<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
Form 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d)of the Securities Exchange
Act of 1934, for the quarter ended March 31, 1998
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
--------------------------
Commission File Number 1-11913
--------------------------
Aetna Inc.
(Exact name of registrant as specified in its charter)
Connecticut 02-0488491
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
151 Farmington Avenue
Hartford, Connecticut 06156
(Address of principal executive offices) (ZIP Code)
(860) 273-0123
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Capital Stock (par value $.01) 145,474,674
- ------------------------------------- ------------------------------------
(Class) Shares Outstanding at March 31, 1998
================================================================================
<PAGE> 2
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders'
Equity 6
Consolidated Statements of Cash Flows 7
Condensed Notes to Financial Statements 8
Independent Auditors' Review Report 18
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations. 19
Item 3. Quantitative and Qualitative Disclosures
About Market Risk. 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 36
Item 5. Other Information. 37
Item 6. Exhibits and Reports on Form 8-K. 38
Signatures 39
Page 2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
(Millions, except per common share data) 1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Revenue:
Premiums $3,238.6 $3,087.4
Net investment income 812.7 840.1
Fees and other income 550.5 557.7
Net realized capital gains 31.7 1.5
- ---------------------------------------------------------------------------------------------------------
Total revenue 4,633.5 4,486.7
- ---------------------------------------------------------------------------------------------------------
Benefits and expenses:
Current and future benefits 3,270.6 3,157.1
Operating expenses 878.2 834.1
Interest expense 56.9 56.0
Amortization of goodwill and other acquired
intangible assets 96.2 92.7
Amortization of deferred policy acquisition costs 52.4 45.4
Reduction of loss on discontinued products -- (172.5)
Reduction of severance and facilities reserve -- (14.0)
- ---------------------------------------------------------------------------------------------------------
Total benefits and expenses 4,354.3 3,998.8
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 279.2 487.9
Income taxes (benefits)
Current 131.5 123.9
Deferred (19.8) 84.7
- ---------------------------------------------------------------------------------------------------------
Total income taxes 111.7 208.6
- ---------------------------------------------------------------------------------------------------------
Net income $ 167.5 $ 279.3
=========================================================================================================
Net income applicable to common ownership $ 153.6 $ 265.4
=========================================================================================================
Results per common share:
Basic $ 1.05 $ 1.77
Diluted 1.05 1.72
Dividends declared $ .20 $ .20
- ---------------------------------------------------------------------------------------------------------
</TABLE>
See Condensed Notes to Financial Statements.
Page 3
<PAGE> 4
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
(Millions) 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investments:
Debt securities available for sale, at fair value
(amortized cost $33,047.0 and $32,694.0) $ 34,600.5 $34,245.0
Equity securities, at fair value(cost $845.1
and $824.4) 1,126.9 1,041.4
Short-term investments 1,083.7 1,003.9
Mortgage loans 4,006.6 4,207.8
Real estate 339.9 369.5
Policy loans 763.9 746.9
Other 1,014.7 947.4
- ------------------------------------------------------------------------------------------------------
Total investments 42,936.2 42,561.9
- ------------------------------------------------------------------------------------------------------
Cash and cash equivalents 1,445.2 1,805.8
Short-term investments under securities loan agreement 2,199.8 --
Accrued investment income 568.5 545.8
Premiums due and other receivables 1,884.8 1,381.0
Deferred policy acquisition costs 2,425.7 2,367.3
Goodwill and other acquired intangible assets 8,410.5 8,506.3
Other assets 867.4 875.1
Separate Accounts assets 42,133.8 37,957.4
- ------------------------------------------------------------------------------------------------------
Total assets $102,871.9 $96,000.6
======================================================================================================
</TABLE>
See Condensed Notes to Financial Statements.
Page 4
<PAGE> 5
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
March 31, December 31,
(Millions, except share and per common share data) 1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Liabilities:
Future policy benefits $ 18,438.3 $17,837.1
Unpaid claims 3,319.2 3,294.4
Unearned premiums 186.0 359.2
Policyholders' funds left with the Company 18,344.2 18,761.2
- ------------------------------------------------------------------------------------------------------
Total insurance liabilities 40,287.7 40,251.9
Dividends payable to shareholders 36.0 36.1
Short-term debt 479.2 252.1
Long-term debt 2,208.9 2,346.2
Payables under securities loan agreement 2,199.8 --
Current income taxes 308.2 320.5
Deferred income taxes 210.5 223.3
Other liabilities 3,164.2 2,931.9
Minority and participating policyholders' interests 235.7 237.7
Separate Accounts liabilities 42,108.6 37,930.5
- ------------------------------------------------------------------------------------------------------
Total liabilities 91,238.8 84,530.2
- ------------------------------------------------------------------------------------------------------
Aetna-obligated mandatorily redeemable
preferred securities of subsidiary
limited liability company holding
primarily debentures guaranteed by Aetna 275.0 275.0
- ------------------------------------------------------------------------------------------------------
Commitments and Contingent Liabilities
(Notes 5 and 12)
Shareholders' Equity:
Class C voting mandatorily convertible
preferred stock ($.01 par value; 15,000,000
shares authorized; 11,654,481 in 1998 and
11,655,206 in 1997 issued and outstanding) 865.4 865.4
Common stock ($.01 par value; 500,000,000
shares authorized; 145,474,674 in 1998 and
145,794,844 in 1997 issued and outstanding) 3,613.8 3,644.4
Accumulated other comprehensive income 375.7 307.1
Retained earnings 6,503.2 6,378.5
- ------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,358.1 11,195.4
- ------------------------------------------------------------------------------------------------------
Total liabilities, redeemable preferred securities and
shareholders' equity $102,871.9 $96,000.6
======================================================================================================
Shareholders' equity per common share $ 72.13 $ 70.85
======================================================================================================
</TABLE>
See Condensed Notes to Financial Statements.
Page 5
<PAGE> 6
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
(Millions, except share data) Income
------------------------- Class C Voting
Unrealized Mandatorily
Retained Gains (Losses) Foreign Convertible Common
Three Months Ended March 31, 1998 Total Earnings on Securities Currency Preferred Stock Stock
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1997 $11,195.4 $6,378.5 $ 504.1 $(197.0) $865.4 $3,644.4
Comprehensive income:
Net income 167.5 167.5
Other comprehensive income, net
of tax:
Unrealized gains on securities
($100.3 pretax) (1) 65.2 65.2
Foreign currency ($5.3 pretax) 3.4 3.4
---------
Other comprehensive income 68.6
---------
Total comprehensive income 236.1
=========
Common stock issued for benefit
plans (141,530 shares) 6.3 6.3
Repurchase of common shares
(461,700 shares) (36.9) (36.9)
Common stock dividends (28.9) (28.9)
Preferred stock dividends (13.9) (13.9)
- -----------------------------------------------------------------------------------------------------------------------------
Balances at March 31, 1998 $11,358.1 $6,503.2 $ 569.3 $(193.6) $865.4 $3,613.8
=============================================================================================================================
Three Months Ended March 31, 1997
- -----------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 $10,889.7 $5,651.5 $ 454.2 $(114.2) $865.4 $4,032.8
Comprehensive income:
Net income 279.3 279.3
Other comprehensive loss, net
of tax:
Unrealized losses on securities
(($308.9) pretax) (1) (200.8) (200.8)
Foreign currency ($7.2 pretax) 4.7 4.7
---------
Other comprehensive loss (196.1)
---------
Total comprehensive income 83.2
=========
Common stock issued for benefit
plans (856,713 shares) 68.5 68.5
Repurchase of common shares
(1,113,000 shares) (89.8) (89.8)
Common stock dividends (29.9) (29.9)
Preferred stock dividends (13.9) (13.9)
- -----------------------------------------------------------------------------------------------------------------------------
Balances at March 31, 1997 $10,907.8 $5,887.0 $ 253.4 $(109.5) $865.4 $4,011.5
=============================================================================================================================
</TABLE>
(1) Net of reclassification adjustments.
See Condensed Notes to Financial Statements.
Page 6
<PAGE> 7
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
(Millions) 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 167.5 $ 279.3
Adjustments to reconcile net income to net
cash used for operating activities:
(Increase) Decrease in accrued investment income (21.3) 7.6
Increase in premiums due and other receivables (166.5) (49.5)
Increase in deferred policy acquisition costs (70.2) (75.3)
Depreciation and amortization 126.8 137.6
(Decrease) Increase in income taxes (58.6) 135.1
Net decrease (increase) in other assets and other liabilities 11.0 (282.0)
Decrease in insurance liabilities (145.8) (306.5)
Net realized capital gains (31.7) (1.5)
Amortization of net investment discounts (39.6) (31.5)
Other, net (11.8) 6.5
- --------------------------------------------------------------------------------------------------------------
Net cash used for operating activities (240.2) (180.2)
- --------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Proceeds from sales of:
Debt securities available for sale 5,332.4 4,582.8
Equity securities 174.3 123.3
Mortgage loans 11.2 13.6
Real estate 80.0 177.5
Other investments 18.3 134.2
Short-term investments 5,961.1 4,607.0
Investment maturities and repayments of:
Debt securities available for sale 965.0 1,023.7
Mortgage loans 285.8 249.0
Cost of investments in:
Debt securities available for sale (6,286.1) (5,112.4)
Equity securities (177.6) (157.1)
Mortgage loans (60.1) (41.7)
Real estate (18.3) (8.1)
Other investments (75.7) (391.4)
Short-term investments (6,051.0) (4,759.1)
Decrease (Increase) in property and equipment 7.7 (14.7)
Net decrease in Separate Accounts 1.8 46.9
Other, net 21.5 (6.7)
- --------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 190.3 466.8
- --------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 450.8 461.4
Withdrawals of investment contracts (775.6) (686.8)
Issuance of long-term debt - .1
Repayment of long-term debt (141.2) (3.7)
Net increase in short-term debt 229.9 151.1
Common stock issued under benefit plans 6.3 68.5
Common stock acquired (36.9) (89.8)
Dividends paid to shareholders (43.0) (43.8)
- --------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (309.7) (143.0)
- --------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (1.0) .1
- --------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (360.6) 143.7
Cash and cash equivalents, beginning of period 1,805.8 1,462.6
- --------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 1,445.2 $ 1,606.3
==============================================================================================================
Supplemental Cash Flow Information:
Interest paid $ 89.7 $ 96.0
Income taxes paid 141.9 61.8
- --------------------------------------------------------------------------------------------------------------
</TABLE>
See Condensed Notes to Financial Statements.
Page 7
<PAGE> 8
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include Aetna Inc. and its majority-owned
subsidiaries (collectively, the "Company"), including Aetna Services, Inc.
("Aetna Services") and Aetna U.S. Healthcare Inc. ("Aetna U.S. Healthcare").
Less than majority-owned entities in which the Company has at least a 20%
interest are reported on the equity basis. These consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles and are unaudited. Certain reclassifications have been made to 1997
financial information to conform to the 1998 presentation. These interim
statements necessarily rely heavily on estimates, including assumptions as to
annualized tax rates. In the opinion of management, all adjustments necessary
for a fair statement of results for the interim periods have been made. All such
adjustments are of a normal, recurring nature. The accompanying condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes as presented in the
Company's 1997 Annual Report on Form 10-K. Certain financial information that is
normally included in annual financial statements prepared in accordance with
generally accepted accounting principles, but that is not required for interim
reporting purposes, has been condensed or omitted.
(2) New Accounting Standards
On January 1, 1998, the Company adopted Statement of Position ("SOP") 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use, issued by the American Institute of Certified Public Accountants ("AICPA").
This statement requires that certain costs incurred in developing internal-use
computer software be capitalized, and provides guidance for determining whether
computer software is considered to be for internal use. The Company will
amortize these costs over a period of 3 to 5 years. Previously, the Company
expensed the cost of internal-use computer software as incurred. The adoption of
this statement resulted in an increase to the results of operations of $8.5
million after tax, or $.06 per diluted common share in the first quarter of
1998.
Financial Accounting Standard ("FAS") No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, was issued in
June 1996 and provides accounting and reporting standards for transfers of
financial assets and extinguishments of liabilities.
Page 8
<PAGE> 9
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(2) New Accounting Standards (continued)
FAS No. 125 was effective for 1997 financial statements; however, certain
provisions relating to accounting for repurchase agreements and securities
lending were not effective until January 1, 1998. The adoption of those
provisions effective in 1998, did not have a material effect on the Company's
financial position or results of operations.
(3) Future Application of Accounting Standard
In December 1997, the AICPA issued SOP 97-3, Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments, which provides guidance for
determining when an insurance or other enterprise should recognize a liability
for guaranty-fund and other insurance-related assessments and guidance for
measuring the liability. This statement is effective for 1999 financial
statements, with early adoption permitted. The Company does not expect adoption
of this statement to have a material effect on its financial position or results
of operations.
(4) Earnings Per Common Share
A reconciliation of the numerator and denominator of the basic and diluted
earnings per common share ("EPS") for the three months ended March 31 was as
follows:
<TABLE>
<CAPTION>
Income Shares Per Common
(Millions, except per common share data) (Numerator) (Denominator) Share Amount
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1998 (1)
Net income $167.5
Less: preferred stock dividends 13.9
------
Basic EPS
Income applicable to common ownership 153.6 145.6 $1.05
====== =====
Effect of dilutive securities:
Stock options and other (2) 1.2
-----
Diluted EPS
Income applicable to common ownership
and assumed conversions $153.6 146.8 $1.05
===========================================================================================================
1997
Net income $279.3
Less: preferred stock dividends 13.9
------
Basic EPS
Income applicable to common ownership 265.4 150.0 $1.77
=====
Effect of dilutive securities:
Stock options and other (2) 1.6
Convertible preferred stock 13.9 10.8
------ -----
Diluted EPS
Income applicable to common ownership
and assumed conversions $279.3 162.4 $1.72
===========================================================================================================
</TABLE>
(1) The common stock issuable related to Class C Voting Manditorily Convertible
Preferred Stock (11.3 million weighted average shares) was not included in
the computation of diluted earnings per common share in 1998 because to do
so would be antidilutive.
(2) Options to purchase shares of common stock in 1998 and 1997 of 1.6 million
and .1 million, respectively, (with exercise prices ranging from $80.25 -
$112.63) were not included in the calculation of diluted earnings per common
share because the options' exercise price was greater than the average
market price of common shares.
Page 9
<PAGE> 10
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(5) Other Acquisitions and Dispositions
The Company and New York Life Insurance Company ("New York Life") entered into
definitive agreements, dated as of March 15, 1998, for the Company to acquire
New York Life's NYLCare health business for $1.05 billion in cash. In addition
to the cash purchase price, payments totaling up to $300 million (up to $150
million in each of two years) may be made to the extent that pre-determined
earnings and membership targets are achieved. No such payments are payable
prior to the year 2000.
The transaction is anticipated to be completed in the third quarter of 1998 and
is subject to approval by certain state regulators and other customary closing
conditions. In April 1998, the Federal Trade Commission granted early
termination to the waiting period for the transaction under the
Hart-Scott-Rodino Antitrust Improvements Act. The transaction is currently
expected to ultimately be financed by the issuance of medium- or long-term fixed
income securities.
(6) Investments
Net investment income includes amounts allocable to experience rated
contractholders of $315 million and $339 million for the three months ended
March 31, 1998 and 1997, respectively. Interest credited to contractholders is
included in current and future benefits.
Net realized capital gains allocable to experience rated contractholders of $8
million and $30 million for the three months ended March 31, 1998 and 1997,
respectively, were deducted from net realized capital gains as reflected on the
Consolidated Statements of Income, and an offsetting amount is reflected on the
Consolidated Balance Sheets in policyholders' funds left with the Company.
Page 10
<PAGE> 11
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(6) Investments (continued)
The total recorded investment in mortgage loans that are considered to be
impaired (including problem loans, restructured loans and potential problem
loans) and related specific reserves are presented in the table below.
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------------ -------------------------
Total Total
Recorded Specific Recorded Specific
(Millions) Investment Reserves Investment Reserves
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Supporting discontinued products $167.0 $23.4 $206.5 $25.8
Supporting experience rated products 106.9 16.7 110.8 16.7
Supporting remaining products 57.2 9.6 65.6 8.7
- --------------------------------------------------------------------------------------------------------------
Total Impaired Loans $331.1(1) $49.7 $382.9(1) $51.2
==============================================================================================================
</TABLE>
(1) Includes impaired loans of $92.4 million and $127.7 million, respectively,
for which no specific reserves are considered necessary.
The activity in the specific and general reserves for the three months ended
March 31, 1998 and 1997 is summarized below:
<TABLE>
<CAPTION>
Supporting
Supporting Experience Supporting
Discontinued Rated Remaining
(Millions) Products Products Products Total
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $ 68.7 $31.6 $14.2 $114.5
Credited to net realized loss -- -- (2.0) (2.0)
Charged (credited) to other accounts (30.0)(1) (2.0)(1) 4.8 (27.2)
Principal write-offs (.4) -- (1.1) (1.5)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 31, 1998(2) $ 38.3 $29.6 $15.9 $ 83.8
================================================================================================================
Balance at December 31, 1996 $136.7 $74.7 $35.6 $247.0
Credited to other accounts -- (.2)(1) -- (.2)
Principal write-offs (.1) (1.3) (1.0) (2.4)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 31, 1997(2) $136.6 $73.2 $34.6 $244.4
================================================================================================================
</TABLE>
(1) Reflects adjustments to reserves related to assets supporting discontinued
products and experience rated products which do not affect the Company's
results of operations.
(2) Total reserves at March 31, 1998 and 1997 include $49.7 million and $143.6
million of specific reserves, respectively, and $34.1 million and $100.8
million of general reserves, respectively.
Income earned (pretax) and cash received on the average recorded investment in
impaired loans was as follows:
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
----------------------------- ------------------------------
Average Average
Impaired Income Cash Impaired Income Cash
(Millions) Loans Earned Received Loans Earned Received
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Supporting discontinued products $186.7 $3.3 $3.5 $381.0 $10.2 $ 8.5
Supporting experience rated products 108.9 3.0 2.9 238.4 4.7 4.7
Supporting remaining products 59.8 2.5 2.4 139.2 2.5 2.5
- --------------------------------------------------------------------------------------------------------------------------
Total $355.4 $8.8 $8.8 $758.6 $17.4 $15.7
==========================================================================================================================
</TABLE>
Page 11
<PAGE> 12
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(7) Supplemental Cash Flow Information
Significant noncash investing and financing activities include acquisition of
real estate through foreclosures (including in-substance foreclosures) of
mortgage loans amounting to $4 million and $18 million for the three months
ended March 31, 1998 and 1997, respectively.
(8) Additional Information - Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income (loss) related to changes in
unrealized gains (losses) on securities (excluding those related to experience
rated contractholders and discontinued products) were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------
(Millions) 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Unrealized holding gains (losses) arising during the period (1) $127.4 $(155.0)
Less: reclassification adjustment for gains and other items
included in net income (2) 62.2 45.8
- ----------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $ 65.2 $(200.8)
====================================================================================================
</TABLE>
(1) Pretax unrealized holding gains (losses) arising during the period were
$196.0 million and $(238.5) million for 1998 and 1997, respectively.
(2) Pretax reclassification adjustments for gains and other items included in
net income were $95.5 million and $69.5 million for 1998 and 1997,
respectively.
(9) Severance and Facilities Charges
In 1996, the Company established severance and facilities reserves in connection
with the integration of the health businesses and certain other actions taken or
to be taken in order to make its businesses more competitive.
Activity for the three months ended March 31, 1998 within the severance and
facilities reserves (pretax) and positions eliminated related to such actions
were as follows:
<TABLE>
<CAPTION>
(Millions) Reserve Positions
- -------------------------------------------------------------------------------
<S> <C> <C>
Balance at December 31, 1997 $405.4 2,950
Actions taken (21.5)(1) (277)
- -------------------------------------------------------------------------------
Balance at March 31, 1998 $383.9 2,673
===============================================================================
</TABLE>
(1) Includes $10.8 million of severance-related actions. Other actions include
asset write-offs, vacated leased property payments and other exit costs.
Page 12
<PAGE> 13
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(9) Severance and Facilities Charges (continued)
The 277 positions eliminated during the three months ended March 31, 1998
related to the following segments: 84.8% - Aetna U.S. Healthcare, 8.3% - Aetna
Retirement Services and 6.9% - Corporate. The Aetna U.S. Healthcare severance
actions are now expected to be substantially completed by March 31, 1999 as a
result of addressing customer service issues during the transition period. The
Aetna Retirement Services severance actions are expected to be substantially
completed by September 30, 1998. The severance actions and vacating of certain
leased office space related to the Corporate segment were substantially
completed in 1997. In connection with the sale of the Company's
property-casualty operations in 1996, the Company vacated, and the purchaser
subleased, at market rates for a period of eight years, the space that the
Company occupied in the CityPlace office facility in Hartford. The remaining
lease payments (net of expected subrentals) on the facilities (other than the
CityPlace office facility) are payable over approximately the next two years.
(10) Discontinued Products
The Company discontinued the sale of its fully guaranteed large case pension
products (single-premium annuities ("SPAs") and guaranteed investment contracts
("GICs")) in 1993. Under the Company's accounting for these discontinued
products, a reserve for anticipated future losses from these products was
established and the reserve is reviewed by management quarterly. As long as the
reserve continues to represent management's then best estimate of expected
future losses, results of operations of the discontinued products, including net
realized capital gains and losses, are credited/charged to the reserve and do
not affect the Company's results of operations. As a result of continued
favorable developments in real estate markets, in the first quarter of 1997 the
Company released $173 million (pretax) of the reserve related to GICs. The
current reserve reflects management's best estimate of anticipated future
losses. To the extent that aggregate future losses on discontinued products are
greater or less than anticipated, the Company's results of operations would be
adversely or positively affected, respectively. The discussion below presents
information for the discontinued SPAs and GICs on a combined basis. (Refer to
the Company's 1997 Annual Report for a more complete discussion of the reserve
for anticipated future losses on discontinued products.)
Page 13
<PAGE> 14
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(10) Discontinued Products (continued)
At the time of discontinuance, a receivable from Large Case Pensions' continuing
products equivalent to the net present value of the anticipated cash flow
shortfalls was established for the discontinued products. Interest on the
receivable is accrued at the discount rate which was used to calculate the loss
on discontinuance. The offsetting payable, on which interest is similarly
accrued, is reflected in continuing products. Interest on the payable generally
offsets the investment income on the assets available to fund the shortfall. At
March 31, 1998, the receivable from continuing products, net of related deferred
taxes payable of $46 million on the accrued interest income, was $520 million.
During the three months ended March 31, 1998, and the twelve months ended
December 31, 1997, no funding of the receivable took place. The receivable is
eliminated in consolidation.
Results of discontinued products were as follows (pretax, in millions):
<TABLE>
<CAPTION>
Charged (Credited)
to Reserve for
Three months ended March 31, 1998 Results Future Losses Net(1)
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $137.7 $ -- $137.7
Net realized capital gains 65.1 (65.1) --
Interest earned on receivable
from continuing products 8.6 -- 8.6
Other income 5.9 -- 5.9
- --------------------------------------------------------------------------------------------------
Total revenue 217.3 (65.1) 152.2
- --------------------------------------------------------------------------------------------------
Current and future benefits 147.5 1.6 149.1
Operating expenses 3.1 -- 3.1
- --------------------------------------------------------------------------------------------------
Total benefits and expenses 150.6 1.6 152.2
- --------------------------------------------------------------------------------------------------
Results of discontinued products $ 66.7 $(66.7) $ --
==================================================================================================
Three months ended March 31, 1997
- --------------------------------------------------------------------------------------------------
Net investment income $178.6 $ -- $178.6
Net realized capital gains 30.5 (30.5) --
Interest earned on receivable
from continuing products 8.3 -- 8.3
Other income 7.4 -- 7.4
- --------------------------------------------------------------------------------------------------
Total revenue 224.8 (30.5) 194.3
- --------------------------------------------------------------------------------------------------
Current and future benefits 169.5 21.9 191.4
Operating expenses 2.9 -- 2.9
- --------------------------------------------------------------------------------------------------
Total benefits and expenses 172.4 21.9 194.3
- --------------------------------------------------------------------------------------------------
Results of discontinued products $ 52.4 $(52.4) $ --
==================================================================================================
</TABLE>
(1) Amounts are reflected in the March 31, 1998 and 1997 Consolidated Statements
of Income, except for interest earned on the receivable from continuing
products which is eliminated in consolidation.
Page 14
<PAGE> 15
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(10) Discontinued Products (continued)
Assets and liabilities of discontinued products at March 31, 1998 were as
follows (1):
<TABLE>
<CAPTION>
(Millions)
- ----------------------------------------------------------------------------------------
<S> <C>
Debt securities available for sale $6,315.4
Mortgage loans 928.6
Real estate 113.4
Short-term and other investments 695.8
- ----------------------------------------------------------------------------------------
Total investments 8,053.2
Current and deferred income taxes 198.5
Receivable from continuing products (2) 566.4
- ----------------------------------------------------------------------------------------
Total assets $8,818.1
========================================================================================
Future policy benefits $4,733.3
Policyholders' funds left with the Company 2,022.4
Reserve for anticipated future losses on
discontinued products 1,218.4
Other 844.0
- ----------------------------------------------------------------------------------------
Total liabilities $8,818.1
========================================================================================
</TABLE>
(1) Assets supporting the discontinued products are distinguished from other
continuing operations assets.
(2) The receivable from continuing products is eliminated in consolidation.
Net unrealized capital gains on available for sale debt securities are included
above in other liabilities and are not reflected in consolidated shareholders'
equity. The reserve for anticipated future losses is included in future policy
benefits on the Consolidated Balance Sheets.
The activity in the reserve for anticipated future losses on discontinued
products for the three months ended March 31, 1998 was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
- ----------------------------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1997 $1,151.7
Results of discontinued products 66.7
- ----------------------------------------------------------------------------------------
Reserve at March 31, 1998 $1,218.4
========================================================================================
</TABLE>
(11) Debt and Guarantee of Debt Securities
Aetna Inc. has fully and unconditionally guaranteed the payment of all
principal, premium, if any, and interest on all outstanding debt securities of
Aetna Services, including the $348 million 9.5% Subordinated Debentures due 2024
(the "Subordinated Debentures") issued to Aetna Capital L.L.C. ("ACLLC"), a
wholly owned subsidiary of Aetna Services (collectively the "Aetna Services
Debt"). ACLLC has issued $275 million of redeemable preferred stock and the
Subordinated Debentures represent substantially all of the assets of ACLLC.
Page 15
<PAGE> 16
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(11) Debt and Guarantee of Debt Securities (continued)
Aetna Services has a revolving credit facility in an aggregate amount of $1.5
billion with a worldwide group of banks that terminates in June 2001. Various
interest rate options are available under the facility and any borrowings mature
on the expiration date of the applicable credit commitment. Aetna Services pays
facility fees ranging from .065% to .20% per annum, depending upon its long-term
senior unsecured debt rating. The facility fee at March 31, 1998 is at an annual
rate of .08%. The facility also supports Aetna Services' commercial paper
borrowing program. As a guarantor of any amounts outstanding under the credit
facility, Aetna Inc. is required to maintain shareholders' equity, excluding net
unrealized capital gains and losses, of at least $7.5 billion.
Consolidated financial statements of Aetna Services have not been presented
herein or in any separate reports filed with the Securities and Exchange
Commission because management has determined that such financial statements
would not be material to holders of the Aetna Services Debt. Summarized
consolidated financial information for Aetna Services is as follows (in
millions):
Balance Sheets Information:
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Total investments (excluding
Separate Accounts) $43,549.8 $41,020.9
- -------------------------------------------------------------------------------
Total assets $92,307.2 $85,138.9
- -------------------------------------------------------------------------------
Total insurance liabilities $38,743.3 $38,620.0
- -------------------------------------------------------------------------------
Total liabilities $88,903.2 $82,160.2
- -------------------------------------------------------------------------------
Total redeemable preferred stock $ 275.0 $ 275.0
- -------------------------------------------------------------------------------
Total shareholder's equity $ 3,129.0 $ 2,703.7
- -------------------------------------------------------------------------------
</TABLE>
Statements of Income Information:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------
1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Total revenue $2,467.7 $3,155.2
- --------------------------------------------------------------------------------
Total benefits and expenses $2,230.3 $2,706.0
- --------------------------------------------------------------------------------
Income before income taxes $ 237.3 $ 449.2
- --------------------------------------------------------------------------------
Net income $ 162.3 $ 273.8
- --------------------------------------------------------------------------------
</TABLE>
Page 16
<PAGE> 17
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Continued)
(11) Debt and Guarantee of Debt Securities (continued)
The amount of dividends which may be paid to Aetna Services or Aetna U.S.
Healthcare by their domestic insurance and HMO subsidiaries at March 31, 1998
without prior approval by state regulatory authorities is limited to
approximately $647 million in the aggregate. There are no such restrictions on
distributions from Aetna Services or Aetna U.S. Healthcare to Aetna Inc. or on
distributions from Aetna Inc. to its shareholders.
(12) Litigation
Purported Class Action Complaints were filed in the United States District Court
for the Eastern District of Pennsylvania on November 5, 1997 by Eileen
Herskowitz and Michael Wolin, and on December 4, 1997 by Pamela Goodman and
Michael J. Oring. Other purported Class Action Complaints were filed in the
United States District Court for the District of Connecticut on November 25,
1997 by Evelyn Silvert, on November 26, 1997 by the Rainbow Fund, Inc., and on
December 24, 1997 by Terry B. Cohen. The Complaints seek, among other remedies,
unspecified damages resulting from defendants' alleged violations of federal
securities laws. The Complaints allege that the Company and three of its current
or former officers or directors, Ronald E. Compton, Richard L. Huber, and
Leonard Abramson, are liable for certain misrepresentations and omissions
regarding, among other matters, the integration of the merger with U.S.
Healthcare and the Company's medical claim reserves. The Connecticut actions
have been transferred to the United States District Court for the Eastern
District of Pennsylvania for consolidated pretrial proceedings with the cases
pending there. The litigation is still in the preliminary stages, and the
Company is defending the actions vigorously.
The Company is also involved in numerous other lawsuits arising, for the most
part, in the ordinary course of its business operations, including litigation in
its health business concerning benefit plan coverage and other decisions made by
the Company, and alleged medical malpractice by participating providers. While
the ultimate outcome of these other lawsuits cannot be determined at this time,
after consideration of the defenses available to the Company and any related
reserves established, they are not expected to result in liability for amounts
material to the financial condition of the Company, although they may adversely
affect results of operations in future periods.
Page 17
<PAGE> 18
Independent Auditors' Review Report
The Board of Directors
Aetna Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Aetna
Inc. and Subsidiaries as of March 31, 1998, and the related condensed
consolidated statements of income, shareholders' equity and cash flows for the
three-month periods ended March 31, 1998 and 1997. These condensed consolidated
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements for them
to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Aetna Inc. and Subsidiaries as of
December 31, 1997, and the related consolidated statements of income,
shareholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 3, 1998, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1997, is fairly presented, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ KPMG Peat Marwick LLP
Hartford, Connecticut
May 5, 1998
Page 18
<PAGE> 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis presents a review of Aetna Inc. and its
subsidiaries (collectively, the "Company") for the three months ended March 31,
1998 and 1997. This review should be read in conjunction with the consolidated
financial statements and other data presented herein.
OVERVIEW
General
The Company's current operations include three core businesses - Aetna U.S.
Healthcare, Aetna Retirement Services and Aetna International. Aetna U.S.
Healthcare provides a full spectrum of managed care, indemnity, and group life
and disability insurance products. Aetna Retirement Services offers a range of
financial services and individual life insurance products. Aetna International,
through subsidiaries and joint venture operations, sells primarily life
insurance, health insurance and financial services products in non-U.S. markets.
The Company also has a Large Case Pensions business which manages a variety of
retirement products for defined benefit and defined contribution plans.
Consolidated Results
The Company reported net income of $168 million for the three months ended March
31, 1998 compared to $279 million for the same period in 1997. Earnings per
diluted common share for the three months ended March 31, 1998 were $1.05,
compared with $1.72 a year ago.
Net income for the first three months of 1998 reflects $16 million of costs
related to Year 2000 remediation. Results for the first three months of 1997
included reductions in the severance and facilities reserve for Aetna U.S.
Healthcare of $9 million and a benefit of $108 million related to a reserve
reduction for Large Case Pensions. Results also included net realized capital
gains of $21 million for the three months ended March 31, 1998 and net realized
capital losses of $16 million for the three months ended March 31, 1997.
Excluding these items, earnings were $163 million for the three months ended
March 31, 1998 compared to $178 million for the same period in 1997.
The Company adopted American Institute of Certified Public Accountants Statement
of Position 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use, in the first quarter of 1998, which requires the
capitalization and amortization of certain internal-use software. Previously,
the Company expensed these costs. As a result of this new standard, earnings for
the three months ended March 31, 1998 included a net benefit from capitalizing
internal-use software of $9 million.
Page 19
<PAGE> 20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW (CONTINUED)
Business Results
As discussed more fully in the following sections, Aetna U.S. Healthcare's
earnings decreased in the first quarter of 1998 primarily due to lower Indemnity
and PPO results, increased Medicare HMO medical costs and additional spending to
improve customer service levels in the Health Risk business. Aetna Retirement
Services' earnings increased in the first quarter of 1998, primarily due to a
one-time benefit from the restructuring of a reinsurance arrangement related to
the participating life insurance business and higher fee income earned on a
growing base of assets under management. Aetna International's earnings also
improved in the first quarter of 1998 compared to the first quarter of 1997
primarily due to its Brazilian operations, which were acquired in April 1997,
as well as new pension business in Mexico. Large Case Pensions' results
continue to decline as capital is redeployed to other businesses of the Company.
Acquisition of NYLCare Health Business
The Company and New York Life Insurance Company ("New York Life") entered into
definitive agreements, dated as of March 15, 1998, for the Company to acquire
New York Life's NYLCare health business for $1.05 billion in cash. In addition
to the cash purchase price, payments totaling up to $300 million (up to $150
million in each of two years) may be made to the extent that pre-determined
earnings and membership targets are achieved. No such payments are payable prior
to the year 2000.
The transaction is anticipated to be completed in the third quarter of 1998 and
is subject to approval by certain state regulators and other customary closing
conditions. In April 1998, the Federal Trade Commission granted early
termination to the waiting period for the transaction under the
Hart-Scott-Rodino Antitrust Improvements Act. The transaction is currently
expected to ultimately be financed by the issuance of medium- or long-term fixed
income securities.
After the closing of the transaction, the Company's future results will be
affected by, among other things, the operating results of the NYLCare health
business, the costs of financing the transaction and the amortization of
intangible assets (primarily goodwill) expected to be created as a result of the
transaction.
Page 20
<PAGE> 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------------
(Millions) 1998 1997 %Change
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $2,839.0 $2,686.1 5.7%
Net investment income 121.7 103.6 17.5
Fees and other income 351.0 378.1 (7.2)
Net realized capital gains (losses) 11.0 (12.9) --
- ----------------------------------------------------------------------------------------------------
Total revenue 3,322.7 3,154.9 5.3
- ----------------------------------------------------------------------------------------------------
Current and future benefits 2,436.6 2,249.9 8.3
Operating expenses 610.6 591.4 3.2
Amortization of goodwill and other
acquired intangible assets 90.7 90.4 .3
Amortization of deferred policy
acquisition costs .1 4.5 (97.8)
Reduction of severance and facilities
reserve -- (14.0) 100.0
- ----------------------------------------------------------------------------------------------------
Total benefits and expenses 3,138.0 2,922.2 7.4
- ----------------------------------------------------------------------------------------------------
Income before income taxes 184.7 232.7 (20.6)
Income taxes 85.9 118.5 (27.5)
- ----------------------------------------------------------------------------------------------------
Net income (1) $ 98.8 $ 114.2 (13.5)
====================================================================================================
Net realized capital gains (losses),
net of tax (included above) $ 7.1 $ (26.4) --
====================================================================================================
</TABLE>
(1) Net income for the three months ended March 31, 1998 includes a net benefit
from capitalizing internal-use software of $4.3 million.
Aetna U.S. Healthcare's net income for the three months ended March 31, 1998
decreased $15 million compared to the same period for 1997. Results for the
three months ended March 31, 1998 include costs of $9 million (after tax)
related to Year 2000 remediation. In addition, results include a reduction in
the severance and facilities reserve in the first quarter of 1997 of $9 million
(after tax) and net realized capital gains or losses in both periods. Excluding
these items, results for the three months ended March 31, 1998 decreased $31
million from the same period in 1997 reflecting decreased Health Risk and level
Group Insurance and Other Health earnings.
Net realized capital losses in the first quarter of 1997 include a $33 million
after-tax loss related to the sale of Aetna Professional Management Corporation
("APMC"), a physician practice management business sold on May 1, 1997. The
earnings of APMC were not material to the results of Aetna U.S. Healthcare.
The pending acquisition of the NYLCare health business continues the Company's
strategy to invest in its health business. Included in the acquisition are
NYLCare's health maintenance organization ("HMO"), point-of-service ("POS"),
preferred provider organization ("PPO") and indemnity health businesses as well
as its group life and disability businesses. At year-end 1997, the NYLCare
health business had approximately 2.2 million health members.
Page 21
<PAGE> 22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Business Results
In order to provide a comparison that management believes better reflects the
underlying performance of Aetna U.S. Healthcare, the earnings discussion that
follows excludes amortization of goodwill and other acquired intangible assets,
Year 2000 costs in the first quarter of 1998, the reduction in the severance and
facilities reserve in the first quarter of 1997, and net realized capital gains
or losses in both periods.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------
(Millions) 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Health Risk $ 93.7 $125.3
Group Insurance and Other Health 81.6 80.6
- -----------------------------------------------------------------------------------------
Total Aetna U.S. Healthcare (1) $175.3 $205.9
=========================================================================================
Commercial HMO Medical Loss Ratio 82.7% 82.3%
- -----------------------------------------------------------------------------------------
Medicare HMO Medical Loss Ratio 92.8% 90.1%
- -----------------------------------------------------------------------------------------
Health Risk Medical Loss Ratio 85.2% 82.6%
- -----------------------------------------------------------------------------------------
</TABLE>
(1) Net income for the three months ended March 31, 1998 includes a net benefit
from capitalizing internal-use software of $4.3 million.
Health Risk
Earnings for the Health Risk business (which includes all health products for
which Aetna U.S. Healthcare assumes all or a majority of health care costs and
utilization risk) for the three months ended March 31, 1998 were affected by
several factors.
Indemnity and PPO results for the three months ended March 31, 1998 were lower
than the same period a year ago due to declining membership, in part reflecting
a shift to managed care products, as well as favorable reserve adjustments in
the first quarter of 1997 that did not occur in the 1998 period.
Health Risk earnings for the three months ended March 31, 1998 also reflect
increased operating expenses related to customer service enhancements, which are
expected to continue until targeted levels of performance have been achieved.
The Health Risk SG&A ratio was 11.7% for the three months ended March 31, 1998
compared with 11.6% in the 1997 period.
Results were also affected by favorable HMO results due to enrollment growth and
premium rate increases partially offset by higher Medicare HMO medical costs.
Premiums per member per month ("PMPM") increased 1% for Commercial HMO business
and 2% for Medicare HMO business, due to premium rate increases offset in part
by the impact of geographic mix. Commercial HMO medical costs PMPM increased 2%
primarily resulting from higher inpatient facility costs and Medicare HMO
medical costs PMPM increased 4% primarily due to higher inpatient facility and
pharmacy costs. The Commercial HMO medical loss ratio for the three months ended
March 31, 1998 was essentially level with the same period a year ago reflecting
membership growth in regions with higher medical loss ratios and improvements in
regional medical loss ratios. The Medicare HMO medical loss ratio for the three
months ended March 31, 1998 increased when compared to the same period a year
ago due to higher medical costs resulting from increased utilization.
Page 22
<PAGE> 23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
For the Health Risk business, reserves reflect estimates of the ultimate cost of
claims that have been incurred but not yet reported or paid. Claim reserves are
based on a number of factors including those derived from historical claim
experience. Medical claims payable are estimated periodically, and any resulting
adjustments are reflected in current period results in current and future
benefits.
Group Insurance and Other Health
Group Insurance and Other Health includes group life and disability insurance
and long-term care insurance, offered on both an insured and employer-funded
basis, and all health products offered on an employer-funded basis. Results for
the first three months of 1998 were level when compared with the same period in
1997.
Membership
Aetna U.S. Healthcare's membership was as follows:
<TABLE>
<CAPTION>
March 31, 1998 March 31, 1997(1)
--------------------------------- ----------------------------------
(Thousands) Risk Nonrisk Total Risk Nonrisk Total
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HMO
Commercial (2) 3,851 523 4,374 3,501 565 4,066
Medicare 399 16 415 330 18 348
Medicaid 94 -- 94 132 -- 132
- ------------------------------------------------------------------------------------------------------------------
Total HMO 4,344 539 4,883 3,963 583 4,546
POS 274 2,527 2,801 330 2,432 2,762
PPO 598 2,867 3,465 743 2,943 3,686
Indemnity 269 2,237 2,506 445 2,355 2,800
- ------------------------------------------------------------------------------------------------------------------
Total Health Membership 5,485 8,170 13,655 5,481 8,313 13,794
==================================================================================================================
Group Insurance: (3)
Group Life 9,554 9,789
Disability 2,699 2,390
Long-Term Care 99 97
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Health membership as of March 31, 1997 reflects improved data as a result of
system and plan conversions. The conversions predominately affected
Indemnity and PPO membership and had an immaterial impact on all other
health products. March 31, 1997 membership reflects adjustments which
continued to occur through the latter half of 1997 as applied to March 31,
1997 membership previously reported.
(2) Includes 976 thousand POS members who access primary care physicians and
referred care through an HMO network at March 31, 1998 and 856 thousand at
March 31, 1997.
(3) Group Insurance membership as of March 31, 1997 reflects improved data as a
result of the conversion to a new membership reporting system. March 31,
1997 membership reflects adjustments which continued to occur through the
latter half of 1997 as applied to March 31, 1997 membership previously
reported. Many Group Insurance members participate in more than one type of
Aetna U.S. Healthcare coverage and are counted in each.
Total Health membership as of March 31, 1998 decreased by 139 thousand members
when compared to March 31, 1997. Membership increases in Commercial HMO,
Medicare HMO and POS were more than offset by declines in Indemnity, PPO and
Medicaid enrollment. The decline in Indemnity enrollment reflects, among other
factors, the continued migration of Indemnity members to managed care products.
Total HMO membership as of March 31, 1998 increased by 337 thousand members, or
7%, when compared to March 31, 1997.
Page 23
<PAGE> 24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Total Revenue and Expense
Revenue for Aetna U.S. Healthcare, excluding revenue in the first quarter of
1997 related to certain Medicare administrative services no longer provided by
Aetna U.S. Healthcare, and excluding net realized capital gains or losses,
increased by $168 million, or 5%, for the three months ended March 31, 1998
compared to the same period in 1997. This growth was primarily due to membership
growth in Commercial and Medicare HMOs partially offset by lower Indemnity and
PPO membership, as well as to premium rate increases on business being renewed
during the first three months of 1998.
Operating expenses for Aetna U.S. Healthcare, excluding operating expenses in
the first quarter of 1997 related to certain Medicare administrative services no
longer provided by Aetna U.S. Healthcare, increased by $32 million, or 6%, for
the three months ended March 31, 1998 compared with the same period in 1997,
primarily related to higher HMO membership and customer service enhancements.
Page 24
<PAGE> 25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA RETIREMENT SERVICES
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------------------
(Millions) 1998 1997 % Change
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums (1) $ 40.3 $ 40.4 (.2)%
Net investment income 267.6 272.6 (1.8)
Fees and other income 162.7 134.4 21.1
Net realized capital (losses) gains (2.2) 5.4 --
- -------------------------------------------------------------------------------------------
Total revenue 468.4 452.8 3.4
- -------------------------------------------------------------------------------------------
Current and future benefits 250.3 266.2 (6.0)
Operating expenses 101.7 81.4 24.9
Amortization of deferred policy
acquisition costs 34.0 21.4 58.9
- -------------------------------------------------------------------------------------------
Total benefits and expenses 386.0 369.0 4.6
- -------------------------------------------------------------------------------------------
Income before income taxes 82.4 83.8 (1.7)
Income taxes 24.1 27.4 (12.0)
- -------------------------------------------------------------------------------------------
Net income (2) $ 58.3 $ 56.4 3.4
===========================================================================================
Net realized capital (losses) gains,
net of tax (included above) $ (1.4) $ 3.5 --
===========================================================================================
Deposits not included in premiums
above:
Annuities - fixed options $ 333.1 $ 280.2 18.9
Annuities - variable options 907.1 818.1 10.9
Individual Life Insurance 131.1 120.5 8.8
- -------------------------------------------------------------------------------------------
Total $ 1,371.3 $ 1,218.8 12.5
===========================================================================================
Assets under management: (3)
Annuities - fixed options $12,069.9 $11,767.9 2.6
Annuities - variable options (4) 22,852.1 15,047.7 51.9
- -------------------------------------------------------------------------------------------
Subtotal Annuities 34,922.0 26,815.6 30.2
Other investment advisory (5) 10,346.5 4,095.5 152.6
- -------------------------------------------------------------------------------------------
Financial services 45,268.5 30,911.1 46.4
Individual Life Insurance 3,207.6 2,900.7 10.6
- -------------------------------------------------------------------------------------------
Total $48,476.1 $33,811.8 43.4
===========================================================================================
Individual life insurance
coverage issued $ 1,226.4 $ 1,403.0 (12.6)
===========================================================================================
Individual life insurance
coverage in force $49,733.5 $49,338.8 .8
===========================================================================================
</TABLE>
(1) Includes $14.3 million for the three months ended March 31, 1998 and $16.4
million for the three months ended March 31, 1997 for annuity premiums on
contracts converting from the accumulation phase to payout options with life
contingencies.
(2) Net income for the three months ended March 31, 1998 includes a net benefit
from capitalizing internal-use software of $1.7 million.
(3) Excludes net unrealized capital gains of approximately $565.3 million at
March 31, 1998 and $50.1 million at March 31, 1997.
(4) Includes $6,029.3 million at March 31, 1998 and $4,888.9 million at March
31, 1997 of assets held and managed by unaffiliated mutual funds.
(5) The March 31, 1998 balance includes the transfer of $3,163.5 million of
assets that were previously reported in the Large Case Pensions segment,
reflecting the consolidation of certain products which complement Aetna
Retirement Services' business strategy.
Aetna Retirement Services' ("ARS") net income for the three months ended March
31, 1998 increased $2 million compared to the same period in 1997. Results for
the three months ended March 31, 1998 include costs of $4 million related to
Year 2000 remediation. Excluding Year 2000 costs and net realized capital gains
or losses, results for the three months ended March 31, 1998 increased $11
million, or 21%, compared to the first quarter of 1997, reflecting improved
earnings from both financial services products and individual life insurance
products, as shown below.
Page 25
<PAGE> 26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA RETIREMENT SERVICES (CONTINUED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
(Millions) 1998 1997
- -----------------------------------------------------------------------------------
<S> <C> <C>
Financial services $40.8 $36.6
Individual life insurance 23.0 16.3
- -----------------------------------------------------------------------------------
Total $63.8 $52.9
===================================================================================
</TABLE>
The increase in earnings for financial services products reflects increased fee
income primarily from increased assets under management. Assets under management
(excluding approximately $3 billion of assets under management that were
previously reported in the Large Case Pensions segment) increased by 36%
primarily due to appreciation in the stock market and additional net deposits
(deposits less surrenders) as well as the inclusion of assets under management
of Financial Network Investment Corporation ("FNIC"), which was acquired in July
1997.
Partially offsetting the increases in fee income were increased operating
expenses, including expenses of FNIC. The three months ended March 31, 1998
reflect increased expenses due to business growth and continued strategic
investments. However, operating expenses as a percentage of assets under
management declined in both periods.
Earnings from individual life insurance products increased $7 million, primarily
due to a one-time benefit from the termination of a reinsurance arrangement
related to the participating life insurance business.
Of the $12.1 billion and $11.8 billion of fixed annuity assets under management
at March 31, 1998 and 1997, 25% were fully guaranteed and 75% were experience
rated. The average annualized earned rates on investments supporting fully
guaranteed investment contracts were 7.5% and 7.9% and the average annualized
earned rates on investments supporting experience rated investment contracts
were 8.0% and 8.1% for the three months ended March 31, 1998 and 1997,
respectively. The average annualized credited rates on fully guaranteed
investment contracts were 6.5% and 6.7% and the average annualized credited
rates on experience rated investment contracts were 5.9% and 6.0% for the three
months ended March 31, 1998 and 1997, respectively. The resulting annualized
interest margins on fully guaranteed investment contracts were 1.0% and 1.2% and
on experience rated investment contracts was 2.1% for the each of the three
months ended March 31, 1998 and 1997, respectively.
Page 26
<PAGE> 27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------------------
(Millions) 1998 1997 % Change
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $319.3 $317.4 .6%
Net investment income 118.3 92.3 28.2
Fees and other income 31.9 34.1 (6.5)
Net realized capital (losses) gains (12.3) 3.9 --
- ------------------------------------------------------------------------------------------
Total revenue 457.2 447.7 2.1
- ------------------------------------------------------------------------------------------
Current and future benefits 277.7 276.3 .5
Operating expenses 114.6 100.4 14.1
Interest expense 2.7 1.7 58.8
Amortization of goodwill and
other acquired intangible assets 5.1 2.3 121.7
Amortization of deferred policy
acquisition costs 18.3 19.5 (6.2)
- ------------------------------------------------------------------------------------------
Total benefits and expenses 418.4 400.2 4.5
- ------------------------------------------------------------------------------------------
Income before income taxes 38.8 47.5 (18.3)
Income taxes 10.8 16.5 (34.5)
- ------------------------------------------------------------------------------------------
Net income (1) $ 28.0 $ 31.0 (9.7)
==========================================================================================
Net realized capital (losses) gains,
net of tax (included above) $ (7.8) $ 3.5 --
==========================================================================================
</TABLE>
(1) Net income for the three months ended March 31, 1998 includes a net benefit
from capitalizing internal-use software of $.3 million.
Aetna International's net income for the three months ended March 31, 1998
decreased by $3 million compared with the same period in 1997. Results for the
three months ended March 31, 1998 include costs of $2 million related to Year
2000 remediation. Excluding Year 2000 costs and net realized capital gains or
losses, results for the three months ended March 31, 1998 increased $10 million,
or 36%, from the corresponding prior year period. The increase in 1998 results,
as shown below, primarily reflect the Company's operations in Brazil, which were
acquired in April 1997, and new pension business in Mexico.
Earnings by major geographic location, excluding Year 2000 costs and net
realized capital gains or losses, were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------
(Millions) 1998 1997
- -------------------------------------------------------------------------------------
<S> <C> <C>
Asia Pacific (1) $12.3 $12.1
Americas (2) 28.6 16.1
Other (3) (3.4) (.7)
- -------------------------------------------------------------------------------------
Total $37.5 $27.5
=====================================================================================
</TABLE>
(1) Includes Hong Kong, Taiwan, Indonesia, Malaysia, Philippines, and New
Zealand.
(2) Includes Argentina, Brazil, Canada, Mexico, Venezuela, Chile and Peru.
(3) Includes general and other miscellaneous expenses.
Page 27
<PAGE> 28
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------------
(Millions) 1998 1997 % Change
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 40.0 $ 43.5 (8.0)%
Net investment income 303.7 365.6 (16.9)
Fees and other income (1) 4.6 8.9 (48.3)
Net realized capital gains 37.9 4.9 --
- ------------------------------------------------------------------------------------------
Total revenue 386.2 422.9 (8.7)
- ------------------------------------------------------------------------------------------
Current and future benefits 306.0 364.7 (16.1)
Operating expenses (1) 6.0 7.6 (21.1)
Reduction of loss on discontinued
products -- (172.5) 100.0
- ------------------------------------------------------------------------------------------
Total benefits and expenses 312.0 199.8 56.2
- ------------------------------------------------------------------------------------------
Income before income taxes 74.2 223.1 (66.7)
Income taxes 27.0 81.7 (67.0)
- ------------------------------------------------------------------------------------------
Net income $ 47.2 $ 141.4 (66.6)
==========================================================================================
Net realized capital gains,
net of tax (included above) $ 24.7 $ 3.2 --
==========================================================================================
Deposits not included in premiums
above $ 267.4 $ 505.0 (47.0)
==========================================================================================
Assets under management (1) (2) (3) $30,008.9 $33,567.1 (10.6)
==========================================================================================
</TABLE>
(1) Three months ended March 31, 1997 included $2.0 million of fees and other
income and $.8 million of operating expenses and, at March 31, 1997, assets
of $2,759.2 million which are currently reported in the ARS segment,
reflecting the consolidating of the Company's investment advisory services
and certain other products which complement ARS' business strategy.
(2) Excludes net unrealized capital gains of approximately $590.7 million at
March 31, 1998 and $17.0 million at March 31, 1997.
(3) Includes assets under management of $7,265.6 million at March 31, 1998 and
$8,206.3 million at March 31, 1997 related to discontinued products.
Large Case Pensions' net income for the three months ended March 31, 1998
decreased by $94 million compared with the same period in 1997. Results for the
three months ended March 31, 1998 include costs of $.1 million related to Year
2000 remediation. Excluding Year 2000 costs in 1998, the reduction of the loss
on discontinued products in 1997 and net realized capital gains in both periods,
results for the three months ended March 31, 1998 decreased $7 million, or 24%,
from the same period in 1997. Earnings decreased as net investment income was
reduced as capital supporting the Large Case Pensions segment was redeployed to
other businesses of the Company as obligations matured.
Assets under management at March 31, 1998 were 11% lower than a year earlier,
primarily as a result of the continuing runoff of underlying liabilities and
consolidation into the ARS segment of the Company's investment advisory services
and certain other products which complement ARS' business strategy.
Page 28
<PAGE> 29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
General account assets supporting experience rated products (where the customer,
not the Company, assumes investment and other risks) may be subject to
participant or contractholder withdrawal. Participant withdrawals are generally
subject to significant tax and plan constraints. Experience rated contractholder
and participant withdrawals and transfers were as follows (excluding
contractholder transfers to other Company products):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------
(Millions) 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Scheduled contract maturities
and benefit payments (1) $237.1 $226.8
Contractholder withdrawals other
than scheduled contract maturities
and benefit payments 72.7 85.8
Participant directed withdrawals 27.8 33.9
- --------------------------------------------------------------------------------------
</TABLE>
(1) Includes payments made upon contract maturity and other amounts distributed
in accordance with contract schedules.
Discontinued Products
Results of operations of discontinued products, including net realized capital
gains or losses, are credited or charged to the reserve for anticipated losses.
To the extent that aggregate future losses on the products are greater than
anticipated, the Company's results of operations would be adversely affected,
and positively affected to the extent future losses are less than anticipated.
Management reviews the adequacy of the discontinued products reserve quarterly.
In the first quarter of 1997 as a result of continued favorable developments in
real estate markets, the Company released $173 million (pretax) of the reserve
related to guaranteed investment contracts ("GICs"). The current reserve
reflects management's best estimate of anticipated future losses. The discussion
below presents information for single-premium annuities ("SPAs") and GIC
products on a combined basis.
The results of discontinued products were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------
(Millions) 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Interest margin $(6.4) $ 5.9
Net realized capital gains (1) 42.3 19.8
Interest earned on receivable from
continuing products 5.6 5.4
Other, net (.3) 1.9
- --------------------------------------------------------------------------------------
Results of discontinued products,
after tax $41.2 $33.0
======================================================================================
Results of discontinued products,
pretax $66.7 $52.4
======================================================================================
Net realized capital gains from sales
of bonds, after tax (included above) $23.1 $ 3.8
======================================================================================
</TABLE>
(1) Includes net realized capital gains of $21.2 million for the three months
ended March 31, 1998 and $16.0 million for the three months ended March 31,
1997 related to continued favorable developments in real estate markets.
The interest margin is the difference between earnings on invested assets and
interest credited to contractholders.
Page 29
<PAGE> 30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
Total assets supporting discontinued products and the reserve include a
receivable from continuing products of $520 million after tax at March 31, 1998.
Interest income accrues on this receivable at the discount rate used to
calculate the reserve.
The activity in the reserve for anticipated future losses on discontinued
products was as follows (pretax):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
(Millions) 1998
- --------------------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1997 $1,151.7
Results of discontinued products 66.7
- --------------------------------------------------------------------------------
Reserve at March 31, 1998 $1,218.4
================================================================================
</TABLE>
Distributions on discontinued products were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
(Millions) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Scheduled contract maturities,
settlements and benefit
payments $467.5 $443.1
Participant directed withdrawals 6.4 10.0
- --------------------------------------------------------------------------------
</TABLE>
See Note 10 of Condensed Notes to Financial Statements for additional
information.
CORPORATE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------------
(Millions, after tax) 1998 1997 % Change
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest expense $35.2 $35.2 --
Other expense, net (1) 26.3 28.8 (8.7)%
Net realized capital losses (gains) 1.7 (.3) --
- --------------------------------------------------------------------------------------------
</TABLE>
(1) For the first quarter of 1998, other expense includes a net benefit from
capitalizing internal-use software of $2.2 million.
The Corporate segment includes interest expense and other expenses which are not
directly related to the Company's business segments. "Other Expense" includes
corporate expenses such as staff area expenses, advertising and contributions,
which are partially offset by net investment income.
Included in other expense for the three months ended March 31, 1998 are costs of
$2 million related to Year 2000 remediation.
Page 30
<PAGE> 31
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
GENERAL ACCOUNT INVESTMENTS
Risk Management and Market Sensitive Instruments
Interest rate risk is managed within a tight duration band, and credit risk is
managed by maintaining high average quality ratings and diversified sector
exposure within the debt securities portfolio. The Company's use of derivatives
is generally limited to hedging purposes and has principally consisted of using
foreign exchange forward contracts, futures contracts, interest rate swap
agreements and warrants to hedge interest rate risk, equity price risk and
foreign exchange risk (collectively, market risk).
The Company regularly evaluates market risk which addresses, among other things,
levels of or changes in domestic and/or foreign interest rates (short-term or
long-term), duration, exchange rates, prepayment rates, equity markets or credit
ratings/spreads.
Management also, on a quarterly basis, reviews hypothetical net losses in the
consolidated near-term financial position, results of operations or cash flows
under certain assumed market rate changes.
Based on the Company's overall exposure to market risk, the Company believes
that these hypothetical changes in market rates and prices would not materially
affect the consolidated near-term financial position, results of operations or
cash flows of the Company as of March 31, 1998. See the Company's 1997 Annual
Report for a more complete discussion of "Risk Management and Market Sensitive
Instruments".
Debt Securities
Debt securities represented 81% of the Company's total general account invested
assets at March 31, 1998 and 80% at December 31, 1997. Debt securities were as
follows:
<TABLE>
<CAPTION>
March 31, December 31,
(Millions) 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 6,315.4 $ 6,471.4
Supporting experience rated products 15,242.1 15,322.8
Supporting remaining products 13,043.0 12,450.8
- ------------------------------------------------------------------------------------------
Total debt securities (1) $34,600.5 $34,245.0
==========================================================================================
</TABLE>
(1) Total debt securities include "Below Investment Grade" securities of $2.0
billion at March 31, 1998 and December 31, 1997 of which 60.4% at March 31,
1998 and 61.5% at December 31, 1997 support discontinued and experience
rated products. See the Company's 1997 Annual Report for a discussion of
"Below Investment Grade" securities.
Debt securities reflected net unrealized capital gains of $1.6 billion at
March 31, 1998 and December 31, 1997. Of the net unrealized capital gains at
March 31, 1998, $356 million related to assets supporting discontinued products
and $663 million related to assets supporting experience rated contracts.
Page 31
<PAGE> 32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
GENERAL ACCOUNT INVESTMENTS (CONTINUED)
Residential Collateralized Mortgage Obligations
Included in the Company's debt securities were residential collateralized
mortgage obligations ("CMOs") as follows:
<TABLE>
<CAPTION>
March 31, December 31,
(Millions) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 105.3 $ 104.0
Supporting experience rated products 2,044.2 2,060.8
Supporting remaining products 497.8 545.6
- ---------------------------------------------------------------------------------------------
Total residential CMOs (1) $2,647.3 $2,710.4
=============================================================================================
</TABLE>
(1) The amortized cost of total residential CMOs was $2,507.1 million at March
31, 1998 and $2,549.6 million at December 31, 1997.
There are various categories of CMOs which are subject to different degrees of
risk from changes in interest rates and, for nonagency-backed CMOs, defaults.
The principal risks inherent in holding CMOs are prepayment and extension risks
related to dramatic decreases and increases in interest rates resulting in the
repayment of principal from the underlying mortgages either earlier or later
than originally anticipated. At March 31, 1998, approximately 2% and at December
31, 1997, approximately 3% of the Company's CMO holdings were invested in CMOs
that are subject to more prepayment and extension risk than traditional CMOs
(such as interest- or principal-only strips).
Mortgage Loans
At March 31, 1998 and December 31, 1997, the Company's mortgage loan
investments, net of impairment reserves, were as follows:
<TABLE>
<CAPTION>
March 31, December 31,
(Millions) 1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 928.6 $ 976.9
Supporting experience rated products 1,538.9 1,671.9
Supporting remaining products 1,539.1 1,559.0
- --------------------------------------------------------------------------------------------
Total mortgage loan investments $4,006.6 $4,207.8
============================================================================================
</TABLE>
Problem, restructured, and potential problem loans included in mortgage loans
were $331 million at March 31, 1998 and $388 million at December 31, 1997 of
which 83% at March 31, 1998 and 84% at December 31, 1997 support discontinued
and experience rated products. See the Company's 1997 Annual Report for a
discussion of problem, restructured and potential problem loans. Specific
impairment reserves on these loans were $50 million at March 31, 1998 and $51
million at December 31, 1997. (See Note 6 of Condensed Notes to Financial
Statements).
During the first three months of 1998, the Company continued to manage its
mortgage loan portfolio to reduce the balance in absolute terms and relative to
invested assets, and to reduce its overall risk. The $201 million decrease in
the mortgage loan portfolio primarily reflects the effect of loan prepayments
and repayments of maturing loans.
Page 32
<PAGE> 33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
GENERAL ACCOUNT INVESTMENTS (CONTINUED)
Real Estate
The Company's real estate balances, net of write-downs and reserves, were $340
million at March 31, 1998 and $370 million at December 31, 1997.
For the three months ended March 31, 1997, net realized capital losses from real
estate write-downs and changes in the valuation reserves were $6.3 million. No
material write-downs or changes in the valuation reserves occurred during the
three months ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The liquidity needs of the Company's businesses are generally met from cash
provided by investing activities (asset maturities and sales), premiums,
deposits, income received on investments and financings. The Company's
businesses use cash primarily for claim and benefit payments, contract
withdrawals and operating expenses. In addition, the Company uses cash to
invest in core businesses, repurchase common stock and pay shareholder
dividends.
During the first three months of 1998, net cash generated from investing,
financing and operating activities was used to make approximately $8 million of
investments in core businesses, repurchase approximately $37 million of common
stock and pay approximately $43 million of dividends to shareholders.
During the corresponding period of 1997, net cash generated from investing,
financing and operating activities was used to make approximately $130 million
of investments in core businesses, repurchase approximately $90 million of
common stock and pay approximately $44 million of dividends to shareholders. See
"Consolidated Statements of Cash Flows" for additional information.
Dividends
On February 27, 1998, the Company's Board of Directors declared a quarterly
dividend of $.20 per share of common stock and $1.18945 per share of 6.25% Class
C Voting Mandatorily Convertible Preferred Stock to shareholders of record at
the close of business on April 24, 1998, payable May 15, 1998.
Financings and Financing Capacity
Substantially all of the Company's short-term and long-term borrowings and
financings are conducted through Aetna Services, Inc. and are fully and
unconditionally guaranteed by Aetna Inc. (See Note 11 of Condensed Notes to
Financial Statements).
The Company has significant short-term liquidity supporting its businesses. The
Company uses short-term borrowings from time to time to address timing
differences between receipts and disbursements. The maximum amount of domestic
short-term borrowings outstanding was $721 million during the first three months
of 1998 and $554 million during the first three months of 1997.
Page 33
<PAGE> 34
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Financings and Financing Capacity (Continued)
The acquisition of the NYLCare health business, which is anticipated to be
completed in the third quarter of 1998, is currently expected to ultimately be
financed by the issuance of medium- or long-term fixed income securities.
Common Stock Transactions
In September 1997, the Board authorized the repurchase of up to 7.5 million
shares of common stock. As of March 31, 1998, 2,830,000 shares of common stock
had been repurchased at a cost of $220 million, of which 461,700 shares at a
cost of $37 million were repurchased during the three months ended March 31,
1998.
NEW ACCOUNTING STANDARDS
See Note 2 of Condensed Notes to Financial Statements for a discussion of
recently issued accounting standards.
YEAR 2000
During the first three months of 1998 the Company incurred $16 million of costs
for company-owned systems and applications related to Year 2000 remediation. A
large majority of these costs are currently believed to be incremental expenses
that will not recur in the Year 2000 or thereafter. Year 2000 remediation costs
were not material in 1997. See "Year 2000" in the Company's 1997 Annual Report
for more detail.
REGULATORY ENVIRONMENT
A variety of legislative and regulatory proposals have been made at both the
federal and state government levels to address various aspects of the health
care system.
Legislation to reform the federal Medicare program was passed by Congress on
July 31, 1997 and was signed into law. Certain provisions of this legislation
began to phase in, beginning on January 1, 1998, changes to the Medicare risk
HMO premium determination methodology that will generally reduce the premiums
payable to the Company as compared with the methodology previously used. The
level and extent of any reductions will vary by geographic market and other
factors. While the phase-in provisions have provided the Company with an
opportunity to offset some of such premium reductions by adjusting the
supplemental premiums payable by members and the benefits included in the
Company's products, competition, regulation and other factors may result in such
adjustments not fully offsetting such premium reductions.
Page 34
<PAGE> 35
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT (CONTINUED)
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), was
enacted to (i) ensure portability of coverage to individuals changing jobs or
moving to individual coverage by limiting preexisting condition exclusions, (ii)
guarantee availability of coverage to employees in the small group market, and
(iii) prevent exclusion of individuals from coverage under group plans based on
health status. This legislation was effective on July 1, 1997. Other federal
legislation, effective January 1, 1998, mandated minimum hospital stays after
childbirth and parity in applying lifetime limits to mental health benefits.
Congress and many states, including states in which the Company has substantial
managed care membership, are considering legislation or regulation related to
the operation of health plans. Such legislation or regulation varies, but
includes, among other things, one or more of the following: (i) mandatory
maternity and other lengths of stay, (ii) regulation of utilization review,
(iii) mandated expanded consumer disclosures, (iv) mandatory direct access to
specialists including OB/GYNs and chiropractors, (v) mandatory point-of-service
benefits, (vi) mandatory or expanded coverage of experimental procedures and
drugs, (vii) third party review of denials of benefits, (viii) liability for
negligent denials of benefits, (ix) assessments, surcharges or taxes on premiums
or provider payments to fund uncompensated care, graduate medical education or
government programs, (x) extension of malpractice and other liability for
medical and other decisions from providers to health plans, (xi) required
payment for emergency services, (xii) mandated internal and external grievance
and appeal procedures, (xiii) hearings on termination of physicians from
networks, (xiv) prohibition of so-called "gag" clauses, and (xv) provisions
similar to those in HIPAA.
Other potential legislative and regulatory changes related to health plans that
are receiving a high level of attention at both the state and federal levels
include, but are not limited to, (i) eliminating or reducing the scope of ERISA
preemption of state laws; (ii) required payment levels for out of network care;
(iii) prohibition or limitation of arrangements designed to manage medical costs
and improve quality of care, such as capitated arrangements with providers or
provider financial incentives; (iv) limitations on utilization management
methods; (v) regulation of the composition of the Company's provider networks,
such as any willing provider or pharmacy laws; and (vi) changes to licensure or
certification requirements.
At this time, the Company is unable to predict the impact of the foregoing
federal or state legislation or regulation, or of any future legislation or
regulatory changes that may be enacted, although it can be anticipated that
certain of these measures, if enacted, would adversely affect the Company.
Moreover, there can be no assurance that the Company can recoup, through higher
premiums or other measures, the increased costs of mandated benefits or the
other increased costs caused by such legislation or regulation.
For other important information regarding regulation of the Company's health and
other businesses, see the Company's 1997 Annual Report on Form 10-K.
Page 35
<PAGE> 36
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
FORWARD-LOOKING INFORMATION/RISK FACTORS
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a
"safe harbor" for forward-looking statements, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. The Company desires to
take advantage of these safe harbor provisions.
See "Forward Looking Information/Risk Factors", "Regulatory Environment" and the
"Outlook" section of each business segment in the Company's 1997 Annual Report
for information regarding important factors that may materially affect the
Company.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
See information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General Account Investments".
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Purported Class Action Complaints were filed in the United States District Court
for the Eastern District of Pennsylvania on November 5, 1997 by Eileen
Herskowitz and Michael Wolin, and on December 4, 1997 by Pamela Goodman and
Michael J. Oring. Other purported Class Action Complaints were filed in the
United States District Court for the District of Connecticut on November 25,
1997 by Evelyn Silvert, on November 26, 1997 by the Rainbow Fund, Inc., and on
December 24, 1997 by Terry B. Cohen. The Complaints seek, among other remedies,
unspecified damages resulting from defendants' alleged violations of federal
securities laws. The Complaints allege that the Company and three of its current
or former officers or directors, Ronald E. Compton, Richard L. Huber, and
Leonard Abramson, are liable for certain misrepresentations and omissions
regarding, among other matters, the integration of the merger with U.S.
Healthcare and the Company's medical claim reserves. The Connecticut actions
have been transferred to the United States District Court for the Eastern
District of Pennsylvania for consolidated pretrial proceedings with the cases
pending there. The litigation is still in the preliminary stages, and the
Company is defending the actions vigorously.
The Company is also involved in numerous other lawsuits arising, for the most
part, in the ordinary course of its business operations, including litigation in
its health business concerning benefit plan coverage and other decisions made by
the Company, and alleged medical malpractice by participating providers. While
the ultimate outcome of these other lawsuits cannot be determined at this time,
after consideration of the defenses available to the Company and any related
reserves established, they are not expected to result in liability for amounts
material to the financial condition of the Company, although they may adversely
affect results of operations in future periods.
Page 36
<PAGE> 37
PART II. OTHER INFORMATION (Continued)
Item 5. Other Information.
(a) NAIC IRIS Ratios
The NAIC IRIS ratios cover 12 categories of financial data with defined usual
ranges for each category. The ratios are intended to provide insurance
regulators "early warnings" as to when a given company might warrant special
attention. An insurance company may fall out of the usual range for one or more
ratios and such variances may result from specific transactions that are in
themselves immaterial or eliminated at the consolidated level. As of the date of
this filing, none of Aetna Inc.'s significant subsidiaries had more than two
IRIS ratios that were outside of the NAIC usual ranges for 1997.
(b) Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed Charges
and Preferred Stock Dividends
The following table sets forth the Company's and Aetna Services' ratio of
earnings to fixed charges and ratio of earnings to combined fixed charges and
preferred stock dividends for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Years Ended
March 31, December 31,
------------------ --------------------------------------------
Aetna Inc. 1998 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed Charges 4.23 5.74 2.45 4.97 4.74 (a)
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.32 4.46 2.10 4.97 4.74 (a)
</TABLE>
(a) The Company reported a pretax loss from continuing operations in 1993 which
was inadequate to cover fixed charges by $1.0 billion.
<TABLE>
<CAPTION>
Three Months Ended Years Ended
March 31, December 31,
------------------ ----------------------
Aetna Services, Inc. 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Ratio of Earnings to Fixed Charges 3.77 5.78 2.44
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.77 5.78 2.44
</TABLE>
For purposes of computing both the ratio of earnings to fixed charges and the
ratio of earnings to combined fixed charges and preferred stock dividends,
"earnings" represent consolidated earnings from continuing operations before
income taxes, cumulative effect adjustments and extraordinary items plus fixed
charges and minority interest. "Fixed charges" consist of interest (and the
portion of rental expense deemed representative of the interest factor) and
includes the dividends paid to preferred shareholders of a subsidiary. (See Note
15 of Notes to Financial Statements in the Company's 1997 Annual Report.) During
1995, 1994, and 1993 there was no preferred stock outstanding, and as a result,
the ratios of earnings to combined fixed charges and preferred stock dividends
were the same as the ratios of earnings to fixed charges.
Page 37
<PAGE> 38
PART II. OTHER INFORMATION (Continued)
Item 5. Other Information. (Continued)
(c) Ratings
The ratings of certain of Aetna Inc.'s subsidiaries follow:
<TABLE>
<CAPTION>
Rating Agencies
-------------------------------------------------
Moody's
Duff & Investors Standard
A.M. Best Phelps Service & Poor's
-------------------------------------------------
<S> <C> <C> <C> <C>
Aetna Services, Inc.(senior debt)**
February 4, 1997 * A A2 A-
May 6, 1998 * A A2 A
Aetna Services, Inc.(commercial paper)**
February 4, 1997 * D-1 P-1 A-2
May 6, 1998 * D-1 P-1 A-1
Aetna Life Insurance Company(claims paying)
February 4, 1997 A AA- Aa3 A
May 6, 1998 A AA- A1 A+
Aetna Life Insurance and Annuity Company(claims paying)
February 4, 1997 A+ AA+ Aa2 AA-
May 6, 1998 A+ AA+ Aa3 AA-
</TABLE>
* Nonrated by the agency.
** Fully and unconditionally guaranteed by Aetna Inc.
In addition, certain of the Company's HMO subsidiaries are rated on their claims
paying ability by A.M. Best. All such ratings are in the "Excellent" or
"Superior" categories.
A.M. Best ratings are on review and Standard & Poor's, Moody's Investors Service
and Duff & Phelps ratings are on credit watch or review for possible downgrade.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(10) Material Contracts.
Amendment to 1996 Stock Incentive Plan*
(12) Statement Re: Computation of Ratios.
Statement re: computation of ratio of earnings to fixed charges and
ratio of earnings to combined fixed charges and preferred stock
dividends for the three months ended March 31, 1998 and for the
years ended December 31, 1997, 1996, 1995, 1994 and 1993 for the
Company and for the three months ended March 31, 1998 and for the
years ended December 31, 1997 and 1996 for Aetna Services, Inc.
(15) Letter Re: Unaudited Interim Financial Information.
Letter from KPMG Peat Marwick LLP acknowledging awareness of the use
of a report on unaudited interim financial information, dated May 5,
1998.
(27) Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on March 16, 1998 related to the NYLCare
acquisition.
Page 38
<PAGE> 39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Aetna Inc.
---------------------------
(Registrant)
Date May 6, 1998 By /s/ Alan M. Bennett
---------------------------
Alan M. Bennett
Vice President
and Corporate Controller
(Chief Accounting Officer)
Page 39
<PAGE> 1
02-27-98
Exhibit 10
Amendment to 1996 Stock Incentive Plan
- --------------------------------------
"That Section 13(c) of the 1996 Stock Incentive Plan of this company is
hereby amended to delete the words 'or pursuant to a qualified domestic
relations order'; that Section 2 is hereby amended to add the following
additional language to the definition of 'Eligible Employee': 'Any
individual the Company designates as, or otherwise determines to be, an
independent contractor shall not be considered an Eligible Employee, and
such designation or determination shall govern regardless of whether such
individual is ultimately determined to be an employee pursuant to the Code
or any other applicable law'; and that Section 3 is hereby amended to add
the following additional language at the end of the second paragraph:
'(including authorizing the Chief Executive Officer of the Company to
designate Participants or make Awards under the Plan within limits
prescribed by the Committee).'
<PAGE> 1
EXHIBIT 12
AETNA INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND RATIO OF EARNINGS TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
<TABLE>
<CAPTION>
Three Months Ended Years Ended
March 31, December 31,
------------------- -------------------------------------------------------------
(Millions) 1998 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Pretax income (loss) from
continuing operations $279.2 $1,511.2 $338.7 $726.2 $627.5 $(1,014.7)
Add back fixed charges 85.0 321.9 245.1 187.0 170.8 154.7
Minority interest (4.9) 14.7 16.4 16.1 11.4 7.0
- -----------------------------------------------------------------------------------------------------------------------------
Income (loss) as adjusted $359.3 $1,847.8 $600.2 $929.3 $809.7 $ (853.0)
=============================================================================================================================
Fixed charges:
Interest on indebtedness (1) $ 56.9 $ 235.8 $168.3 $115.9 $ 98.6 77.4
Portion of rents representative
of interest factor 28.1 86.1 76.8 71.1 72.2 77.3
- -----------------------------------------------------------------------------------------------------------------------------
Total fixed charges $ 85.0 $ 321.9 $245.1 $187.0 $170.8 $ 154.7
=============================================================================================================================
Preferred stock dividend
requirements 23.2 92.4 41.1 -- -- --
- -----------------------------------------------------------------------------------------------------------------------------
Total combined fixed charges
and preferred stock dividend
requirements $108.2 $ 414.3 $286.2 $187.0 $170.8 $ 154.7
=============================================================================================================================
Ratio of earnings to fixed
charges 4.23 5.74 2.45 4.97 4.74 (5.51)
=============================================================================================================================
Ratio of earnings to combined
fixed charges and preferred
stock dividends 3.32 4.46 2.10 4.97 4.74 (5.51)
=============================================================================================================================
</TABLE>
(1) For the three months ended March 31, 1998 and years ended December 31, 1997,
1996, 1995 and 1994, interest on indebtedness includes the dividends paid to
preferred shareholders of a subsidiary. (See Note 14 of Notes to Financial
Statements in the Company's 1997 Annual Report.)
Page 1
<PAGE> 2
Exhibit 12 (Continued)
AETNA SERVICES, INC. (1)
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND RATIO OF EARNINGS TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
<TABLE>
<CAPTION>
Three Months Ended Years Ended
March 31, December 31,
------------------ --------------------------
(Millions) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pretax income from continuing
operations $237.3 $1,505.2 $335.0
Add back fixed charges 84.0 318.1 243.8
Minority interest (4.7) 15.7 16.4
- ---------------------------------------------------------------------------------------------------------------------
Income as adjusted $316.6 $1,839.0 $595.2
=====================================================================================================================
Fixed charges:
Interest on indebtedness (2) $ 56.9 $ 234.0 $168.3
Portion of rents representative
of interest factor 27.1 84.1 75.5
- ---------------------------------------------------------------------------------------------------------------------
Total fixed charges $ 84.0 $ 318.1 $243.8
=====================================================================================================================
Preferred stock dividend
requirements -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total combined fixed charges
and preferred stock dividend
requirements $ 84.0 $ 318.1 $243.8
=====================================================================================================================
Ratio of earnings to fixed
charges 3.77 5.78 2.44
=====================================================================================================================
Ratio of earnings to combined
fixed charges and preferred
stock dividends 3.77 5.78 2.44
=====================================================================================================================
</TABLE>
(1) Aetna Inc. has fully and unconditionally guaranteed the payment of all
principal, premium, if any, and interest on all outstanding debt securities
of Aetna Services, Inc. (See Note 13 of Notes to Financial Statements in the
Company's 1997 Annual Report.)
(2) Includes the dividends paid to preferred shareholders of a subsidiary.(See
Note 14 of Notes to Financial Statements in the Company's 1997 Annual
Report.)
Page 2
<PAGE> 1
Exhibit 15
Letter Re: Unaudited Interim Financial Information
- --------------------------------------------------
Aetna Inc.
Hartford, Connecticut
Ladies and Gentlemen:
Re: Registration Statements No. 33-52819, 33-52819-01, 333-07167, 333-07169,
333-08427, 333-08429 and 333-08431
With respect to the subject registration statements, we acknowledge our
awareness of the use therein of our report dated May 5, 1998 related to our
review of interim financial information.
Pursuant to Rule 436(c) under the Securities Act of 1933, such report is not
considered a part of a registration statement prepared or certified by an
accountant or a report prepared or certified by an accountant within the meaning
of Sections 7 and 11 of the Act.
/s/ KPMG Peat Marwick LLP
Hartford, Connecticut
May 5, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-Q FOR THE THREE MONTHS ENDED MARCH
31, 1998 FOR AETNA INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 34,601
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 1,127
<MORTGAGE> 4,007
<REAL-ESTATE> 340
<TOTAL-INVEST> 42,936
<CASH> 1,445
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 2,426
<TOTAL-ASSETS> 102,872
<POLICY-LOSSES> 18,438
<UNEARNED-PREMIUMS> 186
<POLICY-OTHER> 3,319
<POLICY-HOLDER-FUNDS> 18,344
<NOTES-PAYABLE> 2,209
865
0
<COMMON> 3,614
<OTHER-SE> 6,879
<TOTAL-LIABILITY-AND-EQUITY> 102,872
3,239
<INVESTMENT-INCOME> 813
<INVESTMENT-GAINS> 32
<OTHER-INCOME> 550
<BENEFITS> 3,271
<UNDERWRITING-AMORTIZATION> 52
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 279
<INCOME-TAX> 112
<INCOME-CONTINUING> 167
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 167
<EPS-PRIMARY> 1.05<F1>
<EPS-DILUTED> 1.05<F2>
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>THE EPS-PRIMARY TAG REPRESENTS BASIC EPS UNDER SFAS 128.
<F2>THE EPS-DILUTED TAG REPRESENTS DILUTED EPS UNDER SFAS 128.
</FN>
</TABLE>
