CIGNA
Executive Overview 52
Liquidity and Capital Resources 61
Critical Accounting Estimates 64
Segment Reporting 65
Health Services 66
Integrated Medical 68
International Markets 69
Group Disability and Other 71
Corporate 72
Investment Assets 72
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is intended to provide information to assist you in better
understanding and evaluating our financial condition as of March 31, 2020
compared with December 31, 2019 and our results of operations for the three
months ended March 31, 2020 compared with the same period last year and intended
to help you understand the ongoing trends in our business. We encourage you to
read this MD&A in conjunction with our Consolidated Financial Statements
included in Part I, Item 1 of this Form 10-Q and our Annual Report on Form 10-K
for the year ended December 31, 2019 ("2019 Form 10-K"), in particular the "Risk
Factors" contained in Part I, Item 1A of that form as such Risk Factors are
supplemented by the information contained in Part II, Item 1A of this Form 10-Q.
Unless otherwise indicated, financial information in the MD&A is presented in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"). See Note 2 to the Consolidated Financial Statements in our
2019 Form 10-K for additional information regarding the Company's significant
accounting policies and Note 3 to the Consolidated Financial Statements in this
Form 10-Q for updates to those accounting policies resulting from adopting new
accounting guidance. The preparation of interim consolidated financial
statements necessarily relies heavily on estimates. This and certain other
factors call for caution in estimating full-year results based on interim
results of operations. In some of our financial tables in this MD&A, we present
either percentage changes or "N/M" when those changes are so large as to become
not meaningful. Changes in percentages are expressed in basis points ("bps").
In this MD&A, our consolidated measures "adjusted income from operations,"
earnings per share on that same basis and "adjusted revenues" are not determined
in accordance with GAAP and should not be viewed as substitutes for the most
directly comparable GAAP measures of "shareholders' net income," "earnings per
share" and "total revenues." We also use pre-tax adjusted income from operations
and adjusted revenues to measure the results of our segments.
We use adjusted income from operations as our principal financial measure of
operating performance because management believes it best reflects the
underlying results of our business operations and permits analysis of trends in
underlying revenue, expenses and profitability. We define adjusted income from
operations as shareholders' net income (or income before taxes for the segment
metric) excluding realized investment gains and losses, amortization
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of acquired intangible assets, special items, and for periods prior to 2020,
results of Anthem, Inc. and Coventry Health Care Inc. ("Coventry")
(collectively, the "transitioning clients") (see the "Key Transactions and
Business Developments" section of the MD&A for further discussion of
transitioning clients). Cigna's share of certain realized investment results of
its joint ventures reported in the International Markets segment using the
equity method of accounting are also excluded. Income or expense amounts
excluded from adjusted income from operations because they are not indicative of
underlying performance or the responsibility of operating segment management
include:
•Realized investment gains (losses) including changes in market values of
certain financial instruments between balance sheet dates, as well as gains and
losses associated with invested asset sales.
•Amortization of acquired intangible assets because these relate to costs
incurred for acquisitions.
•Results of transitioning clients, for periods prior to 2020, because those
results are not indicative of ongoing results.
•Special items, if any, that management believes are not representative of the
underlying results of operations due to the nature or size of these matters.
The term "Adjusted revenues" is defined as total revenues excluding the
following adjustments: revenue contribution from transitioning clients for
periods prior to 2020, special items and Cigna's share of certain realized
investment results of its joint ventures reported in the International Markets
segment using the equity method of accounting. We exclude these items from this
measure because management believes they are not indicative of past or future
underlying performance of the business.
.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements are
based on Cigna's current expectations and projections about future trends,
events and uncertainties. These statements are not historical facts.
Forward-looking statements may include, among others, statements concerning
future financial or operating performance, including our ability to deliver
affordable, personalized and innovative solutions for our customers and clients,
in light of the challenges presented by the COVID-19 pandemic; future growth,
business strategy, strategic or operational initiatives, including our
organizational efficiency plan; economic, regulatory or competitive
environments, particularly with respect to the pace and extent of change in
these areas; financing or capital deployment plans and amounts available for
future deployment; our prospects for growth in the coming years; strategic
transactions, including the merger ("Merger") with Express Scripts Holding
Company and the sale of our U.S.Group Disability and Life business; our ongoing
operational response to the COVID-19 pandemic; and other statements regarding
Cigna's future beliefs, expectations, plans, intentions, financial condition or
performance. You may identify forward-looking statements by the use of words
such as "believe," "expect," "plan," "intend," "anticipate," "estimate,"
"predict," "potential," "may," "should," "will" or other words or expressions of
similar meaning, although not all forward-looking statements contain such terms.
Forward-looking statements are subject to risks and uncertainties, both known
and unknown, that could cause actual results to differ materially from those
expressed or implied in forward-looking statements. Such risks and uncertainties
include, but are not limited to: our ability to achieve our financial, strategic
and operational plans or initiatives; our ability to predict and manage medical
and pharmacy costs and price effectively; our ability to adapt to changes or
trends in an evolving and rapidly changing industry; our ability to effectively
differentiate our products and services from those of our competitors and
maintain or increase market share; our ability to develop and maintain good
relationships with physicians, hospitals, other health care providers,
producers, consultants and pharmaceutical manufacturers; changes in the pharmacy
provider marketplace or pharmacy networks; changes in drug pricing; the impact
of modifications to our operations and processes; our ability to identify
potential strategic
51
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transactions and realize the expected benefits (including anticipated synergies)
of such transactions in full or within the anticipated time frame, including
with respect to the Merger and the sale of our Group Disability and Life
business, as well as our ability to integrate or separate operations, resources
and systems; the substantial level of government regulation over our business
and the potential effects of new laws or regulations or changes in existing laws
or regulations; the outcome of litigation, regulatory audits, investigations,
actions or guaranty fund assessments; uncertainties surrounding participation in
government-sponsored programs such as Medicare; the effectiveness and security
of our information technology and other business systems and those of our key
suppliers or other third parties; the impact of our debt service obligations on
the availability of funds for other business purposes; unfavorable industry,
economic or political conditions, including foreign currency movements; acts of
civil unrest, war, terrorism, natural disasters or pandemics; reinsurance credit
risk, the scale and scope of the COVID-19 pandemic and its potential impact on
our business, operating results, cash flows and financial condition, as well as
on our employees, clients, customers, suppliers and partners and on the U.S. and
global economies, as well as more specific risks and uncertainties discussed in
Part I, Item 1A - Risk Factors, as such Risk Factors are supplemented by
information contained in Part II, Item 1A of this Form 10-Q, and Part II, Item 7
- Management's Discussion and Analysis of Financial Condition and Results of
Operations of our 2019 Form 10-K and as described from time to time in our
future reports filed with the Securities and Exchange Commission (the "SEC").
You should not place undue reliance on forward-looking statements which speak
only as of the date they are made, are not guarantees of future performance or
results, and are subject to risks, uncertainties and assumptions that are
difficult to predict or quantify. Cigna undertakes no obligation to update or
revise any forward-looking statement, whether as a result of new information,
future events or otherwise, except as may be required by law.
EXECUTIVE OVERVIEW
Cigna Corporation , together with its subsidiaries (either individually or
collectively referred to as "Cigna," the "Company," "we," "our" or "us") is a
global health service organization with a mission of helping those we serve
improve their health, well-being and peace of mind. Our evolved strategy in
support of our mission is Go Deeper, Go Local, Go Beyond using a differentiated
set of pharmacy, medical, dental, disability, life and accident insurance and
related products and services offered by our subsidiaries. For further
information on our business and strategy, see Item 1, "Business" in our 2019
Form 10-K.
COVID-19 Update
The novel strain of coronavirus ("COVID-19") was declared a pandemic by the
World Health Organization in March 2020 because the virus had surfaced in nearly
all regions around the world. As the world fights the COVID-19 pandemic, Cigna
remains focused on delivering peace of mind during these unprecedented times. We
have taken several actions to drive affordability and reduce uncertainty for our
customers, increase flexibility for providers, support mental health in our
communities, and care for our colleagues around the world. To date, these
actions include:
Answering the Call for Affordability
Waived customer out-of-pocket costs, through May 31, 2020 , for COVID-19 related
to:
•diagnostic testing
?office visits for testing
?telehealth screenings (medical and dental)
?treatment
52
--------------------------------------------------------------------------------Ensuring Access to Care
•offered free standard shipping of up to 90-day supplies for prescription maintenance medications and 24/7 access to pharmacists. •deployed hundreds of Cigna clinicians to telehealth providerMDLIVE to increase virtual care capacity. •providedBuoy Health symptom checker customized for Cigna customers and Express Scripts members in theU.S. with next best action guides and multi-language symptom checker Infermedica for international customers. •maintained in-home medication infusions by Accredo nurses so vulnerable patients can avoid travel. •expanded ourEmployee Assistance Program services for Cigna customers and household members. •added a new furlough package that offers a prescription savings program (Inside Rx), a dental savings card, and more for customers.
Supporting the
•made it easier for hospitals to transfer COVID-19 patients to long-term acute care hospitals and subacute facilities. •waived prior authorizations for patient transfers, emergency department visits, and home health care services. •donated medications toWashington University for a COVID-19 treatment clinical trial.
Advocating for
•launched a social connector initiative for Medicare Advantage customers to help mitigate feelings of loneliness. •offered free on-demand webinars to the public to help manage fear and anxiety while building resiliency. •created a 24/7 toll-free help line to the public to speak with behavioral health clinicians. •established partnership withSilverCloud Health , a digital mental health platform for Express Scripts clients and members. •sent more than 5,000 greeting cards to seniors from our employees and their families.
Taking Care of Our Workforce
•allU.S. employees able to do so are working from home until further notice. •allotted 10 Emergency Time Off days for ourU.S. colleagues to use for COVID-19 related absences through 2020. •lifted the restriction on Paid Time Off being used before it is accrued, until further notice. •U.S.-based employees with worksite-essential roles receive a 20% pay premium. •created an employee-focused COVID-19 resource site on our Company's Intranet. •enhanced our employee recognition program.
Assisting Our Communities
Cigna and theCigna Foundation have: •launched the Brave ofHeart Fund with a$25 million grant to provide financial assistance to survivors of front-lineU.S. healthcare workers who gave their lives in the fight against COVID-19. The Fund was created in partnership with theNew York Life Foundation . Cigna will also provide emotional support services to their families. •committed over$1 million to nonprofits addressing food insecurity and health care support needs in theU.S. •donated$250 thousand towards relief efforts inChina during the earliest days of the outbreak. Going forward, we will continue to work with our clients, customers, providers and employees by expanding on the immediate support we have already implemented and by continuing partnerships with the goal of quickly adapting to how customers are accessing care during the pandemic. We have also taken actions to implement our business continuity plans over our operations. The Company is mitigating risk associated with prescription drug supply through our ability to operate and leverage purchasing volume across the pharmaceutical supply chain. These continuity plans have also impacted our employees and partners through global office closures, reductions in operating hours, travel restrictions, changes in operating 53 -------------------------------------------------------------------------------- procedures and enhancements for employees that cannot work remotely. We did not incur significant disruptions to our operations during the three months endedMarch 31, 2020 from COVID-19. As further discussed in Note 2 to the Consolidated Financial Statements, the effects of the COVID-19 pandemic began to emerge in theU.S. at the end of the first quarter of 2020 and were not material to our results for that period across all segments of our business. Additionally, discussion of the impact of COVID-19 on our investment portfolio and related considerations regarding our investment outlook can be found in Note 11 to the Consolidated Financial Statements and in the "Investment Assets" discussion of this MD&A, respectively. While it is difficult to quantify the impact of the COVID-19 pandemic on our results for the remainder of 2020 and beyond, we believe that such results may be impacted by, among other things, lower customer volumes due to rising unemployment levels and higher medical costs to treat those affected by the virus, offset by lower elective medical procedures. Additionally, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted onMarch 27, 2020 inthe United States . The impact of this new legislation was not material to the Company's financial results for the three months endedMarch 31, 2020 . The Company did not request any funding under the CARES Act. However, inApril 2020 the Company received$41 million from the provider relief fund, all of which has been returned to theU.S. Department of Health and Human Services . The Company has taken actions to enhance our liquidity that, combined with our other sources of liquidity described in the "Liquidity and Capital Resources Outlook" below, and our current projections for operating cash flows, we believe are sufficient to support our operations and meet our obligations.
The situation surrounding COVID-19 remains fluid, and we are actively managing our response and assessing impacts to our financial position and operating results, as well as adverse developments in our business.
For further information regarding the impact of COVID-19 on the Company, please see "Risk Factors" contained in Part I, Item 1A of the 2019 Form 10-K as such Risk Factors are supplemented by the information contained in Part II, Item 1A of this Form 10-Q. See Note 1 to the Consolidated Financial Statements for a description of our segments. Unless otherwise specified, the commentary provided below describes our results for the three months endedMarch 31, 2020 compared with the same period in 2019. 54 -------------------------------------------------------------------------------- Summarized below are certain key measures of our performance by segment for the three months endedMarch 31, 2020 and 2019: Financial highlights by segment Three Months Ended March 31, (Dollars in millions, except per share amounts) 2020 2019 %
Change
Revenues
Adjusted revenues by segment Health Services$ 27,168 $ 22,460 21% Integrated Medical 9,860 9,195 7 International Markets 1,470 1,394 5 Group Disability and Other 1,339 1,296
3
Corporate, net eliminations (1,445) (916) (58) Adjusted revenues 38,392 33,429 15 Revenue contribution from transitioning clients - 4,489
N/M
Net realized investment results from certain equity method investments (10) 28 N/M Special items 87 - N/M Total revenues$ 38,469 $ 37,946 1% Shareholders' net income$ 1,181 $ 1,368 (14)% Adjusted income from operations$ 1,758 $ 1,498 17% Earnings per share (diluted) Shareholders' net income$ 3.15 $ 3.56 (12)% Adjusted income from operations$ 4.69 $ 3.90
20%
Pre-tax adjusted income from operations by segment Health Services$ 1,082 $ 994 9% Integrated Medical 1,199 1,170 2 International Markets 282 206 37 Group Disability and Other 77 84
(8)
Corporate, net eliminations (405) (490)
17
Consolidated pre-tax adjusted income from operations 2,235 1,964
14
Adjustment for transitioning clients - 660
N/M
Income attributable to noncontrolling interests 9 5
80
Realized investment gains (losses) (98) 38
N/M
Amortization of acquired intangible assets (498) (743) 33 Special items (251) (136) (85) Income before income taxes$ 1,397 $ 1,788 (22)%
For further analysis and explanation of each segment's results, see the "Segment Reporting" section of this MD&A.
55
--------------------------------------------------------------------------------Consolidated Results of Operations (GAAP basis)
Three Months Ended
March 31,
(Dollars in millions) 2020 2019 % Change
Pharmacy revenues $ 25,098 $ 25,179 - %
Premiums 10,840 9,971 9
Fees and other revenues 2,178 2,450 (11)
Net investment income 353 346 2
Total revenues 38,469 37,946 1
Pharmacy and other service costs 24,190 24,050 1
Medical costs and other benefit expenses 8,322 7,620 9
Selling, general and administrative expenses 3,398 3,303 3
Amortization of acquired intangible assets 498 743 (33)
Total benefits and expenses 36,408 35,716 2
Income from operations 2,061 2,230 (8)
Interest expense and other (391) (452) 13
Debt extinguishment costs (185) - N/M
Net realized investment gains (losses) (88) 10 N/M
Income before income taxes 1,397 1,788 (22)
Total income taxes 208 416 (50)
Net income 1,189 1,372 (13)
Less: net income attributable to noncontrolling interests 8 4 100
Shareholders' net income $ 1,181 $ 1,368 (14) %
Consolidated effective tax rate 14.9 % 23.3 % (840) bps
Medical customers (in thousands)
Integrated Medical 15,552 15,421 1 %
International Markets 1,666 1,572 6
Total 17,218 16,993 1 %
Reconciliation of Shareholders' Net Income (GAAP) to Adjusted Income from Operations
Diluted Earnings Per
$ in millions Share
Three Months Ended Three Months Ended
March 31, March 31,
2020 2019 2020 2019
Shareholders' net income $ 1,181 $ 1,368 $ 3.15 $ 3.56 After-tax adjustments required to reconcile to adjusted income from operations Net realized investment (gains) losses
77 (38) 0.21 (0.10)
Amortization of acquired intangible assets 309 564 0.82 1.47
Adjustment for transitioning clients - (504) - (1.31)
Special items
Debt extinguishment costs 140 - 0.38 -
Integration and transaction-related costs 74 108 0.20 0.28
Charge for organizational efficiency plan 24 - 0.06 -
Charges associated with litigation matters 19 - 0.05 -
Contractual adjustment for a former client (66) - (0.18) -
Total special items 191 108 0.51 0.28
Adjusted income from operations $ 1,758 $ 1,498 $ 4.69 $ 3.90
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Commentary: Three Months Ended March 31, 2020 versus Three Months Ended March
31, 2019
Unless indicated otherwise, the commentary presented below, and in the segment
discussions that follow, compare results for the three months ended March 31,
2020 with results for the three months ended March 31, 2019 .
Earnings and Revenue
Shareholders' net income decreased, driven by the absence of 2019 earnings from
transitioning clients, costs associated with the debt tender and optional
redemption completed in March 2020 and realized investment losses, partially
offset by higher adjusted income from operations, lower amortization of acquired
intangibles and lower income taxes.
Adjusted income from operations increased, driven by higher earnings in the
Health Services, Integrated Medical and International Markets segments. Please
refer to the individual segment discussions below for further detail.
Medical customers increased primarily as a result of growth in the Select
segment, partially offset by declines in the National Accounts segment.
Pharmacy revenues increased, driven by growth in adjusted pharmacy script
volumes, including the insourcing of Integrated Medical pharmacy volumes. See
the Health Services segment discussion for further detail.
Premiums increased, primarily resulting from customer growth and rate increases.
Other Components of Consolidated Results of Operations
•Pharmacy and other service costs, see the Health Services segment discussion.
•Medical costs and other benefit expenses increased, primarily due to Integrated
Medical segment customer growth in the insured business as well as medical cost
inflation.
•Selling, general and administrative expenses increased, primarily due to the
health insurance industry tax in 2020 that had been suspended in 2019.
•Amortization of acquired intangible assets in 2020 primarily reflects lower
amortization of customer-related intangibles associated with the transitioning
clients.
•The consolidated effective tax rate declined, primarily due to recognizing
incremental federal and state tax benefits, partially offset by the return of
the nondeductible health insurance industry tax.
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Key Transactions and Business Developments
Merger with Express Scripts
As discussed in more detail in our 2019 Form 10-K, Cigna acquired Express
Scripts on December 20, 2018 in a cash and stock transaction valued at $52.8
billion . We continue to incur costs related to this transaction, including costs
to integrate the Cigna and Express Scripts operations. These costs are being
reported in "integration and transaction-related costs" as a special item and
excluded from adjusted income from operations because they are not indicative of
future underlying performance of the business.
On January 30, 2019 , Anthem exercised its early termination right and terminated
its pharmacy benefit management services agreement with us, effective March 1,
2019 . There was a twelve-month transition period that ended March 1, 2020 . We
excluded the results of Express Scripts' contract with Anthem (and also
Coventry) from our non-GAAP reporting metrics for 2019 "adjusted revenues" and
"adjusted income from operations" and refer to these clients as "transitioning
clients." As of December 31, 2019 , the transition was substantially complete;
therefore, beginning in 2020, we no longer exclude results of transitioning
clients from our reported adjusted revenues and adjusted income from operations.
Agreement to sell Group Disability and Life business
As discussed in Note 6 to the Consolidated Financial Statements, Cigna entered into a definitive agreement inDecember 2019 to sell theU.S. Group Disability and Life business to New York Life Insurance Company for$6.3 billion . The "Liquidity" section of this MD&A provides further discussion of the impact of this pending divestiture on our liquidity and capital resources.
Organizational Efficiency Plan
Consistent with our commitment to affordability for our customers and clients, during the fourth quarter of 2019 the Company committed to a plan to increase our organizational alignment and operational efficiency and reduce costs. As a result, we recognized a charge in selling, general and administrative expenses of$207 million , pre-tax ($162 million , after-tax) in the fourth quarter of 2019 and an additional charge of$31 million pre-tax ($24 million , after-tax) in the first quarter of 2020. We expect to realize annualized after-tax savings of approximately$200 million . A substantial portion of the savings is expected to be realized in 2020. See Note 15 to the Consolidated Financial Statements for discussion. Industry Developments and Other Matters Our 2019 Form 10-K provides a detailed description of The Patient Protection and Affordable Care Act ("ACA") provisions and other legislative initiatives that impact our health care and pharmacy services businesses, including regulations issued by theCenters for Medicare & Medicaid Services ("CMS") and the Departments of theTreasury andHealth and Human Services . The health care and pharmacy services businesses continue to operate in a dynamic environment, and the laws and regulations applicable to these businesses, including the ACA, continue to be subject to legislative, regulatory and judicial challenges. The following table provides an update on the expected impact of these items and other matters: 58 -------------------------------------------------------------------------------- Item Description
COVID-19-related In response to the COVID-19 public health emergency,
provided additional flexibility to industry participants. These regulatory
actions provide for, among other things, client and customer premium deferrals
of varying lengths to avoid the cancellation or non-renewal of policies;
mandating or requesting waiver of customer cost-share and other associated
costs related to COVID-19 testing or treatment, as well as future vaccine
immunizations; extending claims filing deadlines for providers, customers and
facilities; mandating or encouraging waiver of customer cost-share related to
telemedicine services, as well as requiring certain reimbursement levels for
telemedicine providers to encourage its utilization; enacting coverage and
reimbursement requirements at in-network levels for certain services received
from out-of-network providers; revising or suspending the use of certain
medical management procedures; and mandating prescription drug benefit
administration requirements related to, among other things, formulary
exceptions and restrictions, and prior authorization and prescription drug
refill limits. We are diligently working with federal, state and local
governments to deliver access to simple, affordable and predictable health care
and continue to monitor developments.Medicare Advantage MA Rates: Final MA reimbursement rates for 2021 were published by CMS in April ("MA")
2020. We do not expect the new rates to have a material impact on our
consolidated results of operations in 2021.
Risk Adjustment: As discussed in the "Regulation" and "Risk Factors" sections
of our 2019 Form 10-K, our MA business is subject to reviews, including risk
adjustment data validation ("RADV") audits by CMS and
the
Inspector General ("OIG"). We expect that CMS, OIG and other federal agencies
will continue to closely scrutinize components of the Medicare program.
The "Regulation" section of the 2019 Form 10-K also discusses a proposed rule
issued by CMS in 2018 for RADV audits of contract year 2011 and all subsequent
years that included, among other things, extrapolation of the error rate
related to RADV audit findings without applying the adjustment for underlying
fee-for-service data errors as currently contemplated by CMS' RADV audit
methodology. RADV audits for our contract years 2011 through 2015 are currently
in process. CMS has announced its intent to use third-party auditors to audit
all Medicare Advantage contracts by either a comprehensive or a targeted RADV
review for each contract year. If the proposed rule is adopted in its current
form, it could result in some combination of degraded plan benefits, higher
monthly premiums and reduced choice for the population served by all MA
insurers. The Company, along with other MA organizations and additional
interested parties, submitted comments to CMS on the proposed rule as part of
the notice-and-comment rulemaking process. The comment period concluded on
August 28, 2019 . If CMS adopts the rule as proposed,
there could be a material
impact on the Company's future results of operations, though we expect the rule
would be subject to legal challenges. In addition, the Company is subject to
OIG RADV audits that are in process. Certain CMS and OIG audit activities,
including the CMS RADV audit for contract year 2015 and two OIG targeted
reviews, have been suspended for an indeterminate amount of time as a result of
the COVID-19 public health emergency.
Also, as described in Note 19 to the Consolidated Financial Statements, the
U.S. Department of Justice is currently conducting an
industry-wide
investigation of risk adjustment data submission practices and business
processes, which in the case of certain other MA organizations has resulted in
litigation.
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Item Description
Public Health ACA Cost-Sharing Reduction Subsidies: The ACA provides for cost-sharing Exchanges
reductions that offset the amount that qualifying customers pay for deductibles,
copays and coinsurance. The federal government stopped funding insurers for the
cost-sharing reduction subsidies in 2017. Certain insurers have sued the federal
government for failure to pay cost-sharing reduction subsidies and the matter
remains unresolved. To date, judges in six of those actions have ruled in favor
of the insurers, all of which are presently under appeal. The Court of Appeals
for the Federal Circuit heard oral argument in the first set of consolidated
appeals on January 9, 2020 . As described in Note 19 to the Consolidated
Financial Statements, as a result of the Supreme Court
decision in
we filed a lawsuit in May against the federal government seeking payment of
these subsidies. Our premium rates for the 2019 and 2020 plan years reflected a
lack of government funding for cost-sharing reduction subsidies.
Affordable Care Act As described in the "Business - Regulation" section of our 2019 Form 10-K, a
federal district court ruled that the "individual mandate" in the ACA is
unconstitutional. On appeal, the Court of Appeals for the Fifth Circuit agreed
that the "individual mandate" is unconstitutional but ordered the district court
to reexamine whether the other provisions of the ACA can remain in effect,
thereby leaving in doubt whether the entire ACA is unconstitutional until there
is a final judicial determination on appeal. The U.S. House of Representatives filed petitions seeking
to appeal the Fifth
Circuit's ruling to the U.S. Supreme Court . On March 2, 2020, the Supreme Court
agreed to hear the appeals and we expect the case will be argued during the next
court term which runs from October 2020 through June 2021.
Risk Mitigation Programs - Individual ACA Business In 2016, we recorded an allowance for the balance of our ACA risk corridors receivable based on court decisions and the large program deficit. OnApril 27, 2020 , theU.S. Supreme Court ruled that insurers are entitled to the full amount due under the risk corridors program. TheSupreme Court remanded the cases before it to the lower courts for further proceedings consistent with its opinion. The decision does not order an immediate issuance of payment and the timing of any payments is unclear. As ofMarch 31, 2020 , the Company has$120 million in uncollected risk corridors payments. As described in Note 19 to the Consolidated Financial Statements, we filed a lawsuit inMay 2020 seeking payment of these funds. Following each program year, risk adjustment balances are subject to audit adjustment by CMS through the RADV program. RADV audits commenced with the 2017 benefit year. CMS published the final RADV transfers for the 2017 benefit year in 2019 along with guidance that the settlement will not take place until 2021. The 2018 benefit year data validation error rates are expected to be released by CMS inMay 2020 . Based on the information currently available, we adjust our risk adjustment balance to reflect the expected outcome of the RADV program. The following table presents our balances associated with the risk adjustment program and RADV audit adjustments as ofMarch 31, 2020 andDecember 31, 2019 . Net Receivable (Payable) Balance March 31, December 31, (In millions) 2020 2019 Risk Adjustment Receivables (1) $ 53$ 47 Payables (2) (234) (213) Total risk adjustment balance $ (181)$ (166) (1)Receivables, net of allowances, are reported in Accounts receivable,net in the Consolidated Balance Sheets. (2)Payables are reported in Accrued expenses and other liabilities (current) in the Consolidated Balance Sheets. 60 -------------------------------------------------------------------------------- Charges for the risk adjustment program, including any RADV adjustments, were$15 million pre-tax ($12 million after tax) for the three months endedMarch 31, 2020 compared with$40 million pre-tax ($30 million after tax) for the same period in 2019. LIQUIDITY AND CAPITAL RESOURCES Liquidity We maintain liquidity at two levels: the subsidiary level and the parent company level. Liquidity requirements at the subsidiary level generally consist of: •medical costs, pharmacy and other benefit payments; •expense requirements, primarily for employee compensation and benefits, information technology and facilities costs; •income taxes; and •debt service. Our subsidiaries normally meet their liquidity requirements by: •maintaining appropriate levels of cash, cash equivalents and short-term investments; •using cash flows from operating activities; •matching investment durations to those estimated for the related insurance and contractholder liabilities; •selling investments; and •borrowing from affiliates, subject to applicable regulatory limits. Liquidity requirements at the parent company level generally consist of: •debt service and dividend payments to shareholders; •lending to subsidiaries as needed; and •pension plan funding. The parent company normally meets its liquidity requirements by: •maintaining appropriate levels of cash and various types of marketable investments; •collecting dividends from its subsidiaries; •using proceeds from issuing debt and common stock; and •borrowing from its subsidiaries, subject to applicable regulatory limits. Dividends from our insurance,Health Maintenance Organization ("HMO") and foreign subsidiaries are subject to regulatory restrictions. See Note 20 to the Consolidated Financial Statements in our 2019 Form 10-K for additional information regarding these restrictions. Most of Express Scripts' subsidiaries are not subject to regulatory restrictions regarding dividends and therefore provide significant financial flexibility to Cigna. 61 --------------------------------------------------------------------------------
Cash flows for the three months ended
Three Months Ended March 31,
(In millions) 2020 2019
Operating activities $ 1,887 $ 3,192
Investing activities $ (269) $ 475
Financing activities $ (1,818) $ (2,534)
The following discussion explains variances in the various categories of cash
flows for the three months ended March 31, 2020 compared with the same period in
2019.
Operating activities
Cash flows from operating activities consist principally of cash receipts and
disbursements for pharmacy revenues and costs, premiums, fees, investment
income, taxes, benefit costs and other expenses.
Cash flows from operating activities decreased, primarily driven by absence of
2019 cash receipts from transitioning clients and higher inventory purchases in
the first quarter of 2020 partially offset by business growth in Health Services
and Integrated Medical.
Investing and Financing activities
Cash used in investing activities increased, primarily due to lower net
investment sales.
Cash used in finance activities decreased, primarily due to proceeds from
issuance of new debt coupled with lower short-term debt repayments, partially
offset by the debt tender and redemption payments.
We maintain a share repurchase program authorized by our Board of Directors.
Under this program, we may repurchase shares from time to time, depending on
market conditions and alternate uses of capital. The timing and actual number of
shares repurchased will depend on a variety of factors including price, general
business and market conditions and alternate uses of capital. The share
repurchase program may be effected through open market purchases or privately
negotiated transactions in compliance with Rule 10b-18 under the Securities
Exchange Act of 1934, as amended, including through Rule 10b5-1 trading plans.
The program may be suspended or discontinued at any time.
For the three months ended March 31, 2020 , we repurchased 5.4 million shares for
approximately $980 million . From April 1, 2020 through April 30, 2020 we
repurchased 475,000 shares for approximately $79 million . Share repurchase
authority was $2.9 billion as of April 30, 2020 .
Capital Resources
Our capital resources (primarily cash flows from operating activities and
proceeds from the issuance of debt and equity securities) provide protection for
policyholders, furnish the financial strength to underwrite insurance risks and
facilitate continued business growth.
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In December 2019 , Cigna entered into a definitive agreement to sell the U.S.
Group Disability and Life business to New York Life Insurance Company for $6.3
billion . The sale is expected to close by the third quarter of 2020 subject to
applicable regulatory approvals and other customary closing conditions. Cigna
estimates to receive approximately $5.3 billion of net after-tax proceeds from
this transaction and expects to use these proceeds for share repurchase and
repayment of debt in 2020.
In 2018, Cigna entered into a five-year revolving credit agreement and term loan
credit agreement in financing the Express Scripts acquisition. Cigna had
immaterial letters of credit outstanding under the revolving credit agreement as
of March 31, 2020 . The term loan was repaid in full and the agreement was
terminated in the fourth quarter of 2019. In the fourth quarter of 2019, Cigna
entered into an additional 364-day revolving credit agreement that matures in
October 2020 .
On April 1, 2020 , the Company borrowed an aggregate principal amount of $1.4
billion under a new 364-Day term loan credit agreement. The Company entered into
this agreement to further enhance its liquidity position in light of disruption
in the commercial paper market and used a portion of the proceeds to pay down
amounts outstanding under its commercial paper facility. See Note 8 to the
Consolidated Financial Statements for further information on our credit
agreements.
At March 31, 2020 , our debt-to-capitalization ratio was 44.7%, a decline from
45.2% at December 31, 2019 . We have a near-term focus on accelerated debt
repayment and expect to continue to deleverage into the upper 30%s by the end of
2020 using cash flows from operating activities and a portion of the proceeds
from the sale of the Group Disability and Life business.
Management, guided by regulatory requirements and rating agency capital
guidelines, determines the amount of capital resources that we maintain.
Management allocates resources to new long-term business commitments when
returns, considering the risks, look promising and when the resources available
to support existing business are adequate.
We prioritize our use of capital resources to:
•provide the capital necessary to support growth and maintain or improve the
financial strength ratings of subsidiaries and to fund pension obligations;
•consider acquisitions that are strategically and economically advantageous; and
•return capital to investors primarily through share repurchases.
Our capital management strategy to support the liquidity and regulatory capital
requirements of our foreign operations and certain international growth
initiatives is to retain overseas a significant portion of the earnings
generated by our foreign operations. This strategy does not materially limit our
ability to meet our liquidity and capital needs in the United States .
Liquidity and Capital Resources Outlook
We maintain sufficient liquidity to meet our cash needs through our cash and
cash equivalents balances, cash flows from operations, commercial paper program,
credit agreements, and the issuance of long-term debt. As of March 31, 2020 , we
had $4.25 billion of undrawn committed capacity under our revolving credit
agreements, $2.5 billion of remaining capacity under our commercial paper
program, and approximately $4.8 billion in cash and short-term investments,
approximately $1.6 billion of which was held by the parent company or certain
nonregulated subsidiaries. We actively monitor our debt obligations and engage
in issuance or redemption activities as needed in
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--------------------------------------------------------------------------------accordance with our capital management strategy. A description of our outstanding debt can be found in Note 8 to the Consolidated Financial Statements.
We currently expect the required contributions for 2020 and 2021 under the Pension Protection Act of 2006 to be immaterial. See Note 16 to the Consolidated Financial Statements for additional information regarding our pension plans.
Our cash projections may not be realized and the demand for funds could exceed available cash if our ongoing businesses experience unexpected shortfalls in earnings or we experience material adverse effects from one or more risks or uncertainties described more fully in the Risk Factors section of our 2019 Form 10-K and Part II, Item 1A of this Form 10-Q. Though we believe we have adequate sources of liquidity, significant disruption or volatility in the capital and credit markets could affect our ability to access those markets for additional borrowings or increase costs. In addition to the sources of liquidity discussed above, the parent company can borrow an additional$680 million from its insurance subsidiaries without further state approval. Guarantees and Contractual Obligations We are contingently liable for various contractual obligations entered into in the ordinary course of business. See Note 19 to the Consolidated Financial Statements for discussion of various guarantees. We have updated long-term debt obligations as ofMarch 31, 2020 previously provided in our 2019 Form 10-K. There have been no material changes to the other information presented in our table of guarantees and contractual obligations as set forth in our 2019 Form 10-K. (In millions, on an Less than 1 1-3 4-5 After 5 undiscounted basis) Total year (1) years years years On-Balance Sheet Long-term debt(1) 52,971 4,896 6,573 7,110 34,392 (1)Amounts reflect cash obligations for the remainder of 2020 and include scheduled interest payments and current maturities of long-term debt. Finance leases are included in long-term debt and primarily represent obligations for information technology network storage, servers and equipment. See Note 17 to the Consolidated Financial Statements for information regarding finance leases. Amounts do not include payments for the$1.4B term loan entered into onApril 1, 2020 . See Note 8 to the Consolidated Financial Statements for information regarding our long-term debt. CRITICAL ACCOUNTING ESTIMATES The preparation of Consolidated Financial Statements in accordance with GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures in the Consolidated Financial Statements. Management considers an accounting estimate to be critical if: •it requires assumptions to be made that were uncertain at the time the estimate was made; and •changes in the estimate or different estimates that could have been selected could have a material effect on our consolidated results of operations or financial condition. Management has discussed how critical accounting estimates are developed and selected with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosures presented in our 2019 Form 10-K. We regularly evaluate items that may impact critical accounting estimates. Our most critical accounting estimates, as 64 -------------------------------------------------------------------------------- well as the effect of hypothetical changes in material assumptions used to develop each estimate, are described in the 2019 Form 10-K. As ofMarch 31, 2020 , other than as follows, there were no significant changes to the critical accounting estimates from what was reported in our 2019 Form 10-K. Balance Sheet Caption / Nature of Critical Accounting Effect if Different Assumptions Used Estimate Assessment of unrealized losses on debt securities Certain debt securities with a fair value below amortized If we subsequently determine that the cost are carried at fair value with changes in fair value excess of amortized cost over fair value recorded in Accumulated other comprehensive income. For is due to credit loss for any or all of these investments, we have determined that the decline in these debt securities, the amount fair value below its amortized cost is not due to credit recorded in Accumulated other concerns. To make this determination, we evaluate the comprehensive income would be expected recovery in value and our intent to sell or the reclassified to shareholders' net income likelihood of a required sale of the debt security prior as credit loss expense. to an expected recovery. In making this evaluation, we consider a number of general and specific factors including the regulatory, economic and market environments, severity of the decline, and the financial health and specific near term prospects of the issuer. The after-tax amounts as ofMarch 31 in Accumulated other comprehensive income for debt securities in an unrealized loss position were as follows (in millions): March 31, 2020 - ($350 )
See Note 11 to the Consolidated Financial Statements for
additional discussion of our review of declines in fair
value, including information regarding our accounting
policies for debt securities, which were updated to
reflect our adoption of ASU 2016-13 as of
SEGMENT REPORTING
The following section of this MD&A discusses the results of each of our
segments. See Note 1 to the Consolidated Financial Statements for a description
of our segments.
In segment discussions, we present adjusted revenues and "pre-tax adjusted
income from operations," defined as income before taxes excluding realized
investment gains (losses), amortization of acquired intangible assets, special
items and, for periods prior to 2020, results of transitioning clients. Ratios
presented in this segment discussion exclude the same items as pre-tax adjusted
income from operations. See Note 20 to the Consolidated Financial Statements for
additional discussion of these metrics and a reconciliation of income before
income taxes to pre-tax adjusted income from operations, as well as a
reconciliation of total revenues to adjusted revenues. Note 20 to the
Consolidated Financial Statements also explains that segment revenues include
both external revenues and sales between segments that are eliminated in
Corporate.
In these segment discussions, we also present "pre-tax adjusted margin," defined
as pre-tax adjusted income from operations divided by adjusted revenues.
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Health Services Segment
The Health Services segment includes pharmacy benefit management, specialty
pharmacy services, clinical solutions, home delivery and health management
services. As described in the introduction to Segment Reporting, performance of
the Health Services segment is measured using pre-tax adjusted income from
operations.
The key factors that impact Health Services revenues and costs of revenues are
volume, mix of claims and price. These key factors are discussed further below.
See Note 2 to the Consolidated Financial Statements included in our 2019 Form
10-K for additional information on revenue and cost recognition policies for
this segment.
•As our clients' claim volumes increase or decrease, our resulting revenues and
cost of revenues correspondingly increase or decrease. Our gross profit could
also increase or decrease as a result of changes in purchasing discounts.
•The mix of claims generally considers the type of drug and distribution method
used for dispensing and fulfilling. As our mix of drugs changes, our resulting
pharmacy revenues and cost of revenues correspondingly may increase or decrease.
The primary driver of fluctuations within our mix of claims is the generic fill
rate. Generally, higher generic fill rates reduce revenues, as generic drugs are
typically priced lower than the branded drugs they replace. However, as
ingredient cost paid to pharmacies on generic drugs is incrementally lower than
the price charged to our clients, higher generic fill rates generally have a
favorable impact on our gross profit. The home delivery generic fill rate is
currently lower than the network generic fill rate as fewer generic
substitutions are available among maintenance medications (such as therapies for
chronic conditions) commonly dispensed from home delivery pharmacies as compared
to acute medications that are primarily dispensed by pharmacies in our retail
networks.
•Our client contract pricing is impacted by our ongoing ability to negotiate
supply chain contracts for pharmacy network, pharmaceutical and wholesaler
purchasing, and manufacturer rebates. As we seek to improve the effectiveness of
our integrated solutions for the benefit of our clients, we are continuously
innovating and optimizing the supply chain. Our gross profit could also increase
or decrease as a result of supply chain initiatives implemented. Inflation also
impacts our pricing because most of our contracts provide that we bill clients
and pay pharmacies based on a generally recognized price index for
pharmaceuticals. Therefore, the rate of inflation for prescription drugs and our
efforts to manage this inflation for our clients can affect our revenues and
cost of revenues.
In this MD&A, we present revenues and gross profit, as well as adjusted revenues
and adjusted gross profit, consistent with our segment reporting metrics, which
exclude special items and, for periods prior to 2020, contributions from
transitioning clients. As of December 31, 2019 , the transition of these clients
was substantially complete; therefore, beginning in 2020, we no longer exclude
results of transitioning clients from our adjusted revenues, pre-tax adjusted
income from operations, and pre-tax adjusted margin. See the "Key Transactions
and Business Developments" section of our 2019 Form 10-K MD&A for further
discussion of transitioning clients and why we present this information.
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Results of Operations
Three Months Ended
Financial Summary March 31, Change Favorable
(In millions) 2020 2019 (Unfavorable)
Total revenues $ 27,255 $ 26,949 1 %
Less: transitioning clients - (4,489) N/M
Less: contractual adjustment for a former client $ (87) $ - N/M
Adjusted revenues(1) $ 27,168 $ 22,460 21 %
Gross profit $ 1,701 $ 2,114 (20) %
Adjusted gross profit(1) $ 1,614 $ 1,396 16 %
Pre-tax adjusted income from operations $ 1,082 $ 994 9 %
Pre-tax adjusted margin 4.0 % 4.4 % (40) bps
Three Months Ended
March 31, Change Favorable
(Dollars and adjusted scripts in millions) 2020 2019 (Unfavorable)
Selected Financial Information(1)
Pharmacy revenue by distribution channel
Adjusted network revenues $ 12,791 $ 9,268 38 %
Adjusted home delivery and specialty revenues 12,005 11,041 9 %
Other revenues 1,242 1,122 11 %
Total adjusted pharmacy revenues $ 26,038 $ 21,431 21 %
Pharmacy script volume
Adjusted network scripts(2) 288 222 30 %
Adjusted home delivery and specialty
scripts(2) 72 70 3 %
Total adjusted scripts(2) 360 292 23 %
Generic fill rate
Network 88.2 % 87.8 % 40 bps
Home delivery 84.8 % 84.4 % 40 bps
Overall generic fill rate 87.9 % 87.4 % 50 bps
(1)Amounts exclude special items and, for periods prior to 2020, contributions
from transitioning clients.
(2)Non-specialty network scripts filled through 90-day programs and home
delivery scripts are multiplied by three. All other network and specialty
scripts are counted as one script.
Three Months Ended March 31, 2020 versus Three Months Ended March 31, 2019
In the third quarter of 2019, Integrated Medical's Commercial customers
transitioned to Express Scripts' retail pharmacy network. In the first quarter
of 2020, Integrated Medical's Government customers transitioned to Express
Scripts' retail pharmacy network.
Adjusted network revenues. The increase reflected the transition of Integrated
Medical's customers; higher prices, primarily due to increased inflation on
branded drugs; and higher claims volume. This increase was partially offset by
claims mix, due to the increase in the generic fill rate.
Adjusted home delivery and specialty revenues. The increase reflected higher
prices, primarily due to an increase in inflation on branded drugs; higher
claims volume, primarily due to higher home delivery and specialty claims
volume; and claims mix, primarily due to an increase in specialty pharmacy care
partially offset by an increase in the generic fill rate.
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--------------------------------------------------------------------------------Adjusted gross profit. The increase reflected customer growth, higher adjusted pharmacy scripts volumes, specialty pharmacy care and benefits from the effective management of supply chain.
Pre-tax adjusted income from operations. The increase reflected customer growth, higher adjusted pharmacy scripts volumes, specialty pharmacy care and benefits from the effective management of supply chain, partially offset by an increase in operating expenses. Integrated Medical Segment Integrated Medical consists of a Commercial operating segment that includes our employer-sponsored medical coverage and a Government operating segment that includes Medicare offerings for seniors and individual insurance offerings both on and off the public health insurance exchanges. As described in the introduction to Segment Reporting, performance of the Integrated Medical segment is measured using pre-tax adjusted income from operations. Key factors affecting profitability for this segment include: •customer growth; •revenues from integrated specialty products, including pharmacy services sold to clients and customers across all funding solutions; •percentage of Medicare Advantage customers in plans eligible for quality bonus payments; •benefit expenses as a percentage of premiums (medical care ratio or "MCR") for our insured commercial and government businesses; and •selling, general and administrative expense as a percentage of adjusted revenues (expense ratio). Results of Operations Financial Summary Three Months Ended March 31, Change Favorable (In millions) 2020 2019 (Unfavorable) Adjusted revenues$ 9,860 $ 9,195 7 % Pre-tax adjusted income from operations$ 1,199 $ 1,170 2 % Pre-tax adjusted margin 12.2 % 12.7 % (50) bps Medical care ratio 78.3 % 78.9 % 60 bps Expense ratio 21.8 % 22.2 % 40 bps As of March 31, (In thousands) 2020 2019 % Change Integrated Medical Customers Commercial 2,133 1,991 7 % Government 1,412 1,405 - % Insured 3,545 3,396 4 % Service 12,007 12,025 - % Total 15,552 15,421 1 % As of March 31, As of December (In millions) 2020 31, 2019 % Change
Unpaid claims and claim expenses - Integrated Medical
$ 2,892 4 % 68 -------------------------------------------------------------------------------- Three Months EndedMarch 31, 2020 versus Three Months EndedMarch 31, 2019 Adjusted revenues. The increase for the three months endedMarch 31, 2020 compared with the same period in 2019 reflects customer growth in our Commercial Risk and Medicare Advantage businesses, as well as higher premium rates due to underlying medical cost trend and the resumption of the health insurance industry tax. Pre-tax adjusted income from operations. The increase for the three months endedMarch 31, 2020 compared with the same period in 2019 reflects increased contribution from our Commercial Risk business and specialty products, partially offset by lower margins in our Individual and Medicare businesses. Medical care ratio. The medical care ratio decreased for the three months endedMarch 31, 2020 compared with the same period in 2019, primarily reflecting the return of the health insurance industry tax and reduced utilization late in the quarter, partially offset by the impact of an additional calendar day in the first quarter of 2020 as compared to 2019. Expense ratio. The expense ratio decreased for the three months endedMarch 31, 2020 compared with the same period in 2019, reflecting higher risk revenues due to customer growth and the resumption of the health insurance industry tax. Other Items Affecting Integrated Medical Results Unpaid Claims and Claim Expenses Our unpaid claims and claim expenses liability was higher as ofMarch 31, 2020 compared withDecember 31, 2019 , primarily due to seasonality in our stop loss products. Medical Customers Our medical customer base was higher atMarch 31, 2020 compared with the same period in 2019, primarily reflecting growth in our Select and Middle Market segments partially offset by a lower customer base in our National Accounts. A medical customer is defined as a person meeting any one of the following criteria: •is covered under a medical insurance policy, managed care arrangement or service agreement issued by us; •has access to our provider network for covered services under their medical plan; or •has medical claims that are administered by us. International Markets Segment As described in the introduction to Segment Reporting, performance of the International Markets segment is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations for this segment are: 69 -------------------------------------------------------------------------------- •premium growth, including new business and customer retention; •benefit expenses as a percentage of premiums (loss ratio); •selling, general and administrative expense and acquisition expense as a percentage of revenues (expense ratio and acquisition cost ratio); and •the impact of foreign currency movements. Results of Operations Financial Summary Three Months Ended March 31, Change Favorable (In millions) 2020 2019 (Unfavorable) Adjusted revenues$ 1,470 $ 1,394 5 % Pre-tax adjusted income from operations $ 282$ 206 37 % Pre-tax adjusted margin 19.2 % 14.8 % 440 bps Loss ratio 57.8 % 57.2 % (60) bps Acquisition cost ratio 9.1 % 12.3 % 320 bps Expense ratio (excluding acquisition costs) 17.4 % 19.1 % 170 bps Three Months EndedMarch 31, 2020 versus Three Months EndedMarch 31, 2019 Adjusted revenues increased mainly due to business growth inAsia andEurope , partially offset by unfavorable foreign currency movements. Pre-tax adjusted income from operations increased due to lower acquisition and expense ratios and business growth primarily inAsia , partially offset by higher benefit expenses and unfavorable foreign currency movements. The segment's loss ratio was less favorable due to higher claims inAsia . The acquisition cost ratio decreased reflecting an update to our commission deferral process, partially offset by higher amortization inAsia . The decrease in the expense ratio (excluding acquisition costs) was driven by lower spend across markets. Other Items Affecting International Markets ResultsSouth Korea is the single largest geographic market for our International Markets segment. For the three months endedMarch 31, 2020 ,South Korea generated 37% of the segment's adjusted revenues and 63% of the segment's pre-tax adjusted income from operations. 70 -------------------------------------------------------------------------------- Group Disability and Other As described in the introduction of Segment Reporting, performance of Group Disability and Other is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations are: •premium growth, including new business and customer retention; •net investment income; •benefit expenses as a percentage of premiums (loss ratio); and •selling, general and administrative expense as a percentage of revenues excluding net investment income (expense ratio). Results of Operations Financial Summary Three Months Ended March 31, Change Favorable (In millions) 2020 2019 (Unfavorable) Adjusted revenues$ 1,339 $ 1,296 3 % Pre-tax adjusted income from operations $ 77$ 84 (8) % Pre-tax adjusted margin 5.8 % 6.5 % (70) bps
Three Months Ended
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--------------------------------------------------------------------------------Corporate
Corporate reflects amounts not allocated to operating segments, including net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment and other operations), certain litigation matters, expense associated with our frozen pension plans, charitable contributions, severance, certain overhead and project costs and intersegment eliminations for products and services sold between segments. Financial Summary Three Months Ended March 31, Change Favorable
(Unfavorable)
(In millions) 2020 2019 Pre-tax adjusted loss from operations$ (405) $ (490) 17 %
Three Months Ended
INVESTMENT ASSETS The following table presents our investment asset portfolio excluding separate account assets as ofMarch 31, 2020 andDecember 31, 2019 . Additional information regarding our investment assets is included in Notes 11, 12, 13 and 14 to the Consolidated Financial Statements. (In millions) March 31, 2020 December 31, 2019 Debt securities$ 22,573 $ 23,755 Equity securities 347 303 Commercial mortgage loans 1,935 1,947 Policy loans 1,344 1,357 Other long-term investments 2,735 2,403 Short-term investments 306 423 Total$ 29,240 $ 30,188 Investments classified as assets of business held for sale (1)$ (7,659) $ (7,709) Investments per Consolidated Balance Sheets $
21,581 $ 22,479
(1) The table above includes$7.7 billion as ofMarch 31, 2020 andDecember 31, 2019 of investments associated with theU.S. Group Disability and Life business that are held for sale toNew York Life . Under the terms of the definitive agreement, some of the assets currently associated with the Group Disability and Life business can be substituted for other assets. The assets that will transfer toNew York Life will be primarily debt securities and, to a lesser extent, commercial mortgage loans and short-term investments.Debt Securities Investments in debt securities include publicly-traded and privately-placed bonds, mortgage and other asset-backed securities and preferred stocks redeemable by the investor. These investments are classified as available for sale and are carried at fair value on our balance sheet. Additional information regarding valuation methodologies, key inputs and controls is included in Note 12 to the Consolidated Financial Statements. More detailed information about debt securities by type of issuer and maturity dates is included in Note 11 to the Consolidated Financial Statements. 72 --------------------------------------------------------------------------------
The following table reflects our portfolio of debt securities by type of issuer
as of
March 31, December 31,
(In millions) 2020 2019
Federal government and agency $ 627 $ 733
State and local government 777 810
Foreign government 2,178 2,256
Corporate 18,503 19,420
Mortgage and other asset-backed 488 536
Total $ 22,573 $ 23,755
Our debt securities portfolio decreased during the three months of 2020
reflecting a decrease in valuations due to increases in yields, net sales and
maturities and decreases in foreign exchange rates. The increase in yields are a
result of spread widening at the end of March due to growing concerns related to
COVID-19 and its related economic impacts. As of March 31, 2020 , $20.3 billion ,
or 90% of the debt securities in our investment portfolio were investment grade
(Baa and above, or equivalent) and the remaining $2.2 billion were below
investment grade. The majority of the bonds that are below investment grade are
rated at the higher end of the non-investment grade spectrum. These quality
characteristics have not materially changed from the prior year and are
consistent with our investment strategy. Investments in debt securities are
diversified by issuer, geography and industry as appropriate.
Foreign government obligations are concentrated in Asia , primarily South Korea ,
consistent with our risk management practice and local regulatory requirements
of our international business operations. Corporate debt securities include
private placement assets of $7.2 billion . These investments are generally less
marketable than publicly-traded bonds; however yields on these investments tend
to be higher than yields on publicly-traded bonds with comparable credit risk.
We perform a credit analysis of each issuer and require financial and other
covenants that allow us to monitor issuers for deteriorating financial strength
and pursue remedial actions, if warranted.
In addition to amounts classified as debt securities in our Consolidated Balance
Sheets, we participate in an insurance joint venture in China with a 50%
ownership interest. This entity had an investment portfolio of approximately
$8.5 billion supporting its business that is primarily invested in Chinese
corporate and government debt securities. We account for this joint venture on
the equity method of accounting and report it in Other assets. There were no
investments with a material unrealized loss as of March 31, 2020 .
Commercial Mortgage Loans
Our commercial mortgage loans are fixed rate loans, diversified by property
type, location and borrower. Loans are secured by high quality commercial
properties and are generally made at less than 65% of the property's value at
origination of the loan. Property value, debt service coverage, quality,
building tenancy and stability of cash flows are all important financial
underwriting considerations. We hold no direct residential mortgage loans and do
not originate or service securitized mortgage loans.
Commercial real estate capital markets were very active for well-leased, quality
commercial real estate located in strong institutional investment markets
through much of the first quarter. The vast majority of properties securing the
mortgages in our mortgage loan portfolio possess these characteristics. Real
estate market activity has been negatively impacted by COVID-19 with
concentrated weakness in hotels and regional malls, however our mortgage loan
portfolio is well-diversified by property type and geography with no material
exposure to hotels. The Company has no commercial mortgage loan exposure to
regional malls.
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As of March 31, 2020 , the $1.9 billion commercial mortgage loan portfolio
consisted of approximately 65 loans that are in good standing. Given the quality
and diversity of the underlying real estate, positive debt service coverage and
significant borrower cash investment generally ranging between 30 and 40%, we
remain confident that the vast majority of borrowers will continue to perform as
expected under their contract terms.
Other Long-term Investments
Other long-term investments of $2.7 billion as of March 31, 2020 included
investments in securities limited partnerships and real estate limited
partnerships, as well as direct investments in real estate joint ventures. These
entities typically invest in mezzanine debt or equity of privately-held
companies (securities partnerships) and equity real estate. Given our
subordinate position in the capital structure of these underlying entities, we
assume a higher level of risk for higher expected returns. To mitigate risk,
these investments are diversified across approximately 175 separate partnerships
and approximately 90 general partners who manage one or more of these
partnerships. Also, the underlying investments are diversified by industry
sector or property type and geographic region. No single partnership investment
exceeded 4% of our securities and real estate partnership portfolio.
The increase in other long-term investments is largely driven by net new funding
to limited partnerships and real estate joint ventures, as well as increases in
value of the investments held by these entities. Income from these investments
is generally reported on a one quarter lag due to the timing of when financial
information is received from the general partner or manager of the investments.
As a result of the economic impacts of COVID-19, we expect to recognize declines
in values during 2020. The magnitude of the declines could be significant,
depending in part on the length and extent of the economic shutdown, the speed
of the recovery, and the overall economic impacts.
Problem and Potential Problem Investments
"Problem" bonds and commercial mortgage loans are either delinquent by 60 days
or more or have been restructured as to terms, including concessions by us for
modification of interest rate, principal payment or maturity date. "Potential
problem" bonds and commercial mortgage loans are considered current (no payment
is more than 59 days past due), but management believes they have certain
characteristics that increase the likelihood that they may become problems.
The amount of problem or potential problem investments as of March 31, 2020 and
December 31, 2019 was not material.
Investment Outlook
Public equity markets achieved new highs during the first quarter, reflecting
the continued strength of the U.S. economy. However, concerns related to
COVID-19 and its related economic impacts have driven significant declines and
elevated volatility in U.S. public equity markets since mid-February. Fixed
income markets have been impacted as well, with a significant decline in
Treasury rates more than offset by an increase in credit spreads as a result of
investor uncertainty related to the severity and duration of the recession that
has since unfolded. We continue to actively monitor the economic impact of the
pandemic, as well as fiscal and monetary responses, and their potential impact
on the portfolio. We expect continued market volatility and portfolio impacts,
particularly in certain sectors such as retail, hospitality and energy, as well
as other areas most severely impacted by COVID-19 and the related shutdowns.
Future realized and unrealized investment results will be driven largely by
market conditions that exist when a transaction occurs or at the reporting date.
These future conditions are not reasonably predictable; however, we believe that
the vast majority of our investments will continue to perform under their
contractual terms. Based on our strategy to match the duration of invested
assets to the duration of insurance and contractholder liabilities, we expect to
hold a significant portion of these assets for the long term. Although future
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--------------------------------------------------------------------------------impairment losses resulting from interest rate movements and credit deterioration due to both investment-specific and the global economic uncertainties discussed above remain possible, we do not expect these losses to have a material adverse effect on our financial condition or liquidity.
MARKET RISK Financial Instruments Our assets and liabilities include certain financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. Our primary market risk exposures are interest rate risk and foreign currency exchange rate risk. We encourage you to read this in conjunction with "Market Risk - Financial Instruments" included in the MD&A section of our 2019 Form 10-K. Given the transactions in our long term-debt further described in Note 8 to the Consolidated Financial Statements, in the event of a 100 basis point increase in interest rates, the fair value of the Company's long-term debt would decrease approximately$2.7 billion atMarch 31, 2020 , compared to approximately$2.5 billion atDecember 31, 2019 . Other than this, there were no material changes in our risk exposures from those reported in our 2019 Form 10-K.
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