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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K/A
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 for the fiscal year ended DECEMBER 31, 1998
COMMISSION FILE NUMBER 1-11913
AETNA INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
CONNECTICUT 02-0488491
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
151 FARMINGTON AVENUE, HARTFORD, CONNECTICUT 06156 (860) 273-0123
(Address of principal executive offices) (ZIP Code) (Registrant's telephone number, including area code)
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Common Stock $.01 par value New York Stock Exchange
6 3/8% Notes due August 15, 2003 New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K/A or any amendment to
this Form 10-K/A. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of January 31, 2000 was $7,467,027,791.
As of January 31, 2000, 141,289,941 shares of the registrant's Common Stock $.01
par value were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement to be filed on or about March 15,
1999 (the "Proxy Statement"). (Parts III and IV)
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TABLE OF CONTENTS
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PART I
Item 1. Business.
A. Organization of Business. 3
B. Financial Information about Industry Segments. 4
C. Description of Industry Segments.
1. Aetna U.S. Healthcare. 4
2. Aetna Retirement Services. 12
3. Aetna International. 16
4. Large Case Pensions. 17
5. General Account Investments. 18
6. Other Matters.
a. Regulation. 19
b. NAIC IRIS Ratios. 21
c. Ratios of Earnings to Fixed Charges and Earnings
to Combined Fixed Charges and Preferred Stock Dividends. 22
d. Trademarks. 22
e. Ratings. 23
f. Miscellaneous. 23
Item 2. Properties. 24
Item 3. Legal Proceedings. 24
Item 4. Submission of Matters to a Vote of Security Holders. 24
Executive Officers of Aetna Inc. 25
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. 26
Item 6. Selected Financial Data. 27
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations. 28
Item 7A. Quantitative and Qualitative Disclosure About Market Risk. 59
Item 8. Financial Statements and Supplementary Data. 59
Item 9. Changes in and disagreements with Accountants on Accounting and Financial
Disclosure. 59
PART III
Item 10. Directors and Executive Officers of the Registrant. 59
Item 11. Executive Compensation. 60
Item 12. Security Ownership of Certain Beneficial Owners and Management. 60
Item 13. Certain Relationships and Related Transactions. 60
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 61
Index to Financial Statement Schedules. 117
Signatures. 130
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SIGNIFICANT FINANCIAL AND ACCOUNTING DEVELOPMENTS
Following a review by the staff of the Securities and Exchange Commission, Aetna
Inc. and its subsidiaries (collectively, the "Company") concluded that it would
restate its 1998 Form 10-K and 1999 Form 10-Qs. The purpose of this Form 10-K/A
is to restate the Company's 1998 financial statements, and to add certain other
disclosures (the "Restatement") to reflect, among other things and to the extent
applicable, the following changes:
- - Changes to the classification and timing of amounts earned by the Company
following the 1997 sale of Human Affairs International, Incorporated
("HAI"). Contingent payments earned by the Company originally recorded as
reductions of medical costs and as other income on a quarterly basis in
1998 have instead been recorded as a realized capital gain during the
fourth quarter of 1998;
- - A liability relating to the extension period (2000-2003) of an unfavorable
pharmacy contract originally recorded by the Company in connection with the
July, 1998 acquisition of NYLCare has been reversed to reflect the
elimination of this liability and reduction of goodwill;
- - The breakout of salaries and benefits expense originally included in other
operating expenses for each period presented;
- - The reclassification of the Company's initial capital contributions to
separate accounts and other excess funds not held to fund current separate
account liabilities to other invested assets, originally recorded to
separate account assets;
- - The reclassification of certain long-term debt (Puttable Reset Securities)
to short-term debt;
- - Expanded disclosures regarding the Company's 1996 severance and facilities
charges, discontinued products, goodwill amortization as well as other
accounting policies; and
- - The inclusion of information regarding reinsurance in the Notes to the
Consolidated Financial Statements, originally included in Form 10-K
schedules.
The principal effects of these changes on the accompanying financial statements
are presented in Note 2 to the Consolidated Financial Statements.
For purposes of this Report on Form 10-K/A, and in accordance with Rule 12b-15
under the Securities and Exchange Act of 1934, as amended, the Company has
amended and restated in its entirety each item of the 1998 Form 10-K which has
been affected by the Restatement. In order to preserve the nature and character
of the disclosures originally set forth in the Form 10-K filed on February 26,
1999, this Form 10-K/A does not reflect events occurring after the filing of the
original Form 10-K, or modify or update those disclosures in any way, except as
required to reflect the effects of the Restatement. The Company will file its
1999 Form 10-K on or before March 30, 2000.
Item 1. Business.
A. Organization of Business
Aetna Inc. and its subsidiaries (collectively, the "Company") constitute one of
the nation's largest health benefits companies, based on membership, and one of
the nation's largest insurance and financial services organizations centered
around three core businesses: health care, retirement services and
international.
Aetna Inc., a Connecticut corporation, became the parent corporation of Aetna
Services, Inc. ("Aetna Services") and Aetna U.S. Healthcare Inc. (formerly U.S.
Healthcare, Inc.) as a result of a merger transaction on July 19, 1996. The
merger was accounted for as a purchase of U.S. Healthcare. (See Note 4 of Notes
to Consolidated Financial Statements in Item 14(a) of this Report on Form
10-K/A.) Aetna sold its property-casualty operations on April 2, 1996. (See Note
5 of Notes to Consolidated Financial Statements in Item 14(a) of this Report on
Form 10-K/A for a discussion of certain indemnifications and other information
related to the property-casualty sale.) Aetna acquired New York Life Insurance
Company's NYLCare health business ("NYLCare") on July 15, 1998 and Aetna sold
its domestic individual life insurance business on October 1, 1998.
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The Company's business operations are conducted in the following segments: Aetna
U.S. Healthcare, Aetna Retirement Services, Aetna International and Large Case
Pensions. The principal products included in these segments are:
Aetna U.S. Healthcare:
Health products (including health maintenance organization,
point-of-service, preferred provider organization and indemnity products)
Group life and disability insurance
Long-term care insurance
Aetna Retirement Services:
Financial services (including annuity contracts, investment advisory
services, financial planning and pension plan administrative services)
Aetna International:
Primarily life and health insurance and financial retirement services
Large Case Pensions:
Retirement products (including pension and annuity products) primarily for
defined benefit and defined contribution plans
In addition, the Corporate segment includes interest expense and corporate
expenses not directly related to the Company's business segments, such as staff
area expenses, national advertising and contributions.
B. Financial Information about Industry Segments
Required financial information by industry segment is set forth in Notes 20, 21
and 22 of Notes to Consolidated Financial Statements, which is incorporated
herein by reference to Item 14(a) of this Report on Form 10-K/A. Revenue and
income from continuing operations attributable to each industry segment are
incorporated herein by reference to the Selected Financial Data in Item 6 of
this Report on Form 10-K/A.
Certain reclassifications have been made to the 1997 and 1996 financial
information to conform to the 1998 presentation.
C. Description of Industry Segments
1. Aetna U.S. Healthcare
Products and Services
Aetna U.S. Healthcare provides a full spectrum of health products (managed care
and indemnity) and group insurance products (life, disability and long-term
care) on both an insured and an employer-funded basis. Under insured plans, the
Company assumes all or a majority of health care cost, utilization, mortality,
morbidity or other risk depending on the product. Under employer-funded plans,
the plan sponsor, and not the Company, assumes all or a majority of these risks.
Aetna U.S. Healthcare consists of the Health Risk business and the Group
Insurance and Other Health business.
Health products include health maintenance organization, point-of-service,
preferred provider organization and indemnity products. The Health Risk business
includes health products offered on an insured basis.
The Group Insurance and Other Health business 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.
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The following table summarizes premiums and fees and other income for the Health
Risk and Group Insurance and Other Health businesses:
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As Restated
(Millions) 1998 (1) 1997 1996
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Health Risk $ 11,780.8 $ 9,735.0 $ 6,749.5
Group Insurance and Other Health 2,666.5 2,573.5 2,511.6
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Total Aetna U.S. Healthcare $ 14,447.3 $ 12,308.5 $ 9,261.1*
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U.S. Healthcare Pre Merger (historical amounts) N/A*** N/A*** $ 2,384.7**
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(1) Includes results for NYLCare since July 15, 1998.
* Includes U.S. Healthcare premiums and fees and other income from July 19,
1996 through December 31, 1996.
** Reflects premiums and fees and other income from January 1, 1996 through
July 18, 1996.
***Not applicable.
Under insured plans, Aetna U.S. Healthcare charges a premium and under
employer-funded plans, Aetna U.S. Healthcare charges a fee for administrative
and claim services.
The principal Commercial health products offered by Aetna U.S. Healthcare are:
Health Maintenance Organization ("HMO") plans offer comprehensive managed care
benefits generally through participating network physicians, hospitals and other
providers. When an individual enrolls in one of the Company's HMOs, he or she
selects a primary care physician ("PCP") from among the physicians participating
in the Aetna U.S. Healthcare network. PCPs generally are family practitioners,
internists, general practitioners or pediatricians who provide necessary
preventive and primary medical care, and are generally responsible for
coordinating other necessary health care, including making referrals to
participating network specialists. Preventive care and quality improvement are
emphasized in these plans. The Company offers HMO plans with varying levels of
copayments which result in different levels of premium rates. HMO plans are
principally offered on an insured basis. Commercial HMO membership totaled 4.4
million as of December 31, 1998, 3.3 million as of December 31, 1997 and 3.0
million as of December 31, 1996.
Point-of-Service ("POS") plans blend the characteristics of HMO and indemnity
plans. Members can have comprehensive HMO-style benefits through network
providers with minimum out-of-pocket expense (copayments) and also can go
directly, without a referral, to any provider they choose, subject to, among
other things, certain deductibles and coinsurance, with member cost sharing
limited by out-of-pocket maximums. POS plans are offered on both an insured and
employer-funded basis. Commercial POS membership totaled 4.1 million as of
December 31, 1998, 3.7 million as of December 31, 1997 and 3.5 million as of
December 31, 1996.
Preferred Provider Organization ("PPO") plans offer the member the ability to
select any health care provider, with benefits paid at a higher level when care
is received from a network provider. Coverage is subject to deductibles and
coinsurance, with member cost sharing limited by out-of-pocket maximums. PPO
plans are offered on both an insured and employer-funded basis. PPO membership
totaled 4.0 million as of December 31, 1998, 3.6 million as of December 31, 1997
and 3.7 million as of December 31, 1996.
Indemnity plans offer the member the ability to select any health care provider
for covered services. Some managed care and medical cost containment features
may be included in these plans, such as inpatient precertification, limiting
payments to reasonable and customary charges and benefits for preventive
services. Coverage is subject to deductibles and coinsurance, with member cost
sharing limited by out-of-pocket maximums. Indemnity plans are offered on both
an insured and employer-funded basis. Indemnity membership totaled 2.5 million
as of December 31, 1998, 2.6 million as of December 31, 1997 and 3.1 million as
of December 31, 1996.
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In addition to Commercial health products, the Company also offers coverage for
Medicare beneficiaries and individuals eligible for Medicaid benefits and
subsidized children's health insurance programs. Such coverages include the
following:
Through annual contracts with the Health Care Financing Administration ("HCFA"),
Aetna U.S. Healthcare HMOs offer coverage for Medicare-eligible individuals in
certain geographic areas. Generally, services must be obtained through network
providers, with the exception of emergency and urgent care. Members generally
receive enhanced benefits over standard Medicare fee-for-service coverage,
including vision, hearing and pharmacy coverage. Such Medicare plans are offered
on an insured basis. Medicare membership totaled .5 million as of December 31,
1998, .4 million as of December 31, 1997 and .3 million as of December 31, 1996.
The Company exited certain unprofitable Medicare markets effective January 1,
1999. The Company will continue to review the profitability of its Medicare
business in certain markets.
The Company also served as an administrator of Medicare benefits in certain
states, providing claim services for physicians, hospitals, skilled nursing
facilities and home health agencies in exchange for a fee. The contract with
HCFA to provide these services expired on September 30, 1997.
The Company has contracts with certain state and local agencies to offer
coverage for individuals eligible for Medicaid and subsidized children's health
insurance programs. Benefits are determined by the contracting agencies. This
coverage is offered on an insured basis. This coverage membership totaled .1
million as of December 31, 1998, 1997 and 1996.
Aetna U.S. Healthcare offers a variety of specialty health care coverages
offered as either supplements to health products or as stand-alone products.
Such coverages include indemnity and managed dental plans and prescription drug
and vision programs.
These specialty health coverages and services are included in either Health Risk
or Group Insurance and Other Health business, with the exception of behavioral
health (including employee assistance programs) and network-based workers'
compensation case management services, which are included in Group Insurance and
Other Health.
During 1997, the Company sold certain subsidiaries primarily to more effectively
focus its health business resources. On December 5, 1997, the Company sold Human
Affairs International ("HAI"), a behavioral health management business. Aetna
U.S. Healthcare continues to market HAI's behavioral health services, including
employee assistance programs, through a long-term strategic arrangement with the
acquiring company. During 1997, the Company also sold Healthcare Data
Interchange Corporation ("HDIC"), a provider of health care electronic data
interchange services, and Aetna Professional Management Corporation ("APMC"), a
physician practice management business.
Aetna U.S. Healthcare group insurance products consist primarily of the
following:
Group Life Insurance consists principally of renewable term coverage, the
amounts of which may be fixed or linked to individual employee wage levels.
Basic and supplemental term coverage and spouse and dependent coverages are
available. Group universal life and accidental death benefit coverages are also
available. Group life insurance is offered on an insured basis. Group life
insurance membership totaled 9.8 million as of December 31, 1998 and 1997 and
9.6 million as of December 31, 1996.
Group Disability Insurance provides coverage for disabled employees' income
replacement benefits for both short-term disability and long-term disability.
The Company also offers a managed disability product with additional case
management features. Group disability insurance coverages are offered on both an
insured and employer-funded basis. Group disability membership totaled 2.6
million as of December 31, 1998 and 1997 and 2.4 million as of December 31,
1996.
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Long-Term Care Insurance provides coverage for long-term care expenses in a
nursing home, adult day care or home setting. Long-term care insurance is
offered on an insured basis. Long-term care membership totaled .1 million as of
December 31, 1998, 1997 and 1996.
Many group insurance members participate in more than one type of Aetna U.S.
Healthcare coverage and are counted in each.
Provider Networks
General
Aetna U.S. Healthcare provides members of its managed care plans with access to
health care services through networks of independent health care providers. The
Company contracts with providers to participate in its provider networks in
order to provide members with broad access to high quality, cost effective
medical care. The providers in the Company's networks are independent
contractors and are neither employees nor agents of the Company.
The HMOs operated by Aetna U.S. Healthcare most closely adhere to the individual
practice model. Under the individual practice model, the HMO contracts with
independent physicians who are broadly dispersed throughout a community and who
care for patients in their own offices. Participating physicians generally also
have patients who are not members of the Company's HMOs. In the Company's HMOs,
the primary care physician plays an important role in practicing preventive
medicine and acts on behalf of the HMO member to coordinate the care provided by
specialist physicians, hospitals, and other health care providers.
Aetna U.S. Healthcare uses a variety of practices to help contain the rate of
increase in the cost of medical services. In addition to contracts with health
care providers, such procedures include the development and implementation of
standards for the appropriate utilization of health care resources and working
with health care providers to review data in order to help them improve
consistency and quality.
At December 31, 1998, Aetna U.S. Healthcare had approximately 385,000 providers
in its networks nationwide.
Contracting
Primary Care Physicians
Compensation by the Company's HMOs to directly contracted PCPs is principally on
a capitated basis, although fee-for-service contracts also exist. Under a
capitation arrangement, physicians receive a monthly fixed fee for each HMO
member, regardless of the medical services provided to the member. In some
instances, the capitation rate is subject to adjustment based on the attainment
of certain criteria including comprehensiveness of care, quality of care and
utilization. This quality-based incentive program is administered via the
Company's Quality Care Compensation System. In a fee-for-service arrangement,
network physicians are paid for health care services provided to the member
based upon a fee schedule.
Hospitals
The Company typically enters into contracts that provide for all-inclusive per
diem and per case, with fixed rates for ambulatory surgery and emergency room
services. Certain contracted hospitals' final compensation is based upon
attainment of agreed-upon quality and other measures. The Company has some
hospital contracts that pay a percentage of billed charges.
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Aetna U.S. Healthcare HMOs generally require precertification of elective
admissions and monitoring of the length of hospital stays. Participating
physicians generally admit their HMO patients to participating hospitals using
referral procedures that direct the hospital to contact the Company's patient
management unit, which confirms the patient's membership status while obtaining
pertinent data. This unit also coordinates related activities, including the
subsequent transition to the home environment and home care, if necessary. Case
management assistance for complex or "catastrophic" cases is provided by a
special case unit.
Specialist and Ancillary Services
Specialist physicians participating in the Company's networks are generally
reimbursed at contracted rates per visit or procedure.
Aetna U.S. Healthcare's HMOs have capitated payment arrangements for most mental
health, substance abuse, laboratory, radiology, diagnostic imaging, podiatric
and physical therapy services.
Integrated Delivery Systems
Aetna U.S. Healthcare has developed contractual relationships with Integrated
Delivery Systems ("IDS") to provide comprehensive medical and hospital services.
Under these arrangements, the Company's HMOs contract with an IDS for a fixed,
per member fee or a percentage of premium. These arrangements cover most or all
of the care required by the member which is generally delivered by the IDS and
its affiliated PCPs, hospitals and specialists.
Quality Assessment
Quality assessment programs begin with the initial selection of providers.
Physicians wanting to participate in the Company's HMO networks must satisfy an
extensive set of criteria, including licensing, hospital admission privileges,
demonstrated proficiency, written references, patient access, office standards,
after-hours coverage and many other factors. Hospitals also have an extensive
set of criteria, including HCFA and the Joint Commission on Accreditation of
Healthcare Organizations ("JCAHO") accreditation.
Participating physicians are recredentialed regularly. Recredentialing of PCPs
covers many aspects of patient care including an analysis of member grievances
filed with the Company, the transfer and termination rate of members from the
practice, on-site interviews, analysis of utilization patterns, extensive member
surveys and analysis of drug prescription patterns. Committees, each composed of
a peer group of participating private physicians, review participating PCPs
being considered for recredentialing.
The Company also offers quality and outcome measurement and improvement
programs, and health care data analysis systems for providers and purchasers of
health care.
The Company seeks accreditation for certain of its HMO plans from the National
Committee for Quality Assurance ("NCQA"), a national organization established to
review the quality and medical management systems of HMOs and other managed care
plans. Accreditation by NCQA is a nationally recognized standard. As of December
31, 1998, 20 of the Company's HMOs have received full 3 year accreditation by
NCQA.
Principal Markets and Sales
Total health membership is widely dispersed throughout the United States. The
Company offers a robust array of benefit plans, many of which are available in
all 50 states.
Products offered by the Group Insurance and Other Health business are available
in all 50 states. Depending on the product, the Company markets to small groups
up to National Accounts (i.e., those with at least 3,000 eligible lives).
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The following table presents total health membership by region and funding
arrangement, for the years indicated:
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1998 (1) 1997 1996
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(Thousands) Risk Nonrisk Total Risk Nonrisk Total Risk Nonrisk Total
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mid-Atlantic 1,759 1,268 3,027 1,863 1,159 3,022 1,911 1,115 3,026
Northeast 1,347 708 2,055 1,089 735 1,824 1,127 776 1,903
Southeast 1,320 1,723 3,043 752 1,717 2,469 594 1,784 2,378
Mid-West 715 1,916 2,631 503 1,915 2,418 459 1,966 2,425
West Central 1,184 1,648 2,832 405 1,862 2,267 484 1,823 2,307
West 978 1,099 2,077 723 1,011 1,734 730 969 1,699
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Total Health
Membership (2) 7,303 8,362 15,665 5,335 8,399 13,734 5,305 8,433 13,738
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(1) Health membership for NYLCare at the date of acquisition was 2,117 members.
(2) Includes the following products: Commercial, Medicare and Medicaid HMO,
POS, PPO and Indemnity.
For membership composition of Aetna U.S. Healthcare's products by funding
arrangement, see Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") - Aetna U.S. Healthcare - Membership in Item 7 of
this Report on Form 10-K/A.
For both Health Risk and Group Insurance and Other Health businesses, products
and services are marketed primarily to employers for the benefit of employees
and their dependents. Frequently, employers offer employees a choice of
coverages, from which the employee makes his or her selection during a
designated annual open enrollment period. In some instances, Aetna U.S.
Healthcare is the only health care coverage offered. Employers pay all or a
portion of the monthly premiums, and employees, through payroll deductions, pay
any premium not provided as an employee benefit.
Within the Health Risk business, Medicare coverage is sold on an individual
basis as well as through employer groups to their retirees. Medicaid and
subsidized children's health insurance programs are marketed to individuals
rather than employer groups.
Aetna U.S. Healthcare products are sold primarily through Company sales
personnel who frequently work with independent consultants and brokers who
assist in the production and servicing of business. Sales representatives also
sell to employers on a direct basis.
For large customers, independent consultants and brokers are frequently involved
in employer health plan selection decisions and sales.
Marketing and sales efforts are promoted by an advertising program which
includes television, radio, billboards and print media, supported by market
research and direct marketing efforts.
Health Pricing
For insured Commercial plans, customer contracts are generally established in
advance of the policy period, for a duration of one year. In determining the
premium rates to be charged to the customer, prospective and retrospective
rating methodologies are used.
Under prospective rating, a fixed premium rate is determined at the beginning of
the policy period. Unanticipated increases in medical costs cannot be recovered
in the current policy year; however, prior experience for a product in the
aggregate is considered, among other factors, in determining premium rates for
future periods. Federally-qualified HMOs are required to set premiums in this
manner.
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Aetna U.S. Healthcare Commercial HMO plans establish premium rates prior to
contract inception, without regard to actual utilization of services incurred by
individual members, using one of three approved community rating methods. These
rates may vary from account to account to reflect projected family size and
contract mix, benefit levels, renewal date, and other factors. Under one of
these methods, "traditional community rating", an HMO establishes premium rates
based on its revenue requirements for its entire enrollment in a given
community. Under "community rating by class", an HMO establishes premium rates
based on its revenue requirements for broad classes of membership distinguished
by factors such as age and sex. Under "group specific community rating", an HMO
establishes premium rates based on the HMO's revenue requirements for providing
services to the group. State laws, in certain of the states in which the Company
operates HMOs, require the filing with and approval by the state of HMO premium
rates, and certain states may prohibit the use of one or more of these rating
methods. In addition to reviewing anticipated medical costs, some states also
review anticipated administrative costs as part of the approval process. Future
results of the Company could be affected if the premium rates requested by the
Company are not approved or are adjusted downward by state regulators.
Under retrospective rating, a preliminary premium rate is determined at the
beginning of the policy period. Once the policy period has ended, the actual
experience is reviewed. If the experience is positive (i.e., actual claim costs
and other expenses are less than those expected) then a refund is credited to
the policy. If the experience is negative, then the resulting deficit may, in
certain instances, be recovered through contractual provisions; otherwise the
deficit is considered in setting future premium levels. If a customer elects to
terminate coverage, these deficits generally cannot be recovered. Retrospective
rating is often used for non-HMO, employee funded plans which exceed 300 lives.
Aetna U.S. Healthcare has contracts with HCFA to provide HMO coverage to
Medicare beneficiaries who choose health care coverage through an HMO. Under
these annual contracts, HCFA pays the HMO at a capitated rate based on
membership and adjusted for demographic factors and a user fee. Inflation,
changes in utilization patterns and benefit plans, demographic factors such as
age and sex, and both local county and national fee for service average per
capita Medicare costs are considered in the rate calculation process. Amounts
payable under Medicare risk arrangements are subject to annual unilateral
revision by HCFA. In addition to premiums received from HCFA, some of the
Medicare products offered by Aetna U.S. Healthcare require a modest premium to
be paid by the member. Under Medicare risk arrangements, Aetna U.S. Healthcare
assumes the risk of higher than expected medical expenses. Medicare contracts
generate higher per member per month revenues, but also higher per member per
month medical expenses, than Commercial plans.
Aetna U.S. Healthcare also has HMO contracts with a variety of federal
government employee groups under the Federal Employees Health Benefit Program.
Premium rates are subject to federal government review and audit. Premium rates
for these contracts are set prospectively but are subject to retrospective
adjustments.
Premiums and fees from the federal government accounted for 21% of Aetna U.S.
Healthcare's revenue in 1998. Contracts with HCFA accounted for 84% of these
premiums and fees, with the balance from federal employee related benefit
programs.
The Company has contracts with state and local agencies to provide fully-insured
health benefits to persons eligible for Medicaid and subsidized children's
health insurance program benefits. These contracts are generally for a period of
one to three years. Aetna U.S. Healthcare receives a fixed monthly payment based
on membership in return for the coverage of health care services. The rates are
subject to periodic unilateral revision by the contracting agencies. Aetna U.S.
Healthcare assumes the risk of higher than expected medical expenses.
Contracts with the customer to provide administrative services for
employer-funded plans are generally for a period of one year. Aetna U.S.
Healthcare has entered into certain guarantees with respect to certain functions
such as customer service response time, claim processing accuracy and claim
processing turnaround time, as well as certain guarantees that claim expenses to
be incurred by the customer will fall within a certain range. With any of these
guarantees, Aetna U.S. Healthcare is financially at risk if the conditions of
the arrangements are not met, though the maximum at risk is typically 10% - 30%
of fees for the customer involved.
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Competition
Competition in the health care industry has intensified in recent years,
primarily due to more aggressive marketing and pricing, a proliferation of
competing products, including new products developed in an effort to contain
health care costs, and increased quality and price sensitivity. New entrants
into the marketplace as well as significant consolidation within the industry
have also contributed to the more intense competitive environment.
Aetna U.S. Healthcare believes that the most significant factors which
distinguish competing health plans are quality of service and managed care
programs (including NCQA accreditation status), comprehensiveness of coverage,
cost (including both premium and member out-of-pocket costs), product design,
financial stability and the geographic scope of provider networks and the
providers available in such networks. Aetna U.S. Healthcare believes that it is
competitive in each of these areas. The ability to increase the number of
persons covered by Aetna U.S. Healthcare benefits or to increase revenues is
affected by competition in any particular area. In addition, the ability to
increase the number of persons enrolled in Health Risk products is affected by
the desire and ability of employers to self fund their health coverage.
Competition may also affect the availability of services from health care
providers, including primary care physicians, specialists and hospitals.
Within the Health Risk business, Aetna U.S. Healthcare competes with local and
regional managed care plans, in addition to managed care plans sponsored by
large health insurance companies and Blue Cross/Blue Shield plans. Additional
competitors include other types of medical and dental provider organizations,
various specialty service providers, integrated health care delivery
organizations, and in certain plans, with programs sponsored by the federal or
state governments.
Within the Other Health component of the Group Insurance and Other Health
business, Aetna U.S. Healthcare competes primarily with other commercial
insurance companies and third party administrators.
For the Group Insurance industry, Aetna U.S. Healthcare believes that the most
significant factors which distinguish competing companies are price, quality of
service, comprehensiveness of coverage, and product array and design. Specialty
carriers have increased market penetration in the life and disability business.
The deeply-penetrated group life market remains highly competitive.
Reserves
For the Health Risk business, medical claims payable reflects estimates of the
ultimate cost of claims that have been incurred but not yet reported and
reported but not yet paid. Medical claims payable 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.
For Group Insurance products, reserves are established as premiums become due to
reflect the present value of expected future obligations net of the present
value of expected future premiums. Policy reserves for group paid-up life
insurance generally reflect long-term fixed obligations and are computed on the
basis of assumed or guaranteed yield and benefit payments. Assumptions are based
on the Company's historical claim experience. For long-term disability products,
reserves are established for (i) lives currently in payment status (using both
standard industry, as well as the Company's own morbidity and interest rate
assumptions), (ii) lives who have not yet satisfied the waiting period, but are
expected to do so and (iii) claims that have been incurred but not reported.
Long-term care reserves are a long-term obligation calculated using industry
data for morbidity and mortality assumptions. Reserves for unpaid claims for
other group health products (including short duration contracts) are estimated
periodically and any resulting adjustments are reflected in current earnings.
Group health and group insurance premiums are generally recorded as premium
revenue over the term of the coverage. Some group contracts allow for premiums
to be adjusted to reflect emerging experience. Such premiums are recognized as
the related experience emerges.
Page 11
<PAGE> 12
Reinsurance
Aetna U.S. Healthcare uses reinsurance agreements with nonaffiliated insurers
for Group Insurance businesses to control its exposure to large losses and
certain other risks. The Company maintains catastrophic life reinsurance which
provides protection against accidents involving five or more covered lives. For
disability business, certain reinsurance arrangements have been established to
reflect the circumstances of the specific disability risks. These include an
excess individual amount arrangement for a particular market segment of the
disability business, a quota share treaty for another market segment of the
disability business, and facultative treaties on a case by case basis. In
addition, the Company carries excess medical malpractice professional liability
insurance.
Group Life Insurance In Force and Other Statistical Data
The following table summarizes changes in group life insurance in force before
deductions for reinsurance ceded to other companies for the years indicated:
<TABLE>
<CAPTION>
(Dollars in Millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
In force, end of year $ 378,727 $ 316,478 $ 309,999
- ----------------------------------------------------------------------------------------------------------
Terminations (lapses and all other) $ 14,018 $ 10,678 $ 10,714
- ----------------------------------------------------------------------------------------------------------
Number of policies and contracts in force, end of year:
Group Life Contracts (1) 14,044 13,849 15,288
Group Conversion Policies (2) 31,024 32,660 33,538
- ----------------------------------------------------------------------------------------------------------
</TABLE>
(1) Due to the diversity of coverages and size of covered groups, statistics
are not provided for average size of policies in force.
(2) Reflects conversion privileges exercised by insureds under group life
policies to replace those policies with individual life policies.
Factors Affecting Forward-Looking Information
For information regarding certain important factors that may materially affect
Aetna U.S. Healthcare's business, see MD&A - Forward-Looking Information/Risk
Factors, Aetna U.S. Healthcare - Outlook and financial results discussions in
Item 7 of this Report on Form 10-K/A.
2. Aetna Retirement Services
Products and Services
Aetna Retirement Services ("ARS") offers financial services products primarily
through Aetna Life Insurance and Annuity Company ("ALIAC") and Aetna Insurance
Company of America ("AICA") indirect, wholly owned subsidiaries of the Company.
Prior to October 1, 1998, ARS also offered individual life insurance products
through ALIAC. Investment advisory services are offered through ALIAC and Aeltus
Investment Management Inc. ("Aeltus"), registered investment advisers and
indirect, wholly owned subsidiaries of the Company. Aeltus is also an adviser to
Aetna mutual funds. Financial planning services are offered through Financial
Network Investment Corporation ("FNIC"), a broker/dealer acquired in 1997, and
Aetna Financial Services, Inc. ("AFSI"), indirect wholly owned subsidiaries of
the Company.
Financial Services
Financial services products principally include annuity contracts that offer a
variety of funding and payout options for individual and employer-sponsored
retirement plans qualified under Internal Revenue Code Sections 401, 403, 408
and 457 (collectively, "qualified plans") and nonqualified annuity contracts.
These contracts may be deferred or immediate ("payout annuities"). Financial
services also include investment advisory services, financial planning and
pension plan administrative services.
Page 12
<PAGE> 13
Individual Life Insurance
Individual life insurance products include universal life and variable universal
life, which have both life insurance and investment characteristics, traditional
whole life and term insurance. ARS' domestic individual life insurance business
was sold on October 1, 1998. The transaction was generally in the form of an
indemnity reinsurance arrangement. See MD&A - Overview and Aetna Retirement
Services in Item 7 of this Report on Form 10-K/A for more information.
Investment Options
ARS products provide annuity and certain life insurance customers with variable
and/or fixed investment options. Variable ("nonguaranteed") options provide for
full assumption by the customer of investment risks. Assets supporting variable
options are held in separate accounts that invest in Aetna mutual funds and/or
unaffiliated mutual funds. Aetna mutual funds include funds managed by Aeltus
and, beginning in 1997, funds managed by outside investment advisors under
subadvisory arrangements. Separate account investment income and realized
capital gains and losses are not reflected in the Company's consolidated results
of operations. Fixed options can be either "fully guaranteed" or "experience
rated". Fully guaranteed options provide guarantees on investment return,
maturity values, and if applicable, benefit payments. Experience rated options
require the customer to assume investment (including realized capital gains and
losses) and other risks subject, among other things, to certain minimum
guarantees. The effect of investment performance (as long as minimum guarantees
are not triggered) does not impact the Company's consolidated results.
Fees and Investment Margins
Insurance charges, investment management or other fees earned by ARS vary by
product and depend, among other factors, on the funding option selected by the
customer under the product. For variable annuities or life insurance products
where assets are allocated to variable funding options, ARS charges the separate
account an asset-based insurance fee and expense charge. In addition, where the
customer selects an Aetna mutual fund as a variable funding option, ARS receives
an asset-based investment management fee and, in the case of those funds
subadvised by outside managers, ARS pays a subadvisory fee to the fund manager.
For unaffiliated mutual funds, ARS receives distribution fees and/or expense
reimbursements. For fixed funding options, ARS derives an investment margin,
which is based on the difference between income earned on the investments
supporting the liability and interest credited to customers. Other fees or
charges, such as administrative fees, may be assessed depending on the nature of
the product.
ARS also provides direct investment advisory services to unaffiliated customers
through Aeltus and FNIC generally for fees based on assets under management.
FNIC provides financial planning services generally for fees which may or may
not be asset based.
Assets Under Management
The substantial portion of fees or other charges and investment margins are
based on assets under management. Assets under management are principally
affected by deposits, investment growth (i.e., interest credited to customer
accounts for fixed options or market performance for variable options) and
persistency (i.e., customer retention). Assets under management, excluding net
unrealized capital gains and losses on debt securities other than those held in
separate accounts, were $51.9 billion at December 31, 1998, $45.0 billion at
December 31, 1997 and $32.1 billion at December 31, 1996. Approximately 95% of
assets under management at December 31, 1998 and 94% at December 31, 1997,
allowed for contractholder withdrawal. Approximately 84% at December 31, 1998
and 77% at December 31, 1997 are subject to market value adjustments and/or
deferred surrender charges.
Page 13
<PAGE> 14
To encourage customer retention and recover acquisition expenses, contracts
typically impose a surrender charge on policyholder balances withdrawn within a
period of time after the contract's inception which may be waived at the
Company's discretion. The period of time and level of the charge vary by
product. In addition, an approach incorporated into recent variable annuity
contracts with fixed funding options allows contractholders to receive an
incremental interest rate if withdrawals from the fixed account are spread over
a period of five years. Further, more favorable credited rates may be offered
after policies have been in force for a period of time. Existing tax penalties
on annuity distributions prior to age 59-1/2 provide further disincentive to
customers for premature surrenders of annuity balances, but generally do not
impede transfers of those balances to products of competitors.
Life Insurance In Force and Other Statistical Data
For individual life insurance products, life insurance in force is a key
determinant of earnings as contract charges for cost of insurance coverage are
typically based on amounts of coverage in force less accumulated policy
reserves. The key drivers of life insurance in force are new sales, surrenders
and mortality. The following table summarizes changes in life insurance in force
before deductions for reinsurance ceded to other companies:
(Amounts in millions, except number of policies and average size of policies in
force)
<TABLE>
<CAPTION>
(Millions) 1998 (1) 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales and additions:
Permanent:
Nonparticipating $ 3,522 $ 4,281 $ 4,357
Participating 13 13 12
Term:
Nonparticipating 513 1,586 1,382
Participating 18 53 133
- ------------------------------------------------------------------------------
Total $ 4,066 $ 5,933 $ 5,884
===============================================================================
Terminations:
Surrenders and conversions $ 1,807 $ 1,865 $ 1,646
Lapses 2,046 2,126 2,098
Other 323 1,130 330
- -------------------------------------------------------------------------------
Total $ 4,176 $ 5,121 $ 4,074
===============================================================================
In force, end of year:
Permanent $ 39,275 $ 36,614 $ 35,883
Term 10,410 13,181 13,100
- -------------------------------------------------------------------------------
Total $ 49,685 $ 49,795 $ 48,983
===============================================================================
Number of policies in force,
end of year:
Nonparticipating 554,776 597,221 627,233
Participating 90,904 97,533 105,098
- -------------------------------------------------------------------------------
Total 645,680 694,754 732,331
===============================================================================
Average size of policies in force,
end of year:
Nonparticipating $ 79,357 $ 72,654 $ 66,385
Participating 62,266 65,664 69,883
- -------------------------------------------------------------------------------
</TABLE>
(1) As a result of the sale of the individual life business on October 1, 1998,
substantially all of the in force amounts are being ceded to an outside
company.
See Note 14 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a discussion of participating life insurance
contracts.
The following table summarizes premiums and deposits for ARS:
<TABLE>
<CAPTION>
(Millions) 1998 (1) 1997 1996
- ------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 131.9 $ 158.5 $ 180.7
Deposits 5,142.5 4,969.0 4,564.8
- ------------------------------------------------------------
$ 5,274.4 $ 5,127.5 $ 4,745.5
============================================================
</TABLE>
(1) 1998 amounts reflect the operations of the individual life business through
the sale date of October 1, 1998.
Page 14
<PAGE> 15
Principal Markets and Method of Distribution
ARS products and services are offered primarily to individuals, pension plans,
small businesses and employer-sponsored groups in the health care, government,
education (collectively "not-for-profit" organizations) and corporate markets.
ARS products generally are sold through pension professionals, independent
agents and brokers, third party administrators, banks, dedicated career agents
and financial planners.
Competition
ARS competes with other insurance companies, as well as an array of financial
services companies including banks, mutual funds and other investment managers.
Principal competitive factors are reputation for investment performance, product
features, service, cost and the perceived financial strength of the investment
manager or sponsor.
Competition may affect, among other matters, both business growth and the
pricing of ARS' products and services.
Reserves
Reserves for limited payment contracts (annuities with life contingent payout)
are computed on the basis of assumed investment yield, mortality, morbidity and
expenses and include a margin for adverse deviation. The assumptions vary by
plan, year of issue and policy duration. Reserves for investment contracts
(deferred annuities and immediate annuities without life contingent payouts) are
equal to cumulative deposits plus credited interest less withdrawals and charges
thereon. Of those investment contracts which are experience rated, the reserves
also reflect net realized capital gains/losses (which ARS reflects through
credited rates on an amortized basis) and unrealized capital gains/losses
related to Financial Accounting Standard ("FAS") No. 115.
Prior to the sale of the individual life business on October 1, 1998, reserves
for universal life products were equal to cumulative deposits less withdrawals
and charges plus credited interest thereon, plus/less net realized capital
gains/losses (which were reflected through credited rates on an amortized
basis). These reserves also included unrealized capital gains/losses related to
FAS No. 115. As a result of the sale and transfer of assets supporting the
business, reserves for universal life products will no longer include net
realized capital gains/losses and unrealized gains/losses related to FAS No. 115
for the years ended December 31, 1998 and beyond. Reserves for all other fixed
individual life contracts are computed on a basis consistent with that described
above for limited payment contracts.
Because the sale was substantially in the form of an indemnity reinsurance
agreement, the Company reported an addition to its reinsurance receivable
approximating the total ARS individual life reserves at the sale date.
Reserves, as described above, are computed amounts that, with additions from
premiums and deposits to be received and with interest on such reserves
compounded annually at assumed rates, are expected to be sufficient to meet the
Company's policy obligations at their maturities or to pay expected death or
retirement benefits or other withdrawal requests.
Factors Affecting Forward-Looking Information
For information regarding certain important factors that may materially affect
ARS' business, see MD&A - Forward-Looking Information/Risk Factors, Aetna
Retirement Services - Outlook and financial results discussions in Item 7 of
this Report on Form 10-K/A.
Page 15
<PAGE> 16
3. Aetna International
Aetna International, through subsidiaries and joint venture affiliates, sells
primarily life and health insurance and financial retirement services products
in markets outside of the United States.
The Company continues to increase its investments in emerging international and
financial services markets, where it believes demographic and other
characteristics afford the opportunity for long-term business growth. The
Company seeks to enter new emerging markets in their early stages of
development, seeking to be among the first foreign entrants, and then to build
sufficient scale of operations to compete with local and other foreign
companies. The Company also explores opportunities for additional investments,
or divestitures where appropriate, in markets where it has established
operations.
The Company may invest in a new market or increase its position in a market
through a combination of acquisitions, joint ventures and de novo initiatives.
Over the past 5 years, the Company has invested $1.1 billion in its
international operations, of which $245 million was invested in 1998, a majority
of which related to the acquisition of a 74.5% ownership interest in Cruz
Blanca, a private health insurance company in Chile.
Aetna International conducts its business in several major geographic locations:
- Asia Pacific - Operations are conducted through majority-owned
subsidiaries in Indonesia, Malaysia, New Zealand, the Philippines,
Taiwan and Thailand as well as through equity affiliates in China and
Hong Kong. The products and services sold by these businesses include
individual and group life and health insurance, deposit administration
and related financial products and services.
- Americas - Operations are conducted through wholly owned and
majority-owned subsidiaries in Argentina, Canada, Chile and equity
affiliates in Brazil, Mexico, Peru, and Venezuela. The products and
services sold by these businesses include individual and group life
and health insurance, annuities, personal and commercial
property-casualty insurance, and pension fund administration services.
- Other - Includes general and other miscellaneous expenses.
Each of the affiliates through which Aetna International conducts business
operates within guidelines established by the Company. Methods of distributing
products vary by country and product depending on local laws, customs and the
needs of the particular customer segment. Distribution channels include career
agents, independent agents and brokers, financial institutions and direct sales.
Competition varies by country and includes well established local companies, as
well as foreign based companies with a strong international presence.
Page 16
<PAGE> 17
The following table sets forth Aetna International's revenue and operating
earnings or losses by major geographic location (including its share of net
income in minority owned affiliates and excluding Year 2000 costs in 1998 and
net realized capital gains or losses in all three years) and premiums, before
deductions for reinsurance ceded to other companies:
<TABLE>
<CAPTION>
Revenue Operating Earnings
------------------------------------------ ---------------------------------------------
(Millions) 1998 1997 1996 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Asia Pacific (1) $ 1,191.6 $ 1,092.6 $ 869.9 $ 65.2 $ 55.7 $ 53.8
Americas (2) 982.5 863.1 742.7 112.9 83.0 59.1
- --------------------------------------------------------------------------------------------------------------------
Other (3) 2.4 3.1 11.9 (12.4) (10.0) (7.4)
- --------------------------------------------------------------------------------------------------------------------
$ 2,176.5 $ 1,958.8 $ 1,624.5 $ 165.7 $ 128.7 $ 105.5
====================================================================================================================
</TABLE>
(1) Includes China, Hong Kong, Indonesia, Malaysia, New Zealand, Philippines,
Taiwan and Thailand.
(2) Includes Argentina, Brazil, Canada, Chile, Mexico, Peru and Venezuela.
(3) Includes general and other miscellaneous expenses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums (included in
revenue above) $ 1,578.5 $ 1,434.1 $ 1,166.1
- --------------------------------------------------------------------------------
</TABLE>
Factors Affecting Forward-Looking Information
For information regarding certain important factors that may materially affect
Aetna International's business, see MD&A - Forward-Looking Information/Risk
Factors, Aetna International - Outlook and financial results discussions in Item
7 of this Report on Form 10-K/A.
4. Large Case Pensions
Principal Products
Large Case Pensions manages a variety of retirement products (including pension
and annuity products) offered to IRC Section 401 qualified defined benefit and
defined contribution plans. Contracts provide nonguaranteed, partially
guaranteed (experience rated) and fully guaranteed investment options through
general and Separate Account products. The majority of Large Case Pensions'
products that use Separate Accounts provide contractholders with a vehicle for
investments under which the contractholders assume the investment risk as well
as the benefit of favorable performance. Large Case Pensions earns a management
fee on these Separate Accounts.
In 1993, the Company discontinued its fully guaranteed large case pension
products. (For additional information, see MD&A - Large Case Pensions in Item 7
of this Report on Form 10-K/A.)
Factors Affecting Forward-Looking Information
For information regarding certain important factors that may materially affect
Large Case Pension's business, see MD&A - Forward-Looking Information/Risk
Factors, Large Case Pensions - Outlook and financial results discussions in Item
7 of this Report on Form 10-K/A.
Page 17
<PAGE> 18
5. General Account Investments
Consistent with the nature of the contract obligations involved in the Company's
health, life, annuity and pension operations, the majority of general account
assets have been invested in intermediate and long-term, fixed-income
obligations such as treasury obligations, mortgage-backed securities, corporate
debt securities and mortgage loans.
For information concerning the valuation of investments, see Notes 1, 6, and 9
of Notes to Consolidated Financial Statements in Item 14(a) of this Report on
Form 10-K/A.
The following table sets forth the distribution of invested assets, cash and
cash equivalents and accrued investment income of the Company's general account
portfolio (excluding Discontinued Operations) as of the end of the years
indicated: (1) (2)
<TABLE>
<CAPTION>
As Restated
--------------------------------------------
(Millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Debt securities:
Bonds:
U.S. government and government agencies and authorities $ 1,998.6 $ 3,928.6 $ 3,773.1
States, municipalities and political subdivisions 550.1 206.6 355.3
U.S. corporate securities:
Utilities 2,578.0 2,505.5 2,420.3
Financial 4,945.9 5,216.8 4,546.5
Transportation/capital goods 2,501.9 2,589.4 2,492.8
Health care/consumer products 2,656.3 1,735.3 1,803.7
Natural resources 1,550.7 1,559.9 1,317.9
Other corporate securities 1,355.8 1,506.2 1,519.8
- -----------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 15,588.6 15,113.1 14,101.0
- -----------------------------------------------------------------------------------------------------------------
Foreign:
Government, including political subdivisions 2,883.8 2,629.8 2,505.4
Utilities 676.6 689.1 790.2
Other 2,868.0 3,830.4 3,513.1
- -----------------------------------------------------------------------------------------------------------------
Total foreign securities 6,428.4 7,149.3 6,808.7
- -----------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 2,322.7 1,812.5 1,848.4
Collateralized mortgage obligations 2,041.2 2,710.4 2,764.7
- -----------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 4,363.9 4,522.9 4,613.1
- -----------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed securities 2,123.2 1,622.0 1,144.3
Other asset-backed securities 971.0 1,635.1 1,464.6
- -----------------------------------------------------------------------------------------------------------------
Total bonds 32,023.8 34,177.6 32,260.1
Redeemable preferred stocks 157.0 67.4 76.2
- -----------------------------------------------------------------------------------------------------------------
Total debt securities 32,180.8 34,245.0 32,336.3
- -----------------------------------------------------------------------------------------------------------------
Equity securities:
Common stocks 566.9 866.4 1,185.3
Nonredeemable preferred stocks 233.6 175.0 147.5
- -----------------------------------------------------------------------------------------------------------------
Total equity securities 800.5 1,041.4 1,332.8
- -----------------------------------------------------------------------------------------------------------------
Short-term investments 942.2 1,003.9 723.2
Mortgage loans 3,553.0 4,207.8 6,700.9
Real estate 270.3 369.5 850.2
Policy loans 458.7 746.9 707.3
Other 1,300.3 974.3 900.4
- -----------------------------------------------------------------------------------------------------------------
Total investments $ 39,505.8 $ 42,588.8 $ 43,551.1
=================================================================================================================
Cash and cash equivalents $ 1,951.5 $ 1,805.8 $ 1,462.6
=================================================================================================================
Accrued investment income $ 537.1 $ 545.8 $ 598.6
=================================================================================================================
</TABLE>
(1) Excludes Separate Accounts.
(2) Includes $7.1 billion in 1998, $7.9 billion in 1997 and $8.7 billion in
1996 of investments supporting discontinued products.
Page 18
<PAGE> 19
The following table summarizes the Company's investment results: (1)
<TABLE>
<CAPTION>
(Dollar amounts in millions) As Restated
Net Earned Net Net Realized Change in Net
Investment Investment Capital Unrealized Capital
Income (2) Income Rate (3) Gains (4) Gains and Losses (5)
- --------------------------------------------------------------------------------------------------------
For the year:
<S> <C> <C> <C> <C>
1998 $ 3,190.9 7.6% $ 271.8 $ (198.8)
1997 3,377.5 7.7 334.2 (50.7)
1996 3,565.2 8.0 134.4 10.8
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes Separate Accounts, investments in affiliates and Discontinued
Operations.
(2) Net investment income excludes net realized capital gains and losses, as
well as income taxes and includes investment expenses.
(3) The Earned Net Investment Income Rate for any given year is equal to (a)
net investment income divided by (b) the average amount of cash, invested
assets, excluding unrealized gains and losses, and accrued investment
income for the year.
(4) Net realized capital gains exclude income taxes and gains and losses
allocable to experience-rated pension contractholders.
(5) Net unrealized capital gains (losses) exclude federal income taxes and
changes in unrealized capital gains (losses) related to experience-rated
contractholders and discontinued products.
6. Other Matters
a. Regulation
General
The Company's operations are subject to comprehensive regulation throughout the
United States and the foreign jurisdictions in which it does business. The laws
of these jurisdictions establish supervisory agencies, including state health,
insurance and securities departments, with broad authority to grant licenses to
transact business and regulate many aspects of the products and services offered
by the Company, as well as solvency and reserve adequacy. Many agencies also
regulate investment activities on the basis of quality, diversification, and
other quantitative criteria. The Company's operations and accounts are subject
to examination at regular intervals by certain of these regulators.
Health Care
The federal government and the states in which the Company conducts its HMO and
other health operations have adopted laws and regulations that govern the
business activities of the Company to varying degrees. These laws and
regulations may restrict how the Company conducts its businesses and may result
in additional burdens and costs to the Company. Areas of governmental regulation
include licensure, premium rates, benefits, service areas, quality assurance
procedures, plan design, eligibility requirements, provider rates of payment,
surcharges on provider payments, provider contract forms, underwriting,
financial arrangements, financial condition (including reserves) and corporate
governance. These laws and regulations are subject to amendments and changing
interpretations in each jurisdiction.
States generally require HMOs to obtain a certificate of authority prior to
commencing operations. To establish an HMO in any state where it does not
presently operate an HMO, the Company generally has to obtain such a
certificate. The time necessary to obtain such a certificate varies from state
to state. Each HMO must file periodic financial and operating reports with the
states in which it does business. In addition, the HMOs are subject to state
examination and periodic license renewal.
The provision of services to certain employee health benefit plans is subject to
the Employee Retirement Income Security Act of 1974 ("ERISA"), a complex set of
laws and regulations subject to interpretation and enforcement by the Internal
Revenue Service and the Department of Labor ("DOL"). ERISA regulates certain
aspects of the relationships between the Company and employers who maintain
employee benefit plans subject to ERISA. Some of the administrative services and
other activities of the Company may also be subject to regulation under ERISA.
In addition, some states require licensure or registration of companies
providing third party claims administration services for benefit plans.
Page 19
<PAGE> 20
Many legislative and regulatory changes related to health products have recently
been enacted or are being seriously considered by the federal and state
governments. For a discussion of these matters see MD&A - Regulatory Environment
in Item 7 of this Report on Form 10-K/A. For information regarding regulation of
pricing by the Company's HMOs, see "Aetna U.S. Healthcare - Health Pricing", on
page 9.
Investment and Retirement Products and Services
Operations conducted by ARS and Large Case Pensions are subject to regulation by
various government agencies where the Company conducts business, in particular
the insurance departments of Connecticut and New York. Among other matters,
these agencies may regulate premium rates, trade practices, agent licensing,
policy forms, underwriting and claims practices, the maximum interest rates that
can be charged on life insurance policy loans, and the minimum rates that must
be provided for accumulation of surrender value.
The Securities and Exchange Commission ("SEC"), the National Association of
Securities Dealers ("NASD") and, to a lesser extent, the states regulate the
sales and investment management activities and operations of broker-dealer and
investment advisory subsidiaries of the Company. Regulations of the SEC, DOL and
Internal Revenue Service also impact certain of the Company's pension, annuity,
life insurance and other investment and retirement products. These products
involve Separate Accounts of ALIAC and AICA and mutual funds registered under
the Investment Company Act of 1940.
International
The nature and extent of regulations affecting the Company's international
operations varies by jurisdiction and line of business. Most operations are
subject to local insurance laws. These laws typically regulate the types of
business that can be written, policy forms and terms, currency, permitted
investments, reserves, taxation and other matters affecting the conduct of the
business. International operations are also subject to a variety of additional
investment and other controls that may be imposed by governments. Certain
jurisdictions may require that portions of the business be reinsured through
designated state-affiliated institutions. As a foreign investor, the Company is
also subject to a variety of restrictions regarding permitted levels of equity
ownership, remittance of foreign earnings, repatriation of capital, exchange of
currency, and entry into new lines of business. Regulation of international
operations may also be subject to other political factors not typically
associated with doing business in the United States, such as more rapid change
of regulatory policy, possible nationalization of businesses, hostilities and
unrest.
Federal Employee Benefit Regulation
ARS and Large Case Pensions also provide a variety of products and services to
employee benefit plans that are covered by ERISA.
In December 1993, in a case involving an employee benefit plan and an insurance
company, the United States Supreme Court ruled that assets in the insurance
company's general account that were attributable to a portion of a group pension
contract issued to the plan that was not a "guaranteed benefit contract" were
"plan assets" for purposes of ERISA and that the insurance company was an ERISA
fiduciary with respect to those assets. In reaching its decision, the Court
declined to follow a 1975 DOL interpretive bulletin that had suggested that
insurance company general account assets were not plan assets.
Page 20
<PAGE> 21
The Small Business Job Protection Act (the "Act") was signed into law in 1996.
The Act created a framework for resolving potential issues raised by the Supreme
Court decision. The Act provides that, absent criminal conduct, insurers
generally will not have liability with respect to general account assets held
under contracts that are not guaranteed benefit contracts based on claims that
those assets are plan assets. The relief afforded extends to conduct that
occurred before the date that is eighteen months after the DOL issues final
regulations required by the Act, except as provided in the anti-avoidance
portion of the regulations. The regulations, which were proposed by the DOL on
December 22, 1997, will address ERISA's application to the general account
assets of insurers attributable to contracts issued on or before December 31,
1998 that are not guaranteed benefit contracts. The conference report relating
to the Act states that contracts issued after December 31, 1998 that are not
guaranteed benefit contracts will be subject to ERISA's fiduciary obligations.
The Company is not currently able to predict how these matters may ultimately
affect its businesses.
HMO and Insurance Holding Company Laws
A number of states, including Connecticut, regulate affiliated groups of HMOs
and insurers such as the Company under holding company statutes. These laws may
require these companies to maintain certain levels of equity. For information
regarding restrictions on certain payments of dividends or other distributions
by HMO and insurance company subsidiaries of the Company, see MD&A - Liquidity
and Capital Resources in Item 7 of this Report on Form 10-K/A. Some of these
laws also regulate changes in control (as do Connecticut corporate laws), and
other matters such as transactions with affiliates. See also Note 18 of Notes to
Consolidated Financial Statements in Item 14(a) of this Report on Form 10-K/A.
Insurance Company Guaranty Fund Assessments
Under insurance guaranty fund laws existing in all states, insurers doing
business in those states can be assessed (up to prescribed limits) for certain
obligations of insolvent insurance companies to policyholders and claimants. The
after-tax charges to earnings for guaranty fund obligations were $3 million as
of December 31, 1998, $5 million as of December 31, 1997 and $4 million as of
December 31, 1996. While the Company has historically recovered more than half
of guaranty fund assessments through statutorily permitted premium tax offsets,
significant increases in assessments could jeopardize future efforts to recover
such assessments. For information regarding certain other potential regulatory
changes relating to the Company's businesses, see MD&A - Regulatory Environment
and Forward-Looking Information/Risk Factors. (See Note 1 of Notes to
Consolidated Financial Statements for future accounting standards related to
guaranty fund assessments.)
b. 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. In 1998, none of
Aetna Inc.'s significant insurance subsidiaries had more than two IRIS ratios
that were outside of the NAIC usual ranges.
Management does not expect that any of the Company's significant subsidiaries
will have more than two IRIS ratios outside of the NAIC usual ranges for 1999.
See MD&A - Liquidity and Capital Resources in Item 7 of this Report on Form
10-K/A for additional discussion regarding solvency regulation.
Page 21
<PAGE> 22
c. 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' ratios of
earnings to fixed charges and ratios of earnings to combined fixed charges and
preferred stock dividends for the years indicated:
<TABLE>
<CAPTION>
(Millions)
Aetna Inc. 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed Charges 4.96 5.74 2.45 4.97 4.74
Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends 3.94 4.46 2.10 4.97 4.74
</TABLE>
<TABLE>
<CAPTION>
(Millions)
Aetna Services, Inc. 1998 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Ratio of Earnings to Fixed Charges 4.31 5.78 2.44
Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends 4.31 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
include the dividends paid to preferred shareholders of a subsidiary. (See Note
16 of Notes to Consolidated Financial Statements in Item 14(a) of this Report on
Form 10-K/A.) During 1994 and 1995, there was no preferred stock outstanding. 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.
d. Trademarks
The trademarks Aetna (Registered Trademark), Aetna U.S. Healthcare (Registered
Trademark), U.S. Healthcare (Registered Trademark), and Aetna Retirement
Services (Registered Trademark), together with the corresponding design logos
are owned by the Company. The Company considers these trademarks and its other
trademarks and trade names important in the operation of its business. However,
the business of the Company is not dependent on any individual trademark or
trade name.
Page 22
<PAGE> 23
e. 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)**
November 3, 1998 * A A3 A
February 1, 1999 (1) * A A3 A
Aetna Services, Inc. (commercial paper)**
November 3, 1998 * D-1 P-2 A-1
February 1, 1999 (1) * D-1 P-2 A-1
Aetna Life Insurance Company (claims paying)
November 3, 1998 A AA- A1 A+
February 1, 1999 (1) A AA- A1 A+
Aetna Life Insurance and Annuity Company (claims paying)
November 3, 1998 A AA Aa3 AA-
February 1, 1999 (1) A AA Aa3 AA-
</TABLE>
* Nonrated by the agency.
** Fully and unconditionally guaranteed by Aetna Inc.
(1) These ratings are currently under review by certain rating agencies pending
completion of their analysis of the pending Prudential health care
acquisition. Duff and Phelps Credit Rating Company has the debt ratings of
Aetna on credit watch negative. Standard and Poor's has the debt and claims
paying ratings on credit watch negative. Moody's Investors Service has the
debt and claims paying ratings on outlook negative.
f. Miscellaneous
The Company had approximately 33,500 domestic employees at December 31, 1998. In
addition, the Company had approximately 7,600 international employees at
December 31, 1998 in its majority and wholly owned non-U.S. subsidiaries.
Management believes that the Company's computer facilities, systems and related
procedures are adequate to meet its business needs. The Company's data
processing systems and backup and security policies, practices and procedures
are regularly evaluated by the Company's management and its internal auditors
and are modified as considered necessary. See MD&A for information regarding the
Company's efforts to prepare its systems, applications and facilities to
accommodate Year 2000 date-sensitive information.
The federal government is a significant customer of the Aetna U.S. Healthcare
segment and the Company, accounting for approximately 15% of the Company's
consolidated revenue in 1998. No other customer accounted for 10% or more of the
Company's consolidated revenues in 1998. No other segment of the Company's
business is dependent upon a single customer or a few customers, the loss of
which would have a significant effect on the earnings of the segment. See Notes
20, 21 and 22 of Notes to Consolidated Financial Statements in Item 14(a) of
this Report on Form 10-K/A regarding segment information.
The loss of business from any one, or a few, independent brokers or agents would
not have a material adverse effect on the earnings of the Company or any of its
segments.
Page 23
<PAGE> 24
Item 2. Properties.
The home office of the Company is a building complex located at 151 Farmington
Avenue, Hartford, Connecticut, with approximately 1.6 million square feet. The
Company and certain of its subsidiaries also own or lease other space in the
greater Hartford area, Blue Bell, Pennsylvania and Fairfield, New Jersey, as
well as various field locations throughout the country. The Company believes its
properties are adequate and suitable for its business as presently conducted.
The foregoing does not include numerous investment properties held by the
Company in its general and Separate Accounts.
Item 3. 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 Connecticut actions were transferred to
the United States District Court for the Eastern District of Pennsylvania (the
"Court") for consolidated pretrial proceedings with the cases pending there. The
plaintiffs filed a Consolidated and Amended Complaint (the "Complaint") seeking,
among other remedies, unspecified damages resulting from defendants' alleged
violations of federal securities laws. The Complaint alleged 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
Company and the individual defendants filed a motion to dismiss the Complaint on
July 31, 1998. On February 2, 1999, the Court dismissed the Complaint, but
granted the plaintiffs leave to file a second amended complaint. On February 22,
1999, the plaintiffs filed a second amended complaint against the Company,
Ronald E. Compton and Richard L. Huber. 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 bad faith,
medical malpractice and other litigation in its health business. Aetna U.S.
Healthcare of California, Inc., an indirect subsidiary of the Company, is
currently a party to such an action brought by Teresa Goodrich, individually and
as successor in interest of David Goodrich. The action was originally filed in
March 1996 in Superior Court for the state of California, county of San
Bernardino. The action alleges damages for unpaid medical bills, punitive
damages and compensatory damages for wrongful death based upon alleged denial of
claims for services provided to David Goodrich by out of network providers
without prior authorization. On January 20, 1999 a jury rendered a verdict in
favor of the plaintiff for $750,000 for unpaid medical bills, $3.7 million for
wrongful death and $116 million for punitive damages. Aetna U.S. Healthcare of
California, Inc. intends to appeal the verdict and will continue to vigorously
defend this matter. 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.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Page 24
<PAGE> 25
EXECUTIVE OFFICERS OF AETNA INC.*
The Chairman of the Company is elected and all other executive officers listed
below are appointed by the Board of Directors of the Company at its Annual
Meeting each year to hold office until the next Annual Meeting of the Board or
until their successors are elected or appointed. None of these officers have
family relationships with any other executive officer or Director.
<TABLE>
<CAPTION>
Business Experience
Name of Officer Principal Position Age * During Past Five Years *
- --------------- ------------------ --- ----------------------
<S> <C> <C> <C>
Richard L. Huber Chairman, Chief Executive
Officer and President 62 (1)
Michael J. Cardillo Executive Vice President,
Aetna U.S. Healthcare 55 (2)
Frederick C. Copeland, Jr. Executive Vice President,
International 57 (3)
Timothy A. Holt Senior Vice President,
Aetna Investment Management
Group 45 (4)
Thomas J. McInerney Executive Vice President,
Aetna Retirement Services 42 (5)
Alan J. Weber Vice Chairman for Strategy
and Finance 49 (6)
</TABLE>
* As of February 26, 1999.
(1)
Mr. Huber was named Chairman on March 1, 1998 and Chief Executive Officer and
President on July 28, 1997. He had served as Vice Chairman for Strategy and
Finance since February 1995. He served as President and Chief Operating Officer
of Grupo Wasserstein Perella from September 1994 to February 1995 and as Vice
Chairman of Continental Bank from 1990 to September 1994.
(2)
Mr. Cardillo has served in his current position since July 19, 1996. He also
serves as President of Aetna U.S. Healthcare Inc. a position he assumed in March
1997 after serving as Co-President since July 19, 1996. Mr. Cardillo had been
Co-President of U.S. Healthcare Inc. since 1995 and Principal Marketing Officer
since 1989.
(3)
Mr. Copeland assumed his current position on July 19, 1996. He also serves as
President and Chief Executive Officer of Aetna International, Inc., a position
he assumed in April 1996, after having served as President of Aetna
International since July 1995. From January 1993 to July 1995, he served as
Chairman, President and Chief Executive Officer of Fleet Bank, N.A.,
Connecticut. From September 1987 to January 1993, he served as President and
Chief Executive Officer of Citibank Canada.
(4)
Mr. Holt assumed his current position on January 29, 1999, having served as Vice
President, Aetna Investment Management Group since September 1997. From 1996 to
September 1997, he served as Vice President and Chief Financial Officer of Aetna
Retirement Services. He served as Vice President, Portfolio Management Group,
from 1992 to 1996.
Page 25
<PAGE> 26
(5)
Mr. McInerney assumed his current position on August 18, 1997, having served as
Vice President, Strategic Planning, since March 1997. He also currently serves
as President, Aetna Retirement Services, Inc. From 1996 to 1997, he served as
Vice President, National Accounts, for Aetna Health Plans and then as Vice
President, National Accounts and Sales and Marketing, for the successor
business, Aetna U.S. Healthcare. During 1995 and 1996, he also served as Vice
President, Corporate Strategy. From 1992 to 1996, Mr. McInerney served as Vice
President, Large Case Pensions.
(6)
Mr. Weber assumed his current position on August 1, 1998. From July 1994 to July
1998 Mr. Weber served as Chairman of Citibank International and from October
1988 to July 1994, he served as Executive Vice President, Financial Institutions
and Transaction Services, of Citibank, N.A.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Aetna Inc.'s common stock is listed on the New York Stock Exchange. Its symbol
is AET. As of January 31, 2000, there were 17,704 record holders of the common
stock.
The dividends declared and the high and low sales prices with respect to the
Company's common stock for each quarterly period for the past two years are
included under the heading "Quarterly Data" in Item 14(a) of this Report on Form
10-K/A.
Information regarding restrictions on the Company's present and future ability
to pay dividends is incorporated herein by reference from Note 18 of Notes to
Consolidated Financial Statements in Item 14(a) of this Report on Form 10-K/A
and MD&A Liquidity and Capital Resources in Item 7 of this Report on Form
10-K/A.
Page 26
<PAGE> 27
Item 6. Selected Financial Data.
<TABLE>
<CAPTION>
As
Restated
(Millions, except per common share data) 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums:
Aetna U.S. Healthcare $ 13,006.2 $10,844.6 $ 7,765.2 $ 5,949.7 $ 5,611.5
Aetna Retirement Services 131.9 158.5 180.7 260.2 235.7
Aetna International 1,578.5 1,434.1 1,166.1 1,038.5 887.1
Large Case Pensions 122.7 155.0 214.1 244.4 123.5
- ---------------------------------------------------------------------------------------------------------------------------------
Total premiums 14,839.3 12,592.2 9,326.1 7,492.8 6,857.8
- ---------------------------------------------------------------------------------------------------------------------------------
Net Investment Income, Fees and Other
Income, and Net Realized Capital Gains (Losses):
Aetna U.S. Healthcare 2,113.2 2,056.8 1,968.5 1,665.7 1,527.6
Aetna Retirement Services 1,755.5 1,744.0 1,581.5 1,445.9 1,269.1
Aetna International 569.1 541.4 464.9 421.3 409.9
Large Case Pensions 1,228.5 1,467.5 1,761.5 2,004.0 2,120.8
Corporate: Other 123.5 138.3 98.0 9.7 (9.7)
- ---------------------------------------------------------------------------------------------------------------------------------
Total net investment income, fees and other income,
and net realized capital gains (losses) 5,789.8 5,948.0 5,874.4 5,546.6 5,317.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 20,629.1 $18,540.2 $15,200.5 $13,039.4 $12,175.5
=================================================================================================================================
Income from continuing operations:
Aetna U.S. Healthcare $ 431.0 $ 453.8 $ 58.7 $ 286.0 $ 341.7
Aetna Retirement Services 300.0 257.1 186.2 198.0 159.1
Aetna International 136.0 142.4 109.9 86.6 71.2
Large Case Pensions 169.9 234.2 258.4 89.2 54.4
Corporate: Interest (155.9) (147.5) (103.9) (70.4) (60.5)
Other (32.9) (38.9) (304.2) (115.5) (156.5)
- ---------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 848.1 901.1 205.1 473.9 409.4
- ---------------------------------------------------------------------------------------------------------------------------------
Net income 848.1 901.1 651.0 251.7 467.5
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized capital gains (losses), net of tax (included above) 173.9 198.4 85.9 29.5 (41.2)
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets 105,129.9 96,000.6 92,912.9 84,323.7 75,486.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total long-term debt 2,214.5 2,346.2 2,380.0 989.1 1,079.2
- ---------------------------------------------------------------------------------------------------------------------------------
Aetna-obligated mandatorily redeemable preferred
securities of subsidiary limited liability company
holding primarily debentures guaranteed by Aetna 275.0 275.0 275.0 275.0 275.0
- ---------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity 11,388.9 11,195.4 10,889.7 7,272.8 5,503.0
- ---------------------------------------------------------------------------------------------------------------------------------
Per Common Share Data:
Income from continuing operations
Basic $ 5.50 $ 5.67 $ 1.37 $ 4.18 $ 3.64
Diluted 5.41 5.60 1.36 4.14 3.62
Net Income
Basic 5.50 5.67 4.77 2.22 4.15
Diluted 5.41 5.60 4.72 2.20 4.14
Dividends declared .80 .80 1.29 2.76 2.76
Shareholders' equity 74.51 70.85 66.79 63.39 48.85
Market price at year end 78.63 70.56 80.00 69.25 47.13
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations for significant events
affecting the comparability of current year results with 1997 and 1996 results.
Page 27
<PAGE> 28
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Management's Discussion and Analysis of Financial Condition and Results of
Operations addresses the financial condition of Aetna Inc. and its subsidiaries
(collectively, the "Company") as of December 31, 1998 and 1997, and its results
of operations for 1998, 1997 and 1996. This Management's Discussion and Analysis
should be read in its entirety, since it contains detailed information that is
important to understand the Company's results and financial condition.
RESTATEMENT
Following a review by the staff of the Securities and Exchange Commission, the
Company concluded that it would restate its 1998 Form 10-K and 1999 Form 10-Qs
(the "Restatement"). For additional information concerning the Restatement refer
to "Significant Financial and Accounting Developments" contained elsewhere in
this Form 10-K/A.
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, other health and
group insurance products. Aetna Retirement Services offers a range of financial
services products including fixed and variable annuity contracts, investment
advisory services, financial services and pension plan administrative services.
Aetna International, through subsidiaries and joint venture operations, sells
primarily life insurance, health insurance and financial retirement services
products in markets outside of the United States. The Company also has a Large
Case Pensions business which manages a variety of retirement products for
defined benefit and defined contribution plans.
The Company sold its property-casualty operations on April 2, 1996. See Note 5
of Notes to Consolidated Financial Statements for a discussion of certain
indemnifications and other information related to this sale.
Consolidated Results
The Company reported income from continuing operations of $848 million in 1998,
$901 million in 1997 and $205 million in 1996. The 1998 results include a gain
related to the sale of the domestic individual life insurance business of $64
million and Year 2000 costs of $108 million. Results also include a benefit of
$29 million in 1997 and a charge of $588 million in 1996, primarily related to
severance and facilities actions. Reductions of the reserve for loss on
discontinued products for Large Case Pensions of $44 million in 1998, $108
million in 1997 and $132 million in 1996 also are included in net income.
Excluding these factors and net realized capital gains, income from continuing
operations would have been $675 million in 1998, $565 million in 1997 and $576
million in 1996.
Acquisition of the NYLCare Health Business
On July 15, 1998, the Company acquired New York Life Insurance Company's ("NYL")
NYLCare health business ("NYLCare") for a purchase price of $1.08 billion in
cash, subject to adjustment as provided in the transaction agreements.
Originally, in addition to the cash purchase price, payments totaling up to $300
million (up to $150 million in each of two years) were potentially payable to
the extent that predetermined earnings and membership targets in future periods
were achieved (the "Earnout").
On January 29, 1999, the Company and NYL agreed to resolve all purchase price
adjustments and obligations under the Earnout. Under this agreement, the Company
paid NYL an additional $50 million to resolve such matters. As a result, the
total purchase price is approximately $1.1 billion.
Page 28
<PAGE> 29
The Company funded the acquisition with cash made available from issuing
additional commercial paper. The Company issued $300 million of debt in the
fourth quarter of 1998 and expects to issue additional medium- or long-term
fixed income securities in 1999, subject to market conditions, to replace some
of the commercial paper.
Since the closing, the Company's results have been affected by, among other
things, the operating results of NYLCare, the costs of financing the transaction
and the amortization of intangible assets (primarily goodwill) created by the
transaction. The financing costs are reflected in the Corporate segment. See
"Aetna U.S. Healthcare" and "Corporate," as well as Note 5 of Notes to
Consolidated Financial Statements, for further discussion.
Agreement to Acquire Prudential Health Care Business
On December 9, 1998, the Company entered into definitive agreements with The
Prudential Insurance Company of America to acquire the Prudential health care
business ("PHC") for $1 billion. The Company currently expects to complete the
acquisition in the second quarter of 1999. The acquisition is subject to
approval by federal antitrust and state regulators, and other customary closing
conditions.
The Company expects to finance the transaction by issuing $500 million of
three-year senior notes to the seller and by using cash the Company expects to
receive as a result of issuing additional commercial paper prior to the closing.
The Company expects to issue additional fixed income securities to replace some
of this commercial paper.
After the closing, the Company's results will be affected by, among other
things, the operating results of the Prudential health care 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. See
"Aetna U.S. Healthcare" and "Corporate," as well as Note 5 of Notes to
Consolidated Financial Statements, for further discussion.
Sale of Domestic Individual Life Insurance Business
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln National Corporation ("Lincoln") for $1 billion in cash. The
sale resulted in an after-tax gain of approximately $152 million. Since the
principal agreement to sell this business was generally in the form of an
indemnity reinsurance arrangement, the Company will defer approximately $88
million of the gain and will amortize it over approximately 15 years. The
Company recognized $64 million of the gain in the 1998 fourth quarter for the
portion of the agreement that relates to the Company's agency sales force and
brokerage distribution channel. The Company was obligated to sever its
relationships with, and make available to Lincoln, its sales force, including
its agents, employee sales managers and brokerage distribution channel. The
Company has no relationships with its former life agents and brokers subsequent
to the closing.
In the 1998 fourth quarter, the Company used approximately $300 million of the
sale proceeds to repay outstanding commercial paper incurred in connection with
the NYLCare acquisition. The Company expects to use the remaining sale proceeds
for general corporate purposes, including repayment of debt, internal growth,
acquisitions and share repurchases. For more details about the transaction and
the indemnity reinsurance arrangement, see "Aetna Retirement Services" and Note
5 of Notes to Consolidated Financial Statements.
Page 29
<PAGE> 30
AETNA U.S. HEALTHCARE
Operating Summary
<TABLE>
<CAPTION>
As Restated
(Millions) 1998 (1) 1997 1996 (1)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 13,006.2 $ 10,844.6 $ 7,765.2
Net investment income 537.2 451.2 414.6
Fees and other income 1,441.1 1,463.9 1,495.9
Net realized capital gains 134.9 141.7 58.0
- ------------------------------------------------------------------------------------------------------------------
Total revenue 15,119.4 12,901.4 9,733.7
- ------------------------------------------------------------------------------------------------------------------
Current and future benefits 11,186.5 9,239.2 6,622.4
Operating expenses 2,752.0 2,479.2 2,351.5
Amortization of goodwill and other acquired intangible assets 381.3 362.9 169.4
Amortization of deferred policy acquisition costs .6 20.3 11.9
Severance and facilities charges (reserve reductions) - (45.0) 453.0
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 799.0 844.8 125.5
Income taxes 368.0 391.0 66.8
- ------------------------------------------------------------------------------------------------------------------
Net income (2) $ 431.0 $ 453.8 $ 58.7
==================================================================================================================
Net realized capital gains, net of tax (included above) $ 88.2 $ 69.9 $ 37.9
==================================================================================================================
</TABLE>
(1) Operating results include NYLCare since July 15, 1998 and U.S. Healthcare,
Inc. ("U.S. Healthcare") since July 19, 1996.
(2) Net income for 1998 includes a net benefit from capitalizing internal-use
software of $17.4 million.
Aetna U.S. Healthcare consists of the Health Risk business and the Group
Insurance and Other Health business. Health products include health maintenance
organization ("HMO"), point-of-service ("POS"), preferred provider organization
("PPO") and indemnity products. The Health Risk business includes health plans
offered on an insured basis. The Group Insurance and Other Health business
includes group life and disability insurance and long-term care insurance,
offered on both an insured and employer-funded basis, and all health plans
offered on an employer-funded basis. Under insured plans, the Company assumes
all or a majority of health care cost, utilization, mortality, morbidity or
other risk, depending on the product. Under employer-funded plans, the customer,
and not the Company, assumes all or a majority of these risks.
Results
Aetna U.S. Healthcare's net income decreased $23 million in 1998 and increased
$395 million in 1997. The 1998 results include costs related to Year 2000 of $64
million (after tax). The results also reflect benefits of $29 million in 1997
and expenses of $321 million in 1996, primarily related to severance and
facilities actions (see "Severance and Facilities Charges"), and net realized
capital gains in all three years. Excluding these items, results increased $53
million in 1998 while the 1997 results were comparable to 1996. These results
reflect the inclusion of NYLCare since July 15, 1998 and the inclusion of U.S.
Healthcare since July 19, 1996.
Net realized capital gains in 1998 include $39 million after-tax of contingent
consideration following the Company's 1997 sale of its behavioral health
subsidiary, Human Affairs International, Incorporated ("HAI"). The Company
records these amounts as they become realizable. Refer to Note 5 of Notes to
Consolidated Financial Statements for further discussion. Net realized capital
gains for 1997 include a $31 million after-tax gain from the sale of three
subsidiaries, including HAI. These businesses were sold primarily to more
effectively focus health business resources. Net realized capital gains for 1996
include a $15 million after-tax gain from the sale of an HMO subsidiary. The
earnings of these subsidiaries were not material to the results of Aetna U.S.
Healthcare.
Page 30
<PAGE> 31
The remainder of the Aetna U.S. Healthcare discussion compares actual results
for 1998 to actual 1997 results and to 1996 results on a pro forma basis, as if
the merger with U.S. Healthcare had occurred at the beginning of 1996.
Operating Summary
<TABLE>
<CAPTION>
As Restated Pro forma (2)
(Millions) 1998 (1) 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 13,006.2 $ 10,844.6 $ 10,096.6
Net investment income 537.2 451.2 441.3
Fees and other income 1,441.1 1,463.9 1,549.2
Net realized capital gains 134.9 141.7 52.5
- -------------------------------------------------------------------------------------------------------------------
Total revenue 15,119.4 12,901.4 12,139.6
- -------------------------------------------------------------------------------------------------------------------
Current and future benefits 11,186.5 9,239.2 8,387.0
Operating expenses 2,752.0 2,479.2 2,683.3
Amortization of goodwill and other acquired intangible assets 381.3 362.9 364.6
Amortization of deferred policy acquisition costs .6 20.3 11.9
Severance and facilities charges(reserve reductions) - (45.0) 453.0
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 799.0 844.8 239.8
Income taxes 368.0 391.0 146.7
- -------------------------------------------------------------------------------------------------------------------
Net income (3) $ 431.0 $ 453.8 $ 93.1
===================================================================================================================
Net realized capital gains, net of tax (included above) $ 88.2 $ 69.9 $ 34.4
===================================================================================================================
</TABLE>
(1) Operating results include NYLCare since July 15, 1998.
(2) Represents financial information as though the merger with U.S. Healthcare
occurred on January 1, 1996. The 1996 pro forma operating summary and
information derived from the summary are not necessarily indicative of
results of operations had the merger occurred at the beginning of 1996, nor
are they necessarily indicative of future results.
(3) Net income for 1998 includes a net benefit from capitalizing internal-use
software of $17.4 million.
In order to provide a comparison that management believes better reflects the
underlying performance of Aetna U.S. Healthcare, the operating earnings
discussion that follows excludes amortization of goodwill and other acquired
intangible assets (including the goodwill associated with the U.S. Healthcare
and NYLCare acquisitions), Year 2000 costs in 1998, the severance and facilities
actions in 1997 and 1996, and net realized capital gains in all three years.
<TABLE>
<CAPTION>
As Restated
(Millions) 1998(1)(2) 1997(1) 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating earnings:
Health Risk $ 368.7 $ 312.9 $ 461.9
Group Insurance and Other Health 350.3 340.7 218.2
- --------------------------------------------------------------------------------------------
Total Aetna U.S. Healthcare $ 719.0 $ 653.6 $ 680.1
============================================================================================
Commercial HMO Medical Loss Ratio 82.5% 84.2% 79.3%
- --------------------------------------------------------------------------------------------
Commercial HMO Premium PMPM $ 134.68 $ 132.57 $ 130.89
- --------------------------------------------------------------------------------------------
Commercial HMO Medical Cost PMPM $ 111.08 $ 111.69 $ 103.83
- --------------------------------------------------------------------------------------------
Medicare HMO Medical Loss Ratio 93.0% 93.4% 89.7%
- --------------------------------------------------------------------------------------------
Medicare HMO Premium PMPM $ 474.67 $ 459.69 $ 437.34
- --------------------------------------------------------------------------------------------
Medicare HMO Medical Cost PMPM $ 441.63 $ 429.31 $ 392.14
- --------------------------------------------------------------------------------------------
</TABLE>
(1) Operating results include NYLCare since July 15, 1998 and U.S. Healthcare
since July 19, 1996.
(2) Includes a net benefit from capitalizing internal-use software of $17.4
million in 1998.
Health Risk
The increase in Health Risk earnings of $56 million for 1998 reflects favorable
HMO results due to membership growth, premium rate increases, the impact of
medical cost initiatives, higher net investment income and the acquisition of
NYLCare. These increases were partially offset by lower Indemnity and PPO
results and increased operating expenses related to customer service
enhancements. The 1997 Health Risk earnings reflected significantly increased
HMO medical costs, which more than offset the benefit of increased HMO
membership and HMO premium rate increases. The 1997 HMO medical cost increases
include a $103 million after-tax charge in the third quarter of 1997 for the
re-estimation of HMO medical claims reserves, a majority of which relates to
1997 claims.
Page 31
<PAGE> 32
Commercial HMO premiums per member per month ("PMPM") increased 2% in 1998, when
compared to 1997, and 1% in 1997, when compared to 1996. These increases were
due to premium rate increases, offset in part by customers selecting lower
premium plans and a shift in the geographic mix of membership growth.
Commercial HMO medical costs PMPM decreased by 1% in 1998, when compared to
1997, and increased 8% in 1997, when compared to 1996. The decrease in 1998 is
due primarily to favorable results of medical cost initiatives, geographic mix
and customer changes in benefit plans partially offset by higher pharmacy,
physician and outpatient utilization. The increase in 1997 was primarily due to
higher inpatient facility and physician costs.
The Commercial HMO medical loss ratio decreased in 1998, when compared to 1997,
as growth in premiums due to rate increases exceeded increases in medical costs,
reflecting the benefit of medical cost initiatives.
Medicare HMO premiums PMPM increased by 3% in 1998, when compared to 1997, and
5% in 1997, when compared to 1996, due to Health Care Financing Administration
("HCFA") rate increases and increases in supplemental premiums.
Medicare HMO medical costs PMPM increased by 3% in 1998 when compared to 1997
and 10% in 1997 when compared to 1996. The higher medical costs in 1998 were
primarily due to higher pharmacy, physician and outpatient utilization and
medical cost inflation. The higher medical costs were partially offset by the
impact of the NYLCare acquisition, geographic mix and benefit changes. The
higher medical costs in 1997 were primarily due to higher inpatient facility,
physician and pharmacy costs.
For the Health Risk business, medical claims payable reflect estimates of the
ultimate cost of claims that have been incurred but not yet reported and
reported but not yet paid. Medical claims payable 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.
Group Insurance and Other Health
Group Insurance and Other Health results for 1998 reflect higher net investment
income and the acquisition of NYLCare. Results include comparable favorable
developments in claim benefit reserve estimates for life and disability products
in both 1998 (including the NYLCare group business) and 1997. Results in 1997
also reflect increased product sales, higher administrative service contract
fees resulting from rate increases and changes in product mix and lower
operating expenses as a percentage of revenue due to continued cost reduction
efforts.
Page 32
<PAGE> 33
Membership
Aetna U.S. Healthcare's membership was as follows:
<TABLE>
<CAPTION>
December 31, 1998 (1) December 31, 1997
---------------------------------- --------------------------------
(Thousands) Risk Nonrisk Total Risk Nonrisk Total
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HMO
Commercial (2) 5,104 640 5,744 3,642 584 4,226
Medicare 535 - 535 382 19 401
Medicaid 132 - 132 98 - 98
- ---------------------------------------------------------------------------------------------------------
Total HMO 5,771 640 6,411 4,122 603 4,725
POS (2) 261 2,509 2,770 310 2,473 2,783
PPO 1,089 2,943 4,032 609 3,012 3,621
Indemnity 182 2,270 2,452 294 2,311 2,605
- ---------------------------------------------------------------------------------------------------------
Total Health Membership 7,303 8,362 15,665 5,335 8,399 13,734
=========================================================================================================
Group Insurance: (3)
Group Life 9,769 9,822
Disability 2,592 2,559
Long-Term Care 91 97
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(1) Health membership for NYLCare at the date of acquisition was 2,117 members
including 1,186 Commercial HMO risk, 111 Medicare HMO risk, 56 Medicaid HMO
risk, 135 HMO nonrisk, 452 PPO risk and 177 PPO nonrisk. Group Insurance
NYLCare membership at the date of acquisition was 791 members.
(2) Commercial HMO includes POS members who access primary care physicians and
referred care through an HMO network of 1,329 at December 31, 1998 and 885
at December 31, 1997.
(3) Group Insurance membership as of December 31, 1997 reflects improved data
as a result of the conversion to a new membership reporting system.
December 31, 1997 membership reflects adjustments which continued to occur
through the first quarter of 1998, as applied to December 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 December 31, 1998 increased by approximately 2
million members when compared to December 31, 1997 due to the acquisition of
NYLCare. Excluding the impact of the NYLCare acquisition, the membership
increases in Commercial HMO, Medicare HMO, and POS were more than offset by
declines in Indemnity and PPO enrollment. Total HMO membership as of December
31, 1998 increased by 1.7 million members, or 36%, when compared to December 31,
1997.
Total Revenue and Expense
Aetna U.S. Healthcare's revenues increased by $2.3 billion in 1998 and $1.0
billion in 1997, excluding revenue in 1996 associated with investments in
primary care physician practices, as well as premiums related to the Civilian
Health and Medical Program of the Uniformed Services ("CHAMPUS") contract, which
was not renewed, revenue related to certain Medicare administrative services no
longer provided by Aetna U.S. Healthcare and also excluding net realized capital
gains. 1998 revenue growth was primarily due to the acquisition of NYLCare, as
well as premium rate increases and membership growth in Commercial and Medicare
HMO and POS products, partially offset by lower Indemnity and PPO membership.
Also during 1998, Aetna U.S. Healthcare recorded higher investment income due to
a higher investment portfolio balance (including the acquired assets of
NYLCare), a shift in strategy to higher yielding investments and an increase in
equity partnership income.
Aetna U.S. Healthcare's operating expenses increased by $273 million, or 11% in
1998, and decreased $14 million, or .6% in 1997, excluding operating expenses in
1996 associated with investments in primary care physician practices, as well as
operating expenses related to CHAMPUS and certain Medicare administrative
services no longer provided by Aetna U.S. Healthcare. The increase in 1998
reflects the acquisition of NYLCare, as well as HMO membership increases,
customer service enhancements and costs related to Year 2000. However, operating
expenses as a percentage of revenue decreased from 1997. The decrease in 1997
reflects the impact of continuing cost reduction efforts, which also resulted in
a reduction in operating expenses as a percentage of revenue.
Page 33
<PAGE> 34
Agreement to Acquire Prudential Health Care Business
On December 9, 1998, the Company entered into an agreement to acquire the
Prudential health care business. Included in the acquisition are the Prudential
health care HMO, POS, PPO and Indemnity health lines, as well as its dental
business. At December 31, 1998, the Prudential health care business had
approximately 6.2 million health members and 8 million dental members. See
"Overview" for a further discussion of the purchase.
Outlook
With the increased importance of managed care to the Company, the ability to
profitably grow the managed care risk business and obtain adequate pricing in an
increasingly competitive environment, while effectively managing medical costs
and operating expenses, is of critical importance.
Premiums in the Health Risk business are generally fixed by contract for
one-year periods and, accordingly, costs in excess of those reflected in pricing
cannot be recovered by prospectively or retrospectively raising premiums during
the year.
For 1999, the Company is targeting commercial premium increases that seek to
maintain or enhance margin. The Company is attempting to improve profitability
by increasing premiums and by addressing cost increases in its contracting with
providers and through other cost management efforts. However, the 1999 premium
rate increases set by the federal government for Medicare risk products averaged
approximately 2%, which the Company believes will be below the rate of medical
cost inflation. In an effort to improve its medical loss ratio, the Company has
made plan benefit changes and added premiums for supplemental benefits. In
addition, the Company has exited certain Medicare markets as of January 1, 1999.
The Company will continue to review the profitability of the Medicare business
in certain markets. There can be no assurances, however, that any premium
increases, benefit changes, or cost savings achieved through recontracting will
be sufficient to offset the increases in medical costs, as well as any increases
in other operating costs, due to potential governmental action (including rate
decreases or reduction of rate increases), business conditions (including
intensification of competition) and other factors.
Results for the Group Insurance and Other Health businesses are only expected to
be level or to increase slightly in 1999. See "Regulatory Environment" and
"Forward-Looking Information/Risk Factors" for information regarding other
important factors that may materially affect Aetna U.S. Healthcare.
Page 34
<PAGE> 35
AETNA RETIREMENT SERVICES
Operating Summary
<TABLE>
<CAPTION>
(Millions) 1998 (1) 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums (2) $ 131.9 $ 158.5 $ 180.7
Net investment income 1,024.5 1,114.7 1,086.7
Fees and other income 728.0 591.7 467.7
Net realized capital gains 3.0 37.6 27.1
- -------------------------------------------------------------------------------------------------------------
Total revenue 1,887.4 1,902.5 1,762.2
- -------------------------------------------------------------------------------------------------------------
Current and future benefits (2) 918.2 1,034.1 1,035.9
Operating expenses 407.1 385.6 337.5
Amortization of deferred policy acquisition costs 128.3 110.6 74.3
Severance and facilities charge, net 1.5 - 49.0
- -------------------------------------------------------------------------------------------------------------
Income before income taxes 432.3 372.2 265.5
Income taxes 132.3 115.1 79.3
- -------------------------------------------------------------------------------------------------------------
Net income (3) $ 300.0 $ 257.1 $ 186.2
=============================================================================================================
Net realized capital gains, net of tax (included above) $ 2.0 $ 24.2 $ 17.8
=============================================================================================================
Deposits not included in premiums above:
Annuities - fixed options $ 1,125.6 $ 1,191.4 $ 1,362.3
Annuities - variable options 3,642.7 3,291.2 2,759.3
Individual life insurance 374.2 486.4 443.2
- -------------------------------------------------------------------------------------------------------------
Total $ 5,142.5 $ 4,969.0 $ 4,564.8
=============================================================================================================
Assets under management:(4)
Annuities - fixed options $ 12,131.1 $ 12,056.3 $ 11,692.4
Annuities - variable options (5) 25,527.0 20,076.9 14,468.1
Other investment advisory (6) 14,268.6 10,069.0 3,288.1
- -------------------------------------------------------------------------------------------------------------
Financial services 51,926.7 42,202.2 29,448.6
Individual life insurance - 2,749.9 2,614.1
- -------------------------------------------------------------------------------------------------------------
Total $ 51,926.7 $ 44,952.1 $ 32,062.7
=============================================================================================================
</TABLE>
(1) Operating results reflect the operations of the individual life business
through the sale date of October 1, 1998.
(2) Includes $56.8 million in 1998, $59.1 million in 1997 and $71.8 million in
1996, for annuity premiums on contracts converting from the accumulation
phase to payout options with life contingencies.
(3) Net income for 1998 includes a net benefit from capitalizing internal-use
software of $8.6 million.
(4) Excludes net unrealized capital gains of $496.9 million at December 31,
1998, $551.6 million at December 31, 1997 and $366.0 million at December
31, 1996.
(5) Includes $7,467.5 million at December 31, 1998, $5,069.9 million at
December 31, 1997 and $4,633.2 million at December 31, 1996, related to
assets invested through Aetna Retirement Services' ("ARS") products in
unaffiliated mutual funds.
(6) The December 31, 1997 balance includes the transfer of $4,078.5 million of
assets under management that were previously reported in the Large Case
Pensions segment, reflecting the consolidation of the Company's investment
advisory services and migration of certain other pension products that
complement ARS' business strategy.
ARS offers financial services products, including fixed and variable annuity
contracts, investment advisory services, financial planning services and pension
plan administrative services. ARS' domestic individual life insurance business
was sold on October 1, 1998.
ARS' net income increased $43 million in 1998 and $71 million in 1997. ARS' 1998
net income includes Year 2000 costs of $23 million and a gain related to the
sale of the Life business of $64 million (included in fees and other income).
Results also include a net after-tax severance and facilities charge of $1
million in 1998 and $32 million in 1996. (See Note 10 of Notes to Consolidated
Financial Statements for additional information.) Excluding these factors and
net realized capital gains in all three years, ARS' results, as shown below,
increased $25 million in 1998, $33 million in 1997 and $29 million in 1996.
<TABLE>
<CAPTION>
(Millions) 1998 (1) 1997 1996
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Financial services $ 186.5 $ 157.8 $ 120.7
Individual life insurance 71.5 75.1 79.5
- ------------------------------------------------------------------------
Total $ 258.0 $ 232.9 $ 200.2
========================================================================
</TABLE>
(1) Reflects the operations of the individual life business through the sale
date of October 1, 1998.
Page 35
<PAGE> 36
The increases in 1998 and 1997 earnings for financial services primarily reflect
increased fee income from higher levels of assets under management. Assets under
management increased by 23% in 1998 and 29% in 1997, excluding assets under
management that were previously reported in the Large Case Pensions segment.
Assets under management grew primarily because of appreciation in the stock
market and additional net deposits (i.e., deposits less surrenders) and, in
1997, the inclusion of assets from the acquisition of Financial Network
Investment Corporation ("FNIC") (discussed below). Operating expenses as a
percentage of assets under management declined in both years.
Premiums relate to traditional life insurance and annuity products containing
life contingencies. Premiums decreased by $27 million in 1998, following a
decrease of $22 million in 1997. The decrease in 1998 was due to the sale of the
domestic individual life insurance business on October 1, 1998. The decrease in
1997 was due to a shift from annuity products containing life contingencies to
annuity products not involving life contingencies, and in part, from ceasing to
write structured settlement business.
Annuity deposits increased 6% in 1998 and 9% in 1997, reflecting business
growth. Life deposits decreased by 23% in 1998 due to the sale of the Life
business on October 1, 1998 and increased 10% in 1997, reflecting business
growth.
Of the $12.1 billion at December 31, 1998 and December 31, 1997 and $11.7
billion at December 31, 1996 of fixed annuity assets under management, 25% were
fully guaranteed and 75% were experience rated. The average earned rate on
investments supporting fully guaranteed investment contracts was 7.6%, 7.8% and
7.9%, and the average earned rate on investments supporting experience rated
investment contracts was 7.8%, 7.9% and 8.0% for the years ended December 31,
1998, 1997 and 1996. The average credited rate on fully guaranteed investment
contracts was 6.5%, 6.6% and 6.7%, and the average credited rate on experience
rated investment contracts was 5.8%, 5.9% and 6.0% for the years ended December
31, 1998, 1997 and 1996. The resulting interest margins on fully guaranteed
investment contracts were 1.1%, 1.2% and 1.2% and on experience rated investment
contracts was 2.0% for the years ended December 31, 1998, 1997 and 1996.
In 1997, in connection with the Company's efforts to expand its financial
planning business, the Company acquired FNIC. FNIC is a broker/dealer licensed
in all 50 states and includes more than 2,591 registered representatives and 179
branch offices in 36 states. The purchase price was not material to the Company.
Sale of Domestic Individual Life Insurance Business
The Company's sale of its domestic individual life insurance business to Lincoln
on October 1, 1998 included approximately $50 billion of individual life
insurance in force. The Company was obligated to sever its relationships with,
and make available to Lincoln, its sales force, including its agents, employee
sales managers and brokerage distribution channel. The Company has no
relationships with its former life agents and brokers subsequent to the closing.
The transaction was generally in the form of an indemnity reinsurance
arrangement and covers the following lines of insurance: traditional life,
universal life, participating life, sponsored life and corporate-owned life
insurance and pension life. Pension life results, which are reported in
Financial Services, are not material to ARS' results and, therefore, are not
included below. Revenues from the business lines sold were $399 million for 1998
through the sale date, $553 million for 1997 and $538 million for 1996. See
"Overview" and Note 5 of Notes to Consolidated Financial Statements for further
discussion of the sale.
Outlook
ARS' strategy is to increase assets under management and improve profitability
by focusing on strategic markets and products in the financial services
business. In doing so, ARS may take a variety of actions intended to improve its
investment and product management, marketing, distribution and customer service.
ARS also may seek acquisitions or divestitures in order to align its businesses
with strategic and financial targets or build scale.
See "Forward-Looking Information/Risk Factors" for information regarding other
important factors that may materially affect ARS.
Page 36
<PAGE> 37
AETNA INTERNATIONAL
Operating Summary
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 1,578.5 $ 1,434.1 $ 1,166.1
Net investment income (1) 459.8 384.4 334.2
Fees and other income 138.2 140.3 124.2
Net realized capital gains (losses) (28.9) 16.7 6.5
- -------------------------------------------------------------------------------------------------------------------
Total revenue 2,147.6 1,975.5 1,631.0
- -------------------------------------------------------------------------------------------------------------------
Current and future benefits 1,336.6 1,206.3 996.8
Operating expenses 505.6 462.0 377.2
Interest expense 11.1 7.8 8.2
Amortization of goodwill and other acquired intangible assets 16.0 16.3 3.0
Amortization of deferred policy acquisition costs 86.4 86.6 73.9
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 191.9 196.5 171.9
Income taxes 55.9 54.1 62.0
- -------------------------------------------------------------------------------------------------------------------
Net income (2) $ 136.0 $ 142.4 $ 109.9
===================================================================================================================
Net realized capital gains (losses), net of tax (included above) $ (22.2) $ 13.7 $ 4.4
===================================================================================================================
</TABLE>
(1) Includes $96.5 million in 1998, $51.5 million in 1997 and $16.8 million in
1996 of earnings from Aetna International subsidiaries that are carried on
the equity basis.
(2) Net income for 1998 includes a net benefit from capitalizing internal-use
software of $2.0 million.
Aetna International, through subsidiaries and joint venture affiliates, sells
primarily life insurance and health insurance and financial retirement services
products in markets outside of the United States.
Earnings by major geographic location, excluding Year 2000 costs in 1998 and net
realized capital gains or losses in all three years, are as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- --------------------------------------------------------------
<S> <C> <C> <C>
Asia Pacific (1) $ 65.2 $ 55.7 $ 53.8
Americas (2) 112.9 83.0 59.1
Other (3) (12.4) (10.0) (7.4)
- --------------------------------------------------------------
Total $ 165.7 $ 128.7 $ 105.5
==============================================================
</TABLE>
(1) Includes China, Hong Kong, Indonesia, Malaysia, New Zealand, Philippines,
Taiwan and Thailand.
(2) Includes Argentina, Brazil, Canada, Chile, Mexico, Peru and Venezuela.
(3) Includes general and other miscellaneous expenses.
Aetna International's net income decreased $6 million in 1998 and increased $33
million in 1997. Results in 1998 include Year 2000 costs of $8 million.
Excluding Year 2000 costs and net realized capital gains or losses, earnings
increased $37 million in 1998 and $23 million in 1997. Results in 1998 primarily
reflect earnings growth from the Company's operations in Brazil, which were
acquired in April 1997, as well as from operations in Taiwan, Canada and the
Mexican pension business. These results were offset in part by other Mexican
operations and an overall weakening of foreign currencies versus the U.S.
dollar. Results in 1997 primarily reflect the Company's operations in Brazil,
earnings growth in Taiwan and Canada and favorable investment performance in
certain Asia Pacific and Latin American businesses. This earnings growth was
partially offset by increased losses related to start-up operations, primarily
those in the Philippines and Argentina, and fourth quarter weakening of foreign
currencies in Asia.
Premiums in 1998 were 10% higher than in 1997, following a 23% increase in 1997
premiums as compared with 1996. The premium growth rate in 1998 was adversely
affected by the overall weakening of foreign currencies versus the U.S. dollar.
The increases in premiums in 1997 were primarily due to increased insurance
product sales in Taiwan and Chile.
During 1998, Aetna International continued to grow with new and expanded
presence in China, Chile, Thailand, Venezuela and New Zealand. In January 1999,
Aetna International also acquired the largest health care company in Argentina
and entered into a pension joint venture in Poland. See Notes 5 and 23 of Notes
to Consolidated Financial Statements for additional information.
Page 37
<PAGE> 38
Outlook
Aetna International seeks to invest in emerging markets outside the U.S. that
have the potential for attractive long-term returns. The Company also explores
opportunities for additional investments, or divestitures, where appropriate, in
certain mature markets where it currently has a presence. These investments are
generally made through the acquisition of part or all of an existing company or
a start-up investment.
Brazil has recently experienced a significant devaluation in its currency which
could also have a broader impact on growth in Latin America. Currency
devaluations in Brazil, or the Company's other established operations, could
adversely affect operating earnings when translated into U.S. dollars. This
effect may be offset somewhat by increased interest rate returns on investments
resulting from the economic conditions that lead to the devaluation. In
addition, currency devaluation could reduce losses from start-up operations when
translated into U.S. dollars.
See "Forward-Looking Information/Risk Factors" for information regarding other
important factors that may materially affect Aetna International.
LARGE CASE PENSIONS
Operating Summary
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 122.7 $ 155.0 $ 214.1
Net investment income 1,152.5 1,408.7 1,649.2
Fees and other income (1) 18.5 28.1 81.4
Net realized capital gains 57.5 30.7 30.9
- -----------------------------------------------------------------------------------------------------------
Total revenue 1,351.2 1,622.5 1,975.6
- -----------------------------------------------------------------------------------------------------------
Current and future benefits 1,122.4 1,372.4 1,723.6
Operating expenses (1) 24.4 34.8 58.6
Reductions of loss on discontinued products (68.0) (172.5) (202.3)
- -----------------------------------------------------------------------------------------------------------
Income before income taxes 272.4 387.8 395.7
Income taxes 102.5 153.6 137.3
- -----------------------------------------------------------------------------------------------------------
Net income $ 169.9 $ 234.2 $ 258.4
===========================================================================================================
Net realized capital gains, net of tax (included above) $ 37.4 $ 20.8 $ 20.8
===========================================================================================================
Deposits not included in premiums above:
Fully guaranteed discontinued products $ 17.7 $ 14.0 $ 17.7
Experience rated 251.3 735.4 789.0
Nonguaranteed 950.2 849.2 975.1
- -----------------------------------------------------------------------------------------------------------
Total $ 1,219.2 $ 1,598.6 $ 1,781.8
===========================================================================================================
Assets under management: (1) (2)
Fully guaranteed discontinued products $ 6,737.9 $ 7,548.9 $ 8,477.1
Experience rated 9,546.9 11,114.7 16,103.2
Nonguaranteed 12,120.0 11,070.2 10,749.3
- -----------------------------------------------------------------------------------------------------------
Total $ 28,404.8 $ 29,733.8 $ 35,329.6
===========================================================================================================
</TABLE>
(1) 1997 includes $7.0 million of fees and other income and $1.8 million of
operating expenses and, at December 31, 1997, assets of $285.2 million that
are currently reported in the ARS segment. 1996 includes $15.7 million of
fees and other income and $12.7 million of operating expenses and, at
December 31, 1996, assets of $3,608.0 million that are currently reported
in the ARS segment. This reflects the consolidation of the Company's
investment advisory services and certain other products that complement
ARS' business strategy.
(2) Excludes net unrealized capital gains of $621.0 million at December 31,
1998, $645.4 million at December 31, 1997 and $321.4 million at December
31, 1996.
The Large Case Pensions segment manages a variety of retirement products
(including pension and annuity products) primarily for defined benefit and
defined contribution plans. These products provide a variety of funding and
benefit payment distribution options and other services. Certain products
provide investment guarantees.
Page 38
<PAGE> 39
Large Case Pensions' net income decreased $64 million in 1998 and $24 million in
1997. Primarily as a result of favorable investment performance during 1998, the
Company released $44 million (after tax) of the reserve related to discontinued
products. Also, as a result of continued favorable developments in real estate
markets, the Company released $108 million (after tax) in 1997 and $132 million
(after tax) in 1996 of the reserve related to discontinued products. Large Case
Pensions' earnings, excluding Year 2000 costs of approximately $1 million (after
tax) in 1998, the reductions of the reserve for loss on discontinued products
and net realized capital gains in all three years decreased $15 million in 1998
and decreased slightly in 1997. The 1998 and 1997 decreases continue to reflect
the redeployment of capital supporting this business and the consolidation into
the ARS segment of certain products and services, partially offset by lower
expenses in both years.
Assets under management decreased during 1998 and 1997. The 1998 and 1997
decreases primarily resulted from the continuing runoff of underlying
liabilities and consolidation into the ARS segment of the Company's investment
advisory services and certain other products that complement ARS' business
strategy.
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. Experience rated contractholder and
participant withdrawals and transfers were as follows (excluding contractholder
transfers to other Company products):
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Scheduled contract maturities and benefit payments (1) $ 935.5 $ 905.0 $ 1,089.1
Contractholder withdrawals other than scheduled contract maturities and
benefit payments (2) $ 431.8 $ 358.1 $ 506.2
Participant withdrawals (2) $ 98.3 $ 130.0 $ 170.8
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes payments made upon contract maturity and other amounts distributed
in accordance with contract schedules.
(2) At December 31, 1998, approximately $1.3 billion of experience rated
pension contracts allowed for unscheduled contractholder withdrawals,
subject to timing restrictions and formula-based market value adjustments.
Further, approximately $2.7 billion of such contracts supported by general
account assets could be withdrawn or transferred to other plan investment
options at the direction of plan participants, without market value
adjustment.
Outlook
Large Case Pensions' earnings are expected to continue to decline in 1999 as
reductions in investment income on capital supporting maturing obligations are
redeployed to other businesses of the Company.
See "Forward-Looking Information/Risk Factors" for information regarding other
important factors that may materially affect Large Case Pensions.
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. The Company established a reserve for anticipated future
losses on these products based on the present value of the difference between
(a) the expected cash flows from the assets supporting these products and (b)
the cash flows expected to be required to meet the product obligations.
Results of operations of discontinued products, including net realized capital
gains or losses, are credited or charged to the reserve for anticipated losses.
The Company's results of operations would be adversely affected to the extent
that future losses on the products are greater than anticipated and positively
affected to the extent future losses are less than anticipated.
Page 39
<PAGE> 40
The factors contributing to changes in the reserve for anticipated future losses
are: operating income or loss, realized capital gains or losses and mortality
gains or losses. Operating income or loss is equal to revenue less expenses.
Realized capital gains or losses reflect the excess (deficit) of sales price
over (below) the carrying value of assets sold. Mortality gains or losses
reflect the mortality and retirement experience related to SPAs. A mortality
gain (loss) occurs when an annuitant or a beneficiary dies sooner (later) than
expected. A retirement gain will occur on some contracts if an annuitant retires
later than expected (a loss if an annuitant retires earlier than expected).
The results of discontinued products were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest margin (deficit) (1) $ (22.7) $ 15.1 $ 26.3
Net realized capital gains 75.8 175.4 79.2
Interest earned on receivable from continuing products 22.4 21.5 29.7
Other, net 3.6 2.8 16.3
- ------------------------------------------------------------------------------------------------------------------
Results of discontinued products, after tax $ 79.1 $ 214.8 $ 151.5
==================================================================================================================
Results of discontinued products, pretax $ 130.4 $ 337.4 $ 230.3
==================================================================================================================
Net realized capital gains from sales of bonds, after tax (included above) $ 52.5 $ 36.6 $ 7.7
==================================================================================================================
</TABLE>
(1) The interest margin (deficit) is the difference between earnings on
invested assets and interest credited to contractholders.
The interest margin (deficit) decrease in 1998 and 1997 is primarily due to
lower investment income, reflecting the decline in assets used to fund
contractual liability runoff, as well as lower yields due to a shift in the
investment portfolio to fixed income bonds. The 1998 net realized capital gains
reflect gains of $28 million related to continued favorable developments in real
estate markets as well as gains of $53 million from the sale of bonds. The 1997
net realized capital gains primarily reflect $100 million of gains related to
continued favorable developments in real estate markets (including gains of $24
million related to the securitization of commercial mortgage loans), gains of
$37 million from the sale of bonds and gains of $37 million resulting from the
sale of investments in order to meet liquidity needs. The 1996 net realized
capital gains include $73 million related to favorable developments in real
estate markets.
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 that was used to calculate the
reserve. Total assets supporting discontinued products and the reserve include a
receivable from continuing products of $493 million at December 31, 1998 and
$515 million at December 31, 1997, net of related deferred taxes payable.
The reserve for anticipated future losses on discontinued products represents
the present value (at the risk-free rate at the time of discontinuance,
consistent with the duration of the liabilities) of the difference between the
expected cash flows from the assets supporting discontinued products and the
cash flows expected to be required to meet the obligations of the outstanding
contracts. Calculation of the reserve for anticipated future losses requires
projection of both the amount and the timing of cash flows over approximately
the next 30 years, including consideration of, among other things, future
investment results, participant withdrawal and mortality rates, as well as the
cost of asset management and customer service. There have been no significant
changes to the assumptions underlying the calculation of the reserve related to
the projection of the amount and timing of cash flows.
The projection of future investment results considers assumptions for interest
rates, bond discount rates and performance of mortgage loans and real estate.
Mortgage loan assumptions represent management's best estimate of current and
future levels of rent growth, vacancy and expenses based upon market conditions
at each reporting date. The performance of real estate assets has been
consistently estimated using the most recent forecasts available. During 1997, a
bond default assumption was included to reflect historical default experience,
since the bond portfolio increased as a percentage of the overall investment
portfolio and reflected more bond credit risk, concurrent with the decline in
the commercial mortgage loan and real estate portfolios.
Page 40
<PAGE> 41
The previous years' actual participant withdrawal experience is used for the
current year assumption. Prior to 1995, the Company used the 1983 Group
Annuitant Mortality table published by the Society of Actuaries (the "Society").
In 1995, the Society published the 1994 Uninsured Pensioner's mortality table
which has been used since then.
The Company's assumptions about the cost of asset management and customer
service reflect actual investment and general expenses allocated over invested
assets. Since inception, the expense assumption has increased as the level of
fixed expenses has not declined as rapidly as the liability run-off.
The activity in the reserve for anticipated future losses on discontinued
products was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
- --------------------------------------------------
<S> <C>
Reserve at December 31, 1995 $ 958.8
Operating income 92.9
Net realized capital gains 121.8
Mortality and other 15.6
Reserve reduction (202.3)
- --------------------------------------------------
Reserve at December 31, 1996 986.8
Operating income 58.7
Net realized capital gains 269.9
Mortality and other 8.8
Reserve reduction (172.5)
- --------------------------------------------------
Reserve at December 31, 1997 1,151.7
Operating loss (6.6)
Net realized capital gains 116.6
Mortality and other 20.4
Reserve reduction (68.0)
- --------------------------------------------------
Reserve at December 31, 1998 $ 1,214.1
==================================================
</TABLE>
Management reviews the adequacy of the discontinued products reserve quarterly
and, as further discussed above, primarily due to favorable investment
performance, $44 million ($68 million pretax) of the reserve was released in
1998. Similar reviews resulted in the Company's release of $108 million ($173
million pretax) in 1997 and $132 million ($202 million pretax) in 1996 of the
reserve due to continued favorable developments in real estate markets. The
current reserve reflects management's best estimate of anticipated future
losses.
The anticipated run-off of the December 31, 1998 reserve balance is as follows:
<TABLE>
<CAPTION>
(Millions)
- -----------------------------------
<S> <C>
1999 $ 29.9
2000 30.6
2001 31.1
2002 31.7
2003 - 2007 172.9
2008 - 2012 193.1
2013 - 2017 189.2
Thereafter 535.6
- -----------------------------------
</TABLE>
The above assumes that assets are held until maturity and that the reserve
run-off is proportional to the liability runoff.
The expected (as of December 31, 1993) and actual liability balances for the GIC
and SPA liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
Expected Actual
------------------------ --------------------------
(Millions) GIC SPA GIC SPA
- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996 $ 4,642.0 $ 4,786.7 $ 3,288.7 $ 4,793.7
1997 3,173.9 4,685.8 2,321.4 4,763.0
1998 2,029.6 4,581.3 1,546.0 4,653.5
- ------------------------------------------------------------------
</TABLE>
Page 41
<PAGE> 42
The GIC balances are lower than expected in each period as several
contractholders redeemed their contracts prior to contract maturity. The SPA
balances in each period are higher because of additional amounts received under
existing contracts.
The discontinued products investment portfolio is as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------- -------------------------
(Millions) Amount Percent Amount Percent
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Debt Securities $ 5,890.5 83.0% $ 6,471.4 81.5%
Mortgage Loans 754.2 10.6 976.9 12.3
Real Estate 104.2 1.5 116.9 1.5
Equities 98.5 1.4 5.6 .1
Short-term and other investments 252.2 3.5 365.7 4.6
- --------------------------------------------------------------------------------------------
Total $ 7,099.6 100.0% $ 7,936.5 100.0%
============================================================================================
</TABLE>
The investment portfolio declined in 1998 as assets were used to pay off
contractual liabilities. As mentioned above, the composition of the investment
portfolio has changed since inception. Mortgage loans have decreased from $5.4
billion (37% of the investment portfolio) at December 31, 1993 to the current
level. This was a result of maturities, prepayments and the securitization and
sale of commercial mortgages. Also, real estate decreased from $.5 billion (4%
of the investment portfolio) at December 31, 1993 to the current level primarily
as a result of sales. The resulting proceeds were reinvested in debt securities
and equities.
The change in the composition of the overall investment portfolio resulted in a
change in the quality of the portfolio since 1993. As the Company's exposure to
commercial mortgage loans and real estate has diminished, additional investment
return has been achieved by increasing the risk of the bond portfolio. At
December 31, 1993, approximately 60% of the debt securities had a quality rating
of AAA or AA and at December 31, 1998 approximately 32% of the debt securities
have a quality rating of AAA or AA. However, management believes the level of
risk in the total portfolio of assets supporting discontinued products was lower
at December 31, 1998 when compared to December 31, 1993.
Distributions on discontinued products were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Scheduled contract maturities, settlements and benefit payments $ 1,433.5 $ 1,683.1 $ 2,609.0
Participant directed withdrawals 21.4 36.4 52.0
- --------------------------------------------------------------------------------------------------------
</TABLE>
Cash required to fund these distributions was provided by earnings and scheduled
payments on, and sales of, invested assets.
At December 31, 1998, scheduled maturities, future benefit payments and other
expected payments, including future interest, were as follows:
<TABLE>
<CAPTION>
(Millions)
- ----------------------------------
<S> <C>
1999 $1,255.0
2000 895.7
2001 816.8
2002 674.4
2003 531.7
2004 -- 2008 2,273.0
2009 -- 2013 1,966.3
2014 -- 2018 1,583.6
2019 -- 2023 1,182.9
Thereafter 2,097.7
- ----------------------------------
</TABLE>
Refer to Note 11 of Notes to Consolidated Financial Statements and "General
Account Investments" for additional information.
Page 42
<PAGE> 43
CORPORATE
Operating Summary
<TABLE>
<CAPTION>
(Millions, after tax) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest expense $ 155.9 $ 147.5 $ 103.9
- ---------------------------------------------------------------------------------------------------------------------------
Other expense:
Severance and facilities charges (1) $ - $ - $ 235.5
Other operating expenses, net 106.7 108.7 110.5
Interest income on life sale (1998) and property-casualty sale (1996) proceeds (5.3) - (36.8)
Net realized capital gains (2) (68.5) (69.8) (5.0)
- ---------------------------------------------------------------------------------------------------------------------------
Total other expense $ 32.9 $ 38.9 $ 304.2
===========================================================================================================================
</TABLE>
(1) See Note 10 of Notes to Consolidated Financial Statements for additional
information.
(2) After-tax net realized capital gains in 1998 include gains of $74.4 million
related to the sale of the Company's remaining investment in Travelers
Property Casualty Corporation ("TPCC"). After-tax net realized capital
gains in 1997 include gains of $98.1 million related to sales of portions
of the Company's investment in TPCC offset by an after-tax realized capital
loss of $28.6 million related to the write-down of certain properties that
the Company had classified as held for sale.
The Corporate segment includes interest expense and other expenses that 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.
The 1998 increase in interest expense primarily results from additional debt
incurred in connection with the NYLCare acquisition. The 1997 increase in
interest expense primarily results from additional debt incurred in connection
with the U.S. Healthcare merger.
Included in other operating expenses are Year 2000 costs of $11 million for
1998. Other operating expenses were comparable in 1998 and 1997.
Outlook
The Company continues to review its cost structure, in particular its corporate
operating expenses, for possible efficiencies and costs savings. Interest
expense is expected to increase in 1999 as a result of the additional debt that
will be incurred to finance the Prudential acquisition.
See "Forward-Looking Information/Risk Factors" for information regarding other
important factors that may materially affect the Company.
SEVERANCE AND FACILITIES CHARGES
During 1996, the Company established severance and facilities reserves of $865
million pretax in the Aetna U.S. Healthcare, Aetna Retirement Services and
Corporate segments to reflect the integration of the health businesses of the
Company and U.S. Healthcare and certain other actions taken or to be taken in
order to make its businesses more competitive. The charges included costs
associated with involuntary employee terminations, asset disposals and
consolidating and eliminating certain processing operations and associated real
estate obligations. The Company anticipated the principal long-term benefits of
this severance and facilities plan (the "plan") would result in lower workforce
costs, simplification of operating procedures and economies of scale associated
with large customer service centers. In addition, the Company continued to
experience rapid growth and a number of the workforce reductions contemplated in
the original plan were offset by the hiring of other employees to continue to
maintain appropriate customer service levels.
Page 43
<PAGE> 44
The Company's 1996 provision was developed based on management's best judgment
and estimates at that time and is included in other liabilities in the
Consolidated Balance Sheets. The Company anticipated the plan to be
substantially completed over an approximate two-year time-frame, given the
complexity of the actions, which included executing staffing and system changes
while maintaining customer service levels and other service center consolidation
processes. As the Company began to execute the plan, it adjusted certain
estimates based on more current information related to the actions to be
undertaken, as further discussed below. The following table summarizes the 1996
charges by segment:
<TABLE>
<CAPTION>
Asset Vacated
(Millions) Severance Disposals Leases Other CityPlace Total
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Aetna U.S. Healthcare $ 277.9 $ 84.9 $ 64.5 $ 25.7 $ - $ 453.0
Aetna Retirement Services 42.8 1.5 1.9 2.8 - 49.0
Corporate: Other 28.5 18.0 21.0 3.0 292.2 362.7
- -------------------------------------------------------------------------------------------------------
Total Company $ 349.2 $ 104.4 $ 87.4 $ 31.5 $ 292.2 $ 864.7
=======================================================================================================
</TABLE>
1996 Charges
Aetna U.S. Healthcare recorded a charge of $423 million pretax related to
actions taken or expected to be taken with respect to the integration of the
health businesses. This charge does not include costs to exit certain activities
of U.S. Healthcare and corresponding involuntary termination benefits as these
costs were included as part of the purchase price. The plan, which the Company
began to formulate in the second quarter of 1996, included the consolidation and
reduction from over 40 service centers into 16 as well as the reduction of
overlapping functions in both the home and field offices. In addition,
approximately 18 physician practice management offices were to be closed.
The severance portion of this charge was based on the plan to eliminate 7,500
positions (primarily service center, medical management, administrative and data
center personnel). The asset disposal portion of the charge was primarily
related to the disposition or abandonment of obsolete information technology
assets associated with employees who were to be terminated or data and service
centers which were to be closed. The portion of the charge for vacated lease
property was related to the site closures for service centers, as well as the
physician practice management offices. The "other" portion of the charge
primarily included: costs associated with the exit from the Medicare claim fee
for service business; costs incurred in terminating contractual obligations
related to the purchase and development of an HMO system platform which existed
prior to the Company's acquisition of U.S. Healthcare and incremental costs to
be incurred in connection with the shutdown of service centers.
In addition, Aetna U.S. Healthcare recorded a charge in 1996 of $30 million
pretax, not related to the U.S. Healthcare merger, for actions taken or expected
to be taken to reduce information technology costs. The severance portion of
this charge included a plan to eliminate 675 positions. By year end 1996, a
large portion of these actions were completed.
Aetna Retirement Services recorded a $49 million pretax charge related to
actions taken or expected to be taken to improve its cost structure relative to
its competitors. This included the consolidation of certain field office
locations into other field office locations within the same geographic area and
the consolidation of work space due to downsizing of operations in certain
locations. The severance portion of the charge was based on a plan to eliminate
723 positions (primarily customer service, sales and information technology
support staff). The asset disposal portion of this charge related to the
write-off of personal computers of the terminated employees. The vacated leases
portion of the charge related to the closing of the field offices while the
"other" portion of this charge related to buy-out costs incurred in connection
with the termination of certain sales agent contracts.
Page 44
<PAGE> 45
In connection with the sale of the Company's property-casualty operations, the
Company vacated the CityPlace office in Hartford and the purchaser subleased the
space at market rates for a period of eight years. The Company recorded a charge
of $292 million pretax representing the present value of the difference between
the rent required to be paid by the Company under the lease and the future
rentals expected to be received by the Company. The Company also recorded a
charge of $71 million pretax for actions taken or expected to be taken to reduce
the level of corporate expenses and other costs previously absorbed by the
property-casualty operations. The severance portion of this charge included the
planned elimination of 475 positions. The asset disposal and vacated leases
portion of this charge included the exit of four corporate facilities as well as
the disposal of related computer hardware, telecommunications equipment and
personal computers. The "other" portion of the charge related to costs to
eliminate certain processing functions in the investment operations area
resulting from the Company's sale of its property-casualty operations.
Certain aspects of the Company's original plan were refined, resulting in the
reallocation of accruals between restructuring categories, although the overall
reserve remained the same. Refinements in 1996 and 1998 were not significant.
The following table summarizes the 1996 severance and facilities charges and
activity through December 31, 1998 (pretax):
<TABLE>
<CAPTION>
Asset Vacated
(Millions) Severance Disposals Leases Other CityPlace (1) Total
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 Charges $ 349.2 $ 104.4 $ 87.4 $ 31.5 $ 292.2 $ 864.7
1996 Actions (84.6) (25.4) (17.4) (6.9) (5.2) (139.5)
1996 Refinement (1.3) - - 1.3 - -
- -----------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1996 263.3 79.0 70.0 25.9 287.0 725.2
1997 Actions (120.8) (91.4) (25.1) (36.9) (.6) (274.8)
1997 Reduction (45.0) - - - - (45.0)
1997 Refinement (57.0) 33.4 (3.4) 27.0 - -
- -----------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1997 40.5 21.0 41.5 16.0 286.4 405.4
1998 Actions (45.8) (19.4) (37.6) (12.8) 1.1 (114.5)
1998 Addition 4.0 - - - - 4.0
1998 Reduction (2.5) - - - - (2.5)
1998 Refinement 8.7 (1.6) (3.9) (3.2) - -
- -----------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1998 $ 4.9 $ - $ - $ - $ 287.5 $ 292.4
=======================================================================================================================
</TABLE>
(1) Refer to Note 23 for further discussion.
1996 Activity
During 1996, Aetna U.S. Healthcare closed three service centers, and
consolidated and eliminated medical management activities at nine sites. Aetna
U.S. Healthcare also closed 18 physician practice management offices. Pursuant
to these actions, a total of 1,886 Aetna U.S. Healthcare positions were
eliminated. During 1996, Aetna Retirement Services eliminated 199 positions and
Corporate eliminated 336 positions.
1997 Activity
During 1997, Aetna U.S. Healthcare closed 10 service centers, and consolidated
and eliminated medical management activities at 37 sites. Pursuant to these
actions, a total of 2,503 Aetna U.S. Healthcare positions were eliminated. Aetna
Retirement Services eliminated 163 positions and closed nine field offices
during 1997. Also, Aetna Retirement Services wrote off the majority of personal
computers of the terminated employees during 1997. Corporate eliminated 136
positions during 1997.
The Company's policy is to review the adequacy of the aggregate severance and
facilities reserve on a quarterly basis. This review includes an assessment of
the adequacy of the remaining reserve balance to complete the remaining
activities planned at the end of each quarter. As a result of these quarterly
reviews, the Company reduced the severance and facilities reserve for the Aetna
U.S. Healthcare segment by $14 million in the first quarter of 1997 and $31
million in the second quarter of 1997. These reductions in the reserve
(representing approximately 1,200 positions) were based on the Company's
continued assessment of actual attrition which was higher as compared to
attrition assumptions contemplated in the original plan.
Page 45
<PAGE> 46
The severance reserve was refined due to changes in business circumstances,
including customer service levels. In order to ensure an appropriate level of
service to Aetna U.S. Healthcare's customers and providers, the Company decided
not to proceed with six previously planned site closings. This decision resulted
in approximately 900 fewer job eliminations. In addition, the Company
experienced continued higher attrition levels, principally in certain patient
management and service center sites, resulting in an additional 700 fewer job
eliminations than anticipated.
During the same time period, disposal estimates that were contemplated for
certain information technology fixed assets (since they would not benefit future
operations) were also refined in the Aetna U.S. Healthcare segment. These assets
included personal computers, data center computer equipment for a data center
that would cease operations and telecommunications equipment associated with
planned service center consolidations. The need for the refined disposal
estimates included the following: (i) lower expected values for some information
technology assets contemplated in the reserve and more complete inventory
information which resulted in additional asset disposals; (ii) increased
information technology labor costs incurred in connection with the systems that
were to be shutdown, including deactivating and dismantling the systems; and
(iii) additional costs associated with the closure of a duplicate data center
including labor costs to disconnect and dispose of information technology
equipment. In addition, disposals were higher than contemplated in the original
plan related to the exit of physician practice management offices for certain
items such as leasehold improvements and other costs with no future economic
benefit to the Company.
The refinement of the "other" reserve represented an increase in the costs
associated with the shut down of service centers that were contemplated in the
original plan primarily in the Aetna U.S. Healthcare segment. Such costs were
primarily associated with labor costs of employees retained specifically to
perform exit activities including inventorying and disposing of assets and
coordinating site closure activities at service centers where operations had
ceased. These exit activities also included higher costs for employee resources
at field locations involved in the deactivation of claims systems.
1998 Activity
During 1998, Aetna U.S. Healthcare closed five service centers, and consolidated
and eliminated medical management activities at two sites. Pursuant to these
actions, a total of 1,000 Aetna U.S. Healthcare positions were eliminated. Aetna
Retirement Services eliminated 116 positions and completed the buy-out of the
sales agents contracts. Corporate eliminated 28 positions during 1998.
The 1998 addition to the severance and facilities reserve relates to anticipated
severance actions as a result of the sale of the domestic individual life
business, which included approximately 55 positions to be eliminated. These
severance actions are expected to be substantially complete by March 31, 1999.
The severance reserve relating to the Aetna Retirement Services segment was
reduced in 1998 upon substantial completion of the original plan and actions.
GENERAL ACCOUNT INVESTMENTS
Investments disclosed in this section relate to the Company's total general
account portfolio (including assets supporting discontinued products and
experience rated products).
The Company's investment objective is to fund policyholder and other liabilities
in a manner that enhances shareholder and contractholder value, subject to
appropriate risk constraints. The Company seeks to meet this investment
objective through a mix of investments that reflect the characteristics of the
liabilities they support, diversify the types of investment risks by interest
rate, liquidity, credit and equity price risk, and achieve asset diversification
by investment type, industry, issuer and geographic location. The Company
regularly projects duration and cash flow characteristics of its liabilities and
makes appropriate adjustments in its investment portfolios.
Page 46
<PAGE> 47
Total Investments
<TABLE>
<CAPTION>
As Restated
December 31,
-------------------------------------
(Millions) 1998 1997
- --------------------------------------------------------------------
<S> <C> <C>
Debt securities $ 32,180.8 $ 34,245.0
Equity securities 800.5 1,041.4
Short-term investments 942.2 1,003.9
Mortgage loans 3,553.0 4,207.8
Real estate 270.3 369.5
Policy loans 458.7 746.9
Other 1,300.3 974.3
- --------------------------------------------------------------------
Total investments $ 39,505.8 $ 42,588.8
====================================================================
</TABLE>
Debt Securities
Available for sale debt securities represented 81% of the Company's total
general account invested assets at December 31, 1998 and 80% at December 31,
1997 and supported the following types of businesses:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- -----------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 5,890.5 $ 6,471.4
Supporting experience rated products 13,197.3 15,322.8
Supporting remaining products 13,093.0 12,450.8
- -----------------------------------------------------------------------------------
Total debt securities $ 32,180.8 $ 34,245.0
===================================================================================
</TABLE>
Debt securities reflect net unrealized capital gains of $1.5 billion at December
31, 1998 compared with $1.6 billion at December 31, 1997. Of the net unrealized
capital gains at December 31, 1998, $362 million relate to assets supporting
discontinued products and $576 million relate to experience rated pension
contractholders.
The debt securities in the Company's portfolio are generally rated by external
rating agencies, and, if not externally rated, are rated by the Company on a
basis believed to be similar to that used by the rating agencies. The Company's
investments in debt securities had an average quality rating of A+ as of
December 31, 1998 and AA- as of December 31, 1997, (33% were AAA at December 31,
1998 and 36% were AAA at December 31, 1997). "Below investment grade" debt
securities carry a rating of below BBB-/Baa3 and represent 6% of the portfolio
at December 31, 1998 and December 31, 1997, of which 51% at December 31, 1998
and 62% at December 31, 1997 support discontinued and experience rated products.
See Note 6 of Notes to Consolidated Financial Statements for disclosures related
to debt securities by market sector.
Residential Collateralized Mortgage Obligations
Included in the Company's debt securities are residential collateralized
mortgage obligations ("CMOs") of $2.0 billion at December 31, 1998 and $2.7
billion at December 31, 1997. There are various categories of CMOs that are
subject to different degrees of risk from changes in interest rates and, for
nonagency-backed CMOs, defaults. Approximately 67% of the Company's residential
CMO holdings were backed by government agencies, such as GNMA, FNMA and FHLMC,
at December 31, 1998 and 76% at December 31, 1997. 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
December 31, 1998, approximately 2% and at December 31, 1997, approximately 3%
of the Company's CMO holdings were invested in amounts that are subject to more
prepayment and extension risk than traditional CMOs (such as interest- or
principal-only strips).
Page 47
<PAGE> 48
Mortgage Loans
At December 31, 1998 and 1997, the Company's mortgage loan investments, net of
impairment reserves, supported the following types of businesses:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 754.2 $ 976.9
Supporting experience rated products 1,183.3 1,671.9
Supporting remaining products 1,615.5 1,559.0
- ------------------------------------------------------------------------
Total mortgage loans $ 3,553.0 $ 4,207.8
========================================================================
</TABLE>
During 1998, the Company continued to manage its mortgage loan portfolio to
reduce the balance in absolute terms, relative to invested assets, and to reduce
its overall risk. The $655 million decrease during 1998 in the total mortgage
loan portfolio primarily reflects loan prepayments and repayments of maturing
loans. In December 1997, the Company completed the sale and securitization of
approximately $803 million of commercial mortgage loans primarily supporting
discontinued fully guaranteed large case pension products, and retained
approximately $210 million of subordinate and residual certificates that were
classified as available-for-sale debt securities. The net proceeds from the sale
were approximately $635 million. Realized capital gains on the sale and
securitization were approximately $42 million (pretax), of which $37 million
(pretax) was recorded as part of the reserve for anticipated future losses on
discontinued products.
Problem, restructured and potential problem loans included in mortgage loans
were $301 million at December 31, 1998 and $388 million at December 31, 1997, of
which 86% at December 31, 1998 and 84% at December 31, 1997 support discontinued
and experience rated products. Specific impairment reserves on these loans were
$48 million at December 31, 1998 and $51 million at December 31, 1997. See Note
6 of Notes to Consolidated Financial Statements for additional information.
At December 31, 1998 scheduled mortgage loan principal repayments were as
follows:
<TABLE>
<CAPTION>
(Millions)
- -------------------------------
<S> <C>
1999 $ 418.4
2000 444.5
2001 121.6
2002 178.5
2003 647.7
Thereafter 1,806.3
- -------------------------------
</TABLE>
Risk Management and Market Sensitive Instruments
The Company regularly evaluates the appropriateness of investments relative to
its management approved investment guidelines (and operates within those
guidelines) and the business objective of the portfolios. The Company manages
interest rate risk by seeking to maintain a tight duration band, while credit
risk is managed by seeking to maintain high average quality ratings and
diversified sector exposure within the debt securities portfolio. In connection
with its investment and risk management objectives, the Company also uses
financial instruments whose market value is at least partially determined by,
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.
The Company's use of derivatives is generally limited to hedging purposes and
has principally consisted of using interest rate swap agreements, futures
contracts, warrants, foreign exchange forward contracts, currency swap
agreements and written options to hedge interest rate, equity price and foreign
exchange risks. These instruments, viewed separately, subject the Company to
varying degrees of interest rate, equity price, foreign exchange and credit
risk. However, when used for hedging, the expectation is that these instruments
would reduce overall risk. See Note 7 of Notes to Consolidated Financial
Statements for additional information.
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<PAGE> 49
The risks associated with investments supporting experience rated pension,
annuity and life products are assumed by those contractholders and not by the
Company (subject to, among other things, certain minimum guarantees).
Anticipated future losses associated with investments supporting discontinued
fully guaranteed large case pension products are provided for in the reserve for
anticipated future losses (see "Large Case Pensions -- Discontinued Products").
Risks associated with the investments and liabilities related to experience
rated pension, annuity and life products and discontinued fully guaranteed large
case pension products are not included in the analysis presented below.
The following discussion about the Company's risk management activities includes
forward-looking statements that involve risk and uncertainties. Set forth below
are management's projections of hypothetical net losses in fair value of
shareholders' equity of the Company's market sensitive instruments if certain
assumed changes in market rates and prices were to occur (sensitivity analysis).
These instruments are not leveraged and are held for purposes other than
trading. While the Company believes that the assumed market rate changes are
reasonably possible in the near term, actual results may differ, particularly as
a result of any management actions that would be taken to mitigate such
hypothetical losses in fair value of shareholders' equity. Based on the
Company's overall exposure to interest rate risk, equity price risk and foreign
exchange risk, the Company believes that these 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.
Interest Rate Risk
Assuming an immediate increase of 100 basis points in interest rates, the net
hypothetical loss in fair value of shareholders' equity related to financial and
derivative instruments is estimated to be $180 million (after tax), (1.6% of
total shareholders' equity) at December 31, 1998, and $79 million (after tax),
(.7% of total shareholders' equity) at December 31, 1997. The Company believes
that an interest rate shift of this magnitude represents a moderately adverse
scenario and is approximately equal to the historical annual volatility of
interest rate movements for the Company's intermediate-term available-for-sale
debt securities. The Company has included corresponding changes in certain
insurance liabilities in this sensitivity analysis.
The potential effect of interest rate risk on near-term net income, cash flow
and fair value was determined based on commonly used models. The models project
the impact of interest rate changes on a wide range of factors, including
duration, prepayment, put options and call options. Fair value was estimated
based on the net present value of cash flows or duration estimates using a
representative set of likely future interest rate scenarios.
Equity Price Risk
The Company's available-for-sale equity securities consist primarily of domestic
stocks, as well as certain foreign holdings. Assuming an immediate decrease of
10% in equity prices for domestic and foreign equity securities generally, and
25% for Southeast Asian and Latin American emerging market equity securities,
the hypothetical loss in fair value of shareholders' equity related to financial
and derivative instruments is estimated to be $77 million (after tax), (.7% of
total shareholders' equity) at December 31, 1998, and $92 million (after tax),
(.8% of total shareholders' equity) at December 31, 1997.
Foreign Exchange Risk
The Company selectively hedges to manage its foreign exchange risk. The Company
generally uses short-term foreign exchange forward contracts to hedge its
foreign exchange risk arising from certain non-dollar denominated investment
securities and investments in certain foreign affiliates.
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<PAGE> 50
Assuming a foreign exchange rate volatility of 10% generally, and 25% for
certain Southeast Asian and Latin American emerging market currencies, the net
hypothetical loss in fair value of shareholders' equity related to financial and
derivative instruments is estimated to be $206 million (after tax), (1.8% of
total shareholders' equity) at December 31, 1998, and $168 million (after tax),
(1.5% of total shareholders' equity) at December 31, 1997. Approximately 80% at
December 31, 1998 and 75% at December 31, 1997 of total foreign exchange risk is
comprised of Brazil, Mexico, Taiwan, Chile, Malaysia and Canada. Included in the
calculation of net hypothetical loss above is $129 million (after tax) at
December 31, 1998 and $77 million (after tax) at December 31, 1997 related to
equity investments in foreign affiliates, primarily Brazil and Mexico. Foreign
exchange exposure is calculated by: (1) translating the local reporting currency
into U.S. dollars using foreign exchange rates at December 31 and (2) applying
the market volatility rate to the translated amount.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Generally, the Company meets its operating requirements by maintaining
appropriate levels of liquidity in its investment portfolio and using overall
cash flows from premiums, deposits and income received on investments. Overall
cash flows are used primarily for claim and benefit payments, contract
withdrawals and operating expenses.
The Company's current liquidity objectives are to maximize the use of available
cash to fund ongoing operating needs, pay shareholder dividends, strategically
invest in core businesses and meet any common stock repurchase objectives.
During 1998, net cash generated from investing, financing and operating
activities was used to make approximately $1.2 billion of investments in core
businesses and acquisitions, pay approximately $395 million for common stock
repurchases and pay approximately $171 million of dividends to shareholders. In
1997, net cash generated by investing, financing and operating activities was
used to make approximately $500 million of investments in core businesses, pay
approximately $523 million for common stock repurchases and pay approximately
$175 million of dividends to shareholders.
The Company monitors the duration of its debt securities portfolio (which is
highly marketable) and mortgage loans, and executes its purchases and sales of
these investments with the objective of having adequate funds available to
satisfy the Company's maturing liabilities.
Dividends
The Board of Directors (the "Board") reviews Aetna's common stock dividend each
quarter. Among the factors considered by the Board in determining the amount of
each dividend are the Company's results of operations and the capital
requirements, growth and other characteristics of its businesses.
Financings, Financing Capacity and Capitalization
Substantially all of the Company's borrowings and financings are conducted
through Aetna Services, Inc. and are fully and unconditionally guaranteed by
Aetna Inc. See Note 15 of Notes to Consolidated Financial Statements for
additional information.
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 cash receipts and disbursements and in 1998 used these
borrowings to finance acquisitions due to market conditions. The maximum amount
of domestic short-term borrowings outstanding was $1.8 billion in 1998, $858
million in 1997 and $483 million in 1996. Aetna Services, Inc. also has a
revolving credit facility in an aggregate amount of $1.5 billion with a
worldwide group of banks and other financing entities. The facility terminates
in June 2001. See Note 15 of Notes to Consolidated Financial Statements for
additional information.
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<PAGE> 51
The Company's total debt to capital ratio (total debt divided by total debt and
shareholders' equity, adjusted for unrealized gains or losses on
available-for-sale investment securities and redeemable preferred securities)
was 24.1% at the end of 1998, 19.1% at the end of 1997 and 19.9% at the end of
1996.
The Company continually monitors existing and alternative financing sources to
support the Company's capital and liquidity needs, including, but not limited
to, debt issuance, preferred or common stock issuance, intercompany borrowings
and pledging or selling of assets.
Common Stock Transactions
In September 1997, the Board authorized the repurchase of 7.5 million shares of
its common stock. As of December 31, 1998, all 7.5 million shares of common
stock have been repurchased pursuant to this authorization at a cost of $578
million, of which 5.1 million shares at a cost of $395 million were repurchased
during 1998. In January 1999, the Board authorized the repurchase of an
additional 5.0 million shares of common stock.
The Company issued 576,387 shares in 1998, 1,883,945 shares in 1997 and
1,563,491 shares in 1996 for benefit plans. The Company issued 34,988,615 shares
of common stock on July 19, 1996 in connection with the U.S. Healthcare merger.
Restrictions on Certain Payments by the Company
The Company's business operations are conducted through Aetna Services, Inc. and
Aetna U.S. Healthcare Inc. and their respective subsidiaries (which principally
consist of HMOs and insurance companies). In addition to general state law
restrictions on payments of dividends and other distributions to shareholders
applicable to all corporations, HMOs and insurance companies are subject to
further state regulations that, among other things, may require those companies
to maintain certain levels of equity, and restrict the amount of dividends and
other distributions that may be paid to their parent corporations. These
regulations are not directly applicable to Aetna Services, Inc., Aetna U.S.
Healthcare Inc., or Aetna Inc., as none is an HMO or insurance company. The
additional regulations applicable to the Company's indirect HMO and insurance
company subsidiaries are not expected to affect the ability of Aetna Inc. to pay
dividends, or the ability of any of the Company's subsidiaries to service their
outstanding debt or preferred stock obligations.
Solvency Regulation
In recent years, state insurance regulators have adopted changes in statutory
accounting practices and other initiatives to strengthen solvency regulation.
The National Association of Insurance Commissioners ("NAIC") adopted risk-based
capital ("RBC") standards for life insurers that are designed to identify weakly
capitalized companies by comparing the company's adjusted surplus to its
required surplus ("RBC ratio"). The RBC ratio is designed to reflect the risk
profile of the company. Within certain ratio ranges, regulators have increasing
authority to take action as the RBC ratio decreases. There are four levels of
regulatory action, ranging from requiring insurers to submit a comprehensive
plan to the state insurance commissioner to requiring the state insurance
commissioner to place the insurer under regulatory control. The RBC ratio for
each of the Company's primary life insurance subsidiaries as measured at
December 31, 1998 was above the levels that would require regulatory action.
External rating agencies use their own RBC standards as part of determining a
company's rating. The RBC framework described above for life insurers was
recently extended by the NAIC to health organizations, including HMOs. Although
most states have not yet adopted these rules at December 31, 1998, each of
Aetna's HMOs has a surplus that exceeded the highest threshold specified by the
NAIC's RBC rules.
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GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
Goodwill and other acquired intangible assets were $9.1 billion at December 31,
1998, or approximately 80% of consolidated shareholders' equity. The
amortization of goodwill and other acquired intangible assets was $400 million
in 1998, or approximately 28% of pretax income. The amortization of other
acquired intangible assets reflects management's estimate of the useful life of
acquired intangible assets (primarily customer lists, health provider networks
and computer systems), generally over various periods not exceeding 25 years.
Management's estimate of the useful life of goodwill, which represents the
excess of cost over the fair value of net assets acquired, is over periods not
exceeding 40 years. The risk associated with the carrying value of goodwill and
other acquired intangible assets is whether future operating income (before
amortization of goodwill and other acquired intangible assets) will be
sufficient on an undiscounted basis to recover the carrying value. The Company
regularly evaluates the recoverability of goodwill and other acquired intangible
assets and believes such amounts are currently recoverable. However, any
significant change in the useful lives of goodwill or other acquired intangible
assets, as estimated by management, could have a material adverse affect on
results of operations and financial condition.
YEAR 2000
The Company relies heavily on information technology ("IT") systems and other
systems and facilities, such as telephones, building access control systems and
heating and ventilation equipment ("embedded systems") to conduct its business.
The Company also has business relationships with health care providers,
financial institutions, financial intermediaries, public utilities and other
critical vendors, as well as regulators and customers who are themselves reliant
on IT and embedded systems to conduct their businesses.
State of Readiness
In 1997, the Company organized a multidisciplinary Year 2000 Project Team that
includes outside consultants. The Year 2000 Project Team and the Company's
businesses have developed and are currently executing a comprehensive plan
designed to make the Company's mission-critical IT systems and embedded systems
Year 2000 ready. Outside consultants have reviewed the Company's overall
process, plan and progress to date. The Company's plan for IT systems consists
of several phases: (i) inventory -- identifying all IT systems and risk rating
each according to its potential business impact; (ii) assessment -- identifying
IT systems that use date functions and assessing them for Year 2000
functionality; (iii) remediation -- reprogramming, or replacing where necessary,
inventoried items to make them Year 2000 ready; and (iv) testing and
certification -- testing the code modifications and new inventory with other
associated systems, including extensive date testing, and performing quality
assurance testing to determine if they will successfully operate in the
post-1999 environment.
The Company completed the inventory and assessment phases for substantially all
of its IT systems by year-end 1997. The Company's IT systems are currently in
the remediation and testing and certification phases. The Company has completed
the remediation of substantially all of its mission-critical IT systems and is
scheduled to complete the remediation of its other IT systems by March 30, 1999,
and the testing and certification of all of its IT systems by mid-1999.
The Company has inventoried and risk rated substantially all of its embedded
systems. The results of these processes indicate that embedded systems should
not present a material Year 2000 risk to the Company. The Company's remaining
steps include testing selected embedded systems and remediating and certifying
systems that exhibit Year 2000 issues. The Company is focusing its testing and
remediation efforts on select embedded systems of its mission-critical
facilities, such as data centers, service centers, communications centers and
select office locations. The Company plans to complete the testing of these
systems by mid-1999, and the remediation and certification of these systems by
year-end 1999.
The Company believes that its Year 2000 project generally is on schedule and
does not expect the pending acquisition of PHC to have a material impact on the
completion of its Year 2000 project.
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<PAGE> 53
External Relationships
The Company also faces the risk that one or more of its critical suppliers or
customers ("external relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own Year 2000 issues,
including those associated with its own external relationships. The Company has
completed its inventory of external relationships and risk rated each external
relationship based upon the potential business impact, available alternatives
and cost of substitution. In the case of mission-critical suppliers, such as
banks, financial intermediaries (such as stock exchanges), telecommunications
providers and other utilities, mutual fund companies, IT vendors, financial
market data providers, national pharmacy chains, electronic claims
clearinghouses, major physician groups and major hospitals, the Company is
engaged in discussions with the third parties and is attempting to obtain
detailed information as to those parties' Year 2000 plans and state of
readiness.
The Company, however, does not have sufficient information at the current time
to predict whether its external relationships will be Year 2000 ready.
Year 2000 Costs
Total Year 2000 project costs were $108 million (after tax) in 1998 and are
currently estimated to be at least $85 million (after tax) in 1999. A large
majority of these costs are expected to be incremental expenses that will not
recur in the year 2000 or thereafter. Year 2000 costs were not material in 1997.
The Company expenses these costs as incurred and funds these costs through
operating cash flows.
Year 2000 readiness is critical to the Company. The Company has redeployed some
resources from noncritical system enhancements to address Year 2000 issues. Due
to the importance of IT systems to the Company's business, management has not
deferred mission-critical systems enhancements to become Year 2000 ready. The
Company does not expect these redeployments and deferrals to have a material
impact on the Company's financial condition or results of operations.
Risks and Contingency/Recovery Planning
If the Company's Year 2000 issues were unresolved, potential consequences would
include, among other possibilities, the inability to accurately and timely
process benefits claims; update customers' accounts; process financial
transactions; bill customers; assess exposure to risks; determine liquidity
requirements or report accurate data to management, shareholders, customers,
regulators and others; as well as business interruptions or shutdowns; financial
losses; reputational harm; increased scrutiny by regulators; and litigation
related to Year 2000 issues. The Company's international affiliates face
additional Year 2000 risk due to the diverse environments in which they operate.
The Company is attempting to limit the potential impact of the Year 2000 by
monitoring the progress of its own Year 2000 project and those of its critical
external relationships and by developing contingency/recovery plans. The Company
cannot guarantee that it will be able to resolve all of its Year 2000 issues.
Any critical unresolved Year 2000 issues at the Company or its external
relationships, however, could have a material adverse effect on the Company's
results of operations, liquidity or financial condition.
The Company has begun to develop contingency/recovery plans aimed at affecting
the continuity of critical business functions before and after December 31,
1999. As part of that process, the Company has begun to develop reasonably
possible failure scenarios for its critical IT systems and external
relationships, and the embedded systems in its critical facilities. Once these
scenarios are identified, the Company will develop plans that are designed to
reduce the impact on the Company, and provide methods of returning to normal
operations, if one or more of those scenarios occur. The Company expects
contingency/recovery planning to be substantially complete by September 1999.
See "Forward-Looking Information/Risk Factors" for factors that could cause
actual Year 2000 results to differ from the Company's expectations.
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REGULATORY ENVIRONMENT
The federal and state governments continue to enact and seriously consider many
legislative and regulatory proposals that have or would materially impact
various aspects of the health care system. Many of these changes are described
below. While we anticipate that certain of these measures would adversely affect
us, at this time we cannot predict the extent of this impact.
MEDICARE
In 1997, the federal government passed legislation related to Medicare that
changed the method for determining premiums that the government pays to HMOs for
Medicare members. In general, the new method has and will reduce the premiums
payable to us compared to the old method, although the level and extent of the
reductions varies by geographic market and depends on other factors. The
legislation also requires us to pay a "user fee." The changes began to be phased
in on January 1, 1998 and will continue over five years. While the phase-in
provisions provide us with an opportunity to offset some of the premium
reductions and the user fee by adjusting the supplemental premiums that members
pay to us and by adjusting the benefits included in our products, because of
competition and other factors, the adjustments we can make may not fully offset
the reductions in premiums from the government. Because of these reduced
premiums and the user fee, as well as other factors including new Medicare +
Choice regulations issued by HCFA, we decided not to renew our Medicare HMO
contracts in certain areas effective January 1, 1999. The federal government
also announced in January 1999 that it planned to begin to phase in risk
adjustments to its premium payments over a five-year period commencing January
1, 2000. It is anticipated that the net impact of these risk adjustments will be
to reduce the premiums payable to the Company. It is uncertain whether we can
fully offset or recoup, through higher supplemental premiums, reduced benefits,
or market withdrawals, the impact of such reduced premiums.
HIPAA AND RELATED FEDERAL LEGISLATION
The federal government enacted the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") in 1997. The legislation has three main
effects:
- - It limits pre-existing condition exclusions that apply to individuals
changing jobs or moving to individual coverage;
- - It guarantees that employees in the small group market have available
health coverage; and
- - It prevents exclusion of individuals from coverage under group plans based
on health status.
Other federal legislation, effective January 1, 1998, mandates minimum hospital
stays after childbirth and that health plans apply lifetime limits to mental
health benefits with parity.
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OTHER LEGISLATION AND REGULATION
The federal government and many states, including states in which we have
substantial managed care membership, have enacted or are seriously considering
additional legislation or regulation related to managed care. This legislation
or regulation includes, among other things, the following:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- - Assessments, surcharges or taxes on premiums or - Mandatory expanded coverage for emergency services
provider payments to fund uncompensated care,
graduate medical education, high risk pools, - Mandated liberalized definitions of medical
guaranty funds, or government programs necessity
- - Changes to licensure or certification requirements - Mandated liberalized internal and external
- - Eliminating or reducing the scope of ERISA grievance and appeal procedures (including
pre-emption of state medical and bad faith expedited decision making)
liability laws, exposing health plans to expanded - Mandatory maternity and other lengths of hospital
liability to punitive and other extra-contractual inpatient stay
damages - Mandatory point-of-service benefits for HMO plans
- - Extension of malpractice and other liability for - Prohibition of so-called "gag" and similar clauses
medical and other decisions from providers to - Prohibitions on incentives based on utilization
health plans - Prohibition or limitation of arrangements designed
- - Hearings and limitations on termination of to manage medical costs and improve quality of
providers from networks care, such as capitated arrangements with providers
- - Increased reserve and capital requirements or provider financial incentives
- Regulation of and restrictions on utilization
- - Liability for negligent denials or delays in management and review
coverage - Regulation of the composition of provider networks,
such as any willing provider and pharmacy laws
- - Mandatory coverage of experimental procedures and - Required payment levels for out-of-network care
drugs - Third party review of denials of benefits
- - Mandatory direct access to specialists for patients (including denials based on a lack of medical
with chronic conditions necessity)
- - Mandatory direct access to specialists (including
OB/GYNs) and chiropractors
- - Mandated expanded consumer disclosures and notices
</TABLE>
It is uncertain whether we 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.
The health business also may be adversely impacted by court and regulatory
decisions that expand the interpretations of existing statutes and regulations,
impose medical or bad faith liability, increase our responsibilities under
ERISA, or reduce the scope of ERISA pre-emption.
For other important information regarding regulation of our health and other
businesses, see "Forward-Looking Information/Risk Factors" and our 1998 Form
10-K/A.
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 (1) those statements
are identified as forward-looking, and (2) the statements are accompanied by
meaningful cautionary statements that identify important factors that could
cause actual results to differ materially from those discussed in the statement.
We want to take advantage of these safe harbor provisions.
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<PAGE> 56
Certain information contained in this Management's Discussion and Analysis is
forward-looking within the meaning of the 1995 Act or Securities and Exchange
Commission rules. This information includes, but is not limited to: (1) the
information that appears under the headings "Outlook" in the discussion of
results of operations of each of our businesses, (2) "General Account
Investments - Risk Management and Market Sensitive Instruments" and (3) "Year
2000." In writing this Management's Discussion and Analysis, we also used the
following words, or variations of these words and similar expressions, where we
intended to identify forward-looking statements:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- Expects - Anticipates - Plans - Seeks
- Projects - Intends - Believes - Estimates
</TABLE>
These forward-looking statements rely on a number of assumptions concerning
future events, and are subject to a number of significant uncertainties and
other factors, many of which are outside our control, that could cause actual
results to differ materially from these statements. You should not put undue
reliance on these forward-looking statements. We disclaim any intention or
obligation to update or revise forward-looking statements, whether as a result
of new information, future events or otherwise.
Set forth below are certain important risk factors that, in addition to general
economic conditions and other factors (some of which are discussed elsewhere in
this Annual Report), may affect these forward-looking statements and our
businesses generally. In addition, you may read our reports filed with the
Securities and Exchange Commission, including our 1998 Form 10-K/A, for a more
detailed description of certain uncertainties and factors that could cause
actual results to differ materially from these forward-looking statements.
Certain Factors Particular to Health Operations
Medical costs could increase beyond our expectations for a contract year.
Premiums in our Health Risk business are generally fixed by contract for
one-year periods. We cannot recover actual costs for the contract year that are
higher than those estimated and reflected in pricing through higher premiums
from customers. However, contracts renew periodically during the year and the
Company may be able to reflect increased costs as these contracts renew.
Factors that may increase medical costs for the contract year include increased
utilization, increases in provider contract rates, increases in noncontracted
provider charges, adverse changes in legislation and regulation, changes in
health practices and medical technologies, price increases in pharmaceuticals
and durable medical equipment and other factors.
Actual costs of medical claims could exceed the estimates reflected in our
reserves. For the Health Risk business, our medical claims payable reflect
estimates of the ultimate cost of claims incurred by members but not yet
reported to us, and claims reported to us but not yet paid. Estimates of medical
claims payable are based on a number of factors, including those derived from
historical claim experience. We estimate medical claims payable periodically,
and we reflect any adjustments to our estimates in our current period results.
We establish reserves for Group Insurance products as premiums become due. These
reserves reflect the present value of expected future obligations net of the
present value of expected future premiums. Policy reserves for group paid-up
life insurance generally reflect long-term fixed obligations. We compute these
reserves on the basis of assumed or guaranteed yield and benefit payments. Our
assumptions are based on our historical claim experience. For long-term
disability products, we establish reserves for: (1) lives currently in payment
status (using standard industry, as well as our own, morbidity and interest rate
assumptions), (2) lives who have not yet satisfied the waiting period, but who
we expect will do so, and (3) claims that have been incurred but not reported to
us. Long-term care reserves are a long-term obligation, and we calculate them
using industry data for morbidity and mortality assumptions.
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Federal and state governments may adopt legislation and regulations that
adversely affect our health business. As discussed above (see "Regulatory
Environment"), the federal and many state governments have enacted or are
actively considering certain legislative and regulatory changes related to
health products. At this time we are unable to predict the impact of future
changes, although we anticipate that certain of these measures, if enacted,
could adversely affect health operations through:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- - reducing premiums - regulating levels and permitted lines of business
- - reducing our ability to manage medical costs - imposing financial assessments
- - increasing medical costs and operating expenses - regulating business practices
</TABLE>
Our profitability growth depends in part on an efficient integration of acquired
health operations. We acquired the NYLCare health business in July 1998 and
agreed to acquire the Prudential health care business in December 1998 (we
currently expect to close the PHC transaction in the second quarter of 1999).
Factors that can affect the efficiency of our integration include, but are not
limited to, our success in: (1) integrating management, products, legal
entities, networks and information systems on a timely basis, (2) applying
managed care expertise and techniques throughout a broader membership base and
(3) eliminating duplicative administrative and customer service functions.
Changes in our business mix can affect our profitability. If employers and
individuals select plans with higher copayments, deductibles or coinsurance then
certain of our medical costs would be lower, but we also would receive lower
premiums for these plans. In addition, our profitability may become more
sensitive to changes in medical costs and premiums if:
- - more employers switch to self-funded coverage (where the employer bears
most or all of the medical cost risk);
- - our Medicare risk membership increases relative to our commercial risk
membership (Medicare plans have both relatively higher premiums and medical
costs); and/or
- - health products with relatively higher medical loss ratios are purchased.
Also, adverse publicity, like the kind currently occurring, regarding managed
care may negatively influence participants' or employers' decisions to select
managed care plans generally, and our health plans, specifically.
Government payors can determine premiums. In government-funded health programs
such as Medicare and Medicaid, the government payor determines the premium
levels. If the government payor reduces the premium levels or increases premiums
by less than our cost increases and the Company cannot offset these with
supplemental premiums and changes in benefit plans, then we could be adversely
affected.
Changes in accreditation of our health plans could affect our competitiveness.
Accreditation by independent quality accrediting agencies, such as the National
Committee for Quality Assurance, is an important competitive factor for certain
of our HMO plans. If our plans were to lose or be denied accreditation it could
adversely affect customer selection of our health products, and, in some
jurisdictions, could affect our licensure status.
Certain Factors Particular to Financial Services Operations
Significant changes in financial markets could affect earnings. Significant
changes in financial markets could impact the level of assets under management
in our Aetna Retirement Services, Large Case Pensions and Aetna International
businesses, and, in turn, our level of asset-based fees in those businesses. For
example, significant increases in interest rates or decreases in equity markets
would directly affect the level of assets under management and, in addition, may
increase the level of withdrawals and decrease the level of deposits by
customers. Customers under those circumstances may seek to diversify among asset
managers or seek investment alternatives that we do not offer. Significant
declines in the value of investments also may affect our ability to pass through
investment losses to certain experience rated customers, whether due to
triggering minimum guarantees or other business reasons.
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Decreases in ratings could affect assets under management. Decreases in the
claims-paying ratings of our domestic financial services subsidiaries could have
the effect of decreasing new sales and deposits and increasing withdrawals and
surrenders in our Aetna Retirement Services and Large Case Pensions businesses.
Such changes in sales and deposits, withdrawals and surrenders would adversely
affect the level of asset-based fees of those businesses. The claims-paying
ratings of these subsidiaries are currently under review by certain rating
agencies pending completion of their analysis of the pending Prudential health
care acquisition.
Early withdrawal of assets could affect earnings. We incur up-front costs, such
as commissions, when we sell our annuity, life insurance and other financial
services products, including international financial services products. We
generally defer these costs and recognize them over time. As a result, the
retention of assets under those products is an important component of
profitability. We generally seek to structure our products and sales to
encourage retention of assets under management or recover costs, through
surrender charges, higher credited rates to customers if we retain their assets
for longer periods, paying renewal commissions, paying service fees or other
terms. However, if customers withdraw assets earlier than we anticipated when we
priced the products, it would adversely affect profitability. We also may
experience competitive pressure to lower margins.
Certain Factors Particular to International Operations
Devaluation of foreign currencies reduces earnings calculated in U.S. dollars.
We hedge our foreign exchange risk on a selective basis. However, we generally
do not hedge the currency exposure of our investments in foreign affiliates,
since we view these investments as long term. In preparing our consolidated
financial statements, we translate our results from the foreign currency in
which we operate in a particular country into U.S. dollars. Devaluation of a
country's currency, however, could adversely affect our results of operations
when translated into U.S. dollars. Also, when economies are considered highly
inflationary (generally, cumulative inflation levels in excess of 100% over a
three-year period), we then recognize changes in the value of net monetary
assets or liabilities currently in earnings, rather than through shareholders'
equity. This would potentially make our reported earnings more volatile. In
addition, although we consider foreign exchange trends when deciding to invest
in particular countries, currency devaluation also may affect the value of our
international investments when translated into U.S. dollars. See "Aetna
International - Outlook" for a discussion of the recent currency devaluation in
Brazil.
International markets are subject to additional risks. Our Aetna International
operations involve certain other risks not typically associated with doing
business in the United States. These risks include investment and other controls
that may be imposed by governments, such as:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- - Permitted levels of equity ownership of companies - Restrictions on entry into new lines of business
by foreign persons - Requirements that portions of business be
- - Restrictions on remittances of foreign earnings or reinsured through state-affiliated institutions
repatriation of capital - Other restrictions affecting the conduct of business
- - Currency exchange controls
</TABLE>
Additionally, it may be more difficult for us to manage interest rate risk
because of the relatively short duration of investments that are available in
currencies that match long-term liabilities for international fixed-rate
products. Foreign economies may also experience increased volatility of equity
markets and high rates of inflation. They also may be subject to other political
and economic factors, such as more rapid change of regulatory policy. We
generally do not insure against foreign political risks.
Other Factors Affecting All of Our Businesses
Retention of our key senior executives is important to our operations. Our
success is dependent, in part, on our ability to attract and retain key senior
executives. We entered into employment agreements with certain of these
executives, although an employment agreement does not guarantee that an
executive's services with us will continue.
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<PAGE> 59
Adverse changes in regulation could affect the operations of each of our
businesses. In addition to our health business, each of our other businesses is
subject to comprehensive regulation. These businesses could be adversely
affected by:
- - Increases in minimum capital and other financial viability requirements for
health and other insurance operations.
- - Removal of barriers preventing banks from engaging in insurance and mutual
fund businesses.
- - Changes in the taxation of insurance companies. For example, the President
of the United States' revenue proposal would require life insurance
companies to pay tax on certain income earned prior to 1984. Under current
law, that income is deferred for tax purposes. If this tax change, which is
currently just a proposal, were enacted then we would recognize a one-time
charge to income in the amount of the tax.
- - Changes in the tax treatment of annuity, pension and other insurance
products as well as changes in capital gains tax rates. Certain of these
changes, should they occur, could affect the attractiveness to customers of
our retirement services products compared to investment alternatives
offered by our competitors.
Successful completion of our Year 2000 Project is important to operations. If we
do not resolve critical Year 2000 issues, or if third parties with whom we have
external relationships do not resolve critical Year 2000 issues, then those
issues could have a material adverse effect on our results of operations,
liquidity or financial condition. In addition, our expectations about the future
costs and timely and successful completion of our Year 2000 program are subject
to uncertainties that could cause actual results to differ materially from what
we discussed under "Year 2000." Factors that could influence our future costs
and the completion dates and effectiveness of our remediation, testing and
certification and contingency planning efforts include our success in
identifying IT systems and embedded systems that contain two-digit year codes,
the nature and amount of required reprogramming, testing and certification, the
rate and magnitude of related labor and consulting costs, the availability of
qualified personnel and the success of our external relationships in addressing
their own Year 2000 issues. See "Year 2000."
Litigation can increase our expenses. Litigation also could adversely affect us,
both through costs of defense and adverse results or settlements. See Note 23 of
Notes to Consolidated Financial Statements and our 1998 Form 10-K/A for
information regarding litigation, including current shareholder litigation and
certain litigation related to our health business.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The response to this Item is set forth in Item 7 of this Report on Form 10-K/A
under the heading "Management's Discussion and Analysis of Financial Condition
and Results of Operations-General Account Investments".
Item 8. Consolidated Financial Statements and Supplementary Data.
The response to this Item is set forth in Item 14(a) of this Report on Form
10-K/A.
Item 9. Changes in and disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information concerning Executive Officers is included in Part I pursuant to
General Instruction G to Form 10-K.
Information concerning Directors and concerning compliance with Section 16 (a)
of the Securities Exchange Act of 1934 is incorporated herein by reference to
the Proxy Statement.
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Item 11. Executive Compensation.
The information under the captions "Director Compensation in 1998" and
"Executive Compensation" in the Proxy Statement is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information under the caption "Security Ownership of Certain Beneficial
Owners, Directors, Nominees and Executive Officers" in the Proxy Statement is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information under the caption "Certain Transactions and Relationships" in
the Proxy Statement is incorporated herein by reference.
Page 60
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PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.*
(a) The following documents are filed as part of this report:
1. Financial statements:
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
As Restated
For the years ended December 31,
(Millions, except per common share data) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Premiums $ 14,839.3 $ 12,592.2 $ 9,326.1
Net investment income 3,190.9 3,377.5 3,565.2
Fees and other income 2,327.1 2,236.3 2,174.8
Net realized capital gains 271.8 334.2 134.4
- -----------------------------------------------------------------------------------------------------------------
Total revenue 20,629.1 18,540.2 15,200.5
- -----------------------------------------------------------------------------------------------------------------
Benefits and Expenses:
Current and future benefits 14,563.7 12,852.0 10,378.7
Operating expenses:
Salaries and related benefits 1,666.2 1,650.4 1,595.1
Other 2,191.1 1,910.8 1,724.7
Interest expense 250.9 235.8 168.3
Amortization of goodwill and other acquired intangible assets 400.1 380.0 172.5
Amortization of deferred policy acquisition costs 215.3 217.5 160.1
Reductions of loss on discontinued products (68.0) (172.5) (202.3)
Severance and facilities charges (reserve reductions), net 1.5 (45.0) 864.7
- -----------------------------------------------------------------------------------------------------------------
Total benefits and expenses 19,220.8 17,029.0 14,861.8
- -----------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 1,408.3 1,511.2 338.7
Income taxes 560.2 610.1 133.6
- -----------------------------------------------------------------------------------------------------------------
Income from continuing operations 848.1 901.1 205.1
Discontinued Operations, net of tax:
Income from operations - - 182.2
Gain on sale - - 263.7
- -----------------------------------------------------------------------------------------------------------------
Net income $ 848.1 $ 901.1 $ 651.0
=================================================================================================================
Net income applicable to common ownership $ 792.8 $ 845.6 $ 625.9
=================================================================================================================
Results Per Common Share:
Income from continuing operations:
Basic $ 5.50 $ 5.67 $ 1.37
Diluted 5.41 5.60 1.36
Net income:
Basic $ 5.50 $ 5.67 $ 4.77
Diluted 5.41 5.60 4.72
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
Page 61
<PAGE> 62
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As Restated
As of December 31,
(Millions, except per common share data) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investments:
Debt securities available for sale, at fair value (amortized cost $30,730.1 and
$32,694.0) $32,180.8 $34,245.0
Equity securities, at fair value (cost $762.6 and $824.4) 800.5 1,041.4
Short-term investments 942.2 1,003.9
Mortgage loans 3,553.0 4,207.8
Real estate 270.3 369.5
Policy loans 458.7 746.9
Other 1,300.3 974.3
- -----------------------------------------------------------------------------------------------------------------------
Total investments 39,505.8 42,588.8
- -----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 1,951.5 1,805.8
Short-term investments under securities loan agreement 753.6 -
Accrued investment income 537.1 545.8
Premiums due and other receivables 1,478.1 1,205.8
Reinsurance recoverables 3,897.2 175.2
Deferred income taxes 46.6 -
Deferred policy acquisition costs 1,768.6 2,367.3
Goodwill and other acquired intangible assets 9,143.5 8,506.3
Other assets 1,111.9 875.1
Separate Accounts assets 44,936.0 37,930.5
- -----------------------------------------------------------------------------------------------------------------------
Total assets $105,129.9 $96,000.6
=======================================================================================================================
Liabilities:
Future policy benefits $ 18,541.1 $17,837.1
Unpaid claims 3,953.9 3,294.4
Unearned premiums 428.9 359.2
Policyholders' funds left with the Company 17,632.5 18,761.2
- -----------------------------------------------------------------------------------------------------------------------
Total insurance liabilities 40,556.4 40,251.9
Dividends payable to shareholders 35.2 36.1
Short-term debt 1,370.1 252.1
Long-term debt 2,214.5 2,346.2
Payables under securities loan agreement 753.6 -
Current income taxes 444.8 320.5
Deferred income taxes - 223.3
Other liabilities 3,007.0 2,931.9
Minority and participating policyholders' interests 148.4 237.7
Separate Accounts liabilities 44,936.0 37,930.5
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities 93,466.0 84,530.2
- -----------------------------------------------------------------------------------------------------------------------
Aetna-obligated mandatorily redeemable preferred securities of subsidiary limited
liability company holding primarily debentures guaranteed by Aetna 275.0 275.0
- -----------------------------------------------------------------------------------------------------------------------
Commitments and Contingent Liabilities (Notes 5, 7 and 23)
Shareholders' Equity:
Class C voting mandatorily convertible preferred stock ($.01 par value; 15,000,000
shares authorized; 11,614,816 in 1998 and 11,655,206 in 1997 issued and outstanding) 862.1 865.4
Common stock ($.01 par value; 500,000,000 shares authorized; 141,272,628 in 1998 and
145,794,844 in 1997 issued and outstanding) 3,292.4 3,644.4
Accumulated other comprehensive income 177.8 307.1
Retained earnings 7,056.6 6,378.5
- -----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,388.9 11,195.4
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities, redeemable preferred securities and shareholders' equity $105,129.9 $96,000.6
=======================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
Page 62
<PAGE> 63
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Three years ended December 31, 1998
---------------------------------------------------------------------------------------
Accumulated Other
Comprehensive Income
Class C Voting --------------------------
Mandatorily Unrealized
Convertible Common Gains (Losses) Foreign Retained
(Millions, except share data) Total Preferred Stock Stock on Securities Currency Earnings
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 $7,272.8 $ - $1,436.1 $ 797.0 $(155.9) $5,195.6
- ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 651.0 651.0
Other comprehensive loss, net of tax:
Unrealized losses on securities
($(527.6) pretax)(1) (342.8) (342.8)
Foreign currency ($64.2 pretax) 41.7 41.7
------------
Other comprehensive loss (301.1)
------------
Total comprehensive income 349.9
============
Issued for U.S. Healthcare merger:
Class C voting mandatorily convertible
preferred stock (11,655,546 shares) 865.4 865.4
Common shares (34,988,615 shares) 2,580.1 2,580.1
Stock options 24.8 24.8
Common stock issued for benefit plans
(1,563,491 shares) 75.1 75.1
Repurchase of common shares
(1,194,400 shares) (83.3) (83.3)
Common stock dividends (170.0) (170.0)
Preferred stock dividends (25.1) (25.1)
- ---------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 10,889.7 865.4 4,032.8 454.2 (114.2) 5,651.5
=================================================================================================================================
Comprehensive income:
Net income 901.1 901.1
Other comprehensive loss, net of tax:
Unrealized gains on securities
($81.8 pretax)(1) 49.9 49.9
Foreign currency ($(127.3) pretax) (82.8) (82.8)
------------
Other comprehensive loss (32.9)
------------
Total comprehensive income 868.2
============
Common stock issued for benefit plans
(1,883,945 shares) 134.7 134.7
Repurchase of common shares
(6,173,900 shares) (523.1) (523.1)
Common stock dividends (118.6) (118.6)
Preferred stock dividends (55.5) (55.5)
=================================================================================================================================
Balances at December 31, 1997 11,195.4 865.4 3,644.4 504.1 (197.0) 6,378.5
=================================================================================================================================
Comprehensive income:
Net income 848.1 848.1
Other comprehensive loss, net of tax:
Unrealized losses on securities
($(179.8) pretax)(1) (116.9) (116.9)
Foreign currency ($(19.1) pretax) (12.4) (12.4)
------------
Other comprehensive loss (129.3)
------------
Total comprehensive income 718.8
============
Common stock issued for benefit plans
(576,387 shares) 39.6 39.6
Repurchase of common shares
(5,131,700 shares) (394.9) (394.9)
Conversion of preferred securities
(40,390 preferred shares converted to
33,097 common shares) - (3.3) 3.3
Common stock dividends (114.7) (114.7)
Preferred stock dividends (55.3) (55.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $11,388.9 $862.1 $3,292.4 $ 387.2 $(209.4) $7,056.6
=================================================================================================================================
</TABLE>
(1) Net of reclassification adjustments.
See Notes to Consolidated Financial Statements.
Page 63
<PAGE> 64
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
As Restated
For the years ended December 31,
(Millions, except per common share data) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 848.1 $ 901.1 $ 651.0
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization (including investment discounts and premiums) 451.4 374.2 207.4
Gain related to sale of life business (98.9) - -
Gain on sale of Discontinued Operations - - (263.7)
Income from Discontinued Operations - - (182.2)
Net realized capital gains (271.8) (334.2) (134.4)
Changes in assets and liabilities:
Decrease in accrued investment income 8.5 46.0 24.9
(Increase) Decrease in premiums due and other receivables (92.6) (245.8) 12.0
Increase in deferred policy acquisition costs (278.9) (302.4) (275.1)
(Decrease) Increase in income taxes (91.2) 323.3 (155.8)
Net (increase) decrease in other assets and other liabilities (262.2) (193.0) 209.8
Increase in other insurance liabilities 598.4 656.4 673.7
Other, net (2.2) 4.9 5.5
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 808.6 1,230.5 773.1
- --------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Proceeds from sales of:
Debt securities available for sale 20,254.6 16,247.8 13,625.6
Equity securities 833.4 961.4 565.6
Mortgage loans 90.4 1,078.8 154.9
Real estate 136.5 626.8 689.5
Other investments 639.1 924.7 838.6
Short-term investments 21,229.1 19,957.0 34,679.2
Discontinued Operations - - 4,134.1
Life business 1,000.0 - -
Investment maturities and repayments of:
Debt securities available for sale 2,849.4 3,913.9 3,567.0
Mortgage loans 918.4 1,726.5 1,569.7
Cost of investments in:
Debt securities available for sale (20,602.6) (21,310.1) (16,922.5)
Equity securities (481.5) (626.1) (859.5)
Mortgage loans (319.2) (255.3) (360.5)
Real estate (38.5) (66.8) (116.4)
Other investments (4,238.8) (1,571.5) (1,155.6)
Short-term investments (21,126.0) (20,291.7) (34,703.0)
U.S. Healthcare - - (5,243.9)
NYLCare health business (1,080.6) - -
Increase in property and equipment (123.2) (92.4) (78.2)
Increase in Separate Accounts 26.7 65.0 61.7
Other, net (97.4) 83.0 (46.7)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash (used for) provided by investing activities (130.2) 1,371.0 399.6
- --------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 2,046.4 1,872.5 1,968.1
Withdrawals of investment contracts (3,150.9) (3,481.1) (5,191.6)
Issuance of long-term debt 25.7 4.7 1,389.3
Repayment of long-term debt (153.0) (34.3) -
Net increase (decrease) in short-term debt 1,122.3 (46.7) (109.4)
Common stock issued under benefit plans 39.6 134.7 75.1
Common stock acquired (394.9) (523.1) (83.3)
Dividends paid to shareholders (170.9) (174.9) (237.3)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (635.7) (2,248.2) (2,189.1)
- --------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (5.8) (10.1) (0.3)
- --------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 36.9 343.2 (1,016.7)
Cash acquired from NYLCare health business 108.8 - -
Cash acquired from U.S. Healthcare - - 766.6
Cash and cash equivalents, beginning of year 1,805.8 1,462.6 1,712.7
================================================================================================================================
Cash and cash equivalents, end of year $ 1,951.5 $ 1,805.8 $ 1,462.6
================================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
Page 64
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Aetna Inc., through its subsidiaries, provides health care benefits, group
insurance and financial services. Aetna Inc. has four reportable segments:
Aetna U.S. Healthcare, Aetna Retirement Services, Aetna International and Large
Case Pensions. Aetna U.S. Healthcare provides a full spectrum of managed care,
indemnity, other health and group insurance products. Aetna Retirement Services
offers financial services. Aetna International, through subsidiaries and joint
venture operations, sells primarily life insurance, health insurance and
financial retirement services products in markets outside of the United States.
Large Case Pensions manages a variety of retirement products for primarily
defined benefit and defined contribution plans in the U.S. These segments are
distinct businesses that offer different products and services. They are
managed separately as each business requires different market strategies,
technology and capital allocation. The accounting policies of the segments are
the same as those described in the summary of significant accounting policies.
Aetna Inc. evaluates performance of these business segments based on operating
earnings (net income excluding net realized capital gains and losses and any
other items such as Year 2000 costs, severance and facilities actions,
reduction of the reserve for discontinued products, etc.). All footnote
disclosures reflect continuing operations unless otherwise noted.
PRINCIPLES OF CONSOLIDATION AND RESTATEMENT
The consolidated financial statements include Aetna Inc. and its majority-owned
subsidiaries (collectively, the "Company"), including Aetna Services, Inc.
("Aetna Services") and, from July 19, 1996, Aetna U.S. Healthcare Inc. (Refer
to Note 4.) 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. Certain reclassifications have been made to 1997 and 1996 financial
information to conform to the 1998 presentation.
Subsequent to the issuance of the Company's 1998 financial statements and the
filing of its 1998 Form 10-K with the Securities and Exchange Commission (the
"SEC"), and following discussions with representatives of the SEC's Division of
Corporate Finance and Office of the Chief Accountant concerning its review of
the Corporation's financial statements, the Company concluded it would restate
its 1998 financial statements and related disclosures. (Refer to Note 2.)
NEW ACCOUNTING STANDARDS
Employers' Disclosure about Pensions and Other Postretirement Benefits
As of December 31, 1998, the Company adopted Financial Accounting Standard
("FAS") No. 132, Employers' Disclosure about Pensions and Other Postretirement
Benefits. This statement amends Financial Accounting Standards Board ("FASB")
Statements Nos. 87, 88 and 106 and standardizes the disclosure requirements for
pensions and other postretirement benefits to provide additional information,
primarily relating to plan assets and benefit obligations. (Refer to Note 13.)
Disclosures about Segments of an Enterprise and Related Information
As of December 31, 1998, the Company adopted FAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. This statement establishes
standards for the reporting of information relating to operating segments. This
statement supersedes FAS No. 14, Financial Reporting for Segments of a Business
Enterprise, which requires reporting segment information by industry and
geographic area (industry approach). Under FAS No. 131, operating segments are
defined as components of a company for which separate financial information is
available and is used by management to allocate resources and assess
performance (management approach). The adoption of this statement did not
change the composition or the results of operations of any of the operating
segments of the Company, which are consistent with the management approach.
(Refer to Notes 20, 21 and 22.)
Page 65
<PAGE> 66
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use
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 (in process at, and subsequent to the adoption
date) be capitalized and provides guidance for determining whether computer
software is considered to be for internal use. The Company is amortizing these
costs over a period of three to five years. Previously, the Company expensed
the cost of internal-use computer software as incurred. The adoption of this
statement resulted in a net after-tax increase to the results of operations of
$33 million, or $0.22 per diluted common share, for the year ended December 31,
1998.
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities
In June 1996, the FASB issued FAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, that provides
accounting and reporting standards for transfers of financial assets and
extinguishments of liabilities. 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.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do
Not Transfer Insurance Risk
In October 1998, the AICPA issued SOP 98-7, Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk, which
provides guidance on how to account for all insurance and reinsurance contracts
that do not transfer insurance risk, except for long-duration life and health
insurance contracts. This statement is effective for the Company's financial
statements beginning January 1, 2000, with early adoption permitted. The
Company is currently evaluating the impact of the adoption of this statement
and the potential effect on its financial position and results of operations.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued FAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This standard requires companies to record
all derivatives on the balance sheet as either assets or liabilities and
measure those instruments at fair value. The manner in which companies are to
record gains or losses resulting from changes in the values of those
derivatives depends on the use of the derivative and whether it qualifies for
hedge accounting. This standard is effective for the Company's financial
statements beginning January 1, 2000, with early adoption permitted. The
Company is currently evaluating the impact of the adoption of this statement
and the potential effect on its financial position and results of operations.
Accounting by Insurance and Other Enterprises for Insurance-Related Assessments
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 the Company's 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.
Page 66
<PAGE> 67
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from reported results using those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, money market instruments and
other debt issues with a maturity of 90 days or less when purchased.
INVESTMENTS
Debt and equity securities are classified as available for sale and carried at
fair value. These available-for-sale securities support three types of business
products: experience-rated products, discontinued products and general account
liabilities.
Experience-rated products are products where the customer, not the Company,
assumes investment (including realized capital gains) and other risks, subject
to, among other things, minimum guarantees provided by the Company in some
instances. The effect of investment performance (as long as minimum guarantees
are not triggered) is allocated to the customer account daily, based on the
underlying investment's experience and therefore, does not impact the Company's
results of operations. Realized and unrealized capital gains and losses on
investments supporting these products are reflected in policyholders' funds
left with the Company.
When the Company discontinued the sale of its fully guaranteed large case
pension products (refer to Note 11), it established a reserve for anticipated
future losses from these products and segregated the related investments. These
investments are managed as a separate portfolio. Investment income and net
realized capital gains and losses on this separate portfolio are
credited/charged to the reserve and therefore, do not impact the Company's
results of operations. Unrealized capital gains or losses on this separate
portfolio are reflected in other liabilities.
Investment income and realized capital gains and losses on investments
supporting general account liabilities are reflected in the Company's results
of operations. Unrealized capital gains and losses related to investments
supporting general account liabilities are reflected in shareholders' equity,
net of related income taxes. Purchases and sales of debt and equity securities
are recorded on the trade date. Sales of mortgage loans and real estate are
recorded on the closing date.
Fair values for debt and equity securities are based on quoted market prices or
dealer quotations. Where quoted market prices or dealer quotations are not
available, fair values are measured utilizing quoted market prices for similar
securities or by using discounted cash flow methods. Cost for mortgage-backed
securities is adjusted for unamortized premiums and discounts, which are
amortized using the interest method over the estimated remaining term of the
securities, adjusted for anticipated prepayments. The Company does not accrue
interest on problem debt securities when management believes the collection of
interest is unlikely.
The Company engages in securities lending whereby certain securities from its
portfolio are loaned to other institutions for short periods of time. Initial
collateral, primarily cash, is required at a rate of 102% of the market value
of a loaned domestic security and 105% of the market value of a loaned foreign
security. The collateral is deposited by the borrower with a lending agent, and
retained and invested by the lending agent according to the Company's
guidelines to generate additional income. The market value of the loaned
securities is monitored on a daily basis, with additional collateral obtained
or refunded as the market value of the loaned securities fluctuates.
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<PAGE> 68
Mortgage loans and policy loans are carried at unpaid principal balances, net
of impairment reserves. A mortgage loan is considered impaired when it is
probable that the Company will be unable to collect amounts due according to
the contractual terms of the loan agreement (delays of up to 60 days may not
result in a loan being considered impaired). The Company accrues interest
income on impaired loans to the extent it is deemed collectible and the loan
continues to perform under its original or restructured terms. Interest income
on problem loans is generally recognized on a cash basis. Cash payments on
loans in the process of foreclosure are generally treated as a return of
principal. For impaired loans, a specific impairment reserve is established for
the difference between the recorded investment in the loan and the estimated
fair value of the collateral. The Company applies this loan impairment policy
individually to all loans in the portfolio and does not aggregate loans for the
purpose of applying such provisions. The Company records full or partial
charge-offs of loans at the time an event occurs affecting the legal status of
the loan, typically at the time of foreclosure (actual or in-substance) or upon
a loan modification giving rise to forgiveness of debt. A general reserve is
established for losses management believes are likely to arise from loans in
the portfolio, other than for those losses that have been specifically
reserved. The Company does not accrue interest on impaired loans when
management believes the collection of interest is unlikely.
Investment real estate, which the Company has the intent to hold for the
production of income, is carried at depreciated cost, including capital
additions, net of write-downs for other than temporary declines in fair value.
Properties held for sale (primarily acquired through foreclosure) are carried
at the lower of cost or fair value less estimated selling costs. Adjustments to
the carrying value of properties held for sale are recorded in a valuation
reserve when the fair value less estimated selling costs is below cost. Fair
value is generally estimated using a discounted future cash flow analysis in
conjunction with comparable sales information. Property valuations are reviewed
regularly by the Company's investment management group.
Short-term investments, consisting primarily of money market instruments and
other debt purchased with an original maturity of 91 days to one year, are
considered available for sale and are carried at fair value, which approximates
amortized cost.
Other invested assets consist primarily of partnerships and equity
subsidiaries. Partnerships and equity subsidiaries are carried on an equity
basis.
The Company utilizes foreign exchange forward contracts, futures contracts,
swap agreements, warrants and written options for other than trading purposes
in order to hedge interest rate, equity price and foreign exchange risks
(collectively, market risk). (Refer to Note 7.)
Foreign exchange forward contracts, which are designated at inception and are
effective as hedges of foreign translation and transaction exposures related to
investments classified as available for sale, are accounted for using the
deferral method. Accordingly, realized and unrealized gains and losses from
these foreign exchange forward contracts are deferred on the Consolidated
Balance Sheets, net of tax, in accumulated other comprehensive income. Upon
disposal of the hedged item, deferred gains and losses are recognized in net
realized capital gains or losses. Excess realized or unrealized gain or loss,
if any, from the foreign exchange forward contract compared to the foreign
investment being hedged, is reported as a net realized capital gain or loss.
Futures contracts are carried at fair value and require daily cash settlement.
Changes in the fair value of futures contracts that qualify as hedges are
deferred and recognized as an adjustment to the hedged asset or liability.
Deferred gains or losses on such futures contracts are amortized over the life
of the acquired asset or liability as a yield adjustment or through net
realized capital gains or losses upon disposal of an asset. Changes in the fair
value of futures contracts that do not qualify as hedges are recorded in net
realized capital gains or losses. Hedge designation requires specific asset or
liability identification, a probability at inception of high correlation with
the position underlying the hedge, and that such high correlation be maintained
throughout the hedge period. If a hedging instrument ceases to be highly
correlated with the position underlying the hedge, hedge accounting ceases at
that date and excess gains and losses on the hedging instrument are reflected
in net realized capital gains or losses.
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<PAGE> 69
Interest rate and currency swap agreements, which are designated as interest
rate or currency risk management instruments at inception, are accounted for
using the accrual method. Accordingly, the difference between amounts paid and
received on such agreements is reported in net investment income. There is no
recognition in the Consolidated Balance Sheets of changes in the fair value of
these agreements.
Warrants represent the right to purchase specific securities and are accounted
for as hedges. Upon exercise, the cost of the warrants is added to the basis of
the securities purchased.
Written options are contracts that grant the purchaser, for a fee, the right
but not the obligation, to buy or sell a financial instrument at a contracted
price within a specified period of time. Changes in the fair value of the
option are reported in realized capital gains.
FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign subsidiaries, where the local
currency is the functional currency, are translated into U.S. dollars at the
exchange rate in effect at each year end for assets and liabilities and average
exchange rates during the year for results of operations. The related
unrealized gains or losses resulting from translation of the net assets are
included in accumulated other comprehensive income. If the economy of the
country where a foreign subsidiary is located is considered highly inflationary
(generally, cumulative inflation levels in excess of 100% over a three-year
period), changes in the value of net monetary assets or liabilities would be
recognized currently in earnings.
GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
Goodwill, which represents the excess of cost over the fair value of net assets
acquired, is amortized on a straight-line basis over periods not exceeding 40
years. Other acquired intangible assets, which are primarily customer lists,
health provider networks and computer systems, are amortized on a straight-line
basis over various periods not exceeding 25 years.
The Company regularly evaluates the recoverability of goodwill and other
acquired intangible assets. The carrying value of such assets would be reduced
through a direct write-off if, in management's judgment, it was probable that
projected future operating income (before amortization of goodwill and other
acquired intangible assets) would not be sufficient on an undiscounted basis to
recover the carrying value. Operating earnings considered in such an analysis
are those of the entity acquired, if separately identifiable, or the business
segment that acquired the entity if the entity's earnings are not separately
identifiable.
OTHER LONG-LIVED ASSETS
The Company evaluates the potential impairment of long-lived assets (premises
and equipment) when events or changes in circumstances indicate that the
carrying amount of a long-lived asset may not be recoverable. If it is
determined that the carrying value of long-lived assets may not be recoverable
based upon the relevant facts and circumstances, the Company estimates the
future undiscounted cash flows (grouped at the company-wide level) expected to
result from the use of the asset and its eventual disposition. If the sum of
the expected undiscounted future cash flows is less than the carrying value of
the asset, the Company will recognize an impairment loss in the Consolidated
Statements of Income for the difference between the carrying value of the asset
and its fair value.
DEFERRED POLICY ACQUISITION COSTS
Certain costs of acquiring certain insurance business are deferred. These
costs, all of which vary with and are primarily related to the production of
new and renewal business, consist principally of commissions, certain expenses
of underwriting and issuing contracts, and certain agency expenses. For certain
annuity and pension contracts, such costs are amortized in proportion to
estimated gross profits and adjusted to reflect actual gross profits over the
life of the contracts (up to 20 years for annuity and pension contracts).
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<PAGE> 70
From time to time, modifications may be made to deferred annuity contract
features, such as shortening the surrender charge period or waiving the
surrender charge, changing the mortality and expense fees, etc. Unamortized
deferred policy acquisition costs associated with these modified contracts are
not written off, but rather, continue to be associated with the original block
of business to which such costs were previously recorded and are amortized
based on revised estimates of expected gross profits after the modification.
Unamortized deferred policy acquisition costs related to deferred annuity
products were $893 million and $810 million as of December 31, 1998 and 1997,
respectively.
Deferred policy acquisition costs are written off to the extent that it is
determined that future policy premiums and investment income or gross profits
are not adequate to cover related expenses.
SEPARATE ACCOUNTS
Separate Accounts assets and liabilities generally represent funds maintained
to meet specific investment objectives of contractholders who bear the
investment risk, subject, in some cases, to minimum guaranteed rates.
Investment income and investment gains and losses generally accrue directly to
such contractholders. The assets of each account are legally segregated and are
not subject to claims that arise out of any other business of the Company. The
assets and liabilities are carried at market value. Deposits, net investment
income and realized capital gains and losses on Separate Accounts assets are
not reflected in the Consolidated Statements of Income. Management fees charged
to contractholders are included in fees and other income.
INSURANCE LIABILITIES
Future policy benefits include reserves for limited payment and traditional
life insurance contracts. (Refer to Note 5 for further discussion on the sale
of the individual life insurance business.) Reserves for universal life
contracts are equal to cumulative premiums less charges plus credited interest
thereon. Reserves for traditional life insurance contracts represent the
present value of future benefits to be paid to or on behalf of policyholders
and related expenses less the present value of future net premiums. Reserves
for limited payment and traditional life contracts are computed on the basis of
assumed investment yield, mortality, morbidity and expenses, including a margin
for adverse deviation. Such assumptions generally vary by plan, year of issue
and policy duration. Reserve interest rates averaged 6.56% in 1998. Investment
yield is based on the Company's experience. Mortality, morbidity and withdrawal
rate assumptions are based on the Company's experience and are periodically
reviewed against both industry standards and experience.
Policyholders' funds left with the Company include reserves for pension and
annuity investment contracts. Reserves on such contracts are equal to
cumulative deposits less charges plus credited interest thereon (rates averaged
9.19% in 1998), net of adjustments for investment experience that the Company
is entitled to reflect in future credited interest. Reserves on contracts
subject to experience rating reflect the rights of contractholders, plan
participants and the Company.
Unpaid claims related to the Company's prepaid health care services (primarily
health maintenance organizations) consist principally of medical claims and
capitation costs. Medical claims include estimates of payments to be made on
claims reported and estimates of health care services rendered but not reported
to the Company as of the balance sheet date. Such estimates include the cost of
services that will continue to be rendered after the balance sheet date if the
Company is obligated to pay for such services in accordance with contract
provisions or regulatory requirements. Reserves for unpaid claims for indemnity
and PPO products (including short-duration contracts) and medical claims
payable reflect estimates, derived from past experience, of the ultimate cost
of incurred claims, including claims that have been incurred but not reported,
and claims that have been reported, but not settled. The Company discounts
certain claim liabilities related to group long-term disability and premium
waiver contracts. Generally, the discount rates reflect the expected investment
returns for the asset portfolios that support these liabilities. The discount
rates used ranged from 2.5% to 6.8% as of December 31, 1998 (except for
experience-rated contracts where the discount rates are set equal to
contractually specified levels). Unpaid claims payable are estimated
periodically and any resulting adjustments are reflected in results of
operations.
Premium deficiency losses are recognized when it is probable that expected
claim expenses will exceed future premiums on existing health and other
insurance contracts. For purposes of premium deficiency losses, contracts are
grouped in a manner consistent with the Company's method of acquiring,
servicing and measuring the profitability of such contracts.
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<PAGE> 71
INTERSEGMENT TRANSACTIONS
The Company accounts for intersegment loans as if the loans were to third
parties, that is, at current market rates. The intersegment loans and related
interest are eliminated in consolidation.
REVENUE RECOGNITION
Premium revenue for prepaid health care services is recognized as income in the
month in which the enrollee is entitled to receive health care services.
Premium revenue for group life and disability products is recognized as income
over the term of the coverage.
Some group contracts allow for premiums to be adjusted to reflect actual
experience. Such premiums are reasonably estimable (based on actual experience
of the customer emerging under the contract and the terms of the underlying
contract) and are recognized as the experience emerges.
For certain annuity contracts, charges assessed against policyholders' funds
for the cost of insurance, surrender charges, actuarial margin and other fees
are recorded as revenue in fees and other income. Other amounts received for
these contracts are reflected as deposits and are not recorded as revenue.
Related policy benefits are recorded in relation to the associated premiums or
gross profit so that profits are recognized over the expected lives of the
contracts. When annuity payments with life contingencies begin under contracts
that were initially investment contracts, the accumulated balance in the
account is treated as a single premium for the purchase of an annuity,
reflected as an offsetting amount in both premiums and current and future
benefits in the Consolidated Statements of Income.
Fees and other income are derived primarily from contracts for claim processing
or other administrative services and are recorded over the period the service
is provided.
ALLOCATIONS OF EXPENSES
The Company allocates centrally incurred costs associated with specific
internal goods or services provided to a segment, such as employee services,
technology services and rent, to the business segments based on a reasonable
method of each specific cost (e.g., usage, headcount, compensation or square
footage occupied). Interest expense on third-party borrowings is not currently
allocated to the reporting segments, since it is not used as a basis for
measuring the operating performance of the segment.
INCOME TAXES
The Company is taxed at regular corporate rates after adjusting income reported
for financial statement purposes for certain items. The Company files a
consolidated federal income tax return. Foreign subsidiaries and U.S.
subsidiaries operating outside of the United States are taxed under applicable
foreign statutes. Deferred income tax expenses/benefits result from changes
during the year in cumulative temporary differences between the tax basis and
book basis of assets and liabilities.
REINSURANCE
The Company utilizes reinsurance agreements to reduce exposure to large losses
in certain aspects of its insurance business. Reinsurance permits recovery of a
portion of losses from reinsurers, although it does not discharge the primary
liability of the Company as direct insurer of the risks reinsured. Only those
reinsurance recoverables deemed probable of recovery are reflected as assets.
(Refer to Notes 5 and 19.)
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<PAGE> 72
2. RESTATEMENT
Subsequent to the issuance of the Company's 1998 financial statements and the
filing of its 1998 Form 10-K with the Securities and Exchange Commission (the
"SEC"), and following discussions with representatives of the SEC's Division of
Corporate Finance and Office of the Chief Accountant concerning its review of
the Corporation's financial statements, the Company concluded that it would
restate its 1998 and first, second and third quarter 1999 financial statements
and related disclosures to reflect, among other things, the following changes:
- - Changes to the classification and timing of amounts earned by the Company
following the 1997 sale of Human Affairs International, Incorporated
("HAI"). Contingent payments earned by the Company originally recorded as
reductions of medical costs and as other income on a quarterly basis in
1998 have instead been recorded as a realized capital gain during the
fourth quarter of 1998;
- - A liability relating to the extension period (2000-2003) of an unfavorable
pharmacy contract originally recorded by the Company in connection with
the July, 1998 acquisition of NYLCare has been reversed to reflect the
elimination of this liability and reduction of goodwill;
- - The breakout of salaries and benefits expense originally included in other
operating expenses for each period presented;
- - The reclassification of the Company's initial capital contributions to
separate accounts and other excess funds not held to fund current separate
account liabilities to other invested assets, originally recorded to
separate account assets;
- - The reclassification of certain long-term debt (Puttable Reset Securities)
to short-term debt;
- - Expanded disclosures regarding the Company's 1996 severance and facilities
charges, discontinued products, goodwill amortization as well as other
accounting policies; and
- - The inclusion of information regarding reinsurance in the Notes to the
Consolidated Financial Statements, originally included in Form 10-K
schedules.
As a result of the foregoing and other factors, the Company's 1998 financial
statements have been restated from amounts previously reported. In addition,
while the 1997 and 1996 statements of income have not been restated, salaries
and benefits expense originally included in other operating expenses have been
separately identified.
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Consolidated Statements of Income:
<TABLE>
<CAPTION>
For the years ended December 31,
---------------------------------------------------------------
1998
----------------------------
As Previously
(Millions, except per common share data) As Restated Reported 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Premiums $14,839.3 $14,839.3 $ 12,592.2 $ 9,326.1
Net investment income 3,190.9 3,190.9 3,377.5 3,565.2
Fees and other income 2,327.1 2,362.1 2,236.3 2,174.8
Net realized capital gains 271.8 211.8 334.2 134.4
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue 20,629.1 20,604.1 18,540.2 15,200.5
- -------------------------------------------------------------------------------------------------------------------------------
Benefits and Expenses:
Current and future benefits 14,563.7 14,538.7 12,852.0 10,378.7
Operating expenses:
Salaries and related benefits 1,666.2 - 1,650.4 1,595.1
Other 2,191.1 3,857.3 1,910.8 1,724.7
Interest expense 250.9 250.9 235.8 168.3
Amortization of goodwill and other acquired intangible
assets 400.1 400.1 380.0 172.5
Amortization of deferred policy acquisition costs 215.3 215.3 217.5 160.1
Reductions of loss on discontinued products (68.0) (68.0) (172.5) (202.3)
Severance and facilities charges (reserve reductions), net 1.5 1.5 (45.0) 864.7
- -------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 19,220.8 19,195.8 17,029.0 14,861.8
- -------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 1,408.3 1,408.3 1,511.2 338.7
Income taxes 560.2 560.2 610.1 133.6
- -------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 848.1 848.1 901.1 205.1
Discontinued Operations, net of tax:
Income from operations - - - 182.2
Gain on sale - - - 263.7
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 848.1 $ 848.1 $ 901.1 $ 651.0
===============================================================================================================================
Net income applicable to common ownership $ 792.8 $ 792.8 $ 845.6 $ 625.9
===============================================================================================================================
Results Per Common Share:
Income from continuing operations:
Basic $ 5.50 $ 5.50 $ 5.67 $ 1.37
Diluted 5.41 5.41 5.60 1.36
Net income:
Basic $ 5.50 $ 5.50 $ 5.67 $ 4.77
Diluted 5.41 5.41 5.60 4.72
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
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Consolidated Balance Sheets:
<TABLE>
<CAPTION>
As of December 31,
-----------------------------------------------------------
1998 1997
------------------------ ------------------------------
As As Previously As As Previously
(Millions, except per common share data) Restated Reported Restated Reported
- ------------------------------------------------------------------------------------- ------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments:
Debt securities available for sale, at fair value
(amortized cost $30,730.1 and $32,694.0) $ 32,180.8 $ 32,180.8 $34,245.0 $34,245.0
Equity securities, at fair value (cost $762.6 and
$824.4) 800.5 800.5 1,041.4 1,041.4
Short-term investments 942.2 942.2 1,003.9 1,003.9
Mortgage loans 3,553.0 3,553.0 4,207.8 4,207.8
Real estate 270.3 270.3 369.5 369.5
Policy loans 458.7 458.7 746.9 746.9
Other 1,300.3 1,264.5 974.3 947.4
- ------------------------------------------------------------------------------------------------------------------------
Total investments 39,505.8 39,470.0 42,588.8 42,561.9
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 1,951.5 1,951.5 1,805.8 1,805.8
Short-term investments under securities loan agreement 753.6 753.6 - -
Accrued investment income 537.1 537.1 545.8 545.8
Premiums due and other receivables 1,478.1 1,478.1 1,205.8 1,205.8
Reinsurance recoverables 3,897.2 3,897.2 175.2 175.2
Deferred income taxes 46.6 53.0 - -
Deferred policy acquisition costs 1,768.6 1,768.6 2,367.3 2,367.3
Goodwill and other acquired intangible assets 9,143.5 9,155.3 8,506.3 8,506.3
Other assets 1,111.9 1,111.9 875.1 875.1
Separate Accounts assets 44,936.0 44,971.8 37,930.5 37,957.4
- ------------------------------------------------------------------------------------------------------------------------
Total assets $105,129.9 $105,148.1 $96,000.6 $96,000.6
========================================================================================================================
Liabilities:
Future policy benefits $ 18,541.1 $ 18,541.1 $17,837.1 $17,837.1
Unpaid claims 3,953.9 3,953.9 3,294.4 3,294.4
Unearned premiums 428.9 428.9 359.2 359.2
Policyholders' funds left with the Company 17,632.5 17,632.5 18,761.2 18,761.2
- ------------------------------------------------------------------------------------------------------------------------
Total insurance liabilities 40,556.4 40,556.4 40,251.9 40,251.9
- ------------------------------------------------------------------------------------------------------------------------
Dividends payable to shareholders 35.2 35.2 36.1 36.1
Short-term debt 1,370.1 1,063.4 252.1 252.1
Long-term debt 2,214.5 2,521.2 2,346.2 2,346.2
Payables under securities loan agreement 753.6 753.6 - -
Current income taxes 444.8 444.8 320.5 320.5
Deferred income taxes - - 223.3 223.3
Other liabilities 3,007.0 3,025.2 2,931.9 2,931.9
Minority and participating policyholders' interests 148.4 148.4 237.7 237.7
Separate Accounts liabilities 44,936.0 44,936.0 37,930.5 37,930.5
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 93,466.0 93,484.2 84,530.2 84,530.2
- ------------------------------------------------------------------------------------------------------------------------
Aetna-obligated mandatorily redeemable preferred
securities of subsidiary limited liability company
holding primarily debentures guaranteed by Aetna 275.0 275.0 275.0 275.0
- ------------------------------------------------------------------------------------------------------------------------
Commitments and Contingent Liabilities (Notes 4, 6 and
21)
Shareholders' Equity:
Class C voting mandatorily convertible preferred stock
($.01 par value; 15,000,000 shares authorized;
11,614,816 in 1998 and 11,655,206 in 1997 issued and
outstanding) 862.1 862.1 865.4 865.4
Common stock ($.01 par value; 500,000,000 shares
authorized; 141,272,628 in 1998 and 145,794,844 in
1997 issued and outstanding) 3,292.4 3,292.4 3,644.4 3,644.4
Accumulated other comprehensive income 177.8 177.8 307.1 307.1
Retained earnings 7,056.6 7,056.6 6,378.5 6,378.5
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,388.9 11,388.9 11,195.4 11,195.4
========================================================================================================================
Total liabilities, redeemable preferred securities and
shareholders' equity $105,129.9 $105,148.1 $96,000.6 $96,000.6
========================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
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3. EARNINGS PER COMMON SHARE
A reconciliation of the numerator and denominator of the basic and diluted
earnings per common share ("EPS") is as follows:
<TABLE>
<CAPTION>
Per Common
Income Shares Share
(Millions, except per common share data) (Numerator) (Denominator) Amount
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1998
Net income $848.1
Less: Preferred stock dividends 55.3
--------
Basic EPS
Income applicable to common ownership 792.8 144.1 $5.50
=====
Effect of dilutive securities:
Stock options and other (1) 1.1
Convertible preferred stock 55.3 11.6
-------- ------
Diluted EPS
Income applicable to common ownership and assumed conversions $848.1 156.8 $5.41
================================================================================================================================
1997
Net income $901.1
Less: Preferred stock dividends 55.5
--------
Basic EPS
Income applicable to common ownership 845.6 149.2 $5.67
=====
Effect of dilutive securities:
Stock options and other (1) 1.5
Convertible preferred stock 55.5 10.2
-------- ------
Diluted EPS
Income applicable to common ownership and assumed conversions $901.1 160.9 $5.60
================================================================================================================================
1996(2)(3)
Income from continuing operations $205.1
Less: Preferred stock dividends 25.1
--------
Basic EPS
Income applicable to common ownership $180.0 131.3 $1.37
====== =====
Effect of dilutive securities:
Stock options and other (1) 1.2
------
Diluted EPS
Income applicable to common ownership and assumed conversions $180.0 132.5 $1.36
================================================================================================================================
</TABLE>
(1) Options to purchase shares of common stock in 1998, 1997 and 1996 of 3.0
million shares, .2 million shares and 1.2 million shares, respectively,
(with exercise prices ranging from $71.50 - $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.
(2) The issuable common stock related to Class C voting mandatorily
convertible preferred stock (5.3 million weighted average shares) was not
included in the computation of diluted earnings per common share in 1996
because to do so would be anti-dilutive.
(3) In 1996, basic and diluted earnings per common share related to
Discontinued Operations were $3.40 and $3.36, respectively.
4. MERGER WITH U.S. HEALTHCARE
The merger with U.S. Healthcare was consummated on July 19, 1996. As a result
of the merger, each outstanding share of Aetna Services common stock became a
share of common stock of Aetna Inc. Each outstanding share of U.S. Healthcare
common stock and Class B Stock became a right to receive $34.20 in cash, 0.2246
shares of Aetna Inc. common stock and 0.0749 shares of Aetna Inc. Class C
Voting Preferred Stock. The Company's consolidated results of operations
include U.S. Healthcare from July 19, 1996.
The merger was accounted for as a purchase. Total consideration of
approximately $8.9 billion resulted in $7.9 billion, net of related deferred
taxes, representing the excess of the purchase price over the fair values of
the net assets acquired, being allocated to goodwill and other acquired
intangible assets and is being amortized over a 40-year period for goodwill and
over a range of five to 25 years for other acquired intangible assets.
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<PAGE> 76
5. OTHER ACQUISITIONS AND DISPOSITIONS
Aetna U.S. Healthcare
On December 9, 1998, the Company entered into definitive agreements with The
Prudential Insurance Company of America to acquire the Prudential health care
business for $1 billion. The Company currently expects to complete the
acquisition in the second quarter of 1999. The acquisition is subject to
approval by federal antitrust and state regulators, and other customary closing
conditions.
On July 15, 1998, the Company acquired New York Life Insurance Company's
("NYL") NYLCare health business for a purchase price of $1.08 billion in cash,
including an adjustment as provided in the transaction agreements. The
acquisition was accounted for as a purchase.
The excess of the cash payment over the fair value of the net assets acquired
resulted in approximately $950 million, net of related deferred taxes, being
primarily allocated to goodwill and other acquired intangible assets, which is
being amortized over a 40-year period for goodwill and over a range of three to
20 years for other acquired intangible assets.
In addition to recording the assets and liabilities acquired at fair value, the
purchase price allocation included approximately $35 million pretax related to
an unfavorable contract with an affiliate of NYL for providing pharmaceutical
benefits services (the "pharmacy contract"). As a condition of closing the
transaction, the pharmacy contract was extended from January 1, 2000 through
December 31, 2003 (the "extension period"). The terms of the extension period
were believed to reflect an appropriate market price, however the terms of the
pharmacy contract prior to January 1, 2000 were determined to be unfavorable.
The purchase price allocation related to the pharmacy contract is being
amortized over the period from closing to December 31, 1999. For the period
from July 16, 1998 through December 31, 1998, approximately $16 million pretax
was amortized as a reduction of pharmacy costs. Also, a $64 million liability
related to the expected costs associated with involuntarily terminating certain
NYLCare employees and the costs related to the exiting of leased NYLCare
facilities was established as part of the purchase price allocation.
The excess of the purchase price over the fair value of the net assets acquired
resulted in approximately $1.15 billion, net of related deferred taxes, being
allocated to goodwill and other acquired intangible assets, which is being
amortized over a 40-year period for goodwill and over a range of three to 20
years for other acquired intangible assets.
The Company's consolidated results of operations include the NYLCare health
business from July 15, 1998. Originally, in addition to the cash purchase
price, payments totaling up to $300 million (up to $150 million in each of two
years) were potentially payable to the extent that predetermined earnings and
membership targets in future periods were achieved (the "Earnout"). On January
29, 1999, the Company and NYL agreed to resolve all purchase price adjustments
and obligations under the Earnout. Under this agreement, the Company paid NYL
an additional $50 million to resolve such matters. As a result, the total
purchase price is approximately $1.1 billion.
During 1997, the Company's health business sold subsidiaries that were involved
in physician practice management, health electronic data interchange services
and behavioral health management. The sale of these entities resulted in a net
after-tax realized capital gain of $31 million ($82 million pretax). At the
time of the sale of the behavioral health management business, Human Affairs
International Incorporated ("HAI"), the Company entered into a long-term
strategic provider relationship that will provide its health members continued
access to HAI's, as well as the purchaser's, participating behavioral health
professionals at a fixed rate over the life of the agreement. Also, the Company
may earn contingent consideration of up to $300 million ($60 million maximum
per year) during the period from the closing date through the year 2002 for any
increases in targeted Aetna U.S. Healthcare's members (on an equivalent member
basis) served by HAI subsequent to the sale.
Page 76
<PAGE> 77
The calculation of the contingent consideration is based on an increase in
equivalent membership served by HAI for any contract year (member months, or
each member served for a given month, divided by 12), subject to certain
adjustments, and a maximum of $60 million per year. The contingent
consideration is recognized as realized capital gains when realizable. During
1998, $60 million ($39 million after-tax) of contingent consideration was
earned and recognized as a capital gain in the fourth quarter. The contingent
consideration does not affect the fixed rates under the long-term strategic
provider agreement.
Aetna Retirement Services
On October 1, 1998, the Company sold its domestic individual life insurance
business to Lincoln National Corporation ("Lincoln") for $1 billion in cash,
subject to adjustment as provided by the related agreements. The transaction
was generally in the form of an indemnity reinsurance arrangement, under which
Lincoln contractually assumed from the Company certain policyholder liabilities
and obligations, although the Company remains directly obligated to
policyholders. Assets related to and supporting the life policies were
transferred to Lincoln and the Company recorded a reinsurance receivable from
Lincoln. The transaction resulted in an after-tax gain on the sale of
approximately $152 million, of which $88 million will be deferred and amortized
over approximately 15 years.
Revenues for the business lines sold to Lincoln were $399 million, $553 million
and $538 million for 1998 (through the sale date), 1997 and 1996, respectively.
Net income for these business lines, excluding Year 2000 costs in 1998 and net
realized capital gains in all periods, was $72 million, $75 million and $80
million for 1998 (through the sale date), 1997 and 1996, respectively. Premiums
ceded and reinsurance recoveries made in 1998 totaled $153 million and $58
million, respectively.
Aetna International
On September 1, 1998, the Company acquired a 74.5% ownership interest in Cruz
Blanca, a private health insurance company in Chile, for approximately $92
million.
The total amount of Aetna International's investments in 1998, excluding its
investment in Cruz Blanca, was approximately $150 million. These investments
were individually not material.
In April 1997, the Company acquired a 49% ownership interest for approximately
$300 million in a Brazilian joint venture that provides health and life
insurance, as well as private pension plan products. The joint venture is being
accounted for on the equity basis. In late 1996, the Company acquired certain
interests in two similar joint ventures with its Mexican partner, in addition
to increasing its existing equity ownership in Mexico. The total amount of
these investments was $171 million. Additional investments in the pension
products joint venture totalled $50 million in 1997.
Other
The Company also acquired the following entities during 1997: Financial Network
Investment Corporation; Virginia Mason Health Plan, Inc.; Frontier Health
Holdings, Inc.; and Financial Life Assurance Company of Canada. The purchase
price of these acquisitions, both individually and in the aggregate, were not
material.
On April 2, 1996, the Company sold its property-casualty operations to an
affiliate of The Travelers Insurance Group Inc. ("Travelers") for approximately
$4.1 billion in cash. The sale resulted in an after-tax gain of $264 million
($218 million pretax). The operating results of the property-casualty
operations are presented as Discontinued Operations through the sale date.
Operating results for the period from January 1 to April 2, 1996 included total
revenue of $1.5 billion, income before income taxes of $263 million, income
taxes of $81 million and income of $182 million.
As a result of the sale, the Company retained no property-casualty liabilities
other than those associated with indemnifying Travelers for a portion of
certain potential liability exposures. While there can be no assurances,
management currently does not believe that the aggregate ultimate loss arising
from these indemnifications, if any, will be material to the annual net income,
liquidity or financial condition of the Company, although it is reasonably
possible.
Page 77
<PAGE> 78
6. INVESTMENTS
Debt securities available for sale at December 31 were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
1998 (Millions) Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bonds:
U.S. government and government agencies and authorities $ 1,863.8 $ 136.4 $ 1.6 $ 1,998.6
States, municipalities and political subdivisions 531.8 18.6 .3 550.1
U.S. corporate securities:
Utilities 2,454.8 135.6 12.4 2,578.0
Financial 4,739.1 215.6 8.8 4,945.9
Transportation/capital goods 2,313.7 193.7 5.5 2,501.9
Health care/consumer products 2,495.2 167.6 6.5 2,656.3
Natural resources 1,494.3 72.9 16.5 1,550.7
Other corporate securities 1,314.5 86.0 44.7 1,355.8
- ----------------------------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 14,811.6 871.4 94.4 15,588.6
- ----------------------------------------------------------------------------------------------------------------------------------
Foreign:
Government, including political subdivisions 2,722.6 243.1 81.9 2,883.8
Utilities 589.8 92.0 5.2 676.6
Other 2,802.2 126.6 60.8 2,868.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total foreign securities 6,114.6 461.7 147.9 6,428.4
- ----------------------------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 2,248.8 78.9 5.0 2,322.7
Collateralized mortgage obligations 1,929.2 122.4 10.4 2,041.2
- ----------------------------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 4,178.0 201.3 15.4 4,363.9
- ----------------------------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed securities (1) 2,121.8 44.3 42.9 2,123.2
Other asset-backed securities (2) 954.9 17.2 1.1 971.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total bonds 30,576.5 1,750.9 303.6 32,023.8
Redeemable preferred stocks 153.6 4.4 1.0 157.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities $30,730.1 $1,755.3 $304.6 $32,180.8
==================================================================================================================================
1997 (Millions)
- ----------------------------------------------------------------------------------------------------------------------------------
Bonds:
U.S. government and government agencies and authorities $ 3,762.3 $168.0 $ 1.7 $ 3,928.6
States, municipalities and political subdivisions 190.7 16.1 .2 206.6
U.S. corporate securities:
Utilities 2,382.6 125.1 2.2 2,505.5
Financial 5,049.4 169.8 2.4 5,216.8
Transportation/capital goods 2,417.7 174.7 3.0 2,589.4
Health care/consumer products 1,641.5 97.7 3.9 1,735.3
Natural resources 1,467.1 93.5 .7 1,559.9
Other corporate securities 1,418.9 88.2 .9 1,506.2
- ----------------------------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 14,377.2 749.0 13.1 15,113.1
- ----------------------------------------------------------------------------------------------------------------------------------
Foreign:
Government, including political subdivisions 2,514.7 161.6 46.5 2,629.8
Utilities 612.4 76.9 .2 689.1
Other 3,714.8 188.5 72.9 3,830.4
- ----------------------------------------------------------------------------------------------------------------------------------
Total foreign securities 6,841.9 427.0 119.6 7,149.3
- ----------------------------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 1,707.5 107.3 2.3 1,812.5
Collateralized mortgage obligations 2,549.6 162.8 2.0 2,710.4
- ----------------------------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 4,257.1 270.1 4.3 4,522.9
- ----------------------------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed securities (1) 1,586.2 42.0 6.2 1,622.0
Other asset-backed securities (2) 1,612.9 23.0 .8 1,635.1
- ----------------------------------------------------------------------------------------------------------------------------------
Total bonds 32,628.3 1,695.2 145.9 34,177.6
Redeemable preferred stocks 65.7 1.7 - 67.4
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities $32,694.0 $1,696.9 $145.9 $34,245.0
==================================================================================================================================
</TABLE>
(1) Includes approximately $178.1 million and $209.6 million of subordinate and
residual certificates at December 31, 1998 and 1997, respectively, from a
securitization of approximately $802.7 million of commercial mortgage loans
in 1997 (proceeds of approximately $635.1 million) which were retained by
the Company.
(2) Includes approximately $89.2 million and $97.9 million of subordinate and
residual certificates at December 31, 1998 and 1997, respectively, from a
1995 mortgage loan securitization which were retained by the Company.
Page 78
<PAGE> 79
At December 31, 1998 and 1997, net unrealized appreciation on
available-for-sale debt securities included $576 million and $678 million,
respectively, related to experience-rated contracts and $362 million and $388
million, respectively, related to discontinued products (refer to Note 11),
which were not reflected in shareholders' equity.
The carrying and fair value of debt securities are shown below by contractual
maturity. Actual maturities may differ from contractual maturities because
securities may be restructured, called or prepaid.
<TABLE>
<CAPTION>
Amortized Fair
1998 (Millions) Cost Value
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Due to mature:
One year or less $ 1,734.9 $ 1,762.7
After one year through five years 6,934.0 7,107.9
After five years through ten years 7,169.1 7,420.9
After ten years 7,637.4 8,431.2
Mortgage-backed securities 6,299.8 6,487.1
Other asset-backed securities 954.9 971.0
- ---------------------------------------------------------------------------------------------
Total $30,730.1 $32,180.8
=============================================================================================
</TABLE>
Investments in equity securities at December 31 were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Cost $762.6 $ 824.4
Gross unrealized capital gains 81.1 287.6
Gross unrealized capital losses (43.2) (70.6)
- ---------------------------------------------------------------------------------------------
Fair value $800.5 $ 1,041.4
=============================================================================================
</TABLE>
Real estate holdings at December 31 were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Properties held for sale $223.8 $328.3
Investment real estate 137.6 142.5
- ---------------------------------------------------------------------------------------------
361.4 470.8
Valuation reserve (91.1) (101.3)
- ---------------------------------------------------------------------------------------------
Net carrying value of real estate $270.3 $369.5
=============================================================================================
</TABLE>
Accumulated depreciation for investment real estate was $60 million at December
31, 1998 and 1997.
Total real estate write-downs included in the net carrying value of the
Company's real estate holdings at December 31, 1998 and 1997 were $122 million
and $160 million, respectively, (including $104 million and $116 million,
respectively, attributable to assets supporting discontinued products).
At December 31, 1998 and 1997, 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 were as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------------ ------------------------------
Total Total
Recorded Specific Recorded Specific
(Millions) Investment Reserves Investment Reserves
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Supporting discontinued products $161.9 $22.9 $206.5 $25.8
Supporting experience-rated products 95.7 21.7 110.8 16.7
Supporting remaining products 43.6 3.2 70.2 8.7
==============================================================================================================================
Total impaired loans $301.2(1) $47.8 $387.5(1) $51.2
==============================================================================================================================
</TABLE>
(1) Includes impaired loans of $96.0 million and $127.7 million, respectively,
for which no specific reserves are considered necessary.
Page 79
<PAGE> 80
The activity in the specific and general mortgage loan impairment reserves for
the periods indicated 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, 1996 $136.7 $ 74.7 $ 35.6 $247.0
- -----------------------------------------------------------------------------------------------------------------------
Credited to net realized capital gains - - (10.6) (10.6)
Credited to other accounts (25.0)(1) (20.0)(1) - (45.0)
Principal write-offs (43.0) (23.1) (10.8) (76.9)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 (2) 68.7 31.6 14.2 114.5
- -----------------------------------------------------------------------------------------------------------------------
Credited to net realized capital gains - - (8.0) (8.0)
(Credited) Charged to other accounts (37.0)(1) (2.0)(1) 4.7 (34.3)
Principal write-offs (2.2) - (3.1) (5.3)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 (2) $ 29.5 $ 29.6 $ 7.8 $ 66.9
=======================================================================================================================
</TABLE>
(1) Reflects adjustments to reserves related to assets supporting
experience-rated products and discontinued products, which do not affect
the Company's results of operations.
(2) Total reserves at December 31, 1998 and 1997 include $47.8 million and
$51.2 million of specific reserves and $19.1 million and $63.3 million of
general reserves, respectively.
Income earned (pretax) and cash received on the average recorded investment in
impaired loans for the twelve months ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 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 $172.8 $13.5 $13.8 $343.1 $36.9 $30.2
Supporting experience-rated products 104.1 9.9 10.1 195.3 17.6 14.5
Supporting remaining products 47.9 3.4 3.0 112.2 12.5 10.3
- -------------------------------------------------------------------------------------------------------------------------------
Total $324.8 $26.8 $26.9 $650.6 $67.0 $55.0
===============================================================================================================================
</TABLE>
Significant noncash investing and financing activities include the acquisition
of real estate through foreclosures of mortgage loans amounting to $13 million
and $33 million for 1998 and 1997, respectively.
At December 31, 1998 and 1997, the Company's mortgage loan balances net of
specific impairment reserves by geographic region and property type were as
follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 (Millions) 1998 1997
- --------------------------------------------------------- ---------------------------------------------------------
<S> <C> <C> <S> <C> <C>
South Atlantic $ 554.3 $ 790.0 Office $1,519.4 $2,009.2
Middle Atlantic 760.7 948.4 Retail 647.2 901.9
New England 294.3 417.9 Apartment 123.0 140.0
South Central 92.5 116.0 Hotel/Motel 182.6 239.6
North Central 410.3 522.8 Industrial 267.9 325.1
Pacific and Mountain 636.8 886.6 Mixed Use 238.4 263.8
Non-U.S. 823.2 589.4 Other 593.6 391.5
- --------------------------------------------------------- ---------------------------------------------------------
Total 3,572.1 4,271.1 Total 3,572.1 4,271.1
Less: general impairment Less: general impairment
reserve 19.1 63.3 reserve 19.1 63.3
- --------------------------------------------------------- ---------------------------------------------------------
Net mortgage loan balance $ 3,553.0 $4,207.8 Net mortgage loan balance $3,553.0 $4,207.8
========================================================= =========================================================
</TABLE>
Page 80
<PAGE> 81
7. FINANCIAL INSTRUMENTS
ESTIMATED FAIR VALUE
The carrying values and estimated fair values of certain of the Company's
financial instruments at December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
As Restated
1998 1997
------------------------ -------------------------
Carrying Estimated Fair Carrying Estimated Fair
(Millions) Value Value Value Value
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Mortgage loans $ 3,553.0 $ 3,597.1 $ 4,207.8 $ 4,327.0
Liabilities:
Investment contract liabilities:
With a fixed maturity $ 4,758.4 $ 4,814.1 $ 5,897.1 $ 6,022.6
Without a fixed maturity 11,812.1 11,194.9 11,932.0 11,438.8
Long-term debt 2,214.5 2,269.0 2,346.2 2,390.6
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Fair value estimates are made at a specific point in time, based on available
market information and judgments about the financial instrument, such as
estimates of timing and amount of future cash flows. Such estimates do not
reflect any premium or discount that could result from offering for sale at one
time the Company's entire holdings of a particular financial instrument, nor do
they consider the tax impact of the realization of unrealized capital gains or
losses. In many cases, the fair value estimates cannot be substantiated by
comparison to independent markets, nor can the disclosed value be realized in
immediate settlement of the instrument. In evaluating the Company's management
of interest rate, equity price, liquidity, and foreign exchange risks, the fair
values of all assets and liabilities should be taken into consideration, not
only those presented above.
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the above financial instruments:
Mortgage loans: Fair values are estimated by discounting expected mortgage loan
cash flows at market rates that reflect the rates at which similar loans would
be made to similar borrowers. The rates reflect management's assessment of the
credit quality and the remaining duration of the loans. The fair value
estimates of mortgage loans of lower credit quality, including problem and
restructured loans, are based on the estimated fair value of the underlying
collateral.
Investment contract liabilities (included in policyholders' funds left with the
Company):
With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
Without a fixed maturity: Fair value is estimated as the amount payable to the
contractholder upon demand. However, the Company has the right under such
contracts to delay payment of withdrawals that may ultimately result in paying
an amount different than that determined to be payable on demand.
Long-term debt: Fair value is based on quoted market prices for the same or
similar issued debt or, if no quoted market prices are available, on the
current rates estimated to be available to the Company for debt of similar
terms and remaining maturities.
Page 81
<PAGE> 82
OFF-BALANCE-SHEET AND OTHER FINANCIAL INSTRUMENTS
The notional amounts, carrying values and estimated fair values of the
Company's off-balance-sheet and other financial instruments at December 31 were
as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------------------ ------------------------------------
Carrying Carrying
Value Estimated Value Estimated
Notional Asset Fair Notional Asset Fair
(Millions) Amount (Liability) Value Amount (Liability) Value
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Foreign exchange forward contracts - sell:
Related to net investments in foreign
affiliates $192.4 $ (2.7) $ (3.3) $157.8 $ .8 $1.0
Related to investments in nondollar-
denominated assets 33.6 (.1) (.1) 42.7 .6 .6
Foreign exchange forward contracts - buy:
Related to net investments in foreign
affiliates - - - 11.9 - -
Related to investments in nondollar-
denominated assets 2.3 - - 25.0 1.5 1.5
Futures contracts to purchase securities 293.4 (4.3) (4.3) 8.5 .1 .1
Futures contracts to sell securities 966.4 10.9 10.9 10.0 .2 .2
Interest rate swaps 43.0 - 8.5 43.0 - 7.2
Currency swaps 19.8 - .5 - - -
Warrants to purchase securities 26.5 1.6 1.6 19.6 6.7 6.7
Written options 50.0 .1 .1 - - -
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The notional amounts of these instruments do not represent the Company's risk
of loss. The fair value of these instruments was estimated based on quoted
market prices, dealer quotations or internal price estimates believed to be
comparable to dealer quotations. These fair value amounts reflect the estimated
amounts that the Company would have to pay or would receive if the contracts
were terminated.
The Company engages in hedging activities to manage interest rate, equity price
and foreign exchange risks. Such hedging activities have principally consisted
of using off-balance-sheet instruments that involve, to varying degrees,
elements of market risk and credit risk in excess of the amounts recognized in
the Consolidated Balance Sheets. The Company evaluates the risks associated
with these instruments in a manner similar to that used to evaluate the risks
associated with on-balance-sheet financial instruments. Unlike on-balance-sheet
financial instruments, where credit risk is generally represented by the
notional or principal amount, the off-balance-sheet financial instruments' risk
of credit loss generally is significantly less than the notional value of the
instrument and is represented by the positive fair value of the instrument. The
Company generally does not require collateral or other security to support the
financial instruments discussed below. However, the Company controls its credit
risk exposure through credit approvals, credit limits and regular monitoring
procedures. There were no material concentrations of off-balance-sheet
financial instruments at December 31, 1998 or December 31, 1997.
Foreign Exchange Forward Contracts:
Foreign exchange forward contracts are agreements to exchange fixed amounts of
two different currencies at a specified future date and at a specified price.
The Company selectively hedges to manage its foreign exchange risk. The Company
generally utilizes short-term foreign exchange forward contracts to hedge its
foreign exchange exposure arising from certain investments in foreign
affiliates and nondollar-denominated investment securities.
Futures Contracts:
Futures contracts represent commitments to either purchase or sell securities
at a specified future date and at a specified price or yield. Futures contracts
trade on organized exchanges and, therefore, have minimal credit risk.
Page 82
<PAGE> 83
Interest Rate and Currency Swaps:
The Company utilizes interest rate swaps to manage certain exposures related to
changes in interest rates primarily by exchanging variable-rate returns for
fixed-rate returns. The Company also utilizes currency swaps to manage certain
exposures related to changes in foreign currency values primarily by exchanging
currencies and agreeing to re-exchange the currencies at the same rate of
exchange at a specified future date.
Warrants:
Warrants are instruments giving the Company the right, but not the obligation
to buy a security at a given price during a specified period.
Written Options:
Written options are contracts that give the holder the right, but not the
obligation to buy a financial instrument at a given price during a specified
period. Written options may be used to manage certain exposure to changes in
interest rates.
8. NET INVESTMENT INCOME
Sources of net investment income were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Debt securities $2,387.4 $2,365.3 $2,313.3
Equity securities 38.5 42.1 34.0
Short-term investments 71.5 51.8 61.3
Mortgage loans 353.1 610.1 761.8
Real estate 86.3 182.6 300.2
Policy loans 36.4 39.9 37.2
Other 240.3 175.5 155.2
Cash equivalents 127.3 114.9 135.1
- ----------------------------------------------------------------------------------------------
Gross investment income 3,340.8 3,582.2 3,798.1
Less: investment expenses 149.9 204.7 232.9
- ----------------------------------------------------------------------------------------------
Net investment income (1)(2) $3,190.9 $3,377.5 $3,565.2
- ----------------------------------------------------------------------------------------------
</TABLE>
(1) Includes $10.1 million, $15.6 million and $67.1 million from real estate
held for sale during 1998, 1997 and 1996, respectively.
(2) Includes amounts allocable to experience-rated contractholders of $1.2
billion, $1.3 billion and $1.4 billion during 1998, 1997 and 1996,
respectively. Interest credited to contractholders is included in current
and future benefits.
Page 83
<PAGE> 84
9. CAPITAL GAINS AND LOSSES ON INVESTMENT OPERATIONS AND OTHER
Realized capital gains or losses are the difference between the carrying value
and sale proceeds of specific investments sold. Provisions for impairments and
changes in the fair value of real estate held for sale are also included in net
realized capital gains or losses.
Net realized capital gains (losses), excluding amounts allocable to
experience-rated contractholders and discontinued products, on investments were
as follows:
<TABLE>
<CAPTION>
As
Restated
(Millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Debt securities $ 51.7 $ 49.8 $ (11.8)
Equity securities (1) 166.2 231.2 46.3
Mortgage loans 19.9 19.2 33.9
Real estate 3.2 13.5 4.7
Sales of subsidiaries (2) 60.0 82.3 60.1
Other (3) (29.2) (61.8) 1.2
- ----------------------------------------------------------------------------------------------------
Pretax realized capital gains $271.8 $ 334.2 $ 134.4
====================================================================================================
After-tax realized capital gains $173.9 $ 198.4 $ 85.9
====================================================================================================
</TABLE>
(1) Includes pretax realized capital gains of $74.4 million and $151.0 million
in 1998 and 1997, respectively, related to the sale of the Company's
investment in Travelers Property Casualty Corp.
(2) Realized capital gains in 1998 include a net pretax gain of $60.0 million
associated with the sale of HAI. (Refer to Note 5.) Realized capital gains
in 1997 include net pretax gains associated with the sale of HAI and
certain other health subsidiaries. (Refer to Note 5.) Realized capital
gains in 1996 include pretax gains of $39.3 million from the sale of Aetna
Realty Investors and $20.8 million from the sale of Aetna Health Plans of
Western Pennsylvania.
(3) Includes pretax realized capital losses of $12.7 million in 1998 for
futures contracts related to investments sold as part of the sale of the
individual life business and $44.0 million in 1997 related to the
write-down of certain properties that the Company had classified as held
for sale.
Net realized capital gains of $125 million, $221 million and $199 million for
1998, 1997 and 1996, respectively, allocable to experience-rated
contractholders were deducted from net realized capital gains and an offsetting
amount was reflected in policyholders' funds left with the Company.
Proceeds from the sale of available-for-sale debt securities and the related
gross gains and losses were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Proceeds on sales $20,254.6 $16,247.8 $13,625.6
Gross gains 174.8 90.2 77.6
Gross losses 123.1 40.4 89.4
- ---------------------------------------------------------------------------------
</TABLE>
Changes in shareholders' equity related to changes in accumulated other
comprehensive income (unrealized capital gains and losses on securities and
foreign currency) (excluding those related to experience-rated contractholders
and discontinued products) were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Continuing Operations:
Debt securities $ 28.2 $ 194.5 $(225.8)
Equity securities (179.1) (152.4) 307.5
Foreign exchange and other, net (47.9) (92.8) (70.9)
Discontinued Operations - - (474.0)
- -----------------------------------------------------------------------------------------------------
Subtotal (198.8) (50.7) (463.2)
Decrease in deferred income taxes (69.5) (17.8) (162.1)
- -----------------------------------------------------------------------------------------------------
Net changes in accumulated other comprehensive income $ (129.3) $ (32.9) $(301.1)
=====================================================================================================
</TABLE>
Page 84
<PAGE> 85
Shareholders' equity included the following accumulated other comprehensive
income which are net of amounts allocable to experience-rated contractholders
and discontinued products at December 31:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Debt securities available for sale:
Gross unrealized capital gains $ 678.5 $ 563.0
Gross unrealized capital losses (164.9) (77.6)
- --------------------------------------------------------------------------------------
513.6 485.4
- --------------------------------------------------------------------------------------
Equity securities:
Gross unrealized capital gains 81.1 287.6
Gross unrealized capital losses (43.2) (70.6)
- --------------------------------------------------------------------------------------
37.9 217.0
- --------------------------------------------------------------------------------------
Foreign exchange and other, net (277.9) (230.0)
Deferred income taxes (95.8) (165.3)
- --------------------------------------------------------------------------------------
Net accumulated other comprehensive income $ 177.8 $ 307.1
======================================================================================
</TABLE>
Additional Information - Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income related to changes in
unrealized gains on securities (excluding those related to experience-rated
contractholders and discontinued products) were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unrealized holding gains (losses) arising during the period (1) $ 107.6 $385.3 $(189.0)
Less: reclassification adjustment for gains and other items
included in net income (2) 224.5 335.4 153.8
- --------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $(116.9) $ 49.9 $(342.8)
- --------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Pretax unrealized holding gains (losses) arising during the period were
$165.6 million, $592.8 million and ($290.8) million for 1998, 1997 and
1996, respectively.
(2) Pretax reclassification adjustments for gains and other items included in
net income were $345.4 million, $511.0 million and $236.8 million for 1998,
1997 and 1996, respectively.
10. SEVERANCE AND FACILITIES CHARGES
During 1996, the Company established severance and facilities reserves of $865
million pretax in the Aetna U.S. Healthcare, Aetna Retirement Services and
Corporate segments to reflect the integration of the health businesses of the
Company and U.S. Healthcare and certain other actions taken or to be taken in
order to make its businesses more competitive. The charges included costs
associated with involuntary employee terminations, asset disposals and
consolidating and eliminating certain processing operations and associated real
estate obligations. The Company anticipated the principal long-term benefits of
this severance and facilities plan (the "plan") would result in lower workforce
costs, simplification of operating procedures and economies of scale associated
with large customer service centers. In addition, the Company continued to
experience rapid growth and a number of the workforce reductions contemplated
in the original plan were offset by the hiring of other employees to continue
to maintain appropriate customer service levels.
The Company's 1996 provision was developed based on management's best judgment
and estimates at that time and is included in other liabilities in the
Consolidated Balance Sheets. The Company anticipated the plan to be
substantially completed over an approximate two-year time-frame, given the
complexity of the actions, which included executing staffing and system changes
while maintaining customer service levels and other service center
consolidation processes. As the Company began to execute the plan, it adjusted
certain estimates based on more current information related to the actions to
be undertaken, as further discussed below. The following table summarizes the
1996 charges by segment:
<TABLE>
<CAPTION>
Asset Vacated
(Millions) Severance Disposals Leases Other CityPlace Total
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Aetna U.S. Healthcare $277.9 $ 84.9 $64.5 $25.7 $ - $453.0
Aetna Retirement Services 42.8 1.5 1.9 2.8 - 49.0
Corporate: Other 28.5 18.0 21.0 3.0 292.2 362.7
- -----------------------------------------------------------------------------------------------------------------------------
Total Company $349.2 $104.4 $87.4 $31.5 $292.2 $864.7
=============================================================================================================================
</TABLE>
Page 85
<PAGE> 86
1996 Charges
Aetna U.S. Healthcare recorded a charge of $423 million pretax related to
actions taken or expected to be taken with respect to the integration of the
health businesses. This charge does not include costs to exit certain
activities of U.S. Healthcare and corresponding involuntary termination
benefits as these costs were included as part of the purchase price. The plan,
which the Company began to formulate in the second quarter of 1996, included
the consolidation and reduction from over 40 service centers into 16 as well as
the reduction of overlapping functions in both the home and field offices. In
addition, approximately 18 physician practice management offices were to be
closed.
The severance portion of this charge was based on the plan to eliminate 7,500
positions (primarily service center, medical management, administrative and
data center personnel). The asset disposal portion of the charge was primarily
related to the disposition or abandonment of obsolete information technology
assets associated with employees who were to be terminated or data and service
centers which were to be closed. The portion of the charge for vacated lease
property was related to the site closures for service centers, as well as the
physician practice management offices. The "other" portion of the charge
primarily included: costs associated with the exit from the Medicare claim fee
for service business; costs incurred in terminating contractual obligations
related to the purchase and development of an HMO system platform which existed
prior to the Company's acquisition of U.S. Healthcare and incremental costs to
be incurred in connection with the shutdown of service centers.
In addition, Aetna U.S. Healthcare recorded a charge in 1996 of $30 million
pretax, not related to the U.S. Healthcare merger, for actions taken or
expected to be taken to reduce information technology costs. The severance
portion of this charge included a plan to eliminate 675 positions. By year end
1996, a large portion of these actions were completed.
Aetna Retirement Services recorded a $49 million pretax charge related to
actions taken or expected to be taken to improve its cost structure relative to
its competitors. This included the consolidation of certain field office
locations into other field office locations within the same geographic area and
the consolidation of work space due to downsizing of operations in certain
locations. The severance portion of the charge was based on a plan to eliminate
723 positions (primarily customer service, sales and information technology
support staff). The asset disposal portion of this charge related to the
write-off of personal computers of the terminated employees. The vacated leases
portion of the charge related to the closing of the field offices while the
"other" portion of this charge related to buy-out costs incurred in connection
with the termination of certain sales agent contracts.
In connection with the sale of the Company's property-casualty operations, the
Company vacated the CityPlace office in Hartford and the purchaser subleased
the space at market rates for a period of eight years. The Company recorded a
charge of $292 million pretax representing the present value of the difference
between the rent required to be paid by the Company under the lease and the
future rentals expected to be received by the Company. The Company also
recorded a charge of $71 million pretax for actions taken or expected to be
taken to reduce the level of corporate expenses and other costs previously
absorbed by the property-casualty operations. The severance portion of this
charge included the planned elimination of 475 positions. The asset disposal
and vacated leases portion of this charge included the exit of four corporate
facilities as well as the disposal of related computer hardware,
telecommunications equipment and personal computers. The "other" portion of the
charge related to costs to eliminate certain processing functions in the
investment operations area resulting from the Company's sale of its
property-casualty operations.
Page 86
<PAGE> 87
Certain aspects of the Company's original plan were refined, resulting in the
reallocation of accruals between restructuring categories, although the overall
reserve remained the same. Refinements in 1996 and 1998 were not significant.
The following table summarizes the 1996 severance and facilities charges and
activity through December 31, 1998 (pretax):
<TABLE>
<CAPTION>
Asset Vacated
(Millions) Severance Disposals Leases Other CityPlace (1) Total
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 Charges $ 349.2 $ 104.4 $ 87.4 $ 31.5 $ 292.2 $ 864.7
1996 Actions (84.6) (25.4) (17.4) (6.9) (5.2) (139.5)
1996 Refinement (1.3) - - 1.3 - -
- ----------------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1996 263.3 79.0 70.0 25.9 287.0 725.2
1997 Actions (120.8) (91.4) (25.1) (36.9) (.6) (274.8)
1997 Reduction (45.0) - - - - (45.0)
1997 Refinement (57.0) 33.4 (3.4) 27.0 - -
- ----------------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1997 40.5 21.0 41.5 16.0 286.4 405.4
1998 Actions (45.8) (19.4) (37.6) (12.8) 1.1 (114.5)
1998 Addition 4.0 - - - - 4.0
1998 Reduction (2.5) - - - - (2.5)
1998 Refinement 8.7 (1.6) (3.9) (3.2) - -
- ----------------------------------------------------------------------------------------------------------------------------
Reserve Balance at December 31, 1998 $ 4.9 $ - $ - $ - $ 287.5 $ 292.4
============================================================================================================================
</TABLE>
(1) Refer to Note 23 for further discussion.
1996 Activity
During 1996, Aetna U.S. Healthcare closed three service centers, and
consolidated and eliminated medical management activities at nine sites. Aetna
U.S. Healthcare also closed 18 physician practice management offices. Pursuant
to these actions, a total of 1,886 Aetna U.S. Healthcare positions were
eliminated. During 1996, Aetna Retirement Services eliminated 199 positions and
Corporate eliminated 336 positions.
1997 Activity
During 1997, Aetna U.S. Healthcare closed 10 service centers, and consolidated
and eliminated medical management activities at 37 sites. Pursuant to these
actions, a total of 2,503 Aetna U.S. Healthcare positions were eliminated.
Aetna Retirement Services eliminated 163 positions and closed nine field
offices during 1997. Also, Aetna Retirement Services wrote off the majority of
personal computers of the terminated employees during 1997. Corporate
eliminated 136 positions during 1997.
The Company's policy is to review the adequacy of the aggregate severance and
facilities reserve on a quarterly basis. This review includes an assessment of
the adequacy of the remaining reserve balance to complete the remaining
activities planned at the end of each quarter. As a result of these quarterly
reviews, the Company reduced the severance and facilities reserve for the Aetna
U.S. Healthcare segment by $14 million in the first quarter of 1997 and $31
million in the second quarter of 1997. These reductions in the reserve
(representing approximately 1,200 positions) were based on the Company's
continued assessment of actual attrition which was higher as compared to
attrition assumptions contemplated in the original plan.
The severance reserve was refined due to changes in business circumstances,
including customer service levels. In order to ensure an appropriate level of
service to Aetna U.S. Healthcare's customers and providers, the Company decided
not to proceed with six previously planned site closings. This decision
resulted in approximately 900 fewer job eliminations. In addition, the Company
experienced continued higher attrition levels, principally in certain patient
management and service center sites, resulting in an additional 700 fewer job
eliminations than anticipated.
Page 87
<PAGE> 88
During the same time period, disposal estimates that were contemplated for
certain information technology fixed assets (since they would not benefit
future operations) were also refined in the Aetna U.S. Healthcare segment.
These assets included personal computers, data center computer equipment for a
data center that would cease operations and telecommunications equipment
associated with planned service center consolidations. The need for the refined
disposal estimates included the following: (i) lower expected values for some
information technology assets contemplated in the reserve and more complete
inventory information which resulted in additional asset disposals; (ii)
increased information technology labor costs incurred in connection with the
systems that were to be shutdown, including deactivating and dismantling the
systems; and (iii) additional costs associated with the closure of a duplicate
data center including labor costs to disconnect and dispose of information
technology equipment. In addition, disposals were higher than contemplated in
the original plan related to the exit of physician practice management offices
for certain items such as leasehold improvements and other costs with no future
economic benefit to the Company.
The refinement of the "other" reserve represented an increase in the costs
associated with the shut down of service centers that were contemplated in the
original plan primarily in the Aetna U.S. Healthcare segment. Such costs were
primarily associated with labor costs of employees retained specifically to
perform exit activities including inventorying and disposing of assets and
coordinating site closure activities at service centers where operations had
ceased. These exit activities also included higher costs for employee resources
at field locations involved in the deactivation of claims systems.
1998 Activity
During 1998, Aetna U.S. Healthcare closed five service centers, and
consolidated and eliminated medical management activities at two sites.
Pursuant to these actions, a total of 1,000 Aetna U.S. Healthcare positions
were eliminated. Aetna Retirement Services eliminated 116 positions and
completed the buy-out of the sales agents contracts. Corporate eliminated 28
positions during 1998.
The 1998 addition to the severance and facilities reserve relates to
anticipated severance actions as a result of the sale of the domestic
individual life business, which included approximately 55 positions to be
eliminated. These severance actions are expected to be substantially complete
by March 31, 1999. The severance reserve relating to the Aetna Retirement
Services segment was reduced in 1998 upon substantial completion of the
original plan and actions.
11. 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. The Company's results of
operations would be adversely affected to the extent that future losses on the
products are greater than anticipated and positively affected to the extent
future losses are less than anticipated. The current reserve reflects
management's best estimate of anticipated future losses.
The factors contributing to changes in the reserve for anticipated future
losses are: operating income or loss, realized capital gains or losses and
mortality gains or losses. Operating income or loss is equal to revenue less
expenses. Realized capital gains or losses reflect the excess (deficit) of
sales price over (below) the carrying value of assets sold. Mortality gains or
losses reflect the mortality and retirement experience related to SPAs. A
mortality gain (loss) occurs when an annuitant or a beneficiary dies sooner
(later) than expected. A retirement gain will occur on some contracts if an
annuitant retires later than expected (a loss if an annuitant retires earlier
than expected).
Page 88
<PAGE> 89
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 that was used to calculate the
reserve. 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 December
31, 1998, the receivable from continuing products, net of related deferred
taxes payable of $55 million on the accrued interest income, was $493 million.
At December 31, 1997, the receivable from continuing products, net of the
related deferred taxes payable of $43 million on the accrued interest income
was $515 million. This amount is eliminated in consolidation.
Results of discontinued products were as follows (pretax):
<TABLE>
<CAPTION>
Charged (Credited)
to Reserve for
(Millions) Results Future Losses Net(1)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1998
Net investment income $ 530.9 $ - $530.9
Net realized capital gains 116.6 (116.6) -
Interest earned on receivable from continuing products 34.4 - 34.4
Other income 28.5 - 28.5
- ---------------------------------------------------------------------------------------------------------------
Total revenue 710.4 (116.6) 593.8
- ---------------------------------------------------------------------------------------------------------------
Current and future benefits 565.8 13.8 579.6
Operating expenses 14.2 - 14.2
- ---------------------------------------------------------------------------------------------------------------
Total benefits and expenses 580.0 13.8 593.8
- ---------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 130.4 $ (130.4) $ -
===============================================================================================================
1997
Net investment income $ 675.5 $ - $675.5
Net realized capital gains (2) 269.9 (269.9) -
Interest earned on receivable from continuing products 33.1 - 33.1
Other income 25.3 - 25.3
- ---------------------------------------------------------------------------------------------------------------
Total revenue 1,003.8 (269.9) 733.9
- ---------------------------------------------------------------------------------------------------------------
Current and future benefits 652.3 67.5 719.8
Operating expenses 14.1 - 14.1
- ---------------------------------------------------------------------------------------------------------------
Total benefits and expenses 666.4 67.5 733.9
- ---------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 337.4 $(337.4) $ -
===============================================================================================================
1996
Net investment income $ 818.3 $ - $818.3
Net realized capital gains 121.8 (121.8) -
Interest earned on receivable from continuing products 45.7 - 45.7
Change in accounting policy - FAS No. 121 8.3 - 8.3
Other income 31.5 - 31.5
- ---------------------------------------------------------------------------------------------------------------
Total revenue 1,025.6 (121.8) 903.8
- ---------------------------------------------------------------------------------------------------------------
Current and future benefits 777.8 108.5 886.3
Operating expenses 17.5 - 17.5
- ---------------------------------------------------------------------------------------------------------------
Total benefits and expenses 795.3 108.5 903.8
- ---------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 230.3 $(230.3) $ -
===============================================================================================================
</TABLE>
(1) Amounts are reflected in the 1998, 1997 and 1996 Consolidated Statements
of Income, except for interest earned on the receivable from continuing
products, which is eliminated in consolidation.
(2) Includes net realized capital gains of $154.4 million (pretax) related to
continued favorable developments in real estate markets (including gains
of $37.4 million (pretax) related to the securitization of commercial
mortgage loans), as well as $57.4 million (pretax) resulting from the sale
of investments in order to meet liquidity needs.
Net realized capital gains from the sale of bonds supporting discontinued
products were $81 million, $56 million and $12 million (pretax) for 1998, 1997
and 1996, respectively.
Page 89
<PAGE> 90
Assets and liabilities supporting discontinued products at December 31 were as
follows: (1)
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Debt securities available for sale $5,890.5 $6,471.4
Mortgage loans 754.2 976.9
Real estate 104.2 116.9
Short-term and other investments 350.7 371.3
- ------------------------------------------------------------------------------------------------------------
Total investments 7,099.6 7,936.5
Short-term investments under securities loan agreement 143.9 -
Current and deferred income taxes 187.5 165.6
Receivable from continuing products (2) 548.0 557.8
- ------------------------------------------------------------------------------------------------------------
Total assets $7,979.0 $8,659.9
============================================================================================================
Future policy benefits $4,653.5 $4,763.0
Policyholders' funds left with the Company 1,546.0 2,321.4
Reserve for anticipated future losses on discontinued products 1,214.1 1,151.7
Payables under securities loan agreement 143.9 -
Other 421.5 423.8
============================================================================================================
Total liabilities $7,979.0 $8,659.9
============================================================================================================
</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 reserve for anticipated future losses on discontinued products represents
the present value (at the risk-free rate at the time of discontinuance,
consistent with the duration of the liabilities) of the difference between the
expected cash flows from the assets supporting discontinued products and the
cash flows expected to be required to meet the obligations of the outstanding
contracts. Calculation of the reserve for anticipated future losses requires
projection of both the amount and the timing of cash flows over approximately
the next 30 years, including consideration of, among other things, future
investment results, participant withdrawal and mortality rates and the cost of
asset management and customer service. There have been no significant changes
to the assumptions underlying the calculation of the reserve related to the
projection of the amount and timing of cash flows.
The projection of future investment results considers assumptions for interest
rates, bond discount rates and performance of mortgage loans and real estate.
Mortgage loan assumptions represent management's best estimate of current and
future levels of rent growth, vacancy and expenses based upon market conditions
at each reporting date. The performance of real estate assets has been
consistently estimated using the most recent forecasts available. During 1997,
a bond default assumption was included to reflect historical default
experience, since the bond portfolio increased as a percentage of the overall
investment portfolio and reflected more bond credit risk, concurrent with the
decline in the commercial mortgage loan and real estate portfolios.
The previous years' actual participant withdrawal experience is used for the
current year assumption. Prior to 1995, the Company used the 1983 Group
Annuitant Mortality table published by the Society of Actuaries (the
"Society"). In 1995, the Society published the 1994 Uninsured Pensioner's
mortality table which has been used since then.
The Company's assumptions about the cost of asset management and customer
service reflect actual investment and general expenses allocated over invested
assets. Since inception, the expense assumption has increased as the level of
fixed expenses has not declined as rapidly as the liability run-off.
Page 90
<PAGE> 91
The activity in the reserve for anticipated future losses on discontinued
products was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
- ---------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1995 $ 958.8
Operating income 92.9
Net realized capital gains 121.8
Mortality and other 15.6
Reserve reduction (202.3)
- ---------------------------------------------------------------------
Reserve at December 31, 1996 986.8
Operating income 58.7
Net realized capital gains 269.9
Mortality and other 8.8
Reserve reduction (172.5)
- ---------------------------------------------------------------------
Reserve at December 31, 1997 1,151.7
Operating loss (6.6)
Net realized capital gains 116.6
Mortality and other 20.4
Reserve reduction (68.0)
- ---------------------------------------------------------------------
Reserve at December 31, 1998 $1,214.1
=====================================================================
</TABLE>
Management reviews the adequacy of the discontinued products reserve quarterly
and, as a result, primarily due to favorable investment performance, $44
million ($68 million pretax) of the reserve was released in 1998. Similar
reviews resulted in the Company's release of $108 million ($173 million pretax)
in 1997 and $132 million ($202 million pretax) in 1996 of the reserve due to
continued favorable developments in real estate markets. The current reserve
reflects management's best estimate of anticipated future losses.
The anticipated run-off of the December 31, 1998 reserve balance is as follows:
<TABLE>
<CAPTION>
(Millions)
- -----------------------------------------------------------------------
<S> <C>
1999 $29.9
2000 30.6
2001 31.1
2002 31.7
2003 - 2007 172.9
2008 - 2012 193.1
2013 - 2017 189.2
Thereafter 535.6
- -----------------------------------------------------------------------
</TABLE>
The above assumes that assets are held until maturity and that the reserve
run-off is proportional to the liability run-off.
The expected (as of December 31, 1993) and actual liability balances for the
GIC and SPA liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
Expected Actual
---------------------- ----------------------
(Millions) GIC SPA GIC SPA
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996 $4,642.0 $4,786.7 $3,288.7 $4,793.7
1997 3,173.9 4,685.8 2,321.4 4,763.0
1998 2,029.6 4,581.3 1,546.0 4,653.5
- -----------------------------------------------------------------------------------------------------
</TABLE>
The GIC balances are lower than expected in each period as several
contractholders redeemed their contracts prior to contract maturity. The SPA
balances in each period are higher because of additional amounts received under
existing contracts.
Page 91
<PAGE> 92
12. INCOME TAXES
Income taxes (benefits) for continuing operations consist of the following:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current taxes:
Federal $ 601.7 $407.1 $ 231.9
State 39.9 34.6 15.6
Foreign 21.0 25.1 10.4
- ----------------------------------------------------------------------------------------------------------
662.6 466.8 257.9
- ----------------------------------------------------------------------------------------------------------
Deferred taxes (benefits):
Federal (111.4) 141.2 (139.9)
State (.2) 4.4 2.4
Foreign 9.2 (2.3) 13.2
- ----------------------------------------------------------------------------------------------------------
(102.4) 143.3 (124.3)
- ----------------------------------------------------------------------------------------------------------
Total $ 560.2 $610.1 $ 133.6
==========================================================================================================
</TABLE>
Income taxes were different from the amount computed by applying the federal
income tax rate to income from continuing operations before income taxes as
follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income from U.S. operations $1,196.4 $1,261.8 $155.9
Income from non-U.S. operations 211.9 249.4 182.8
- -----------------------------------------------------------------------------------------------------------
Income before income taxes 1,408.3 1,511.2 338.7
Tax rate 35% 35% 35%
- -----------------------------------------------------------------------------------------------------------
Application of the tax rate 492.9 528.9 118.5
Tax effect of:
Tax-exempt interest (4.1) (2.6) (4.4)
Foreign operations (11.4) (18.3) (4.9)
Excludable dividends (11.7) (10.1) (10.5)
Goodwill amortization 67.8 66.5 30.7
State income taxes 25.9 25.4 11.7
Other, net .8 20.3 (7.5)
- -----------------------------------------------------------------------------------------------------------
Income taxes $ 560.2 $ 610.1 $133.6
- -----------------------------------------------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences that give rise to deferred tax assets
and deferred tax liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
As Restated
(Millions) 1998 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Insurance reserves $ 360.6 $ 325.4
Reserve for anticipated future losses on discontinued products 407.0 392.3
Reserve for severance and facilities charges 126.7 167.4
Impairment reserves 32.8 38.0
Other postretirement benefits 188.5 191.3
Net operating loss carryforward 25.3 27.7
Deferred compensation and other 106.0 64.3
Other 10.8 24.1
- ---------------------------------------------------------------------------------------------------------------
Total gross assets 1,257.7 1,230.5
Less: valuation allowance 21.4 20.2
- ---------------------------------------------------------------------------------------------------------------
Assets, net of valuation allowance 1,236.3 1,210.3
- ---------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred policy acquisition costs 542.3 651.5
Acquired intangibles other than goodwill 382.2 432.8
Accumulated other comprehensive income 91.6 132.2
Market discount 54.4 56.3
Other 119.2 160.8
- ---------------------------------------------------------------------------------------------------------------
Total gross liabilities 1,189.7 1,433.6
- ---------------------------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 46.6 $ (223.3)
===============================================================================================================
</TABLE>
Page 92
<PAGE> 93
Valuation allowances are provided when it is considered unlikely that deferred
tax assets will be realized. The valuation allowance relates to future tax
benefits on certain purchased domestic and foreign net operating losses.
Management believes that it is more likely than not that the Company will
realize the benefit of the net deferred tax asset of $53 million. The Company
expects sufficient taxable income in the future to realize the net deferred tax
asset because of the Company's long-term history of having taxable income,
which is projected to continue.
The Company has not recognized U.S. deferred taxes related to an estimated
cumulative amount of undistributed earnings of approximately $467 million on
its foreign corporations because the Company does not expect to repatriate
these earnings. A U.S. deferred tax liability will be recognized when the
Company expects that it will recover these undistributed earnings in a taxable
manner, such as through a receipt of dividends or a sale of the investment.
The "Policyholders' Surplus Account," which arose under prior tax law, is
generally that portion of a life insurance company's statutory income that has
not been subject to taxation. As of December 31, 1983, no further additions
could be made to the Policyholders' Surplus Account for tax return purposes
under the Deficit Reduction Act of 1984. The balance in such account was $935
million at December 31, 1998, adjusted for Internal Revenue Service (the
"Service") audits finalized to date. This amount would be taxed only under
certain conditions. No income taxes have been provided on this amount, since
management believes under current tax law the conditions under which such taxes
would become payable are remote.
The Service has completed its examination of the consolidated federal income
tax returns of Aetna Services and affiliated companies through 1990 and U.S.
Healthcare through 1994. Discussions are being held with the Service with
respect to proposed adjustments. Management believes there are adequate
defenses against, or sufficient reserves to provide for, any such adjustments.
The Service is continuing its examination for the years 1991 through 1994 for
Aetna Services.
The Company paid net income taxes of $553 million, $378 million and $249
million in 1998, 1997 and 1996, respectively.
13. BENEFIT PLANS
The Company has noncontributory defined benefit pension plans covering
substantially all Aetna Services employees and certain agents. The plan
provides pension benefits based on years of service and average annual
compensation (measured over 60 consecutive months of highest earnings in a 120
month period). Contributions are determined by using the Projected Unit Credit
Method and, for qualified plans subject to ERISA requirements, are limited to
amounts that are tax deductible.
Plans assets, primarily investments in domestic equities and fixed-income
instruments, are held in trust, and benefit payments are administered by Aetna
Life Insurance Company and affiliates. Approximately 7% of the plan assets at
December 31, 1998 are held in the general account of Aetna Life Insurance
Company.
Components of the net periodic benefit cost in continuing operations were as
follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actual return on plan assets $ 70.2 $ 731.4 $ 373.1
Service cost (76.0) (74.9) (77.7)
Interest cost (239.0) (231.4) (217.0)
Net amortization and deferral 255.6 (476.1) (128.8)
- -----------------------------------------------------------------------------------------------------------------
Net periodic benefit income (cost) (1) $ 10.8 $ (51.0) $ (50.4)
=================================================================================================================
</TABLE>
(1) A curtailment loss of $95.6 million (pretax) is included in the gain on the
sale of Discontinued Operations in 1996.
Page 93
<PAGE> 94
As of the measurement date (September 30), the status of the defined benefit
pension plans was as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Projected benefit obligation, beginning of year $3,273.7 $3,149.8
Service cost 76.0 74.9
Interest cost 239.0 231.4
Actuarial loss (gain) 254.6 (33.3)
Benefits paid (171.1) (149.1)
- ----------------------------------------------------------------------------------------------------------------
Projected benefit obligation, end of year $3,672.2 $3,273.7
- ----------------------------------------------------------------------------------------------------------------
Fair value of plan assets, beginning of year $3,587.5 $2,932.3
Actual return on plan assets 70.2 731.4
Employer contribution 79.7 72.9
Benefits paid (171.1) (149.1)
- ----------------------------------------------------------------------------------------------------------------
Fair value of plan assets, end of year $3,566.3 $3,587.5
- ----------------------------------------------------------------------------------------------------------------
Fair value of plan assets in excess of (less than) projected benefit obligation $ (105.9) $ 313.8
Unrecognized net loss (gain) 97.9 (413.0)
Unrecognized prior service cost/other 3.7 (.1)
Unrecognized net asset at date of adoption of FAS No. 87 (.2) 4.7
- ----------------------------------------------------------------------------------------------------------------
Accrued pension cost $ (4.5) $ (94.6)
================================================================================================================
Weighted average discount rate 7.0% 7.5%
Expected return on plan assets 9.0% 9.0%
Rate of compensation increase 4.0% 4.5%
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
The defined benefit plans included above with benefit obligations in excess of
assets (unfunded plans) had projected benefit obligations of $206 million and
$176 million for 1998 and 1997, respectively. The 1998 and 1997 accumulated
benefit obligations for these plans were $173 million and $148 million,
respectively.
The Company also has a defined contribution pension plan which covers
substantially all of its former U.S. Healthcare employees, subject to certain
age and service requirements. The Company's contribution for each eligible
employee is a percentage of the employee's compensation, as defined. Pretax
charges for this defined contribution pension plan were $16 million in 1998 and
1997 and $7 million for the period from July 19, 1996 through December 31,
1996.
In addition to providing pension benefits, the Company currently provides
certain health care and life insurance benefits for retired employees of Aetna
Services. A comprehensive medical and dental plan is offered to all full-time
employees retiring at age 50 with 15 years of service or at age 65 with 10
years of service. There is a cap on the portion of the cost paid by the Company
relating to medical and dental benefits. Retirees are generally required to
contribute to the plans based on their years of service with the Company. The
plan assets are held in trust and administered by Aetna Life Insurance Company.
Components of the net periodic postretirement benefit cost in continuing
operations were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actual return on plan assets $ 2.6 $ 2.4 $ 1.4
Service cost (5.7) (5.9) (7.3)
Interest cost (30.7) (30.2) (34.7)
Net amortization 24.1 24.9 26.4
================================================================================================
Net periodic benefit cost (1) $ (9.7) $ (8.8) $(14.2)
================================================================================================
</TABLE>
(1) A curtailment gain of $77.4 million (pretax) is included in the gain on the
sale of Discontinued Operations in 1996.
Page 94
<PAGE> 95
As of the measurement date (September 30), the status of the postretirement
benefit plans (other than pensions) was as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated benefit obligation, beginning of year $426.5 $417.2
Service cost 5.7 5.9
Interest cost 30.7 30.2
Actuarial loss 36.4 .8
Benefits paid (35.2) (27.6)
- -------------------------------------------------------------------------------------------------
Accumulated benefit obligation, end of year $464.1 $426.5
- -------------------------------------------------------------------------------------------------
Fair value of plan assets, beginning of year $ 55.7 $ 54.0
Actual return on plan assets 2.6 2.4
Employer contribution 33.9 26.9
Benefits paid (35.2) (27.6)
- -------------------------------------------------------------------------------------------------
Fair value of plan assets, end of year $ 57.0 $ 55.7
- -------------------------------------------------------------------------------------------------
Accumulated benefit obligation in excess of fair value of plan assets $407.1 $370.8
Unrecognized net gain 39.3 78.8
Prior service cost 57.2 78.5
- -------------------------------------------------------------------------------------------------
Accrued postretirement benefit costs $503.6 $528.1
- -------------------------------------------------------------------------------------------------
Weighted average discount rate 7.0% 7.5%
Expected return on plan assets 7.0% 7.0%
- -------------------------------------------------------------------------------------------------
</TABLE>
The health care cost trend rate for the 1998 valuation decreased gradually from
8.5% for 1999 to 5.5% by the year 2005. For the 1997 valuation, the rates
decreased gradually from 9.0% for 1998 to 5.5% by the year 2005. A
one-percentage-point change (increase or decrease) in assumed health care cost
trend rates would have the following effects:
<TABLE>
<CAPTION>
(Millions) Increase Decrease
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Effect on total of service and interest cost components $ 1.6 $ (1.3)
Effect on postretirement benefit obligation $21.8 $ (18.4)
- ------------------------------------------------------------------------------------------
</TABLE>
It is the Company's practice to fund amounts for postretirement life insurance
benefits to the extent the contribution is deductible for federal income taxes.
The plan assets are held in trust and administered by Aetna Life Insurance
Company. The assets are in the general account of Aetna Life Insurance Company,
and the expected rate of return on the plan assets was 7% for 1998, 1997 and
1996.
The Company's retiree health benefit plan for former U.S. Healthcare employees
is a defined contribution plan which covers substantially all such employees,
subject to certain age and service requirements. Contributions are at the
Company's sole discretion. Accumulated contributions and interest thereon are
used to fund all or a portion of the premiums for health care benefit coverage
for eligible retired employees and their eligible spouses. When funds are
exhausted, the Company has no obligation to make any further contributions or
payments. No contributions have been made to this retiree health benefit plan
since July 19, 1996.
Effective January 1, 1999, the Company terminated the defined contribution
pension plan related to former U.S. Healthcare employees and provided for
eligibility for those employees in its noncontributory defined pension and
postretirement benefit plans, as well as extended eligibility to employees of
the acquired NYLCare health business in such plans.
Page 95
<PAGE> 96
Also, effective January 1, 1999, the Company changed the formula for providing
pension benefits from the existing final average pay formula to a cash balance
formula, which will credit employees annually with an amount equal to a
percentage of eligible pay based on age and years of service as well as an
interest credit based on individual account balances. The formula also provides
for a transition period until December 31, 2006, which allows certain employees
to receive vested benefits at the higher of the final average pay or cash
balance formula. The changing of this formula will not have a material effect
on the Company's results of operations, liquidity or financial condition.
Incentive Savings Plans - Substantially all Aetna Services employees are
eligible to participate in a savings plan under which designated contributions,
which may be invested in common stock of Aetna Inc. or certain other
investments, are matched, up to 5% of compensation, by the Company. The U.S.
Healthcare savings plan provides for a match of up to 2% of compensation in
common stock of Aetna Inc. Effective January 1, 1999, contributions to this
plan ceased and such employees became eligible to participate in the Company's
incentive savings plan. Pretax charges to operations (including continuing and
Discontinued Operations in 1996) for the incentive savings plans were $42
million, $39 million and $50 million for 1998, 1997 and 1996, respectively.
Plan trustees held 3,795,808 shares, 4,177,786 shares and 4,514,258 shares of
the Company's common stock for plan participants at the end of 1998, 1997 and
1996, respectively.
Stock Incentive Plans - The Company's Stock Incentive Plans (the "Plans")
provides for stock options (see "Stock Options" below), deferred contingent
common stock or equivalent cash awards (see "Incentive Units" below) or
restricted stock to employees. The maximum number of shares of common stock
initially issuable under the Plans is 23,270,000. At December 31, 1998,
13,936,244 shares were available for grant under the Plans.
The compensation expense charged to operations related to the Incentive Units
was $20 million, $22 million, and $27 million, pretax, for 1998, 1997 and 1996,
respectively. The Company does not recognize compensation expense for stock
options granted at or above the market price on the date of grant under its
stock incentive plans. FAS No. 123, Accounting for Stock-Based Compensation,
requires disclosure of pro forma net income as if the fair value method of
valuing stock option grants were applied to such grants (disclosure
alternative). The Company's net income and earnings per common share, on a pro
forma basis, which may not be indicative of pro forma effects in future years,
would have been as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income:
As reported $ 848.1 $ 901.1 $ 651.0
Pro forma $ 820.7 $ 886.3 $ 643.1
Basic earnings per common share:
As reported $ 5.50 $ 5.67 $ 4.77
Pro forma $ 5.33 $ 5.57 $ 4.71
Diluted earnings per common share:
As reported $ 5.41 $ 5.60 $ 4.72
Pro forma $ 5.25 $ 5.51 $ 4.67
- -------------------------------------------------------------------------------------------------
</TABLE>
The fair value of the stock options included in the pro forma amounts shown
above was estimated as of the grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
<TABLE>
<CAPTION>
(Millions) 1998 1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dividend yield 1% 1% 2%
Expected volatility 30% 30% 26%
Risk-free interest rate 6% 7% 6%
Expected life 3 years 4 years 4 years
- -------------------------------------------------------------------------------------------------
</TABLE>
The weighted-average grant date fair values for options granted in 1998, 1997
and 1996 were $22.17, $29.17, and $17.00, respectively.
Page 96
<PAGE> 97
Stock Options - Executive, middle management and non-management employees may
be granted options to purchase common stock of the Company at or above the
market price on the date of grant. Options generally become 100% vested three
years after the grant is made, with one-third of the options vesting each year.
From time to time, the Company has issued options with different vesting
provisions. Vested options may be exercised at any time during the 10 years
after grant, except in certain circumstances generally related to employment
termination or retirement.
At the end of the 10-year period, any unexercised options expire.
Stock option transactions for 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- -------------------------- --------------------------
Weighted Average Weighted Average Weighted Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 5,267,294 $63.12 7,228,550 $58.99 4,883,661 $53.72
Granted 3,684,854 $86.18 385,025 $94.22 3,185,180 $70.78
Exchanged for U.S. Healthcare options
(1) - $ - - $ - 800,610 $32.72
Exercised (572,715) $58.07 (1,821,113) $51.94 (1,438,730) $51.94
Expired or forfeited (468,665) $80.50 (525,168) $68.55 (202,171) $62.02
- -----------------------------------------------------------------------------------------------------------------------------
Outstanding, end of year 7,910,768 $73.20 5,267,294 $63.12 7,228,550 $58.99
============================================================================================================================
Options exercisable at year end 4,020,928 $63.53 2,614,399 $54.90 2,749,017 $47.47
============================================================================================================================
</TABLE>
(1) Effective with the merger, stock options of Aetna Inc. were substituted
for that portion of options outstanding under the previous U.S. Healthcare
plans that were not satisfied in cash in the merger.
The following is a summary of information regarding options outstanding and
options exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------- ------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Prices Outstanding Life (Years) Price Exercisable Price
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$14.83 - $ 38.72 402,440 7 $34.31 402,440 $34.31
$41.50 - $ 46.75 250,651 5 $44.95 250,651 $44.95
$50.50 - $ 57.00 1,194,014 6 $54.74 1,121,014 $54.60
$61.63 - $ 78.96 2,620,040 8 $70.68 1,587,163 $70.23
$80.19 - $ 112.63 3,443,623 10 $88.11 659,660 $87.48
----------------------------------------------------------------------------------------------------------------
7,910,768 4,020,928
================================================================================================================
</TABLE>
Page 97
<PAGE> 98
Incentive Units - Executives may, from time to time, be granted incentive
units, which are rights to receive common stock or an equivalent value in cash.
Of the two cycles of incentive unit grants outstanding, each vests at the end
of a four-year vesting period (currently 1998 and 2000), conditioned upon the
employee's continued employment during that period and achievement of specified
Company performance goals related to the Company's total return to shareholders
over the four-year measurement period. The incentive units may vest within a
range from 0% to 175% at the end of the four-year period based on the
attainment of these performance goals. Interim measurements of compensation
expense are made at each reporting period based on the Company's estimated
periodic stock price and estimated forfeitures, over the four-year vesting
period. Compensation expense is recognized over the four-year vesting period;
no compensation expense is recognized at the date of grant. The incentive unit
holders are not entitled to dividends during the vesting period.
Incentive unit transactions related to the 1996 Plan under which holders may be
entitled to receive common stock, are as follows:
<TABLE>
<CAPTION>
Number of Incentive Units
------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding, beginning of year 575,145 368,217 564,920
Granted 28,625 433,500 3,425
Vested - (202,852) (191,928)
Expired or forfeited (11,950) (23,720) (8,200)
- ------------------------------------------------------------------------------------------------------
Outstanding, end of year 591,820 575,145 368,217
- ------------------------------------------------------------------------------------------------------
</TABLE>
The weighted-average grant date fair values for incentive units granted in
1998, 1997 and 1996 were $80.64, $85.17 and $71.88, respectively.
14. PARTICIPATING POLICYHOLDERS' INTERESTS
Under participating life insurance contracts issued by the Company, the
policyholder is entitled to share in the earnings of such contracts. This
business is accounted for in the Company's consolidated financial statements on
a statutory basis, since any adjustments to policy acquisition costs and
reserves on this business would have no effect on the Company's net income or
shareholders' equity. Statutory premiums, assets and liabilities allocable to
the participating policyholders were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 (1) 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums $ 44.4 $ 63.8 $ 48.4
Assets $ 124.2 $ 733.5 $ 702.1
Liabilities $ 81.7 $ 640.3 $ 613.3
- -----------------------------------------------------------------------------------------------
</TABLE>
(1) The domestic individual life business was sold on October 1, 1998 (refer to
Note 5 for further discussion).
Page 98
<PAGE> 99
15. DEBT AND GUARANTEE OF DEBT SECURITIES
<TABLE>
<CAPTION>
As Restated
(Millions) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Long-term debt:
Domestic:
Notes, 8.625% due 1998 $ - $ 99.9
Notes, 6.75% due 2001 299.8 299.7
Notes, 6.375% due 2003 199.4 199.2
Notes, 7.125% due 2006 348.0 347.8
Debentures, 6.75% due 2013 199.9 199.8
Eurodollar Notes, 7.75% due 2016 63.5 63.6
Debentures, 8% due 2017 (1) 140.0 170.0
Note, 3% due 2009 1.6 5.6
Debentures, 7.25% due 2023 199.9 200.0
Debentures, 7.625% due 2026 446.1 446.0
Debentures, 6.97% due 2036 (puttable at par in 2004) 300.0 300.0
International:
Mortgage Notes, 6.5%-11.875% due in varying amounts to 2006 16.3 14.6
- ---------------------------------------------------------------------------------------------------------------------
Total $2,214.5 $2,346.2
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Subject to various redemption options which began on January 15, 1997.
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., a wholly
owned subsidiary of Aetna Services (refer to Note 16) (collectively, the "Aetna
Services Debt"). Aggregate maturities of long-term debt and sinking fund
requirements for 1999 through 2001 are $1 million, $1 million, $306 million,
respectively, no maturities in 2002, $199 million in 2003 and $2,013 million,
thereafter.
On November 18, 1998, Aetna Services issued $300 million of 5.66% Puttable
Reset Securities ("PURS") due 2009. The PURS are structured such that, on
November 29, 1999 (the "Reset Date") the remarketing agents may elect to
remarket the PURS, whereby the annual interest rate on the securities will be
reset to a specified base rate (10-year Treasury rate plus a defined spread).
If the remarketing agents elect not to remarket the securities, Aetna Services
will be required to repurchase the PURS in full on November 29, 1999, unless at
least 10% of the holders elect to hold the PURS to maturity (subject to the
interest reset described above). The PURS cannot be redeemed prior to the Reset
Date. The Company received a premium for the remarketing component of the
securities. The PURS are included in short-term debt on the Company's
Consolidated Balance Sheets.
At December 31, 1998, $1.1 billion of short-term borrowings were outstanding.
In addition, 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 .2% per annum,
depending upon its long-term senior unsecured debt rating. The facility fee at
December 31, 1998 is at an annual rate of .08%. The facility also supports
Aetna Services' commercial paper borrowing program. As a guarantor to the
credit facility, Aetna Inc. is required to maintain shareholders' equity,
excluding accumulated other comprehensive income, of at least $7.5 billion.
Total interest paid by the Company was $212 million, $239 million and $130
million in 1998, 1997 and 1996, respectively.
Page 99
<PAGE> 100
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 at December 31 and for
the year then ended, is as follows (in millions):
<TABLE>
<CAPTION>
Balance Sheets Information: As Restated
---------------------------
1998 1997
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total investments (excluding Separate Accounts) $38,349.7 $41,047.8
- --------------------------------------------------------------------------------------------------------
Total assets $93,190.9 $85,138.9
- --------------------------------------------------------------------------------------------------------
Total insurance liabilities $38,566.9 $38,620.0
- --------------------------------------------------------------------------------------------------------
Total liabilities $90,770.3 $82,160.2
- --------------------------------------------------------------------------------------------------------
Total redeemable preferred stock $ 275.0 $ 275.0
- --------------------------------------------------------------------------------------------------------
Total shareholder's equity $ 2,145.6 $ 2,703.7
- --------------------------------------------------------------------------------------------------------
</TABLE>
Statements of Income Information:
<TABLE>
<S> <C> <C>
Total revenue $10,616.9 $10,390.7
- --------------------------------------------------------------------------------------------------------
Total benefits and expenses $ 9,454.2 $ 8,885.5
- --------------------------------------------------------------------------------------------------------
Income before income taxes $ 1,162.7 $ 1,505.2
- --------------------------------------------------------------------------------------------------------
Net income $ 766.4 $ 975.9
- --------------------------------------------------------------------------------------------------------
</TABLE>
16. AETNA-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
LIMITED LIABILITY COMPANY HOLDING PRIMARILY DEBENTURES GUARANTEED BY AETNA
On November 22, 1994, Aetna Capital L.L.C. ("ACLLC"), a wholly owned subsidiary
of Aetna Services, issued $275 million (11,000,000 shares) of 9.5% Cumulative
Monthly Income Preferred Securities, Series A. The securities are redeemable,
at the option of ACLLC with Aetna Services' consent, in whole or in part, from
time to time, on or after November 30, 1999, or at any time under certain
limited circumstances related to tax events, at a redemption price of $25 per
security plus accumulated and unpaid dividends to the redemption date. The
securities are scheduled to become due and payable in 2024. The maturity date
may be changed under certain circumstances.
ACLLC loaned the proceeds from the preferred stock issuance and the common
capital contributions to Aetna Services. In return, Aetna Services issued to
ACLLC approximately $348 million principal amount of 9.5% Subordinated
Debentures due in 2024, which are fully and unconditionally guaranteed by Aetna
Inc. on a subordinated basis. (Refer to Note 15.) These Subordinated Debentures
represent substantially all of the assets of ACLLC. Interest on these
debentures is payable monthly, and under certain circumstances, principal may
be due prior to or later than the original maturity date. This loan is
eliminated in the Consolidated Balance Sheets. The interest and other payment
dates on the debentures correspond to the distribution and other payment dates
on the preferred and common securities of ACLLC. Aetna Inc.'s obligations under
the debentures and related agreements, taken together, constitute a full and
unconditional guarantee of payments due on the preferred securities of ACLLC.
17. CAPITAL STOCK
In addition to the capital stock disclosed on the Consolidated Balance Sheets,
Aetna Inc. has the following authorized capital stock: 15,000,000 shares of
Class A Voting Preferred Stock, $.01 par value per share; 15,000,000 shares of
Class B Voting Preferred Stock, $.01 par value per share; and 15,000,000 shares
of Class D Non-Voting Preferred Stock, par value $.01 per share. At December
31, 1998 and 1997, 12,424,092 and 12,585,929 common shares, respectively, were
reserved for issuance under Aetna Inc.'s stock option plans.
Page 100
<PAGE> 101
Each share of Class C Stock is mandatorily convertible into one share of common
stock on July 19, 2000. Dividends accrue on a daily basis at an annual rate of
$4.7578 per share and are payable upon declaration by Aetna Inc.'s Board of
Directors (the "Board"). Aetna Inc. may, at its option, redeem the Class C
Stock during the period July 19, 1999 to July 18, 2000 for shares of Aetna Inc.
common stock based on specified formulas. The number of shares of common stock
to be issued for each share of Class C Stock pursuant to an optional redemption
will be based on a ratio, calculated as the greater of: (a) $76.125 (plus any
accrued but unpaid dividends) divided by the then current market price of the
common stock determined two trading days prior to the notice date of the intent
to redeem; or (b) .8197 of a share of common stock. Each share of Class C Stock
is also convertible, prior to the mandatory redemption date in whole or part,
at the option of the holder, into .8197 of a share of common stock.
Pursuant to Aetna Inc.'s Rights Agreement, one share purchase right (a "Right")
is attached to each share of outstanding common stock and common stock
subsequently issued, prior to the time at which the Rights become exercisable,
expire or are redeemed.
The Rights trade with the common stock until they become exercisable. The
Rights become exercisable 10 days after: (i) a public announcement that a
person or group ("person") has acquired 15% or more of the outstanding shares
of common stock or 10% or more of the outstanding shares of common stock if
such person is declared by the Board to be an "adverse person" (a "triggering
acquisition"); or (ii) a person commences a tender offer or exchange offer, the
consummation of which could result in such person owning 15% or more of the
common stock; or (iii), in either event, such later date as the Board may
determine.
Upon becoming exercisable, each Right will entitle the holder thereof (the
"Holder") to purchase one one-hundredth of a share of Aetna Inc.'s Class B
Voting Preferred Stock, Series A (a "Fractional Preferred Share") at a price of
$200 (the "Exercise Price"). Each Fractional Preferred Share has dividend,
voting and liquidation rights designed to make it approximately equal in value
to one share of common stock. Under certain circumstances, including a
triggering acquisition, each Right (other than Rights that were or are owned by
the acquirer, which are void) thereafter will entitle the Holder to purchase
common stock (or economically equivalent securities, under certain
circumstances) worth twice the Exercise Price. Under certain circumstances,
including certain acquisitions of Aetna Inc. in a merger or sale of its assets,
each Right thereafter will entitle the Holder to purchase equity securities of
the acquirer at a 50% discount.
Under certain circumstances, Aetna Inc. may redeem all of the Rights at a price
of $.01 per Right. The Rights will expire on November 7, 1999, unless earlier
redeemed. The Rights have no dilutive effect on earnings per share until
exercised.
18. DIVIDEND RESTRICTIONS AND SHAREHOLDERS' EQUITY
The Company's business operations are conducted through Aetna Services and
Aetna U.S. Healthcare and their respective subsidiaries (which principally
consist of HMOs and insurance companies). In addition to general state law
restrictions on payments of dividends and other distributions to shareholders
applicable to all corporations, HMOs and insurance companies are subject to
further state regulations that, among other things, may require such companies
to maintain certain levels of equity, and restrict the amount of dividends and
other distributions that may be paid to their parent corporations. These
regulations are not directly applicable to Aetna Services, Aetna U.S.
Healthcare or Aetna Inc., as none is an HMO or insurance company. The
additional regulations applicable to the Company's indirect HMO and insurance
company subsidiaries are not expected to affect the ability of Aetna Inc. to
pay dividends, or the ability of any of the Company's subsidiaries to service
their outstanding debt or preferred stock obligations.
The amount of dividends that may be paid to Aetna Services or Aetna U.S.
Healthcare by their domestic insurance and HMO subsidiaries at December 31,
1998 without prior approval by state regulatory authorities is limited to
approximately $501 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.
Page 101
<PAGE> 102
The combined statutory net income for the years ended and statutory surplus as
of December 31 for the domestic insurance and HMO subsidiaries of the Company,
reflecting intercompany eliminations, were as follows:
<TABLE>
<CAPTION>
(Millions) 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Statutory net income $591.0 $ 759.5
Statutory surplus $2,993.2 3,361.3
- ----------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1998, the Company does not utilize any statutory accounting
practices which are not prescribed by state regulatory authorities that,
individually or in the aggregate, materially affect statutory surplus.
19. REINSURANCE
The Company utilizes reinsurance agreements to reduce its exposure to large
losses in certain aspects of its insurance business. These reinsurance
agreements permit recovery of a portion of losses from reinsurers, although it
does not discharge the primary liability of the Company as direct insurer of
the risks reinsured. The Company evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities or economic characteristics of its reinsurers.
Earned premiums for the years ended December 31 were as follows:
<TABLE>
<CAPTION>
Percentage
Ceded to Assumed of Amount
Gross Other from Other Net Assumed
(Millions) Amount Companies Companies Amount to Net
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998(1)
Life insurance $ 2,486.7 $ 299.6 $ 68.6 $ 2,255.7 3.0%
Accident and health insurance 12,344.3 78.0 279.0 12,545.3 2.2%
Property-casualty insurance 75.3 38.9 1.9 38.3 5.0%
============================================================================================================================
Total premiums $14,906.3 $ 416.5 $ 349.5 $14,839.3 2.4%
============================================================================================================================
1997(1)
Life insurance $ 2,209.5 $ 88.2 $ 29.5 $ 2,150.8 1.4%
Accident and health insurance 10,441.5 62.6 5.5 10,384.4 .1%
Property-casualty insurance 82.5 30.9 5.4 57.0 9.5%
============================================================================================================================
Total premiums $12,733.5 $ 181.7 $ 40.4 $12,592.2 .3%
============================================================================================================================
1996(1)
Life insurance $ 2,285.5 $ 85.6 $ 42.8 $ 2,242.7 1.9%
Accident and health insurance 7,073.2 62.1 23.5 7,034.6 .3%
Property-casualty insurance 95.1 50.1 3.8 48.8 7.8%
============================================================================================================================
Total premiums $ 9,453.8 $ 197.8 $ 70.1 $9,326.1 .8%
============================================================================================================================
</TABLE>
(1) Excludes intercompany transactions.
There is not a material difference between premiums on a written basis versus
an earned basis. Reinsurance recoveries were $3,371.3 million, $193.9 million
and $178.5 million in 1998, 1997 and 1996, respectively. Net life insurance in
force was $445.2 billion, $387.8 billion and $381.4 billion at December 31,
1998, 1997 and 1996, respectively.
Page 102
<PAGE> 103
20. SEGMENT INFORMATION
Summarized financial information for the Company's principal operations was as
follows:
<TABLE>
<CAPTION>
As Restated Aetna As Restated
Aetna U.S. Retirement Aetna Large Case Corporate Total
1998 (Millions) Healthcare Services International Pensions and Other (1) Company
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues from external customers $14,447.3 $ 859.9 $ 1,716.7 $ 141.2 $ 1.3 $ 17,166.4
Net investment income 537.2 1,024.5 363.3 1,152.5 16.9 3,094.4
Equity in earnings of subsidiaries - - 96.5 - - 96.5
==============================================================================================================================
Total revenue excluding realized
capital gains (losses) $14,984.5 $ 1,884.4 $ 2,176.5 $ 1,293.7 $ 18.2 $ 20,357.3
==============================================================================================================================
Interest expense $ - $ - $ 11.1 $ - $ 239.8 $ 250.9
- ------------------------------------------------------------------------------------------------------------------------------
Amortization $ 381.9 $ 131.1 $ 102.4 $ - $ - $ 615.4
- ------------------------------------------------------------------------------------------------------------------------------
Income taxes (benefits) $ 368.0 $ 132.3 $ 55.9 $ 102.5 $ (98.5) $ 560.2
- ------------------------------------------------------------------------------------------------------------------------------
Operating earnings (losses) (2) $ 407.1 $ 258.0 $ 165.7 $ 89.7 $(245.9) $ 674.6
Other items (3) (64.3) 40.0 (7.5) 42.8 (11.4) (.4)
Realized capital gains (losses), net
of tax 88.2 2.0 (22.2) 37.4 68.5 173.9
==============================================================================================================================
Net income (loss) $ 431.0 $ 300.0 $ 136.0 $ 169.9 $(188.8) $ 848.1
==============================================================================================================================
Segment assets (4) $18,600.8 $47,843.3 $8,017.4 $30,651.1 $ 17.3 $105,129.9
- ------------------------------------------------------------------------------------------------------------------------------
Investment in equity subsidiaries $ - $ - $ 493.1 $ - $ - $ 493.1
- ------------------------------------------------------------------------------------------------------------------------------
Expenditures for long-lived assets $ 9.6 $ 10.4 $ 42.5 $ .2 $ - $ 62.7
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Corporate and Other includes interest, staff area expenses, advertising,
contributions, net investment income and other general expenses, as well
as consolidating adjustments.
(2) Operating earnings are net income (loss) excluding net realized capital
gains and losses and any other items. While operating earnings is the
measure of profit or loss used by the Company's management when assessing
performance or making operating decisions, it does not replace operating
income or net income as a measure of profitability.
(3) Other items excluded from operating earnings include Year 2000 costs for
all segments, an after-tax gain related to the sale of the domestic life
insurance business of $64.0 million and a net after-tax severance and
facilities charge of $1.0 million in the Aetna Retirement Services segment
and an after-tax benefit of $44.2 million from reductions of the reserve
for anticipated future losses on discontinued products in the Large Case
Pensions segment.
(4) Large Case Pensions assets include $7.2 billion attributable to
discontinued products.
Page 103
<PAGE> 104
<TABLE>
<CAPTION>
Aetna
Aetna U.S. Retirement Aetna Large Case Corporate Total
1997 (Millions) Healthcare Services International Pensions and Other (1) Company
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues from external customers $12,308.5 $ 750.2 $1,574.4 $ 183.1 $ 12.3 $ 14,828.5
Net investment income 451.2 1,114.7 332.9 1,408.7 18.5 3,326.0
Equity in earnings of subsidiaries - - 51.5 - - 51.5
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized
capital gains (losses) $12,759.7 $ 1,864.9 $1,958.8 $ 1,591.8 $ 30.8 $ 18,206.0
==============================================================================================================================
Interest expense $ .6 $ .5 $ 7.8 $ - $ 226.9 $ 235.8
- ------------------------------------------------------------------------------------------------------------------------------
Amortization $ 383.2 $ 111.4 $ 102.9 $ - $ - $ 597.5
- ------------------------------------------------------------------------------------------------------------------------------
Income taxes (benefits) $ 391.0 $ 115.1 $ 54.1 $ 153.6 $ (103.7) $ 610.1
- ------------------------------------------------------------------------------------------------------------------------------
Operating earnings (losses) (2) $ 354.6 $ 232.9 $ 128.7 $ 105.0 $ (256.2) $ 565.0
Other items (3) 29.3 - - 108.4 - 137.7
Realized capital gains, net of tax 69.9 24.2 13.7 20.8 69.8 198.4
==============================================================================================================================
Net income (loss) $ 453.8 $ 257.1 $ 142.4 $ 234.2 $ (186.4) $ 901.1
==============================================================================================================================
Segment assets (4) $15,938.5 $40,916.6 $6,521.5 $ 32,325.2 $ 298.8 $ 96,000.6
- ------------------------------------------------------------------------------------------------------------------------------
Investment in equity subsidiaries $ - $ - $ 372.6 $ - $ - $ 372.6
- ------------------------------------------------------------------------------------------------------------------------------
Expenditures for long-lived assets $ 9.5 $ 11.2 $ 43.4 $ .2 $ - $ 64.3
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Corporate and Other includes interest, staff area expenses, advertising,
contributions, net investment income and other general expenses, as well
as consolidating adjustments.
(2) Operating earnings are net income (loss) excluding net realized capital
gains and losses and any other items. While operating earnings is the
measure of profit or loss used by the Company's management when assessing
performance or making operating decisions, it does not replace operating
income or net income as a measure of profitability.
(3) Other items excluded from operating earnings include an after-tax benefit
of $29.3 million from the reduction of the severance and facilities
reserve in the Aetna U.S. Healthcare segment and a $108.4 million
after-tax benefit from reductions of the reserve for anticipated future
losses on discontinued products in the Large Case Pensions segment.
(4) Large Case Pensions assets include $7.9 billion of assets attributable to
discontinued products.
<TABLE>
<CAPTION>
Aetna
Aetna U.S. Retirement Aetna Large Case Corporate Total
1996 (Millions) Healthcare Services International Pensions and Other (1) Company
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues from external customers $ 9,261.1 $ 648.4 $1,290.3 $ 295.5 $ 5.6 $ 11,500.9
Net investment income 414.6 1,086.7 317.4 1,649.2 80.5 3,548.4
Equity in earnings of subsidiaries - - 16.8 - - 16.8
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized
capital gains (losses) $ 9,675.7 $ 1,735.1 $1,624.5 $ 1,944.7 $ 86.1 $ 15,066.1
============================================================================================================================
Interest expense $ .2 $ - $ 8.2 $ - $ 159.9 $ 168.3
- ----------------------------------------------------------------------------------------------------------------------------
Amortization $ 181.3 $ 74.4 $ 76.9 $ - $ - $ 332.6
- ----------------------------------------------------------------------------------------------------------------------------
Income taxes (benefits) $ 66.8 $ 79.3 $ 62.0 $ 137.3 $ (211.8) $ 133.6
- ----------------------------------------------------------------------------------------------------------------------------
Operating earnings (losses) (2) $ 341.3 $ 200.2 $ 105.5 $ 106.1 $ (177.6) $ 575.5
Discontinued operations, net of tax - - - - 445.9 445.9
Other items (3) (320.5) (31.8) - 131.5 (235.5) (456.3)
Realized capital gains, net of tax 37.9 17.8 4.4 20.8 5.0 85.9
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 58.7 $ 186.2 $ 109.9 $ 258.4 $ 37.8 $ 651.0
=============================================================================================================================
</TABLE>
(1) Corporate and Other includes interest, staff area expenses, advertising,
contributions, net investment income and other general expenses, as well
as consolidating adjustments.
(2) Operating earnings are net income (loss) excluding net realized capital
gains and losses and any other items. While operating earnings is the
measure of profit or loss used by the Company's management when assessing
performance or making operating decisions, it does not replace operating
income or net income as a measure of profitability.
(3) Other items excluded from operating earnings include an after-tax benefit
of $131.5 million from reductions of the reserve for anticipated future
losses on discontinued products in the Large Case Pensions segment and
after-tax severance and facilities and other charges of $320.5 million in
the Aetna U.S. Healthcare segment, $31.8 million in the Aetna Retirement
Services segment and $235.5 million in the Corporate segment.
Page 104
<PAGE> 105
21. GEOGRAPHIC INFORMATION
Selected financial information by country was as follows:
<TABLE>
<CAPTION>
As Restated As Restated
1998 1997 1996
--------------------------- ---------------------------- ------------
Revenues Revenues from Revenues
from External Long-Lived External Long-Lived from External
(Millions) Customers Assets Customers Assets Customers
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
United States $15,449.7 $ 877.8 $13,254.1 $669.2 $10,210.6
Taiwan 780.1 86.9 697.1 79.2 525.5
Chile 349.0 57.0 322.0 56.5 273.5
Canada 306.5 15.1 273.1 20.9 237.0
Malaysia 165.8 47.8 215.8 31.1 218.6
New Zealand 48.5 5.4 - - -
Argentina 12.1 5.6 6.8 2.5 4.3
Other foreign countries 54.7 16.3 59.6 15.7 31.4
- -------------------------------------------------------------------------------------------------------------------------
Total $17,166.4 $1,111.9 $14,828.5 $875.1 $11,500.9
=========================================================================================================================
</TABLE>
22. REVENUES FROM EXTERNAL CUSTOMERS BY PRODUCT
Revenues from external customers by product were as follows:
<TABLE>
<CAPTION>
As Restated
(Millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Health risk $11,979.4 $ 9,813.9 $ 6,803.0
Group insurance and other health 2,923.0 2,812.0 2,720.4
Individual life (1) 1,194.7 1,219.4 1,037.0
Financial services 761.3 608.0 497.2
Large case pensions 141.2 183.1 295.5
Other 166.8 192.1 147.8
- --------------------------------------------------------------------------------------------------------
Total revenue from external customers $17,166.4 $14,828.5 $11,500.9
========================================================================================================
</TABLE>
(1) The domestic individual life business was sold on October 1, 1998 (refer
to Note 5 for further discussion).
23. COMMITMENTS AND CONTINGENT LIABILITIES
COMMITMENTS
In January 1999, the Company acquired Asistencia Medica Social Argentina,
Argentina's largest health maintenance organization, for approximately $100
million. The Company also announced the formation of a pension joint venture
with Poland's sixth-largest bank. The Company's interest in the joint venture
is not material.
LEASES
The Company has entered into operating leases for office space and certain
computer and other equipment. Rental expenses for these items were $224
million, $192 million and $179 million for 1998, 1997 and 1996, respectively.
The future net minimum payments under noncancelable leases for 1999 through
2003 are estimated to be $247 million, $183 million, $127 million, $106 million
and $89 million, respectively, and $307 million thereafter.
In connection with the property-casualty sale, 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. In
1996, the Company recorded a charge of $292 million pretax ($190 million after
tax) which represents the present value of the difference between rent required
to be paid by the Company under the lease and future rentals expected to be
received by the Company. Lease payments are charged to this reserve as they are
made and will continue to be charged to this reserve over the remaining lease
term. At December 31, 1998, the balance in this facilities reserve was $288
million. Future payments under the lease, net of expected subrentals (which are
to be applied against the reserve and are not included in the future net
minimum payments above), are approximately $36 million in each of the next five
years and $179 million attributable to the subsequent five years.
Page 105
<PAGE> 106
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 State 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 Connecticut actions were transferred
to the United States District Court for the Eastern District of Pennsylvania
(the "Court") for consolidated pretrial proceedings with the cases pending
there. The plaintiffs filed a Consolidated and Amended Complaint (the
"Complaint") seeking, among other remedies, unspecified damages resulting from
defendants' alleged violations of federal securities laws. The Complaint
alleged 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 Company and the individual defendants filed a
motion to dismiss the Complaints on July 31, 1998. On February 2, 1999, the
Court dismissed the Complaints, but granted the plaintiffs leave to file a
second amended complaint. On February 22, 1999, the plaintiffs filed a second
amended complaint against the Company, Ronald E. Compton and Richard L. Huber.
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 bad faith,
medical malpractice and other litigation in its health business. Aetna U.S.
Healthcare of California, Inc., an indirect subsidiary of the Company, is
currently a party to such an action brought by Teresa Goodrich, individually
and as successor in interest of David Goodrich. The action was originally filed
in March 1996 in Superior Court for the state of California, county of San
Bernardino. The action alleges damages for unpaid medical bills, punitive
damages and compensatory damages for wrongful death based upon alleged denial
of claims for services provided to David Goodrich by out of network providers
without prior authorization. On January 20, 1999 a jury rendered a verdict in
favor of the plaintiff for $750,000 for unpaid medical bills, $3.7 million for
wrongful death and $116 million for punitive damages. Aetna U.S. Healthcare of
California, Inc. intends to appeal the verdict and will continue to vigorously
defend this matter. 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 106
<PAGE> 107
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the financial statements of Aetna Inc., which
have been prepared in accordance with generally accepted accounting principles.
The financial statements are the product of a number of processes that include
the gathering of financial data developed from the records of the Company's
day-to-day business transactions. Informed judgments and estimates are used for
those transactions not yet complete or for which the ultimate effects cannot be
measured precisely. The Company emphasizes the selection and training of
personnel who are qualified to perform these functions. In addition, Company
personnel are subject to rigorous standards of ethical conduct that are widely
communicated throughout the organization.
The Company's internal controls are designed to reasonably assure that Company
assets are safeguarded from unauthorized use or disposition and that Company
transactions are authorized, executed and recorded properly. Company personnel
maintain and monitor these internal controls on an ongoing basis. In addition,
the Company's internal auditors review and report upon the functioning of these
controls with the right of full access to all Company personnel.
The Company engages KPMG LLP as independent auditors to audit its financial
statements and express their opinion thereon. Their audits include reviews and
tests of the Company's internal controls to the extent they believe necessary
to determine and conduct the audit procedures that support their opinion.
Members of that firm also have the right of full access to each member of
management in conducting their audits. The report of KPMG LLP appears below.
Aetna's Board of Directors has an Audit Committee composed solely of
independent directors. The Committee meets periodically with management, the
internal auditors and KPMG LLP to oversee and monitor the work of each and to
inquire of each as to their assessment of the performance of the others in
their work relating to the Company's financial statements. Both the independent
and internal auditors have, at all times, the right of full access to the Audit
Committee, without management present, to discuss any matter they believe
should be brought to the attention of the Committee.
Page 107
<PAGE> 108
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors
Aetna Inc.:
We have audited the accompanying consolidated balance sheets of Aetna Inc. and
Subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the aforementioned consolidated financial statements present
fairly, in all material respects, the financial position of Aetna Inc. and
Subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1998, in conformity with generally accepted accounting principles.
As discussed in Note 2, the accompanying consolidated financial statements have
been restated.
/s/ KPMG LLP
Hartford, Connecticut
February 3, 1999, except as to
the fourth paragraph of Note 23,
which is as of February 22, 1999
and Note 2, which is as of
February 7, 2000
Page 108
<PAGE> 109
QUARTERLY DATA (UNAUDITED)
<TABLE>
<CAPTION>
First Quarter Second Quarter
------------------------ --------------------------
As As
As Previously As Previously
1998 (1)(2) (Millions, except per common share data) Restated Reported Restated Reported
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenue $ 4,624.8 $4,633.5 $4,819.3 $ 4,828.1
- ------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 264.2 $ 279.2 $ 417.8 $ 432.8
Income taxes 106.5 111.7 161.8 167.1
==============================================================================================================================
Net income $ 157.7 $ 167.5 $ 256.0 $ 265.7
==============================================================================================================================
Net income applicable to common shareholders $ 143.8 $ 153.6 $ 242.1 $ 251.8
==============================================================================================================================
Per Common Share Results: (3)
Net income
Basic $ .99 $ 1.05 $ 1.67 $ 1.74
Diluted .98 1.05 1.63 1.69
- ------------------------------------------------------------------------------------------------------------------------------
Common Stock Data:
Dividends declared $ .20 $ .20 $ .20 $ .20
Common stock prices, high 87.69 87.69 88.19 88.19
Common stock prices, low 69.63 69.63 71.31 71.31
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Third Quarter Fourth Quarter
------------------------ ---------------------------
As As
As Previously As Previously
1998 (1)(2) (Millions, except per common share data) Restated Reported Restated Reported
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenue $5,430.5 $5,439.2 $5,754.5 $5,703.3
- ------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 335.3 $ 350.3 $ 391.0 $ 346.0
Income taxes 132.7 137.9 159.2 143.5
==============================================================================================================================
Net income $ 202.6 $ 212.4 $ 231.8 $ 202.5
==============================================================================================================================
Net income applicable to common shareholders $ 188.8 $ 198.6 $ 218.1 $ 188.8
==============================================================================================================================
Per Common Share Results: (3)
Net income
Basic $ 1.32 $ 1.38 $ 1.53 $ 1.33
Diluted 1.30 1.36 1.50 1.31
- ------------------------------------------------------------------------------------------------------------------------------
Common Stock Data:
Dividends declared $ .20 $ .20 $ .20 $ .20
Common stock prices, high 80.31 80.31 82.13 82.13
Common stock prices, low 60.19 60.19 63.56 63.56
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Third quarter includes a benefit of $44.2 million after tax ($68.0 million
pretax) from a reduction of the reserve for loss on discontinued products.
(2) Fourth quarter includes a gain related to the sale of the life business of
$64 million after tax ($98.9 million pretax) and a net after-tax severance
and facilities charge of $1 million.
(3) Calculation of the earnings per share is based on weighted average shares
outstanding during each quarter and, accordingly, the sum may not equal
the total for the year.
Page 109
<PAGE> 110
<TABLE>
<CAPTION>
1997 (1)(2)(3) (Millions, except per common share data) First Second Third Fourth
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenue $4,486.7 $ 4,628.3 $4,632.3 $ 4,792.9
- ------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 487.9 $ 370.1 $ 211.2 $ 442.0
Income taxes 208.6 140.0 93.4 168.1
- ------------------------------------------------------------------------------------------------------------------------------
Net income $ 279.3 $ 230.1 $ 117.8 $ 273.9
==============================================================================================================================
Net income applicable to common shareholders $ 265.4 $ 216.2 $ 104.0 $ 260.0
==============================================================================================================================
Per Common Share Results: (4)
Net income
Basic $ 1.77 $ 1.44 $ .70 $ 1.76
Diluted 1.72 1.43 .69 1.71
- ------------------------------------------------------------------------------------------------------------------------------
Common Stock Data:
Dividends declared $ .20 $ .20 $ .20 $ .20
Common stock prices, high 92.88 112.75 117.00 80.38
Common stock prices, low 74.00 83.63 81.00 67.00
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) First quarter includes a benefit of $108.4 million after tax ($172.5
million pretax) from a reduction of the reserve for loss on discontinued
products.
(2) First and second quarters include after-tax reductions of the severance
and facilities reserves of $9.1 million and $20.2 million, respectively.
(3) The third quarter includes an increase in the reserve for HMO medical
claims of $103.0 million after tax ($161 million pretax), the majority of
which relates to the first two quarters of 1997.
(4) Calculation of the earnings per share is based on weighted average shares
outstanding during each quarter and, accordingly, the sum may not equal
the total for the year.
2. Financial statement schedules:
The supporting schedules of the consolidated entity are included in this Item
14. See Index to Financial Statement Schedules on page 117.
3. Exhibits: *
(3) Articles of Incorporation and By-Laws.
Aetna Inc. Amended and Restated Certificate of Incorporation, incorporated
herein by reference to the Company's Registration Statement on Form S-4 (File
No. 333-5791) filed on June 12, 1996.
Aetna Inc. Bylaws, as amended, incorporated herein by reference to the
Company's Form 10-K filed on February 28, 1997.
(4) Instruments defining the rights of security holders, including indentures.
Senior Indenture, dated July 1, 1996, between the Company, Aetna Services, Inc.
(formerly Aetna Life and Casualty Company), and State Street Bank and Trust
Company of Connecticut, National Association, as Trustee, incorporated herein
by reference to the Company's Form 10-Q filed on October 25, 1996.
Form of Subordinated Indenture, dated as of July 1, 1996, among the Company,
Aetna Services, Inc., and State Street Bank and Trust Company of Connecticut,
National Association, as Trustee (including the forms of Subordinated Debt
Securities and Subordinated Debt Guarantees), incorporated herein by reference
to the Company's and Aetna Services, Inc.'s Amendment No. 1 to its Registration
Statement on Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02;
333-52321-03; 333-52321-04; 333-52321-05) filed on June 19, 1998.
Form of Junior Subordinated Indenture among the Company, Aetna Services, Inc.,
and The First National Bank of Chicago, as Trustee, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Amendment No. 1 to its
Registration Statement on Form S-3 (File Nos. 333-52321; 333-52321-01;
333-52321-02; 333-52321-03; 333-52321-04; 333-52321-05) filed on June 19, 1998.
Page 110
<PAGE> 111
Form of Supplemental Indenture to be used in connection with the issuance of
Junior Subordinated Debt Securities and Preferred Securities (including the
forms of the Junior Subordinated Debt Securities and Junior Subordinated Debt
Guarantees), incorporated herein by reference to the Company's and Aetna
Services, Inc.'s Amendment No. 1 to its Registration Statement on Form S-3
(File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03; 333-52321-04;
333-52321-05) filed on June 19, 1998.
Declaration of Trust of Aetna Capital Trust I, incorporated herein by reference
to the Company's and Aetna Services, Inc.'s Registration Statement on Form S-3
(File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03; 333-52321-04;
333-52321-05) filed on May 11, 1998.
Declaration of Trust of Aetna Capital Trust II, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Declaration of Trust of Aetna Capital Trust III, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Declaration of Trust of Aetna Capital Trust IV, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Certificate of Trust of Aetna Capital Trust I, incorporated herein by reference
to the Company's and Aetna Services, Inc.'s Registration Statement on Form S-3
(File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03; 333-52321-04;
333-52321-05) filed on May 11, 1998.
Certificate of Trust of Aetna Capital Trust II, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Certificate of Trust of Aetna Capital Trust III, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Certificate of Trust of Aetna Capital Trust IV, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Registration Statement on
Form S-3 (File Nos. 333-52321; 333-52321-01; 333-52321-02; 333-52321-03;
333-52321-04; 333-52321-05) filed on May 11, 1998.
Form of Amended and Restated Declaration of Trust for each of Aetna Capital
Trust I, II, III, and IV (including the form of Preferred Securities),
incorporated herein by reference to the Company's and Aetna Services, Inc.'s
Amendment No. 1 to its Registration Statement on Form S-3 (File Nos. 333-52321;
333-52321-01; 333-52321-02; 333-52321-03; 333-52321-04; 333-52321-05) filed on
June 19, 1998.
Form of Guarantee Agreement among the Company, Aetna Services, Inc., and The
First National Bank of Chicago, as Trustee, with respect to each of Aetna
Capital Trust I, II, III and IV's Preferred Securities, incorporated herein by
reference to the Company's and Aetna Services, Inc.'s Amendment No. 1 to its
Registration Statement on Form S-3 (File Nos. 333-52321; 333-52321-01;
333-52321-02; 333-52321-03; 333-52321-04; 333-52321-05) filed on June 19, 1998.
Designations, Rights and Preferences of Class B Voting Preferred Stock; Class B
Voting Preferred Stock, Series A; and 6.25% Class C Voting Preferred Stock;
incorporated herein by reference to Exhibit 4.1 to the Company's Form 8-K filed
on July 26, 1996.
Page 111
<PAGE> 112
Aetna Inc. Rights Agreement, incorporated herein by reference to the Company's
Form 8-K filed on July 26, 1996.
Indenture, dated as of October 15, 1986, between Aetna Services, Inc. (formerly
Aetna Life and Casualty Company) and The First National Bank of Boston,
Trustee, incorporated herein by reference to the Company's Form 10-K filed on
February 26, 1999.
First Indenture Supplement, dated as of August 1, 1996, to Indenture, dated as
of October 15, 1986, between Aetna Services, Inc. and State Street Bank and
Trust Company, as Successor Trustee, incorporated herein by reference to the
Company's Form 10-Q filed on October 25, 1996.
Indenture, dated as of August 1, 1993, between Aetna Services, Inc. and State
Street Bank and Trust Company of Connecticut, National Association, as Trustee,
incorporated herein by reference to Aetna Services, Inc.'s Registration
Statement on Form S-3 (File No. 33-50427).
First Indenture Supplement, dated as of August 1, 1996, to the Indenture dated
as of August 1, 1993 between Aetna Services, Inc. and State Street Bank and
Trust Company of Connecticut, National Association, as Trustee, incorporated
herein by reference to the Company's Form 10-Q filed on October 25, 1996.
Written Action, dated as of November 15, 1994, establishing the terms of Series
A Preferred Securities of Aetna Capital L.L.C., incorporated herein by
reference to Aetna Services, Inc.'s Form 8-K filed on November 22, 1994.
Subordinated Indenture, dated as of November 1, 1994, between Aetna Services,
Inc. and The First National Bank of Chicago, as Trustee, incorporated herein by
reference to Aetna Services, Inc.'s Form 8-K filed on November 22, 1994.
First Indenture Supplement, dated as of August 1, 1996, to the Indenture, dated
as of November 1, 1994, between Aetna Services, Inc. and The First National
Bank of Chicago, as Trustee, incorporated herein by reference to the Company's
Form 10-Q filed on October 25, 1996.
Payment and Guarantee Agreement, dated November 22, 1994, of Aetna Services,
Inc. with respect to Aetna Capital L.L.C., incorporated herein by reference to
Aetna Services, Inc.'s Form 8-K filed on November 22, 1994.
Payment and Guarantee Agreement, dated as of August 1, 1996, of Aetna Inc. with
respect to Aetna Capital L.L.C., incorporated herein by reference to the
Company's Form 10-Q filed on October 25, 1996.
Amendment No. 1, dated as of August 1, 1996, to the Fiscal Agency Agreement,
dated as of July 17, 1986, between Aetna Services, Inc. and State Street Bank
and Trust Company, as successor Fiscal Agent, incorporated herein by reference
to the Company's Form 10-Q filed on October 25, 1996.
(10) Material contracts.
Employment Agreement, dated as of March 30, 1996, by and between U.S.
Healthcare, Inc. and Michael Cardillo, incorporated herein by reference to the
Company's Form 10-Q filed on October 25, 1996.**
Stock Purchase Agreement, dated as of November 28, 1995, between The Travelers
Insurance Group Inc. and Aetna Services, Inc. relating to the purchase and sale
of 100% of the Common Stock of The Aetna Casualty and Surety Company and The
Standard Fire Insurance Company, incorporated herein by reference to Aetna
Services, Inc.'s 1995 Form 10-K.
Letter Agreement, dated as of January 19, 1995, between Aetna Services, Inc.
and Richard L. Huber, incorporated herein by reference to Aetna Services,
Inc.'s 1995 Form 10-K.**
Employment Agreement, dated as of December 19, 1995, between Aetna Services,
Inc. and Daniel P. Kearney, incorporated herein by reference to Aetna Services,
Inc.'s 1995 Form 10-K.**
Page 112
<PAGE> 113
Letter Agreement, dated as of January 31, 1996, between Aetna Services, Inc.
and The Travelers Insurance Group Inc., incorporated herein by reference to
Aetna Services, Inc.'s Form 10-Q filed on April 26, 1996.
Amendment, dated as of April 2, 1996, to Stock Purchase Agreement, dated as of
November 28, 1995, between Aetna Services, Inc. and The Travelers Insurance
Group Inc., incorporated herein by reference to Aetna Services, Inc.'s Form
10-Q filed on April 26, 1996.
Registration Rights Agreement, dated as of March 30, 1996, between the Company
and Leonard Abramson, incorporated herein by reference to Aetna Services,
Inc.'s Form 10-Q filed on April 26, 1996.
Amendment No. 1, dated as of May 30, 1996, to the Registration Rights
Agreement, dated as of March 30, 1996, between the Company and Leonard
Abramson, incorporated herein by reference to the Company's Registration
Statement on Form S-4 (Registration No. 333-5791) filed on June 12, 1996.
Amended and Restated Agreement, dated as of May 30, 1996, between the Company
and Leonard Abramson, incorporated herein by reference to the Company's
Registration Statement on Form S-4 (Registration No. 333-5791) filed on June
12, 1996.
The Aetna Inc. 1996 Stock Incentive Plan, incorporated herein by reference to
the Company's Registration Statement on Form S-4 (Registration No. 333-5791)
filed on June 12, 1996.**
The Aetna Inc. Annual Incentive Plan, incorporated herein by reference to the
Company's Registration Statement on Form S-4 (Registration No. 333-5791) filed
on June 12, 1996.**
The Aetna Inc. Non-Employee Director Deferred Stock and Deferred Compensation
Plan, as amended, incorporated herein by reference to Company's Form 10-K filed
on February 28, 1997.**
The Supplemental Pension Benefit Plan for Certain Employees of Aetna Services,
Inc., incorporated herein by reference to the Company's Form 10-Q filed on
October 25, 1996.**
Amendment No. 1, dated March 1, 1996 to Letter Agreement, dated January 19,
1995, between Aetna Services, Inc. and Richard L. Huber, incorporated herein by
reference to the Company's Registration Statement on Form S-4 (Registration No.
333-5791) filed on June 12, 1996.**
Amended and Restated U.S. Healthcare, Inc. Savings Plan, incorporated herein by
reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.**
Amended and Restated Pension Plan for Employees of U.S. Healthcare, Inc.,
incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form 10-K
filed on March 25, 1996.**
Split Dollar Insurance Agreement, dated as of February 1, 1990, among Madlyn K.
Abramson, Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith
Abramson and David B. Soll, and U.S. Healthcare, Inc., and the related
Collateral Assignment Agreement, dated as of February 1, 1990, among Madlyn K.
Abramson, Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith
Abramson and David B. Soll, and U.S. Healthcare, Inc., incorporated herein by
reference to U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.
Split Dollar Insurance Agreement, dated as of January 21, 1991, among Marcy A.
Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson, David B.
Soll, Jerome Goodman and Edward M. Glickman, and U.S. Healthcare, Inc., and the
related Collateral Assignment Agreement, dated as of January 21, 1991, among
Marcy A. Shoemaker (formerly Marcy Abramson), Nancy Wolfson, Judith Abramson,
David B. Soll, Jerome Goodman and Edward M. Glickman, and U.S. Healthcare,
Inc., incorporated herein by reference to U.S. Healthcare, Inc.'s 1995 Form
10-K filed on March 25, 1996.
Page 113
<PAGE> 114
Description of Deferred Compensation Plan, incorporated herein by reference to
U.S. Healthcare, Inc.'s 1995 Form 10-K filed on March 25, 1996.**
Voting Agreement, dated as of March 30, 1996, among Leonard Abramson, Aetna
Life Insurance Company and Aetna Life Insurance and Annuity Company,
incorporated herein by reference to Aetna Services, Inc.'s Form 10-Q filed on
April 26, 1996.
Agreement and Plan of Merger, dated as of March 30, 1996, among Aetna Services,
Inc., U.S. Healthcare, Inc., the Company, Antelope Sub, Inc. and New Merger
Corporation, incorporated herein by reference to Aetna Services, Inc.'s Form
10-Q filed on April 26, 1996.
Amendment No. 1, dated as of May 30, 1996, to the Agreement and Plan of Merger,
dated as of March 30, 1996, among Aetna Services, Inc., U.S. Healthcare, Inc.,
the Company, Antelope Sub. Inc. and New Merger Corporation, incorporated herein
by reference to the Company's Registration Statement on Form S-4 (Registration
No. 333-5791) filed on June 12, 1996.
Aetna Services, Inc. Credit Facility, incorporated herein by reference to Aetna
Services, Inc.'s Form 8-K filed on July 16, 1996.
Notification from Aetna Services, Inc. dated October 22, 1996 electing to
reduce Credit Facility to $1.5 billion, incorporated herein by reference to the
Company's Form 10-K filed on February 28, 1997.
Amendment, dated as of September 4, 1997, to the Amended and Restated
Agreement, dated as of May 30, 1996, between the Company and Leonard Abramson,
incorporated herein by reference to the Company's Form 10-Q filed on November
4, 1997.
Amendment, dated as of September 8, 1997, to Employment Agreement, as of
December 19, 1995, between Aetna Services, Inc. and Daniel P. Kearney,
incorporated herein by reference to the Company's Form 10-Q filed on November
4, 1997.**
Amendment No. 1, dated as of December 31, 1996, to the Supplemental Pension
Benefit Plan for Certain Employees of Aetna Services, Inc., incorporated herein
by reference to the Company's Form 10-Q filed on May 6, 1997.**
Amendment No. 2, dated as of February 28, 1997, to the Supplemental Pension
Benefit Plan for Certain Employees of Aetna Services, Inc., incorporated herein
by reference to the Company's Form 10-Q filed on May 6, 1997.**
Employment Agreement, dated as of March 6, 1997, by and between the Company and
Joseph Sebastianelli, incorporated herein by reference to the Company's Form
10-Q filed on May 6, 1997.**
Amendment dated as of April 9, 1997, to the Amended and Restated Agreement,
dated as of May 10, 996, between the Company and Leonard Abramson, incorporated
herein by reference to the Company's Form 10-Q filed on May 6, 1997.
Amendment dated as of July 22, 1996, to Letter Agreement, dated as of January
19, 1995, between the Company and Richard L. Huber incorporated herein by
reference to the Company's Form 10-Q filed on May 6, 1997.**
Amendment dated as of July 22, 1996, to Employment Agreement, dated as of
January 19, 1995, between the Company and Ronald E. Compton, incorporated
herein by reference to the Company's Form 10-Q filed on May 6, 1997.**
Amendment dated as of July 22, 1996, to Employment Agreement, dated as of
December 19, 1995, between Aetna Services, Inc. and Daniel P. Kearney,
incorporated herein by reference to the Company's Form 10-Q filed on May 6,
1997.**
Page 114
<PAGE> 115
Employment Agreement, dated as of December 21, 1995, by and between Aetna
Services, Inc. and Frederick C. Copeland, Jr., as amended, incorporated herein
by reference to the Company's Form 10-K filed on March 3, 1998.**
Employment Agreement, dated as of December 21, 1995, by and between Aetna
Services, Inc. and Thomas McInerney, as amended, incorporated herein by
reference to the Company's Form 10-K filed on March 3, 1998.**
Description of certain arrangements not embodied in formal documents, as
described under the headings "Director Compensation" and "Executive
Compensation", are incorporated herein by reference to the Company's 1999 Proxy
Statement.
Assignment dated June 29, 1998 of Credit Agreement dated as of June 28, 1996,
incorporated herein by reference to the Company's Form 10-Q filed on August 8,
1998.
The Aetna Inc. 1998 Stock Incentive Plan, incorporated herein by reference to
the Company's Registration Statement on Form S-8 (Registration No. 333-68881)
filed on December 14, 1998.
(11) Statement re: computation of per share earnings.
Incorporated herein by reference to Note 3 of Notes to Consolidated Financial
Statements in Item 14(a) of this Report on Form 10-K/A.
(12) Statement re: computation of ratios.
Statement re: computation of ratio of earnings to fixed charges for the Company
for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 and Aetna
Services for the years ended December 31, 1998, 1997 and 1996, incorporated
herein by reference to the Company's Form 10-K filed on February 26, 1999.
Statement re: computation of ratio of earnings to combined fixed charges and
preferred stock dividends for the Company for the years ended December 31,
1998, 1997, 1996, 1995 and 1994 and Aetna Services for the years ended December
31, 1998, 1997 and 1996, incorporated herein by reference to the Company's Form
10-K filed on February 26, 1999.
(13) Annual Report to security holders.
None.
(21) Subsidiaries of the registrant.
A listing of subsidiaries of Aetna Inc. is incorporated herein by reference to
the Company's Form 10-K filed on February 26, 1999.
(23) Consents of experts and counsel.
Consent of Independent Auditors to Incorporation by Reference in the
Registration Statements on Form S-3 and Form S-8.
(24) Powers of attorney, incorporated herein by reference to the Company's Form
10-K filed on February 26, 1999.
Page 115
<PAGE> 116
(27) Financial data schedule.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on November 18, 1998 relating to the
Underwriting Agreement and Pricing Agreement for the Puttable Reset Securities
(PURS) issued by the Company. The Company also filed a report on Form 8-K on
December 9, 1998 related to the Prudential health care acquisition.
* Exhibits other than those listed are omitted because they are not required
or are not applicable. Copies of exhibits are available without charge by
writing to the Office of the Corporate Secretary, Aetna Inc., 151
Farmington Avenue, Hartford, Connecticut 06156.
** Management contract or compensatory plan or arrangement.
Page 116
<PAGE> 117
INDEX TO FINANCIAL STATEMENT SCHEDULES
AETNA INC.
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report 118
I Summary of Investments - Other than Investments in Affiliates as of
December 31, 1998. 119
II Condensed Financial Information of the Registrant:
Balance sheet of Aetna Inc. as of December 31, 1998 and 1997
and the related statements of income, shareholders' equity and
cash flows for the years ended December 31, 1998, 1997 and
1996. 120
III Supplementary Insurance Information as of and for the years ended
December 31, 1998, 1997 and 1996. 126
V Valuation and Qualifying Accounts and Reserves for the years ended
December 31, 1998, 1997 and 1996. 129
</TABLE>
Certain of the required information is shown in the Consolidated Financial
Statements or Notes thereto in Item 14(a) of this Report on Form 10-K/A.
Certain information has been omitted from the schedules filed because the
information is not applicable.
Certain reclassifications have been made to the 1997 and 1996 financial
information to conform to the 1998 presentation.
Page 117
<PAGE> 118
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors
Aetna Inc.:
Under date of February 3, 1999, February 22, 1999 as to Note 23, and February
7, 2000 as to Note 2 we reported on the consolidated balance sheets of Aetna
Inc. and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1998, as contained in
the 1998 annual report on Form 10-K/A as amended on February 7, 2000. These
consolidated financial statements and our report thereon are included herein in
the annual report on Form 10-K/A for the year 1998. In connection with our
audits of the aforementioned consolidated financial statements, we also audited
the related financial statement schedules as listed in the accompanying index.
These financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
As discussed in Note 2, the accompanying consolidated financial statements have
been restated.
/s/ KPMG LLP
Hartford, Connecticut
February 3, 1999, and with respect
to the restatement February 7, 2000
Page 118
<PAGE> 119
AETNA INC. AND SUBSIDIARIES
SCHEDULE I
Summary of Investments - Other than Investments in Affiliates
As of December 31, 1998
<TABLE>
<CAPTION>
As Restated
Amount
at which
As Restated shown in the
(Millions) Cost Value* balance sheet
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Debt securities:
Bonds:
U. S. government and government agencies and authorities $ 1,863.8 $ 1,998.6 $ 1,998.6
States, municipalities and political subdivisions 531.8 550.1 550.1
U.S. corporate securities:
Utilities 2,454.8 2,578.0 2,578.0
Financial 4,739.1 4,945.9 4,945.9
Transportation/capital goods 2,313.7 2,501.9 2,501.9
Health care/consumer products 2,495.2 2,656.3 2,656.3
Natural resources 1,494.3 1,550.7 1,550.7
Other corporate securities 1,314.5 1,355.8 1,355.8
- ----------------------------------------------------------------------------------------------------------------------------------
Total U.S. corporate securities 14,811.6 15,588.6 15,588.6
- ----------------------------------------------------------------------------------------------------------------------------------
Foreign:
Government, including political subdivisions 2,722.6 2,883.8 2,883.8
Utilities 589.8 676.6 676.6
Other 2,802.2 2,868.0 2,868.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total foreign securities 6,114.6 6,428.4 6,428.4
- ----------------------------------------------------------------------------------------------------------------------------------
Residential mortgage-backed securities:
Pass-throughs 2,248.8 2,322.7 2,322.7
Collateralized mortgage obligations 1,929.2 2,041.2 2,041.2
- ----------------------------------------------------------------------------------------------------------------------------------
Total residential mortgage-backed securities 4,178.0 4,363.9 4,363.9
- ----------------------------------------------------------------------------------------------------------------------------------
Commercial/Multifamily mortgage-backed securities 2,121.8 2,123.2 2,123.2
Other asset-backed securities 954.9 971.0 971.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total bonds 30,576.5 32,023.8 32,023.8
Redeemable preferred stocks 153.6 157.0 157.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities $ 30,730.1 $ 32,180.8 $ 32,180.8
==================================================================================================================================
Equity securities:
Common stocks:
Public utilities $ 16.3 $ 20.4 $ 20.4
Banks, trust and insurance companies 16.5 19.5 19.5
Industrial, miscellaneous and all other 500.3 527.0 527.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total common stocks 533.1 566.9 566.9
Nonredeemable preferred stocks 229.5 233.6 233.6
==================================================================================================================================
Total equity securities $ 762.6 $ 800.5 $ 800.5
==================================================================================================================================
Short-term investments $ 942.2 $ 942.2
Mortgage loans 3,553.0 3,553.0
Real estate 270.3 270.3
Policy loans 458.7 458.7
Other 807.2(1) 1,300.3(2)
==================================================================================================================================
Total investments $ 37,524.1 $ 39,505.8
==================================================================================================================================
</TABLE>
* See Notes 1 and 6 of Notes to Consolidated Financial Statements in Item
14(a) of this Report on Form 10-K/A.
(1) Excludes investments in affiliates of $493.1 million.
(2) Includes investments in affiliates of $493.1 million.
Page 119
<PAGE> 120
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Statements of Income
<TABLE>
<CAPTION>
For the year ended December 31,
(Millions) 1998 1997 1996
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $ 2.0 $ .5 $ 1.2
----------------------------------------------------------------------------------------------------------------------------
Total revenue 2.0 .5 1.2
Operating expenses - - .2
----------------------------------------------------------------------------------------------------------------------------
Total expenses - - .2
----------------------------------------------------------------------------------------------------------------------------
Income before income taxes and equity in earnings of affiliates 2.0 .5 1.0
Income taxes .6 .1 .5
Equity in earnings of affiliates 846.7 900.7 204.6
----------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 848.1 901.1 205.1
Discontinued Operations, net of tax:
Income from operations - - 182.2
Gain on sale - - 263.7
----------------------------------------------------------------------------------------------------------------------------
Net income $ 848.1 $ 901.1 $ 651.0
============================================================================================================================
</TABLE>
See Notes to Condensed Financial Statements.
Page 120
<PAGE> 121
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Balance Sheets
<TABLE>
<CAPTION>
As of December 31,
(Millions, except share data) 1998 1997
-----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investments:
Short-term investments $ 3.1 $ 3.2
Investments in affiliates 11,400.7 11,049.2
-----------------------------------------------------------------------------------------------------------
Total investments 11,403.8 11,052.4
Cash and cash equivalents 15.8 22.1
Due from affiliates 2.2 5.4
Affiliate dividends receivable 50.0 200.0
Deferred income taxes 1.5 1.1
-----------------------------------------------------------------------------------------------------------
Total assets $ 11,473.3 $ 11,281.0
===========================================================================================================
Liabilities:
Dividends payable to shareholders $ 35.2 $ 36.1
Other liabilities 29.0 29.3
Current income taxes 20.2 20.2
-----------------------------------------------------------------------------------------------------------
Total liabilities 84.4 85.6
-----------------------------------------------------------------------------------------------------------
Shareholders' Equity:
Class C Voting Mandatorily Convertible Preferred Stock ($.01 par value;
15,000,000 shares authorized;
11,614,816 in 1998 and 11,655,206 in 1997 issued and outstanding) 862.1 865.4
Common stock ($.01 par value; 500,000,000 shares authorized,
141,272,628 in 1998 and 145,794,844 in 1997 issued and
outstanding) 3,292.4 3,644.4
Accumulated other comprehensive income 177.8 307.1
Retained earnings 7,056.6 6,378.5
-----------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,388.9 11,195.4
-----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 11,473.3 $ 11,281.0
===========================================================================================================
</TABLE>
See Notes to Condensed Financial Statements.
Page 121
<PAGE> 122
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Statements of Shareholders' Equity
<TABLE>
<CAPTION>
For the three years ended December 31, 1998
-----------------------------------------------------------------------------
Class C
Accumulated Other Voting
Comprehensive Income Mandatorily
Unrealized Foreign Convertible
Retained Gains(Losses) Currency Preferred Common
(Millions, except share data) Total Earnings on Securities Gains(Losses) Stock Stock
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1995 $ 7,272.8 $ 5,195.6 $ 797.0 $ (155.9) $ - $ 1,436.1
====================================================================================================================================
Comprehensive income:
Net income 651.0 651.0
Other comprehensive loss, net of tax:
Unrealized losses on securities
(($527.6) pretax) (342.8) (342.8)
Foreign currency ($64.2 pretax) 41.7 41.7
---------
Other comprehensive loss (301.1)
---------
Total comprehensive income 349.9
=========
Issued for U.S. Healthcare merger:
Class C voting mandatorily convertible
preferred stock (11,655,546 shares) 865.4 865.4
Common shares (34,988,615 shares) 2,580.1 2,580.1
Stock options 24.8 24.8
Common stock issued for benefit plans
(1,563,491 shares) 75.1 75.1
Repurchase of common shares (1,194,400 shares) (83.3) (83.3)
Common stock dividends (170.0) (170.0)
Preferred stock dividends (25.1) (25.1)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 $ 10,889.7 $5,651.5 $ 454.2 $ (114.2) $ 865.4 $ 4,032.8
====================================================================================================================================
Comprehensive income:
Net income 901.1 901.1
Other comprehensive loss, net of tax:
Unrealized gains on securities ($81.8
pretax) 49.9 49.9
Foreign currency (($127.3) pretax) (82.8) (82.8)
---------
Other comprehensive loss (32.9)
---------
Total comprehensive income 868.2
=========
Common stock issued for benefit
plans (1,883,945 shares) 134.7 134.7
Repurchase of common shares (6,173,900 shares) (523.1) (523.1)
Common stock dividends (118.6) (118.6)
Preferred stock dividends (55.5) (55.5)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 $ 11,195.4 $ 6,378.5 $ 504.1 $ (197.0) $ 865.4 $ 3,644.4
====================================================================================================================================
Comprehensive income:
Net income 848.1 848.1
Other comprehensive loss, net of tax:
Unrealized losses on securities
(($179.8) pretax) (116.9) (116.9)
Foreign currency (($19.1) pretax) (12.4) (12.4)
---------
Other comprehensive loss (129.3)
---------
Total comprehensive income 718.8
=========
Common stock issued for benefit
plans (576,387 shares) 39.6 39.6
Repurchase of common shares (5,131,700 shares) (394.9) (394.9)
Conversion of preferred securities (40,390
preferred shares converted to 33,097 shares) - (3.3) 3.3
Common stock dividends (114.7) (114.7)
Preferred stock dividends (55.3) (55.3)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $ 11,388.9 $ 7,056.6 $ 387.2 $ (209.4) $862.1 $ 3,292.4
====================================================================================================================================
</TABLE>
See Notes to the Condensed Financial Statements.
Page 122
<PAGE> 123
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Statements of Cash Flows
<TABLE>
<CAPTION>
For the year ended December 31,
-----------------------------------------------------
(Millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 848.1 $ 901.1 $ 651.0
Adjustments to reconcile net income to net cash (used for)
provided by operating activities:
Equity in earnings of affiliates (846.7) (900.7) (204.6)
Income from Discontinued Operations - - (182.2)
Gain on sale of Discontinued Operations - - (263.7)
Other, net 2.4 (8.4) 27.7
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities 3.8 (8.0) 28.2
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Proceeds from sales of short-term investments 431.6 619.4 184.4
Cost of investments in short-term investments (431.5) (613.8) (193.2)
Cost of investment in U.S. Healthcare - - (5,243.9)
Capital contributions to affiliates - (160.0) (500.0)
Dividends received from affiliates 520.0 746.2 5,938.0
Other, net (4.0) (25.3) 35.2
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 516.1 566.5 220.5
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Common stock issued under benefit plans 39.6 134.7 75.1
Common shares repurchased (394.9) (523.1) (83.3)
Dividends paid to shareholders (170.9) (174.9) (237.3)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (526.2) (563.3) (245.5)
- ------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (6.3) (4.8) 3.2
Cash and cash equivalents, beginning of year 22.1 26.9 23.7
- ------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 15.8 $ 22.1 $ 26.9
==============================================================================================================================
Supplemental disclosure of cash flow information:
Interest paid $ - $ - $ -
Income taxes received, net $ 1.0 $ 1.0 $ .5
==============================================================================================================================
</TABLE>
See Notes to Condensed Financial Statements.
Page 123
<PAGE> 124
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Notes to Condensed Financial Statements
1. Background of Organization
Aetna Inc. was incorporated under the Stock Corporation Act of the state of
Connecticut on March 25, 1996 for the purpose of effecting the combination of
Aetna Services, Inc. ("Aetna Services") (formerly Aetna Life and Casualty
Company) and Aetna U.S. Healthcare Inc. ("Aetna U.S. Healthcare") (formerly
U.S. Healthcare, Inc. ("U.S. Healthcare")) in accordance with the terms of the
Agreement and Plan of Merger dated as of March 30, 1996. The merger was
consummated on July 19, 1996. As a result, Aetna Services and Aetna U.S.
Healthcare are each direct wholly owned subsidiaries of Aetna Inc.
The accompanying condensed financial statements include for 1996, the results
of operations of Aetna Services from January 1, 1996 and of Aetna U.S.
Healthcare from July 19, 1996 which are reflected as Equity in Earnings of
Affiliates on the Statement of Income. These financial statements should be
read in conjunction with the Consolidated Financial Statements and Notes
thereto in Item 14(a) of this Report on Form 10-K/A.
2. 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. ACLLC has issued $275 million of
redeemable preferred stock and the Subordinated Debentures represent
substantially all of the assets of ACLLC. See Note 16 of Notes to Consolidated
Financial Statements in Item 14(a) of this Report on Form 10-K/A for a
description of outstanding debt.
3. Dividends
Cash dividends paid to Aetna Inc. by Aetna Services were $.5 billion, $.4
billion and $5.3 billion in 1998, 1997 and 1996. Cash dividends paid to Aetna
Inc. by Aetna U.S. Healthcare were $.3 billion and $.6 billion in 1997 and
1996, respectively. No dividends were paid by Aetna U.S. Healthcare in 1998.
Also, in 1997 Aetna U.S. Healthcare made a non-cash dividend of $.3 billion to
Aetna Inc. The 1996 dividends included the dividend by Aetna Services of the
net proceeds from the sale of the property-casualty operations. The 1996
dividends from Aetna Services were used to finance the cash portion of the U.S.
Healthcare merger consideration. See Note 18 of Notes to Consolidated Financial
Statements in Item 14(a) of this Report on Form 10-K/A for a description of
dividend restrictions.
Page 124
<PAGE> 125
AETNA INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information
AETNA INC.
Notes to Condensed Financial Statements (Continued)
4. New Accounting Standards
See Note 1 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a description of new accounting standards.
5. Discontinued Products
See Note 11 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a description of discontinued products.
6. Other Acquisitions and Dispositions
See Note 5 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a description of other acquisitions and dispositions.
7. Severance and Facilities Charges
See Note 10 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a description of the severance and facilities
charges.
8. Income Taxes
See Note 12 of Notes to Consolidated Financial Statements in Item 14(a) of this
Report on Form 10-K/A for a description of income taxes.
Page 125
<PAGE> 126
AETNA INC. AND SUBSIDIARIES
SCHEDULE III
Supplementary Insurance Information
As of and for the year ended December 31, 1998
<TABLE>
<CAPTION>
Deferred Unpaid Policyholders'
policy Future claims funds left
acquisition policy and claims Unearned with the Premium
Segment costs benefits expenses premiums Company revenue
- ---------------------------------------------------------------------------------------------------------------------------------
(Millions)
<S> <C> <C> <C> <C> <C> <C>
Aetna U.S. Healthcare $ 3.6 $ 1,165.8 $ 3,807.1 $ 306.3 $ 608.5 $ 13,006.2
Aetna Retirement Services 893.1 4,178.0 14.4 - 11,473.9 131.9
Aetna International 871.9 4,429.3 131.0 122.6 343.7 1,578.5
Large Case Pensions - 8,768.0 1.4 - 5,206.4 122.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total $ 1,768.6 $ 18,541.1 $ 3,953.9 $ 428.9 $ 17,632.5 $ 14,839.3
=================================================================================================================================
<CAPTION>
As Restated
------------------------------
Other income Amortization
(including of deferred
realized Current policy Other
Net investment capital gains and future acquisition operating Premiums
Segment income (1) and losses) benefits costs expenses (3) written (4)
- ---------------------------------------------------------------------------------------------------------------------------------
(Millions)
<S> <C> <C> <C> <C> <C> <C>
Aetna U.S. Healthcare $ 537.2 $ 1,576.0 $ 11,186.5 $ .6 $ 3,133.3 $ 12,058.7
Aetna Retirement Services 1,024.5 731.0 918.2 128.3 408.6 -
Aetna International 459.8 109.3 1,336.6 86.4 532.7 594.7
Large Case Pensions 1,152.5 76.0 1,054.4 (2) - 24.4 -
Corporate 16.9 106.6 - - 410.8 -
- ---------------------------------------------------------------------------------------------------------------------------------
Total $ 3,190.9 $ 2,598.9 $ 14,495.7 $ 215.3 $ 4,509.8 $ 12,653.4
=================================================================================================================================
</TABLE>
(1) The allocation of net investment income is based upon the investment year
method or specific identification of certain portfolios within specific
segments.
(2) Includes reductions of the loss on discontinued products.
(3) Includes operating expenses, interest expense, amortization of goodwill and
other acquired intangible assets and severance and facilities charges
(reserve reductions).
(4) Excludes life insurance business pursuant to Regulation S-X.
Page 126
<PAGE> 127
AETNA INC. AND SUBSIDIARIES
SCHEDULE III
Supplementary Insurance Information
As of and for the year ended December 31, 1997
<TABLE>
<CAPTION>
Deferred Unpaid Policyholders'
policy Future claims funds left
acquisition policy and claims Unearned with the Premium
Segment costs benefits expenses premiums Company revenue
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(Millions)
Aetna U.S. Healthcare $ 19.5 $ 1,166.5 $ 3,163.5 $ 254.2 $ 556.9 $ 10,844.6
Aetna Retirement Services 1,645.3 4,111.9 40.4 - 11,339.5 158.5
Aetna International 702.5 3,430.7 89.0 105.0 384.1 1,434.1
Large Case Pensions - 9,128.0 1.5 - 6,480.7 155.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 2,367.3 $ 17,837.1 $ 3,294.4 $ 359.2 $ 18,761.2 $ 12,592.2
==================================================================================================================================
Amortization
Other income of deferred
(including realized Current policy Other
Net investment capital gains and future acquisition operating Premiums
Segment income (1) and losses) benefits costs expenses (3) written (4)
- ----------------------------------------------------------------------------------------------------------------------------------
(Millions)
Aetna U.S. Healthcare $ 451.2 $ 1,605.6 $ 9,239.2 $ 20.3 $ 2,797.1 $ 10,001.9
Aetna Retirement Services 1,114.7 629.3 1,034.1 110.6 385.6 -
Aetna International 384.4 157.0 1,206.3 86.6 486.1 465.0
Large Case Pensions 1,408.7 58.8 1,199.9 (2) - 34.8 -
Corporate 18.5 119.8 - - 428.4 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 3,377.5 $ 2,570.5 $ 12,679.5 $ 217.5 $ 4,132.0 $ 10,466.9
==================================================================================================================================
</TABLE>
(1) The allocation of net investment income is based upon the investment year
method or specific identification of certain portfolios within specific
segments.
(2) Includes reductions of the loss on discontinued products.
(3) Includes operating expenses, interest expense, amortization of goodwill
and other acquired intangible assets and severance and facilities charges
(reserve reductions).
(4) Excludes life insurance business pursuant to Regulation S-X.
Page 127
<PAGE> 128
AETNA INC. AND SUBSIDIARIES
SCHEDULE III
Supplementary Insurance Information
As of and for the year ended December 31, 1996
<TABLE>
<CAPTION>
Deferred Unpaid Policyholders'
policy Future claims funds left
acquisition policy and claims Unearned with the Premium
Segment costs benefits expenses premiums Company revenue
- --------------------------------------------------------------------------------------------------------------------------------
(Millions)
<S> <C> <C> <C> <C> <C> <C>
Aetna U.S. Healthcare $ 39.2 $ 1,309.2 $ 2,924.2 $ 252.8 $ 579.9 $ 7,765.2
Aetna Retirement Services 1,488.1 3,935.8 30.1 - 10,868.1 180.7
Aetna International 699.6 3,370.1 73.5 80.8 434.0 1,166.1
Large Case Pensions - 9,168.3 1.4 - 8,019.7 214.1
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 2,226.9 $ 17,783.4 $ 3,029.2 $ 333.6 $ 19,901.7 $ 9,326.1
================================================================================================================================
Other income
(including Amortization of
Net realized Current deferred policy Other
investment capital gains and future acquisition operating Premiums
Segment income (1) and losses) benefits costs expenses (3) written (4)
- --------------------------------------------------------------------------------------------------------------------------------
(Millions)
Aetna U.S. Healthcare $ 414.6 $ 1,553.9 $ 6,622.4 $ 11.9 $ 2,973.9 $ 6,982.8
Aetna Retirement Services 1,086.7 494.8 1,035.9 74.3 386.5 -
Aetna International 334.2 130.7 996.8 73.9 388.4 292.0
Large Case Pensions 1,649.2 112.3 1,521.3 (2) - 58.6 -
Corporate 80.5 17.5 - - 717.9 -
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 3,565.2 $ 2,309.2 $ 10,176.4 $ 160.1 $ 4,525.3 $ 7,274.8
================================================================================================================================
</TABLE>
(1) The allocation of net investment income is based upon the investment year
method or specific identification of certain portfolios within specific
segments.
(2) Includes reductions of the loss on discontinued products.
(3) Includes operating expenses, interest expense, amortization of goodwill
and other acquired intangible assets and severance and facilities charges.
(4) Excludes life insurance business pursuant to Regulation S-X.
Page 128
<PAGE> 129
AETNA INC. AND SUBSIDIARIES
SCHEDULE V
Valuation and Qualifying Accounts and Reserves
For the years ended December 31,
(Millions)
<TABLE>
<CAPTION>
Additions
---------------------------------
Charged
Balance at Charged (credited) to
Balance at beginning of (credited) to other Deductions- Balance
beginning period as costs accounts- describe at end of
of period Adjustments adjusted and expenses (1) describe (2) (3) period
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998
- ----
Asset valuation
reserves:
Mortgage loans $ 114.5 $ - $ 114.5 $ (8.0) $ (34.3) $ (5.3) $ 66.9
Real Estate 101.3 - 101.3 5.5 2.8 (18.5) 91.1
Other 2.8 - 2.8 - - - 2.8
- -----------------------------------------------------------------------------------------------------------------------------------
$ 218.6 $ - $ 218.6 $ (2.5) $ (31.5) $ (23.8) $ 160.8
===================================================================================================================================
1997
- ----
Asset valuation
reserves:
Mortgage loans $ 247.0 $ - $ 247.0 $ (10.6) $ (45.0) $ (76.9) $ 114.5
Real Estate 142.1 - 142.1 6.1 14.8 (61.7) 101.3
Other 2.8 - 2.8 - - - 2.8
- -----------------------------------------------------------------------------------------------------------------------------------
$ 391.9 $ - $ 391.9 $ (4.5) $ (30.2) $ (138.6) $ 218.6
===================================================================================================================================
1996
- ----
Asset valuation
reserves:
Mortgage loans $ 604.9 $ - $ 604.9 $ (33.0) $ (67.6) $ (257.3) $ 247.0
Real Estate 130.6 52.9(4) 183.5 27.1 1.9 (70.4) 142.1
Other 2.8 - 2.8 - - - 2.8
- -----------------------------------------------------------------------------------------------------------------------------------
$ 738.3 $ 52.9 $ 791.2 $ (5.9) $ (65.7) $ (327.7) $ 391.9
===================================================================================================================================
</TABLE>
(1) Charged (credited) to net realized capital (gains) losses in the
Consolidated Statements of Income.
(2) Reflects additions to (reductions of) reserves related to assets
supporting experience rated contracts and discontinued products for which
a corresponding reduction was included in Policyholders' Funds Left with
the Company in the Consolidated Balance Sheets and the reserve for future
losses, respectively.
(3) Reduction in reserves is primarily a result of related asset write-downs
(including foreclosures of real estate) and sales.
(4) As a result of the adoption of FAS No. 121, valuation reserves at January
1, 1996 were increased by $52.9 million in connection with the reversal of
previously recorded accumulated depreciation related to properties held
for sale.
Page 129
<PAGE> 130
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: February 15, 2000 AETNA INC.
By /s/ Alan M. Bennett
--------------------
Alan M. Bennett
Vice President and
Corporate Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on February 15, 2000.
<TABLE>
<S> <C>
* *
- -------------------------------------------------------- -----------------------------------------------------------
Richard L. Huber, Earl G. Graves, Director
Chairman, Chief Executive Officer,
President and Director *
-----------------------------------------------------------
(Principal Executive Officer) Gerald Greenwald, Director
* *
- -------------------------------------------------------- -----------------------------------------------------------
Leonard Abramson, Director Ellen M. Hancock, Director
* *
- -------------------------------------------------------- -----------------------------------------------------------
Betsy Z. Cohen, Director Michael H. Jordan, Director
* *
- -------------------------------------------------------- -----------------------------------------------------------
William H. Donaldson, Director Jack D. Kuehler, Director
* *
- -------------------------------------------------------- -----------------------------------------------------------
Barbara Hackman Franklin, Director Frank R. O'Keefe, Jr., Director
*
- -------------------------------------------------------- -----------------------------------------------------------
Jeffrey E. Garten, Director Judith Rodin, Director
* *
- -------------------------------------------------------- -----------------------------------------------------------
Jerome S. Goodman, Director Alan J. Weber
Vice Chairman for Strategy and Finance
(Principal Financial Officer)
/s/ Alan M. Bennett
- --------------------------------------------------------
Alan M. Bennett, Vice President
and Corporate Controller
</TABLE>
*By /s/ Alan M. Bennett
-----------------------------------------------
(Attorney-in-Fact)
Page 130
<PAGE> 131
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Filing
Number Description of Exhibit Method
- ------- ----------------------- ------
<S> <C> <C>
23 Consents of experts and counsel. Electronic
Consent of Independent Auditors to Incorporation by Reference in
the Registration Statements on Form S-3 and Form S-8.
27 Financial data schedule for December 31, 1998. Electronic
</TABLE>
Page 131
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Aetna Inc.:
We consent to incorporation by reference in the Registration Statements (No.
333-07169, No. 333-08427, No. 333-08429, No. 333-08431, No. 333-68881, No.
333-52321, No. 333-52321-01, No. 333-52321-02, No. 333-52321-03, No.
333-52321-04 and No. 333-52321-05) filed by Aetna Inc. or its Subsidiaries of
our reports dated February 3, 1999, February 22, 1999 as to Note 23 and February
7, 2000 as to Note 2, relating to the consolidated balance sheets of Aetna Inc.
and Subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of income, shareholders' equity, and cash flows and related schedules
for each of the years in the three-year period ended December 31, 1998, which
reports appear in or are incorporated by reference in the December 31, 1998
annual report on Form 10-K/A of Aetna Inc.
/s/ KPMG LLP
Hartford, Connecticut
February 15, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements contained in the Form 10-K for the fiscal year ended
December 31, 1998 for Aetna Inc. and is qualified in its entirety by reference
to such statements.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<DEBT-HELD-FOR-SALE> 32,181 34,245
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 801 1,041
<MORTGAGE> 3,553 4,208
<REAL-ESTATE> 270 370
<TOTAL-INVEST> 39,506 42,589
<CASH> 1,952 1,806
<RECOVER-REINSURE> 3,897 0
<DEFERRED-ACQUISITION> 1,769 2,367
<TOTAL-ASSETS> 105,130 96,001
<POLICY-LOSSES> 18,541 17,837
<UNEARNED-PREMIUMS> 429 359
<POLICY-OTHER> 3,954 3,294
<POLICY-HOLDER-FUNDS> 17,633 18,761
<NOTES-PAYABLE> 3,585 2,598
862 865
0 0
<COMMON> 3,292 3,644
<OTHER-SE> 7,234 6,686
<TOTAL-LIABILITY-AND-EQUITY> 105,130 96,001
14,839 12,592
<INVESTMENT-INCOME> 3,191 3,393
<INVESTMENT-GAINS> 272 334
<OTHER-INCOME> 2,327 2,234
<BENEFITS> 14,496 12,680
<UNDERWRITING-AMORTIZATION> 215 218
<UNDERWRITING-OTHER> 0 0
<INCOME-PRETAX> 1,408 1,511
<INCOME-TAX> 560 610
<INCOME-CONTINUING> 848 901
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 848 901
<EPS-BASIC> 5.50 5.67
<EPS-DILUTED> 5.41 5.60
<RESERVE-OPEN> 0 0
<PROVISION-CURRENT> 0 0
<PROVISION-PRIOR> 0 0
<PAYMENTS-CURRENT> 0 0
<PAYMENTS-PRIOR> 0 0
<RESERVE-CLOSE> 0 0
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
