<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 September 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)
Connecticut 02-0488491
(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)
(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) 141,351,061
------------------------------------- ---------------------------------------------
(Class) Shares Outstanding at September 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 29
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. 30
Item 3. Quantitative and Qualitative Disclosures
About Market Risk. 60
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 61
Item 5. Other Information. 68
Item 6. Exhibits and Reports on Form 8-K. 70
Signatures 72
</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 Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
(Millions, except per common share data) 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Premiums $ 6,589.7 $ 5,574.8 $19,742.7 $ 14,598.0
Net investment income 816.1 748.6 2,340.5 2,232.6
Fees and other income 693.5 651.9 2,106.6 1,755.7
Net realized capital gains (losses) 32.7 93.6 (20.9) 120.5
--------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,132.0 7,068.9 24,168.9 18,706.8
--------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Current and future benefits 6,088.4 5,147.1 18,248.9 13,647.5
Operating expenses:
Salaries and related benefits 697.6 600.5 2,074.6 1,572.9
Other 809.0 697.8 2,354.1 1,854.7
Interest expense 79.7 72.4 230.4 201.1
Amortization of goodwill and other acquired intangible assets 117.4 111.7 351.3 325.1
Amortization of deferred policy acquisition costs 68.5 52.2 185.6 153.9
Reduction of reserve for anticipated future loss on discontinued - - (146.0) (77.2
products
--------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 7,860.6 6,681.7 23,298.9 17,678.0
--------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 271.4 387.2 870.0 1,028.8
Income taxes:
Current 63.8 79.7 254.0 232.3
Deferred 30.2 112.2 82.8 214.1
--------------------------------------------------------------------------------------------------------------------------------
Total income taxes 94.0 191.9 336.8 446.4
--------------------------------------------------------------------------------------------------------------------------------
Net income $ 177.4 $ 195.3 $ 533.2 $ 582.4
================================================================================================================================
Net income applicable to common ownership $ 177.4 $ 192.4 $ 533.2 $ 551.9
================================================================================================================================
Results per common share:
Basic $ 1.26 $ 1.30 $ 3.78 $ 3.84
Diluted 1.24 1.29 3.73 3.81
Dividends declared .20 .20 .60 .60
--------------------------------------------------------------------------------------------------------------------------------
</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>
September 30, December 31,
(Millions, except share data) 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investments:
Debt securities available for sale, at fair value (amortized cost $31,245.4 and $ 30,921.2 $ 28,661.6
$29,409.4)
Debt securities held to maturity, at amortized cost 169.7 -
Equity securities, at fair value (cost $751.8 and $732.6) 854.4 791.1
Short-term investments 763.4 788.2
Mortgage loans 3,186.6 3,238.2
Commercial loans 1,054.1 -
Real estate 512.6 361.8
Policy loans 874.4 541.5
Other 1,665.8 1,394.8
-----------------------------------------------------------------------------------------------------------------------------
Total investments 40,002.2 35,777.2
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 2,968.0 2,504.5
Short-term investments under securities loan agreement 1,248.0 1,037.5
Accrued investment income 524.3 466.5
Premiums due and other receivables 2,741.7 2,751.1
Reinsurance recoverables 3,938.3 3,881.1
Deferred income taxes 146.1 352.0
Deferred policy acquisition costs 2,526.8 2,059.8
Goodwill and other acquired intangible assets 8,842.4 9,335.4
Other assets 1,897.7 1,341.7
Separate Accounts assets 55,189.0 53,332.2
-----------------------------------------------------------------------------------------------------------------------------
Total assets $120,024.5 $112,839.0
=============================================================================================================================
Liabilities:
Insurance liabilities:
Future policy benefits $ 23,419.6 $ 17,599.3
Unpaid claims 5,076.4 4,976.5
Unearned premiums 237.6 507.1
Policyholders' funds left with the Company 14,881.5 15,481.4
-----------------------------------------------------------------------------------------------------------------------------
Total insurance liabilities 43,615.1 38,564.3
-----------------------------------------------------------------------------------------------------------------------------
Dividends payable to shareholders 28.3 28.5
Short-term debt 1,794.0 1,887.7
Long-term debt 2,377.4 2,677.9
Payables under securities loan agreement 1,248.0 1,037.5
Current income taxes 300.4 307.6
Other liabilities 3,993.5 4,195.5
Minority and participating policyholders' interests 165.4 117.4
Separate Accounts liabilities 55,189.0 53,332.2
-----------------------------------------------------------------------------------------------------------------------------
Total liabilities 108,711.1 102,148.6
-----------------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities (Notes 4 and 12)
Shareholders' equity:
Common stock ($.01 par value; 500,000,000 shares authorized; 141,351,061 in 2000 and
142,680,694 in 1999 issued and outstanding) 3,650.3 3,719.3
Accumulated other comprehensive loss (412.4) (655.6)
Retained earnings 8,075.5 7,626.7
-----------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 11,313.4 10,690.4
-----------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $120,024.5 $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
Nine Months Ended September 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 533.2 533.2
Other comprehensive income, net of tax:
Unrealized gains on securities
($258.3 pretax) (1) 167.9 167.9
Foreign currency ($102.2 pretax) 75.3 75.3
---------
Other comprehensive income 243.2
---------
Total comprehensive income 776.4
=========
Common stock issued for benefit
plans (457,367 shares) 25.6 25.6
Repurchase of common shares
(1,787,000 shares) (94.6) (94.6)
Common stock dividends (84.4) (84.4)
-----------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 2000 $11,313.4 $ - $3,650.3 $ (38.2) $(374.2) $8,075.5
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1998 $11,388.9 $ 862.1 $3,292.4 $ 382.5 $(204.7) $7,056.6
Comprehensive income:
Net income 582.4 582.4
Other comprehensive loss, net of tax:
Unrealized losses on securities
($(566.2) pretax) (1) (368.0) (368.0)
Foreign currency ($(165.8) pretax) (108.2) (108.2)
---------
Other comprehensive loss (476.2)
---------
Total comprehensive income 106.2
=========
Common stock issued for benefit
plans (586,543 shares) 39.3 39.3
Repurchase of common shares
(1,704,800 shares) (131.7) (131.7)
Conversion of preferred securities
(11,614,816 preferred shares converted
to 9,519,486 common shares) - (862.1) 862.1
Issuance of stock appreciation rights 32.5 32.5
Common stock dividends (88.3) (88.3)
Preferred stock dividends (30.5) (30.5)
-----------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 1999 $11,316.4 $ - $4,094.6 $ 14.5 $(312.9) $7,520.2
===================================================================================================================================
</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>
Nine Months Ended September 30,
-------------------------------
(Millions) 2000 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 533.2 $ 582.4
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization (including investment discounts and premiums) 478.0 514.2
Net realized capital (gains) losses 20.9 (120.5)
Changes in assets and liabilities:
(Increase) decrease in accrued investment income (.6) 45.4
Increase in premiums due and other receivables (91.6) (290.0)
Increase in deferred policy acquisition costs (323.4) (293.7)
Increase (decrease) in income taxes 92.1 (148.3)
Net (increase) decrease in other assets and other liabilities (184.3) 67.1
Increase in insurance liabilities 125.0 652.4
Other, net 44.0 29.9
---------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 693.3 1,038.9
---------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales and investment maturities of:
Debt securities available for sale 19,804.3 15,597.5
Equity securities 2,141.3 375.2
Mortgage loans 519.7 321.4
Real estate 33.5 21.9
Commercial loans 158.5 -
Other investments 1,712.6 471.3
Short-term investments 14,212.5 13,033.9
NYLCare Texas 420.0 -
Cost of investments in:
Debt securities available for sale (20,244.8) (15,513.6)
Debt securities held to maturity (66.0) -
Equity securities (1,092.7) (293.4)
Mortgage loans (493.8) (315.9)
Real estate (26.0) (43.2)
Commercial loans (86.2) -
Other investments (1,552.4) (605.6)
Short-term investments (13,937.3) (12,475.6)
Acquisitions:
Prudential health care business - (512.5)
NYLCare health care business - (48.8)
Other (75.0) (150.5)
Increase in property and equipment (51.1) (258.5)
Other, net (52.3) (30.3)
---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 1,324.8 (426.7)
---------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Deposits and interest credited for investment contracts 1,462.0 2,008.1
Withdrawals of investment contracts (2,337.2) (2,605.4)
Repayment of long-term debt - (31.3)
Net decrease in short-term debt (394.3) 241.3
Common stock issued under benefit plans 25.6 39.3
Common stock acquired (94.6) (121.7)
Dividends paid to shareholders (84.6) (124.0)
Other, net (126.8) (105.1)
---------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities (1,549.9) (698.8)
---------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (4.7) (1.4)
---------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 463.5 (88.0)
Cash acquired from Prudential health care business - 261.6
Cash and cash equivalents, beginning of period 2,504.5 1,951.5
---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 2,968.0 $ 2,125.1
=====================================================================================================================
Supplemental cash flow information:
Interest paid $ 287.0 $ 212.5
Income taxes paid 239.9 414.7
---------------------------------------------------------------------------------------------------------------------
</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
nine-month periods ended August 31. 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 Standards
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standard ("FAS") No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities which
replaces FAS No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. This standard revises the methods
for accounting for securitizations and other transfers of financial assets and
collateral as outlined in FAS No. 125, and requires certain additional
disclosures. For transfers and servicing of financial assets and
extinguishments of liabilities, this standard will be effective for the
Company's June 30, 2001 financial statements. However, for disclosures
regarding securitizations and collateral, as well as the accounting for
recognition and reclassification of collateral, this standard will be
effective for the Company's December 31, 2000 financial statements. The
Company is currently evaluating the impact of the adoption of this standard,
however it does not expect the adoption of this standard to have a material
effect on its 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)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1998, the FASB issued 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, this standard is
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, as amended, and currently does not believe that it
will have a material effect on the Company's financial position or results of
operations.
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
(the "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, in two effectively
simultaneous steps: (1) 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; and (2) 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 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 new standalone
health company will be named Aetna Inc.
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 transaction. Such amounts are
currently estimated to be approximately $200 million to $250 million after tax
and relate to payments for certain compensation-related arrangements, costs
for outside financial and legal advisors, income taxes related to legal entity
realignment pursuant to the Agreement, insurance for indemnification-related
matters, payments for settlement of certain Aetna employee stock options held
by individuals who will become employees of ING and various other expenses
related to the change in control of Aetna Inc.
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.
Page 8
<PAGE> 9
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
2. RECENT DEVELOPMENTS (CONTINUED)
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 55 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 $270 million at September 30, 2000. Legislation to increase
these payments is currently pending in Congress. However, it is uncertain
whether this legislation will be enacted and, if enacted, whether increases in
payments would be sufficient to encourage the Company to remain in these
service areas. Absent any sufficient increases in payments, the Company will
exit these markets on December 31, 2000 and write off such identifiable
goodwill at that time.
Page 9
<PAGE> 10
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 nine months ended
September 30, was as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30, Income Shares Per Common
(Millions, except per common share data) (Numerator) (Denominator) Share Amount
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000
Basic EPS
Net income $177.4 141.2 $1.26
====== =====
Effect of dilutive securities:
Stock options and other (1) 1.9
------
Diluted EPS
Income applicable to common ownership and assumed conversions $177.4 143.1 $1.24
============================================================================================================================
1999
Net income $195.3
Less: preferred stock dividends (2) 2.9
------
Basic EPS
Income applicable to common ownership $192.4 148.4 $1.30
====== =====
Effect of dilutive securities:
Stock options and other (1) 1.0
------
Diluted EPS
Income applicable to common ownership and assumed conversions $192.4 149.4 $1.29
============================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, Income Shares Per Common
(Millions, except per common share data) (Numerator) (Denominator) Share Amount
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000
Basic EPS
Net income $533.2 141.2 $3.78
====== =====
Effect of dilutive securities:
Stock options and other (3) 1.6
-------
Diluted EPS
Income applicable to common ownership and assumed conversions $533.2 142.8 $3.73
============================================================================================================================
1999
Net income $582.4
Less: preferred stock dividends (2) 30.5
------
Basic EPS
Income applicable to common ownership $551.9 143.6 $3.84
====== =====
Effect of dilutive securities:
Stock options and other (3) 1.1
-------
Diluted EPS
Income applicable to common ownership and assumed conversions $551.9 144.7 $3.81
============================================================================================================================
</TABLE>
(1) Options to purchase shares of common stock and stock appreciation rights
("SARs") for the three months ended September 30, 2000 and 1999 of 9.4
million shares (with exercise prices ranging from $61.63 to $112.63) and
7.0 million shares (with exercise prices ranging from $74.63 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) On July 19, 1999, the Company redeemed all of its Class C preferred
stock. (Refer to Note 5.)
(3) Options to purchase shares of common stock and SARs for the nine months
ended September 30, 2000 and 1999 of 9.5 million shares (with exercise
prices ranging from $58.06 to $112.63) and 5.9 million shares (with
exercise prices ranging from $81.56 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 10
<PAGE> 11
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 nine months ended September 30, 2000, the Company recorded
asset amortization of $7 million and $20 million pretax, respectively, related
to the fair value adjustment of the reinsurance agreement ($42 million pretax in
1999 (from August 6, 1999 through September 30, 1999)); liability amortization
of $2 million and $24 million pretax, respectively, related to the fair value
adjustment of the unfavorable component of the contracts underlying the acquired
medical risk business ($43 million pretax in 1999); and asset amortization of $2
million and $13 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 nine months
ended September 30, 2000 was $4 million and $11 million pretax, respectively ($2
million pretax in 1999). 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 nine months ended September 30, 2000, reinsurance
recoveries under this agreement (reflected as a reduction of current and future
benefits) were $48 million and $94 million pretax, respectively ($27 million
pretax in 1999). The premium is subject to adjustment if medical costs of PHC
are below these threshold medical loss ratio levels.
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 members 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 nine months ended September 30, 2000, the Company recorded total fees for
servicing the Prudential ASO business of approximately $86 million and $290
million pretax, respectively, ($90 million in 1999) including supplemental
fees of approximately $28 million and $112 million pretax, respectively, ($40
million in 1999) 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 11
<PAGE> 12
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
Aetna U.S. Healthcare (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
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 September 19, 2000, Aetna International, Inc. ("Aetna International"), with
the consent of ING, entered into an agreement to sell its remaining Mexican
operations to its partner, Grupo Financiero BBVA Bancomer, S.A. de C.V., for
approximately $693 million. The sale is expected to close in the fourth
quarter of 2000, subject to Mexican regulatory approval. Operating earnings
from the Mexican operations were approximately $61 million and $37 million for
the nine months ended September 30, 2000 and 1999, respectively.
On August 18, 2000, Aetna International sold its 50 percent ownership interest
in a Venezuelan joint venture, Seguros Mercantil, to its Venezuelan partner,
Mercantil Servicios Financieros for approximately $17 million. The sale
resulted in an after-tax capital loss of approximately $9 million. The
earnings of Seguros Mercantil were not material to the Company.
On July 19, 2000, Aetna International signed an agreement to sell its New
Zealand operation, Aetna Health Limited, to The Southern Cross Medical Care
Society. Approval from the New Zealand Commerce Commission has been received,
and the sale is now expected to close in the fourth quarter of 2000. The
earnings of Aetna Health Limited 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 $18 million for the nine months ended September
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 $25 million for the nine months ended September 30,
1999.
Page 12
<PAGE> 13
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
5. CAPITAL STOCK
On July 19, 1999, the Company redeemed all outstanding shares of its 6.25%
Class C Voting Mandatorily Convertible Preferred Stock ("Preferred Stock").
Holders of the Preferred Stock received .8197 shares of Aetna common stock for
each share of Preferred Stock. Approximately 9.5 million shares of Aetna
common stock were issued to effect the redemption.
6. INVESTMENTS
Net investment income includes amounts allocable to experience-rated
contractholders of $241 million and $251 million for the three months ended
September 30, 2000 and 1999, respectively, and $737 and $764 million for the
nine months ended September 30, 2000 and 1999, respectively. Interest credited
to contractholders is included in current and future benefits.
Net realized capital losses allocable to experience-rated contractholders of
$3 million and $27 million for the three months ended September 30, 2000 and
1999, respectively, and $54 million and $18 million for the nine months ended
September 30, 2000 and 1999, respectively, were deducted from net realized
capital gains (losses) 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>
September 30, 2000 December 31, 1999
------------------------------- ------------------------------
Total Total
Recorded Specific Recorded Specific
(Millions) Investment Reserves Investment Reserves
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Supporting discontinued products $125.7 $21.5 $158.9 $22.2
Supporting experience-rated products 52.5 7.9 66.9 8.8
Supporting remaining products 48.8 4.8 59.2 1.1
------------------------------------------------------------------------------------------------------------------------
Total impaired loans $227.0(1) $34.2 $285.0 (1) $32.1
========================================================================================================================
</TABLE>
(1) Includes impaired loans of $54.6 million and $109.0 million at September
30, 2000 and December 31, 1999, respectively, for which no specific
reserves are considered necessary.
Page 13
<PAGE> 14
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
6. INVESTMENTS (CONTINUED)
The activity in the specific and general reserves for the nine months ended
September 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 gains (losses) (.5) (.8) (.6) (1.9)
Charged to other accounts - - 1.9 1.9
Principal write-offs - - (1.1) (1.1)
-------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2000 $28.4 $14.8 $ 5.0 $48.2(1)
===================================================================================================================
Balance at December 31, 1998 $29.5 $29.6 $ 7.8 $66.9
Credited to net realized capital gains (losses) - - (.2) (.2)
Charged to other accounts - - 1.8 1.8
Principal write-offs (.6) (4.4) (.5) (5.5)
-------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999 $28.9 $25.2 $ 8.9 $63.0(1)
===================================================================================================================
</TABLE>
(1) Total reserves at September 30, 2000 and 1999 include $34.2 million and
$43.7 million of specific reserves, respectively, and $14.0 million and
$19.3 million of general reserves, respectively.
Income earned (pretax) and cash received on the average recorded investment in
impaired loans were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 2000 September 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 $150.6 $2.3 $2.3 $156.1 $ 7.5 $ 7.6
Supporting experience-rated products 65.0 1.8 1.8 70.2 5.1 5.0
Supporting remaining products 66.2 3.2 2.8 57.8 8.6 8.4
------------------------------------------------------------------------------------------------------------
Total $281.8 $7.3 $6.9 $284.1 $21.2 $21.0
============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1999 September 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 $157.9 $3.1 $3.0 $158.8 $ 9.1 $ 9.0
Supporting experience-rated products 95.3 2.8 2.6 94.2 7.1 6.8
Supporting remaining products 29.9 2.7 2.4 35.4 5.8 5.2
-----------------------------------------------------------------------------------------------------------
Total $283.1 $8.6 $8.0 $288.4 $22.0 $21.0
===========================================================================================================
</TABLE>
7. SUPPLEMENTAL CASH FLOW INFORMATION
Significant noncash investing and financing activities included acquisition of
real estate through foreclosures of mortgage loans amounting to $17 million
and $9 million for the nine months ended September 30, 2000 and 1999,
respectively.
Page 14
<PAGE> 15
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. 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>
Nine Months
Ended September 30,
-----------------------
(Millions) 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Unrealized holding gains (losses) arising during the period (1) $153.3 $(325.9)
Less: reclassification adjustment for gains (losses) and other items included in (14.6) 42.1
net income (2)
---------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $167.9 $(368.0)
===============================================================================================================
</TABLE>
(1) Pretax unrealized holding gains (losses) arising during the period were
$235.8 million and $(501.4) million for 2000 and 1999, respectively.
(2) Pretax reclassification adjustments for gains (losses) and other items
included in net income were $(22.5) million and $64.8 million for 2000
and 1999, respectively.
9. 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 consist of: 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
September 30, 2000, the receivable from continuing products, net of related
deferred taxes payable of $75 million on the accrued interest income, was $384
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 15
<PAGE> 16
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
9. DISCONTINUED PRODUCTS (CONTINUED)
Results of discontinued products were as follows (pretax, in millions):
<TABLE>
<CAPTION>
Charged (Credited)
to Reserve for
Three months ended September 30, 2000 Results Future Losses Net(1)
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income $110.1 $ - $110.1
Net realized capital losses (17.7) 17.7 -
Interest earned on receivable from continuing products 6.9 - 6.9
Other income 4.8 - 4.8
------------------------------------------------------------------------------------------------------------------------
Total revenue 104.1 17.7 121.8
------------------------------------------------------------------------------------------------------------------------
Current and future benefits 112.7 6.0 118.7
Operating expenses 3.1 - 3.1
------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 115.8 6.0 121.8
------------------------------------------------------------------------------------------------------------------------
Results of discontinued products $(11.7) $ 11.7 $ -
========================================================================================================================
Three months ended September 30, 1999
------------------------------------------------------------------------------------------------------------------------
Net investment income $116.3 $ - $116.3
Net realized capital losses (12.3) 12.3 -
Interest earned on receivable from continuing products 7.9 - 7.9
Other income 9.1 - 9.1
------------------------------------------------------------------------------------------------------------------------
Total revenue 121.0 12.3 133.3
------------------------------------------------------------------------------------------------------------------------
Current and future benefits 122.4 8.0 130.4
Operating expenses 2.9 - 2.9
------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 125.3 8.0 133.3
------------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ (4.3) $ 4.3 $ -
========================================================================================================================
Nine months ended September 30, 2000
------------------------------------------------------------------------------------------------------------------------
Net investment income $334.0 $ - $334.0
Net realized capital losses (17.6) 17.6 -
Interest earned on receivable from continuing products 23.2 - 23.2
Other income 23.1 - 23.1
------------------------------------------------------------------------------------------------------------------------
Total revenue 362.7 17.6 380.3
------------------------------------------------------------------------------------------------------------------------
Current and future benefits 342.4 27.9 370.3
Operating expenses 10.0 - 10.0
------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 352.4 27.9 380.3
------------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 10.3 $ (10.3) $ -
========================================================================================================================
Nine months ended September 30, 1999
------------------------------------------------------------------------------------------------------------------------
Net investment income $360.1 $ - $360.1
Net realized capital gains 6.0 (6.0) -
Interest earned on receivable from continuing products 24.8 - 24.8
Other income 24.4 - 24.4
------------------------------------------------------------------------------------------------------------------------
Total revenue 415.3 (6.0) 409.3
------------------------------------------------------------------------------------------------------------------------
Current and future benefits 379.5 20.4 399.9
Operating expenses 9.4 - 9.4
------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 388.9 20.4 409.3
------------------------------------------------------------------------------------------------------------------------
Results of discontinued products $ 26.4 $ (26.4) $ -
========================================================================================================================
</TABLE>
(1) Amounts are reflected in the September 30, 2000 and 1999 Consolidated
Statements of Income, except for interest earned on the receivable from
continuing products which was eliminated in consolidation.
Page 16
<PAGE> 17
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
9. DISCONTINUED PRODUCTS (CONTINUED)
Assets and liabilities supporting discontinued products at September 30, 2000
and December 31, 1999 were as follows (1):
<TABLE>
<CAPTION>
September 30, December 31,
(Millions) 2000 1999
----------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Debt securities available for sale $4,208.6 $4,533.0
Mortgage loans 783.4 768.8
Real estate 127.5 112.7
Short-term and other investments 501.9 453.9
----------------------------------------------------------------------------------------------------
Total investments 5,621.4 5,868.4
Short-term investments under securities loan agreement 53.3 243.8
Current and deferred income taxes 65.6 134.1
Receivable from continuing products (2) 458.9 530.6
Other - 82.6
----------------------------------------------------------------------------------------------------
Total assets $6,199.2 $6,859.5
====================================================================================================
Liabilities:
Future policy benefits $4,490.2 $4,566.0
Policyholders' funds left with the Company 630.3 902.1
Reserve for anticipated future losses on discontinued
products 1,011.9 1,147.6
Payables under securities loan agreement 53.3 243.8
Other 13.5 -
----------------------------------------------------------------------------------------------------
Total liabilities $6,199.2 $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 September 30, 2000, net unrealized capital losses on available-for-sale
debt securities are included above in other liabilities. At December 31, 1999,
net unrealized capital losses on available-for-sale debt securities are
included above in other assets. These net unrealized capital losses 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.
Page 17
<PAGE> 18
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
9. DISCONTINUED PRODUCTS (CONTINUED)
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 liabilities have run off.
The activity in the reserve for anticipated future losses on discontinued
products for the nine months ended September 30, 2000 was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
----------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1999 $1,147.6
Operating income 15.1
Net realized capital losses (17.6)
Mortality and other 12.8
Reserve reduction (146.0)
----------------------------------------------------------------------
Reserve at September 30, 2000 $1,011.9
======================================================================
</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. The 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.
10. 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. This credit facility 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 September 30, 2000 is at an annual rate of .08%. There are no
borrowings under this facility as of September 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. This credit
facility 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 September 30, 2000 is at an annual rate of .08%.
There are no borrowings under this facility as of September 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 18
<PAGE> 19
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
10. 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>
September 30, December 31,
2000 1999
-------------------------------------------------------------------------------------------------
<S> <C> <C>
Total investments (excluding Separate Accounts) $ 37,665.2 $ 33,258.1
Total assets 108,504.8 101,154.3
Total insurance liabilities 41,003.7 35,665.1
Total liabilities 105,254.8 98,342.2
Total shareholder's equity 3,250.0 2,812.1
-------------------------------------------------------------------------------------------------
</TABLE>
Statements of Income Information:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 2000 September 30, 2000
-------------------------------------------------------------------------------------------------
<S> <C> <C>
Total revenue $3,489.4 $10,410.1
Total benefits and expenses 3,218.6 9,467.6
Income before income taxes 270.8 942.5
Net income 200.6 634.2
-------------------------------------------------------------------------------------------------
</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 September 30,
2000 without prior approval by state regulatory authorities is limited to
approximately $455 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.
On October 31, 2000, Aetna Services was merged with and into Aetna Inc., and
Aetna Inc. assumed all of Aetna Services' obligations under the Aetna Services
Debt, including the two revolving credit facilities.
Page 19
<PAGE> 20
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. SEGMENT INFORMATION
Summarized financial information for the Company's principal operations for
the three and nine months ended September 30, was as follows:
<TABLE>
<CAPTION>
Aetna
Three Months Ended September 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 $6,226.7 $218.1 $797.9 $ 40.5 $ - $7,283.2
Net investment income 188.9 232.4 126.3 229.7 7.4 784.7
Equity in earnings of subsidiaries - - 31.4 - - 31.4
----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $6,415.6 $450.5 $955.6 $270.2 $ 7.4 $8,099.3
==================================================================================================================================
Operating earnings (losses) (2) $ 77.0 $ 67.0 $ 63.2 $ 19.7 $ (68.8) $ 158.1
Other item (3) - - - - (5.2) (5.2)
Realized capital gains (losses), net of tax 20.3 (7.3) 9.3 3.2 (1.0) 24.5
----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 97.3 $ 59.7 $ 72.5 $ 22.9 $ (75.0) $ 177.4
==================================================================================================================================
1999
Revenues from external customers $5,405.5 $178.4 $595.2 $ 47.6 $ - $6,226.7
Net investment income 163.8 224.8 93.5 241.1 1.9 725.1
Equity in earnings of subsidiaries - - 23.5 - - 23.5
----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $5,569.3 $403.2 $712.2 $288.7 $ 1.9 $6,975.3
==================================================================================================================================
Operating earnings (losses) (2) $ 131.3 $ 55.5 $ 43.5 $ 20.9 $ (67.1) $ 184.1
Realized capital gains (losses), net of tax 26.1 (7.2) (21.4) (3.8) 17.5 11.2
----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 157.4 $ 48.3 $ 22.1 $ 17.1 $ (49.6) $ 195.3
==================================================================================================================================
</TABLE>
(1) Corporate and Other includes interest, staff area expenses, advertising,
contributions, net investment income and other general expenses, as well as
consolidating adjustments.
(2) Operating earnings (losses) is comprised of net 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 item is comprised of an after-tax charge of $5.2 million related to a
shareholder litigation settlement agreement in Corporate and Other in 2000.
(Refer to Note 12.)
Page 20
<PAGE> 21
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
Aetna
Nine Months Ended September 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 $18,810.4 $ 622.9 $2,285.3 $ 130.7 $ - $21,849.3
Net investment income 533.7 683.0 330.9 690.4 11.9 2,249.9
Equity in earnings of subsidiaries - - 90.6 - - 90.6
----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $19,344.1 $1,305.9 $2,706.8 $ 821.1 $ 11.9 $24,189.8
==================================================================================================================================
Operating earnings (losses) (2) $ 282.8 $ 190.3 $ 164.8 $ 50.7 $(212.5) $ 476.1
Other items (3) (14.6) - - 94.9 (5.2) 75.1
Realized capital gains (losses), net of tax (.7) (15.0) (7.6) 8.4 (3.1) (18.0)
----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 267.5 $ 175.3 $ 157.2 $ 154.0 $(220.8) $ 533.2
==================================================================================================================================
1999
Revenues from external customers $14,036.4 $ 478.4 $1,714.6 $ 123.9 $ .4 $16,353.7
Net investment income 443.0 672.3 285.1 756.0 6.2 2,162.6
Equity in earnings of subsidiaries - - 70.0 - - 70.0
----------------------------------------------------------------------------------------------------------------------------------
Total revenue excluding realized capital gains
(losses) $14,479.4 $1,150.7 $2,069.7 $ 879.9 $ 6.6 $18,586.3
==================================================================================================================================
Operating earnings (losses) (2) $ 341.6 $ 153.7 $ 131.9 $ 64.8 $(188.6) $ 503.4
Other item (3) - - - 50.2 - 50.2
Realized capital gains (losses), net of tax 22.4 (4.7) (19.3) 15.4 15.0 28.8
----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 364.0 $ 149.0 $ 112.6 $ 130.4 $(173.6) $ 582.4
==================================================================================================================================
</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 (losses) is comprised of net 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;
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; and an
after-tax charge of $5.2 million related to a shareholder litigation
settlement agreement in Corporate and Other in 2000. (Refer to Note 12.)
Page 21
<PAGE> 22
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
12. 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 September 30, 2000 and
December 31, 1999, the balance in this facilities reserve was $255 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 was completed in the third quarter of 2000. Trial was scheduled
to begin in the fourth quarter of 2000. On October 5, 2000, the Court entered an
order granting preliminary approval to a settlement of the action. Under the
terms of the settlement, which does not involve any admission of wrongdoing, the
Company and its insurance carriers will pay a total of approximately $83 million
into a settlement fund, which will be used to pay claims submitted by members of
the class certified by the Court and to pay fees of the plaintiffs' attorneys. A
substantial portion of the settlement is covered by insurance, but the Company's
earnings for the three and nine months ended September 30, 2000, reflect an
after-tax charge of approximately $5 million to cover its share of the
settlement. The agreement is subject to final court approval. The Court has
scheduled a hearing for December 18, 2000, concerning, among other things,
whether it will grant final approval to the settlement.
Page 22
<PAGE> 23
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
12. 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. On July 26, 2000, the Connecticut court ordered consolidation of the four
Connecticut actions. On October 12, 2000 the plaintiffs in the four Connecticut
actions withdrew their complaints. A fifth, substantially similar complaint was
filed by Barnett Stepak on behalf of a purported class of Aetna Inc.
shareholders on March 28, 2000 in the Supreme Court of New York, New York
County. The complaint in the New York action seeks various forms of relief,
including unspecified damages and equitable remedies. The New York litigation is
in the preliminary stages. Defendants intend to defend the action 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. On August 11, 2000, the Third Circuit
rendered its decision upholding the dismissal of the case.
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. ("Aetna U.S.
Healthcare") 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. Aetna U.S. Healthcare has supplemented its pending motion to
dismiss to address the application of the Maio decision to this case. On October
23, 2000, this case was consolidated in the United States District Court for the
Southern District of Florida (the "Florida District Court") for pre-trial
proceedings as described below in the discussion concerning the Company's MDL
Application.
Page 23
<PAGE> 24
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
12. 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, 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. On October 23, 2000,
this case was consolidated in the Florida District Court for pre-trial
proceedings as described below in the discussion concerning the Company's MDL
Application. 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,
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. In August 2000,
the Court stayed further proceedings pending decision on the Company's MDL
Application (as described below). On October 23, 2000, this case was
consolidated in the Florida District Court for pre-trial proceedings as
described below in the discussion concerning the Company's MDL Application. 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,
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 plaintiffs to file
an amended complaint. The amended complaint was filed on May 15, 2000 and a
second amended complaint on June 28, 2000. On August 15, the Court denied
defendants' demurer but granted, in part, their motion to strike portions of
the second amended complaint and ordered the plaintiffs to file a third amended
complaint. The third amended complaint was filed on August 25, 2000. 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)
12. 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 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.
Prudential had requested the MDL Panel (as defined below) to consolidate this
case with other cases against Prudential for pretrial purposes. On October 23,
2000, this case was consolidated in the Florida District Court for pretrial
proceedings. 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 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. On August 25, 2000, the Company moved to
dismiss the action for failure to state a claim. The Company has supplemented
its pending motion to dismiss to address the application of the Maio decision to
this case. On October 23, 2000, this case was consolidated in the Florida
District Court for pre-trial proceedings as described below in the discussion
concerning the Company's MDL Application. 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 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, but on July 14, 2000,
the Company requested consolidation of that action with others pending against
the Company. On October 23, 2000, this case was consolidated in the Florida
District Court for pre-trial proceedings as described below in the discussion
concerning the Company's MDL Application. 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)
12. 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.
On August 30, 2000, the Company joined in Prudential's motion to dismiss the
complaint for failure to state a claim. Prudential had requested the MDL Panel
to consolidate this case with other cases against Prudential for pretrial
purposes. On October 23, 2000, this case was consolidated in the Florida
District Court for pretrial proceedings. 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. On July 24, 2000, the
Court stayed the action. Prudential had requested the MDL Panel to consolidate
this case with other cases against Prudential for pretrial purposes. On October
23, 2000, this case was consolidated in the Florida District Court for pretrial
proceedings. 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 (the "MDL Panel") 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). Hearing on the MDL Application took place
on September 22, 2000. On October 23, 2000, the MDL Panel consolidated all the
cases the Company had before the MDL Panel for pre-trial proceedings in the
Florida District Court. Similar cases against other managed care companies also
were, and additional similar cases against the Company may be, consolidated in
the Florida District Court for pre-trial proceedings.
Page 26
<PAGE> 27
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
12. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
LITIGATION (CONTINUED)
Health Care Litigation (Continued)
A purported class action was filed in the Florida District Court 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 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. On August 11, 2000, the Company filed a motion to dismiss
the Florida O'Neill Complaint. Briefing on that motion was completed in early
September 2000. Additionally, the Court has scheduled briefing on plaintiffs'
class certification motion to be completed by November 2000. On October 23,
2000, this case was consolidated in the Florida District Court for pre-trial
proceedings as described above. This litigation is in the preliminary stages.
Defendants intend to defend the action vigorously.
A purported class action complaint was filed in the United States District Court
for the District of Connecticut on August 7, 2000 by Glenn O'Brien and
Christopher Gallagher (the "O'Brien Complaint"). The O'Brien Complaint seeks
various forms of relief, including unspecified damages, from Aetna U.S.
Healthcare for alleged violations of ERISA. The O'Brien Complaint alleges that
Aetna U.S. Healthcare does not make adequate disclosure of the operation of its
managed care plans to actual or prospective members. Aetna U.S. Healthcare
intends to defend the action vigorously. Aetna U.S. Healthcare has notified the
Judicial Panel on Multidistrict Litigation of the O'Brien Complaint for
consolidation with the other matters referred to in the MDL Application.
A purported class action complaint was filed in the United States District Court
for the District of Connecticut on September 7, 2000 against Aetna U.S.
Healthcare by Douglas Chapman (the "Chapman Complaint"). The Chapman Complaint
seeks various forms of relief, including unspecified damages, from Aetna U.S.
Healthcare for alleged violations of ERISA. The Chapman Complaint is brought on
behalf of participants in Aetna U.S. Healthcare's PPO, indemnity and third-party
payor plans and relates to the disclosure and determination of usual, customary
and reasonable charges for claims. This litigation is in the preliminary stages,
and the Company intends to defend the action vigorously.
A purported class action complaint was filed in the Florida District Court on
August 11, 2000 by Charles B. Shane, M.D., Edward L. Davis, D.O., et al. (the
"Shane Complaint") against Aetna U.S. Healthcare and other health insurance
company defendants. The Shane Complaint seeks various forms of relief, including
unspecified damages, from defendants for alleged violations of RICO, ERISA and
various state law claims. The Shane Complaint is brought on behalf of a
purported nationwide class of participating physicians against defendants for
alleged inadequate disclosure of reimbursement practices and inadequate and
untimely payment of claims. The Company intends to defend the action vigorously.
Aetna U.S. Healthcare has filed a motion to dismiss the complaint. Aetna U.S.
Healthcare is scheduled to complete class certification briefing in November
2000. Aetna U.S. Healthcare notified the Judicial Panel on Multidistrict
Litigation of the Shane Complaint for consolidation with the other matters
referred to in the MDL Application. On October 23, 2000, this case was
consolidated in the Florida District Court for pre-trial proceedings as
described above.
Page 27
<PAGE> 28
Item 1. Financial Statements.
AETNA INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
12. 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. On August 31, 2000, the Court entered an order and judgement
dismissing the case.
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. The Company has moved to
dismiss the Reese Complaint for failure to state a claim upon which relief can
be granted. 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 care 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 ultimate 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 28
<PAGE> 29
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 September 30, 2000, and the related condensed
consolidated statements of income for the three-month and nine-month periods
ended September 30, 2000 and 1999 and the related condensed consolidated
statements of shareholders' equity and cash flows for the nine-month periods
ended September 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
October 31, 2000
Page 29
<PAGE> 30
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 nine months ended
September 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 September 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 health and dental products (managed
care and indemnity), and group insurance products (life, disability and
long-term care). 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
Aetna U.S. Healthcare
On September 5, 2000, the Company named John W. Rowe, M.D., the new President
and Chief Executive Officer of Aetna U.S. Healthcare and a member of the Aetna
U.S. Healthcare and Aetna Inc. boards of directors, effective September 15,
2000. The Company is continuing a comprehensive review of its health business
model and is in the process of considering and implementing a number of
strategic and operational 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, strengthening management, considering exiting
from certain products or markets, addressing rising medical costs and improving
the efficiency of our operations. At such time as these initiatives are finally
decided and implementation plans developed (which could occur this year), 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 expected 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. Refer to "Aetna U.S. Healthcare - Outlook."
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, in two effectively simultaneous steps: (1) 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 ("New Aetna"); and (2) 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 New Aetna 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. New
Aetna will be named Aetna Inc.
Page 30
<PAGE> 31
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
OVERVIEW (CONTINUED)
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. A shareholders meeting has been
scheduled for November 30, 2000 to consider the transaction and certain other
matters. The Company expects that it will incur certain costs of approximately
$200 - $250 million after tax associated with the transaction. Refer to
"Corporate", "Liquidity and Capital Resources" and Note 2 of the Condensed Notes
to Consolidated Financial Statements for further discussion.
In connection with its spinoff from the Company, New Aetna generally will assume
all liabilities related to the Aetna U.S. Healthcare and Large Case Pensions
businesses. In addition, New Aetna 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.
Consolidated Results
The Company reported net income of $177 million for the three months ended
September 30, 2000 compared to $195 million for the corresponding period in
1999. Net income per diluted common share for the three months ended September
30, 2000 was $1.24, compared with $1.29 a year ago.
Net income includes Year 2000 costs of $14 million for the three months ended
September 30, 1999. Net realized capital gains were $25 million for the three
months ended September 30, 2000 and $11 million for the corresponding period in
1999. Excluding the net realized capital gains in both periods, earnings were
$153 million for the three months ended September 30, 2000 compared to $184
million for the corresponding period in 1999.
The Company reported net income of $533 million for the nine months ended
September 30, 2000 compared to $582 million for the corresponding period in
1999. Net income per diluted common share for the nine months ended September
30, 2000 was $3.73, compared with $3.81 a year ago.
Net income includes Year 2000 costs of $73 million for the nine months ended
September 30, 1999. Net income also includes a reduction of the reserve for
anticipated future loss on discontinued products for Large Case Pensions of $95
million for the nine months ended September 30, 2000 and $50 million for the
corresponding period in 1999. Net realized capital losses were $18 million for
the nine months ended September 30, 2000, and net realized capital gains were
$29 million for the corresponding period in 1999. Excluding the reduction of the
reserve for anticipated future loss on discontinued products and net realized
capital gains or losses in both periods, earnings were $456 million for the nine
months ended September 30, 2000 compared to $503 million for the corresponding
period in 1999.
Page 31
<PAGE> 32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
OVERVIEW (CONTINUED)
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. Included in the acquisition was PHC's risk HMO, POS,
PPO and Indemnity health lines, as well as its dental risk business. 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 Corporate. 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.
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 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
Agreement to sell Mexican Operations
------------------------------------
On September 19, 2000, Aetna International, Inc., with the consent of ING,
entered into an agreement to sell its remaining Mexican operations to its
partner, Grupo Financiero BBVA Bancomer, S.A. de C. V., for approximately $693
million. The sale is expected to close in the fourth quarter of 2000, subject to
Mexican regulatory approval.
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.
Page 32
<PAGE> 33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
OVERVIEW (CONTINUED)
Acquisition of Aetna Heiwa Life Insurance Company Ltd.
------------------------------------------------------
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.
Sale of Canadian Operations
---------------------------
On October 1, 1999, Aetna International, Inc. completed the sale of its Canadian
operations to John Hancock Canadian Holdings Limited, the parent of The Maritime
Life Assurance Company, for approximately $310 million in cash. The Company's
plan to sell its Canadian operations, as well as the closing, was dependent upon
receiving regulatory approval for the sale, which was received on September 30,
1999. Accordingly, a capital loss of $22 million for the sale was recognized
during the third quarter of 1999. The revenue and earnings of the Canadian
operations were not material to the Company. Proceeds from the sale were used
for general corporate purposes, including repayment of debt, internal growth,
share repurchases and acquisitions.
Refer to "Aetna International" and Note 4 of the Condensed Notes to Consolidated
Financial Statements for further discussion of these and other acquisitions and
dispositions.
AETNA U.S. HEALTHCARE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ -------------------------------------
(Millions) 2000 1999(1) % Change 2000 1999 (1) % Change
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $5,739.8 $4,935.8 16.3% $17,309.5 $12,797.5 35.3%
Net investment income 188.9 163.8 15.3 533.7 443.0 20.5
Fees and other income 486.9 469.7 3.7 1,500.9 1,238.9 21.1
Net realized capital gains (losses) 28.5 39.9 (28.6) (16.7) 34.4 -
-------------------------------------------------------------------------------------------------------------------------
Total revenue 6,444.1 5,609.2 14.9 19,327.4 14,513.8 33.2
-------------------------------------------------------------------------------------------------------------------------
Current and future benefits 5,022.0 4,210.1 19.3 15,069.2 10,956.8 37.5
Salaries and related benefits 555.7 478.9 16.0 1,678.1 1,227.3 36.7
Other operating expenses 582.0 537.9 8.2 1,769.1 1,359.5 30.1
Amortization of goodwill and
other acquired intangible assets 109.5 108.6 .8 327.9 312.4 5.0
-------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 6,269.2 5,335.5 17.5 18,844.3 13,856.0 36.0
-------------------------------------------------------------------------------------------------------------------------
Income before income taxes 174.9 273.7 (36.1) 483.1 657.8 (26.6)
Income taxes 77.6 116.3 (33.3) 215.6 293.8 (26.6)
-------------------------------------------------------------------------------------------------------------------------
Net income $ 97.3 $ 157.4 (38.2) $ 267.5 $ 364.0 (26.5)%
=========================================================================================================================
Net realized capital gains (losses),
net of tax (included above) $ 20.3 $ 26.1 (22.2)% $ (.7) $ 22.4 -%
=========================================================================================================================
(1) Results include PHC since August 6, 1999.
</TABLE>
Results
Aetna U.S. Healthcare's net income for the three months ended September 30, 2000
decreased $60 million compared to the corresponding period in 1999. Net income
includes Year 2000 costs of $8 million for the third quarter of 1999. Excluding
net realized capital gains, results for the three months ended September 30,
2000 decreased $54 million, or 41%, compared to the corresponding period in
1999.
Page 33
<PAGE> 34
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Net income for the nine months ended September 30, 2000 decreased $97 million
compared to the corresponding period in 1999. Net income includes Year 2000
costs of $47 million for the nine months ended September 30, 1999. Excluding net
realized capital gains or losses, results for the nine months ended September
30, 2000 decreased $73 million, or 21%, compared to the corresponding period in
1999.
Net realized capital gains and losses for the three and nine months ended
September 30, 2000, respectively, include a capital gain recorded in the third
quarter of 2000 of $38 million after tax resulting from contingent consideration
following the Company's 1997 sale of its behavioral health subsidiary, HAI. The
third quarter of 1999 includes a capital gain of $39 million after tax related
to HAI. The Company records these amounts as they become realizable. During the
three and nine months ended September 30, 2000, the Company has continued to
incur capital losses when rebalancing its investment portfolio as a result of
the rising interest rate environment. These capital losses for the third quarter
of 2000 partially offset the HAI capital gain and more than offset the HAI
capital gain for the nine months ended September 30, 2000.
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 gains or losses.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- ------------------------------
(Millions) 2000 1999(1) 2000 1999(1)
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating earnings:
Health Risk and PHC $ 81.3 $ 145.3 $ 287.9 $ 378.3
Group Insurance and Other Health 82.4 73.4 244.2 215.8
----------------------------------------------------------------------------------------------------------------------
Total Aetna U.S. Healthcare $ 163.7 $ 218.7 $ 532.1 $ 594.1
======================================================================================================================
Commercial HMO Premium PMPM $151.61 $138.01 $149.21 $ 138.72
----------------------------------------------------------------------------------------------------------------------
Commercial HMO Medical Cost PMPM $132.52(2) $115.77(2) $128.33(2) $ 115.10(2)
----------------------------------------------------------------------------------------------------------------------
Commercial HMO Medical Loss Ratio 87.4%(2) 83.9%(2) 86.0% (2) 83.0%(2)
----------------------------------------------------------------------------------------------------------------------
Medicare HMO Premium PMPM $540.10 $490.64 $535.26 $ 488.85
----------------------------------------------------------------------------------------------------------------------
Medicare HMO Medical Cost PMPM $534.45(2) $450.50(2) $518.24(2) $ 444.08(2)
----------------------------------------------------------------------------------------------------------------------
Medicare HMO Medical Loss Ratio 99.0%(2) 91.8%(2) 96.8%(2) 90.8%(2)
----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Results include PHC since 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.
Page 34
<PAGE> 35
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Health Risk and PHC
Health Risk and PHC include health and dental plans offered on both an insured
and employer funded basis and the results of servicing Prudential's ASO
business. Health Risk and PHC operating earnings decreased $64 million for the
three months ended September 30, 2000 and $90 million for the nine months ended
September 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 for the three and nine months ended September 30, 2000 were severance
costs, primarily related to PHC. In addition, the nine month period ended
September 30, 2000 included the New Jersey assessment previously discussed. The
results for both periods reflect a favorable development related to a government
plan arrangement, offset substantially by the unfavorable development in
Medicare HMO related to the resolution or termination of certain provider
contracts, and an increase in net investment income, primarily due to a larger
portfolio resulting from the inclusion of PHC for a full quarter as well as a
higher average yield on the bond portfolio.
For the Health Risk and PHC 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 September 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 9.9% for the
three months ended September 30, 2000 and 7.6% for the nine months ended
September 30, 2000 compared to the corresponding periods of 1999. Excluding PHC,
the increase would have been 8.2% for the three months ended September 30, 2000
and 7.7% for the nine months ended September 30, 2000 compared to the
corresponding periods of 1999. These increases were primarily due to premium
rate increases on renewing business, partially offset by a shift in the
geographic mix of membership and customers selecting lower premium plans.
Commercial HMO medical cost PMPM increased 14.5% for the three months ended
September 30, 2000 and 11.5% for the nine months ended September 30, 2000
compared to the corresponding periods of 1999. Excluding PHC, the increase would
have been 11.6% for the three months ended September 30, 2000 and 10.6% for the
nine months ended September 30, 2000 compared to the corresponding periods of
1999. These increases reflect higher medical costs primarily due to higher
utilization. While the specific factors vary in importance by local market, the
major drivers of the increase in utilization include an increase in inpatient
utilization, a higher number of emergency room visits, increased outpatient
surgery procedures, more specialist office visits and increased costs for
physician-administered injectables.
The Commercial HMO medical loss ratio was 87.4% for the three months ended
September 30, 2000 compared to 83.9% for the three months ended September 30,
1999. This ratio was 86.0% for the nine months ended September 30, 2000 compared
to 83.0% for the corresponding period of 1999. These increases were the result
of an increase in medical costs discussed above. Excluding PHC, the medical loss
ratio would have been 85.1% for the third quarter of 2000 compared to 82.6% for
the third quarter of 1999 and 84.7% for the nine months ended September 30, 2000
compared to 82.4% for the nine months ended September 30, 1999.
Page 35
<PAGE> 36
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Medicare HMO
------------
Medicare HMO premium PMPM increased 10.1% for the three months ended September
30, 2000 and 9.5% for the nine months ended September 30, 2000 compared to the
corresponding periods of 1999. Excluding PHC, the increase would have been 10.3%
for the three months ended September 30, 2000 and 9.6% for the nine months ended
September 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.
Medicare HMO medical cost PMPM increased 18.6% for the three months ended
September 30, 2000 and 16.7% for the nine months ended September 30, 2000
compared to the corresponding periods of 1999. Excluding PHC, the increase would
have been 20.7% for the three months ended September 30, 2000 and 17.3% for the
nine months ended September 30, 2000 compared to the corresponding periods of
1999. These increases reflect higher medical costs resulting primarily from
increased inpatient utilization.
The Medicare HMO medical loss ratio was 99.0% for the three months ended
September 30, 2000 compared to 91.8% for the three months ended September 30,
1999. This ratio was 96.8% for the nine months ended September 30, 2000 compared
to 90.8% for the corresponding period of 1999. Excluding PHC, the medical loss
ratio would have been 99.5% for the third quarter of 2000 compared to 90.9% for
the third quarter of 1999 and 96.9% for the nine months ended September 30, 2000
compared to 90.5% for the nine months ended September 30, 1999. These increases
were due to the increased medical costs discussed above outpacing supplemental
premiums and HCFA rate increases, primarily in the markets the Company has
announced its intent to exit. Excluding these markets, the medical loss ratio
would have been approximately 92.5% for the third quarter of 2000. The Company's
Medicare HMO medical loss ratio was negatively impacted by approximately two
percentage points during the third quarter of 2000 as a result of the
unfavorable development in Medicare HMO related to the resolution or termination
of certain provider contracts.
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 55 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 $270 million at September 30, 2000. Legislation to increase these
payments is currently pending in Congress. However, it is uncertain whether this
legislation will be enacted and, if enacted, whether increases in payments would
be sufficient to encourage the Company to remain in these service areas. Absent
any sufficient increases in payments, the Company will exit these markets on
December 31, 2000 and write off such identifiable goodwill at that time.
Page 36
<PAGE> 37
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 nine months ended September 30, 2000,
reinsurance recoveries under this agreement were $48 million and $94 million
pretax, respectively. During the period August 6, 1999 through September 30,
1999, reinsurance recoveries under this agreement were $27 million pretax. In
addition, results were negatively impacted by $7 million pretax and $6 million
pretax for the three and nine months ended September 30, 2000, respectively, and
$1 million pretax for the period August 6, 1999 through September 30, 1999
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, generally no later than
June 30, 2001. Prudential ASO members will remain Prudential members 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 members 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 nine months ended September 30, 2000, the Company recorded total fees for
servicing the Prudential ASO business of approximately $86 million and $290
million pretax, respectively, including supplemental fees of approximately $28
million and $112 million pretax (reflected as fees and other income) for the
three and nine months ended September 30, 2000, respectively. During the period
August 6, 1999 through September 30, 1999, the Company recorded total fees for
servicing the Prudential ASO business of approximately $90 million pretax,
including supplemental fees of approximately $40 million pretax (reflected as
fees and other income).
Included in these supplemental fees is amortization for the three and nine
months ended September 30, 2000 of $2 million and $13 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 contraccts. 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 $9 million for the three
months ended September 30, 2000 and $28 million for the nine months ended
September 30, 2000 compared to the corresponding periods of 1999. These
increases reflect primarily improved disability experience and improvement in
margins for employer-funded health products, partially offset by lower life
results.
Page 37
<PAGE> 38
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>
September 30, 2000 September 30, 1999
---------------------------------------- --------------------------------------
(Thousands) Risk Nonrisk Total Risk Nonrisk Total
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HMO
Commercial(1) 7,746 861 8,607 8,669 722 9,391
Medicare 619 - 619 706 - 706
Medicaid 144 85 229 171 50 221
---------------------------------------------------------------------------------------------------------------------------
Total HMO 8,509 946 9,455 9,546 772 10,318
POS 340 3,373 3,713 407 3,553 3,960
PPO 774 3,062 3,836 829 3,107 3,936
Indemnity 244 1,944 2,188 260 2,547 2,807
---------------------------------------------------------------------------------------------------------------------------
Total Health Membership 9,867 9,325 19,192 11,042 9,979 21,021
===========================================================================================================================
Dental 14,499 15,817
---------------------------------------------------------------------------------------------------------------------------
Group Insurance:
Group Life 9,077 9,409
Disability 2,209 2,258
Long-Term Care 114 108
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 1,926 thousand POS members at September 30, 2000 and 2,309
thousand POS members at September 30, 1999 who access primary care
physicians and referred care through an HMO network.
Total Health membership as of September 30, 2000 decreased by 1.8 million
members, or 8.7%, when compared to September 30, 1999, due to the loss of
NYLCare Texas members and losses in PHC membership.
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 55 percent of the
Company's total current Medicare membership.
Total Revenue and Expense
Revenue, excluding net realized capital gains and losses, increased by $846
million, or 15%, for the three months ended September 30, 2000 and $4.9 billion,
or 34%, for the nine months ended September 30, 2000 compared to the
corresponding periods of 1999. The increase for the third quarter of 2000 was
primarily due to increases in premium rates and the increase for the nine months
ended September 30, 2000 was primarily due to the acquisition of PHC on August
6, 1999.
Operating expenses, including salaries and related benefits, increased by $121
million, or 12%, for the three months ended September 30, 2000 and $860 million,
or 33%, for the nine months ended September 30, 2000 compared to the
corresponding periods of 1999. These increases are primarily due to the
acquisition of PHC on August 6, 1999. Operating expenses also reflect severance
costs (primarily related to PHC) of $19 million for the three months ended
September 30, 2000 and $61 million for the nine months ended September 30, 2000
as well as increased costs in both periods to support HMO non-risk membership
growth. Operating expenses as a percentage of revenue were 18% for all periods
reported.
Page 38
<PAGE> 39
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Outlook
Potential Charges. As discussed above, the Company is conducting its
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
implementation plans developed (which could occur this year), 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 expected 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.
Medical Costs/Pricing and Other Actions. 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. 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. Legislation to increase these payments
is currently pending in Congress. However, it is uncertain whether this
legislation will be enacted and, if enacted, whether increase in payments would
be sufficient to encourage the Company to remain in these service areas. When a
final determination is made regarding the exit of Medicare service areas, 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. Absent any sufficient increases in payments, the Company will exit
these markets on December 31, 2000 and write off such identifiable goodwill at
that time.
The Company experienced high HMO medical costs in the second and third quarters
of 2000. Premiums for insured health plans 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 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. The Company is also reviewing
its overall commercial market strategy, and plans to either improve or
selectively discontinue certain offerings in those markets that do not meet
profitability or strategic targets.
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 premium
increases to improve 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.
Page 39
<PAGE> 40
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA U.S. HEALTHCARE (CONTINUED)
Prudential Acquisition. Medical loss ratios for the Commercial PHC business are
higher than for the Company's other commercial health risk business. The effect
of these higher ratios is offset, in part, by the reinsurance agreement between
Prudential and the Company, which terminates December 31, 2000. Excluding the
effect of the reinsurance agreement, supplemental fees for servicing PHC's ASO
business and considering an allocation of administrative expenses, other than
severance, the PHC business generated an operating loss for the third quarter of
2000 of approximately $19 million before the related amortization of goodwill
and interest expense. The Company is seeking to improve the medical loss ratios
of the acquired business through underwriting and pricing discipline and medical
cost management initiatives. If the Company is unable to achieve sufficient
improvement in the medical ratios for the acquired business, its results of
operations for periods following termination of the reinsurance agreement could
be materially adversely affected. The administrative costs related to the PHC
business and the ASO business of Prudential that the Company agreed to service
are higher than the administrative costs of the Company's other health business.
The Company is seeking to reduce the level of administrative costs related to
this business. In addition, the Company expects continued declines in the
membership of the acquired PHC business and the ASO business it agreed to
service. If the Company is unable to reduce the level of administrative costs to
correspond with expected levels of membership decline, its results could be
materially adversely affected.
Technology and Other Compliance Expenses. In 2000, the Company also expects to
increase its expenditures on Internet (electronic commerce) initiatives. Also,
the United States Department of Health and Human Services has issued a series of
proposed regulations under the Health Insurance Portability and Accountability
Act relating to, among other things, standardized transaction formats and the
privacy of member health information. These regulations, only some of which have
been finalized, and any corresponding state legislation, will affect the
Company's administration of health and related benefit plans. The Company is
currently reviewing the potential impact of the proposed regulations on its
operations, including its information technology systems. We expect that we will
incur additional expenses in connection with, and that our business could
otherwise be adversely affected by, these regulations. These expenses and the
impact on our business could be material.
Refer to "Forward-Looking Information/Risk Factors".
Page 40
<PAGE> 41
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 September 30, Nine Months Ended September 30,
--------------------------------------- ------------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums(1) $ 41.9 $ 44.2 (5.2)% $ 117.2 $ 86.6 35.3%
Net investment income 232.4 224.8 3.4 683.0 672.3 1.6
Fees and other income 176.2 134.2 31.3 505.7 391.8 29.1
Net realized capital losses (11.2) (11.2) - (23.1) (7.3) -
----------------------------------------------------------------------------------------------------------------------------------
Total revenue 439.3 392.0 12.1 1,282.8 1,143.4 12.2
----------------------------------------------------------------------------------------------------------------------------------
Current and future benefits (1) 200.0 201.1 (.5) 598.2 564.2 6.0
Salaries and related benefits 53.5 46.3 15.6 152.5 125.4 21.6
Operating expenses 63.8 46.7 36.6 178.9 154.7 15.6
Amortization of deferred policy
acquisition costs 36.9 25.9 42.5 96.5 77.6 24.4
----------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 354.2 320.0 10.7 1,026.1 921.9 11.3
----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 85.1 72.0 18.2 256.7 221.5 15.9
Income taxes 25.4 23.7 7.2 81.4 72.5 12.3
----------------------------------------------------------------------------------------------------------------------------------
Net income $ 59.7 $ 48.3 23.6% $ 175.3 $ 149.0 17.7%
==================================================================================================================================
Net realized capital losses,
net of tax (included above) $ (7.3) $ (7.2) (1.4)% $ (15.0) $ (4.7) -%
==================================================================================================================================
Deposits (not included in premiums above):
Annuities -- fixed options $ 337.1 $ 524.2 (35.7)% $ 1,151.7 $ 1,518.5 (24.2)%
Annuities -- variable options 1,095.4 1,330.3 (17.7) 3,577.6 3,875.4 (7.7)
----------------------------------------------------------------------------------------------------------------------------------
Total $1,432.5 $1,854.5 (22.8)% $ 4,729.3 $ 5,393.9 (12.3)%
==================================================================================================================================
Assets under management:
Annuities -- fixed options (2) $12,396.4 $12,557.2 (1.3)%
Annuities -- variable options (3) 36,649.2 29,583.0 23.9
Other investment advisory 23,929.3 17,256.8 38.7
----------------------------------------------------------------------------------------------------------------------------------
Total assets under management 72,974.9 59,397.0 22.9
Assets under administration (4) 8,654.6 3,581.8 141.6
----------------------------------------------------------------------------------------------------------------------------------
Total assets under management and
administration $81,629.5 $62,978.8 29.6%
==================================================================================================================================
</TABLE>
(1) Includes annuity premiums on contracts converting from the accumulation
phase to payout options with life contingencies of $29.3 million for the
three months ended September 30, 2000, $15.9 million for the three months
ended September 30, 1999, $84.5 million for the nine months ended
September 30, 2000 and $53.9 million for the nine months ended September
30, 1999.
(2) Excludes net unrealized capital losses of $117.2 million at September 30,
2000 and $132.2 million at September 30, 1999.
(3) Includes $15,439.3 million at September 30, 2000 and $10,138.7 million at
September 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' net income for the three months ended September 30,
2000 increased $11 million compared to the corresponding period in 1999. Net
income includes Year 2000 costs of $3 million for the three months ended
September 30, 1999. Excluding net realized capital losses, results for the three
months ended September 30, 2000 increased $12 million, or 21%, compared to the
corresponding period in 1999.
Net income for the nine months ended September 30, 2000 increased $26 million
compared to the corresponding period in 1999. Net income includes Year 2000
costs of $14 million for the nine months ended September 30, 1999. Excluding net
realized capital losses, results for the nine months ended September 30, 2000
increased $37 million, or 24%, compared to the corresponding period in 1999.
The increase in earnings for both the three and nine month periods ended
September 30, 2000 primarily reflects an increase in fees and other income,
partially offset by an increase in operating expenses and salaries and related
benefits.
Page 41
<PAGE> 42
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA FINANCIAL SERVICES (CONTINUED)
Substantially all of fees and other income are calculated based on assets under
management and administration. Compared to September 30, 1999, assets under
management and administration at September 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 large new case closed in the second quarter of 2000) and additional net
deposits (i.e., deposits, less surrenders). Deposits for the three and nine
months ended September 30, 2000 decreased 23% and 12%, respectively, compared to
the corresponding periods in 1999. The decrease for the three months ended
September 30, 2000 is primarily due to the inclusion of plan assets from a large
new case and higher individual annuity sales resulting from a new mutual fund
offering in the third quarter of 1999. In addition to the factors contributing
to the three month decrease, the decrease for the nine months ended September
30, 2000 is attributable to the inclusion of plan assets from a large new case
in the first quarter of 1999.
The increases in operating expenses and salaries and related benefits in the
three and nine month periods ended September 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 September 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 7.3%,
and the average annualized earned rate on investments supporting
experience-rated investment contracts was 7.7% and 7.6% for the nine months
ended September 30, 2000 and 1999, respectively. The average annualized credited
rate on fully guaranteed investment contracts was 6.2% and 6.3% for the nine
months ended September 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 nine months ended September 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 42
<PAGE> 43
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- ----------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $ 773.7 $ 562.0 37.7% $2,204.1 $1,623.7 35.7%
Net investment income (1) 157.7 117.0 34.8 421.5 355.1 18.7
Fees and other income 24.2 33.2 (27.1) 81.2 90.9 (10.7)
Net realized capital gains 11.8 43.5 (72.9) 11.3 46.4 (75.6)
-----------------------------------------------------------------------------------------------------------------------------
Total revenue 967.4 755.7 28.0 2,718.1 2,116.1 28.4
-----------------------------------------------------------------------------------------------------------------------------
Current and future benefits 633.0 487.9 29.7 1,860.5 1,373.0 35.5
Salaries and related benefits 62.4 56.4 10.6 170.6 156.1 9.3
Operating expenses 141.3 91.5 54.4 346.7 287.3 20.7
Amortization of goodwill and other
acquired intangible assets 7.3 2.4 - 21.2 10.5 101.9
Amortization of deferred policy
acquisition costs 31.5 26.1 20.7 88.7 75.9 16.9
-----------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 875.5 664.3 31.8 2,487.7 1,902.8 30.7
-----------------------------------------------------------------------------------------------------------------------------
Income before income taxes 91.9 91.4 .5 230.4 213.3 8.0
Income taxes 19.4 69.3 (72.0) 73.2 100.7 (27.3)
-----------------------------------------------------------------------------------------------------------------------------
Net income $ 72.5 $ 22.1 -% $ 157.2 $ 112.6 39.6%
=============================================================================================================================
Net realized capital gains (losses), net
of tax (included above) $ 9.3 $ (21.4) -% $ (7.6) $ (19.3) 60.6%
=============================================================================================================================
</TABLE>
(1) Includes earnings from minority-owned affiliates that are recorded on the
equity method of accounting of $31.4 million for the three months ended
September 30, 2000, $23.5 million for the three months ended September 30,
1999, $90.6 million for the nine months ended September 30, 2000, and
$70.0 million for the nine months ended September 30, 1999.
Results
Aetna International's net income for the three months ended September 30, 2000
increased by $50 million compared to the corresponding period in 1999. Net
income includes Year 2000 costs of $2 million for the three months ended
September 30, 1999. Excluding net realized capital gains or losses, results for
the three months ended September 30, 2000 increased $20 million, or 45%,
compared to the corresponding period in 1999.
Net income for the nine months ended September 30, 2000 increased by $45 million
compared to the corresponding period in 1999. Net income includes Year 2000
costs of $10 million for the nine months ended September 30, 1999. Excluding net
realized capital gains or losses, results for the nine months ended September
30, 2000 increased $33 million, or 25%, compared to the corresponding period in
1999.
Net realized capital gains after tax for the three months ended September 30,
2000 include capital gains of $9 million from the sale of an investment in a
securities company in Taiwan, and $3 million from investment portfolio sales in
Japan. These gains were partially offset by capital losses from investment
portfolio sales in Taiwan and the sale of a health subsidiary in Canada.
Net realized capital losses after tax for the nine months ended September 30,
2000 include capital losses of $16 million from investment portfolio sales in
Japan, $9 million from the sale of a Venezuelan affiliate and $6 million from
the sale of a health subsidiary in Canada. These capital losses were partially
offset by capital gains of $13 million from the sale of two Mexican joint
venture companies, $9 million from the sale of an investment in a securities
company in Taiwan and $5 million from investment portfolio sales in Chile.
Page 43
<PAGE> 44
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 September 30, Nine Months Ended September 30,
---------------------------------- --------------------------------
(Millions) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asia Pacific (1) $ 24.8 $17.4 $73.6 $ 46.7
Americas (2) 40.4 11.9 98.4 56.9
Other (3) (2.0) (2.7) (13.0) (14.5)
------------------------------------------------------------------------------------------------------------------------------
Operating earnings from continuing businesses 63.2 26.6 159.0 89.1
Sold operations (4) - 16.9 5.8 42.8
------------------------------------------------------------------------------------------------------------------------------
Total $ 63.2 $43.5 $164.8 $ 131.9
==============================================================================================================================
</TABLE>
(1) Includes China, Hong Kong, Indonesia, Japan (for the three and nine months
ended September 30, 2000), Malaysia, New Zealand, Philippines, Taiwan and
Thailand.
(2) Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru and Poland.
(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"), and Venezuela for the nine months
ended September 30, 2000 and SMA, FMA, Canada and Venezuela for the three
and nine months ended September 30, 1999.
The increases for both periods in Asia Pacific's earnings from continuing
businesses were due to the addition of earnings from Japan, as well as revenue
growth and expense management in Taiwan. Partially offsetting these increases
was a decrease in Malaysia's results due primarily to a tax holiday and other
tax benefits recognized in 1999.
The increase in the Americas' earnings from continuing businesses for the third
quarter of 2000 was due to improved results in Brazil as a result of lower
insurance premium taxes and increased fee income from the Mexican pension
business. The increase in the Americas' earnings from continuing businesses for
the nine months ended September 30, 2000 was due to stronger results in Mexico
and Brazil, as mentioned above, as well as stronger results in the Mexican
annuity business, most notably in the second quarter of 2000, which was
primarily due to increased investment returns and customer base.
The decrease in the effective tax rate for the three and nine months ended
September 30, 2000, compared to the corresponding periods in 1999, was primarily
due to taxes on undistributed earnings resulting from the sale of the Canadian
operations during the third quarter of 1999 and to a lesser extent, an increase
in earnings from equity affiliates during 2000, which are reported net of income
taxes in net investment income. Partially offsetting the decrease for the nine
month period was $33 million in taxes related to the sale of SMA and FMA in the
first quarter of 2000.
On September 19, 2000, Aetna International, with the consent of ING, entered
into an agreement to sell its Mexican operations to its partner, Grupo
Financiero BBVA Bancomer, S.A. de C. V., for approximately $693 million. The
sale is expected to close in the fourth quarter of 2000, subject to Mexican
regulatory approval. Operating earnings from the Mexican operations were
approximately $61 million for the nine months ended September 30, 2000 and $37
million for the nine months ended September 30, 1999.
On August 18, 2000, Aetna International sold its 50 percent ownership interest
in a Venezuelan joint venture, Seguros Mercantil, to its Venezuelan partner,
Mercantil Servicios Financieros for approximately $17 million. The sale resulted
in a capital loss of approximately $9 million. The earnings of Seguros Mercantil
were not material to Aetna International.
Page 44
<PAGE> 45
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
AETNA INTERNATIONAL (CONTINUED)
On July 19, 2000, Aetna International signed an agreement to sell its New
Zealand operation, Aetna Health Limited, to The Southern Cross Medical Care
Society. Approval from the New Zealand Commerce Commission has been received and
the sale is now expected to close in the fourth quarter of 2000. The earnings of
Aetna Health Limited were not material to Aetna International.
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 for the nine
months ended September 30, 2000 and $18 million for the nine months ended
September 30, 1999.
On November 18, 1999, Aetna International acquired a 33% ownership interest in
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
$10 million during the three months ended September 30, 2000 and $17 million
during the nine months ended September 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 $6 million for the third quarter of 1999 and $25
million for the nine months ended September 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 45
<PAGE> 46
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 September 30, Nine Months Ended September 30,
--------------------------------- ----------------------------------------
(Millions) 2000 1999 % Change 2000 1999 % Change
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $ 34.3 $ 32.8 4.6% $ 111.9 $ 90.2 24.1%
Net investment income 229.7 241.1 (4.7) 690.4 756.0 (8.7)
Fees and other income 6.2 14.8 (58.1) 18.8 33.7 (44.2)
Net realized capital gains (losses) 5.0 (5.7) - 12.2 23.8 (48.7)
------------------------------------------------------------------------------------------------------------------------------
Total revenue 275.2 283.0 (2.8) 833.3 903.7 (7.8)
------------------------------------------------------------------------------------------------------------------------------
Current and future benefits 233.4 248.0 (5.9) 721.0 753.5 (4.3)
Salaries and related benefits 4.1 5.0 (18.0) 12.9 15.0 (14.0)
Operating expenses 1.9 2.5 (24.0) 5.9 8.8 (33.0)
Reduction of reserve for anticipated
future loss on discontinued products - - - (146.0) (77.2) (89.1)
------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 239.4 255.5 (6.3) 593.8 700.1 (15.2)
------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 35.8 27.5 30.2 239.5 203.6 17.6
Income taxes 12.9 10.4 24.0 85.5 73.2 16.8
------------------------------------------------------------------------------------------------------------------------------
Net income $ 22.9 $ 17.1 33.9 $ 154.0 $ 130.4 18.1
==============================================================================================================================
Net realized capital gains (losses), net
of tax (included above) $ 3.2 $ (3.8) - $ 8.4 $ 15.4 (45.5)
==============================================================================================================================
Deposits not included in
premiums above $125.9 $162.7 (22.6) $ 453.2 $ 624.0 (27.4)
==============================================================================================================================
Assets under management (1) (2) $25,189.2 $ 26,670.8 (5.6)
==============================================================================================================================
</TABLE>
(1) Excludes net unrealized capital losses of $108.0 million at September 30,
2000 and net unrealized capital losses of $144.4 million at September 30,
1999.
(2) Includes assets under management of $5,647.7 million at September 30, 2000
and $6,126.9 million at September 30, 1999 related to discontinued
products.
Results
Large Case Pensions' net income for the three months ended September 30, 2000
increased by $6 million compared with the corresponding period in 1999.
Excluding net realized capital gains or losses, results for the three months
ended September 30, 2000 decreased $1 million, or 6%, compared to the
corresponding period in 1999.
Net income for the nine months ended September 30, 2000 increased by $24 million
compared with the corresponding period in 1999. Results include a reduction of
the reserve for anticipated future loss on discontinued products for Large Case
Pensions of $95 million for the nine months ended September 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 nine months
ended September 30, 2000 decreased $14 million, or 22%, compared to the
corresponding period in 1999.
The decrease in results for the three and nine month periods ended September 30,
2000 continues to reflect the redeployment of capital supporting this business
and the continuing run off of liabilities underlying the Large Case Pensions
business.
Page 46
<PAGE> 47
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 September 30, Nine Months Ended September 30,
-------------------------------- ---------------------------------
(Millions) 2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Scheduled contract maturities
and benefit payments (1) $202.4 $233.0 $654.3 $711.5
Contractholder withdrawals other than
scheduled contract maturities and benefit
payments 79.2 161.3 182.6 362.3
Participant directed withdrawals 9.9 16.1 35.6 60.0
----------------------------------------------------------------------------------------------------------------
(1) Includes payments made upon contract maturity and other amounts
distributed in accordance with contract schedules.
</TABLE>
Outlook
Large Case Pensions' earnings in the fourth quarter of 2000 are expected to
substantially decline compared to the third quarter of 2000, as a result of
anticipated decreases in investment income.
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 future 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
consist of: operating income or loss, realized capital gains or losses and
mortality gains or losses. Operating income or loss is equal to revenue less
expenses. Realized capital gains or losses reflect the excess (deficit) of sales
price over (below) the carrying value of assets sold. Mortality gains or losses
reflect the mortality and retirement experience related to SPAs. A mortality
gain (loss) occurs when an annuitant or a beneficiary dies sooner (later) than
expected. A retirement gain will occur on some contracts if an annuitant retires
later than expected (a loss if an annuitant retires earlier than expected).
Page 47
<PAGE> 48
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
The results of discontinued products were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ---------------------------
(Millions) 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest deficit (1) $ (1.7) $ (4.0) $ (5.5) $(12.6)
Net realized capital gains (losses) (11.5) (8.0) (9.6) 3.9
Interest earned on receivable from continuing products 4.5 5.1 15.1 16.1
Other, net 1.3 4.2 8.8 10.1
--------------------------------------------------------------------------------------------------------------------------
Results of discontinued products, after tax $ (7.4) $ (2.7) $ 8.8 $ 17.5
==========================================================================================================================
Results of discontinued products, pretax $(11.7) $ (4.3) $ 10.3 $ 26.4
==========================================================================================================================
Net realized capital losses from sales of bonds,
after tax (included above) $(12.7) $(10.5) $(48.2) $ (2.7)
==========================================================================================================================
</TABLE>
(1) The interest deficit is the difference between earnings on invested assets
and interest credited to contractholders.
Net realized capital losses for the three and nine months ended September 30,
2000 increased compared to the corresponding periods in 1999. These increases
primarily result from realized capital losses on bonds, due to the rising
interest rate environment, partially 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 $384 million at September 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.
Page 48
<PAGE> 49
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LARGE CASE PENSIONS (CONTINUED)
The activity in the reserve for anticipated future losses on discontinued
products for the nine months ended September 30, 2000 was as follows (pretax):
<TABLE>
<CAPTION>
(Millions)
-----------------------------------------------------------------------------------------------------
<S> <C>
Reserve at December 31, 1999 $ 1,147.6
Operating income 15.1
Net realized capital losses (17.6)
Mortality and other 12.8
Reserve reduction (146.0)
-----------------------------------------------------------------------------------------------------
Reserve at September 30, 2000 $ 1,011.9
=====================================================================================================
</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 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 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.
The discontinued products investment portfolio is as follows:
<TABLE>
<CAPTION>
(Millions) September 30, 2000 December 31, 1999
---------------------------------------------------------------------------------------------------------------
Class Amount Percent Amount Percent
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Debt Securities $ 4,208.6 74.9% $ 4,533.0 77.2%
Mortgage Loans 783.4 13.9 768.8 13.1
Real Estate 127.5 2.3 112.7 1.9
Equities 225.5 4.0 239.7 4.1
Short-term and other investments 276.4 4.9 214.2 3.7
---------------------------------------------------------------------------------------------------------------
Total $ 5,621.4 100.0% $ 5,868.4 100.0%
================================================================================================================
</TABLE>
Distributions on discontinued products were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
(Millions) 2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Scheduled contract maturities, settlements
and benefit payments $198.4 $304.1 $697.7 $ 970.8
Participant directed withdrawals 2.2 3.4 7.2 12.0
----------------------------------------------------------------------------------------------------------------------
</TABLE>
Cash required to fund these distributions was provided by earnings and scheduled
payments on, and sales of, invested assets.
Refer to Note 9 of Condensed Notes to Consolidated Financial Statements for
additional information.
Page 49
<PAGE> 50
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
CORPORATE
Operating Summary
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------------
(Millions, after tax) 2000 1999 % Change 2000 1999 % Change
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest expense $50.8 $ 45.7 11.2% $ 147.6 $126.4 16.8%
===============================================================================================================================
Salaries and related benefits $14.2 $ 9.0 57.8% $ 39.3 $ 31.9 23.2%
Other operating expense, net 9.0 12.4 (27.4) 30.8 30.3 1.7
Net realized capital losses (gains) 1.0 (17.5) - 3.1 (15.0) -
-------------------------------------------------------------------------------------------------------------------------------
Total other expense $24.2 $ 3.9 -% $ 73.2 $ 47.2 55.1%
===============================================================================================================================
</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 and an increase
in interest rates. Net realized capital losses for the three and nine months
ended September 30, 2000 primarily consist of losses on the sale of certain
Corporate real estate.
Salaries and related benefits increased $5 million for the three months ended
September 30, 2000 primarily due to executive recruitment and related expenses.
Other operating expenses reflect $5 million related to a shareholder litigation
settlement agreement. (Refer to Note 12 of Condensed Notes to Consolidated
Financial Statements for further discussion.) The decline in other operating
expenses primarily reflects lower advertising expenses and is also the result of
continued cost reduction initiatives. Other operating expenses include Year 2000
costs of $.7 million and $3 million for the three and nine months ended
September 30, 1999, respectively.
Outlook
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. Such amounts are currently
estimated to be approximately $200 million to $250 million after tax and relate
to: payments for certain compensation-related arrangements; costs for outside
financial and legal advisors; income taxes related to legal entity realignment
pursuant to the agreement; costs for insurance related to New Aetna's
indemnification of certain Aetna liabilities; payments for the settlement of
certain Aetna employee stock options held by individuals who will become
employees of ING; and various other expenses related to the change in control of
Aetna.
The Company is continuing a comprehensive review of its health business model
and is in the process of considering and implementing a number of strategic and
operational 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, strengthening management, considering exiting from certain
products or markets, addressing rising medical costs and improving the
efficiency of our operations. At such time as these initiatives are finally
decided and implementation plans developed (which could occur this year), 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 expected 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.
Page 50
<PAGE> 51
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) September 30, 2000 December 31, 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Debt securities available for sale $ 30,921.2 $28,661.6
Debt securities held to maturity 169.7 -
Equity securities 854.4 791.1
Short-term investments 763.4 788.2
Mortgage loans 3,186.6 3,238.2
Commercial loans 1,054.1 -
Real estate 512.6 361.8
Policy loans 874.4 541.5
Other 1,665.8 1,394.8
----------------------------------------------------------------------------------------------------------------
Total investments $ 40,002.2 $35,777.2
================================================================================================================
</TABLE>
Debt Securities
Debt securities represented 78% of the Company's total general account invested
assets at September 30, 2000 and 80% at December 31, 1999 and supported the
following types of businesses:
<TABLE>
<CAPTION>
(Millions) September 30, 2000 December 31, 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 4,208.6 $ 4,533.0
Supporting experience-rated products 11,423.1 11,879.5
Supporting remaining products 15,459.2 12,249.1
----------------------------------------------------------------------------------------------------------------
Total debt securities (1) $31,090.9 $28,661.6
================================================================================================================
</TABLE>
(1) Total debt securities include "Below Investment Grade" securities of $1.9
billion at September 30, 2000 and $2.1 billion at December 31, 1999 of
which 35% at September 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 $324 million at
September 30, 2000 and $748 million at December 31, 1999. Of the net unrealized
capital losses at September 30, 2000, $26 million relate to assets supporting
discontinued products and $148 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 September 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
September 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 51
<PAGE> 52
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
TOTAL INVESTMENTS (CONTINUED)
Mortgage and Commercial Loans
At September 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) September 30, 2000 December 31, 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Supporting discontinued products $ 783.4 $ 768.8
Supporting experience-rated products 676.2 923.4
Supporting remaining products 1,727.0 1,546.0
---------------------------------------------------------------------------------------------------------------------
Total mortgage loans $3,186.6 $3,238.2
=====================================================================================================================
Total commercial loans $1,054.1 $ -
=====================================================================================================================
</TABLE>
During the first nine 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 September 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 $227 million at September 30, 2000 and $285 million at December 31, 1999 of
which 79% supported discontinued and experience-rated products in both periods.
Specific impairment reserves on these loans were $34 million at September 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 6 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, the impact of hypothetical net
losses on the Company's consolidated near-term financial position, results of
operations and cash flows assuming certain changes in market rates and prices
were to occur. 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 effect the consolidated
near-term financial position, results of operations or cash flows of the Company
as of September 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 52
<PAGE> 53
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 nine 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 $85 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 $712 million of investments in core businesses and
acquisitions, pay approximately $122 million for common stock repurchases and
pay approximately $124 million of dividends to shareholders. Refer to the
"Consolidated Statements of Cash Flows" for additional information.
Dividends
On September 29, 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 October 27, 2000, payable November 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. On October 31, 2000, Aetna Services, Inc. was merged with and into
Aetna Inc. Refer to Note 10 of the Condensed Notes to Consolidated Financial
Statements for additional information. As part of the ING transaction, ING will
assume up to approximately $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 nine months
of 2000 and $1.4 billion during the corresponding period in 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
September 30, 2000, of which 1,787,000 shares at a cost of approximately $95
million were repurchased during the first nine months of 2000. The Company
currently expects repurchases of its common stock to be minimal prior to the
closing of the ING transaction.
Page 53
<PAGE> 54
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
New Aetna
The Company currently expects New Aetna to have an initial short-term debt level
at the time of the closing of the ING transaction of approximately $2.0 billion
and a debt to capital ratio lower than Aetna Inc.'s current ratio. It also is a
condition to closing the ING transaction that New Aetna have an investment grade
debt rating of either at least BBB from Standard & Poor's or Baa2 from Moody's
Investors Service.
Aetna currently has revolving credit facilities in an aggregate amount of $2.0
billion. These facilities will not continue following the spinoff and New Aetna
intends to enter into a new revolving credit facility or other borrowing
arrangements, providing for an aggregate borrowing capacity of approximately
$2.5 billion. New Aetna anticipates that these arrangements will include
covenants that will require, among other things, that New Aetna maintain a
certain level of net worth. New Aetna anticipates borrowing under the credit
facility or issuing short-term debt in connection with the spinoff.
The board of directors currently intends that, following the spinoff, New Aetna
will use excess cash flow to repurchase shares or pay down debt, and, as a
result, we currently expect that initially New Aetna will pay a minimal
quarterly dividend. The actual dividend rate for New Aetna common stock will be
determined at a later date. The first dividend is expected to be paid in the
first quarter of 2001. New Aetna's board will be free to change the dividend
practices at any time. The board will base its decisions on, among other things,
general business conditions, financial results, contractual, legal and
regulatory restrictions regarding dividend payments by subsidiaries, practices
of peer companies and any other factors the board may consider to be relevant.
On September 19, 2000, Aetna International signed an agreement to sell its
Mexican operations to its partner, Grupo Financiero BBVA Bancomer, S.A. de C.
V., for approximately $693 million. The sale is expected to close in the fourth
quarter of 2000, subject to Mexican regulatory approval. Under the agreement
between Aetna and ING, New Aetna is entitled to receive approximately $35
million of the sale proceeds.
GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
Goodwill and other acquired intangible assets were $8.8 billion at September 30,
2000, or approximately 78% of consolidated shareholders' equity. The
amortization of goodwill and other acquired intangible assets was $351 million
for the nine months ended September 30, 2000, or approximately 40% 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.
Page 54
<PAGE> 55
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
NEW ACCOUNTING STANDARDS
Refer to Note 1 of the Condensed Notes to Consolidated Financial Statements for
a discussion of recently issued accounting standards.
REGULATORY ENVIRONMENT
Set forth below is important information regarding the regulation of our Health
and Large Case Pensions businesses. For information regarding the regulation of
our Aetna Financial Services and Aetna International businesses, please refer to
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.
Regulation
General
The Company's operations are subject to comprehensive regulation throughout the
United States. Supervisory agencies, including (depending on the state) state
health, insurance, corporation and securities departments, have broad authority
to grant licenses to transact business and regulate many aspects of the products
and services offered by us, as well as solvency and reserve adequacy. Many
agencies also regulate investment activities on the basis of quality,
diversification, and other quantitative criteria. The Company's operations and
accounts are subject to examination at regular intervals by certain of these
regulators.
Health Care
The federal government and the states in which the Company conducts its HMO and
other health operations have adopted laws and regulations that govern its
business activities to varying degrees. These laws and regulations may restrict
how the Company conducts its businesses and may result in additional burdens and
costs to the Company. Areas of governmental regulation include licensure,
premium rates, benefits, service areas, quality assurance procedures, plan
design and disclosures, eligibility requirements, provider rates of payment,
surcharges on provider payments, provider contract forms, underwriting,
financial arrangements, financial condition (including reserves) and corporate
governance. These laws and regulations are subject to amendments and changing
interpretations in each jurisdiction.
States generally require HMOs to obtain a certificate of authority prior to
commencing operations. To establish an HMO in any state where the Company does
not presently operate an HMO, the Company generally has to obtain such a
certificate. The time necessary to obtain such a certificate varies from state
to state. Each HMO must file periodic financial and operating reports with the
states in which it does business. In addition, the Company's HMOs are subject to
state examination and periodic license renewal.
Page 55
<PAGE> 56
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT (CONTINUED)
Recent Medicare Changes
In 1997, the federal government passed legislation related to Medicare that
changed the method for determining premiums that the government pays to HMOs for
Medicare members. In general, the new method has reduced the premiums payable to
the Company compared to the old method, although the level and extent of the
reductions varies by geographic market and depends on other factors. The
legislation also requires the Company to pay a "user fee". The changes began to
be phased in on January 1, 1998 and will continue over five years. The federal
government also announced in 1999 that it planned to begin to phase in risk
adjustments to its premium payments over a five-year period commencing January
1, 2000. It is anticipated that the net impact of the risk adjustments will be
to reduce the premiums payable to the Company. While the phase-in provisions
provide the Company with an opportunity to offset some of the premium
reductions, the risk adjustments and the user fee by adjusting the supplemental
premiums that members pay to the Company and by adjusting the benefits included
in the Company's products, because of competition and other factors, the
adjustments the Company can make may not fully offset the reductions in premiums
from the government. Because of these reduced premiums and the user fee, as well
as other factors including new Medicare+Choice regulations issued by HCFA, the
Company decided not to renew its Medicare HMO contracts (or to reduce contract
service areas) in certain areas effective January 1, 1999, January 1, 2000 and
January 1, 2001. Legislation is currently pending in Congress to increase
payments to HMOs under Medicare. Such legislation may or may not be enacted and
may not be sufficient to encourage the Company to renew those contracts. Refer
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Aetna U.S. Healthcare - Health Risk and PHC - Medicare HMO" for
more information.
HIPAA
The federal government enacted the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") in 1997. The legislation has three main
effects:
- it limits pre-existing condition exclusions that apply to individuals
changing jobs or moving to individual coverage;
- it guarantees that employees in the small group market have available
health coverage; and
- it prevents exclusion of individuals from coverage under group plans based
on health status.
In addition, regulations were recently proposed under HIPAA relating to the
privacy of health information and certain other matters affecting the
administration of health and related plan benefits. Refer to "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Aetna
U.S. Healthcare - Outlook" for more information.
ERISA
The provision of services to certain employee health benefit plans is subject to
the Employee Retirement Income Security Act of 1974 ("ERISA"), a complex set of
laws and regulations subject to interpretation and enforcement by the Internal
Revenue Service and the Department of Labor ("DOL"). ERISA regulates certain
aspects of the relationships between the Company and employers who maintain
employee benefit plans subject to ERISA. Some of the Company's administrative
services and other activities may also be subject to regulation under ERISA. In
addition, some states require licensure or registration of companies providing
third party claims administration services for benefit plans.
Page 56
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT (CONTINUED)
Other Recent Matters
The federal government and many states, including states in which the Company
has substantial managed care membership, have enacted or are seriously
considering additional legislation or regulation related to managed care. Other
federal legislation, effective January 1, 1998, mandates minimum hospital stays
after childbirth and that health plans apply lifetime limits to mental health
benefits with parity.
This legislation or regulation includes, among other things, the following:
- Eliminating or reducing the scope of ERISA pre-emption of state medical and
bad faith claims under state law, exposing health plans to expanded
liability to punitive and other extra-contractual damages
- Extension of malpractice and other liability for medical and other
decisions from providers to health plans
- Liability for negligent denials or delays in coverage
- Mandatory coverage of experimental procedures and drugs
- Mandatory direct access to specialists for patients with chronic conditions
- Mandatory direct access to specialists (including OB/GYNs) and
chiropractors
- Mandated expanded consumer disclosures and notices
- Mandatory expanded coverage for emergency services
- Mandated liberalized definitions of medical necessity
- Mandated liberalized internal and external grievance and appeal procedures
(including expedited decision making)
- Mandatory maternity and other lengths of hospital inpatient stay
- Mandatory point-of-service benefits for HMO plans
- Prohibition of so-called "gag" and similar clauses in physician agreements
- Prohibitions on incentives based on utilization
- Prohibition or limitation of arrangements designed to manage medical costs
and improve quality of care, such as capitated arrangements with providers
or provider financial incentives
- Regulation of and restrictions on utilization management and review
- Regulation of the composition of provider networks, such as any willing
provider and pharmacy laws
- Required payment levels for out-of-network care
- Exempting physicians from the antitrust laws that prohibit price fixing,
group boycotts and other horizontal restraints on competition
Page 57
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT (CONTINUED)
- Restrictions on health plan claim and related procedures
- Regulations relating to procedures to protect the confidentiality of
medical records
- Third-party review of denials of benefits (including denials based on a
lack of medical necessity)
- Restricting or eliminating the use of formularies for prescription drugs
For example, in 1999, the House of Representatives passed the Norwood-Dingell
bill which would (if it became law), among other things, place limits on health
care plans' methods of operations, limit employers' and health care plans'
ability to define medical necessity and permit employers and health care plans
to be sued in state courts for coverage determinations. The Senate has also
passed a version of this bill, although the Senate version would not permit
employers and health care plans to be sued in state courts for coverage
determinations and contains somewhat less restrictive limits on health care plan
methods of operations.
It is uncertain whether the Company can recoup, through higher premiums or other
measures, the increased costs of mandated benefits or the other increased costs
caused by such legislation or regulation.
The Health Care business also may be adversely impacted by court and regulatory
decisions that expand the interpretations of existing statutes and regulations,
impose medical or bad faith liability, increase our responsibilities under
ERISA, or reduce the scope of ERISA pre-emption of state law claims.
Texas Agreement
On April 11, 2000, the Company's Texas HMOs entered into an assurance of
voluntary compliance with the Office of the Attorney General of Texas to settle,
with prejudice and without admission, litigation commenced by the Office of the
Attorney General of Texas in December 1998 regarding certain alleged business
practices and to make additional commitments. The agreement 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 the
Company'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 agreement does not include any finding of fault nor does it
include any fines or penalties. The Company does not expect the agreement to
have a material adverse effect on its financial condition or results of
operations, and the agreement provides for potential relief should such
unexpected impact occur.
Investment and Retirement Products and Services
Operations conducted by the Company are subject to regulation by various
government agencies where the Company conducts business, in particular the
insurance departments of Connecticut and New York. Among other matters, these
agencies may regulate premium rates, trade practices, agent licensing, policy
forms, underwriting and claims practices, the maximum interest rates that can be
charged on life insurance policy loans, and the minimum rates that must be
provided for accumulation of surrender value.
Page 58
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
REGULATORY ENVIRONMENT (CONTINUED)
Federal Employee Benefit Regulation
Large Case Pensions provides a variety of products and services to employee
benefit plans that are covered by ERISA.
In December 1993, in a case involving an employee benefit plan and an insurance
company, the United States Supreme Court ruled that assets in the insurance
company's general account that were attributable to a portion of a group pension
contract issued to the plan that was not a "guaranteed benefit policy" were
"plan assets" for purposes of ERISA and that the insurance company had fiduciary
responsibility with respect to those assets. In reaching its decision, the
Supreme Court declined to follow a 1975 DOL interpretive bulletin that had
suggested that insurance company general account assets were not plan assets.
The Small Business Job Protection Act (the "Act") was signed into law in 1996.
The Act created a framework for resolving potential issues raised by the Supreme
Court decision. The Act provides that, absent criminal conduct, insurers
generally will not have liability with respect to general account assets held
under contracts that are not guaranteed benefit policies based on claims that
those assets are plan assets. The relief afforded extends to conduct that occurs
before the date that is 18 months after the DOL issues final regulations
required by the Act, except as provided in the anti-avoidance portion of the
regulations. The regulations, which were issued on January 5, 2000, address
ERISA's application to the general account assets of insurers attributable to
contracts issued on or before December 31, 1998 that are not guaranteed benefit
policies. The conference report relating to the Act states that policies issued
after December 31, 1998 that are not guaranteed benefit policies will be subject
to ERISA's fiduciary obligations. The Company is not currently able to predict
how these matters may ultimately affect its businesses.
HMO and Insurance Holding Company Laws
A number of states, including Pennsylvania and Connecticut, regulate affiliated
groups of HMOs and insurers such as the Company under holding company statutes.
These laws may require these companies to maintain certain levels of equity. For
information regarding restrictions on certain payments of dividends or other
distributions by HMO and insurance company subsidiaries of the Company, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources". Some of these laws also regulate
changes in control (as do Connecticut and Pennsylvania corporate laws), and
other matters such as transactions with affiliates.
Guaranty Fund Assessments
Under guaranty fund laws existing in all states, insurers doing business in
those states can be assessed (up to prescribed limits) for certain obligations
of insolvent insurance companies to policyholders and claimants. While the
Company historically has recovered more than half of guaranty fund assessments
through statutorily permitted premium tax offsets, significant increases in
assessments could jeopardize future efforts to recover these assessments. Some
states have similar laws relating to HMOs. There were no material charges to
earnings for guaranty fund obligations during 1999, 1998, or 1997. On April 6,
2000, the State of New Jersey enacted the New Jersey Insolvent Health
Maintenance Organization Assistance Fund Act of 2000 (the "New Jersey Act"). The
New Jersey 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
New Jersey Act requires that HMOs in the New Jersey market be assessed a charge
calculated 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 the Company's HMO market
share in New Jersey, of $23 million pretax ($15 million after tax) in the second
quarter of 2000.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
FORWARD-LOOKING INFORMATION/RISK FACTORS
Our Health and Large Case Pensions businesses are subject to, and you should
carefully consider, important risk factors that are described under the heading
"Risk Factors" in the preliminary information statement for New Aetna contained
in the Aetna proxy statement filed with the Securities and Exchange Commission
on October 18, 2000. Those risk factors are incorporated by reference herein.
For information regarding risk factors relating to the Aetna Financial Services
and Aetna International businesses, please refer to Aetna's 1999 Annual Report
on Form 10-K.
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 60
<PAGE> 61
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 was completed in the third quarter of 2000. Trial was scheduled
to begin in the fourth quarter of 2000. On October 5, 2000, the Court entered an
order granting preliminary approval to a settlement of the action. Under the
terms of the settlement, which does not involve any admission of wrongdoing, the
Company and its insurance carriers will pay a total of approximately $83 million
into a settlement fund, which will be used to pay claims submitted by members of
the class certified by the Court and to pay fees of the plaintiffs' attorneys. A
substantial portion of the settlement is covered by insurance, but the Company's
earnings for the three and nine months ended September 30, 2000, reflect an
after-tax charge of approximately $5 million to cover its share of the
settlement. The agreement is subject to final court approval. The Court has
scheduled a hearing for December 18, 2000, concerning, among other things,
whether it will grant final approval to the settlement.
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. On July 26, 2000, the Connecticut court ordered consolidation of the four
Connecticut actions. On October 12, 2000 the plaintiffs in the four Connecticut
actions withdrew their complaints. A fifth, substantially similar complaint was
filed by Barnett Stepak on behalf of a purported class of Aetna Inc.
shareholders on March 28, 2000 in the Supreme Court of New York, New York
County. The complaint in the New York action seeks various forms of relief,
including unspecified damages and equitable remedies. The New York litigation is
in the preliminary stages. Defendants intend to defend the action vigorously.
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Item 1. Legal Proceedings. (Continued)
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. On August 11, 2000, the Third Circuit
rendered its decision upholding the dismissal of the case.
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. ("Aetna U.S.
Healthcare") 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. Aetna U.S. Healthcare has supplemented its pending motion to
dismiss to address the application of the Maio decision to this case. On October
23, 2000, this case was consolidated in the United States District Court for the
Southern District of Florida (the "Florida District Court") for pre-trial
proceedings as described below in the discussion concerning the Company's MDL
Application.
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, 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. On October 23, 2000,
this case was consolidated in the Florida District Court for pre-trial
proceedings as described below in the discussion concerning the Company's MDL
Application. This litigation is in the preliminary stages. Defendants intend to
defend the action vigorously.
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Item 1. Legal Proceedings. (Continued)
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,
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. In August 2000,
the Court stayed further proceedings pending decision on the Company's MDL
Application (as described below). On October 23, 2000, this case was
consolidated in the Florida District Court for pre-trial proceedings as
described below in the discussion concerning the Company's MDL Application. 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,
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 plaintiffs to file
an amended complaint. The amended complaint was filed on May 15, 2000 and a
second amended complaint on June 28, 2000. On August 15, the Court denied
defendants' demurer but granted, in part, their motion to strike portions of
the second amended complaint and ordered the plaintiffs to file a third amended
complaint. The third amended complaint was filed on August 25, 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 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.
Prudential had requested the MDL Panel (as defined below) to consolidate this
case with other cases against Prudential for pretrial purposes. On October 23,
2000, this case was consolidated in the Florida District Court for pretrial
proceedings. This litigation is in the preliminary stages. The Company intends
to defend the action vigorously.
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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 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 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. On August 25, 2000, the Company moved to
dismiss the action for failure to state a claim. The Company has supplemented
its pending motion to dismiss to address the application of the Maio decision to
this case. On October 23, 2000, this case was consolidated in the Florida
District Court for pre-trial proceedings as described below in the discussion
concerning the Company's MDL Application. 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 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, but on July 14, 2000,
the Company requested consolidation of that action with others pending against
the Company. On October 23, 2000, this case was consolidated in the Florida
District Court for pre-trial proceedings as described below in the discussion
concerning the Company's MDL Application. This litigation is in the preliminary
stages. Defendants intend 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 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.
On August 30, 2000, the Company joined in Prudential's motion to dismiss the
complaint for failure to state a claim. Prudential had requested the MDL Panel
to consolidate this case with other cases against Prudential for pretrial
purposes. On October 23, 2000, this case was consolidated in the Florida
District Court for pretrial proceedings. This litigation is in the preliminary
stages. The Company intends to defend the action vigorously.
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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 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. On July 24, 2000, the
Court stayed the action. Prudential had requested the MDL Panel to consolidate
this case with other cases against Prudential for pretrial purposes. On October
23, 2000, this case was consolidated in the Florida District Court for pretrial
proceedings. 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 (the "MDL Panel") 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). Hearing on the MDL Application took place
on September 22, 2000. On October 23, 2000, the MDL Panel consolidated all the
cases the Company had before the MDL Panel for pre-trial proceedings in the
Florida District Court. Similar cases against other managed care companies also
were, and additional similar cases against the Company may be, consolidated in
the Florida District Court for pre-trial proceedings.
A purported class action was filed in the Florida District Court 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 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. On August 11, 2000, the Company filed a motion to dismiss
the Florida O'Neill Complaint. Briefing on that motion was completed in early
September 2000. Additionally, the Court has scheduled briefing on plaintiffs'
class certification motion to be completed by November 2000. On October 23,
2000, this case was consolidated in the Florida District Court for pre-trial
proceedings as described above. This litigation is in the preliminary stages.
Defendants intend to defend the action vigorously.
A purported class action complaint was filed in the United States District Court
for the District of Connecticut on August 7, 2000 by Glenn O'Brien and
Christopher Gallagher (the "O'Brien Complaint"). The O'Brien Complaint seeks
various forms of relief, including unspecified damages, from Aetna U.S.
Healthcare for alleged violations of ERISA. The O'Brien Complaint alleges that
Aetna U.S. Healthcare does not make adequate disclosure of the operation of its
managed care plans to actual or prospective members. Aetna U.S. Healthcare
intends to defend the action vigorously. Aetna U.S. Healthcare has notified the
Judicial Panel on Multidistrict Litigation of the O'Brien Complaint for
consolidation with the other matters referred to in the MDL Application.
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Item 1. Legal Proceedings. (Continued)
A purported class action complaint was filed in the United States District Court
for the District of Connecticut on September 7, 2000 against Aetna U.S.
Healthcare by Douglas Chapman (the "Chapman Complaint"). The Chapman Complaint
seeks various forms of relief, including unspecified damages, from Aetna U.S.
Healthcare for alleged violations of ERISA. The Chapman Complaint is brought on
behalf of participants in Aetna U.S. Healthcare's PPO, indemnity and third-party
payor plans and relates to the disclosure and determination of usual, customary
and reasonable charges for claims. This litigation is in the preliminary stages,
and the Company intends to defend the action vigorously.
A purported class action complaint was filed in the Florida District Court on
August 11, 2000 by Charles B. Shane, M.D., Edward L. Davis, D.O., et al. (the
"Shane Complaint") against Aetna U.S. Healthcare and other health insurance
company defendants. The Shane Complaint seeks various forms of relief, including
unspecified damages, from defendants for alleged violations of RICO, ERISA and
various state law claims. The Shane Complaint is brought on behalf of a
purported nationwide class of participating physicians against defendants for
alleged inadequate disclosure of reimbursement practices and inadequate and
untimely payment of claims. The Company intends to defend the action vigorously.
Aetna U.S. Healthcare has filed a motion to dismiss the complaint. Aetna U.S.
Healthcare is scheduled to complete class certification briefing in November
2000. Aetna U.S. Healthcare notified the Judicial Panel on Multidistrict
Litigation of the Shane Complaint for consolidation with the other matters
referred to in the MDL Application. On October 23, 2000, this case was
consolidated in the Florida District Court for pre-trial proceedings as
described above.
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. On August 31, 2000, the Court entered an order and judgement
dismissing the case.
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. The Company has moved to
dismiss the Reese Complaint for failure to state a claim upon which relief can
be granted. This litigation is in the preliminary stages. The Company intends to
defend the action vigorously.
Page 66
<PAGE> 67
Item 1. Legal Proceedings. (Continued)
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 care 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 ultimate 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 67
<PAGE> 68
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>
Nine Months Ended
September 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 3.62 4.11 4.96 5.74 2.45 4.97
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.62 3.63 3.94 4.46 2.10 4.97
------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended
September 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 3.98 3.61 4.31 5.78 2.44
Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends 3.98 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 nine 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 68
<PAGE> 69
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)**
August 3, 2000 * A A3 A
October 31, 2000 (1) * A A3 A
Aetna Services, Inc. (commercial paper)**
August 3, 2000 * F-1 P-2 A-1
October 31, 2000 (1) * F-1 P-2 A-1
Aetna Life Insurance Company (claims paying/financial strength)
August 3, 2000 A AA- A1 A+
October 31, 2000 (1) A AA- A1 A+
Aetna Life Insurance and Annuity Company
(claims paying/financial strength)
August 3, 2000 A AA Aa3 AA-
October 31, 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 and Poor's has placed the long-term credit ratings
and the ALIAC rating on CreditWatch positive. Standard and 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 69
<PAGE> 70
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(10) Material Contracts
10.1 Letter Agreement dated April 28, 1999 between Aetna Inc. and L. Edward
Shaw, Jr., incorporated herein by reference to Exhibit 10.20 to Aetna
U.S. Healthcare Inc.'s Amendment No. 1 to Registration Statement on
Form 10 filed on October 18, 2000.*
10.2 Restrictive Covenant Agreement dated April 28, 1999 between Aetna Inc.
and L. Edward Shaw, Jr., incorporated herein by reference to Exhibit
10.21 to Aetna U.S. Healthcare Inc.'s Amendment No. 1 to Registration
Statement on Form 10 filed on October 18, 2000.*
10.3 Memorandum Agreement dated September 6, 2000 between Aetna Inc. and
Alan J. Weber, incorporated herein by reference to Exhibit 10.22 to
Aetna U.S. Healthcare Inc.'s Amendment No. 1 to Registration Statement
on Form 10 filed on October 18, 2000.*
10.4 Employment Agreement dated September 6, 2000 by and between Aetna Inc.
and John W. Rowe, M.D., incorporated herein by reference to Exhibit
10.23 to Aetna U.S. Healthcare Inc.'s Amendment No. 1 to Registration
Statement on Form 10 filed on October 18, 2000.*
(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 nine months ended September 30, 2000 and for the
years ended December 31, 1999, 1998, 1997, 1996 and 1995 for Aetna
Inc. and for the nine months ended September 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 October 31, 2000.
(27) Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
Page 70
<PAGE> 71
Item 6. Exhibits and Reports on Form 8-K. (Continued)
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on July 18, 2000 related to an
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 an
announcement that the Company had reached a definitive agreement to sell
its financial services and international businesses to ING Groep, N.V.
The Company filed a report on Form 8-K on September 1, 2000 related to
Aetna U.S. Healthcare Inc.'s filing with the Securities and Exchange
Commission of a Registration Statement on Form 10.
The Company filed a report on Form 8-K on September 6, 2000 related to John
W. Rowe, M.D. becoming President and Chief Executive Officer of Aetna U.S.
Healthcare Inc. and a member of the Aetna Inc. and Aetna U.S. Healthcare
Inc. boards of directors.
The Company filed a report on Form 8-K on November 1, 2000 announcing that
on October 31, 2000 Aetna Services, Inc., a wholly-owned subsidiary of
Aetna Inc., was merged with and into Aetna Inc., with Aetna Inc. being the
surviving entity.
Page 71
<PAGE> 72
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 November 1, 2000 By /s/ Alan M. Bennett
---------------------------------------
Alan M. Bennett
Vice President
and Corporate Controller
(Chief Accounting Officer)
Page 72
<PAGE> 73
AETNA INC.
EXHIBIT INDEX
======================================================
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(10) Material Contracts
10.1 Letter Agreement dated April 28, 1999 between Aetna Inc. and
L. Edward Shaw, Jr., incorporated herein by reference to
Exhibit 10.20 to Aetna U.S. Healthcare Inc.'s Amendment No. 1
to Registration Statement on Form 10 filed on October 18,
2000.*
10.2 Restrictive Covenant Agreement dated April 28, 1999 between
Aetna Inc. and L. Edward Shaw, Jr., incorporated herein by
reference to Exhibit 10.21 to Aetna U.S. Healthcare Inc.'s
Amendment No. 1 to Registration Statement on Form 10 filed on
October 18, 2000.*
10.3 Memorandum Agreement dated September 6, 2000 between Aetna
Inc. and Alan J. Weber, incorporated herein by reference to
Exhibit 10.22 to Aetna U.S. Healthcare Inc.'s Amendment No. 1
to Registration Statement on Form 10 filed on October 18,
2000.*
10.4 Employment Agreement dated September 6, 2000 by and between
Aetna Inc. and John W. Rowe, M.D., incorporated herein by
reference to Exhibit 10.23 to Aetna U.S. Healthcare Inc.'s
Amendment No. 1 to Registration Statement on Form 10 filed on
October 18, 2000.*
(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 nine months ended September
30, 2000 and for the years ended December 31, 1999, 1998,
1997, 1996 and 1995 for Aetna Inc. and for the nine months
ended September 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
October 31, 2000.
(27) Financial Data Schedule.
* Management contract or compensatory plan or arrangement.
Page 73
