Edgar Filing: CIGNA CORP

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the transition period from to

Commission file number 1-08323

Cigna Corporation

(Exact name of registrant as specified in its charter)

Delaware		06-1059331
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
900 Cottage Grove Road Bloomfield, Connecticut		06002
(Address of principal executive offices)		(Zip Code)
(860) 226-6000
Registrant’s telephone number, including area code
(860) 226-6741
Registrant’s facsimile number, including area code
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark				YES	NO
· whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.				R	o
· whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).				R	o
· whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer R	Accelerated filer o	Non-accelerated filer o	Smaller Reporting Company o
· whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).				o	R

As of July 15, 2016, 256,570,151 shares of the issuer’s common stock were outstanding.

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Cigna Corporation

INDEX


PART I	FINANCIAL INFORMATION	Page

Item 1.	Financial Statements (Unaudited)
	Consolidated Statements of Income	1
	Consolidated Statements of Comprehensive Income	2
	Consolidated Balance Sheets	3
	Consolidated Statements of Changes in Total Equity	4
	Consolidated Statements of Cash Flows	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	63
Item 4.	Controls and Procedures	64


PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	65
Item 1.A.	Risk Factors	66
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	67
Item 4.	Mine Safety Disclosures	67
Item 6.	Exhibits	68
SIGNATURE		69
INDEX TO EXHIBITS		E-1

As used herein, “Cigna” or the “Company” refers to one or more of Cigna Corporation and its consolidated subsidiaries.

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Part I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

Cigna Corporation

Consolidated Statements of Income

	Unaudited Three Months Ended June 30,				Unaudited Six Months Ended June 30,
(In millions, except per share amounts)	2016		2015		2016		2015
Revenues
Premiums	$	7,654	$	7,432	$	15,400	$	14,834
Fees and other revenues	1,197		1,117		2,398		2,255
Net investment income	294		297		566		573
Mail order pharmacy revenues	748		625		1,445		1,203
Realized investment gains (losses):
Other than temporary impairments on debt securities	(3)		(10)		(30)		(15)
Other realized investment gains, net	70		31		65		109
Net realized investment gains	67		21		35		94
Total revenues	9,960		9,492		19,844		18,959

Benefits and Expenses
Global Health Care medical costs	4,777		4,577		9,538		9,181
Other benefit expenses	1,414		1,199		2,782		2,468
Mail order pharmacy costs	630		529		1,204		1,021
Other operating expenses	2,289		2,212		4,610		4,416
Amortization of other acquired intangible assets, net	37		39		78		83
Total benefits and expenses	9,147		8,556		18,212		17,169
Income before Income Taxes	813		936		1,632		1,790
Income taxes (benefits):
Current	338		375		632		683
Deferred	(28)		(23)		(17)		(8)
Total income taxes	310		352		615		675
Net Income	503		584		1,017		1,115
Less: Net (Loss) Attributable to Noncontrolling Interests	(7)		(4)		(12)		(6)
Shareholders’ Net Income	$	510	$	588	$	1,029	$	1,121
Shareholders’ Net Income Per Share:
Basic	$	2.00	$	2.30	$	4.03	$	4.38
Diluted	$	1.97	$	2.26	$	3.97	$	4.30
Dividends Declared Per Share	$	-	$	-	$	0.04	$	0.04

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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Cigna Corporation

Consolidated Statements of Comprehensive Income

	Unaudited Three Months Ended June 30,				Unaudited Six Months Ended June 30,
(In millions)	2016		2015		2016		2015
Shareholders’ net income	$	510	$	588	$	1,029	$	1,121
Shareholders’ other comprehensive income (loss):
Net unrealized appreciation (depreciation), securities	177		(234)		350		(146)
Net unrealized appreciation (depreciation), derivatives	(1)		5		(4)		12
Net translation of foreign currencies	(40)		18		41		(86)
Postretirement benefits liability adjustment	8		20		19		31
Shareholders’ other comprehensive income (loss)	144		(191)		406		(189)
Shareholders’ comprehensive income	654		397		1,435		932
Comprehensive income (loss) attributable to noncontrolling interests:
Net (loss) attributable to redeemable noncontrolling interests	(2)		(1)		(3)		(1)
Net (loss) attributable to other noncontrolling interests	(5)		(3)		(9)		(5)
Other comprehensive income (loss) attributable to redeemable noncontrolling interests	(1)		(3)		2		(12)
Total comprehensive income	$	646	$	390	$	1,425	$	914

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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Cigna Corporation

Consolidated Balance Sheets

	Unaudited
	As of		As of
	June 30,		December 31,
(In millions, except per share amounts)	2016		2015
Assets
Investments:
Fixed maturities, at fair value (amortized cost, $18,745; $18,456)	$	20,538	$	19,455
Equity securities, at fair value (cost, $184; $190)	181		190
Commercial mortgage loans	1,814		1,864
Policy loans	1,442		1,419
Other long-term investments	1,419		1,404
Short-term investments	469		381
Total investments	25,863		24,713
Cash and cash equivalents	2,454		1,968
Premiums, accounts and notes receivable, net	4,329		3,694
Reinsurance recoverables	6,705		6,813
Deferred policy acquisition costs	1,785		1,659
Property and equipment	1,556		1,534
Deferred tax assets, net	210		379
Goodwill	6,017		6,019
Other assets, including other intangibles	2,617		2,476
Separate account assets	7,970		7,833
Total assets	$	59,506	$	57,088
Liabilities
Contractholder deposit funds	$	8,464	$	8,443
Future policy benefits	9,953		9,479
Unpaid claims and claim expenses	4,831		4,574
Global Health Care medical costs payable	2,577		2,355
Unearned premiums	618		629
Total insurance and contractholder liabilities	26,443		25,480
Accounts payable, accrued expenses and other liabilities	6,569		6,493
Short-term debt	300		149
Long-term debt	4,789		5,020
Separate account liabilities	7,970		7,833
Total liabilities	46,071		44,975
Contingencies — Note 16
Redeemable noncontrolling interests	71		69
Shareholders’ Equity
Common stock (par value per share, $0.25; shares issued, 296; authorized, 600)	74		74
Additional paid-in capital	2,879		2,859
Accumulated other comprehensive loss	(844)		(1,250)
Retained earnings	13,046		12,121
Less treasury stock, at cost	(1,799)		(1,769)
Total shareholders’ equity	13,356		12,035
Noncontrolling interests	8		9
Total equity	13,364		12,044
Total liabilities and equity	$	59,506	$	57,088
Shareholders’ Equity Per Share	$	52.06	$	46.91

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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Cigna Corporation

Consolidated Statements of Changes in Total Equity

					Accumulated												Redeemable
Unaudited			Additional		Other								Non-				Non-
For the three months ended June 30, 2016	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interests		Equity		Interests

Balance at April 1, 2016	$	74	$	2,874	$	(988)	$	12,541	$	(1,826)	$	12,675	$	9	$	12,684	$	73
Effect of issuing stock for employee benefit plans			10				(5)		27		32				32
Other comprehensive income (loss)					144						144				144		(1)
Net income (loss)							510				510		(5)		505		(2)
Other transactions impacting noncontrolling interests			(5)								(5)		4		(1)		1
Balance at June 30, 2016	$	74	$	2,879	$	(844)	$	13,046	$	(1,799)	$	13,356	$	8	$	13,364	$	71

					Accumulated												Redeemable
			Additional		Other								Non-				Non-
For the three months ended June 30, 2015	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interests		Equity		Interests

Balance at April 1, 2015	$	74	$	2,823	$	(934)	$	10,635	$	(1,656)	$	10,942	$	16	$	10,958	$	83
Effect of issuing stock for employee benefit plans			14				(45)		84		53				53
Other comprehensive (loss)					(191)						(191)				(191)		(3)
Net income (loss)							588				588		(3)		585		(1)
Repurchase of common stock									(100)		(100)				(100)
Other transactions impacting noncontrolling interests			(2)								(2)				(2)		(3)
Balance at June 30, 2015	$	74	$	2,835	$	(1,125)	$	11,178	$	(1,672)	$	11,290	$	13	$	11,303	$	76

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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Cigna Corporation

Consolidated Statements of Changes in Total Equity

					Accumulated												Redeemable
Unaudited			Additional		Other								Non-				Non-
For the six months ended June 30, 2016	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interests		Equity		Interests

Balance at January 1, 2016	$	74	$	2,859	$	(1,250)	$	12,121	$	(1,769)	$	12,035	$	9	$	12,044	$	69
Effect of issuing stock for employee benefit plans			31				(94)		80		17				17
Other comprehensive income					406						406				406		2
Net income (loss)							1,029				1,029		(9)		1,020		(3)
Common dividends declared (per share: $0.04)							(10)				(10)				(10)
Repurchase of common stock									(110)		(110)				(110)
Other transactions impacting noncontrolling interests			(11)								(11)		8		(3)		3
Balance at June 30, 2016	$	74	$	2,879	$	(844)	$	13,046	$	(1,799)	$	13,356	$	8	$	13,364	$	71

					Accumulated												Redeemable
			Additional		Other								Non-				Non-
For the six months ended June 30, 2015	Common		Paid-in		Comprehensive		Retained		Treasury		Shareholders’		controlling		Total		controlling
(In millions)	Stock		Capital		Loss		Earnings		Stock		Equity		Interests		Equity		Interests

Balance at January 1, 2015	$	74	$	2,769	$	(936)	$	10,289	$	(1,422)	$	10,774	$	15	$	10,789	$	90
Effect of issuing stock for employee benefit plans			69				(222)		268		115				115
Other comprehensive (loss)					(189)						(189)				(189)		(12)
Net income (loss)							1,121				1,121		(5)		1,116		(1)
Common dividends declared (per share: $0.04)							(10)				(10)				(10)
Repurchase of common stock									(518)		(518)				(518)
Other transactions impacting noncontrolling interests			(3)								(3)		3		-		(1)
Balance at June 30, 2015	$	74	$	2,835	$	(1,125)	$	11,178	$	(1,672)	$	11,290	$	13	$	11,303	$	76

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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Cigna Corporation

Consolidated Statements of Cash Flows

	Unaudited
	Six Months Ended June 30,
(In millions)	2016		2015
Cash Flows from Operating Activities
Net income	$	1,017	$	1,115
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	310		302
Realized investment (gains)	(35)		(94)
Deferred income taxes	(17)		(8)
Net changes in assets and liabilities, net of non-operating effects:
Premiums, accounts and notes receivable	(520)		(1,007)
Reinsurance recoverables	(4)		(53)
Deferred policy acquisition costs	(123)		(112)
Other assets	(83)		41
Insurance liabilities	607		542
Accounts payable, accrued expenses and other liabilities	(58)		216
Current income taxes	54		117
Loss on extinguishment of debt	-		100
Other, net (1)	48		24
Net cash provided by operating activities (1)	1,196		1,183
Cash Flows from Investing Activities
Proceeds from investments sold:
Fixed maturities and equity securities	712		1,177
Investment maturities and repayments:
Fixed maturities and equity securities	738		691
Commercial mortgage loans	69		341
Other sales, maturities and repayments (primarily short-term and other long-term investments)	356		714
Investments purchased or originated:
Fixed maturities and equity securities	(1,701)		(1,813)
Commercial mortgage loans	(16)		(312)
Other (primarily short-term and other long-term investments)	(401)		(541)
Property and equipment purchases	(254)		(246)
Acquisitions, net of cash acquired	(4)		(107)
Net cash used in investing activities	(501)		(96)
Cash Flows from Financing Activities
Deposits and interest credited to contractholder deposit funds	779		769
Withdrawals and benefit payments from contractholder deposit funds	(703)		(733)
Net change in short-term debt	(111)		(10)
Net proceeds on issuance of long-term debt	-		894
Repayment of long-term debt	-		(938)
Repurchase of common stock	(139)		(536)
Issuance of common stock	14		128
Other, net (1)	(63)		(94)
Net cash (used in) financing activities (1)	(223)		(520)
Effect of foreign currency rate changes on cash and cash equivalents	14		(18)
Net increase in cash and cash equivalents	486		549
Cash and cash equivalents, January 1,	1,968		1,420
Cash and cash equivalents, June 30,	$	2,454	$	1,969
Supplemental Disclosure of Cash Information:
Income taxes paid, net of refunds	$	579	$	519
Interest paid	$	122	$	122

(1) As required by the adoption of ASU 2016-09, the Company retrospectively reclassified $74 million of cash payments from operating to financing activities for the six months ended June 30, 2015. These payments were related to employee tax obligations associated with stock compensation. The comparable amount reported in financing activities for the six months ended June 30, 2016 was $68 million. See Note 2 for further discussion.

The accompanying Notes to the Consolidated Financial Statements (unaudited) are an integral part of these statements.

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CIGNA CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 — Basis of Presentation and Significant Events

Basis of Presentation

Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”) is a global health services organization dedicated to a mission of helping individuals improve their health, well-being and sense of security. To execute on our mission, Cigna’s strategy is to “Go Deep”, “Go Global” and “Go Individual” with a differentiated set of medical, dental, disability, life and accident insurance and related products and services offered by our insurance and other subsidiaries. The majority of these products are offered through employers and other groups (e.g. governmental and non-governmental organizations, unions and associations). Cigna also offers commercial health and dental insurance, Medicare and Medicaid products and health, life and accident insurance coverages to individuals in the U.S. and selected international markets. In addition to its ongoing operations described above, Cigna also has certain run-off operations.

The Consolidated Financial Statements include the accounts of Cigna Corporation and its subsidiaries. Intercompany transactions and accounts have been eliminated in consolidation. These Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Amounts recorded in the Consolidated Financial Statements necessarily reflect management’s estimates and assumptions about medical costs, investment valuation, interest rates and other factors. Significant estimates are discussed throughout these Notes; however, actual results could differ from those estimates. The impact of a change in estimate is generally included in earnings in the period of adjustment. Certain reclassifications have been made to prior year amounts to conform to the current presentation. See Note 2 for further discussion.

These interim Consolidated Financial Statements are unaudited but include all adjustments (including normal recurring adjustments) necessary, in the opinion of management, for a fair statement of financial position and results of operations for the periods reported. The interim Consolidated Financial Statements and Notes should be read in conjunction with the Consolidated Financial Statements and Notes included in the Company’s 2015 Form 10-K. The preparation of interim Consolidated Financial Statements necessarily relies heavily on estimates. This and certain other factors, including the seasonal nature of portions of the health care and related benefits business as well as competitive and other market conditions, call for caution in estimating full year results based on interim results of operations.

Note 2 — Recent Accounting Pronouncements

The Company’s 2015 Form 10-K includes discussion of significant recent accounting pronouncements that either have impacted or may impact our financial statements in the future. The following issuances of, and changes in, accounting pronouncements that apply to the Company have occurred since the Company filed its 2015 Form 10-K.

Recently Adopted Accounting Guidance

Improvements to Employee Share-Based Payment Accounting (Accounting Standards Update (“ASU”) 2016-09). In March 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits or deficiencies to be recorded in the income statement when the awards vest or are settled, requires cash flows related to the excess tax benefits to be classified as an operating activity in the statement of cash flows, permits repurchasing more than was previously allowed of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares are to be presented as a financing activity in the statement of cash flows, and provides an accounting policy election to account for forfeitures as they occur. In addition, the new guidance changes the calculation of common stock equivalents for earnings per share purposes. The new standard is required to be adopted as of January 1, 2017.

As permitted, the Company elected to early adopt the new guidance effective January 1, 2016. Adopting this new guidance resulted in $23 million of tax benefits recorded in net income (in Corporate) during the six months ended June 30, 2016 that previously would have been reported in additional paid-in capital. The change in the calculation of common stock equivalents added approximately one million weighted average shares for the diluted earnings per share calculations for the six months ended June 30, 2016. The Company applied these provisions prospectively.

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The Company retrospectively applied the provisions of the new guidance related to the presentation of employee taxes paid for withheld shares and reclassified $74 million of tax withholding from operating to financing activities in its Consolidated Statement of Cash Flows for the six months ended June 30, 2015. For the six months ended June 30, 2016, the Company reflected $68 million of tax withholding in financing activities. The ability under the new guidance to repurchase more employee shares for tax withholding purposes had no impact on the Company’s financial statements. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.

Amendments to the Consolidation Analysis (ASU 2015-02). The Company adopted this new consolidation guidance effective January 1, 2016 with no material effect on its financial statements. Among other provisions, the guidance defines limited partnerships as variable interest entities unless substantive kick-out rights or participating rights exist. See Note 10 for additional disclosures about various real estate and security limited partnerships that are newly identified as variable interest entities for which the Company is not the primary beneficiary.

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (ASU 2015-07). This amendment removed the requirement to categorize all investments for which fair value is measured using the practical expedient of net asset value (“NAV”) per share within the fair value hierarchy. The Company adopted this new guidance effective January 1, 2016. Upon adoption, the Company began to separately disclose certain separate account investments and provided comparable prior period disclosure. See Note 7 for this separate disclosure information.

Recently Issued Accounting Guidance Not Yet Adopted

Revenue from Contracts with Customers (ASU 2014-09). The FASB issued three new ASUs in 2016 further clarifying the broader revenue guidance:

· “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (ASU 2016-08) that clarifies the definition of principals and agents.

· “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing” (ASU 2016-10) that clarifies guidance and adds examples to help companies properly identify performance obligations. This ASU also illustrates when a license provides a customer with a right to use (point in time) versus a right to access (over time) benefit.

· “Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients” (ASU 2016-12) that clarifies certain aspects of the previously-issued guidance, including the objective of the collectability criterion in the new revenue model.

These clarifications, together with the broader revenue recognition guidance within ASU 2014-09, are required to be adopted beginning January 1, 2018. The Company continues to monitor developing implementation guidance and evaluate these new requirements for its non-insurance customer contracts to determine its method and timing of implementation and any resulting estimated effects on its financial statements.

Financial Instruments — Credit Losses (ASU 2016-13). In June 2016, the FASB issued this new standard that introduces a new approach to estimate credit losses on certain types of financial instruments based on expected losses. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The ASU will be effective January 1, 2020, and early adoption is permitted on January 1, 2019. The Company is evaluating the impact of this new standard on its financial statements and disclosures.

Note 3 — Mergers and Acquisitions

Proposed Merger

On July 23, 2015, the Company entered into a merger agreement with Anthem, Inc. (“Anthem”) and Anthem Merger Sub Corp. (“Merger Sub”), a direct wholly-owned subsidiary of Anthem.

On July 21, 2016, the U.S. Department of Justice (“DOJ”) announced that it is challenging the proposed merger. Given the nature of the concerns raised by the DOJ and the states who joined, Cigna stepped back and evaluated its options under the merger agreement. As part of this evaluation, the Company sought to understand the various and significant concerns that were raised. Management will continue to fulfill its contractual obligations and to defend itself relative to the DOJ. In light of the DOJ’s decision, Cigna does not believe the transaction will close in 2016 and the earliest it could close is 2017, if at all.

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The merger agreement provides (a) for the merger of the Company and Merger Sub, with the Company continuing as the surviving corporation and (b) if certain tax opinions are delivered, immediately following the completion of the initial merger, for the surviving corporation to be merged with and into Anthem, with Anthem continuing as the surviving corporation (collectively, the “merger”). Subject to certain terms, conditions, and customary operating covenants, each share of Cigna common stock issued and outstanding immediately prior to the effective time of the merger would be converted into the right to receive (a) $103.40 in cash, without interest, and (b) 0.5152 of a share of Anthem common stock. The closing price of Anthem common stock on July 28, 2016 was $132.90.

At special shareholders’ meetings held in December 2015, Cigna shareholders approved the merger and Anthem shareholders approved the issuance of shares of Anthem common stock in connection with the merger. Completing the merger remains subject to certain customary conditions, including the receipt of certain necessary governmental and regulatory approvals and the absence of a legal restraint prohibiting the merger. Completing the merger is not subject to a financing condition.

If the merger agreement is terminated under certain circumstances, Anthem will be required to pay Cigna a termination fee of $1.85 billion. Anthem’s obligation to pay the termination fee arises if the merger agreement is terminated because: (1) a governmental entity, such as the Department of Justice or a state Department of Insurance, has prevented the merger for regulatory reasons and that decision is final and non-appealable; or (2) the merger has not closed by January 31, 2017 (subject to extension to April 30, 2017 under certain circumstances) only because all necessary regulatory approvals have not been received.

The merger agreement contains customary covenants, including covenants that Cigna conduct its business in the ordinary course during the period between entering into the merger agreement and closing. In addition, Cigna’s ability to take certain actions prior to closing without Anthem’s consent is subject to certain limitations. These limitations relate to, among other matters, the payment of dividends, capital expenditures, the payment or retirement of indebtedness or the incurrence of new indebtedness, settlement of material claims or proceedings, mergers or acquisitions, and certain employment-related matters.

The Company incurred $34 million pre-tax ($26 million after-tax) for the three months and $74 million pre-tax ($62 million after-tax) for the six months ended June 30, 2016 in costs directly related to the proposed merger. These costs primarily consisted of fees for legal, advisory and other professional services.

Note 4 — Earnings Per Share (“EPS”)

Basic and diluted earnings per share were computed as follows:

			Effect of
(Shares in thousands, dollars in millions, except per share amounts)	Basic		Dilution		Diluted
Three Months Ended June 30,
2016
Shareholders’ net income	$	510			$	510
Shares:
Weighted average	255,381				255,381
Common stock equivalents			4,119		4,119
Total shares	255,381		4,119		259,500
EPS	$	2.00	$	(0.03)	$	1.97

2015
Shareholders’ net income	$	588			$	588
Shares:
Weighted average	255,730				255,730
Common stock equivalents			4,367		4,367
Total shares	255,730		4,367		260,097
EPS	$	2.30	$	(0.04)	$	2.26

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			Effect of
(Shares in thousands, dollars in millions, except per share amounts)	Basic		Dilution		Diluted
Six Months Ended June 30,
2016
Shareholders’ net income	$	1,029			$	1,029
Shares:
Weighted average	255,101				255,101
Common stock equivalents			4,372		4,372
Total shares	255,101		4,372		259,473
EPS	$	4.03	$	(0.06)	$	3.97

2015
Shareholders’ net income	$	1,121			$	1,121
Shares:
Weighted average	256,215				256,215
Common stock equivalents			4,453		4,453
Total shares	256,215		4,453		260,668
EPS	$	4.38	$	(0.08)	$	4.30

The following outstanding employee stock options were not included in the computation of diluted earnings per share for the three months and six months ended June 30, 2016 and 2015 because their effect was anti-dilutive.

	Three Months Ended		Six Months Ended
	June 30,		June 30,
(In millions)	2016	2015	2016	2015
Anti-dilutive options	2.6	-	2.0	0.7

The Company held 39,587,801 shares of common stock in Treasury as of June 30, 2016, and 38,694,585 shares as of June 30, 2015.

Note 5 — Global Health Care Medical Costs Payable

Medical costs payable for the Global Health Care segment reflects estimates of the ultimate cost of claims that have been incurred but not yet reported, those that have been reported but not yet paid (reported claims in process), and other medical care expenses and services payable that are primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities, as follows:

	June 30,		December 31,
(In millions)	2016		2015
Incurred but not yet reported	$	1,956	$	1,757
Reported claims in process	423		470
Physician incentives and other medical care expenses and services payable	198		128
Global Health Care medical costs payable	$	2,577	$	2,355

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Activity in medical costs payable was as follows:

	For the period ended
	June 30,		December 31,
(In millions)	2016		2015
Balance at January 1,	$	2,355	$	2,180
Less: Reinsurance and other amounts recoverable	243		252
Balance at January 1, net	2,112		1,928
Incurred costs related to:
Current year	9,621		18,564
Prior years	(83)		(210)
Total incurred	9,538		18,354
Paid costs related to:
Current year	7,580		16,588
Prior years	1,701		1,582
Total paid	9,281		18,170
Ending Balance, net	2,369		2,112
Add: Reinsurance and other amounts recoverable	208		243
Ending Balance	$	2,577	$	2,355

Reinsurance and other amounts recoverable includes amounts due from reinsurers and policyholders to cover incurred but not reported and pending claims for minimum premium products and certain administrative services only business where the right of offset does not exist. See Note 6 for additional information on reinsurance. For the six months ended June 30, 2016, actual experience differed from the Company’s key assumptions resulting in favorable incurred costs related to prior years’ medical costs payable of $83 million, or 0.4% of the current year incurred costs as reported for the year ended December 31, 2015. Of the favorability, actual completion factors accounted for 0.3%, and actual medical cost trend resulted in 0.1%.

For the year ended December 31, 2015, actual experience differed from the Company’s key assumptions, resulting in favorable incurred costs related to prior years’ medical costs payable of $210 million, or 1.3% of the current year incurred costs as reported for the year ended December 31, 2014. Actual completion factors accounted for 0.4% of favorability, while actual medical cost trend resulted in 0.7%. The remaining 0.2% was related to an increase in the 2014 reinsurance reimbursement rate from the Centers for Medicare and Medicaid Services (“CMS”) under The Patient Protection and Affordable Care Act (“Health Care Reform”).

The impact of prior year development on shareholders’ net income for the six months ended June 30, 2016 was not significant compared with $44 million for the six months ended June 30, 2015. The favorable effect of prior year development in a given period primarily reflects lower than expected utilization of medical services. Incurred costs related to prior years in the table above do not directly correspond to an increase or decrease to shareholders’ net income. The primary reason for the difference is that decreases to prior year incurred costs pertaining to the portion of the liability established for moderately adverse conditions are not considered as impacting shareholders’ net income if they are offset by increases in the current year provision for moderately adverse conditions. The determination of liabilities for Global Health Care medical costs payable requires the Company to make critical accounting estimates. See Note 2(N) to the Consolidated Financial Statements in the Company’s 2015 Form 10-K for further information about the assumptions and estimates used to establish this liability.

Note 6 — Reinsurance

The Company’s insurance subsidiaries enter into agreements with other insurance companies to assume and cede reinsurance. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct or assumed losses. Reinsurance is also used in acquisition and disposition transactions when the underwriting company is not being acquired. Reinsurance does not relieve the originating insurer of liability. The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of its credit risk.

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Effective Exit of GMDB and GMIB Business

In 2013, the Company entered into an agreement with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire”) to effectively exit the guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) businesses via a reinsurance transaction. Berkshire reinsured 100% of the Company’s future claim payments in these businesses, net of other reinsurance arrangements existing at that time. The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.6 billion remaining.

Because this effective exit was accomplished via a reinsurance contract, the amounts related to the reinsured GMDB and GMIB contracts cannot be netted, so the gross assets and liabilities must continue to be measured and reported. The following disclosures provide further context for the methods and assumptions used to determine GMDB assets and liabilities.

GMDB

The Company estimates this liability with an internal model based on its experience and future expectations over an extended period, consistent with the long-term nature of this product. Because the product is premium deficient, the Company records increases to the reserve if it is inadequate based on the model. As a result of the reinsurance transaction, reserve increases have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB assets).

Activity in the future policy benefit reserve for the GMDB business was as follows:

	For the period ended
	June 30,		December 31,
(In millions)	2016		2015
Balance at January 1	$	1,252	$	1,270
Add: Unpaid claims	18		16
Less: Reinsurance and other amounts recoverable	1,164		1,186
Balance at January 1, net	106		100
Add: Incurred benefits	4		3
Less: Paid benefits	(2)		(3)
Ending balance, net	112		106
Less: Unpaid claims	21		18
Add: Reinsurance and other amounts recoverable	1,195		1,164
Ending balance	$	1,286	$	1,252

Benefits paid and incurred are net of ceded amounts. The ending net retained reserve covers ongoing administrative expenses, as well as the minor claims exposure retained by the Company.

The table below presents the account value, net amount at risk and number of underlying contractholders for guarantees assumed by the Company in the event of death. The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date. Unless the Berkshire limit is exceeded, the Company should be reimbursed in full for these payments.

(Dollars in millions, excludes impact of reinsurance ceded)	June 30, 2016		December 31, 2015
Account value	$	10,662	$	11,355
Net amount at risk	$	2,745	$	2,870
Number of contractholders	299,000		324,000

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Effects of Reinsurance

In the Company’s Consolidated Statements of Income, premiums were reported net of amounts ceded to reinsurers and Global Health Care medical costs and other benefit expenses were reported net of reinsurance recoveries in the following amounts:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(In millions)	2016		2015		2016		2015
Ceded premiums
Individual life insurance and annuity business sold	$	40	$	42	$	81	$	83
Other	73		104		168		193
Total	$	113	$	146	$	249	$	276
Reinsurance recoveries
Individual life insurance and annuity business sold	$	66	$	61	$	134	$	147
Other	105		127		201		200
Total	$	171	$	188	$	335	$	347

Reinsurance Recoverables

Components of the Company’s reinsurance recoverables are presented below:

(In millions)

Line of Business	Reinsurer(s)	June 30, 2016		December 31, 2015		Collateral and Other Terms at June 30, 2016

GMDB	Berkshire	$	1,149	$	1,123	100% secured by assets in a trust.

	Other	46		41		99% secured by assets in a trust or letter of credit.

Individual Life and Annuity (sold in 1998)	Lincoln National Life and Lincoln Life & Annuity of New York	3,625		3,705		Both companies’ ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.

Retirement Benefits Business (sold in 2004)	Prudential Retirement Insurance and Annuity	962		995		100% secured by assets in a trust.

Supplemental Benefits Business (2012 acquisition)	Great American Life	306		315		100% secured by assets in a trust.

Global Health Care, Global Supplemental Benefits, Group Disability and Life	Various	538		553		Recoverables arising in the ordinary course of business from approximately 80 reinsurers, including the U.S. Government. Excluding the recoverable from the U.S. Government of approximately $120 million, current balances range from less than $1 million up to $95 million, with 17% secured by assets in trusts or letters of credit.

Other run-off reinsurance	Various	79		81		100% of this balance is secured by assets in trusts.


Total reinsurance recoverables		$	6,705	$	6,813

Over 90% of the Company’s reinsurance recoverables were from companies that were rated A or higher by Standard & Poor’s at June 30, 2016. The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable. As of June 30, 2016, the Company’s recoverables were net of a reserve of approximately $4 million. The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company.

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Note 7 — Fair Value Measurements

The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, equity securities, short-term investments and derivatives. Other financial instruments are measured at fair value under certain conditions, such as when impaired.

Fair value is defined as the price at which an asset could be exchanged in an orderly transaction between market participants at the balance sheet date. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a market participant, not the amount that would be paid to settle the liability with the creditor.

The Company’s financial assets and liabilities carried at fair value have been classified based upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). An asset’s or a liability’s classification is based on the lowest level of input that is significant to its measurement. For example, a financial asset or liability carried at fair value would be classified in Level 3 if unobservable inputs were significant to the instrument’s fair value, even though the measurement may be derived using inputs that are both observable (Levels 1 and 2) and unobservable (Level 3).

The Company estimates fair values using prices from third parties or internal pricing methods. Fair value estimates received from third-party pricing services are based on reported trade activity and quoted market prices when available, and other market information that a market participant may use to estimate fair value. The internal pricing methods are performed by the Company’s investment professionals and generally involve using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality, as well as other qualitative factors. In instances where there is little or no market activity for the same or similar instruments, fair value is estimated using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. These valuation techniques involve some level of estimation and judgment that becomes significant with increasingly complex instruments or pricing models.

The Company is responsible for determining fair value, as well as designating the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs. The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates. The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value. The controls executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations. The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates. The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations. Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls. This on-site review includes a walk-through of inputs of a sample of securities held across various asset types to validate the documented pricing process.

Financial Assets and Financial Liabilities Carried at Fair Value

The following tables provide information as of June 30, 2016 and December 31, 2015 about the Company’s financial assets and liabilities carried at fair value. Separate account assets that are also recorded at fair value on the Company’s Consolidated Balance Sheets are reported separately under the heading “separate account assets” as gains and losses related to these assets generally accrue directly to policyholders.

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	Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(In millions)	(Level 1)		(Level 2)		(Level 3)		Total
June 30, 2016
Financial assets at fair value:
Fixed maturities:
Federal government and agency	$	183	$	568	$	-	$	751
State and local government	-		1,576		-		1,576
Foreign government	-		2,264		6		2,270
Corporate	-		14,961		451		15,412
Mortgage-backed	-		38		-		38
Other asset-backed	-		275		216		491
Total fixed maturities (1)	183		19,682		673		20,538
Equity securities	2		109		70		181
Subtotal	185		19,791		743		20,719
Short-term investments	-		469		-		469
GMIB assets (2)	-		-		975		975
Other derivative assets (3)	-		11		-		11
Total financial assets at fair value, excluding separate accounts	$	185	$	20,271	$	1,718	$	22,174
Financial liabilities at fair value:
GMIB liabilities	$	-	$	-	$	947	$	947
Other derivative liabilities	-		2		-		2
Total financial liabilities at fair value	$	-	$	2	$	947	$	949
December 31, 2015
Financial assets at fair value:
Fixed maturities:
Federal government and agency	$	251	$	528	$	-	$	779
State and local government	-		1,641		-		1,641
Foreign government	-		2,010		4		2,014
Corporate	-		14,122		326		14,448
Mortgage-backed	-		48		1		49
Other asset-backed	-		198		326		524
Total fixed maturities (1)	251		18,547		657		19,455
Equity securities	32		89		69		190
Subtotal