<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------------------
Form 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, for the quarter ended JUNE 30, 2000.
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
---------------------------
Commission File Number 1-11913
---------------------------
Aetna Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Connecticut 02-0488491
<S> <C>
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
151 Farmington Avenue 06156
Hartford, Connecticut (ZIP Code)
(Address of principal executive offices)
</TABLE>
(860) 273-0123
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<S> <C>
Common Capital Stock (par value $.01) 141,149,275
------------------------------------- -------------------------------------------------
(Class) Shares Outstanding at June 30, 2000
</TABLE>
================================================================================
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Condensed Notes to Consolidated Financial Statements 7
Independent Auditors' Review Report 28
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. 29
Item 3. Quantitative and Qualitative Disclosures
About Market Risk. 54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 55
Item 4. Submission of Matters to a Vote of Security Holders. 60
Item 5. Other Information. 61
Item 6. Exhibits and Reports on Form 8-K. 63
Signatures 65
</TABLE>
Page 2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -----------------------
(Millions, except per common share data) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Premiums $ 6,759.1 $4,641.8 $13,153.0 $ 9,023.2
Net investment income 737.7 734.6 1,524.4 1,484.0
Fees and other income 700.3 559.3 1,413.1 1,103.8
Net realized capital gains (losses) (50.5) 9.8 (53.6) 26.9
------------------------------------------------------------------------------------------------------------------------
Total revenue 8,146.6 5,945.5 16,036.9 11,637.9
------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Current and future benefits 6,277.5 4,359.1 12,160.5 8,500.4
Operating expenses:
Salaries and related benefits 711.7 493.1 1,377.0 972.4
Other 756.4 592.4 1,545.1 1,156.9
Interest expense 68.0 64.1 150.7 128.7
Amortization of goodwill and other acquired intangible
assets 117.8 105.7 233.9 213.4
Amortization of deferred policy acquisition costs 58.3 51.7 117.1 101.7
Reduction of reserve for loss on discontinued products (146.0) (77.2) (146.0) (77.2)
------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 7,843.7 5,588.9 15,438.3 10,996.3
------------------------------------------------------------------------------------------------------------------------
Income before income taxes 302.9 356.6 598.6 641.6
Income taxes:
Current 93.4 47.3 190.2 152.6
Deferred 23.1 91.8 52.6 101.9
------------------------------------------------------------------------------------------------------------------------
Total income taxes 116.5 139.1 242.8 254.5
------------------------------------------------------------------------------------------------------------------------
Net income $ 186.4 $ 217.5 $ 355.8 $ 387.1
========================================================================================================================
Net income applicable to common ownership $ 186.4 $ 203.7 $ 355.8 $ 359.5
========================================================================================================================
Results per common share:
Basic $ 1.32 $ 1.45 $ 2.52 $ 2.55
Diluted 1.30 1.43 2.49 2.53
Dividends declared .20 .20 .40 .40
------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
Page 3
<PAGE> 4
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
(Millions, except share data) 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investments:
Debt securities available for sale, at fair value (amortized cost $31,412.9 and
$29,409.4) $ 30,736.0 $ 28,661.6
Debt securities held to maturity, at amortized cost 149.9 -
Equity securities, at fair value (cost $625.6 and $732.6) 711.1 791.1
Short-term investments 574.3 788.2
Mortgage loans 3,168.6 3,238.2
Commercial loans 1,104.2 -
Real estate 496.6 361.8
Policy loans 839.5 541.5
Other 1,702.4 1,394.8
-----------------------------------------------------------------------------------------------------------------------------
Total investments 39,482.6 35,777.2
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 3,754.7 2,504.5
Short-term investments under securities loan agreement 1,346.4 1,037.5
Accrued investment income 520.1 466.5
Premiums due and other receivables 2,361.2 2,751.1
Reinsurance recoverables 3,913.5 3,881.1
Deferred income taxes 340.6 352.0
Deferred policy acquisition costs 2,458.5 2,059.8
Goodwill and other acquired intangible assets 8,959.2 9,335.4
Other assets 1,952.9 1,341.7
Separate Accounts assets 55,145.8 53,332.2
-----------------------------------------------------------------------------------------------------------------------------
Total assets $120,235.5 $112,839.0
=============================================================================================================================
Liabilities:
Insurance liabilities:
Future policy benefits $ 23,497.3 $ 17,599.3
Unpaid claims 4,991.1 4,976.5
Unearned premiums 432.9 507.1
Policyholders' funds left with the Company 14,924.7 15,481.4
-----------------------------------------------------------------------------------------------------------------------------
Total insurance liabilities 43,846.0 38,564.3
-----------------------------------------------------------------------------------------------------------------------------
Dividends payable to shareholders 28.2 28.5
Short-term debt 1,473.4 1,887.7
Long-term debt 2,673.9 2,677.9
Payables under securities loan agreement 1,346.4 1,037.5
Current income taxes 325.6 307.6
Other liabilities 4,150.4 4,195.5
Minority and participating policyholders' interests 161.6 117.4
Separate Accounts liabilities 55,145.8 53,332.2
-----------------------------------------------------------------------------------------------------------------------------
Total liabilities 109,151.3 102,148.6
-----------------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities (Notes 4 and 11)
Shareholders' equity:
Common stock ($.01 par value; 500,000,000 shares authorized; 141,149,275 in 2000 and
142,680,694 in 1999 issued and outstanding) 3,642.0 3,719.3
Accumulated other comprehensive loss (484.2) (655.6
Retained earnings 7,926.4 7,626.7
-----------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,084.2 10,690.4
-----------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $120,235.5 $112,839.0
=============================================================================================================================
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
Page 4
<PAGE> 5
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Loss
Class C Voting ---------------------------
Mandatorily Unrealized
(Millions, except share data) Convertible Common Gains (Losses) Foreign Retained
Six Months Ended June 30, 2000 Total Preferred Stock Stock on Securities Currency Earnings
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1999 $10,690.4 $ - $3,719.3 $(206.1) $ (449.5) $7,626.7
Comprehensive income:
Net income 355.8 355.8
Other comprehensive income, net of tax:
Unrealized gains on securities
($81.4 pretax) (1) 52.9 52.9
Foreign currency ($136.8 pretax) 118.5 118.5
---------
Other comprehensive income 171.4
---------
Total comprehensive income 527.2
=========
Common stock issued for benefit
plans (255,581 shares) 17.3 17.3
Repurchase of common shares
(1,787,000 shares) (94.6) (94.6)
Common stock dividends (56.1) (56.1)
-----------------------------------------------------------------------------------------------------------------------------------
Balances at June 30, 2000 $11,084.2 $ - $3,642.0 $(153.2) $ (331.0) $7,926.4
===================================================================================================================================
<CAPTION>
Six Months Ended June 30, 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1998 $11,388.9 $ 862.1 $3,292.4 $ 387.2 $ (209.4) $7,056.6
Comprehensive loss:
Net income 387.1 387.1
Other comprehensive loss, net of tax:
Unrealized losses on securities
($(503.4) pretax) (1) (327.2) (327.2)
Foreign currency ($(121.0) pretax) (78.8) (78.8)
---------
Other comprehensive loss (406.0)
---------
Total comprehensive loss (18.9)
=========
Common stock issued for benefit
plans (569,495 shares) 42.5 42.5
Repurchase of common shares
(880,000 shares) (72.0) (72.0)
Conversion of preferred securities
(1,776 preferred shares converted to
1,454 common shares) - (.1) .1
Common stock dividends (56.3) (56.3)
Preferred stock dividends (27.6) (27.6)
-----------------------------------------------------------------------------------------------------------------------------------
Balances at June 30, 1999 $11,256.6 $862.0 $3,263.0 $ 60.0 $ (288.2) $7,359.8
===================================================================================================================================
</TABLE>
(1) Net of reclassification adjustments.
See Condensed Notes to Consolidated Financial Statements.
Page 5
<PAGE> 6
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended June 30,
(Millions) 2000 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 355.8 $ 387.1
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization (including investment discounts and premiums) 287.8 217.7
Net realized capital (gains) losses 53.6 (26.9)
Changes in assets and liabilities:
Decrease in accrued investment income 18.9 61.1
(Increase) decrease in premiums due and other receivables 55.0 (68.2)
Increase in deferred policy acquisition costs (238.0) (202.8)
Decrease in income taxes (15.7) (278.2)
Net (increase) decrease in other assets and other liabilities (155.3) 105.0
Increase in insurance liabilities 93.2 73.6
Other, net 29.5 28.4
----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 484.8 296.8
----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales and investment maturities of:
Debt securities available for sale 13,001.4 9,849.7
Equity securities 1,799.5 213.9
Mortgage loans 435.4 228.4
Real estate 12.0 40.9
Commercial loans 19.2 -
Other investments 1,446.0 260.0
Short-term investments 10,225.8 8,231.9
NYLCare Texas 420.0 -
Cost of investments in:
Debt securities available for sale (13,420.7) (9,095.6)
Debt securities held to maturity (44.1) -
Equity securities (621.7) (216.6)
Mortgage loans (356.5) (134.7)
Real estate (14.3) (41.7)
Other investments (866.7) (588.1)
Short-term investments (9,884.6) (8,060.7)
Acquisitions:
NYLCare health care business - (48.8)
Other (75.0) -
Increase in property and equipment (31.6) (11.3)
Other, net 33.5 (28.1)
----------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 2,077.6 599.2
----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Deposits and interest credited for investment contracts 1,044.4 1,386.9
Withdrawals of investment contracts (1,777.4) (1,744.8)
Repayment of long-term debt (1.1) (30.0)
Net decrease in short-term debt (417.0) (194.6)
Common stock issued under benefit plans 17.3 42.5
Common stock acquired (94.6) (72.0)
Dividends paid to shareholders (56.4) (84.1)
Other, net (30.4) (64.5)
----------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (1,315.2) (760.6)
----------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 3.0 (.8)
----------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 1,250.2 134.6
Cash and cash equivalents, beginning of period 2,504.5 1,951.5
----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 3,754.7 $ 2,086.1
======================================================================================================================
Supplemental cash flow information:
Interest paid $ 162.4 $ 117.7
Income taxes paid 193.9 374.5
----------------------------------------------------------------------------------------------------------------------
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
Page 6
<PAGE> 7
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include Aetna Inc. and its majority-owned
subsidiaries (collectively, the "Company"), including Aetna Services, Inc.
("Aetna Services") and Aetna U.S. Healthcare Inc. ("Aetna U.S. Healthcare"). All
significant intercompany balances have been eliminated. Certain non-U.S.
affiliates of the Company report operations on a one-month lag. In such
situations, operations are reported for the three- and six-month periods
beginning December 1 of the previous calendar year and ending May 31 of the
current calendar year. Less than majority-owned entities, in which the Company
has at least a 20% interest, are reported on the equity basis. These
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and are unaudited. Certain
reclassifications have been made to the 1999 financial information to conform to
the 2000 presentation.
These interim statements necessarily rely heavily on estimates, including
assumptions as to annualized tax rates. In the opinion of management, all
adjustments necessary for a fair statement of results for the interim periods
have been made. All such adjustments are of a normal, recurring nature. The
accompanying condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes as
presented in Aetna Inc.'s 1999 Annual Report on Form 10-K. Certain financial
information that is normally included in annual financial statements prepared in
accordance with generally accepted accounting principles, but that is not
required for interim reporting purposes, has been condensed or omitted.
New Accounting Standard
On January 1, 2000, the Company adopted Statement of Position 98-7, Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not
Transfer Insurance Risk, issued by the American Institute of Certified Public
Accountants. This statement 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. The adoption of this
standard did not have a material effect on the Company's financial position or
results of operations.
Future Accounting Standard
In June 1998, the Financial Accounting Standards Board ("FASB") issued Financial
Accounting Standard ("FAS") No. 133, Accounting for Derivative Instruments and
Hedging Activities. In June 2000, further guidance related to accounting for
derivative instruments and hedging activities was provided when the FASB issued
FAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FASB Statement No. 133. This standard, as amended,
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. As amended by FAS No. 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133, these standards are effective for the Company's
financial statements beginning January 1, 2001, with early adoption permitted.
The impact of FAS No. 133, as amended, on the Company's financial statements
will vary based on certain factors including future interpretive guidance from
the FASB, the extent of the Company's hedging activities, the types of hedging
instruments used and the effectiveness of such instruments. The Company is
evaluating the impact of the adoption of this standard and currently does not
believe that this standard will have a material effect on the Company's
financial position or results of operations.
Page 7
<PAGE> 8
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
2. RECENT DEVELOPMENTS
Agreement to Sell Aetna Financial Services and Aetna International
On July 20, 2000, the Company announced that it reached a definitive agreement
to sell its Aetna Financial Services and Aetna International businesses to ING
Groep N.V. ("ING") in a transaction valued at approximately $7.7 billion. Under
the terms of the agreement and in an integrated transaction, the Company will
spin off to its shareholders the shares of a standalone health company that will
be comprised primarily of the Aetna U.S. Healthcare and Large Case Pensions
businesses. Simultaneously, Aetna Inc., which then will be comprised of Aetna
Financial Services and Aetna International, will merge with a newly formed
subsidiary of ING. In exchange for each Aetna Inc. share, Aetna shareholders
will receive one share in the standalone health company, which will be named
Aetna Inc., and approximately $35 per share in cash. When ING acquires Aetna
Inc., that entity is expected to have approximately $2.7 billion in long-term
debt which will be assumed by ING.
The Company's goal is to close the transaction, which is subject to receipt of
required shareholder, regulatory and other consents and approvals, as well as
other closing conditions, by year end 2000. The Company expects that it will
incur certain costs associated with the definitive agreement with ING related to
the consummation of the transaction (including fees for outside financial and
legal advisors and expenses related to the change-in-control of Aetna Inc.) and
such costs may be material.
In connection with its spinoff from the Company, the standalone health company
generally will assume all liabilities related to the Aetna U.S. Healthcare and
Large Case Pensions businesses. In addition, the standalone health company
generally will be responsible for the Company's liabilities other than those
arising out of the Aetna Financial Services and Aetna International businesses
being sold to ING. These liabilities include the post-retirement pension and
other benefits payable to all former employees of the Company, liabilities
arising out of health litigation and certain corporate-level litigation to which
Aetna Inc. is a party, and all liabilities arising out of certain divestiture
transactions consummated by the Company prior to the closing of the health
company's spinoff from the Company.
Other
The Company's Medicare+Choice contracts with the federal government are renewed
for a one-year period each January 1. On June 29, 2000, the Company notified the
Health Care Financing Administration ("HCFA") of its intent to exit a number of
Medicare service areas affecting approximately 340,000 members, or approximately
50 percent of the Company's total current Medicare membership. The termination
of these Medicare+Choice contracts will become effective on December 31, 2000.
The Company may elect to continue to provide Medicare benefits to members in
these service areas, in accordance with HCFA regulations and guidelines, if
legislative or regulatory changes are made that would increase payments from
HCFA to the Company within six months following this notification date.
During the remainder of 2000, the Company will continue to monitor any
legislative or regulatory changes that might increase payments under applicable
Medicare+Choice contracts and then make a final determination, as permitted
under HCFA regulations, depending on the level of any such reimbursement
increase. The Company will also, at such time, evaluate the need for the
establishment of liabilities related to the withdrawal from applicable Medicare
service areas, including employee termination benefits and related costs, as
well as evaluate any impairment related to goodwill still separately
identifiable with such service areas, which is considered recoverable pending a
final decision to exit. Goodwill associated with such Medicare service areas was
approximately $275 million at June 30, 2000.
Page 8
<PAGE> 9
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
3. EARNINGS PER COMMON SHARE
A reconciliation of the numerator and denominator of the basic and diluted
earnings per common share ("EPS") for the three and six months ended June 30,
was as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Income Shares Per Common
(Millions, except per common share data) (Numerator) (Denominator) Share Amount
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000
Basic EPS
Net income $186.4 141.0 $1.32
====== =====
Effect of dilutive securities:
Stock options and other (1) 2.2
---
Diluted EPS
Income applicable to common ownership and assumed conversions $186.4 143.2 $1.30
==============================================================================================================================
1999
Net income $217.5
Less: preferred stock dividends 13.8
------
Basic EPS
Income applicable to common ownership $203.7 140.9 $1.45
====== =====
Effect of dilutive securities:
Stock options and other (1) 1.3
---
Diluted EPS (2)
Income applicable to common ownership and assumed conversions $203.7 142.2 $1.43
==============================================================================================================================
<CAPTION>
Six Months Ended June 30, Income Shares Per Common
(Millions, except per common share data) (Numerator) (Denominator) Share Amount
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000
Basic EPS
Net income $355.8 141.1 $2.52
====== =====
Effect of dilutive securities:
Stock options and other (3) 1.6
---
Diluted EPS
Income applicable to common ownership and assumed conversions $355.8 142.7 $2.49
==============================================================================================================================
1999
Net income $387.1
Less: preferred stock dividends 27.6
------
Basic EPS
Income applicable to common ownership $359.5 141.1 $2.55
====== =====
Effect of dilutive securities:
Stock options and other (3) 1.2
---
Diluted EPS (2)
Income applicable to common ownership and assumed conversions $359.5 142.3 $2.53
==============================================================================================================================
</TABLE>
(1) Options to purchase shares of common stock and stock appreciation rights
("SARs") for the three months ended June 30, 2000 and 1999 of 9.5 million
shares (with exercise prices ranging from $61.63 to $112.63) and 2.2
million shares (with exercise prices ranging from $88.94 to $112.63),
respectively, were not included in the calculation of diluted earnings per
common share because the options' and SARs' exercise price was greater than
the average market price of common shares.
(2) The issuable Aetna common stock related to Class C voting mandatorily
convertible preferred stock ("Class C Shares") (9.5 million weighted
average shares in 1999) was not included in the computation of diluted
earnings per common share for the three and six months ended June 30, 1999
because to do so would be antidilutive. On July 19, 1999, the Company
redeemed all outstanding Class C Shares and issued 9.5 million shares of
Aetna common stock to effect the redemption.
(3) Options to purchase shares of common stock and SARs for the six months
ended June 30, 2000 and 1999 of 9.6 million shares (with exercise prices
ranging from $56.88 to $112.63) and 5.4 million shares (with exercise
prices ranging from $86.25 to $112.63), respectively, were not included in
the calculation of diluted earnings per common share because the options'
and SARs' exercise price was greater than the average market price of
common shares.
Page 9
<PAGE> 10
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS
Aetna U.S. Healthcare
On August 6, 1999, the Company acquired from The Prudential Insurance Company of
America ("Prudential") the Prudential health care business ("PHC") for
approximately $1 billion. The acquisition was accounted for as a purchase. In
addition to recording the assets and liabilities acquired at fair value, the
purchase price allocation at the acquisition date included: (1) an asset of $130
million, representing the fair value adjustment of a reinsurance agreement
(discussed below), primarily reflecting the net benefits to be received from
Prudential over the life of the agreement; (2) a liability of $129 million,
representing a fair value adjustment for the unfavorable component of the
contracts underlying the acquired medical risk business and (3) an asset of $21
million, representing the above-market compensation component related to
supplemental fees to be received under the Company's agreement to service
Prudential's administrative services only ("ASO") contracts (discussed below).
Refer to the Company's 1999 Annual Report on Form 10-K for further discussion of
the PHC acquisition.
During the first quarter 2000, a liability of $15 million was recorded as part
of the purchase price allocation related to the Company's plan to exit certain
leased facilities of the acquired PHC businesses, currently expected to be
completed by March 31, 2001. The purchase price does not reflect any employee
termination benefits for positions that may be eliminated. Such amounts, which
currently are not reasonably estimable, will be expensed as incurred.
For the three and six months ended June 30, 2000, the Company recorded asset
amortization of $6 million and $13 million pretax, respectively, related to the
fair value adjustment of the reinsurance agreement; liability amortization of $9
million and $22 million pretax, respectively, related to the fair value
adjustment of the unfavorable component of the contracts underlying the acquired
medical risk business and asset amortization of $4 million and $11 million
pretax, respectively, related to the above-market compensation component related
to the supplemental fees under the ASO contracts.
The Company and Prudential entered into a reinsurance agreement for which the
Company paid a premium. Premium expense recognized for the three and six months
ended June 30, 2000 was $4 million and $7 million pretax, respectively. Under
the agreement, Prudential has agreed to indemnify the Company from certain
health insurance risks that arise following the closing by reimbursing the
Company for 75% of medical costs (as calculated under the agreement) of PHC in
excess of certain threshold medical loss ratio levels through 2000 for
substantially all the acquired medical and dental risk business. The medical
loss ratio threshold was 83.5% for August 6, 1999 through December 31, 1999 and
is 84% for January 1, 2000 through December 31, 2000. During the three and six
months ended June 30, 2000, reinsurance recoveries under this agreement
(reflected as a reduction of current and future benefits) were $36 million and
$46 million pretax, respectively. The premium is subject to adjustment if
medical costs of PHC are below these threshold medical loss ratio levels.
Prudential has also agreed to indemnify the Company for unanticipated increases
in medical claims payable existing at the acquisition date for a period of up to
nine months following the closing.
The Company also agreed to service Prudential's ASO contracts following the
closing. Prudential is terminating its ASO business and has retained the Company
to service these contracts during the run off period, but no later than June 30,
2001. In exchange for servicing the ASO business, Prudential is remitting fees
received from its ASO customers to the Company, as well as paying certain
supplemental fees. The supplemental fees are fixed in amount and decline over a
period ending 18 months following the closing. During the three and six months
ended June 30, 2000, the Company recorded total fees for servicing the
Prudential ASO business of approximately $98 million and $204 million pretax,
respectively, including supplemental fees of approximately $36 million and $84
million pretax, respectively, which was net of the asset amortization related to
the above-market compensation component related to the supplemental fees under
the ASO contracts described above (reflected as fees and other income).
Page 10
<PAGE> 11
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
In connection with the PHC acquisition, the Company agreed with the U.S.
Department of Justice and the State of Texas to divest certain Texas HMO/POS and
other related businesses ("NYLCare Texas") acquired by the Company as part of
the 1998 acquisition of New York Life Insurance Company's health care business.
Pursuant to this agreement, on March 31, 2000, Aetna U.S. Healthcare completed
the sale of NYLCare Texas to Blue Cross and Blue Shield of Texas, a division of
Health Care Service Corporation, for approximately $420 million in cash. The
sale resulted in an after-tax capital loss of $35 million which was previously
recognized in the fourth quarter of 1999. The after-tax loss included operating
losses from October 1, 1999 through closing. The results of operations of
NYLCare Texas were not material to the Aetna U.S. Healthcare segment or to the
Company's consolidated results of operations.
During the first quarter 2000, Aetna U.S. Healthcare acquired the remaining
minority ownership interest in InteliHealth Inc., which distributes healthcare
information principally through its internet web site and sells health products
to consumers. The aggregate purchase price was not material.
Aetna International
On July 19, 2000, Aetna International Inc. ("Aetna International") signed an
agreement to sell its New Zealand operation, Aetna Health Limited, to Southern
Cross Medical Care Society. The sale is expected to close in the third quarter
of 2000, subject to New Zealand Commerce Commission approval. The earnings of
Aetna Health Limited are not material to the Company.
On July 14, 2000, Aetna International announced an agreement in principle to
sell its 49 percent ownership interest in a Venezuelan joint venture, Seguros
Mercantil, to the Venezuelan majority owner, Mercantil Servicios Financieros.
The sale is expected to close in the third quarter of 2000. The earnings of
Seguros Mercantil are not material to the Company.
On January 14, 2000, Aetna International and its Mexican partner sold two of
their Mexican joint venture companies, Seguros Monterrey Aetna, S.A. and Fianzas
Monterrey Aetna, S.A., to New York Life International, Inc., a subsidiary of New
York Life Insurance Company, for approximately $570 million in cash (Aetna
International's share of the proceeds was approximately $279 million). The sale
resulted in an after-tax capital gain of approximately $13 million. These two
joint ventures contributed operating earnings of approximately $6 million and $7
million for the six months ended June 30, 2000 and 1999, respectively.
On November 18, 1999, Aetna International acquired a 33% ownership interest in
Aetna Heiwa Life Insurance Company Ltd., formerly known as The Heiwa Life
Insurance Company Ltd., of Japan ("Heiwa"), for approximately $20 million.
During the first quarter 2000, Aetna International increased its ownership
interest in Heiwa to 99.82% for approximately $37 million.
On October 1, 1999, Aetna International sold its Canadian operations to John
Hancock Canadian Holdings Limited, the parent of The Maritime Life Assurance
Company, for approximately $310 million in cash. Operating earnings from the
Canadian operations were $19 million for the six months ended June 30, 1999.
Page 11
<PAGE> 12
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
5. INVESTMENTS
Net investment income includes amounts allocable to experience-rated
contractholders of $246 million and $257 million for the three months ended June
30, 2000 and 1999, respectively, and $496 and $513 million for the six months
ended June 30, 2000 and 1999, respectively. Interest credited to contractholders
is included in current and future benefits.
Net realized capital gains (losses) allocable to experience-rated
contractholders of $(19) million and $3 million for the three months ended June
30, 2000 and 1999, respectively, and $(51) million and $9 million for the six
months ended June 30, 2000 and 1999, respectively, were deducted from net
realized capital gains as reflected on the Consolidated Statements of Income,
and an offsetting amount is reflected on the Consolidated Balance Sheets in
policyholders' funds left with the Company.
During the first quarter 2000, as part of the Heiwa acquisition, the Company
acquired approximately $1.2 billion of commercial loans (primarily secured
corporate working capital loans mostly to Japanese borrowers), net of an
allowance for loan losses of approximately $174 million, as adjusted within the
purchase price allocation period. Interest on these loans is accrued and
credited to income based on the principal amount outstanding.
The total recorded investment in mortgage loans that are considered to be
impaired (including problem loans, restructured loans and potential problem
loans) and related specific reserves are presented in the table below.
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
---------------------------- -------------------------------
Total Total
Recorded Specific Recorded Specific
(Millions) Investment Reserves Investment Reserves
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Supporting discontinued products $157.5 $22.2 $158.9 $22.2
Supporting experience-rated products 66.1 8.5 66.9 8.8
Supporting remaining products 66.8 5.7 59.2 1.1
---------------------------------------------------------------------------------------------------------------------
Total impaired loans $290.4(1) $36.4 $285.0(1) $32.1
=====================================================================================================================
</TABLE>
(1) Includes impaired loans of $113.5 million and $109.0 million at June 30,
2000 and December 31, 1999, respectively, for which no specific reserves
are considered necessary.
The activity in the specific and general reserves for the six months ended June
30, 2000 and 1999 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, 1999 $28.9 $15.6 $ 4.8 $49.3
Credited to net realized capital losses - (.3) (.1) (.4)
Charged to other accounts - - 1.8 1.8
Principal write-offs - - (.6) (.6)
-------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2000 $28.9 $15.3 $ 5.9 $50.1(1)
===================================================================================================================
Balance at December 31, 1998 $29.5 $29.6 $ 7.8 $66.9
Charged to other accounts - - 1.4 1.4
Principal write-offs (.6) (4.4) (.2) (5.2)
-------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1999 $28.9 $25.2 $ 9.0 $63.1(1)
===================================================================================================================
</TABLE>
(1) Total reserves at June 30, 2000 and 1999 include $36.4 million and $43.8
million of specific reserves, respectively, and $13.7 million and $19.3
million of general reserves, respectively.
Page 12
<PAGE> 13
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
5. INVESTMENTS (CONTINUED)
Income earned (pretax) and cash received on the average recorded investment in
impaired loans was as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 2000 June 30, 2000
------------------------------ ---------------------------------
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 $157.6 $2.5 $2.5 $157.9 $ 5.2 $ 5.2
Supporting experience-rated products 66.6 1.6 1.7 71.9 3.3 3.3
Supporting remaining products 67.4 2.4 2.8 55.4 5.1 5.6
--------------------------------------------------------------------------------------------------------------------
Total $291.6 $6.5 $7.0 $285.2 $13.6 $14.1
====================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 June 30, 1999
------------------------------ ---------------------------------
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 $158.2 $3.3 $3.3 $159.4 $6.0 $6.0
Supporting experience-rated products 95.5 2.4 2.4 93.9 4.3 4.2
Supporting remaining products 28.6 2.4 2.3 34.8 3.1 2.8
--------------------------------------------------------------------------------------------------------------------
Total $282.3 $8.1 $8.0 $288.1 $13.4 $13.0
====================================================================================================================
</TABLE>
6. SUPPLEMENTAL CASH FLOW INFORMATION
Significant noncash investing and financing activities included acquisition of
real estate through foreclosures of mortgage loans amounting to $6 million and
$8 million for the six months ended June 30, 2000 and 1999, respectively.
7. ADDITIONAL INFORMATION - ACCUMULATED OTHER COMPREHENSIVE LOSS
Changes in accumulated other comprehensive loss related to changes in unrealized
gains (losses) on securities (excluding those related to experience-rated
contractholders and discontinued products) were as follows:
<TABLE>
<CAPTION>
Six Months
Ended June 30,
----------------------
(Millions) 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Unrealized holding gains (losses) arising during the period (1) $48.5 $(270.1)
Less: reclassification adjustment for gains (losses) and other items included in
net income (2) (4.4) 57.1
---------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $52.9 $(327.2)
===============================================================================================================
</TABLE>
(1) Pretax unrealized holding gains (losses) arising during the period were
$74.6 million and $(415.6) million for 2000 and 1999, respectively.
(2) Pretax reclassification adjustments for gains and other items included in
net income were $(6.8) million and $87.8 million for 2000 and 1999,
respectively.
Page 13
<PAGE> 14
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. 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 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 that
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).
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 June 30,
2000, the receivable from continuing products, net of related deferred taxes
payable of $72 million on the accrued interest income, was $380 million. At
December 31, 1999, the receivable from continuing products, net of related
deferred taxes payable of $67 million on accrued interest income, was $464
million. These amounts were eliminated in consolidation.
Page 14
<PAGE> 15
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. DISCONTINUED PRODUCTS (CONTINUED)
Results of discontinued products were as follows (pretax, in millions):
<TABLE>
<CAPTION>
Charged (Credited)
to Reserve for
Three months ended June 30, 2000 Results Future Losses Net (1)
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $ 102.2 $ - $ 102.2
Net realized capital gains - - -
Interest earned on receivable from continuing products 8.2 - 8.2
Other income 5.3 - 5.3
----------------------------------------------------------------------------------------------------------------------
Total revenue 115.7 - 115.7
----------------------------------------------------------------------------------------------------------------------
Current and future benefits 113.5 (1.2) 112.3
Operating expenses 3.4 - 3.4
----------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 116.9 (1.2) 115.7
----------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ (1.2) $ 1.2 $ -
======================================================================================================================
<CAPTION>
Three months ended June 30, 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $ 121.7 $ - $ 121.7
Net realized capital gains 8.1 (8.1) -
Interest earned on receivable from continuing products 8.5 - 8.5
Other income 4.9 - 4.9
----------------------------------------------------------------------------------------------------------------------
Total revenue 143.2 (8.1) 135.1
----------------------------------------------------------------------------------------------------------------------
Current and future benefits 126.9 5.1 132.0
Operating expenses 3.1 - 3.1
----------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 130.0 5.1 135.1
----------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 13.2 $ (13.2) $ -
======================================================================================================================
</TABLE>
(1) Amounts are reflected in the June 30, 2000 and 1999 Consolidated Statements
of Income, except for interest earned on the receivable from continuing
products which was eliminated in consolidation.
<TABLE>
<CAPTION>
Charged (Credited)
to Reserve for
Six months ended June 30, 2000 Results Future Losses Net (1)
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $ 223.9 $ - $ 223.9
Net realized capital gains .1 (.1) -
Interest earned on receivable from continuing products 16.3 - 16.3
Other income 18.3 - 18.3
----------------------------------------------------------------------------------------------------------------------
Total revenue 258.6 (.1) 258.5
----------------------------------------------------------------------------------------------------------------------
Current and future benefits 229.7 21.9 251.6
Operating expenses 6.9 - 6.9
----------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 236.6 21.9 258.5
----------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 22.0 $(22.0) $ -
======================================================================================================================
<CAPTION>
Six months ended June 30, 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $ 243.8 $ - $ 243.8
Net realized capital gains 18.3 (18.3) -
Interest earned on receivable from continuing products 16.9 - 16.9
Other income 15.3 - 15.3
----------------------------------------------------------------------------------------------------------------------
Total revenue 294.3 (18.3) 276.0
----------------------------------------------------------------------------------------------------------------------
Current and future benefits 257.1 12.4 269.5
Operating expenses 6.5 - 6.5
----------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 263.6 12.4 276.0
----------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 30.7 $ (30.7) $ -
======================================================================================================================
</TABLE>
(1) Amounts are reflected in the June 30, 2000 and 1999 Consolidated Statements
of Income, except for interest earned on the receivable from continuing
products which was eliminated in consolidation.
Page 15
<PAGE> 16
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. DISCONTINUED PRODUCTS (CONTINUED)
Assets and liabilities supporting discontinued products at June 30, 2000 and
December 31, 1999 were as follows (1):
<TABLE>
<CAPTION>
June 30, December 31,
(Millions) 2000 1999
----------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Debt securities available for sale $4,319.2 $4,533.0
Mortgage loans 806.9 768.8
Real estate 116.9 112.7
Short-term and other investments 442.5 453.9
----------------------------------------------------------------------------------------------------
Total investments 5,685.5 5,868.4
Short-term investments under securities loan agreement 131.0 243.8
Current and deferred income taxes 69.6 134.1
Receivable from continuing products (2) 452.0 530.6
Other 20.8 82.6
----------------------------------------------------------------------------------------------------
Total assets $6,358.9 $6,859.5
====================================================================================================
Liabilities:
Future policy benefits $4,517.1 $4,566.0
Policyholders' funds left with the Company 687.2 902.1
Reserve for anticipated future losses on discontinued products 1,023.6 1,147.6
Payables under securities loan agreement 131.0 243.8
----------------------------------------------------------------------------------------------------
Total liabilities $6,358.9 $6,859.5
====================================================================================================
</TABLE>
(1) Assets supporting the discontinued products are distinguished from other
continuing operations assets.
(2) The receivable from continuing products was eliminated in consolidation.
At June 30, 2000 and December 31, 1999, net unrealized capital losses on
available-for-sale debt securities are included above in other assets 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. Since 1993, 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.
Page 16
<PAGE> 17
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. DISCONTINUED PRODUCTS (CONTINUED)
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 liabilities have run off.
The activity in the reserve for anticipated future losses on discontinued
products for the six months ended June 30, 2000 was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
----------------------------------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1999 $1,147.6
Operating income 9.9
Net realized capital gains .1
Mortality and other 12.0
Reserve reduction (146.0)
----------------------------------------------------------------------------------------------
Reserve at June 30, 2000 $1,023.6
==============================================================================================
</TABLE>
Management reviews the adequacy of the discontinued products reserve quarterly
and, as a result, $95 million ($146 million pretax) of the reserve was released
in the second quarter 2000 primarily due to favorable performance related to
certain equity investments, favorable mortality and retirement experience and
the decrease in size of the overall bond portfolio which decreased default risk.
A similar review in the second quarter of 1999 resulted in the Company's release
of $50 million ($77 million pretax) of the discontinued products reserve. The
current reserve reflects management's best estimate of anticipated future
losses.
9. DEBT AND GUARANTEE OF DEBT SECURITIES
Aetna Inc. has fully and unconditionally guaranteed the payment of all
principal, premium, if any, and interest on all outstanding debt securities of
Aetna Services (collectively, the "Aetna Services Debt").
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 this 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 June 30, 2000 is
at an annual rate of .08%. There are no borrowings under this facility as of
June 30, 2000. This facility also supports Aetna Services' commercial paper
borrowing program. As a guarantor of any amounts outstanding under this credit
facility, Aetna Inc. is required to maintain shareholders' equity, excluding net
unrealized capital gains and losses (accumulated other comprehensive income
(loss)), of at least $7.5 billion.
Aetna Services also has an additional revolving credit facility in an aggregate
amount of $500 million with a worldwide group of banks that terminates in March
2001. Various interest rate options are available under this facility and any
borrowings mature on the expiration date of the applicable credit commitment.
Aetna Services pays facility fees ranging from .07% to .25% per annum, depending
upon its long-term senior unsecured debt rating. The facility fee at June 30,
2000 is at an annual rate of .08%. There are no borrowings under this facility
as of June 30, 2000. This facility also supports Aetna Services' commercial
paper borrowing program. As a guarantor under this credit facility, Aetna Inc.
is required to maintain shareholders' equity, excluding net unrealized capital
gains and losses (accumulated other comprehensive income (loss)), of at least
$7.5 billion.
Page 17
<PAGE> 18
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
9. DEBT AND GUARANTEE OF DEBT SECURITIES (CONTINUED)
Consolidated financial statements of Aetna Services have not been presented
herein or in any separate reports filed with the Securities and Exchange
Commission because management has determined that such financial statements
would not be material to holders of the Aetna Services Debt. Summarized
consolidated financial information for Aetna Services is as follows (in
millions):
Balance Sheets Information:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------------------------------------------------------------------------------------------
<S> <C> <C>
Total investments (excluding Separate Accounts) $ 37,205.1 $ 33,258.1
Total assets 109,255.0 101,154.3
Total insurance liabilities 41,044.3 35,665.1
Total liabilities 106,100.3 98,342.2
Total shareholder's equity 3,154.7 2,812.1
-------------------------------------------------------------------------------------------------
</TABLE>
Statements of Income Information:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 2000 June 30, 2000
--------------------------------------------------------------------------------------------------
<S> <C> <C>
Total revenue $3,574.9 $6,920.7
Total benefits and expenses 3,195.9 6,249.0
Income before income taxes 379.0 671.7
Net income 255.1 433.6
--------------------------------------------------------------------------------------------------
</TABLE>
The amount of dividends that may be paid to Aetna Services or Aetna U.S.
Healthcare by their domestic insurance and HMO subsidiaries at June 30, 2000
without prior approval by state regulatory authorities is limited to
approximately $452 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 18
<PAGE> 19
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
10. SEGMENT INFORMATION
Summarized financial information for the Company's principal operations for the
three and six months ended June 30, was as follows:
<TABLE>
<CAPTION>
Aetna
Three Months Ended June 30, Aetna U.S. Financial Aetna Large Case Corporate Total
(Millions) Healthcare Services International Pensions and Other (1) Company
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
2000
Revenues from external customers $6,284.0 $ 204.3 $ 928.2 $ 42.9 $ - $ 7,459.4
Net investment income 166.4 221.0 107.6 216.2 2.6 713.8
Equity in earnings of subsidiaries - - 23.9 - - 23.9
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $6,450.4 $ 425.3 $ 1,059.7 $ 259.1 $ 2.6 $ 8,197.1
===================================================================================================================================
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Operating earnings (2) $ 74.0 $ 63.3 $ 52.7 $ 14.4 $(70.4) $ 134.0
Other items (3) (14.6) - - 94.9 - 80.3
Realized capital gains (losses), net of tax (9.4) (1.9) (18.9) 4.4 (2.1) (27.9)
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 50.0 $ 61.4 $ 33.8 $ 113.7 $(72.5) $ 186.4
===================================================================================================================================
<CAPTION>
Aetna
Aetna U.S. Financial Aetna Large Case Corporate Total
(Millions) Healthcare Services International Pensions and Other (1) Company
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1999
Revenues from external customers $4,335.2 $153.4 $ 674.2 $ 38.2 $ .1 $5,201.1
Net investment income 138.5 223.4 97.1 258.3 1.3 718.6
Equity in earnings of subsidiaries - - 16.0 - - 16.0
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $4,473.7 $376.8 $ 787.3 $ 296.5 $ 1.4 $5,935.7
===================================================================================================================================
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Operating earnings (2) $ 104.1 $ 50.9 $ 45.4 $ 21.6 $(61.1) $ 160.9
Other item (3) - - - 50.2 - 50.2
Realized capital gains (losses), net of tax (8.4) .6 3.5 13.2 (2.5) 6.4
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 95.7 $ 51.5 $ 48.9 $ 85.0 $(63.6) $ 217.5
===================================================================================================================================
</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 is comprised of income (loss) excluding realized capital
gains and losses and 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 include an after-tax charge of $14.6 million related to the New
Jersey insolvency assessment in the Aetna U.S. Healthcare segment in 2000
and an after-tax benefit of $94.9 million and $50.2 million from reductions
of the reserve for anticipated future losses on discontinued products in
the Large Case Pensions segment in 2000 and 1999, respectively.
Page 19
<PAGE> 20
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
10. SEGMENT INFORMATION
<TABLE>
<CAPTION>
Aetna
Six Months Ended June 30, Aetna U.S. Financial Aetna Large Case Corporate Total
(Millions) Healthcare Services International Pensions and Other (1) Company
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
2000
Revenues from external customers $ 12,583.7 $ 404.8 $ 1,487.4 $ 90.2 $ - $14,566.1
Net investment income 344.8 450.6 204.6 460.7 4.5 1,465.2
Equity in earnings of subsidiaries - - 59.2 - - 59.2
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $ 12,928.5 $ 855.4 $ 1,751.2 $ 550.9 $ 4.5 $16,090.5
===================================================================================================================================
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Operating earnings (2) $ 205.8 $ 123.3 $ 101.6 $ 31.0 $(143.7) $ 318.0
Other items (3) (14.6) - - 94.9 - 80.3
Realized capital gains (losses), net of tax (21.0) (7.7) (16.9) 5.2 (2.1) (42.5)
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 170.2 $ 115.6 $ 84.7 $ 131.1 $(145.8) $ 355.8
===================================================================================================================================
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
1999
Revenues from external customers $ 8,630.9 $ 300.0 $ 1,119.4 $ 76.3 $ .4 $10,127.0
Net investment income 279.2 447.5 191.6 514.9 4.3 1,437.5
Equity in earnings of subsidiaries - - 46.5 - - 46.5
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $ 8,910.1 $ 747.5 $ 1,357.5 $ 591.2 $ 4.7 $11,611.0
===================================================================================================================================
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Operating earnings (2) $ 210.3 $ 98.2 $ 88.4 $ 43.9 $(121.5) $ 319.3
Other item (3) - - - 50.2 - 50.2
Realized capital gains (losses), net of tax (3.7) 2.5 2.1 19.2 (2.5) 17.6
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 206.6 $ 100.7 $ 90.5 $ 113.3 $(124.0) $ 387.1
===================================================================================================================================
</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 is comprised of income (loss) excluding realized capital
gains and losses and 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 include an after-tax charge of $14.6 million related to the New
Jersey insolvency assessment in the Aetna U.S. Healthcare segment in 2000
and an after-tax benefit of $94.9 million and $50.2 million from reductions
of the reserve for anticipated future losses on discontinued products in
the Large Case Pensions segment in 2000 and 1999, respectively.
Page 20
<PAGE> 21
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES
Commitments
In connection with the sale of its property-casualty operations in 1996, the
Company vacated, and the purchaser subleased, at market rates for a period of
eight years, the space that the Company occupied in the CityPlace office
facility in Hartford. In 1996, the Company recorded a charge of $292 million
pretax ($190 million after tax) which represented 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 facilities reserve as they are made and will continue to be
charged to this reserve over the remaining lease term. At June 30, 2000 and
December 31, 1999, the balance in this facilities reserve was $260 million and
$269 million, respectively.
Litigation
Shareholder Litigation
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 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 Company and the remaining individual defendants filed a motion to dismiss
the second amended complaint, and the Court denied that motion in March 1999. On
August 9, 1999, the Court entered an order certifying as plaintiffs those
persons who purchased Company common stock on the market from March 6, 1997
through 7:00 a.m. on September 29, 1997. Merits discovery was completed in early
2000. On January 31, 2000 plaintiffs filed expert reports. On February 3, 2000,
defendants filed motions for summary judgment. Also on February 3, 2000,
plaintiffs moved for permission to file a third amended complaint. On March 20,
2000, the Court granted plaintiffs leave to file a third amended complaint and
adopted a revised schedule. Pursuant to the revised schedule, defendants filed
new summary judgment motions in May 2000 and the parties conducted expert
discovery which is scheduled to be completed in the third quarter of 2000.
Defendants' summary judgment motions are scheduled to be heard in August 2000,
and trial is now scheduled to begin in the fourth quarter of 2000. Defendants
are defending the actions vigorously.
Page 21
<PAGE> 22
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Shareholder Litigation (Continued)
Four purported shareholder class action complaints were filed in the Superior
Court of Connecticut, Hartford County alleging in substance that the Company and
its directors breached fiduciary duties to shareholders in responding to a
February 24, 2000 letter from Wellpoint Health Networks, Inc. and ING America
Insurance Holdings, Inc. which had invited discussions concerning a possible
transaction. These actions were filed on behalf of George Schore, Michael
Demetrio and Gersh Korsinsky on March 3, 2000, The Rainbow Fund on March 7,
2000, Eleanor Werbowsky on March 7, 2000, and Catherine M. Friend on March 23,
2000. A fifth, substantially similar purported class action complaint was filed
on behalf of Barnett Stepak on March 28, 2000 in the Supreme Court of New York,
New York County. Each action seeks various forms of relief, including
unspecified damages and equitable remedies. This litigation is in the
preliminary stages. Defendants intend to defend these actions vigorously.
Health Care Litigation
The Company is involved in several purported class action lawsuits that are part
of a wave of similar actions targeting the health care industry and, in
particular, the conduct of business by managed care companies.
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on April 19, 1999 by Joseph Maio, Jo
Ann Maio and Gary Bender seeking various forms of relief, including unspecified
damages and treble damages, from the Company and a number of its subsidiaries
for alleged violations of the Racketeer Influenced and Corrupt Organizations Act
("RICO"), the Pennsylvania Unfair Trade Practices and Consumer Protection Law,
and state common law. On September 29, 1999, the Court dismissed the RICO claims
with prejudice and dismissed the state law claims for lack of subject matter
jurisdiction. The Court held, among other things, that the plaintiffs lacked
standing to pursue the federal RICO claims because they had not alleged an
injury in fact. Plaintiffs have appealed the dismissal to the United States
Court of Appeals for the Third Circuit. Oral argument was heard on June 19,
2000, and the appeals court is expected to render a decision on the appeal
during 2000.
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on October 4, 1999 by Anthony Conte
(the "Conte Complaint"). The Conte Complaint seeks various forms of relief,
including unspecified damages, from Aetna U.S. Healthcare Inc. for alleged
violations of the Employee Retirement Income Security Act of 1974 ("ERISA"). The
Conte Complaint alleges that Aetna U.S. Healthcare does not make adequate
disclosure of provider compensation arrangements in the literature that it makes
available to actual or prospective members. The Company intends to defend the
action vigorously and on November 1, 1999, filed a motion to dismiss the
litigation for failure to state a claim upon which relief can be granted. On
December 15, 1999, the Court suspended further proceedings pending the
resolution of the Maio appeal by the United States Court of Appeals for the
Third Circuit.
Page 22
<PAGE> 23
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Health Care Litigation (Continued)
A purported class action complaint was filed in the United States District Court
for the Southern District of Mississippi on October 7, 1999 by Jo Ann O'Neill
(the "Mississippi O'Neill Complaint"). An Amended Complaint was filed on
November 9, 1999 by Jo Ann O'Neill, Lydia K. Rouse and Danny E. Waldrop. The
Mississippi O'Neill Complaint seeks various forms of relief, including
unspecified damages and treble damages and restitution of alleged improper
profits, from the Company, Aetna U.S. Healthcare Inc., Richard L. Huber and
unnamed members of the Board of Directors of Aetna Inc. for alleged violations
of ERISA and RICO. The Mississippi O'Neill Complaint alleges that defendants are
liable for alleged misrepresentations and omissions relating to advertising,
marketing and member materials directed to Aetna HMO members. On November 22,
1999, defendants moved to stay, dismiss or transfer the action to the United
States District Court for the Eastern District of Pennsylvania based on the
Conte and Maio Complaints filed in that court. On January 25, 2000, the Court
suspended further proceedings pending resolution of a motion in cases involving
other defendants to consolidate those actions in a single court. This litigation
is in the preliminary stages. Defendants intend to defend the action vigorously.
A purported class action complaint was filed in the Superior Court of
California, County of Contra Costa on October 28, 1999 by Jeanne E. Curtright in
her individual capacity and on behalf of the general public of the State of
California (the "Curtright Complaint"). The Curtright Complaint seeks various
forms of relief, including injunctive relief, restitution and disgorgement of
amounts allegedly wrongfully acquired, from the Company, Aetna U.S. Healthcare
Inc., Aetna U.S. Healthcare of California Inc. and unnamed "John Doe" defendants
for alleged violations of California Business and Professions Code Sections
17200 and 17500, California Civil Code Section 1750 and state common law in
connection with the sale and marketing of health plans in California. The
Curtright Complaint alleges that defendants are liable for alleged
misrepresentations and omissions relating to advertising, marketing and member
materials directed to Aetna HMO, POS and PPO members and members of the general
public. On December 16, 1999, defendants removed the action to the United States
District Court for the Northern District of California. Plaintiff has moved to
remand the action to state court. The Company has moved to dismiss the Curtright
Complaint for failure to state a claim upon which relief can be granted and
moved for a stay of the action pending resolution of the Maio and Conte matters.
This litigation is in the preliminary stages. Defendants intend to defend the
action vigorously.
A complaint was filed in the Superior Court of the State of California, County
of San Diego on November 5, 1999 by Linda Ross and The Stephen Andrew Olsen
Coalition for Patients Rights, purportedly on behalf of the general public of
the State of California (the "Ross Complaint"). The Ross Complaint seeks various
forms of relief, including injunctive relief, restitution and disgorgement of
amounts allegedly wrongfully acquired, from Aetna Inc., Aetna U.S. Healthcare
Inc., Aetna U.S. Healthcare of California Inc. and additional unnamed "John Doe"
defendants for alleged violations of California Business and Professions Code
Sections 17200 and 17500. The Ross Complaint alleges that defendants are liable
for alleged misrepresentations and omissions relating to advertising, marketing
and member materials directed to Aetna HMO, POS and PPO members and the general
public and for alleged unfair practices relating to contracting of doctors. On
May 5, 2000 the Court denied defendants' demurer but granted in part their
motion to strike portions of the Ross Complaint and ordered plaintiff to file an
amended complaint. The Ross Amended Complaint was filed on May 15, 2000.
Defendants intend to defend the action vigorously.
Page 23
<PAGE> 24
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Health Care Litigation (Continued)
A purported class action complaint was filed in the United States District Court
for the Southern District of Mississippi on November 22, 1999 by Raymond D.
Williamson, III (the "Williamson Complaint"). The Williamson Complaint names as
defendant The Prudential Insurance Company of America, and also names as
defendants Aetna Inc. and Aetna U.S. Healthcare Inc. solely to the extent that
the Company has assumed liability for the actions of Prudential in connection
with the Company's acquisition of the Prudential health care business. The
Williamson Complaint seeks various forms of relief from defendants, including
unspecified damages, treble damages and imposition of a constructive trust, for
alleged violations of RICO and ERISA. The Williamson Complaint alleges that the
Prudential Health Plans engaged in a nationwide fraudulent scheme of
misrepresentation by stating that coverage and treatment decisions were made on
the basis of medical necessity when Prudential allegedly implemented undisclosed
policies designed to deny or limit claims and medical services. On December 30,
1999, the Company moved to stay, dismiss or transfer the action to the United
States District Court for the Eastern District of Pennsylvania based on the fact
that the Maio and Conte Complaints were filed in that court. On January 25,
2000, the Court suspended further proceedings pending resolution of a motion in
cases involving other defendants to consolidate those actions in a single court.
This litigation is in the preliminary stages. The Company intends to defend the
action vigorously.
A purported class action complaint was filed in the United States District Court
for the District of New Jersey on December 3, 1999 by Michael V. Amorosi (the
"Amorosi Complaint"). The Amorosi Complaint seeks various forms of relief,
including unspecified damages, treble damages and restitutionary relief for
unjust enrichment, from Aetna Inc. and Aetna U.S. Healthcare Inc. for alleged
violations of RICO and ERISA. The Amorosi Complaint alleges that defendants told
subscribers that coverage and treatment decisions would be based on medical
necessity but instead took into account undisclosed cost-based criteria that
were unrelated to members' medical needs. On January 7, 2000, the Company moved
to stay, dismiss or transfer the action to the United States District Court for
the Eastern District of Pennsylvania based on the fact that the Maio and Conte
Complaints were filed in that court. This litigation is in the preliminary
stages. The Company intends to defend the action vigorously.
A purported amended class action complaint was filed in the United States
District Court for the Northern District of Alabama on January 19, 2000 by
Eugene Mangieri, M.D. (the "Mangieri Complaint"). The Mangieri Complaint seeks
various forms of relief, including unspecified damages, treble damages and
punitive damages, from Aetna Inc., Aetna U.S. Healthcare Inc. and Richard L.
Huber for alleged violations of RICO. The Mangieri Complaint claims that
physicians suffer actual and potential harm from allegedly coercive terms
contained in their contracts with the Company. On May 15, 2000 the Judicial
Panel on Multidistrict Litigation issued a conditional order transferring the
Mangieri Complaint to the United States District Court for the Southern District
of Florida for consolidated pretrial proceedings in the matter known as In re
Humana, Inc. Managed Care Litigation. On May 30, 2000 the Company filed with the
Panel an objection to that conditional transfer order. This litigation is in the
preliminary stages. Defendants intend to defend the action vigorously.
Page 24
<PAGE> 25
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Health Care Litigation (Continued)
A purported class action complaint was filed in the United States District Court
for the District of New Jersey on April 11, 2000 by Jennifer McCarron and Ira S.
Schwartz (the "McCarron Complaint"). The McCarron Complaint names as defendants
The Prudential Insurance Company of America and health maintenance organizations
that the Company acquired from Prudential on August 6, 1999. The McCarron
Complaint seeks various forms of relief from defendants, including return of
certain premiums, disgorgement of allegedly improper profits and injunctive
relief, for alleged contractual breaches and violations of ERISA. Plaintiffs
purport to represent a class including persons who were Prudential Health Plans
subscribers before and/or after the Company's acquisition of those operations.
The McCarron Complaint alleges that Prudential Health Plans' administration and
disclosure of policies concerning medical necessity determinations violated
contractual and fiduciary duties owed to subscribers. Ms. McCarron additionally
alleges that she was wrongfully denied coverage for certain medical treatments.
This litigation is in the preliminary stages. The Company intends to defend the
action vigorously.
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on May 22, 2000 by John Romero and
Catherine Romero (the "Romero Complaint"). The Romero Complaint names as
defendants The Prudential Insurance Company of America and health maintenance
organizations that the Company acquired from Prudential on August 6, 1999. The
Romero Complaint seeks various forms of relief from defendants, including return
of certain premiums, disgorgement of allegedly improper profits and injunctive
relief, for alleged contractual breaches and violations of ERISA. Plaintiffs
purport to represent a class including persons who were Prudential Health Plan
subscribers before and/or after the Company's acquisition of those operations.
The Romero Complaint alleges that Prudential Health Plans' administration and
disclosure of policies concerning medical necessity determinations violated
contractual and fiduciary duties owed to subscribers. This litigation is in the
preliminary stages. The Company intends to defend the action vigorously.
On July 14, 2000, the Company filed with the Judicial Panel on Multidistrict
Litigation a motion to consolidate and transfer six of the above matters for
pretrial proceedings in the United States District Court for the Eastern
District of Pennsylvania (the "MDL Application"). That motion seeks transfer and
consolidation of the Amorosi, Conte, Curtright, and Mangieri Complaints as well
as both the Mississippi O'Neill Complaint and the Florida O'Neill Complaint (as
defined below).
A purported class action was filed in the United States District Court for the
Southern District of Florida under the caption In re Humana, Inc. Managed Care
Litigation, on June 23, 2000 by Jo Ann O'Neill, Lydia K. Rouse and Danny E.
Waldrop (the "Florida O'Neill Complaint"). The Florida O'Neill Complaint names
as defendants Aetna Inc. and Aetna U.S. Healthcare Inc. The Florida O'Neill
Complaint seeks various forms of relief, including unspecified damages and
treble damages and restitution of alleged improper profits, from the Company and
Aetna U.S. Healthcare Inc. for alleged violations of ERISA and RICO. The Florida
O'Neill Complaint alleges that defendants are liable for alleged
misrepresentations and omissions relating to advertising and marketing materials
directed to Aetna HMO members, and alleges that defendants conspired with other
managed care companies not to disclose alleged industry-wide practices. The
Company sought from the Florida federal court a stay of further proceedings on
the Florida O'Neill Complaint pending a decision on the MDL Application. On July
27, 2000, the Florida federal court denied that motion. The Company's response
to the Florida O'Neill Complaint is due on August 11, 2000. This litigation is
in the preliminary stages. Defendants intend to defend the action vigorously.
Page 25
<PAGE> 26
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Financial Services Litigation
In recent years, several life insurance and annuity companies have been named as
defendants in class action lawsuits relating to life insurance and annuity
pricing and sales practices. Aetna Life Insurance and Annuity Company ("ALIAC"),
a wholly-owned subsidiary of Aetna Inc., is a defendant in two such lawsuits.
A purported class action complaint was filed in the Circuit Court of Lauderdale
County, Alabama on March 28, 2000 by Loretta Shaner against ALIAC (the "Shaner
Complaint"). This case has been removed to the United States District Court for
the Northern District of Alabama. The Shaner Complaint seeks unspecified
compensatory damages from ALIAC and unnamed affiliates of ALIAC. The Shaner
Complaint claims that ALIAC's sale of deferred annuity products for use as
investments in tax-deferred contributory retirement plans (e.g., IRAs) is
improper. This litigation is in the preliminary stages. The Company intends to
defend the action vigorously.
A purported class action complaint was filed in the United States District Court
for the Middle District of Florida on June 30, 2000 by Helen Reese, Richard
Reese, Villere Bergeron and Allan Eckert against ALIAC (the "Reese Complaint").
The Reese Complaint seeks compensatory and punitive damages and injunctive
relief from ALIAC. The Reese Complaint claims that ALIAC engaged in unlawful
sales practices in marketing life insurance policies. This litigation is in the
preliminary stages. The Company intends to defend the action vigorously.
Other Litigation and Regulatory Proceedings
The Company is involved in numerous other lawsuits arising, for the most part,
in the ordinary course of its business operations, including claims of bad
faith, medical malpractice, non-compliance with state regulatory regimes,
marketing misconduct, failure to timely pay medical claims and other litigation
in its health business. Some of these other lawsuits are purported to be class
actions. Aetna U.S. Healthcare of California Inc., an indirect subsidiary of the
Company, is currently a party to a bad faith and medical malpractice 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, among other things, 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. On April 12, 1999, the trial court
amended the judgment to include Aetna Services, Inc., a direct subsidiary of the
Company, as a defendant. On April 27, 1999, Aetna Services, Inc. and Aetna U.S.
Healthcare of California Inc. filed appeals with the California Court of Appeal
and will continue to defend this matter vigorously.
Page 26
<PAGE> 27
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Litigation (Continued)
Other Litigation and Regulatory Proceedings (Continued)
In addition, the Company's business practices are subject to review by various
state insurance and health care regulatory authorities and federal regulatory
authorities. Recently, there has been heightened review by these regulators of
the managed health care industry's business practices, including utilization
management and claim payment practices. As the largest national managed care
organization, the Company regularly is the subject of such reviews and several
such reviews currently are pending, some of which may be resolved during the
remainder of 2000. These reviews may result in changes to or clarifications of
the Company's business practices, and may result in fines, penalties or other
sanctions.
While the outcome of these other lawsuits and regulatory reviews cannot be
determined at this time, after consideration of the defenses available to the
Company, applicable insurance coverage 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 27
<PAGE> 28
INDEPENDENT AUDITORS' REVIEW REPORT
The Board of Directors
Aetna Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Aetna
Inc. and Subsidiaries as of June 30, 2000, and the related condensed
consolidated statements of income for the three-month and six-month periods
ended June 30, 2000 and 1999 and the related condensed consolidated statements
of shareholders' equity and cash flows for the six-month periods ended June 30,
2000 and 1999. These condensed consolidated financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements for them
to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Aetna Inc. and Subsidiaries as of
December 31, 1999, and the related consolidated statements of income,
shareholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 7, 2000, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1999, is fairly presented, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ KPMG LLP
Hartford, Connecticut
August 3, 2000
Page 28
<PAGE> 29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis presents a review of Aetna Inc. and its
subsidiaries (collectively, the "Company") for the three and six months ended
June 30, 2000 and 1999. This review should be read in conjunction with the
consolidated financial statements and other data presented herein as well as the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in Aetna Inc.'s 1999 Annual Report on Form 10-K.
OVERVIEW
General
At June 30, 2000, the Company's operations included three core businesses -
Aetna U.S. Healthcare, Aetna Financial Services and Aetna International. Aetna
U.S. Healthcare provides a full spectrum of managed care, indemnity, and group
life and disability insurance products. Aetna Financial Services markets a wide
array of retirement and investment products to small businesses, educational
institutions, state and local governments, non-profit organizations and
individuals. Aetna International, through subsidiaries and joint venture
operations, sells primarily life insurance, health insurance and financial
services products in markets outside the United States. The Company also has a
Large Case Pensions business that manages a variety of retirement products for
defined benefit and defined contribution plans.
Recent Developments
Agreement to Sell Aetna Financial Services and Aetna International
On July 20, 2000, the Company announced that it reached a definitive agreement
to sell its Aetna Financial Services and Aetna International businesses to ING
Groep N.V. ("ING") in a transaction valued at approximately $7.7 billion. Under
the terms of the agreement and in an integrated transaction, the Company will
spin off to its shareholders the shares of a standalone health company that will
be comprised primarily of the Aetna U.S. Healthcare and Large Case Pensions
businesses. Simultaneously, Aetna Inc., which then will be comprised of Aetna
Financial Services and Aetna International, will merge with a newly formed
subsidiary of ING. In exchange for each Aetna Inc. share, Aetna shareholders
will receive one share in the standalone health company, which will be named
Aetna Inc., and approximately $35 per share in cash. When ING acquires Aetna
Inc., that entity is expected to have approximately $2.7 billion in long-term
debt which will be assumed by ING.
The Company's goal is to close the transaction, which is subject to receipt of
required shareholder, regulatory and other consents and approvals, as well as
other closing conditions, by year end 2000. The Company expects that it will
incur certain costs associated with the definitive agreement with ING related to
the consummation of the transaction (including fees for outside financial and
legal advisors and expenses related to the change-in-control of Aetna Inc.) and
such costs may be material. Refer to "Liquidity and Capital Resources".
In connection with its spinoff from the Company, the standalone health company
generally will assume all liabilities related to the Aetna U.S. Healthcare and
Large Case Pensions businesses. In addition, the standalone health company
generally will be responsible for the Company's liabilities other than those
arising out of the Aetna Financial Services and Aetna International businesses
being sold to ING. These liabilities include the post-retirement pension and
other benefits payable to all former employees of the Company, liabilities
arising out of health litigation and certain corporate-level litigation to which
Aetna Inc. is a party, and all liabilities arising out of certain divestiture
transactions consummated by the Company prior to the closing of the health
company's spinoff from the Company.
Aetna U.S. Healthcare
The Company has initiated a comprehensive review of its health business model
and is in the process of considering and implementing a number of strategic
initiatives with the goal of improving the performance of its health business.
These strategic initiatives include, among other things, modifying Aetna U.S.
Healthcare's product portfolio, improving relations with health care providers
and others, leveraging the use of technology, considering exiting from certain
commercial HMO markets and realigning management. The Company has also retained
an executive recruiting firm to assist in the search for a chief executive
officer for its health business. See "Forward Looking Information/Risk Factors"
for a discussion of important risk factors related to the Company's Aetna U.S.
Healthcare business.
Page 29
<PAGE> 30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
OVERVIEW (CONTINUED)
Consolidated Results
The Company reported net income of $186 million for the three months ended June
30, 2000 compared to $218 million for the corresponding period in 1999. Net
income per diluted common share for the three months ended June 30, 2000 was
$1.30, compared with $1.43 a year ago.
Net income includes Year 2000 costs of $32 million for the three months ended
June 30, 1999. Net income also includes a reduction of the reserve for loss on
discontinued products for Large Case Pensions of $95 million for the three
months ended June 30, 2000 and $50 million for the corresponding period in 1999.
Net realized capital losses were $28 million for the three months ended June 30,
2000, and net realized capital gains were $6 million for the corresponding
period in 1999. Excluding the reduction of the reserve for loss on discontinued
products and net realized capital gains or losses in both periods, earnings were
$119 million for the three months ended June 30, 2000 compared to $161 million
for the corresponding period in 1999.
The Company reported net income of $356 million for the six months ended June
30, 2000 compared to $387 million for the corresponding period in 1999. Net
income per diluted common share for the six months ended June 30, 2000 was
$2.49, compared with $2.53 a year ago.
Net income includes Year 2000 costs of $59 million for the six months ended June
30, 1999. Net income also includes a reduction of the reserve for loss on
discontinued products for Large Case Pensions of $95 million for the six months
ended June 30, 2000 and $50 million for the corresponding period in 1999. Net
realized capital losses were $43 million for the six months ended June 30, 2000,
and net realized capital gains were $18 million for the corresponding period in
1999. Excluding the reduction of the reserve for loss on discontinued products
and net realized capital gains or losses in both periods, earnings were $303
million for the six months ended June 30, 2000 compared to $319 million for the
corresponding period in 1999.
Acquisitions and Dispositions
Aetna U.S. Healthcare
Acquisition of Prudential Health Care Business
On August 6, 1999, the Company acquired from The Prudential Insurance Company of
America ("Prudential") the Prudential health care business ("PHC") for
approximately $1 billion. The Company also agreed to service Prudential's
administrative services only ("ASO") business following the closing. Since the
closing, the Company's results have been affected by, among other things, the
operating results of PHC, the costs of financing the transaction and the
amortization of goodwill and other acquired intangible assets created as a
result of the transaction. The operations, and related amortization of
intangible assets, of PHC are reflected in the Aetna U.S. Healthcare segment,
while the financing costs of the acquisition are reflected in the Corporate
segment. Refer to "Aetna U.S. Healthcare", "Corporate", "Liquidity and Capital
Resources" and Note 4 of the Condensed Notes to Consolidated Financial
Statements for further discussion.
Page 30
<PAGE> 31
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
OVERVIEW (CONTINUED)
Sale of NYLCare Texas
In connection with the PHC acquisition, the Company agreed with the U.S.
Department of Justice and the State of Texas to divest certain Texas HMO/POS and
other related businesses ("NYLCare Texas") acquired by the Company as part of
the 1998 acquisition of New York Life Insurance Company's health care business
("NYLCare"). Pursuant to this agreement, on March 31, 2000, Aetna U.S.
Healthcare completed the sale of NYLCare Texas to Blue Cross and Blue Shield of
Texas ("Blue Cross"), a division of Health Care Service Corporation ("HCSC"),
for approximately $420 million in cash. The sale included approximately 463,000
Commercial HMO risk members, 52,000 Commercial HMO non-risk members and 5,000
PPO members in the Houston, Austin, San Antonio, Corpus Christi, Beaumont,
Dallas-Fort Worth, San Angelo, Texarkana and Amarillo areas. Aetna U.S.
Healthcare retained approximately 127,000 NYLCare Medicare members in Texas
through a reinsurance and administrative services agreement. The sale resulted
in a capital loss of approximately $35 million after tax, which was previously
recognized in the fourth quarter of 1999. The results of operations of NYLCare
Texas were not material to the Aetna U.S. Healthcare segment or to the Company's
consolidated results of operations.
Aetna International
Sale of Mexican Joint Ventures
On January 14, 2000, Aetna International, Inc. and its Mexican partner sold two
of their Mexican joint venture companies, Seguros Monterrey Aetna, S.A. and
Fianzas Monterrey Aetna, S.A., to New York Life International Inc., a subsidiary
of New York Life Insurance Company, for approximately $570 million in cash
(Aetna International, Inc.'s share of the proceeds was approximately $279
million). The sale resulted in a capital gain of approximately $13 million after
tax. The results of operations of these two Mexican joint ventures were not
material to the Aetna International segment or to the Company's consolidated
results of operations.
Refer to "Aetna International" and Note 4 of the Condensed Notes to Consolidated
Financial Statements for further discussion.
Page 31
<PAGE> 32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------- ---------------------------------
(Millions) 2000(1) 1999 % Change 2000(1) 1999 % Change
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $5,785.4 $3,949.1 46.5% $11,569.7 $7,861.7 47.2%
Net investment income 166.4 138.5 20.1 344.8 279.2 23.5
Fees and other income 498.6 386.1 29.1 1,014.0 769.2 31.8
Net realized capital losses (16.1) (12.9) 24.8 (45.2) (5.5) -
-----------------------------------------------------------------------------------------------------------------------
Total revenue 6,434.3 4,460.8 44.2 12,883.3 8,904.6 44.7
-----------------------------------------------------------------------------------------------------------------------
Current and future benefits 5,063.0 3,382.1 49.7 10,047.2 6,746.7 48.9
Salaries and related benefits 576.6 369.8 55.9 1,122.4 748.4 50.0
Other operating expenses 580.5 429.3 35.2 1,187.1 821.6 44.5
Amortization of goodwill and
other acquired intangible assets 109.2 101.9 7.2 218.4 203.8 7.2
-----------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 6,329.3 4,283.1 47.8 12,575.1 8,520.5 47.6
-----------------------------------------------------------------------------------------------------------------------
Income before income taxes 105.0 177.7 (40.9) 308.2 384.1 (19.8)
Income taxes 55.0 82.0 (32.9) 138.0 177.5 (22.3)
-----------------------------------------------------------------------------------------------------------------------
Net income $ 50.0 $ 95.7 (47.8) $ 170.2 $ 206.6 (17.6)%
=======================================================================================================================
Net realized capital losses,
net of tax (included above) $ (9.4) $ (8.4) 11.9% $ (21.0) $ (3.7) -%
=======================================================================================================================
</TABLE>
(1) Results include PHC, which was acquired on August 6, 1999.
Acquisition of the Prudential Health Care Business
On August 6, 1999, the Company acquired PHC. The Company also agreed to service
Prudential's ASO contracts following the acquisition. Included in the
acquisition are PHC's risk HMO, POS, PPO and Indemnity health lines, as well as
its dental risk business. Subsequent to the closing, Aetna U.S. Healthcare's
results have been affected by, among other things, the operating results of PHC
and the amortization of goodwill and other acquired intangible assets created by
the transaction. The results discussed below include PHC for the three and six
months ended June 30, 2000, including results from servicing Prudential's ASO
contracts, following the closing. Refer to "Overview" and Note 4 of the
Condensed Notes to Consolidated Financial Statements for a further discussion of
the PHC acquisition.
Results
Aetna U.S. Healthcare's net income for the three and six months ended June 30,
2000 decreased $46 million and $36 million respectively, compared to the
corresponding periods in 1999. Net income includes Year 2000 costs of $21
million for the second quarter of 1999 and $38 million for the six months ended
June 30, 1999. Net realized capital losses for the three and six months ended
June 30, 2000 primarily reflect the Company's rebalancing of its investment
portfolio in a rising interest rate environment. Excluding net realized capital
losses, results for the three months ended June 30, 2000 decreased $45 million,
or 43% and results for the six months ended June 30, 2000 decreased $19 million,
or 9%, compared to the corresponding periods in 1999.
Page 32
<PAGE> 33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
On April 6, 2000, the State of New Jersey enacted the New Jersey Insolvent
Health Maintenance Organization Assistance Fund Act of 2000 (the "Act"). The Act
is designed to reimburse individuals who were covered by and providers that had
contracts with two New Jersey HMOs prior to their insolvency. The total amount
to be assessed to all HMOs in New Jersey is $50 million. The Act requires that
HMOs in the New Jersey market be assessed a charge based on each HMO's
proportionate share of premiums written in New Jersey relative to all HMO
premiums written in New Jersey. The Company recorded an estimate of its share of
this assessment, based on its HMO market share in New Jersey, of $23 million
pretax ($15 million after-tax) in the second quarter of 2000.
In order to provide a comparison that management believes better reflects the
performance of Aetna U.S. Healthcare, the operating earnings discussion that
follows excludes amortization of goodwill and other acquired intangible assets
and net realized capital losses.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
(Millions) 2000 (1) 1999 2000(1) 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating earnings:
Health Risk and PHC $ 68.5 $ 116.6 $ 206.6 $ 233.0
Group Insurance and Other Health 79.7 70.1 161.8 142.4
---------------------------------------------------------------------------------------------------------------------------
Total Aetna U.S. Healthcare $ 148.2 $ 186.7 $ 368.4 $ 375.4
===========================================================================================================================
Commercial HMO Premium PMPM $148.77 $ 139.68 $148.04 $ 139.19
---------------------------------------------------------------------------------------------------------------------------
Commercial HMO Medical Cost PMPM $129.17 (2) $ 115.19 $126.27 (2) $ 114.66
---------------------------------------------------------------------------------------------------------------------------
Commercial HMO Medical Loss Ratio 86.8% (2) 82.5% 85.3% (2) 82.4%
---------------------------------------------------------------------------------------------------------------------------
Medicare HMO Premium PMPM $533.07 $ 488.93 $532.95 $ 487.16
---------------------------------------------------------------------------------------------------------------------------
Medicare HMO Medical Cost PMPM $518.81 (2) $ 442.01 $510.50 (2) $ 439.69
---------------------------------------------------------------------------------------------------------------------------
Medicare HMO Medical Loss Ratio 97.3% (2) 90.4% 95.8% (2) 90.3%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Results include PHC, which was acquired on August 6, 1999.
(2) Does not include net recoveries under a reinsurance agreement with
Prudential, net amortization of the reinsurance premiums paid, or net
amortization of certain fair value amounts established as part of the PHC
purchasing accounting. Refer to "PHC Agreement" below.
Health Risk and PHC
Health Risk (which includes all health products for which Aetna U.S. Healthcare
assumes all or a majority of health care cost and utilization risk) and PHC
operating earnings decreased $48 million for the three months ended June 30,
2000 and $26 million for the six months ended June 30, 2000 compared to the
corresponding periods of 1999. The decrease in 2000 operating earnings primarily
reflects significantly higher medical costs in both Commercial and Medicare HMO
products. Also contributing to the decrease in results were severance costs,
primarily related to PHC, and the New Jersey assessment discussed above. The
decrease in results was partially offset by the addition of PHC's results,
including the benefit of supplemental fees for servicing Prudential's ASO
customers and net recoveries under the reinsurance agreement with Prudential.
Page 33
<PAGE> 34
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
For the Health Risk business, the liability for medical claims payable reflects
estimates of the ultimate cost of claims that have been incurred but not yet
reported or reported but not yet paid. Medical claims payable are estimated
periodically, and any resulting adjustments are reflected in the current-period
operating results within current and future benefits. Medical claims payable are
based on a number of factors, including those derived from historical claim
experience. An extensive degree of judgment is used in this estimation process,
considerable variability is inherent in such estimates and the adequacy of the
estimate is highly sensitive to changes in medical claims payment patterns and
changes in medical cost trends. A worsening (or improvement) of medical cost
trend or changes in claim payment patterns from those that were assumed in
estimating medical claims payable at June 30, 2000 would cause these estimates
to change in the near term, and such changes could be material.
Commercial HMO
Commercial HMO premium per member per month ("PMPM") increased 6.5% for the
three months ended June 30, 2000 and 6.4% for the six months ended June 30, 2000
compared to the corresponding periods of 1999. Excluding PHC, the increase would
have been 7.1% for the three months ended June 30, 2000 and 7.3% for the six
months ended June 30, 2000 compared to the corresponding periods of 1999. These
increases were primarily due to premium rate increases, partially offset by
customers selecting lower premium plans.
Commercial HMO medical cost PMPM increased 12.1% for the three months ended June
30, 2000 and 10.1% for the six months ended June 30, 2000 compared to the
corresponding periods of 1999. Also, Commercial HMO medical cost PMPM for the
second quarter of 2000 increased 4.7% from the first quarter of 2000. Excluding
PHC, the increase would have been 11.6% for the three months ended June 30, 2000
and 10.0% for the six months ended June 30, 2000 compared to the corresponding
periods of 1999. These increases reflect higher medical costs primarily due to
higher than anticipated utilization specific to second quarter dates of service,
as well as additional medical costs related to the first quarter 2000. While the
specific factors vary in importance by local market, the major drivers of the
increase in utilization included a significant increase in inpatient
utilization, a higher number of emergency room visits, increased outpatient
surgery procedures, and, to a lesser extent, longer maternity length of stays,
more specialist office visits and increased costs for physician-administered
injectables.
The Commercial HMO medical loss ratio was 86.8% for the three months ended June
30, 2000 compared to 82.5% for the three months ended June 30, 1999. This ratio
was 85.3% for the six months ended June 30, 2000 compared to 82.4% for the
corresponding period of 1999. These increases were primarily due to the increase
in medical costs discussed above as well as the addition of the PHC business at
a medical loss ratio of 88.9% for the three months ended June 30, 2000 and 87.2%
for the six months ended June 30, 2000. The second quarter of 2000 MLR of 86.8%
was also higher than the first quarter of 2000 MLR of 83.8% due to the above
factors. Excluding PHC, the medical loss ratio would have been 85.9% for the
three months ended June 30, 2000 and 84.5% for the six months ended June 30,
2000.
Medicare HMO
Medicare HMO premium PMPM increased 9.0% for the three months ended June 30,
2000 and 9.4% for the six months ended June 30, 2000 compared to the
corresponding periods of 1999. Excluding PHC, the increase would have been 8.8%
for the three months ended June 30, 2000 and 9.2% for the six months ended June
30, 2000 compared to the corresponding periods of 1999. These increases were
primarily due to increases in supplemental premiums and Health Care Financing
Administration ("HCFA") rate increases.
Page 34
<PAGE> 35
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Medicare HMO medical cost PMPM increased 17.4% for the three months ended June
30, 2000 and 16.1% for the six months ended June 30, 2000 compared to the
corresponding periods of 1999. Also, Medicare HMO medical cost PMPM for the
second quarter of 2000 increased 3.3% from the first quarter of 2000. Excluding
PHC, the increase would have been 17.1% for the three months ended June 30, 2000
and 15.6% for the six months ended June 30, 2000 compared to the corresponding
periods of 1999. These increases primarily reflect higher medical costs
resulting from increased inpatient utilization, as well as additional medical
costs related to the first quarter of 2000.
The Medicare HMO medical loss ratio was 97.3% for the three months ended June
30, 2000 compared to 90.4% for the three months ended June 30, 1999. This ratio
was 95.8% for the six months ended June 30, 2000 compared to 90.3% for the
corresponding period of 1999. The second quarter of 2000 MLR of 97.3% was also
higher than the first quarter of 2000 MLR of 94.3%. Excluding PHC, the medical
loss ratio would have been 97.3% for the three months ended June 30, 2000 and
95.6% for the six months ended June 30, 2000. These increases were due to the
increased medical costs discussed above outpacing supplemental premiums and HCFA
rate increases.
The Company's Medicare+Choice contracts with the federal government are renewed
for a one-year period each January 1. On June 29, 2000, the Company notified
HCFA of its intent to exit a number of Medicare service areas affecting
approximately 340,000 members, or approximately 50 percent of the Company's
total current Medicare membership. The termination of these Medicare+Choice
contracts will become effective on December 31, 2000. The Company may elect to
continue to provide Medicare benefits to members in these service areas, in
accordance with HCFA regulations and guidelines, if legislative or regulatory
changes are made that would increase payments from HCFA to the Company within
six months following this notification date.
During the remainder of 2000, the Company will continue to monitor any
legislative or regulatory changes that might increase payments under applicable
Medicare+Choice contracts and then make a final determination, as permitted
under HCFA regulations, depending on the level of any such reimbursement
increase. The Company will also, at such time, evaluate the need for the
establishment of liabilities related to the withdrawal from applicable Medicare
service areas, including employee termination benefits and related costs, as
well as evaluate any impairment related to goodwill still separately
identifiable with such service areas, which is considered recoverable pending a
final decision to exit. Goodwill associated with such Medicare service areas was
approximately $275 million at June 30, 2000.
Page 35
<PAGE> 36
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
PHC Agreement
Effective August 6, 1999, the Company and Prudential entered into a reinsurance
agreement for which the Company paid a premium. Under the agreement, Prudential
has agreed to indemnify the Company from certain health insurance risks that
arise following the closing by reimbursing the Company for 75% of medical costs
(as calculated under the agreement) of PHC in excess of certain threshold
medical loss ratio levels through 2000 for substantially all the acquired
medical and dental risk business. The medical loss ratio threshold was 83.5% for
August 6, 1999 through December 31, 1999 and is 84% for January 1, 2000 through
December 31, 2000. During the three and six months ended June 30, 2000,
reinsurance recoveries under this agreement were $36 million and $46 million
pretax, respectively. In addition, results were negatively impacted by $1
million pretax for the three months ended June 30, 2000 and were positively
impacted by $1 million pretax for the six months ended June 30, 2000 related to
the net amortization of: the reinsurance premium paid as part of the
acquisition, the fair value adjustment of the reinsurance agreement and the fair
value adjustment of the unfavorable component of the contracts underlying the
acquired medical risk business recorded as part of the acquisition. Such
reinsurance recoveries and net amortization were reflected in current and future
benefits. Refer to Note 4 of Condensed Notes to Consolidated Financial
Statements.
The Company also agreed to service Prudential's ASO contracts following the
closing. Prudential is terminating its ASO business and has retained the Company
to service these contracts during the run off period, but no later than June 30,
2001. Prudential ASO customers will remain Prudential customers as long as the
contracts remain in force. The Company is maintaining personnel, systems and
other resources necessary to service the ASO business during the run off period,
as it was not feasible to segregate these operating assets from those purchased
in the PHC transaction. In exchange for servicing the ASO business, Prudential
is remitting fees received from its ASO customers to the Company, as well as
paying certain supplemental fees. The supplemental fees are fixed in amount and
decline over a period ending 18 months following the closing. During the three
and six months ended June 30, 2000, the Company recorded total fees for
servicing the Prudential ASO business of approximately $98 million and $204
million pretax, respectively, including supplemental fees of approximately $36
million and $84 million pretax (reflected as fees and other income) for the
three and six month periods ended June 30, 2000, respectively.
Included in these supplemental fees is amortization for the three and six month
periods ended June 30, 2000 of $4 million and $11 million pretax, respectively,
in connection with the above-market compensation component related to the
supplemental fees under the ASO contracts. The results of servicing this
business during the run off period will depend on, among other things, rate
increases that are obtained from renewing customers (most of such rate increases
were implemented by Prudential prior to the Company's servicing of these
contracts), the timing and extent of ASO contract terminations and the cost
structure for servicing these contracts. Refer to Note 4 of Condensed Notes to
Consolidated Financial Statements.
Group Insurance and Other Health
Group Insurance and Other Health includes group life and disability insurance
and long-term care insurance, offered on both an insured and employer-funded
basis, and all health products offered on an employer-funded basis. Group
Insurance and Other Health operating earnings increased $10 million for the
three months ended June 30, 2000 and $19 million for the six months ended June
30, 2000 compared to the corresponding periods of 1999. These increases are
primarily due to rate increases and higher nonrisk health membership levels,
partially offset by increased operating expenses.
Page 36
<PAGE> 37
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Membership
Aetna U.S. Healthcare's membership was as follows:
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
---------------------------------------- --------------------------------------
(Thousands) Risk Nonrisk Total Risk Nonrisk Total
---------------------------------------------------------------------------------------------------------------------------
HMO
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial (1) 7,865 855 8,720 5,434 716 6,150
Medicare 648 - 648 566 - 566
Medicaid 142 77 219 141 39 180
---------------------------------------------------------------------------------------------------------------------------
Total HMO 8,655 932 9,587 6,141 755 6,896
POS 352 3,435 3,787 212 2,451 2,663
PPO 807 3,031 3,838 884 2,945 3,829
Indemnity 251 1,963 2,214 162 2,058 2,220
---------------------------------------------------------------------------------------------------------------------------
Total Health Membership 10,065 9,361 19,426 7,399 8,209 15,608
===========================================================================================================================
Dental 14,628 7,861
---------------------------------------------------------------------------------------------------------------------------
Group Insurance:
Group Life 9,155 9,732
Disability 2,241 2,522
Long-Term Care 112 107
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 1,958 thousand POS members at June 30, 2000 and 1,507 thousand
POS members at June 30, 1999 who access primary care physicians and
referred care through an HMO network.
Total Health membership as of June 30, 2000 increased by 3.8 million members, or
25%, when compared to June 30, 1999, due to the acquisition of PHC, including
ASO members that Aetna U.S. Healthcare has agreed to service, partially offset
by the loss of NYLCare Texas members. Excluding the impact of the PHC members,
growth in total HMO membership was offset by declines in Other Health
membership. Total Health membership decreased by approximately 1.6 million
members from year end 1999 primarily due to losses in PHC membership, which
reflects the impact of price increases, as well as the loss of NYLCare Texas
members.
As discussed above, on June 29, 2000, the Company notified HCFA of its intent to
exit certain Medicare service areas as of December 31, 2000, which would affect
approximately 340,000 Medicare members, or approximately 50 percent of the
Company's total current Medicare membership.
Total Revenue and Expense
Revenue, excluding net realized capital losses, increased by $2.0 billion, or
44%, for the three months ended June 30, 2000 and $4.0 billion, or 45%, for the
six months ended June 30, 2000 compared to the corresponding periods of 1999.
These increases are primarily due to the acquisition of PHC, increases in
premium rates and growth in Commercial HMO membership.
Operating expenses, including salaries and related benefits, increased by $358
million, or 45%, for the three months ended June 30, 2000 and $740 million, or
47%, for the six months ended June 30, 2000 compared to the corresponding
periods of 1999. These increases are primarily due to the acquisition of PHC.
Operating expenses also reflect severance costs (primarily related to PHC) of
$25 million for the three months ended June 30, 2000 and $42 million for the six
months ended June 30, 2000 and increased costs to support Commercial HMO
membership growth. Operating expenses as a percentage of revenue was 18% for all
periods reported.
Page 37
<PAGE> 38
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Outlook
As discussed above, the Company is conducting a comprehensive review of Aetna
U.S. Healthcare's business model and is in the process of considering and
implementing a number of strategic initiatives in this business. At such time as
these initiatives are finally decided and implemented, the Company will evaluate
the need to establish liabilities related to these strategic changes, including
liabilities related to employee termination benefits and related costs, and the
Company will evaluate whether any impairment related to assets of the Company
has occurred. It is reasonably possible that, as a result of the above actions,
the Company will need to establish such liabilities or write down related assets
and that such liabilities and write downs could be material.
As also discussed above, unless legislative or regulatory changes are made prior
to the end of the year to increase payments under Medicare+Choice contracts, the
Company will exit a significant number of its Medicare service areas. The
Company may, however, elect to continue to provide Medicare benefits to members
in the affected service areas if legislative or regulatory changes are made that
would increase payments from HCFA to the Company within six months following the
HCFA notice date. During the remainder of 2000, the Company will continue to
monitor any legislative or regulatory changes that might increase payments under
applicable Medicare+Choice contracts and then make a final determination, as
permitted under HCFA regulations, depending on the level of any such
reimbursement increase. At such time the Company will evaluate the need to
establish liabilities related to this exit, including liabilities related to
employee termination benefits and related costs. Also, the Company will evaluate
whether any impairment related to goodwill still separately identifiable with
such Medicare service areas has occurred.
The Company experienced significantly higher HMO medical costs in the second
quarter of 2000. Premiums in the Health Risk business are generally fixed for
one-year periods and, accordingly, cost levels in excess of those reflected in
pricing, such as those being experienced during 2000, cannot be recovered in the
year through higher premiums. As a result, earnings in the Health Risk business
for the remainder of 2000 and, to a lesser extent, the first half of 2001 are
expected to continue to be materially adversely affected if medical costs
continue to be higher than the cost levels reflected in the Company's pricing.
Significant portions of the Company's Health Risk business renew on January 1,
2001 and on July 1, 2001. For these contracts, the Company has targeted further
premium increases to improve Health Risk profitability. The Company also
attempts to improve profitability by addressing cost increases in its
contracting with providers and through other cost management techniques. There
can be no assurances, however, that premium increases and cost savings achieved
through recontracting and other cost management techniques will be sufficient to
offset the increases in medical costs as well as any increases in other
operating costs, as governmental action (including rate decreases or reduction
of rate increases), business conditions (including intensification of
competition) and other factors may adversely affect the Company's ability to
realize such premium increases and cost savings. These premium increases may
also adversely affect membership levels in the Health Risk business.
Refer to "Forward-Looking Information/Risk Factors" in this Report, "Aetna U.S.
Healthcare - Outlook" and "Forward-Looking Information/Risk Factors" in Aetna
Inc.'s 1999 Annual Report on Form 10-K and Report on Form 10-Q for the period
ended March 31, 2000.
Page 38
<PAGE> 39
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA FINANCIAL SERVICES
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------------- ------------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums (1) $ 39.3 $ 18.8 109.0% $ 75.3 $ 42.4 77.6%
Net investment income 221.0 223.4 (1.1) 450.6 447.5 .7
Fees and other income 165.0 134.6 22.6 329.5 257.6 27.9
Net realized capital gains (losses) (3.0) 1.0 - (11.9) 3.9 -
------------------------------------------------------------------------------------------------------------------------------------
Total revenue 422.3 377.8 11.8 843.5 751.4 12.3
------------------------------------------------------------------------------------------------------------------------------------
Current and future benefits (1) 197.0 180.1 9.4 398.2 363.1 9.7
Salaries and related benefits 50.9 39.5 28.9 99.0 79.1 25.2
Operating expenses 54.7 55.1 (.7) 115.1 108.0 6.6
Amortization of deferred policy
acquisition costs 28.4 26.8 6.0 59.6 51.7 15.3
------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 331.0 301.5 9.8 671.9 601.9 11.6
------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 91.3 76.3 19.7 171.6 149.5 14.8
Income taxes 29.9 24.8 20.6 56.0 48.8 14.8
------------------------------------------------------------------------------------------------------------------------------------
Net income $ 61.4 $ 51.5 19.2% $ 115.6 $ 100.7 14.8%
====================================================================================================================================
Net realized capital gains (losses),
net of tax (included above) $ (1.9) $ .6 -% $ (7.7) $ 2.5 -%
====================================================================================================================================
Deposits (not included in premiums above):
Annuities -- fixed options $ 362.2 $ 449.1 (19.3)% $ 814.6 $ 994.3 (18.1)%
Annuities -- variable options 1,158.1 1,061.0 9.2 2,482.2 2,545.1 (2.5)
------------------------------------------------------------------------------------------------------------------------------------
Total $1,520.3 $1,510.1 .7% $ 3,296.8 $ 3,539.4 (6.9)%
====================================================================================================================================
Assets under management:
Annuities -- fixed options (2) $12,355.4 $12,550.8 (1.6)%
Annuities -- variable options (3) 36,786.5 29,499.5 24.7
Other investment advisory 22,860.5 16,737.6 36.6
------------------------------------------------------------------------------------------------------------------------------------
Total assets under management 72,002.4 58,787.9 22.5
Assets under administration (4) 8,512.1 3,729.4 128.2
------------------------------------------------------------------------------------------------------------------------------------
Total assets under management and
administration $80,514.5 $62,517.3 28.8%
====================================================================================================================================
</TABLE>
(1) Includes annuity premiums on contracts converting from the accumulation
phase to payout options with life contingencies of $26.9 million for the
three months ended June 30, 2000, $16.3 million for the three months ended
June 30, 1999, $55.2 million for the six months ended June 30, 2000 and
$38.0 million for the six months ended June 30, 1999.
(2) Excludes net unrealized capital losses of approximately $241.6 million at
June 30, 2000 and net unrealized capital gains of approximately $2.6
million at June 30, 1999.
(3) Includes $15,324.1 million at June 30, 2000 and $9,699.8 million at June
30, 1999 of assets invested through Aetna Financial Services' products in
unaffiliated mutual funds.
(4) Represents assets for which Aetna Financial Services provides
administrative services only.
Results
Aetna Financial Services' ("AFS") net income for the three months ended June 30,
2000 increased $10 million compared to the corresponding period in 1999. Net
income includes Year 2000 costs of $5 million for the three months ended June
30, 1999. Excluding net realized capital gains or losses, results for the three
months ended June 30, 2000 increased $12 million, or 24%, compared to the
corresponding period in 1999.
Page 39
<PAGE> 40
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA FINANCIAL SERVICES (CONTINUED)
Net income for the six months ended June 30, 2000 increased $15 million compared
to the corresponding period in 1999. Net income includes Year 2000 costs of $11
million for the six months ended June 30, 1999. Excluding net realized capital
gains or losses, results for the six months ended June 30, 2000 increased $25
million, or 26%, compared to the corresponding period in 1999.
The increase in earnings for both the three and six month periods ended June 30,
2000 primarily reflects an increase in fees and other income, partially offset
by an increase in salaries and related benefits.
Substantially all of fees and other income are calculated based on assets under
management and administration. Compared to June 30, 1999, assets under
management and administration at June 30, 2000 increased primarily due to
appreciation in the stock market, new investment advisory and administrative
contracts (including approximately $3.0 billion of assets under administration
from a new large case closed in the second quarter of 2000) and additional net
deposits (i.e., deposits, less surrenders). For the three months ended June 30,
2000, deposits remained relatively level compared to the corresponding period in
1999. Deposits for the six months ended June 30, 2000 decreased 7% compared to
the corresponding period in 1999 primarily resulting from plan assets of a large
new case in the first three months of 1999. Excluding this large case, deposits
for the six months ended June 30, 2000 would have increased 15% compared to the
corresponding period in 1999.
The increases in salaries and related benefits in the three and six month
periods ended June 30, 2000, from the corresponding periods in 1999, primarily
reflect higher staffing levels due to business growth and the implementation of
strategic business initiatives, particularly improving system infrastructures
and adding new distribution capabilities. Despite these overall increases,
annuity operating expenses as a percentage of average assets under management
decreased compared to the corresponding period in 1999.
Of the $12.4 billion and $12.6 billion of fixed annuity assets under management
at June 30, 2000 and 1999, respectively, 25% were fully guaranteed and 75% were
experience-rated in each period. The average annualized earned rate on
investments supporting fully guaranteed investment contracts was 7.5% and 7.4%,
and the average annualized earned rate on investments supporting
experience-rated investment contracts was 7.7% and 7.6% for the six months ended
June 30, 2000 and 1999, respectively. The average annualized credited rate on
fully guaranteed investment contracts was 6.2% and 6.4% for the six months ended
June 30, 2000 and 1999, respectively, and the average annualized credited rate
on experience-rated investment contracts was 5.6% for both periods. The
resulting annualized interest margins on fully guaranteed investment contracts
were 1.3% and 1.0%, and on experience-rated investment contracts were 2.1% and
2.0%, for the six months ended June 30, 2000 and 1999, respectively.
Outlook
As discussed above, the Company has agreed to sell its Aetna Financial Services
business to ING. Refer to "Forward-Looking Information/Risk Factors" in this
Report and "Aetna Financial Services - Outlook" and "Forward-Looking
Information/Risk Factors" in Aetna Inc.'s 1999 Annual Report on Form 10-K.
Page 40
<PAGE> 41
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------- ---------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $ 897.5 $ 645.1 39.1% $1,430.4 $1,061.7 34.7%
Net investment income (1) 131.5 113.1 16.3 263.8 238.1 10.8
Fees and other income 30.7 29.1 5.5 57.0 57.7 (1.2)
Net realized capital gains (losses) (34.8) 5.4 - (.5) 2.9 -
-----------------------------------------------------------------------------------------------------------------------------
Total revenue 1,024.9 792.7 29.3 1,750.7 1,360.4 28.7
-----------------------------------------------------------------------------------------------------------------------------
Current and future benefits 787.6 542.9 45.1 1,227.5 885.1 38.7
Salaries and related benefits 57.0 61.6 (7.5) 108.2 99.7 8.5
Operating expenses 100.8 91.4 10.3 205.4 195.8 4.9
Amortization of goodwill and other
acquired intangible assets 7.8 3.0 160.0 13.9 8.1 71.6
Amortization of deferred policy
acquisition costs 29.7 24.8 19.8 57.2 49.8 14.9
-----------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 982.9 723.7 (35.8) 1,612.2 1,238.5 30.2
-----------------------------------------------------------------------------------------------------------------------------
Income before income taxes 42.0 69.0 (39.1) 138.5 121.9 13.6
Income taxes 8.2 20.1 (59.2) 53.8 31.4 71.3
-----------------------------------------------------------------------------------------------------------------------------
Net income $ 33.8 $ 48.9 (30.9)% $ 84.7 $ 90.5 (6.4)%
=============================================================================================================================
Net realized capital gains (losses), net
of tax (included above) $ (18.9) $ 3.5 - % $ (16.9) $ 2.1 - %
=============================================================================================================================
</TABLE>
(1) Includes earnings from minority-owned affiliates that are recorded on the
equity method of accounting of $23.9 million for the three months ended
June 30, 2000, $16.0 million for the three months ended June 30, 1999,
$59.2 million for the six months ended June 30, 2000, and $46.5 million
for the six months ended June 30, 1999.
Results
Aetna International's net income for the three months ended June 30, 2000
decreased by $15 million compared to the corresponding period in 1999. Net
income includes Year 2000 costs of $5 million for the three months ended June
30, 1999. Excluding net realized capital gains or losses, results for the three
months ended June 30, 2000 increased $7 million, or 16%, compared to the
corresponding period in 1999.
Net income for the six months ended June 30, 2000 decreased by $6 million
compared to the corresponding period in 1999. Net income includes Year 2000
costs of $7 million for the six months ended June 30, 1999. Excluding net
realized capital gains or losses, results for the six months ended June 30, 2000
increased $13 million, or 15%, compared to the corresponding period in 1999.
Net realized capital losses for the three and six months ended June 30, 2000
includes $13 million and $19 million after-tax, respectively, from the sale of
investments in Japan's portfolio and $9 million after-tax relating to the
anticipated sale of Aetna International's ownership interest in its Venezuelan
joint venture.
Page 41
<PAGE> 42
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL (CONTINUED)
Earnings by major geographic location, excluding net realized capital gains or
losses, are as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ----------------------------
(Millions) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asia Pacific (1) $ 27.7 $20.7 $ 48.8 $ 29.3
Americas (2) 29.8 18.5 57.5 45.4
Other (3) (4.8) (3.7) (11.0) (11.8)
-----------------------------------------------------------------------------------------------------------------------------
Operating earnings from continuing businesses 52.7 35.5 95.3 62.9
Sold operations (4) - 9.9 6.3 25.5
-----------------------------------------------------------------------------------------------------------------------------
Total $ 52.7 $45.4 $101.6 $ 88.4
=============================================================================================================================
</TABLE>
(1) Includes China, Hong Kong, Indonesia, Japan (for the three month and six
month periods ended June 30, 2000), Malaysia, New Zealand, Philippines,
Taiwan and Thailand.
(2) Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru, Poland and
Venezuela.
(3) Includes general and other miscellaneous expenses.
(4) Includes the Mexican businesses, Seguros Monterrey Aetna S.A. ("SMA") and
Fianzas Monterrey Aetna S.A. ("FMA"), for the six months ended June
30, 2000 and SMA, FMA and Canada for the three months and six months
ended June 30, 1999.
The increase for both periods in Asia Pacific's earnings from continuing
businesses is due to significant premium growth in Taiwan, the addition of
earnings from Japan and heightened expense control throughout the Asia Pacific
region. Partially offsetting these increases was a decrease in Malaysia results
due primarily to the tax holiday in 1999 and tax adjustments in the second
quarter of 2000.
The increase in the Americas' earnings from continuing businesses for the second
quarter of 2000 is due to stronger results in the Mexican annuity business
primarily due to increased investment returns and customer base as well as
stronger results in Brazil due to an insurance premium tax reduction. The
increase in the Americas' earnings from continuing businesses for the six months
ended June 30, 2000 is due to stronger results in the Mexican pension business
in the first quarter of 2000 primarily due to membership growth and an increase
in fees due to higher average salaries per member, as well as the stronger
results in the second quarter of 2000 for the Mexican annuity business and in
Brazil, as previously mentioned.
The increase in the effective tax rate for the six months ended June 30, 2000
was primarily due to $33 million in taxes related to the sale of SMA and FMA
and, to a lesser extent, an increase in earnings from equity affiliates, which
are reported net of income taxes in net investment income.
On July 19, 2000, Aetna International signed an agreement to sell its New
Zealand operation, Aetna Health Limited, to Southern Cross Medical Care Society.
The sale is expected to close in the third quarter of 2000, subject to New
Zealand Commerce Commission approval. The earnings of Aetna Health Limited are
not material to the Company.
On July 14, 2000, Aetna International announced an agreement in principle to
sell its 49 percent ownership interest in a Venezuelan joint venture, Seguros
Mercantil, to the Venezuelan majority owner, Mercantil Servicios Financieros.
The sale is expected to close in the third quarter of 2000. The earnings of
Seguros Mercantil are not material to the Company.
On January 14, 2000, Aetna International and its Mexican partner sold two of
their Mexican joint venture companies, Seguros Monterrey Aetna, S.A. and Fianzas
Monterrey Aetna, S.A., to New York Life International Inc., a subsidiary of New
York Life Insurance Company, for approximately $570 million in cash (Aetna
International's share of the proceeds was approximately $279 million). The sale
resulted in a capital gain of approximately $13 million. These two joint
ventures contributed operating earnings of approximately $6 million during the
six months ended June 30, 2000 and $7 million for the six month period ended
June 30, 1999.
Page 42
<PAGE> 43
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL (CONTINUED)
On November 18, 1999, Aetna International acquired a 33% ownership interest in
Aetna Heiwa Life Insurance Company Ltd., formerly known as The Heiwa Life
Insurance Company Ltd., of Japan ("Heiwa"), for approximately $20 million.
During the first quarter 2000, Aetna International increased its ownership
interest in Heiwa to 99.82% for approximately $37 million. Heiwa contributed
operating earnings of approximately $3 million during the three months ended
June 30, 2000 and $7 million during the six months ended June 30, 2000.
On October 1, 1999, Aetna International sold its Canadian operations to John
Hancock Canadian Holdings Limited, the parent of The Maritime Life Assurance
Company, for approximately $310 million in cash. Operating earnings from the
Canadian operations were $10 million for the second quarter of 1999 and $19
million for the six month period ended June 30, 1999. Refer to "Aetna
International" in Aetna Inc.'s 1999 Annual Report on Form 10-K for additional
information related to this sale.
Outlook
As discussed above, the Company has agreed to sell its Aetna International
business to ING. Refer to "Forward-Looking Information/Risk Factors" in this
Report and "Aetna International" and "Forward-Looking Information/Risk Factors"
in Aetna Inc.'s 1999 Annual Report on Form 10-K.
Page 43
<PAGE> 44
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -----------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $ 36.9 $ 28.8 28.1 $ 77.6 $ 57.4 35.2
Net investment income 216.2 258.3 (16.3) 460.7 514.9 (10.5)
Fees and other income 6.0 9.4 (36.2) 12.6 18.9 (33.3)
Net realized capital gains 6.6 20.3 (67.5) 7.2 29.5 (75.6)
-----------------------------------------------------------------------------------------------------------------------------
Total revenue 265.7 316.8 (16.1) 558.1 620.7 (10.1)
-----------------------------------------------------------------------------------------------------------------------------
Current and future benefits 229.9 254.0 (9.5) 487.6 505.5 (3.5)
Salaries and related benefits 4.3 4.7 (8.5) 8.8 10.0 (12.0)
Operating expenses 2.0 3.5 (42.9) 4.0 6.3 (36.5)
Reduction of reserve for loss
on discontinued products (146.0) (77.2) 89.1 (146.0) (77.2) 89.1
-----------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 90.2 185.0 (51.2) 354.4 444.6 (20.3)
-----------------------------------------------------------------------------------------------------------------------------
Income before income taxes 175.5 131.8 33.2 203.7 176.1 15.7
Income taxes 61.8 46.8 32.1 72.6 62.8 15.6
-----------------------------------------------------------------------------------------------------------------------------
Net income $ 113.7 $85.0 33.8 $ 131.1 $ 113.3 15.7
=============================================================================================================================
Net realized capital gains, net of
tax (included above) $ 4.4 $13.2 (66.7) $ 5.2 $ 19.2 (72.9)
=============================================================================================================================
Deposits not included in
premiums above $ 164.1 $195.9 (16.2) $ 327.3 $ 461.3 (29.0)
=============================================================================================================================
Assets under management (1) (2) $25,243.8 $27,365.7 (7.8)
=============================================================================================================================
</TABLE>
(1) Excludes net unrealized capital losses of $223.1 million at June 30, 2000
and net unrealized capital losses of $35.5 million at June 30, 1999.
(2) Includes assets under management of $5,787.4 million at June 30, 2000 and
$6,390.1 million at June 30, 1999 related to discontinued products.
Results
Large Case Pensions' net income for the three months ended June 30, 2000
increased by $29 million compared with the corresponding period in 1999. Results
include a reduction of the reserve for loss on discontinued products for Large
Case Pensions of $95 million for the three months ended June 30, 2000 primarily
as a result of favorable investment performance and favorable mortality and
retirement experience and $50 million for the corresponding period in 1999 as a
result of favorable investment performance. Excluding the discontinued products
reserve releases and net realized capital gains, results for the three months
ended June 30, 2000 decreased $7 million, or 33%, compared to the corresponding
period in 1999.
Net income for the six months ended June 30, 2000 increased by $18 million
compared with the corresponding period in 1999. Excluding the discontinued
products reserve releases and net realized capital gains, results for the six
months ended June 30, 2000 decreased $13 million, or 29%, compared to the
corresponding period in 1999.
The decrease in results for the three and six month periods ended June 30, 2000
continues to reflect lower investment income due to the redeployment of capital
supporting this business. Assets under management at June 30, 2000 were 8% lower
than a year earlier. This decrease primarily resulted from the continuing run
off of liabilities underlying the Large Case Pensions business.
Page 44
<PAGE> 45
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
General account assets supporting experience-rated products (where the
contractholder, 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>
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
(Millions) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Scheduled contract maturities
and benefit payments (1) $226.0 $237.3 $451.9 $478.5
Contractholder withdrawals other than
scheduled contract maturities and benefit
payments 48.4 125.7 103.4 201.0
Participant directed withdrawals 14.9 21.5 25.7 43.9
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes payments made upon contract maturity and other amounts distributed
in accordance with contract schedules.
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
the expected cash flows from the assets supporting these products and 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.
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>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- --------------------------
(Millions) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest deficit (1) $ (7.4) $(3.3) $ (3.8) $ (8.6)
Net realized capital gains - 5.3 1.9 11.9
Interest earned on receivable from continuing products 5.3 5.5 10.6 11.0
Other, net 1.2 1.3 7.5 5.9
-------------------------------------------------------------------------------------------------------------------------
Results of discontinued products, after tax $ (.9) $ 8.8 $ 16.2 $ 20.2
=========================================================================================================================
Results of discontinued products, pretax $ (1.2) $13.2 $ 22.0 $ 30.7
=========================================================================================================================
Net realized capital gains (losses) from sales of bonds,
after tax (included above) $(15.3) $ 2.3 $(35.5) $ 7.8
=========================================================================================================================
</TABLE>
(1) The interest deficit is the difference between earnings on invested assets
and interest credited to contractholders.
Page 45
<PAGE> 46
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
Net realized capital gains for the three and six months ended June 30, 2000
decreased compared to the corresponding periods in 1999. These decreases
primarily result from realized capital losses on bonds, due to the rising
interest rate environment, offset by capital gains from the sale of equities.
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 $380 million at June 30, 2000 and $464
million at December 31, 1999, 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. Since 1993, 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.
The activity in the reserve for anticipated future losses on discontinued
products for the six months ended June 30, 2000 was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
-----------------------------------------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1999 $ 1,147.6
Operating income 9.9
Net realized capital gains .1
Mortality and other 12.0
Reserve reduction (146.0)
-----------------------------------------------------------------------------------------------------
Reserve at June 30, 2000 $ 1,023.6
=====================================================================================================
</TABLE>
Page 46
<PAGE> 47
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
Management reviews the adequacy of the discontinued products reserve quarterly
and, as a result, $95 million ($146 million pretax) of the reserve was released
in the second quarter of 2000 primarily due to favorable performance related to
certain equity investments, favorable mortality and retirement experience and
the decrease in size of the overall bond portfolio which decreased default risk.
The current reserve reflects management's best estimate of anticipated future
losses.
The discontinued products investment portfolio is as follows:
<TABLE>
<CAPTION>
(Millions) June 30, 2000 December 31, 1999
----------------------------------------------------------------------------------------------------------------
Class Amount Percent Amount Percent
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Debt Securities $ 4,319.2 76.0% $ 4,533.0 77.2%
Mortgage Loans 806.9 14.2 768.8 13.1
Real Estate 116.9 2.0 112.7 1.9
Equities 200.2 3.5 239.7 4.1
Short-term and other investments 242.3 4.3 214.2 3.7
----------------------------------------------------------------------------------------------------------------
Total $ 5,685.5 100.0% $ 5,868.4 100.0%
================================================================================================================
</TABLE>
Distributions on discontinued products were as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ----------------------------
(Millions) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Scheduled contract maturities, settlements
and benefit payments $248.1 $356.2 $499.3 $ 666.7
Participant directed withdrawals 2.3 4.3 5.0 8.6
-----------------------------------------------------------------------------------------------------------------------
</TABLE>
Cash required to fund these distributions was provided by earnings and scheduled
payments on, and sales of, invested assets.
Refer to Note 8 of Condensed Notes to Consolidated Financial Statements for
additional information.
CORPORATE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- ---------------------------------------
(Millions, after tax) 2000 1999 % Change 2000 1999 % Change
----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest expense $46.8 $ 40.1 16.7 $ 96.8 $ 80.7 20.0
==================================================================================================================================
Salaries and related benefits $14.9 $ 11.4 30.7 $ 25.1 $ 22.9 9.6
Other operating expense, net 8.7 9.6 (9.4) 21.8 17.9 21.8
Net realized capital losses 2.1 2.5 (16.0) 2.1 2.5 (16.0)
----------------------------------------------------------------------------------------------------------------------------------
Total other expense $25.7 $ 23.5 9.4 $ 49.0 $ 43.3 13.2
==================================================================================================================================
</TABLE>
The Corporate segment includes interest expense and other expenses that are not
directly related to the Company's business segments. "Other operating expense,
net" includes corporate expenses, such as staff area expenses, advertising and
contributions, which are partially offset by net investment income.
The 2000 increase in interest expense primarily results from additional debt
incurred in connection with the PHC acquisition in August 1999. Net realized
capital losses in the three and six months ended June 30, 2000 include losses of
$2.8 million on the sale of certain Corporate real estate.
Page 47
<PAGE> 48
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
CORPORATE (CONTINUED)
Other operating expenses include Year 2000 costs of $1 million and $2 million
for the three and six months ended June 30, 1999, respectively. Other operating
expenses increased $4 million in the six months ended June 30, 2000 primarily
resulting from costs related to the Company's prior plan to separate into two
independent publicly traded companies.
As discussed above, the Company has agreed to sell its Aetna Financial Services
and Aetna International businesses to ING, and the Company's goal is to close
this transaction by year end 2000. In connection with closing this transaction,
the Company will be incurring various costs, including fees for outside
financial and legal advisors and expenses related to the change-in-control of
Aetna Inc. The Company will evaluate the need to establish liabilities related
to this transaction, including liabilities related to employee termination
benefits and related costs. It is reasonably possible that the Company will need
to establish such liabilities and that such liabilities and costs could be
material.
Page 48
<PAGE> 49
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
TOTAL INVESTMENTS
Investments disclosed in this section relate to the Company's total general
account portfolio (including assets supporting discontinued products and
experience-rated products).
<TABLE>
<CAPTION>
(Millions) June 30, 2000 December 31, 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Debt securities available for sale $ 30,736.0 $28,661.6
Debt securities held to maturity 149.9 -
Equity securities 711.1 791.1
Short-term investments 574.3 788.2
Mortgage loans 3,168.6 3,238.2
Commercial loans 1,104.2 -
Real estate 496.6 361.8
Policy loans 839.5 541.5
Other 1,702.4 1,394.8
----------------------------------------------------------------------------------------------------------------
Total investments $ 39,482.6 $35,777.2
================================================================================================================
</TABLE>
Debt Securities
Debt securities represented 78% of the Company's total general account invested
assets at June 30, 2000 and 80% at December 31, 1999 and supported the following
types of businesses:
<TABLE>
<CAPTION>
(Millions) June 30, 2000 December 31, 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 4,319.2 $ 4,533.0
Supporting experience-rated products 11,561.7 11,879.5
Supporting remaining products 15,005.0 12,249.1
----------------------------------------------------------------------------------------------------------------
Total debt securities (1) $30,885.9 $28,661.6
================================================================================================================
</TABLE>
(1) Total debt securities include "Below Investment Grade" securities of $2.2
billion at June 30, 2000 and $2.1 billion at December 31, 1999 of which
37% at June 30, 2000 and 46% at December 31, 1999 supported discontinued
and experience-rated products. Refer to Aetna Inc.'s 1999 Annual Report on
Form 10-K for a discussion of "Below Investment Grade" securities.
Debt securities reflected net unrealized capital losses of $677 million at June
30, 2000 and $748 million at December 31, 1999. Of the net unrealized capital
losses at June 30, 2000, $102 million relate to assets supporting discontinued
products and $271 million relate to experience-rated pension contractholders.
Residential Collateralized Mortgage Obligations
Included in the Company's debt securities are residential collateralized
mortgage obligations ("CMOs") of $1.8 billion at June 30, 2000 and $1.7 billion
at December 31, 1999. There are various categories of CMOs that are subject to
different degrees of risk from changes in interest rates and, for CMOs that are
not agency backed, defaults. The principal risks inherent in holding CMOs are
prepayment and extension risks related to dramatic decreases and increases in
interest rates, resulting in the repayment of principal from the underlying
mortgages either earlier or later than originally anticipated. At June 30, 2000,
approximately 2% and at December 31, 1999, approximately 1% of the Company's CMO
holdings were invested in CMOs that are subject to more prepayment and extension
risk than traditional CMOs (such as interest- or principal-only strips).
Page 49
<PAGE> 50
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
TOTAL INVESTMENTS (CONTINUED)
Mortgage and Commercial Loans
At June 30, 2000 and December 31, 1999, the Company's mortgage loan investments,
net of impairment reserves, supported the following types of businesses:
<TABLE>
<CAPTION>
(Millions) June 30, 2000 December 31, 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 806.9 $ 768.8
Supporting experience-rated products 720.6 923.4
Supporting remaining products 1,641.1 1,546.0
---------------------------------------------------------------------------------------------------------------------
Total mortgage loans $3,168.6 $3,238.2
=====================================================================================================================
Total commercial loans $1,104.2 $ -
=====================================================================================================================
</TABLE>
During the first six months of 2000, the Company managed its mortgage loan
portfolio to maintain the balance, relative to invested assets, by selectively
pursuing refinance and new loan opportunities. The mortgage loan portfolio
balance represented 8% at June 30, 2000 and 9% at December 31, 1999 of the
Company's total general account invested assets.
Problem, restructured and potential problem loans included in mortgage loans
were $290 million at June 30, 2000 and $285 million at December 31, 1999 of
which 77% at June 30, 2000 and 79% at December 31, 1999 supported discontinued
and experience-rated products. Specific impairment reserves on these loans were
$36 million at June 30, 2000 and $32 million at December 31, 1999. Refer to
Aetna Inc.'s 1999 Annual Report on Form 10-K for a discussion of problem,
restructured and potential problem loans and Note 5 of the Condensed Notes to
Consolidated Financial Statements for additional information.
During the first quarter 2000, as part of the Heiwa acquisition, the Company
acquired approximately $1.2 billion of commercial loans, net of an allowance for
loan losses of $174 million, as adjusted within the purchase price allocation
period. The commercial loan portfolio primarily consists of secured corporate
working capital loans, mostly to Japanese borrowers.
Risk Management and Market-Sensitive Instruments
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.
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 options to hedge interest rate, equity price and foreign exchange
risks.
The Company regularly evaluates the risk of market-sensitive instruments by
examining, among other things, levels of or changes in domestic and/or foreign
interest rates (short-term or long-term), duration, exchange rates, prepayment
rates, equity markets or credit ratings/spreads.
Management also reviews, on a quarterly basis, hypothetical net losses in the
Company's consolidated near-term financial position, results of operations and
cash flows under certain assumed market rate changes. 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 as of June 30, 2000. Refer to Aetna
Inc.'s 1999 Annual Report on Form 10-K for a more complete discussion of "Risk
Management and Market-Sensitive Instruments".
Page 50
<PAGE> 51
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
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.
During the first six months of 2000, the Company used net cash generated from
investing, financing and operating activities to make approximately $75 million
of investments in core businesses and acquisitions, pay approximately $95
million for common stock repurchases and pay approximately $56 million of
dividends to shareholders. During the corresponding period of 1999, the Company
used net cash generated from investing, financing and operating activities to
make approximately $192 million of investments in core businesses and
acquisitions, pay approximately $72 million for common stock repurchases and pay
approximately $84 million of dividends to shareholders. Refer to the
"Consolidated Statements of Cash Flows" for additional information.
Dividends
On June 30, 2000, the Company's Board of Directors declared a quarterly dividend
of $.20 per share of common stock to shareholders of record at the close of
business July 28, 2000, payable August 15, 2000.
Financings and Financing Capacity
Substantially all of the Company's borrowings and financings are conducted
through Aetna Services, Inc. and are fully and unconditionally guaranteed by
Aetna Inc. Refer to Note 9 of the Condensed Notes to Consolidated Financial
Statements for additional information. As part of the ING transaction, ING will
assume up to $2.7 billion of Aetna Services, Inc.'s long-term debt at closing.
The Company has significant short-term liquidity supporting its businesses. The
Company uses short-term borrowings from time to time to address timing
differences between receipts and disbursements. The maximum amount of domestic
short-term borrowings outstanding was $2.0 billion during the first six months
of 2000 and $1.1 billion during the first six months of 1999.
Common Stock Transactions
On October 8, 1999, the Board of Directors authorized the repurchase of up to 20
million shares of common stock, not to exceed an aggregate purchase price of $1
billion (the "Plan"). Pursuant to the Plan, the Company has repurchased
8,707,000 shares of common stock at a cost of approximately $472 million through
June 30, 2000, of which 1,787,000 shares at a cost of approximately $95 million
were repurchased during the first six months of 2000. The Company currently
expects repurchases of its common stock to be minimal prior to the closing of
the ING transaction.
Page 51
<PAGE> 52
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Standalone Health Company
The Company currently expects the standalone health company to have an initial
short-term debt level at the time of the closing of the ING transaction that
exceeds the Company's domestic short-term debt level at June 30, 2000 and a debt
to capital ratio lower than Aetna Inc.'s current ratio. It also is a condition
to closing the ING transaction that the standalone health company have an
investment grade debt rating of either at least BBB from Standard & Poor's or
Baa2 from Moody's Investors Service.
The dividend and share repurchase policies of the standalone health company will
be determined by the board of directors of that company at a future date and may
vary from the Company's current policies.
GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
Goodwill and other acquired intangible assets were $9.0 billion at June 30,
2000, or approximately 81% of consolidated shareholders' equity. The
amortization of goodwill and other acquired intangible assets was $234 million
for the six months ended June 30, 2000, or approximately 39% 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, workforce 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 effect on results of operations and financial condition.
Refer to "Aetna U.S. Healthcare" for discussion relating to goodwill associated
with certain Medicare service areas which the Company has notified HCFA of its
intent to exit.
NEW ACCOUNTING STANDARDS
Refer to Note 1 of the Condensed Notes to Consolidated Financial Statements for
a discussion of recently issued accounting standards.
Page 52
<PAGE> 53
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT
The "Regulatory Environment" portion of Aetna Inc.'s 1999 Annual Report on Form
10-K and report on Form 10-Q for the period ended March 31, 2000 and "Legal
Proceedings - Other Litigation and Regulatory Proceedings" below contain a
discussion of important regulatory issues related to the Company's businesses.
Additional recent regulatory developments are described below.
- On April 11, 2000, Aetna U.S. Healthcare's Texas HMOs entered into an
Agreement of Voluntary Compliance ("AVC") with the Office of the
Attorney General of Texas ("OAG") to settle, with prejudice and without
admission, litigation commenced by the OAG in December 1998 regarding
certain alleged business practices and to make additional commitments
which the Company believes will help restore public confidence in
managed care. The AVC provides for, among other things, allowing
directly contracted Texas physicians in small group or individual
practice to choose whether to participate in either or both of Aetna
U.S. Healthcare's HMO/HMO-based and PPO/PPO-based product lines; paying
directly contracted capitated primary care physicians with fewer than
100 HMO members on a fee-for-service basis rather than a capitated
basis; expanding independent external review of coverage denials to
include disputes regarding experimental and investigational coverage,
emergency coverage, prescription drug coverage and standing referrals
to specialists; and the creation of an Office of the Ombudsman that
will act as an advocate for members and assist them with appeals or
complaints. The AVC does not include any finding of fault nor does it
include any fines or penalties. The Company does not expect the AVC to
have a material effect on its financial condition or results of
operations, and the AVC provides for potential relief should such
unexpected impact occur.
FORWARD-LOOKING INFORMATION/RISK FACTORS
The "Forward-Looking Information/Risk Factors" portions of Aetna Inc.'s 1999
Annual Report on Form 10-K and Report on Form 10-Q for the period ended March
31, 2000 and the discussion below contain a discussion of important risk factors
related to the Company's businesses.
We also face certain risks related to our pending transaction with ING. Our
ability to complete the pending transaction with ING is subject, among other
things, to receipt of required shareholder, regulatory and other consents and
approvals, receipt of an investment grade debt rating of either at least BBB
from Standard & Poor's or Baa2 from Moody's Investors Service for the standalone
health company (which will be influenced by the results of our health business
prior to the closing of the ING transaction) and the satisfaction of the other
closing conditions specified in the transaction documents. We cannot control the
timing or outcome of these consents and approvals or certain of these other
matters, which could be delayed for a variety of reasons related and unrelated
to the transaction itself. For a description of risk factors that may materially
affect the results of our health business prior to the closing of the ING
transaction, please see the risk factors contained in Aetna's 1999 Report on
Form 10-K and Report on Form 10-Q for the period ended March 31, 2000 filed with
the SEC and in this Report on Form 10-Q.
Page 53
<PAGE> 54
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
FORWARD-LOOKING INFORMATION/RISK FACTORS (CONTINUED)
We are seeking to improve the performance of our health business. The
performance of our health business has been disappointing and results of that
business have declined significantly in 2000. We have initiated a comprehensive
review of our health business model, and we are in the process of considering
and implementing a number of strategic initiatives with the goal of improving
this business, including increasing prices. Our future success will depend in
large part on our ability to design and implement these strategic initiatives.
If these initiatives do not achieve their objective, our results could continue
to be adversely affected. Also, the Company's health business has recently
experienced significant changes in its senior management, and the Company is
currently searching for a new chief executive officer for this business. The
Company's success will also be dependent upon attracting and retaining a chief
executive officer and other members of senior management in this business. For a
description of other risk factors that may materially affect the results and
business of Aetna U.S. Healthcare, please see the risk factors contained in
Aetna's 1999 Report on Form 10-K and Report on Form 10-Q for the period ended
March 31, 2000 filed with the SEC and in this Report on Form 10-Q.
Our profitability growth depends in part on an efficient integration of the PHC
operations. We acquired the PHC operations on August 8, 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. Since the PHC closing, we have
been working on integrating those operations into the operations of Aetna U.S.
Healthcare. Due to the timing of the closing of the PHC acquisition, however,
only a limited number of PHC members have been migrated to Aetna U.S.
Healthcare's products to date. Migration and integration of substantial numbers
of PHC members to Aetna U.S. Healthcare's products is scheduled to occur
effective January 1, 2001 and January 1, 2002. Our ability to profitably grow as
a result of the PHC acquisition is dependent upon the successful migration and
integration of these members on these dates.
Recent regulatory developments and legal proceedings could adversely affect our
businesses. The regulatory developments described in "Regulatory Environment"
and in "Legal Proceedings - Other Litigation and Regulatory Proceedings" in this
Report could adversely affect our businesses by, among other things, increasing
our medical costs and/or operating expenses, reducing our ability to manage
medical costs and/or potentially restricting certain marketing activities. It is
uncertain whether we could counteract, through higher prices or other measures,
these adverse effects.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Refer to the information contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Total Investments".
Page 54
<PAGE> 55
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Shareholder Litigation
----------------------
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 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 Company and the remaining individual defendants filed a motion to dismiss
the second amended complaint, and the Court denied that motion in March 1999. On
August 9, 1999, the Court entered an order certifying as plaintiffs those
persons who purchased Company common stock on the market from March 6, 1997
through 7:00 a.m. on September 29, 1997. Merits discovery was completed in early
2000. On January 31, 2000 plaintiffs filed expert reports. On February 3, 2000,
defendants filed motions for summary judgment. Also on February 3, 2000,
plaintiffs moved for permission to file a third amended complaint. On March 20,
2000, the Court granted plaintiffs leave to file a third amended complaint and
adopted a revised schedule. Pursuant to the revised schedule, defendants filed
new summary judgment motions in May 2000 and the parties conducted expert
discovery which is scheduled to be completed in the third quarter of 2000.
Defendants' summary judgment motions are scheduled to be heard in August 2000,
and trial is now scheduled to begin in the fourth quarter of 2000. Defendants
are defending the actions vigorously.
Four purported shareholder class action complaints were filed in the Superior
Court of Connecticut, Hartford County alleging in substance that the Company and
its directors breached fiduciary duties to shareholders in responding to a
February 24, 2000 letter from Wellpoint Health Networks, Inc. and ING America
Insurance Holdings, Inc. which had invited discussions concerning a possible
transaction. These actions were filed on behalf of George Schore, Michael
Demetrio and Gersh Korsinsky on March 3, 2000, The Rainbow Fund on March 7,
2000, Eleanor Werbowsky on March 7, 2000, and Catherine M. Friend on March 23,
2000. A fifth, substantially similar purported class action complaint was filed
on behalf of Barnett Stepak on March 28, 2000 in the Supreme Court of New York,
New York County. Each action seeks various forms of relief, including
unspecified damages and equitable remedies. This litigation is in the
preliminary stages. Defendants intend to defend these actions vigorously.
Health Care Litigation
----------------------
The Company is involved in several purported class action lawsuits that are part
of a wave of similar actions targeting the health care industry and, in
particular, the conduct of business by managed care companies.
Page 55
<PAGE> 56
Item 1. Legal Proceedings. (Continued)
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on April 19, 1999 by Joseph Maio, Jo
Ann Maio and Gary Bender seeking various forms of relief, including unspecified
damages and treble damages, from the Company and a number of its subsidiaries
for alleged violations of the Racketeer Influenced and Corrupt Organizations Act
("RICO"), the Pennsylvania Unfair Trade Practices and Consumer Protection Law,
and state common law. On September 29, 1999, the Court dismissed the RICO claims
with prejudice and dismissed the state law claims for lack of subject matter
jurisdiction. The Court held, among other things, that the plaintiffs lacked
standing to pursue the federal RICO claims because they had not alleged an
injury in fact. Plaintiffs have appealed the dismissal to the United States
Court of Appeals for the Third Circuit. Oral argument was heard on June 19,
2000, and the appeals court is expected to render a decision on the appeal
during 2000.
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on October 4, 1999 by Anthony Conte
(the "Conte Complaint"). The Conte Complaint seeks various forms of relief,
including unspecified damages, from Aetna U.S. Healthcare Inc. for alleged
violations of the Employee Retirement Income Security Act of 1974 ("ERISA"). The
Conte Complaint alleges that Aetna U.S. Healthcare does not make adequate
disclosure of provider compensation arrangements in the literature that it makes
available to actual or prospective members. The Company intends to defend the
action vigorously and on November 1, 1999, filed a motion to dismiss the
litigation for failure to state a claim upon which relief can be granted. On
December 15, 1999, the Court suspended further proceedings pending the
resolution of the Maio appeal by the United States Court of Appeals for the
Third Circuit.
A purported class action complaint was filed in the United States District Court
for the Southern District of Mississippi on October 7, 1999 by Jo Ann O'Neill
(the "Mississippi O'Neill Complaint"). An Amended Complaint was filed on
November 9, 1999 by Jo Ann O'Neill, Lydia K. Rouse and Danny E. Waldrop. The
Mississippi O'Neill Complaint seeks various forms of relief, including
unspecified damages and treble damages and restitution of alleged improper
profits, from the Company, Aetna U.S. Healthcare Inc., Richard L. Huber and
unnamed members of the Board of Directors of Aetna Inc. for alleged violations
of ERISA and RICO. The Mississippi O'Neill Complaint alleges that defendants are
liable for alleged misrepresentations and omissions relating to advertising,
marketing and member materials directed to Aetna HMO members. On November 22,
1999, defendants moved to stay, dismiss or transfer the action to the United
States District Court for the Eastern District of Pennsylvania based on the
Conte and Maio Complaints filed in that court. On January 25, 2000, the Court
suspended further proceedings pending resolution of a motion in cases involving
other defendants to consolidate those actions in a single court. This litigation
is in the preliminary stages. Defendants intend to defend the action vigorously.
A purported class action complaint was filed in the Superior Court of
California, County of Contra Costa on October 28, 1999 by Jeanne E. Curtright in
her individual capacity and on behalf of the general public of the State of
California (the "Curtright Complaint"). The Curtright Complaint seeks various
forms of relief, including injunctive relief, restitution and disgorgement of
amounts allegedly wrongfully acquired, from the Company, Aetna U.S. Healthcare
Inc., Aetna U.S. Healthcare of California Inc. and unnamed "John Doe" defendants
for alleged violations of California Business and Professions Code Sections
17200 and 17500, California Civil Code Section 1750 and state common law in
connection with the sale and marketing of health plans in California. The
Curtright Complaint alleges that defendants are liable for alleged
misrepresentations and omissions relating to advertising, marketing and member
materials directed to Aetna HMO, POS and PPO members and members of the general
public. On December 16, 1999, defendants removed the action to the United States
District Court for the Northern District of California. Plaintiff has moved to
remand the action to state court. The Company has moved to dismiss the Curtright
Complaint for failure to state a claim upon which relief can be granted and
moved for a stay of the action pending resolution of the Maio and Conte matters.
This litigation is in the preliminary stages. Defendants intend to defend the
action vigorously.
Page 56
<PAGE> 57
Item 1. Legal Proceedings. (Continued)
A complaint was filed in the Superior Court of the State of California, County
of San Diego on November 5, 1999 by Linda Ross and The Stephen Andrew Olsen
Coalition for Patients Rights, purportedly on behalf of the general public of
the State of California (the "Ross Complaint"). The Ross Complaint seeks various
forms of relief, including injunctive relief, restitution and disgorgement of
amounts allegedly wrongfully acquired, from Aetna Inc., Aetna U.S. Healthcare
Inc., Aetna U.S. Healthcare of California Inc. and additional unnamed "John Doe"
defendants for alleged violations of California Business and Professions Code
Sections 17200 and 17500. The Ross Complaint alleges that defendants are liable
for alleged misrepresentations and omissions relating to advertising, marketing
and member materials directed to Aetna HMO, POS and PPO members and the general
public and for alleged unfair practices relating to contracting of doctors. On
May 5, 2000 the Court denied defendants' demurer but granted in part their
motion to strike portions of the Ross Complaint and ordered plaintiff to file an
amended complaint. The Ross Amended Complaint was filed on May 15, 2000.
Defendants intend to defend the action vigorously.
A purported class action complaint was filed in the United States District Court
for the Southern District of Mississippi on November 22, 1999 by Raymond D.
Williamson, III (the "Williamson Complaint"). The Williamson Complaint names as
defendant The Prudential Insurance Company of America, and also names as
defendants Aetna Inc. and Aetna U.S. Healthcare Inc. solely to the extent that
the Company has assumed liability for the actions of Prudential in connection
with the Company's acquisition of the Prudential health care business. The
Williamson Complaint seeks various forms of relief from defendants, including
unspecified damages, treble damages and imposition of a constructive trust, for
alleged violations of RICO and ERISA. The Williamson Complaint alleges that the
Prudential Health Plans engaged in a nationwide fraudulent scheme of
misrepresentation by stating that coverage and treatment decisions were made on
the basis of medical necessity when Prudential allegedly implemented undisclosed
policies designed to deny or limit claims and medical services. On December 30,
1999, the Company moved to stay, dismiss or transfer the action to the United
States District Court for the Eastern District of Pennsylvania based on the fact
that the Maio and Conte Complaints were filed in that court. On January 25,
2000, the Court suspended further proceedings pending resolution of a motion in
cases involving other defendants to consolidate those actions in a single court.
This litigation is in the preliminary stages. The Company intends to defend the
action vigorously.
A purported class action complaint was filed in the United States District Court
for the District of New Jersey on December 3, 1999 by Michael V. Amorosi (the
"Amorosi Complaint"). The Amorosi Complaint seeks various forms of relief,
including unspecified damages, treble damages and restitutionary relief for
unjust enrichment, from Aetna Inc. and Aetna U.S. Healthcare Inc. for alleged
violations of RICO and ERISA. The Amorosi Complaint alleges that defendants told
subscribers that coverage and treatment decisions would be based on medical
necessity but instead took into account undisclosed cost-based criteria that
were unrelated to members' medical needs. On January 7, 2000, the Company moved
to stay, dismiss or transfer the action to the United States District Court for
the Eastern District of Pennsylvania based on the fact that the Maio and Conte
Complaints were filed in that court. This litigation is in the preliminary
stages. The Company intends to defend the action vigorously.
A purported amended class action complaint was filed in the United States
District Court for the Northern District of Alabama on January 19, 2000 by
Eugene Mangieri, M.D. (the "Mangieri Complaint"). The Mangieri Complaint seeks
various forms of relief, including unspecified damages, treble damages and
punitive damages, from Aetna Inc., Aetna U.S. Healthcare Inc. and Richard L.
Huber for alleged violations of RICO. The Mangieri Complaint claims that
physicians suffer actual and potential harm from allegedly coercive terms
contained in their contracts with the Company. On May 15, 2000 the Judicial
Panel on Multidistrict Litigation issued a conditional order transferring the
Mangieri Complaint to the United States District Court for the Southern District
of Florida for consolidated pretrial proceedings in the matter known as In re
Humana, Inc. Managed Care Litigation. On May 30, 2000 the Company filed with the
Panel an objection to that conditional transfer order. This litigation is in the
preliminary stages. Defendants intend to defend the action vigorously.
Page 57
<PAGE> 58
Item 1. Legal Proceedings. (Continued)
A purported class action complaint was filed in the United States District Court
for the District of New Jersey on April 11, 2000 by Jennifer McCarron and Ira S.
Schwartz (the "McCarron Complaint"). The McCarron Complaint names as defendants
The Prudential Insurance Company of America and health maintenance organizations
that the Company acquired from Prudential on August 6, 1999. The McCarron
Complaint seeks various forms of relief from defendants, including return of
certain premiums, disgorgement of allegedly improper profits and injunctive
relief, for alleged contractual breaches and violations of ERISA. Plaintiffs
purport to represent a class including persons who were Prudential Health Plans
subscribers before and/or after the Company's acquisition of those operations.
The McCarron Complaint alleges that Prudential Health Plans' administration and
disclosure of policies concerning medical necessity determinations violated
contractual and fiduciary duties owed to subscribers. Ms. McCarron additionally
alleges that she was wrongfully denied coverage for certain medical treatments.
This litigation is in the preliminary stages. The Company intends to defend the
action vigorously.
A purported class action complaint was filed in the United States District Court
for the Eastern District of Pennsylvania on May 22, 2000 by John Romero and
Catherine Romero (the "Romero Complaint"). The Romero Complaint names as
defendants The Prudential Insurance Company of America and health maintenance
organizations that the Company acquired from Prudential on August 6, 1999. The
Romero Complaint seeks various forms of relief from defendants, including return
of certain premiums, disgorgement of allegedly improper profits and injunctive
relief, for alleged contractual breaches and violations of ERISA. Plaintiffs
purport to represent a class including persons who were Prudential Health Plan
subscribers before and/or after the Company's acquisition of those operations.
The Romero Complaint alleges that Prudential Health Plans' administration and
disclosure of policies concerning medical necessity determinations violated
contractual and fiduciary duties owed to subscribers. This litigation is in the
preliminary stages. The Company intends to defend the action vigorously.
On July 14, 2000, the Company filed with the Judicial Panel on Multidistrict
Litigation a motion to consolidate and transfer six of the above matters for
pretrial proceedings in the United States District Court for the Eastern
District of Pennsylvania (the "MDL Application"). That motion seeks transfer and
consolidation of the Amorosi, Conte, Curtright, and Mangieri Complaints as well
as both the Mississippi O'Neill Complaint and the Florida O'Neill Complaint (as
defined below).
A purported class action was filed in the United States District Court for the
Southern District of Florida under the caption In re Humana, Inc. Managed Care
Litigation, on June 23, 2000 by Jo Ann O'Neill, Lydia K. Rouse and Danny E.
Waldrop (the "Florida O'Neill Complaint"). The Florida O'Neill Complaint names
as defendants Aetna Inc. and Aetna U.S. Healthcare Inc. The Florida O'Neill
Complaint seeks various forms of relief, including unspecified damages and
treble damages and restitution of alleged improper profits, from the Company and
Aetna U.S. Healthcare Inc. for alleged violations of ERISA and RICO. The Florida
O'Neill Complaint alleges that defendants are liable for alleged
misrepresentations and omissions relating to advertising and marketing materials
directed to Aetna HMO members, and alleges that defendants conspired with other
managed care companies not to disclose alleged industry-wide practices. The
Company sought from the Florida federal court a stay of further proceedings on
the Florida O'Neill Complaint pending a decision on the MDL Application. On July
27, 2000, the Florida federal court denied that motion. The Company's response
to the Florida O'Neill Complaint is due on August 11, 2000. This litigation is
in the preliminary stages. Defendants intend to defend the action vigorously.
Page 58
<PAGE> 59
Item 1. Legal Proceedings. (Continued)
Financial Services Litigation
-----------------------------
In recent years, several life insurance and annuity companies have been named as
defendants in class action lawsuits relating to life insurance and annuity
pricing and sales practices. Aetna Life Insurance and Annuity Company ("ALIAC"),
a wholly-owned subsidiary of Aetna Inc., is a defendant in two such lawsuits.
A purported class action complaint was filed in the Circuit Court of Lauderdale
County, Alabama on March 28, 2000 by Loretta Shaner against ALIAC (the "Shaner
Complaint"). This case has been removed to the United States District Court for
the Northern District of Alabama. The Shaner Complaint seeks unspecified
compensatory damages from ALIAC and unnamed affiliates of ALIAC. The Shaner
Complaint claims that ALIAC's sale of deferred annuity products for use as
investments in tax-deferred contributory retirement plans (e.g., IRAs) is
improper. This litigation is in the preliminary stages. The Company intends to
defend the action vigorously.
A purported class action complaint was filed in the United States District Court
for the Middle District of Florida on June 30, 2000 by Helen Reese, Richard
Reese, Villere Bergeron and Allan Eckert against ALIAC (the "Reese Complaint").
The Reese Complaint seeks compensatory and punitive damages and injunctive
relief from ALIAC. The Reese Complaint claims that ALIAC engaged in unlawful
sales practices in marketing life insurance policies. This litigation is in the
preliminary stages. The Company intends to defend the action vigorously.
Other Litigation and Regulatory Proceedings
-------------------------------------------
The Company is involved in numerous other lawsuits arising, for the most part,
in the ordinary course of its business operations, including claims of bad
faith, medical malpractice, non-compliance with state regulatory regimes,
marketing misconduct, failure to timely pay medical claims and other litigation
in its health business. Some of these other lawsuits are purported to be class
actions. Aetna U.S. Healthcare of California Inc., an indirect subsidiary of the
Company, is currently a party to a bad faith and medical malpractice 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, among other things, 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. On April 12, 1999, the trial court
amended the judgment to include Aetna Services, Inc., a direct subsidiary of the
Company, as a defendant. On April 27, 1999, Aetna Services, Inc. and Aetna U.S.
Healthcare of California Inc. filed appeals with the California Court of Appeal
and will continue to defend this matter vigorously.
In addition, the Company's business practices are subject to review by various
state insurance and health care regulatory authorities and federal regulatory
authorities. Recently, there has been heightened review by these regulators of
the managed health care industry's business practices, including utilization
management and claim payment practices. As the largest national managed care
organization, the Company regularly is the subject of such reviews and several
such reviews currently are pending, some of which may be resolved during the
remainder of 2000. These reviews may result in changes to or clarifications of
the Company's business practices, and may result in fines, penalties or other
sanctions.
While the outcome of these other lawsuits and regulatory reviews cannot be
determined at this time, after consideration of the defenses available to the
Company, applicable insurance coverage 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 59
<PAGE> 60
Item 4. Submission of Matters to a Vote of Security Holders.
At the Annual Meeting of Shareholders, held April 28, 2000, four matters were
submitted to a vote: the election of directors for the coming year; the
ratification of the appointment of KPMG LLP as independent public accountants
for the current calendar year; a shareholder proposal to implement cumulative
voting in the election of directors; and a shareholder proposal relating to the
endorsement of the Coalition for Environmentally Responsible Economies or
"CERES" principles. Each of the director candidates was elected and the
appointment of KPMG was ratified. Neither shareholder proposal was adopted. The
detailed results of the voting on these matters follow:
<TABLE>
<CAPTION>
Election of Directors:
Votes Votes
For Withheld
------------ ----------
<S> <C> <C>
Leonard Abramson * 117,187,609 4,442,862
Betzy Z. Cohen 111,586,281 10,044,190
William H. Donaldson 112,284,790 9,345,681
Barbara Hackman Franklin 111,771,574 9,858,897
Jeffrey E. Garten 111,904,993 9,725,478
Jerome S. Goodman 111,624,303 10,006,168
Earl G. Graves 111,809,140 9,821,331
Gerald Greenwald 100,719,567 20,910,904
Ellen M. Hancock 111,865,244 9,765,227
Michael H. Jordan 111,863,452 9,767,019
Jack D. Kuehler 111,850,606 9,779,865
Judith Rodin 111,817,973 9,812,498
</TABLE>
* On June 6, 2000 Leonard Abramson resigned from the Company's Board of
Directors.
Other matters voted upon:
<TABLE>
<CAPTION>
Votes Votes Broker
For Against Abstentions Non-Votes
------------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Ratification of Independent
Public Accountants 120,425,631 740,647 464,193 -
Shareholder Proposal to Implement Cumulative
Voting in Election of Directors 43,013,011 62,201,248 1,291,079 15,125,133
Shareholder Proposal Relating to Endorsement
of the CERES Principles 9,249,993 90,709,687 6,545,658 15,125,133
</TABLE>
Page 60
<PAGE> 61
Item 5. Other Information.
(a) Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed
Charges and Preferred Stock Dividends
The following table sets forth the Company's and Aetna Services' ratio of
earnings to fixed charges and ratio of earnings to combined fixed charges and
preferred stock dividends for the periods indicated.
<TABLE>
<CAPTION>
Six Months Ended
June 30, Years Ended December 31,
--------------------- -------------------------------------------------------------
Aetna Inc. 2000 1999 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed Charges 3.70 4.11 4.96 5.74 2.45 4.97
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.70 3.63 3.94 4.46 2.10 4.97
------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended
June 30, Years Ended December 31,
----------------------- ----------------------------------------------
Aetna Services, Inc. 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed Charges 4.15 3.61 4.31 5.78 2.44
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 4.15 3.61 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. (Refer to
Note 13 of Notes to Consolidated Financial Statements in Aetna Inc.'s 1999
Annual Report on Form 10-K.) For the first six months of 2000 and during 1995
there was no preferred stock outstanding, and as a result, the ratios of
earnings to combined fixed charges and preferred stock dividends were the same
as the ratios of earnings to fixed charges.
Page 61
<PAGE> 62
Item 5. Other Information. (Continued)
(b) Ratings
The ratings of certain Aetna Inc.'s subsidiaries follow:
<TABLE>
<CAPTION>
Rating Agencies
-------------------------------------------------------
Moody's
Investors Standard
A.M. Best Fitch*** Service & Poor's
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Aetna Services, Inc. (senior debt)**
April 26, 2000 * A A3 A
August 3, 2000 (1) * A A3 A
Aetna Services, Inc. (commercial paper)**
April 26, 2000 * F-1 P-2 A-1
August 3, 2000 (1) * F-1 P-2 A-1
Aetna Life Insurance Company (claims paying/financial strength)
April 26, 2000 A AA- A1 A+
August 3, 2000 (1) A AA- A1 A+
Aetna Life Insurance and Annuity Company
(claims paying/financial strength)
April 26, 2000 A AA Aa3 AA-
August 3, 2000 (1) A AA Aa3 AA-
------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Nonrated by the agency.
** Fully and unconditionally guaranteed by Aetna Inc.
*** Formerly known as Duff & Phelps.
(1) A.M. Best has the ALIC rating under review with developing implications
and the ALIAC rating under review with positive implications. Moody's
placed the long-term credit ratings on review, upgrade and the short-term
credit ratings were affirmed and removed from review. Moody's has placed
the ALIC rating on review, downgrade and the ALIAC rating on review,
upgrade. Standard & Poor's affirmed and removed from review the short-term
credit rating. Standard & Poor's has placed the long-term credit ratings
and the ALIAC rating on CreditWatch positive. Standard & Poor's has placed
the ALIC rating on CreditWatch negative. Fitch has placed the short-term
ratings and the ALIAC rating on watch, positive; and the ALIC rating on
watch, evolving.
Page 62
<PAGE> 63
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(2) Plan of Acquisition, Reorganization, Arrangement,
Liquidation or Succession.
2.1 Agreement and Plan of Restructuring and Merger, dated as of
July 19, 2000, among the Company, ING America Insurance
Group Holdings, Inc., ANB Acquisition Corp. and, for
limited purposes only, ING Groep N.V.
(4) Instruments Defining the Rights of Security Holders,
Including Indentures.
4.1 First Amendment, dated as of July 27, 2000, to the Rights
Agreement dated as of September 24, 1999 between the
Company and First Chicago Trust Company of New York, as
Rights Agent, incorporated herein by reference to Exhibit 2
to the Company's Registration Statement on Form 8-A filed
on July 28, 2000.
(10) Material Contracts
10.1 Letter Agreement, dated as of May 25, 2000, by and between
the Company and Richard L. Huber. *
10.2 Employment Agreement, dated as of May 31, 2000, by and
between the Company and William H. Donaldson. *
10.3 Tax Agreement, dated as of May 31, 2000, by and between the
Company and William H. Donaldson. *
10.4 Bonus Agreement, dated as of May 31, 2000, by and between
the Company and William H. Donaldson. *
10.5 Letter Agreement, dated as of June 26, 2000, by and between
the Company and Thomas J. McInerney. *
10.6 Benefits Agreement, dated as of July 5, 2000, by and
between the Company and Thomas J. McInerney. *
10.7 Agreement and Plan of Restructuring and Merger, dated as of
July 19, 2000, among the Company, ING America Insurance
Group Holdings, Inc., ANB Acquisition Corp. and, for
limited purposes only, ING Groep N.V., incorporated herein
by reference to Exhibit 2.1 to this Report on Form 10-Q.
* Management contract or compensatory plan or arrangement.
Page 63
<PAGE> 64
Item 6. Exhibits and Reports on Form 8-K. (Continued)
(a) Exhibits (Continued)
(12) Statement Re: Computation of Ratios.
Statement re: computation of ratio of earnings to fixed
charges and ratio of earnings to combined fixed charges and
preferred stock dividends for the six months ended June 30,
2000 and for the years ended December 31, 1999, 1998, 1997,
1996 and 1995 for Aetna Inc. and for the six months ended
June 30, 2000 and for the years ended December 31, 1999,
1998, 1997 and 1996 for Aetna Services, Inc.
(15) Letter Re: Unaudited Interim Financial Information.
Letter from KPMG LLP acknowledging awareness of the use of
a report on unaudited interim financial information, dated
August 3, 2000.
(27) Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on April 6, 2000 related to the
retention of an executive recruiting firm to assist in the search for a
chief executive officer for the health benefits company.
The Company filed a report on Form 8-K on May 19, 2000 related to the
announcement that Michael J. Cardillo, President of Aetna U.S.
Healthcare, was retiring.
The Company filed a report on Form 8-K on June 1, 2000 related to the
Company's discussions with ING regarding the sale of all or part of
Aetna's financial services and international businesses.
The Company filed a report on Form 8-K on June 16, 2000 related to the
Company's discussions with other interested parties regarding the sale
of all or part of Aetna's financial services and international
businesses.
The Company filed a report on Form 8-K on July 18, 2000 related to the
announcement that preliminary second quarter data reflected
higher-than-anticipated commercial HMO medical costs for the period.
The Company filed a report on Form 8-K on July 20, 2000 related to the
announcement that the Company had reached a definitive agreement to
sell its financial services and international businesses to ING Group.
Page 64
<PAGE> 65
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Aetna Inc.
------------------------------------------
Registrant
Date August 4, 2000 By /s/ Alan M. Bennett
----------------------------------
Alan M. Bennett
Vice President
and Corporate Controller
(Chief Accounting Officer)
Page 65
<PAGE> 66
AETNA INC.
EXHIBIT INDEX
===============================================================
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession.
2.1 Agreement and Plan of Restructuring and Merger, dated as of July
19, 2000, among the Company, ING America Insurance Group
Holdings, Inc., ANB Acquisition Corp. and, for limited purposes
only, ING Groep N.V.
(10) Material Contracts
10.1 Letter Agreement, dated as of May 25, 2000, by and between the
Company and Richard L. Huber. *
10.2 Employment Agreement, dated as of May 31, 2000, by and between
the Company and William H. Donaldson. *
10.3 Tax Agreement, dated as of May 31, 2000, by and between the
Company and William H. Donaldson. *
10.4 Bonus Agreement, dated as of May 31, 2000, by and between the
Company and William H. Donaldson. *
10.5 Letter Agreement, dated as of June 26, 2000, by and between the
Company and Thomas J. McInerney. *
10.6 Benefits Agreement, dated as of July 5, 2000, by and between the
Company and Thomas J. McInerney. *
(12) Statement Re: Computation of Ratios.
Statement re: computation of ratio of earnings to fixed charges
and ratio of earnings to combined fixed charges and preferred
stock dividends for the six months ended June 30, 2000 and for
the years ended December 31, 1999, 1998, 1997, 1996 and 1995 for
Aetna Inc. and for the six months ended June 30, 2000 and for the
years ended December 31, 1999, 1998, 1997 and 1996 for Aetna
Services, Inc.
(15) Letter Re: Unaudited Interim Financial Information.
Letter from KPMG LLP acknowledging awareness of the use of a
report on unaudited interim financial information, dated August
3, 2000.
(27) Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
Page 66
