CIGNA 3-04 10Q/A

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A
(Amendment No. 1)

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

For the quarterly period ended March 31, 2004

OR

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

for the transition period from _____ to _____

Commission file number 1-8323

CIGNA Corporation
(Exact name of registrant as specified in its charter)
   
Delaware 
06-1059331 
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)

One Liberty Place, 1650 Market Street
Philadelphia, Pennsylvania 19192
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (215) 761-1000

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 Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No _

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No _ 

As of March 31, 2004, 141,403,654 shares of the issuer's common stock were outstanding.


Explanatory Note

CIGNA is filing this Amendment to Form 10-Q to reflect the restatement of its financial statements of its unaudited consolidated financial statements for the periods covered by this report. Please see Note 3 to the Financial Statements for specific information related to the restatement.

CIGNA historically accounted for stock option grants as fixed awards under Accounting Principles Board (APB) No. 25 and disclosed in the footnotes to the financial statements the expense based on the fair value of stock options pursuant to Statement of Financial Accounting Standards (SFAS) No. 123. While reviewing changes to its equity compensation plans and during the normal 2004 year-end closing process, CIGNA determined that certain stock option grants under these plans required variable rather than fixed accounting treatment under APB No. 25. Variable accounting should have been used because participants were permitted to elect to pay the option exercise price using restricted stock. As a result, CIGNA determined on February 7, 2005 the need to restate its financial statements included in the Form 10-K for the year ended December 31, 2003 and in each of the Form 10-Q filings for the three quarters ended September 30, 2004. CIGNA's management and the Audit Committee of CIGNA's Board of Directors discussed the restatement with CIGNA's independent registered public accounting firm.

This amended Form 10-Q/A does not attempt to modify or update any other disclosures set forth in the original Form 10-Q, except as required to reflect the effects of the restatement as described in Note 3 to the Financial Statements included in the amended Form 10-Q/A. Additionally, this amended Form 10-Q/A does not purport to provide a general update or discussion of any other developments at CIGNA after the date of the original filing. All information contained in this amended Form 10-Q/A and the original Form 10-Q is subject to updating and supplementing as provided in the periodic reports that CIGNA has filed and will file after the original filing date with the Securities and Exchange Commission. In addition, the filing of this amended Form 10-Q/A shall not be deemed an admission that the original filing, when made, included any untrue statement of material fact or omitted to state a material fact necessary to make a statement made therein not misleading. This amended Form 10-Q/A does not include the items from the original Form 10-Q that are not being amended.

Financial information included in reports on Form 10-K, Form 10-Q and Form 8-K (except the Form 8-K with the date of earliest event reported February 7, 2005) previously filed by CIGNA should not be relied upon and are superseded by the information in this Quarterly Report on Form 10-Q/A. CIGNA will also file amended quarterly reports on Form 10-Q/A for each of the second and third quarters of 2004 and an amended annual report on Form 10-K/A for the year ended December 31, 2003.

2


CIGNA CORPORATION

INDEX

The following Items of the original filing on Form 10-Q are amended as indicated by this Amendment on Form 10-Q/A:

   
Page No
PART I.
FINANCIAL INFORMATION
  
     
 
Item 1. Financial Statements
4
     
 
Consolidated Income Statements
5
 
Consolidated Balance Sheets
6
 
Consolidated Statements of Comprehensive
  
 
     Income and Changes in Shareholders' Equity
7
 
Consolidated Statements of Cash Flows
8
 
Notes to the Financial Statements
9
     
 
Item 2. Management's Discussion and Analysis
  
 
     of Financial Condition and Results of Operations
26
     
 
Item 4. Controls and Procedures
58
     
PART II.
OTHER INFORMATION
58
     
 
Item 6. Exhibits and Reports on Form 8-K
58
     
SIGNATURE
  
59
     
EXHIBIT INDEX
E-1


As used herein, CIGNA refers to one or more of CIGNA Corporation and its consolidated subsidiaries.



3

Part I. FINANCIAL INFORMATION


Please note that the information contained in this Amendment, including the Consolidated Financial Statements and the Notes to the Financial Statements, does not reflect events occurring after the date of the original filing. Such events include, among others, the events described in our quarterly reports on Form 10-Q for the periods ended June 30, 2004 and September 30, 2004 and the events subsequently described in our current reports on Form 8-K. For a description of these events, please read our Exchange Act reports filed since the filing of the Original Form 10-Q.

Item 1. Financial Statements



4

CIGNA CORPORATION
          
CONSOLIDATED STATEMENTS OF INCOME
          
(In millions, except per share amounts)
          
   
 Three Months Ended  
  
   
 March 31,
  
 
  
2004
  
2003
  
   
 (As Restated, See Note 3)
  
REVENUES
          
Premiums and fees
  
$
3,624
  
$
3,915
  
Net investment income
    
603
   
658
 
Other revenues
    
474
   
358
 
Realized investment gains (losses)
    
21
   
(31
)
    Total revenues
    
4,722
   
4,900
 
               
BENEFITS, LOSSES AND EXPENSES
              
Benefits, losses and settlement expenses
    
2,964
   
3,249
 
Policy acquisition expenses
    
64
   
59
 
Other operating expenses
    
1,375
   
1,311
 
    Total benefits, losses and expenses
    
4,403
   
4,619
 
               
INCOME FROM CONTINUING OPERATIONS
             
BEFORE INCOME TAXES
    
319
   
281
 
               
Income taxes (benefits):
              
     Current
    
142
   
(71
)
     Deferred
    
(35
)
  
165
 
    Total taxes
    
107
   
94
 
               
INCOME FROM CONTINUING OPERATIONS
    
212
   
187
 
               
INCOME FROM DISCONTINUED OPERATIONS
    
-
   
48
 
               
INCOME BEFORE CUMULATIVE EFFECT
             
OF ACCOUNTING CHANGE
    
212
   
235
 
               
CUMULATIVE EFFECT OF ACCOUNTING CHANGE,
              
NET OF TAXES
    
(139
)
  
-
 
               
NET INCOME
  
$
73
  
$
235
  
               
               
EARNINGS PER SHARE - BASIC
             
               
INCOME FROM CONTINUING OPERATIONS
  
$
1.51
  
$
1.34
  
INCOME FROM DISCONTINUED OPERATIONS
    
-
   
0.34
 
               
INCOME BEFORE CUMULATIVE EFFECT
             
OF ACCOUNTING CHANGE
    
1.51
   
1.68
 
               
CUMULATIVE EFFECT OF ACCOUNTING CHANGE,
              
NET OF TAXES
    
(0.99
)
  
-
 
               
NET INCOME
  
$
0.52
  
$
1.68
  
               
EARNINGS PER SHARE - DILUTED
             
               
INCOME FROM CONTINUING OPERATIONS
  
$
1.50
  
$
1.34
  
INCOME FROM DISCONTINUED OPERATIONS
    
-
   
0.34
 
               
INCOME BEFORE CUMULATIVE EFFECT
              
OF ACCOUNTING CHANGE
    
1.50
   
1.68
 
               
CUMULATIVE EFFECT OF ACCOUNTING CHANGE,
              
NET OF TAXES
    
(0.98
)
  
-
 
               
NET INCOME
  
$
0.52
  
$
1.68
  
               
               
DIVIDENDS DECLARED PER SHARE
  
$
0.33
  
$
0.33
  
               
The accompanying Notes to the Financial Statements are an integral part of these statements.
5

 
CIGNA CORPORATION
                   
CONSOLIDATED BALANCE SHEETS
                   
(In millions, except per share amounts)
                   
       
As of
       
As of
  
       
March 31,
       
December 31,
  
       
2004
       
2003
  
         (As Restated, See Note 3)     
ASSETS
                   
Investments:
                   
     Fixed maturities, at fair value (amortized cost, $16,754; $15,772)
        
$
18,249
        
$
17,121
  
     Securities supporting experience-rated pension policyholder
                          
     contracts, at fair value (cost, $9,810 and $10,558)
          
10,582
         
11,222
 
     Equity securities, at fair value (cost, $121; $47)
          
164
         
78
 
     Mortgage loans
          
8,563
         
8,655
 
     Policy loans
          
1,555
         
1,572
 
     Real estate
          
245
         
146
 
     Other long-term investments
          
453
         
717
 
     Short-term investments
          
116
         
147
 
          Total investments
          
39,927
         
39,658
 
Cash and cash equivalents
          
1,491
         
1,392
 
Accrued investment income
          
507
         
468
 
Premiums, accounts and notes receivable
          
2,710
         
3,026
 
Reinsurance recoverables
          
6,289
         
6,395
 
Deferred policy acquisition costs
          
612
         
580
 
Property and equipment
          
936
         
973
 
Deferred income taxes
          
1,119
         
1,040
 
Goodwill
         
1,620
         
1,620
 
Other assets, including other intangibles
         
427
         
447
 
Separate account assets
          
37,194
         
35,393
 
                           
          Total assets
        
$
92,832
        
$
90,992
  
                           
LIABILITIES
                          
Contractholder deposit funds
        
$
26,837
        
$
26,979
  
Unpaid claims and claim expenses
          
4,461
         
4,708
 
Future policy benefits
          
11,550
         
11,545
 
Unearned premiums
          
327
         
326
 
          Total insurance and contractholder liabilities
          
43,175
         
43,558
 
Accounts payable, accrued expenses and other liabilities
          
6,181
         
5,960
 
Long-term debt
          
1,513
         
1,500
 
Nonrecourse obligations
          
101
         
23
 
Separate account liabilities
          
37,194
         
35,393
 
          Total liabilities
          
88,164
         
86,434
 
           
         
 
CONTINGENCIES - NOTE 13
                          
                           
SHAREHOLDERS' EQUITY
                          
Common stock (par value per share, $0.25; shares issued, 276; 275)
          
69
         
69
 
Additional paid-in capital
          
3,646
         
3,597
 
Net unrealized appreciation, fixed maturities
  
$
763
        
$
610
        
Net unrealized appreciation, equity securities
    
28
         
29
       
Net unrealized depreciation, derivatives
    
(5
)
        
(12
)
      
Net translation of foreign currencies
    
(5
)
        
(14
)
      
Minimum pension liability adjustment
    
(780
)
        
(667
)
      
     Accumulated other comprehensive income (loss)
         
1
         
(54
)
Retained earnings
          
9,529
         
9,503
 
Less treasury stock, at cost
          
(8,577
)
        
(8,557
)
          Total shareholders' equity
          
4,668
         
4,558
 
                           
          Total liabilities and shareholders' equity
        
$
92,832
        
$
90,992
  
                           
SHAREHOLDERS' EQUITY PER SHARE
        
$
33.01
        
$
32.42
  
                           
The accompanying Notes to the Financial Statements are an integral part of these statements.
                    

 
6
 

CIGNA CORPORATION
                            
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND CHANGES IN
                        
      SHAREHOLDERS' EQUITY
                            
(In millions)
                            
                             
Three Months Ended March 31,
  
2004   
  
 2003
 
   
Compre-
hensive
Income
      
 Share-
holders'
 Equity
  
 Compre-
hensive
Income
      
Share-
holders'
Equity
  
     (As Restated, See Note 3)       (As Restated, See Note 3)  
Common stock
              
$
69
              
$
68
  
                                       
Additional paid-in capital, January 1
                
3,597
               
3,503
 
   Issuance of common stock for employee benefits plans
                
49
               
30
 
Additional paid-in capital, March 31
                
3,646
               
3,533
 
                                       
Accumulated other comprehensive loss, January 1
                
(54
)
              
(202
)
   Net unrealized appreciation, fixed maturities
  
$
153
          
153
 
$
68
          
68
 
   Net unrealized depreciation, equity securities
    
(1
)
        
(1
)
  
(3
)
        
(3
)
      Net unrealized appreciation on securities
    
152
               
65
             
Net unrealized appreciation (depreciation), derivatives
    
7
         
7
   
(2
)
        
(2
)
Net translation of foreign currencies
    
9
         
9
   
14
         
14
 
Minimum pension liability adjustment
   
(113
)
        
(113
)
  
-
         
-
 
      Other comprehensive income
    
55
               
77
             
Accumulated other comprehensive income (loss), March 31
                
1
               
(125
)
                                       
Retained earnings, January 1
                
9,503
               
9,038
 
   Net income
   
73
         
73
   
235
         
235
 
   Common dividends declared
                
(47
)
              
(46
)
Retained earnings, March 31
                
9,529
               
9,227
 
                                       
Treasury stock, January 1
                
(8,557
)
              
(8,510
)
   Other treasury stock transactions, net
                
(20
)
              
(28
)
Treasury stock, March 31
                
(8,577
)
              
(8,538
)
TOTAL COMPREHENSIVE INCOME AND SHAREHOLDERS' EQUITY
  
$
128
        
$
4,668
  
$
312
        
$
4,165
  
                                       
The accompanying Notes to the Financial Statements are an integral part of these statements.
                               
 
7
 
CIGNA CORPORATION
              
CONSOLIDATED STATEMENTS OF CASH FLOWS
              
(In millions)
              
               
   
Three Months Ended March 31,
  
   
2004
      
2003
  
   
 (As Restated, See Note 3)
  
CASH FLOWS FROM OPERATING ACTIVITIES
              
Income from continuing operations
  
$
212
        
$
187
  
Adjustments to reconcile income from continuing operations
                   
   to net cash provided by operating activities:
                    
    Insurance liabilities
    
(380
)
        
(63
)
    Reinsurance recoverables
    
95
         
59
 
    Deferred policy acquisition costs
    
(27
)
        
(19
)
    Premiums, accounts and notes receivable
    
294
         
(16
)
    Accounts payable, accrued expenses and other liabilities
    
(78
)
        
(6
)
    Current income taxes
    
174
         
227
 
    Deferred income taxes
    
(35
)
        
165
 
    Realized investment (gains) losses
   
(21
)
        
31
 
    Depreciation and amortization
    
62
         
63
 
    Gains on sales of businesses (excluding discontinued operations)
   
(14
)
        
(17
)
    Proceeds from sales and maturities of securities supporting
                   
       experience-rated pension policyholder contracts,
                    
       net of purchases
    
782
         
-
 
    Other, net
    
9
         
(59
)
         Net cash provided by operating activities of continuing operations
   
1,073
         
552
 
                     
CASH FLOWS FROM INVESTING ACTIVITIES
                    
Proceeds from investments sold:
                   
    Fixed maturities
   
650
         
1,616
 
    Equity securities
    
3
         
7
 
    Mortgage loans
    
64
         
319
 
    Other (primarily short-term investments)
    
1,338
         
1,198
 
Investment maturities and repayments:
                    
    Fixed maturities
   
187
         
683
 
    Mortgage loans
    
361
         
217
 
Investments purchased:
                    
    Fixed maturities
   
(1,482
)
        
(2,258
)
    Equity securities
    
(6
)
        
(26
)
    Mortgage loans
    
(331
)
        
(498
)
    Other (primarily short-term investments)
    
(1,277
)
        
(1,027
)
Proceeds on sales of businesses
    
-
         
209
 
Property and equipment, net
    
(18
)
        
(26
)
Other, net
    
(4
)
        
-
 
    Net cash provided by (used in) investing activities of
                   
       continuing operations
    
(515
)
        
414
 
                     
CASH FLOWS FROM FINANCING ACTIVITIES
                    
    Deposits and interest credited to contractholder deposit funds
    
1,677
         
1,679
 
    Withdrawals and benefit payments from contractholder deposit funds
    
(2,108
)
        
(1,993
)
    Net change in short-term debt
    
-
         
(3
)
    Repayment of long-term debt
    
-
         
(117
)
    Issuance of common stock
    
19
         
-
 
    Common dividends paid
    
(47
)
        
(46
)
        Net cash used in financing activities of continuing operations
   
(459
)
        
(480
)
                     
Net increase in cash and cash equivalents
    
99
         
486
 
Cash and cash equivalents, beginning of period
    
1,392
         
1,575
 
                     
Cash and cash equivalents, end of period
  
$
1,491
        
$
2,061
  
                     
Supplemental Disclosure of Cash Information:
                    
    Income taxes received, net
 
$
(32
)
      
$
(300
)
    Interest paid
  
$
24
        
$
28
  
                     
The accompanying Notes to the Financial Statements are an integral part of these statements.
                    
 
8

CIGNA CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The consolidated financial statements include the accounts of CIGNA Corporation, its significant subsidiaries, and variable interest entities of which CIGNA is the primary beneficiary, which are referred to collectively as “CIGNA.” Intercompany transactions and accounts have been eliminated in consolidation. These consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States.
 
The interim financial statements are unaudited but include all adjustments (including normal recurring adjustments) necessary, in the opinion of management, for a fair statement of financial position and results of operations for the period reported. The interim consolidated financial statements and notes should be read in conjunction with the Consolidated Financial Statements and Notes in CIGNA’s 2003 Annual Report to Shareholders and Form 10-K and as further amended on the Form 10-K/A filed for the year ended 2003.

The preparation of interim financial statements necessarily relies heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the insurance business as well as competitive and other market conditions, call for caution in estimating full year results based on interim results of operations.

Certain reclassifications have been made to prior period amounts to conform to the 2004 presentation.
 
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS

Derivative Instruments. In April 2003, the Financial Accounting Standards Board (FASB) issued an amendment and finalized an implementation issue related to Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). Implementation of the SFAS 133 amendment and the implementation issue in the third quarter of 2003 had no material effect on CIGNA’s financial statements.

The implementation issue and a Statement of Position issued in 2003 (described below) address accounting for liabilities that provide contractholders with returns based on pools of investments, and each permits a one-time accounting reclassification of associated investment securities from available-for-sale to trading. In the fourth quarter of 2003, CIGNA reclassified securities supporting experience-rated pension policyholder contracts associated with its retirement benefits business to trading, and now reports these securities in a separate balance sheet caption. Under the experience-rating process, unrealized gains and losses recognized for these securities accrue to policyholders. Accordingly, the reclassification did not affect CIGNA's net income.

Long-Duration Contracts. Effective January 1, 2004, CIGNA implemented a Statement of Position (SOP 03-01), “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.”

9


The SOP addresses accounting for certain contractual features of investment-related and universal life contracts and for separate accounts. The cumulative effect of implementing the SOP in the first quarter of 2004 was a reduction to net income of $139 million, of which $136 million resulted from recording liabilities for certain experience-rated pension policyholder contracts based on the appreciated value of associated pools of investments, primarily mortgage loans and real estate. The remaining cumulative effect resulted from implementing the SOP’s requirements applicable to universal life contracts. CIGNA recorded additional benefit expense of $17 million pre-tax in the first quarter of 2004 to reflect the ongoing effect of the SOP’s accounting requirements described above.

The sale of CIGNA's retirement benefits business generally resulted in the transfer of the pool of investments and securities supporting experience-rated pension policyholder contracts discussed above. See Note 4 for information about this sale.

CIGNA’s accounting for reinsurance of guaranteed minimum death benefit contracts and guaranteed minimum income benefit contracts was not affected by the provisions of the SOP.
 
Consolidation. On March 31, 2004, CIGNA implemented FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as revised, that provides criteria for consolidating certain entities based on majority ownership of expected losses or residual returns. As a result, CIGNA recorded additional assets and liabilities, primarily associated with real estate joint ventures, of $98 million each, including $83 million of nonrecourse liabilities. Including the newly consolidated entities, CIGNA has recorded real estate joint venture assets of $165 million and liabilities of $98 million as follows: $13 million of variable rate debt due by 2008; $79 million of nonrecourse obligations; and $6 million of other liabilities.

At March 31, 2004, CIGNA also consolidated amounts associated with certain variable interest entities that issue investment products secured by commercial loan pools. CIGNA has recorded investments of $216 million and nonrecourse liabilities of $38 million as follows: $22 million of nonrecourse obligations and $16 million of other nonrecourse liabilities.

At December 31, 2003, CIGNA had recorded variable interest entities as follows: real estate joint ventures with assets of $20 million and nonrecourse liabilities of $5 million and, for entities that issue investment products secured by commercial loan pools, assets of $215 million and nonrecourse liabilities of $40 million, including $23 million of nonrecourse obligations.

NOTE 3 - RESTATEMENT - STOCK COMPENSATION

Restatement. During a review of CIGNA’s equity compensation plans it was determined that certain stock option grants under these plans required variable accounting rather than fixed accounting treatment under Accounting Principles Board (APB) No. 25. CIGNA previously accounted for these stock option grants as fixed awards under APB No. 25. Variable accounting should have been used because participants were permitted to elect to pay the option exercise price using restricted stock. As a result, CIGNA recorded additional stock-based compensation under the variable method of accounting and associated income tax adjustments.

10

A summary of the significant effects of restatement is as follows:
           
Three Months Ended
   March 31
  
2004
  
2003
  
(In millions)
  
As
Reported
  
As
Restated
  
As
Reported
  
As
Restated
  
Other Operating Expenses
    $
1,367
    $
1,375
    $
1,310
    $
1,311
  
Income from
   Continuing Operations
    $
217
    $
212
    $
188
    $
187
  
Net Income
    $
78
    $
73
    $
236
    $
235
  
Income from
   Continuing Operations
   per share
                          
     Basic
    $
1.55
    $
1.51
    $
1.35
    $
1.34
  
     Diluted
    $
1.54
    $
1.50
    $
1.34
    $
1.34
  
Net Income per share
                          
     Basic
    $
0.56
    $
0.52
    $
1.69
    $
1.68
  
     Diluted
    $
0.55
    $
0.52
    $
1.68
    $
1.68
  
 
           
   
As of
March 31, 2004
  
As of
December 31, 2003
  
(In millions)
  
As Reported
  
As Restated
  
As
Reported
  
As
Restated
  
Deferred Tax Asset
  
$
1,079
  
$
1,119
  
$
1,001
  
$
1,040
  
Shareholders’ Equity
  
$
4,628
  
$
4,668
  
$
4,519
  
$
4,558
  

Stock compensation. CIGNA uses the intrinsic value method of accounting for stock options granted to employees. The following table illustrates the effect on CIGNA’s reported net income and earnings per share (using the Black-Scholes option-pricing model for stock options) if compensation expense was based on the fair value method of accounting for all stock awards.
       
   
Three Months Ended
March 31,
  
(In millions, except per share amounts)
  
2004
  
2003
  
   
(As Restated)
  
Net income as reported
  
$
73
  
$
235
  
Compensation expense for restricted
   stock grants, net of taxes,
   included in net income as reported
   
4
    
4
  
Compensation expense for stock options, net of
   taxes, included in net income as reported
    
5
    
1
  
Total compensation expense for stock
   options and restricted stock grants
   under fair value method for all
   awards, net of taxes
   
(14
)
  
(13
)
Pro forma net income
  
$
68
  
$
227
  
Basic - as reported
  
$
0.52
  
$
1.68
  
Basic - pro forma
  
$
0.49
  
$
1.63
  
Diluted - as reported   $ 0.52   $ 1.68  
Diluted - pro forma
   $ 0.48   $ 1.62  
 
NOTE 4 - ACQUISITIONS AND DISPOSITIONS

CIGNA may from time to time acquire or dispose of assets, subsidiaries or lines of business. Significant transactions are described below.

 
11

Sale of Retirement Benefits Business. On April 1, 2004, CIGNA sold its retirement benefits business, excluding the corporate life insurance business, for cash proceeds of $2.1 billion. The sale is expected to result in an estimated after-tax gain of approximately $675 million, part of which will be recognized in the second quarter of 2004. As this transaction is primarily in the form of a reinsurance arrangement, approximately $475 million of the after-tax gain will be deferred and amortized over future periods and reported in results of continuing operations. These amounts are subject to change pending final determination of the net assets sold, transaction costs and other adjustments.

The sale included reinsurance of approximately $50 billion of liabilities. As a result of derivatives accounting requirements, a portion of the reinsurance liabilities may be adjusted through net income for unrealized changes in the fair value of the related investment portfolio through 2006. The resulting volatility may be material to CIGNA's consolidated net income and shareholders’ equity.

Sale of Lovelace Health Systems, Inc. In January 2003, CIGNA sold the operations of Lovelace, an integrated health care system, for cash proceeds of $209 million and recognized an after-tax gain of $32 million, which is reported in discontinued operations.

Sale of Brazilian Health Care Operations. In January 2003, CIGNA sold its Brazilian health care operations. The sale generated an after-tax gain of $18 million, primarily as a result of the disposition of the net liabilities associated with these operations. The gain is reported in discontinued operations.

Lovelace and Brazilian Health Care Discontinued Operations. Summarized financial data for discontinued operations (which includes Lovelace and the gain on the sale of the Brazilian health care operations) are outlined below:
     
FINANCIAL SUMMARY
 
(In millions)
 
          Three Months Ended
March 31, 2003
Income Statement Data
        
Revenues
    
$—
Loss before income tax benefits
   
$(3)
Income tax benefits
    
(1)
Loss from operations
    
(2)
Gains on sales, net of taxes
   of $25
    
50
Income from discontinued operations
    
$48
 
12

NOTE 5 - RESTRUCTURING PROGRAMS
 
Operational effectiveness review. In the first quarter of 2004, CIGNA adopted a restructuring program associated with planned organizational changes to streamline functional support resources and to adjust its operations to current business volumes. As a result, CIGNA recognized in other operating expenses a total after-tax charge of $49 million ($75 million pre-tax) in the Health Care segment and Corporate primarily for severance costs.

The table below shows CIGNA’s restructuring activity (pre-tax) related to severance and real estate for this program:
 
               
(In millions)
  
Health Care
  
Corporate
  
Total
  
First quarter 2004 charge:
              
   Severance
  
$
39
  
$
31
  
$
70
  
   Real estate and other
    
5
    
—
    
5
  
     Total
    
44
    
31
    
75
  
First quarter 2004 activity:
                    
   Severance
    
(2
)
  
(4
)
  
(6
)
Balance as of March 31, 2004
  
$
42
  
$
27
  
$
69
  

Corporate effectiveness initiative. In the second quarter of 2003, CIGNA adopted a restructuring program to attain certain operational efficiencies in its corporate staff functions and to achieve additional cost savings. As a result, CIGNA recognized in other operating expenses an after-tax charge in Corporate of $9 million ($13 million pre-tax) for severance costs. As of March 31, 2004, $7 million ($11 million pre-tax) of the severance has been paid.
 
NOTE 6 - GUARANTEED MINIMUM DEATH BENEFIT AND INCOME BENEFIT CONTRACTS

CIGNA's reinsurance operations, which were discontinued in 2000 and are now an inactive business in run-off mode, reinsured a guaranteed minimum death benefit under certain variable annuities issued by other insurance companies. These variable annuities are essentially investments in mutual funds combined with a death benefit. CIGNA has equity market risks as a result of this product.

The determination of reserves for guaranteed minimum death benefits requires CIGNA to make critical accounting estimates. If actual experience differs from the assumptions and other considerations (including lapse, partial surrender, mortality, interest rates and volatility) used in estimating these reserves, the resulting change could have a material adverse effect on CIGNA’s consolidated results of operations, and in certain situations, could have a material adverse effect on CIGNA’s financial condition. CIGNA describes the assumptions used to develop the reserves for guaranteed minimum death benefits, and provides the effects of hypothetical changes in those assumptions, on page 13 of CIGNA's 2003 Annual Report to Shareholders as restated. CIGNA regularly evaluates the assumptions used in establishing reserves and changes its estimates if actual experience or other evidence suggests that earlier assumptions should be revised.
 

 

13

CIGNA is providing the following information about its reserving methodology and assumptions for guaranteed minimum death benefits in response to SOP 03-01, described in Note 2, which is effective in the first quarter of 2004.
 
·  
The reserves represent estimates of the present value of net amounts expected to be paid, less the present value of net future premiums and investment returns expected to be received. Included in net amounts expected to be paid is the excess of the guaranteed death benefits over the values of the contractholders’ accounts (based on underlying equity and bond mutual fund investments).
·  
The reserves include an estimate for partial surrenders that essentially lock in the death benefit for a particular policy based on annual election rates that vary from 0-10% depending on the net amount at risk for each policy.
·  
The mean investment performance assumption is 5% considering CIGNA's program to reduce equity market exposures using futures and forward contracts (described below).
·  
The volatility assumption is 16-31%, varying by equity fund type; 4-8%, varying by bond fund type; and 1% for money market funds.
·  
The mortality assumption is 70-75% of the 1994 Group Annuity Mortality table, with 1% annual improvement beginning January 1, 2000.
·  
The lapse rate assumption is 0-15%, depending on contract type, policy duration and the ratio of the net amount at risk to account value.
·  
The discount rate is 5.75%.

 
The table below presents the account value, net amount at risk and average attained age of underlying contractholders for guarantees in the event of death, by type of benefit as of March 31, 2004 and December 31, 2003. The net amount at risk is the death benefit coverage in force or the amount that CIGNA would have to pay if all contractholders had died as of the specified date, and represents the excess of the guaranteed benefit amount over the fair value of the underlying mutual fund investments.
 

14


 
       
   
As of
 
(Dollars in millions)
  
March 31, 2004
  
December 31, 2003
  
Highest annuity value
          
   Account value
  
$
40,523
  
$
41,497
  
   Net amount at risk
  
$
10,057
  
$
10,951
  
   Average attained age of contractholders
    
65
    
65
  
Anniversary value reset
              
   Account value
  
$
3,188
  
$
4,474
  
   Net amount at risk
  
$
278
  
$
309
  
   Average attained age of contractholders
    
59
    
59
  
Other
             
   Account value
  
$
4,472
  
$
6,530
  
   Net amount at risk
  
$
1,277
  
$
1,660
  
   Average attained age of contractholders
    
63
    
64
  
Total
              
   Account value
  
$
48,183
  
$
52,501
  
   Net amount at risk
  
$
11,612
  
$
12,920
  
   Average attained age of contractholders
      (weighted by exposure)
    
64
    
64
  
   Number of contractholders
    
1.3 million
    
1.4 million
  

CIGNA had future policy benefit reserves for these guaranteed minimum death benefit contracts of approximately $1.2 billion as of March 31, 2004 and December 31, 2003. For the three months ended March 31, 2004, benefits incurred were $12 million and benefits paid were $42 million, net of ceded amounts. For the three months ended March 31, 2003, benefits incurred and benefits paid were $89 million each, net of ceded amounts.
 
CIGNA maintains a program to substantially reduce the equity market exposures for guaranteed minimum death benefit contracts by entering into exchange-traded futures contracts and foreign currency forward contracts. CIGNA expects to adjust these futures and forward contract positions and enter into other positions over time, to reflect changing equity market levels and changes in the investment mix of the underlying variable annuity investments. CIGNA recorded in other revenues, pre-tax losses of $31 million for the first quarter of 2004 and pre-tax gains of $56 million for the first quarter of 2003 from these futures and forward contracts. Expense offsets reflecting corresponding changes in liabilities for these guaranteed minimum death benefit contracts are included in benefits, losses and settlement expenses. The notional or face amount of the futures and forward contract positions held by CIGNA at March 31, 2004, was $1.7 billion.
 
CIGNA has also written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees related to minimum income benefits. See Note 13 for further information.

15


 
NOTE 7 - PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
 
Pension benefits. CIGNA funds its qualified pension plans at least at the minimum amount required by the Employee Retirement Income Security Act of 1974 (ERISA). As a result of recent changes in minimum funding requirements, CIGNA expects to make domestic pension plan contributions of approximately $175 million in 2004.
 
Components of net pension cost were as follows:
 
       
   
Three Months
Ended
March 31,
 
(In millions)
  
2004
  
2003
  
Service cost
  
$
22
  
$
20
  
Interest cost
    
55
    
55
  
Expected return on plan
   assets
    
(48
)
  
(50
)
Amortization of
              
net loss from past
   experience
    
18
    
6
  
Net pension cost
  
$
47
  
$
31
  
 
In connection with the sale of the retirement benefits business and the operational effectiveness review, CIGNA had a pension curtailment event, which required CIGNA to remeasure the assets and obligations of its domestic qualified plan as of March 31, 2004. As a result, CIGNA recorded an after-tax charge which decreased equity by $113 million. This charge was primarily due to a reduction in long-term interest rates (from 6.25% to 5.75%) used to determine the accumulated benefit obligation, partially offset by the effect of stock market appreciation on plan assets.
 
Other postretirement benefits. Components of net other postretirement benefit cost were as follows:
 
       
   
Three Months
Ended
March 31,
 
(In millions)
  
2004
  
2003
  
Service cost
  
$
1
  
$
1
  
Interest cost
    
9
    
11
  
Expected return on plan
   assets
    
(1
)
  
(1
)
Amortization of prior
   service cost
    
(4
)
  
(5
)
Net other postretirement
   benefit cost
  
$
5
  
$
6
  

In the first quarter of 2003, CIGNA recognized gains of $4 million after-tax ($6 million pre-tax) for other postretirement benefits in connection with the 2002 health care restructuring program.
 

16

NOTE 8 - INVESTMENTS
 
Realized Investment Gains and Losses

Realized gains and losses on investments, excluding policyholder share, were as follows:
 
       
   
Three Months
Ended
March 31,
 
(In millions)
  
2004
  
2003
  
Fixed maturities
  
$
9
  
$
(23
)
Equity securities
    
2
    
(16
)
Mortgage loans
    
—
    
(1
)
Real estate
    
(2
)
  
(1
)
Derivatives and other
    
12
    
10
  
Realized investment gains
   (losses), before income
   taxes (benefits)
    
21
    
(31
)
Less income taxes
   (benefits)
    
7
    
(10
)
Net realized investment
   gains (losses)
  
$
14
  
$
(21
)
 
Fixed Maturities and Equity Securities
 
Sales of available-for-sale fixed maturities and equity securities, including policyholder share, were as follows:
 
       
   
Three Months
Ended
March 31,
  
(In millions)
  
2004
  
2003
  
Proceeds from sales
  
$
653
  
$
1,623
  
Gross gains on sales
  
$
34
  
$
55
  
Gross losses on sales
  
$
(3
)
$
(39
)

Review of Declines in Fair Value.  Management reviews fixed maturities and equity securities for impairment based on criteria that include:

·  
length of time of decline;
·  
financial health and specific near term prospects of the issuer; and
·  
changes in the regulatory, economic or general market environment of the issuer’s industry or geographic region.

17


As of March 31, 2004, fixed maturities with a decline in fair value from cost (primarily investment grade corporate bonds) were as follows, including the length of time of such decline:

               
 
(In millions)
  
Fair
Value 
 
 Amortized
Cost 
 
 Unrealized Depreciation 
  
One year or less:
                    
Investment grade
  
$
932
  
$
950
  
$
(18
)
Below investment grade
 
$
102
  
$
107
  
$
(5
)
More than one year:
                    
Investment grade
  
$
111
  
$
117
  
$
(6
)
Below investment grade
 
$
56
  
$
58
  
$
(2
)

There were no equity securities with a material decline in fair value from cost at March 31, 2004.
 
NOTE 9 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
Changes in accumulated other comprehensive income (loss) (which exclude policyholder share) were as follows:
 
               
 
(In millions)
  
Pre-Tax
  
Tax (Expense) Benefit
  
After-Tax
 
Three Months Ended March 31,
  
2004
              
Net unrealized appreciation, securities:
              
Unrealized appreciation on securities held
  
$
244
  
$
(85
)
$
159
  
Gains realized on securities
    
(11
)
  
4
    
(7
)
Net unrealized appreciation, securities
  
$
233
  
$
(81
)
$
152
  
Net unrealized appreciation, derivatives
  
$
11
  
$
(4
)
$
7
  
Net translation of foreign currencies
  
$
13
  
$
(4
)
$
9
  
Minimum pension liability adjustment
  
$
(174
)
$
61
  
$
(113
)
2003
                    
Net unrealized appreciation,
   securities:
                    
Unrealized appreciation on securities held
  
$
60
  
$
(20
)
$
40
  
Losses realized on securities
    
39
    
(14
)
  
25
  
Net unrealized appreciation, securities
  
$
99
  
$
(34
)
$
65
  
Net unrealized depreciation, derivatives
  
$
(3
)
$
1
  
$
(2
)
Net translation of foreign currencies:
Net translation on foreign currencies held
  
$
5
  
$
(2
)
$
3
  
Foreign currency translation losses realized
   on sales of businesses
    
17
    
(6
)
  
11
  
Net translation of foreign currencies
  
$
22
  
$
(8
)
$
14
  

 

18

NOTE 10 - EARNINGS PER SHARE
 
Basic and diluted earnings per share (as restated) are computed as follows:
 
               
(Dollars in millions, except per share amounts)
  
Basic
  
Effect of Dilution
  
Diluted
  
Three Months Ended March 31,
                  
2004
                          
Income from continuing operations
        
$
212
        
$
—
        
$
212
  
Shares (in thousands):
                                      
Weighted average
          
139,999
          
—
          
139,999
  
Options and restricted stock grants
                  
1,305
          
1,305
  
Total shares
          
139,999
          
1,305
          
141,304
  
EPS
        
$
1.51
        
$
(0.01
)
      
$
1.50
  
2003
                                      
Income from continuing operations
        
$
187
        
$
—
        
$
187
  
Shares (in thousands):
                                      
Weighted average
          
139,691
          
—
          
139,691
  
Options and restricted stock grants
                  
369
          
369
  
Total shares
          
139,691
          
369
          
140,060
  
EPS
        
$
1.34
        
$
—
        
$
1.34
  
 
Common shares held as Treasury shares were 134,370,451 as of March 31, 2004, and 133,952,466 as of December 31, 2003.

NOTE 11 - REINSURANCE
In the normal course of business, CIGNA’s insurance subsidiaries enter into agreements with other insurance companies to assume and cede reinsurance. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses. Reinsurance does not relieve the originating insurer of liability. CIGNA evaluates the financial condition of its reinsurers and monitors their concentrations of credit risk.

Individual life and annuity reinsurance. CIGNA had a reinsurance recoverable of $5.3 billion at March 31, 2004, and $5.4 billion at December 31, 2003, from Lincoln National Corporation that arose from the 1998 sale of CIGNA’s individual life insurance and annuity business through an indemnity reinsurance arrangement.

Unicover and other run-off reinsurance. The Run-off Reinsurance operations participate in a workers’ compensation reinsurance pool, which ceased accepting new risks in early 1999. This pool was formerly managed by Unicover Managers, Inc. Although an arbitration over the most significant reinsurance (retrocessional) contracts for the pool was completed in 2002, some disputes over collection of amounts due CIGNA from the retrocessionaires continue and may require further arbitration actions to resolve. Also, disputes and arbitrations regarding other reinsurance (retrocessional) contracts for the pool remain and may not be resolved for some time.

Run-off Reinsurance also includes other workers’ compensation reinsurance contracts, as well as personal accident reinsurance contracts, including contracts assumed in the London market. CIGNA obtained retrocessional reinsurance coverage for a significant portion of its liabilities under these contracts. Some of these retrocessionaires have disputed the validity of their contracts with CIGNA and arbitration over some of these disputes has commenced.

19


The retrocessional disputes are not expected to be resolved for some time. In addition, unfavorable claims experience related to workers’ compensation and personal accident exposures is possible and could result in future losses, including losses attributable to the inability to recover amounts from retrocessionaires (either due to disputes with the retrocessionaires or their financial condition).

CIGNA’s reserves for amounts recoverable from retrocessionaires, as well as for reserves for liabilities associated with underlying reinsurance exposures assumed by CIGNA, are considered appropriate as of March 31, 2004, based on current information. However, it is possible that future developments could have a material adverse effect on CIGNA’s consolidated results of operations, and, in certain situations, could have a material adverse effect on CIGNA’s financial condition.

Other reinsurance. CIGNA could have losses if reinsurers fail to indemnify CIGNA on other reinsurance arrangements, whether because of reinsurer insolvencies or contract disputes. However, management does not expect charges for other unrecoverable reinsurance to have a material adverse effect on CIGNA’s consolidated results of operations, liquidity or financial condition.
 
Effects of reinsurance. In CIGNA’s consolidated income statements, premiums and fees were net of ceded premiums, and benefits, losses and settlement expenses were net of reinsurance recoveries, in the following amounts:
 
       
   
Three Months Ended
March 31,
 
(In millions)
  
2004
  
2003
  
Premiums and fees
          
Individual life insurance and
   annuity business sold
  
$
73
  
$
78
  
Other
    
39
    
45
  
Total
  
$
112
  
$
123
  
Reinsurance recoveries
              
Individual life insurance and
   annuity business sold
  
$
79
  
$
75
  
Other
    
38
    
32
  
Total
  
$
117
  
$
107
  

NOTE 12 - SEGMENT INFORMATION

Operating segments generally reflect groups of related products, but the International segment is based on geography. CIGNA measures the financial results of its segments using “segment earnings” which is defined as income (loss) from continuing operations before realized investment gains (losses).

The impact of the restatement as discussed in Note 3, is included in Corporate and is not allocated to the operating segments.

In the third quarter of 2003, CIGNA changed its segment presentation to report its health care operations and its separately managed group disability and life insurance operations as two discrete segments. Previously, results from these operations were combined as a single segment. In addition, CIGNA renamed its segments as Health Care, Disability and Life, Retirement, International, Run-off Reinsurance and Other Operations.

20

Disability and life insurance products which were historically sold in connection with certain experience-rated medical accounts continue to be managed by CIGNA's health care business and are reported in the Health Care segment.

Summarized segment financial information was as follows:

       
   
Three Months
Ended
March 31, 
  
(In millions)
  
2004
  
2003
  
Premiums and fees and other revenues
  
Health Care
  
$
3,095
  
$
3,415
  
Disability and Life
    
475
    
423
  
Retirement
    
250
    
90
  
International
   
241
    
214
  
Run-off Reinsurance
   
(9
)
  
79
  
Other Operations
    
65
    
70
  
Corporate
    
(19
)
  
(18
)
Total
  
$
4,098
  
$
4,273
  
Income (loss) from continuing
   operations
     
Health Care
  
$
156
  
$
125
  
Disability and Life
    
35
    
34
  
Retirement
   
35
    
55
  
International
   
15
    
10
  
Run-off Reinsurance
   
(10
)
  
(15
)
Other Operations
    
10
    
20
  
Corporate (restated)
    
(43
)
  
(21
)
Segment earnings (restated)
    
198
    
208
 
Realized investment gains (losses),
   net of taxes
    
14
    
(21
)
Income from
   continuing operations (restated)
  
$
212
  
$
187
  
 
NOTE 13 - CONTINGENCIES AND OTHER MATTERS

Financial Guarantees

CIGNA, through its subsidiaries, is contingently liable for various financial guarantees provided in the ordinary course of business.

Separate account assets, primarily associated with the retirement benefits business, are contractholder funds maintained in accounts with specific investment objectives. CIGNA records separate account liabilities equal to separate account assets. In certain cases, CIGNA guarantees a minimum level of benefits for retirement and insurance contracts written in separate accounts. CIGNA establishes an additional liability if management believes that CIGNA will be required to make a payment under these guarantees, which include the following:

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·  
CIGNA guarantees that separate account assets will be sufficient to pay certain retiree or life benefits. The sponsoring employers are primarily responsible for ensuring that assets are sufficient to pay these benefits and are required to maintain assets that exceed a certain percentage of benefit obligations. This percentage varies depending on the asset class within a sponsoring employer’s portfolio (for example, a bond fund would require a lower percentage than a riskier equity fund) and thus will vary as the composition of the portfolio changes. If employers do not maintain the required levels of separate account assets, CIGNA has the right to redirect the management of the related assets to provide for benefit payments. As of March 31, 2004, employers maintained assets that exceeded 102% to 132% of benefit obligations. Benefit obligations under these arrangements were $3.5 billion as of March 31, 2004 and December 31, 2003. There were no additional liabilities required for these guarantees as of March 31, 2004, or December 31, 2003.

·  
For certain employer-sponsored savings and retirement plans, CIGNA guarantees that participants will receive the value of their accounts at the time of withdrawal. These guarantees could require payment by CIGNA in the event that a significant number of plan participants withdraw their accounts when the market value of the related separate account assets is less than plan participant account values at the time of withdrawal. Participant account values under these arrangements are invested primarily in fixed income investments and were $1.9 billion as of March 31, 2004, and $2.0 billion as of December 31, 2003. There were no additional liabilities required for these guarantees as of March 31, 2004, or December 31, 2003.

·  
CIGNA guarantees a minimum level of earnings (based on investment, mortality and retirement experience) for a certain group annuity contract. If the actual investment return is less than the minimum guaranteed level, CIGNA is required to fund the difference. The guaranteed benefit obligation was $303 million as of March 31, 2004, and $304 million as of December 31, 2003. CIGNA had additional liabilities for this guarantee of $16 million as of March 31, 2004, and $15 million as of December 31, 2003. The fair value of separate accounts assets for this group annuity contract were as follows:

           
(In millions)
  
March 31, 
2004
  
December 31, 2003
  
Fixed maturities
  
$
354
  
$
342
  
Mortgage loans
    
132
    
134
  
Other
    
2
    
3
  
Total
  
$
488
  
$
479
  

CIGNA guaranteed construction loans of $27 million as of March 31, 2004, and $26 million as of December 31, 2003, related to real estate joint venture investments. The loans are secured by joint venture real estate property with fair values in excess of the loan amounts and mature by 2008, including extension options. CIGNA would be required to repay the construction loans if permanent financing could not be obtained. There were no liabilities required for these guarantees as of March 31, 2004, or December 31, 2003.

CIGNA had indemnification obligations to lenders up to $340 million as of March 31, 2004, and $329 million as of December 31, 2003, related to borrowings by certain real estate joint ventures which CIGNA either records as an investment or consolidates. These borrowings, which are nonrecourse to CIGNA, are secured by the joint ventures’ real estate properties with fair values in excess of the loan amounts and mature at various dates from 2004 to 2015. CIGNA’s indemnification obligations would require payment

 
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to lenders for any actual damages resulting from certain acts such as unauthorized ownership transfers, misappropriation of rental payments by others or environmental damages. Based on initial and ongoing reviews of property management and operations, CIGNA does not expect that payments will be required under these indemnification obligations. Any payments that might be required could be recovered through a refinancing or sale of the assets. In some cases, CIGNA also has recourse to partners for their proportionate share of amounts paid. There were no liabilities required for these indemnification obligations as of March 31, 2004, or December 31, 2003.

As of March 31, 2004 and December 31, 2003, CIGNA guaranteed that it would compensate the lessor for a shortfall of up to $49 million in the market value of leased equipment at the end of the lease. Guarantees of $21 million expire in 2006 and $28 million expire in 2012.

CIGNA has indemnification obligations as of March 31, 2004, and December 31, 2003, in connection with acquisition and disposition transactions. These indemnification obligations are triggered by the breach of representations or covenants provided by CIGNA, such as representations for the presentation of financial statements, the filing of tax returns or the identification of outstanding litigation. These obligations are typically subject to various time limitations, defined by the contract or by operation of law, such as statutes of limitation. In some cases, the maximum potential amount due is subject to contractual limitations based on a percentage of the transaction purchase price, while in other cases limitations are not specified or applicable. CIGNA does not believe that it is possible to determine the maximum potential amount due under these guarantees, since not all amounts due under these indemnification obligations are subject to limitation. There were no liabilities required for these indemnification obligations as of March 31, 2004, or December 31, 2003.

CIGNA does not expect that these guarantees will have a material adverse effect on CIGNA’s consolidated results of operations, liquidity or financial condition.

Guaranteed minimum income benefit contracts. CIGNA has written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees related to minimum income benefits. When annuitants elect to receive these minimum income benefits, CIGNA may be required to make payments based on changes in underlying mutual fund values and interest rates.

CIGNA estimates the fair value of the assets and liabilities associated with these contracts using assumptions as to equity market returns, volatility of the underlying equity and bond mutual fund investments, interest rates, mortality, policy surrenders, credit risk and annuity election rates.

CIGNA is required to disclose the maximum potential undiscounted future payments for guarantees related to minimum income benefits using worst-case assumptions, defined as follows:

·  
No annuitants surrendered their accounts, and
·  
All annuitants lived to elect their benefits, and
·  
All annuitants elected to receive their benefit on the first available date (beginning in 2004 through 2014), and
·  
All underlying mutual fund investment values remained at the March 31, 2004 value of $3.3 billion, with no future returns.

The maximum potential undiscounted payments that CIGNA would make under those assumptions would aggregate $2.3 billion before reinsurance recoveries. CIGNA believes the likelihood of such payment is remote and expects the amount of actual payments to be significantly less than this hypothetical

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undiscounted aggregate amount. CIGNA has purchased reinsurance from third parties which covers 80% of the exposures on these contracts. CIGNA has revised credit risk assumptions for about 25% of the exposures on these contracts.

As of March 31, 2004, CIGNA had liabilities of $90 million related to these contracts and amounts recoverable from reinsurers of $63 million. CIGNA had an additional liability of $39 million associated with the cost of reinsurance as of March 31, 2004. As of December 31, 2003, CIGNA had liabilities of $74 million related to these contracts and amounts recoverable from reinsurers of $51 million. CIGNA had an additional liability of $40 million associated with the cost of reinsurance as of December 31, 2003. In the first quarter of 2003, CIGNA reduced its amount recoverable from reinsurers by $9 million pre-tax related to revised credit risk assumptions. Management believes the current assumptions used to estimate reserves for these liabilities are appropriate.

Regulatory and Industry Developments

CIGNA’s businesses are subject to a changing social, economic, legal, legislative and regulatory environment. Some issues that may affect CIGNA’s businesses include:

·  
initiatives to increase health care regulation;
·  
efforts to expand tort liability of health plans;
·  
class action lawsuits targeting large corporations, including CIGNA;
·  
initiatives to restrict insurance pricing and the application of underwriting standards;
·  
efforts to change risk-based capital and reserve requirements for variable annuities, impacting run-off reinsurance operations; and
·  
efforts to revise federal tax laws.

Health care regulation. The business of administering and insuring employee benefit programs, particularly health care programs, is heavily regulated by federal and state laws and administrative agencies, such as state departments of insurance and the federal Departments of Labor and Justice, as well as the courts. Regulation and judicial decisions have resulted in changes to industry and CIGNA’s business practices and will continue to do so in the future. In addition, CIGNA's subsidiaries are routinely involved with various claims, lawsuits and regulatory audits and investigations that could result in financial liability, changes in business practices, or both. Health care regulation in its various forms could have an adverse effect on CIGNA's health care operations if it inhibits CIGNA's ability to respond to market demands or results in increased medical or administrative costs without improving the quality of care or services. 

The United States Supreme Court heard arguments in March 2004 on a case involving a CIGNA subsidiary in which the issue is preemption by the Employee Retirement Income Security Act (ERISA) of a state law tort claim in circumstances involving a determination, based on medical judgment, that benefits were not covered. A determination that ERISA does not preempt state law would have an adverse effect on the health care industry and on CIGNA.

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) and related regulations have created significant regulatory requirements related to, among other things, the privacy of individually identifiable health care information, electronic data interchange and the security of electronic health information. CIGNA has instituted systems enhancements and training, and has undertaken other administrative efforts to satisfy these requirements.

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Other possible regulatory changes that could have an adverse effect on CIGNA’s health care operations include:

·  
additional mandated benefits or services that increase costs without improving the quality of care;
·  
narrowing of ERISA preemption of state laws;
·  
changes in ERISA regulations resulting in increased administrative burdens and costs;
·  
additional restrictions on the use of prescription drug formularies;
·  
additional privacy legislation and regulations that interfere with the proper use of medical information for research, coordination of medical care and disease management;
·  
additional rules establishing the time periods for payment of health care provider claims that vary from state to state; and
·  
legislation that would exempt independent physicians from antitrust laws.

The health care industry remains under scrutiny by various state and federal government agencies and could be subject to government efforts to bring criminal actions in circumstances that could previously have given rise only to civil or administrative proceedings.

Tax benefits for corporate life insurance. Federal legislation in 1996 eliminated on a prospective basis the tax deductibility of policy loan interest for most leveraged corporate life insurance products, and an Internal Revenue Service (IRS) initiative in 2001 encouraged policyholders to settle tax disputes regarding these products. As a result, some customers have surrendered their policies and management expects earnings associated with these products to continue to