesses which comprise this segment.
Other Operations consist of gain recognition related to the sale of the
individual life insurance and annuity business, corporate life insurance on
which policy loans are outstanding (also called leveraged corporate life
insurance), reinsurance operations, settlement annuity business and certain new
business initiatives. The Corporate caption is used to report other amounts not
allocated to segments, such as interest expense, certain goodwill amortization
and intercompany eliminations.
CIGNA uses operating income (net income excluding after-tax realized
investment results) to measure the financial results of its segments. Operating
income is determined on a basis consistent with the accounting policies for the
consolidated financial statements, except that interest expense on corporate
debt is not allocated to segments. CIGNA allocates substantially all other
corporate general, administrative and systems expenses to segments on systematic
bases. Income taxes are generally computed as if each segment were filing
separate income tax returns.
CIGNA's operations are not materially dependent on one or a few customers,
brokers or agents. Summarized segment financial information for the year ended
and as of December 31 was as follows:
------------------------------------------------------------------------
(In millions) 1998 1997 1996
------------------------------------------------------------------------
Employee Health Care, Life
and Disability Benefits
Premiums and fees and other
revenues $11,963 $10,000 $8,779
Net investment income 589 563 567
---------------------------------------
Segment revenues $12,552 $10,563 $9,346
Income tax expense $361 $232 $261
Operating income $617 $425 $497
Assets under management:
Invested assets $8,388 $8,060 $6,929
Separate account assets 1,702 1,440 1,175
---------------------------------------
Total $10,090 $9,500 $8,104
---------------------------------=======================================
Employee Retirement Benefits
and Investment Services
Premiums and fees and other
revenues $257 $221 $272
Net investment income 1,613 1,655 1,716
---------------------------------------
Segment revenues $1,870 $1,876 $1,988
Income tax expense $117 $101 $98
Operating income $248 $230 $210
Assets under management:
Invested assets $20,543 $21,426 $20,970
Separate account assets 30,718 25,934 19,846
---------------------------------------
Total $51,261 $47,360 $40,816
---------------------------------=======================================
International Life, Health and
Employee Benefits
Premiums and fees and other
revenues $1,231 $1,078 $981
Net investment income 115 122 125
---------------------------------------
Segment revenues $1,346 $1,200 $1,106
Income tax expense $20 $12 $3
Equity in net loss of investee $(18) $-- $--
Operating income $17 $21 $5
Assets under management:
Invested assets $2,774 $2,279 $2,455
Separate account assets 93 67 --
---------------------------------------
Total $2,867 $2,346 $2,455
---------------------------------=======================================
45
----------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------
Property and Casualty
Premiums and fees and other
revenues
International $1,461 $1,552 $1,602
Domestic 1,774 1,862 1,880
---------------------------------------
Ongoing operations 3,235 3,414 3,482
Run-off operations 19 42 179
---------------------------------------
Total $3,254 $3,456 $3,661
-------------------------------=======================================
Net investment income:
International $102 $118 $118
Domestic 231 239 259
---------------------------------------
Ongoing operations 333 357 377
Run-off operations 250 282 302
---------------------------------------
Total $583 $639 $679
-------------------------------=======================================
Segment revenues $3,837 $4,095 $4,340
Income tax expense $19 $102 $87
Operating income:
International $(13) $106 $130
Domestic 85 98 76
---------------------------------------
Ongoing operations 72 204 206
Run-off operations (2) 1 2
---------------------------------------
Total $70 $205 $208
-------------------------------=======================================
Assets under management:
Invested assets:
International $1,938 $1,938 $2,067
Domestic 3,542 3,436 3,779
---------------------------------------
Ongoing operations 5,480 5,374 5,846
Run-off operations 3,552 3,896 4,102
---------------------------------------
Total $9,032 $9,270 $9,948
-------------------------------=======================================
Other Operations
Premiums and fees and other
revenues $1,065 $1,089 $1,027
Net investment income 771 1,235 1,217
---------------------------------------
Segment revenues $1,836 $2,324 $2,244
Income tax expense $167 $88 $82
Operating income $313 $180 $155
Assets under management:
Invested assets $9,968 $15,541 $15,757
Separate account assets 2,295 1,907 1,593
---------------------------------------
Total $12,263 $17,448 $17,350
-------------------------------=======================================
Corporate
Premiums and fees, other
revenues, and eliminations $(194) $(218) $(194)
Net investment income 34 31 29
---------------------------------------
Segment revenues $(160) $(187) $(165)
Income tax benefit $(20) $(23) $(23)
Operating loss $(75) $(90) $(73)
Invested assets $2 $2 $2
-------------------------------=======================================
Realized Investment Gains
Realized investment gains $156 $167 $91
Income tax expense 54 52 37
---------------------------------------
Realized investment gains,
net of taxes $102 $115 $54
-------------------------------=======================================
----------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------
Total
Premiums and fees and other
revenues $17,576 $15,626 $14,526
Net investment income 3,705 4,245 4,333
Realized investment gains 156 167 91
---------------------------------------
Total revenues $21,437 $20,038 $18,950
Income tax expense $718 $564 $545
Operating income $1,190 $971 $1,002
Realized investment gains,
net of taxes 102 115 54
---------------------------------------
Net income $1,292 $1,086 $1,056
-------------------------------=======================================
Assets under management:
Invested assets $50,707 $56,578 $56,061
Separate account assets 34,808 29,348 22,614
---------------------------------------
Total $85,515 $85,926 $78,675
-------------------------------=======================================
Premiums and fees and other revenues by product type were as follows for the
year ended December 31:
----------------------------------------------------------------------
(In millions) 1998 1997 1996
----------------------------------------------------------------------
Health Maintenance Organizations $5,971 $4,451 $3,466
Medical and Dental Indemnity 3,195 2,729 2,513
Property and Casualty 2,957 3,154 3,417
Group Life 1,813 1,797 1,845
Other 3,640 3,495 3,285
----------------------------------------------------------------------
Total $17,576 $15,626 $14,526
-----------------------------------===================================
NOTE 17 -- COST REDUCTION INITIATIVES AND OTHER RESTRUCTURING
A) Employee Health Care, Life and Disability Benefits Restructuring: In the
fourth quarter of 1997, CIGNA adopted a cost reduction plan to restructure its
health care operations which resulted in a pre-tax charge of $32 million ($22
million after-tax) included primarily in Other Operating Expenses in the
Employee Health Care, Life and Disability Benefits segment. The after-tax
components of the charge were as follows: severance, $11 million, for costs
associated with nonvoluntary terminations of approximately 1,300 employees in
various functions and locations; real estate, $4 million, primarily related to
vacated lease space; and other costs, $7 million, primarily related to the exit
of certain operations. As of December 31, 1998, approximately $8 million had
been paid to approximately 1,150 employees, and approximately $4 million had
been paid for real estate and other costs for office closings. CIGNA expects
that this initiative will be substantially completed in 1999 with no material
differences from original estimates.
46
B) Property and Casualty Restructuring: In the fourth quarter of 1998, CIGNA
adopted a cost reduction plan to restructure certain of its domestic and
international property and casualty operations, which resulted in a pre-tax
charge of $28 million ($18 million after-tax) included primarily in Other
Operating Expenses in the Property and Casualty segment. The after-tax
components of the charge were as follows: severance, $12 million, for costs
associated with nonvoluntary terminations of approximately 400 employees in
various functions and locations; and $6 million, primarily related to vacated
lease space. The cash outlays associated with these initiatives will be
substantially completed by the end of 2000 with most occurring in 1999.
Effective December 31, 1995, CIGNA restructured its domestic property and
casualty businesses into two separate operations, ongoing and run-off. As part
of its overall restructuring plan, CIGNA contributed $375 million of additional
capital to the run-off operations which was funded in 1996 through internal
sources. Also, the ongoing operations assumed $125 million of liabilities,
primarily related to employee benefits of the run-off operations and committed
to contribute an additional $50 million to the run-off operations by December
31, 2001. In addition, the ongoing operations reinsured up to $800 million of
claims of the run-off operations in the unlikely event that the statutory
capital and surplus of the run-off operations falls below $25 million. The
property and casualty restructuring is being contested in court by certain
competitors and policyholders. Although CIGNA expects the matter to be in
litigation for some time, it expects to ultimately prevail.
NOTE 18 -- FOREIGN OPERATIONS
CIGNA provides international property and casualty and life and health
insurance coverages on a direct and reinsured basis, primarily in Europe, the
Pacific region, Canada and Latin America.
For the year ended December 31, 1998, 1997 and 1996, the change in Net
Translation of Foreign Currencies reflects increases (decreases) of $12 million
(including taxes of $7 million), $(81) million (including a tax benefit of $43
million), and $(18) million (including a tax benefit of $11 million),
respectively.
Premiums and fees and other revenues by geographic region for the year ended
December 31 were as follows:
---------------------------------------------------
(In millions) 1998 1997 1996
---------------------------------------------------
Domestic $14,800 $12,914 $11,754
Foreign 2,776 2,712 2,772
---------------------------------------------------
Total $17,576 $15,626 $14,526
----------------===================================
CIGNA's aggregate foreign exchange transaction losses and foreign long-lived
assets for the year ended and as of December 31, 1998, 1997 and 1996 were not
material.
NOTE 19 -- CONTINGENCIES
Financial Guarantees
CIGNA, through its subsidiaries, is contingently liable for various
financial guarantees provided in the ordinary course of business. These include
guarantees for the repayment of industrial revenue bonds as well as other debt
instruments. The contractual amounts of financial guarantees reflect CIGNA's
maximum exposure to credit loss in the event of nonperformance. To limit CIGNA's
exposure in the event of default of any guaranteed obligation, various programs
are in place to ascertain the creditworthiness of guaranteed parties and to
monitor this status on a periodic basis. Risk is further reduced primarily
through reinsurance.
The industrial revenue bonds guaranteed directly by CIGNA have remaining
maturities of up to 17 years. The guarantees provide for payment of debt service
only as it becomes due; consequently, an event of default would not cause an
acceleration of scheduled principal and interest payments. The principal amount
of the bonds guaranteed by CIGNA at December 31, 1998 and 1997 was $85 million
and $202 million, respectively. Revenues in connection with industrial revenue
bond guarantees are derived principally from equity participations in the
related projects and are included in net investment income as earned. During
1998, 1997 and 1996, this income was not material.
In addition, CIGNA is liable for municipal guarantee business of $720
million and $816 million at December 31, 1998 and 1997, respectively, which have
maturities of up to 32 years. Such amounts are fully reinsured through a
subsidiary of MBIA Inc., a corporation that guarantees the scheduled payment of
principal and interest for many types of municipal obligations, including
general obligation and special revenue bonds. The nature of this guarantee
business is similar to the reinsurance transactions described in Note 13.
Municipal guarantees provide for
47
payment of debt service only as it becomes due; consequently, an event of
default would not cause an acceleration of scheduled principal and interest
payments. As of December 31, 1998 and 1997, loss reserves and unearned premiums
under these programs were not material.
CIGNA has entered into specialty life reinsurance contracts that guarantee
payments for specified unfavorable changes in variable annuity account values
based on underlying mutual fund investments if account holders expire or elect
to receive periodic income payments. For those accounts with mortality risk,
reserves are established in amounts adequate to meet the estimated future
obligations using various assumptions as to equity market conditions, premiums,
mortality and lapse rates, including provision for adverse deviation. As of
December 31, 1998 and 1997, the amount of recorded liabilities was $52 million
and $29 million, respectively. Although these guarantees may adversely affect
CIGNA's results of operations in future periods, they are not expected to have a
material adverse effect on CIGNA's liquidity or financial condition.
CIGNA also guarantees a minimum level of benefits for certain separate
account contracts and, in the event that separate account assets are
insufficient to fund minimum policy benefits, CIGNA is obligated to fund the
difference. As of December 31, 1998 and 1997, the amount of minimum benefit
guarantees for separate account contracts was $5.4 billion and $4.8 billion,
respectively. Reserves in addition to the separate account liabilities are
established when CIGNA believes a payment will be required under one of these
guarantees. No such reserves were required as of December 31, 1998 and 1997.
Guarantee fees are part of the overall management fee charged to separate
accounts and are recognized in income as earned.
Although the ultimate outcome of any loss contingencies arising from CIGNA's
financial guarantees may adversely affect results of operations in future
periods, they are not expected to have a material adverse effect on CIGNA's
liquidity or financial condition.
Regulatory and Industry Developments
CIGNA's businesses are subject to a changing social, economic, legal,
legislative and regulatory environment that could affect them. Some of the
changes include initiatives to:
o increase health care regulation;
o revise the system of funding cleanup of environmental damages;
o reinterpret insurance contracts long after the policies were written to
provide coverage unanticipated by CIGNA;
o restrict insurance pricing and the application of underwriting standards;
and
o revise federal tax laws.
Some of the more significant issues are discussed below.
Efforts at the federal and state level to increase regulation of the health
care industry could have an adverse effect on CIGNA's health care operations if
they reduce marketplace competition and innovation or result in increased
medical or administrative costs. Matters under consideration that could have an
adverse effect include mandated benefits or services that increase costs without
improving the quality of care, loss of the ERISA preemption of state law through
legislative actions and court decisions, changes in the ERISA regulations
governing claim appeal procedures imposing increased administrative burdens and
costs and restrictions on the use of prescription drug formularies. Due to the
uncertainty associated with the timing and content of any proposals ultimately
adopted, the effect on CIGNA's results of operations, liquidity or financial
condition cannot be reasonably estimated at this time.
Proposals for Superfund reform remain under consideration by Congress. Any
changes in Superfund relating to 1) assigning responsibility, 2) funding cleanup
costs or 3) establishing cleanup standards could affect the liabilities of
policyholders and insurers. Due to uncertainties associated with the timing and
content of any future Superfund legislation, the effect on CIGNA's consolidated
results of operations, liquidity or financial condition cannot be reasonably
estimated at this time.
In early 1999, the Administration proposed a federal budget that would
eliminate the deferral of taxation of certain statutory income of life insurance
companies. As discussed in Note 9, CIGNA has not provided taxes on $450 million
of such income. If the budget provision is enacted, CIGNA will record additional
income tax expense of $158 million to reflect this liability. The proposed
federal budget also would limit the deduction of interest expense on the general
indebtedness of corporations owning non-leveraged corporate life insurance
policies covering the lives of officers, employees or directors. If this latter
provision is enacted as proposed, CIGNA does not anticipate that it will have a
material effect on its
48
consolidated results of operations, liquidity, or financial condition, although
it could have a material adverse effect on the results of operations of the
Employee Retirement Benefits and Investment Services segment.
In 1996, Congress passed legislation that phases out over a three-year
period the tax deductibility of policy loan interest for most leveraged
corporate life insurance products. For 1998 and 1997, revenues of $556 million
and $591 million, respectively, and net income of $42 million and $44 million,
respectively, were from leveraged corporate life insurance products that are
affected by this legislation. CIGNA does not expect this legislation to have a
material adverse effect on its consolidated results of operations, liquidity or
financial condition.
In 1998, the National Association of Insurance Commissioners (NAIC) adopted
risk-based capital guidelines for health maintenance organizations (HMOs). CIGNA
expects its HMO subsidiaries to be adequately capitalized under these guidelines
as they become effective in various jurisdictions in 1999.
In 1998, the NAIC adopted standardized statutory accounting principles.
Since these principles have not been adopted by most of the insurance
departments of various jurisdictions in which CIGNA's insurance subsidiaries are
domiciled, the timing and effects of implementation have not yet been
determined.
CIGNA is contingently liable for possible assessments under regulatory
requirements pertaining to potential insolvencies of unaffiliated insurance
companies and other insurance-related assessments. Mandatory assessments, which
are subject to statutory limits, can be partially recovered through a reduction
in future premium taxes in some states. CIGNA's insurance subsidiaries recorded
pre-tax charges of $46 million, $66 million and $63 million for 1998, 1997 and
1996, respectively, for estimated guaranty fund and other insurance-related
assessments before giving effect to future premium tax recoveries. In addition,
as discussed in Note 2, CIGNA expects to record a $95 million reduction of net
income in the first quarter of 1999 to reflect the effect of implementing SOP
97-3 for insurance-related assessments. Although future assessments and payments
may adversely affect results of operations in future periods, such amounts are
not expected to have a material adverse effect on CIGNA's liquidity or financial
condition.
The eventual effect on CIGNA of the changing environment in which it
operates remains uncertain.
Litigation
CIGNA is continuously involved in numerous lawsuits arising, for the most
part, in the ordinary course of business, either as a liability insurer
defending third-party claims brought against its insureds or as an insurer
defending coverage claims brought against it by its policyholders or other
insurers. One such area of litigation involves policy coverage and judicial
interpretation of legal liability for A&E claims.
While the outcome of all litigation involving CIGNA, including
insurance-related litigation, cannot be determined, litigation (including that
related to A&E claims) is not expected to result in losses that differ from
recorded reserves by amounts that would be material to results of operations,
liquidity or financial condition. Also, reinsurance recoveries related to claims
in litigation, net of the allowance for uncollectible reinsurance, are not
expected to result in recoveries that differ from recorded recoverables by
amounts that would be material to results of operations, liquidity or financial
condition.
49
REPORT OF MANAGEMENT
The management of CIGNA is responsible for the consolidated financial
statements and all other information presented in this Annual Report. The
financial statements have been prepared in conformity with generally accepted
accounting principles, determined by management to be appropriate, and include
amounts based on management's informed estimates and judgments. Financial
information presented elsewhere in this Annual Report is consistent with the
financial statements. The appropriateness of data underlying such financial
information is monitored through internal accounting controls, internal
auditors, independent accountants and the Board of Directors acting through an
Audit Committee.
CIGNA maintains a system of internal accounting controls designed to
reasonably assure the integrity and reliability of financial reporting and to
provide reasonable assurance to management and the Board of Directors that
assets are safeguarded and that transactions are executed in accordance with
management's authorization and recorded properly. The system of internal
accounting controls is supported by the selection and training of qualified
personnel, by the appropriate division of responsibilities and by the
company-wide communication of written policies and procedures.
In its corporate policy addressing business ethics, CIGNA has stated its
intent to achieve the highest level of legal and ethical standards in the
conduct of its business activities. Management provides all employees with a
copy of this policy. Signed statements are obtained annually from all officers,
certain other employees and directors attesting to their review of, and
compliance with, CIGNA's business ethics policy.
The Audit Committee of the Board of Directors reviews and reports to the
full Board on the appropriateness of CIGNA's accounting policies, the adequacy
of its financial controls and the reliability of financial information reported
to the public. The Committee is composed solely of outside directors. Ongoing
Committee activities include reviewing reports of management, internal auditors
and the independent accountants regarding accounting policies and practices,
audit results and internal accounting controls and assessing CIGNA's
relationship with its independent accountants. The Committee has direct access
to the internal auditors and independent accountants and meets with them without
management present.
The consolidated financial statements have been audited by CIGNA's
independent accountants, PricewaterhouseCoopers LLP, in accordance with
generally accepted auditing standards and have been reviewed by the Audit
Committee of the Board of Directors. This audit by PricewaterhouseCoopers LLP
included an evaluation of the internal accounting control structure to the
extent necessary to determine the audit procedures required to express their
opinion on the consolidated financial statements.
Management reviews recommendations of the internal auditors and independent
accountants concerning the system of internal accounting controls and responds
to such recommendations with corrective actions, as appropriate. Management
believes that, as of December 31, 1998, the system of internal accounting
controls is adequate to provide the reasonable assurances discussed herein and
that there are no material deficiencies in the design or operation of the system
of internal accounting controls.
REPORT OF INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers [GRAPHIC OMITTED]
TO THE BOARD OF DIRECTORS
AND SHAREHOLDERS OF CIGNA CORPORATION
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, comprehensive income and changes in
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of CIGNA Corporation and its subsidiaries (the Company)
at December 31, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICEWATERHOUSECOOPERS LLP
Philadelphia, Pennsylvania
February 9, 1999
50
QUARTERLY FINANCIAL DATA (Unaudited)
The following unaudited quarterly financial data are presented on a
consolidated basis for each of the years ended December 31, 1998 and 1997.
Quarterly financial results necessarily rely heavily on estimates. This and
certain other factors, such as the seasonal nature of portions of the insurance
business, require caution in drawing specific conclusions from quarterly
consolidated results.
(In millions, except per share amounts) Three Months Ended
------------------------------------------------------------------------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED RESULTS
1998*
Total revenues $5,411 $5,321 $5,226 $5,479
Income before income taxes 768 471 392 379
Net income 495 308 251 238
Earnings per share:
Basic 2.30 1.44 1.20 1.16
Diluted 2.27 1.42 1.19 1.14
1997 **
Total revenues $4,645 $4,719 $5,182 $5,492
Income before income taxes 437 411 427 375
Net income 288 279 279 240
Earnings per share:
Basic 1.31 1.26 1.26 1.10
Diluted 1.30 1.25 1.25 1.09
STOCK AND DIVIDEND DATA
1998
Price range of common stock - high $69.33 $71.75 $74.50 $82.38
- low $56.00 $67.25 $57.19 $62.00
Dividends declared per common share $.29 $.29 $.29 $.29
------------------------------------------------------------------------------------------------------------------------------
1997
Price range of common stock - high $53.79 $62.42 $66.92 $62.08
- low $45.08 $46.33 $58.44 $50.50
Dividends declared per common share $.28 $.28 $.28 $.28
------------------------------------------------------------------------------------------------------------------------------
*The fourth quarter of 1998 includes after-tax charges of $19 million for
restructuring activities (principally associated with the property and casualty
operations); the first quarter of 1998 includes an after-tax gain of $202
million recognized as of January 1, 1998 in connection with the sale of the
individual life insurance and annuity business.
** The fourth quarter of 1997 includes after-tax charges associated with the
integration of Healthsource and the restructuring of CIGNA's health care
operations of $80 million.
Per share data reflect the three-for-one stock split approved by shareholders on
April 22, 1998.
51
